Unassociated Document


SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 

 
FORM 10-Q
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the quarterly period ended September 30, 2011
 
o
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: 1-15831

MERRIMAN HOLDINGS, INC.
(Exact Name of Registrant as Specified in its Charter)
 
Delaware
 
11-2936371
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)
 
600 California Street, 9th Floor
San Francisco, CA
 
94108
(Address of Principal Executive Offices)
 
(Zip Code)

(415) 248-5600
(Registrant’s Telephone Number, Including Area Code)

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 o

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 o No x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer o
 
Accelerated filer o
Non-accelerated filer o
 
Smaller reporting company x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x

The number of shares of Registrant’s common stock outstanding as of November 10, 2011 was 2,982,391.



 
 

 
 
Merriman Holdings, Inc.
Index
 
   
Page No.
 
PART I FINANCIAL INFORMATION
     
       
ITEM 1. Financial Statements (unaudited)
     
         
Consolidated Statements of Operations For the Three Months and Nine Months Ended September 30, 2011 and 2010
   
3
 
         
Consolidated Statements of Financial Condition as of September 30, 2011 and December 31, 2010
   
4
 
         
Consolidated Statements of Cash Flows For the Nine Months Ended September 30, 2011and 2010
   
5
 
         
Notes to Consolidated Financial Statements
   
6
 
         
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
   
31
 
         
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
   
48
 
         
ITEM 4. Controls and Procedures
   
49
 
         
PART II OTHER INFORMATION
       
         
ITEM 1. Legal Proceedings
   
50
 
         
ITEM 1A. Risk Factors
   
51
 
         
ITEM 6. Exhibits
   
53
 
         
Signatures
   
54
 
         
Certifications
       
 
 
2

 
 
PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements (unaudited)
 
MERRIMAN HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)

   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
   
September 30,
   
September 30,
 
   
2011
   
2010
   
2011
   
2010
 
Revenues:
                       
Commissions
  $ 3,834,121     $ 3,959,937     $ 10,821,486     $ 11,402,663  
Principal transactions
    (910,382 )     (309,422 )     (417,399 )     (133,261 )
Investment banking
    900,879       537,187       8,051,512       8,099,497  
Other
    261,920       49,124       557,759       413,465  
Total revenues
    4,086,538       4,236,826       19,013,358       19,782,364  
Operating expenses:
                               
Compensation and benefits
    3,229,605       4,863,982       15,152,508       15,462,360  
Brokerage and clearing fees
    326,236       361,413       1,087,182       1,131,584  
Professional services
    421,576       456,533       1,342,679       1,195,094  
Occupancy and equipment
    483,834       479,205       1,407,554       1,451,045  
Communications and technology
    491,197       476,941       1,499,666       1,563,417  
Depreciation and amortization
    20,755       99,746       117,160       302,600  
Travel and entertainment
    200,411       303,956       747,028       955,525  
Legal services and litigation settlement expense
    104,322       855,286       549,681       1,867,878  
Cost of underwriting capital
    -       8,000       97,625       968,576  
Other
    492,228       874,232       1,130,565       1,587,580  
Total operating expenses
    5,770,164       8,779,294       23,131,648       26,485,659  
Operating loss
    (1,683,626 )     (4,542,468 )     (4,118,290 )     (6,703,295 )
Other income
    15,000       -       26,601       29,319  
Interest expense, net
    (171,137 )     (3,530 )     (327,548 )     (29,759 )
Loss from continuing operations before income taxes
    (1,839,763 )     (4,545,998 )     (4,419,237 )     (6,703,735 )
Income tax (expense) benefit
    (2,763 )     33,302       (6,107 )     4,285  
Loss from continuing operations
    (1,842,526 )     (4,512,696 )     (4,425,344 )     (6,699,450 )
Income from discontinued operations
    -       -       -       95,104  
Net loss
  $ (1,842,526 )   $ (4,512,696 )   $ (4,425,344 )   $ (6,604,346 )
Preferred stock cash dividend
    (129,433 )     (146,400 )     (407,212 )     (446,100 )
Net loss attributable to common shareholders
  $ (1,971,959 )   $ (4,659,096 )   $ (4,832,556 )   $ (7,050,446 )
Basic and diluted net income (loss) per share:
                               
Loss from continuing operations
  $ (0.69 )   $ (2.22 )   $ (1.78 )   $ (3.47 )
Income from discontinued operations
    -       -       -       0.05  
Net loss
  $ (0.69 )   $ (2.22 )   $ (1.78 )   $ (3.42 )
Net loss attributable to common shareholders
  $ (0.74 )   $ (2.29 )   $ (1.94 )   $ (3.65 )
Weighted average number of common shares:
                               
Basic and diluted
    2,652,285       2,030,584       2,485,935       1,931,781  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
3

 

MERRIMAN HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(unaudited)
 
 
   
September 30,
   
December 31,
 
   
2011
   
2010
 
Assets
               
Cash and cash equivalents
  $ 3,534,659     $ 4,898,093  
Securities owned:
               
Marketable, at fair value
    2,451,905       2,401,722  
Not readily marketable, at estimated fair value
    832,533       2,741,452  
Restricted cash
    680,028       965,000  
Due from clearing broker
    193,171       34,072  
Accounts receivable, net
    395,531       1,574,644  
Prepaid expenses and other assets
    697,766       450,243  
Total assets
  $ 8,785,593     $ 13,065,226  
                 
Liabilities and Stockholders’ Equity
               
                 
Liabilities:
               
Accounts payable
  $ 205,220     $ 361,237  
Commissions and bonus payable
    1,133,884       3,240,021  
Accrued expenses and other
    2,113,621       2,953,747  
Securities sold, not yet purchased
    1,934       -  
Deferred revenue
    475,054       175,712  
Notes payable
    1,755,674       259,532  
Notes payable to related parties
    2,144,413       1,139,305  
Total liabilities
    7,829,800       8,129,554  
                 
Stockholders’ equity:
               
Convertible preferred stock, Series A–$0.0001 par value; 2,000,000 shares
         
authorized; 2,000,000 shares issued and 0 shares outstanding as of
         
September 30, 2011 and December 31, 2010; aggregate liquidation
         
preference of $0
    -       -  
Convertible preferred stock, Series B–$0.0001 par value; 12,500,000 shares
         
authorized; 8,750,000 shares issued and 0 shares outstanding as of
         
September 30, 2011 and December 31, 2010; aggregate liquidation
         
preference of $0
    -       -  
Convertible preferred stock, Series C–$0.0001 par value; 14,200,000 shares
         
authorized; 11,800,000 shares issued and 0 shares outstanding as of
         
September 30, 2011 and December 31, 2010; aggregate liquidation
         
preference of $0
    -       -  
Convertible preferred stock, Series D–$0.0001 par value; 24,000,000
         
shares authorized, 23,720,916 and 23,720,916 shares issued
               
and 19,563,206 and 22,058,128 shares outstanding as of
               
September 30, 2011 and December 31, 2010, respectively;
               
aggregate liquidation preference of $8,412,179 prior to conversion,
         
and pari passu with common stock on conversion
    1,957       2,206  
Common stock, $0.0001 par value; 300,000,000 shares authorized;
         
3,009,453 and 2,384,499 shares issued and 2,980,017 and 
               
2,355,063 shares outstanding as of September 30, 2011 and
               
December 31, 2010, respectively
    301       239  
Common stock payable
    7,193       461,675  
Additional paid-in capital
    135,751,140       134,851,006  
Treasury stock
    (225,613 )     (225,613 )
Accumulated deficit
    (134,579,185 )     (130,153,841 )
Total stockholders’ equity
    955,793       4,935,672  
Total liabilities and stockholders’ equity
  $ 8,785,593     $ 13,065,226  
 
The accompanying notes are an integral part of these consolidated financial statements.

 
4

 
 
MERRIMAN HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)

   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2011
   
2010
 
Cash flows from operating activities:
           
Net loss
  $ (4,425,344 )   $ (6,604,346 )
Adjustments to reconcile net loss to net cash used in operating activities:
         
Depreciation and amortization
    117,160       302,600  
Stock-based compensation
    598,151       1,277,656  
Securities received for services
    (291,345 )     (944,188 )
Unrealized loss on securities owned
    1,789,778       1,069,415  
Others
    123,505       431,964  
Changes in operating assets and liabilities:
               
Securities owned and sold, not yet purchased
    359,282       2,227,442  
Restricted cash
    284,972       107,086  
Due from clearing broker
    (159,099 )     2,361,021  
Accounts receivable
    1,133,886       (729,330 )
Prepaid expenses and other assets
    (361,968 )     146,012  
Accounts payable
    (150,652 )     75,977  
Commissions and bonus payable
    (2,106,137 )     (1,705,409 )
Accrued expenses and other
    (479,678 )     (511,199 )
Net cash used in operating activities
    (3,567,489 )     (2,495,299 )
Cash flows from investing activities:
               
Purchase of equipment and fixtures
    (42,916 )     (28,529 )
Sale of equipment and fixtures
    10,000       -  
Net cash used in investing activities
    (32,916 )     (28,529 )
Cash flows from financing activities:
               
Proceeds from issuance of debt
    5,900,000       23,000,000  
Proceeds from the exercise of stock options
    -       36,720  
Payment of debt
    (3,130,000 )     (18,000,000 )
Payment of preferred stock dividend
    (412,576 )     (448,300 )
Debt service principal payments
    (120,453 )     (206,616 )
Net cash provided by financing activities
    2,236,971       4,381,804  
Increase (decrease) in cash and cash equivalents
    (1,363,434 )     1,857,976  
Cash and cash equivalents at beginning of year
    4,898,093       5,656,750  
Cash and cash equivalents at end of year
  $ 3,534,659     $ 7,514,726  
Supplementary disclosure of cash flow information:
               
Cash paid during the year:
               
Interest
  $ 266,235     $ 1,000,191  
Income taxes
  $ 10,290     $ 35,000  
Noncash investing and financing activities:
               
Equity securities issued in connection with debt
  $ 419,637     $ 206,433  
Cancellation of stock issued in connection with debt
  $ 105,759     $ -  
Warrants issued for legal settlement
  $ -     $ 257,370  
 
The accompanying notes are an integral part of these consolidated financial statements.

 
5

 

MERRIMAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

1. Significant Accounting Policies

Basis of Presentation

The interim unaudited consolidated financial statements included herein for Merriman Holdings, Inc. (formerly Merriman Curhan Ford Group, Inc. and MCF Corporation), or the Company, have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). In the opinion of management, the consolidated financial statements included in this report reflect all normal recurring adjustments that the Company considers necessary for the fair presentation of the consolidated results of operations for the interim periods covered and the consolidated financial condition of the Company at the date of the interim statements of financial condition. Certain information and footnote disclosures normally included in annual consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations. However, the Company believes that the disclosures are adequate to understand the information presented. The operating results for interim periods are not necessarily indicative of the operating results for the entire year. These consolidated financial statements should be read in conjunction with the Company’s 2010 audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K and on Form 10-K/A for the year ended December 31, 2010.

Under Accounting Standards Codification Topic (ASC) 855, “Subsequent Events,” the Company has evaluated all subsequent events through the date these consolidated financial statements were issued.
 
Liquidity

As of September 30, 2011, liquid assets consisted primarily of cash and cash equivalents of $3,535,000 and marketable securities of $2,452,000, totaling $5,987,000.  For the nine months ended September 30, 2011, the Company had negative cash flows from operations of $3,567,000.

During 2011, the Company began the process of eliminating profitless revenue activities and certain discretionary spending.  During the quarter ended September 30, 2011, the Company significantly reduced its operating expenses by eliminating certain non- productive personnel, administrative positions and technology related costs.  Subsequent to September 30, 2011, the Company reduced its emphasis on the profitless research operations and increased its focus on its OTCQX and advisory business.  Additionally, the Company continues to review all expenses to assess their revenue generating potential or risk mitigation effectiveness.  As of September 30, 2011, the Company had 62 full time employees.  The headcount of  the Company as of November 10, 2011 decreased to 29 full time employees.

During November 2011, the Company began offering an opportunity for the holders of the $3,000,000 of Secured Promissory Notes and warrants to convert into common stock and new warrants as follows:

 
1)  
For the Secured Promissory Notes, a number of new shares of common stock of the Company equal to (i) the total amount of principal plus accrued but unpaid interest of the Secured Promissory Notes submitted for cancellation divided by (ii) an amount equal to 80% of the average closing price per share of the Company’s common stock as quoted on the exchange on which it principally trades for the 30 day period ending two days prior to the first closing date (the “AP”); plus

 
2)  
For the warrants, 1.25 new warrants for each warrant converted, with each new warrant carrying an exercise price equal to 110% of the AP

The closing of the sale and purchase of the securities contemplated hereby shall take place without unreasonable delay on one or more dates, following the full execution of the agreements by the Secured Promissory Note holders.

As of November 10, 2011, holders of approximately $1,860,000, or 62%, of the principal amount of this senior debt elected to convert their notes into shares of common stock and warrants to purchase common stock.  If all of the holders of the Secured Promissory Notes agree to convert their notes into common stock, the Company will reduce its annual interest cost by approximately $287,000.

During November 2011, the Company began offering an opportunity for the holders of the $300,000 of Unsecured Promissory Notes to convert into common stock and warrants as follows:

 
1)  
A number of new shares of common Stock of the Company equal to (i) the total amount of principal plus accrued but unpaid interest of the Unsecured Promissory Notes submitted for cancellation divided by (ii) an amount equal to 80% of the average closing price per share of the Company’s common stock as quoted on the exchange on which it principally trades for the 30 day period ending two days prior to the first closing date (the “AP”); plus
 
 
2)  
Warrants to purchase shares of common stock of the Company with a strike price equal to 110% of the AP and in amount with an aggregate exercise price equal to 25% of the principal and interest amount of Unsecured Promissory Notes exchanged.

The closing of the sale and purchase of the securities contemplated hereby shall take place without unreasonable delay on one or more dates, following the full execution of the agreements by the Secured Promissory Note holders.

As of November 10, 2011, none of the holders of the principal amount of this debt have elected to convert their notes into shares of common stock and warrants.  If all of the holders of the Unsecured Promissory Notes agree to convert their notes into common stock, the Company will reduce its annual interest cost by approximately $39,000.

The Company issued Series D Convertible Preferred Stock during September 2009.  The Series D certificate of designation requires that at least 50% of the holders of the Series D Convertible Preferred Stock agree to any amendments to the agreement.  During November 2011, more than 50% of the holders of the outstanding Series D Convertible Preferred Stock of the Company agreed to amend certain provisions of the Series D certificate of designation.  Accordingly, the following amendments will be applicable to all of the outstanding Series D Convertible Preferred Stock; an amendment to require that until such time as the directors declare a dividend, any unpaid and undeclared dividends accumulate, compound and will not be payable, and an amendment to decrease the “full ratchet” anti-dilution provision of the Series D certificate of designation to an amount to equal two times the AP, as applicable to the conversion of the Secured Promissory Notes and Unsecured Promissory Notes described above.  This amendment to the Series D certificate of designation will reduce the Company’s annual Series D Convertible Preferred Stock dividend requirement by approximately $500,000 annually, unless such dividends are declared by the board of directors.

Finally, management believes that it has the ability to delay or reduce expenditures if necessary in order to continue to operate the business for the foreseeable future.  Additionally, management is pursuing raising strategic capital. Failure to generate sufficient cash flows from operations, reduce spending or raise additional capital would have a material adverse effect on the Company’s ability to achieve its intended business objectives.
 
Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses. Actual results could differ from those estimates.

Reclassifications
 
Certain reclassifications have been made to the prior years’ consolidated financial statements to conform to the presentation of the current year’s consolidated financial statements.

Segment Reporting

In January 2011, the Company’s wholly owned broker dealer subsidiary, Merriman Capital, Inc. (MC), formed a new investment banking division, Riverbank Partners (Riverbank), to assist corporate issuers in raising capital through a network of independent investment bankers. Also, in January 2011, the Company repositioned its OTCQX Advisory Services (OTCQX) offering and fee structure. Accordingly, effective January 1, 2011, the Company reorganized its business around three operating segments: MC, Riverbank and OTCQX. The Company's reportable segments are strategic business units that offer products and services which are compatible with our core business strategy.
 
 
6

 
 
MERRIMAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

1. Significant Accounting Policies – continued

Securities Owned

Securities owned in the consolidated statements of financial condition consist of financial instruments carried at fair value with related unrealized gains or losses recognized in the consolidated statements of operations. The securities owned are classified into marketable and non-marketable. Marketable securities are those that can readily be sold, either through an exchange or through a direct sales arrangement. Non-marketable securities are typically securities restricted under the Federal Securities Act of 1933 provided by SEC Rule 144 (Rule 144) or have some restriction on their sale whether or not a buyer is identified.

Accounts Receivable

Accounts receivable are recorded at the invoiced amount and do not bear interest. To the extent deemed necessary, the Company maintains an allowance for estimated losses from the inability of clients to make required payments. The collectability of outstanding invoices is continually assessed. In estimating the allowance for doubtful accounts, the Company considers factors such as historical collections, a client’s current creditworthiness, age of the receivable balance and general economic conditions that may affect a client’s ability to pay. As of September 30, 2011 and December 31, 2010, the Company recorded $53,000 and 436,000 as an allowance for uncollectible accounts, respectively.

Accounts receivable are reported net of liabilities to the extent a legal right of offset exists. As of September 30, 2011, there were no liabilities offset against accounts receivable.

The Company had $0 and $330,000 outstanding accounts receivable pledged as collateral to secure a promissory note as of September 30, 2011 and December 31, 2010, respectively, which are included in accounts receivable, net in the Company’s statements of financial condition. Also refer to Note 3 – Issuance of Notes.

Fair Value of Financial Instruments

Substantially all of the Company’s financial instruments are recorded at fair value or contract amounts that approximate fair value. The carrying amounts of the Company’s financial instruments, which include cash and cash equivalents, restricted cash, due from clearing broker, accounts receivable, accounts payable, commissions and bonus payable, accrued expenses and other, and deferred revenue, approximate their fair values.

Fair Value Measurement—Definition and Hierarchy

The Company follows the provisions of ASC 820, “Fair Value Measurement and Disclosures,” for our financial assets and liabilities. Under ASC 820, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., the “exit price”) in an orderly transaction between market participants at the measurement date.

Where available, fair value is based on observable market prices or parameters or derived from such prices or parameters. Where observable prices or inputs are not available, valuation models are applied. These valuation techniques involve some level of management estimation and judgment, the degree of which is dependent on the price transparency for the instruments or market and the instruments’ complexity. Assets and liabilities recorded at fair value in the consolidated statements of financial condition are categorized based upon the level of judgment associated with the inputs used to measure their fair value. The Company’s financial assets and liabilities measured and reported at fair value are classified and disclosed in one of the following categories:

 
7

 
 
MERRIMAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—CONTINUED
(unaudited)

1. Significant Accounting Policies — continued

Fair Value Measurement—Definition and Hierarchy - continued

Level 1 —Unadjusted, quoted prices are available in active markets for identical assets or liabilities at the measurement date. The types of assets and liabilities carried at Level 1 fair value generally are G-7 government and agency securities, equities listed in active markets, investments in publicly traded mutual funds with quoted market prices and listed derivatives.

Level 2 — Pricing inputs (other than quoted prices included in Level 1) are either directly or indirectly observable for the asset or liability through correlation with market data at the measurement date and for the duration of the instrument’s anticipated life. Fair valued assets which are generally included in this category are stock warrants for which market-based implied volatilities are available, and unregistered common stock.

Level 3 — Pricing inputs are both significant to the fair value measurement and unobservable. These inputs generally reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model. Fair valued assets which are generally included in this category are stock warrants for which market-based implied volatilities are not available.

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes the level in the fair value hierarchy within which the fair value measurement falls in its entirety is determined based on the lowest level of input that is significant to the fair value measurement in its entirety.

For further information on financial assets and liabilities that are measured at fair value on a recurring basis, and a description of valuation techniques, see Note 2 – Fair Value of Assets and Liabilities.

Commissions and Principal Transactions Revenue

Commissions revenue includes revenue resulting from executing trades in stock exchange-listed securities, over-the-counter securities and other transactions as agent for the Company’s clients. Principal transactions consist of a portion of dealer spreads attributed to the Company’s securities trading activities as principal in exchange-listed and other securities, and include transactions derived from activities as a market-maker. Additionally, principal transactions include gains and losses resulting from market price fluctuations that occur while holding positions in trading security inventory. Commissions revenue and related clearing expenses are recorded on a trade-date basis as security transactions occur. Principal transactions in regular-way trades are recorded on the trade date, as if they had settled. Profit and loss arising from all securities and commodities transactions entered into for the account and risk of the Company are recorded on a trade-date basis.

Investment Banking Revenue

Investment banking revenue includes underwriting and private placement agency fees earned through the Company’s participation in public offerings, private placements of equity and convertible debt securities, and fees earned as financial advisor in mergers and acquisitions and similar transactions. Underwriting revenue is earned in securities offerings in which the Company acts as an underwriter and includes management fees, selling concessions and underwriting fees. Fee revenue relating to underwriting commitments is recorded when all significant items relating to the underwriting cycle have been completed and the amount of the underwriting revenue has been determined.

Syndicate expenses related to securities offerings in which the Company acts as underwriter or agent are deferred until the related revenue is recognized or the Company determines that it is more likely than not that the securities offerings will not ultimately be completed. Underwriting revenue is presented net of related expenses. As co-manager for registered equity underwriting transactions, management must estimate the Company’s share of transaction related expenses incurred by the lead manager in order to recognize revenue. Transaction related expenses are deducted from the underwriting fee and therefore reduces the revenue that is recognized as co-manager. Such amounts are adjusted to reflect actual expenses in the period in which the Company receives the final settlement, typically 90 days following the closing of the transaction.

Merger and acquisition fees and other advisory service revenue are generally earned and recognized only upon successful completion of the engagement. Unreimbursed expenses associated with private placement and advisory transactions are recorded as expenses as incurred.

 
8

 
 
MERRIMAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—CONTINUED
(unaudited)

1. Significant Accounting Policies — continued

Riverbank Revenues

The Company recognizes revenues earned by Riverbank on a gross basis in accordance with ASC 605-45, “Revenue Recognition: Principal Agent Considerations,” as the Company is the primary obligor in the arrangements entered into by Riverbank. Revenues earned by Riverbank are recognized consistent with the Company’s revenue recognition policies as disclosed herein.

Other Revenues
 
The Company provides OTCQX Advisory Services, in the form of assistance to its clients in listing on OTCQX, the premier OTC Market tier, along with other services that facilitate their access to institutional capital markets. Effective January 1, 2011, the Company repositioned its service offerings and fee structure for OTCQX. OTCQX Advisory Services revenues are primarily recognized on a straight-line basis from the completion of the due diligence until the end of the engagement term, which is generally one year.

Other revenues consist primarily of revenues generated by the OTCQX Advisory Services. In addition, other nominal amounts which do not conform to the types described above are also recorded as other revenues.

Stock-based Compensation Expense

The Company measures and recognizes compensation expense based on estimated fair values for all stock-based awards made to employees and directors, including stock options, restricted stock and warrants. The Company estimates fair value of stock-based awards on the date of grant using the Black-Scholes option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense in the Company’s consolidated statements of operations over the requisite service periods. Because stock-based compensation expense is based on awards that are ultimately expected to vest, stock-based compensation expense has been reduced to account for estimated forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

To calculate stock-based compensation resulting from the issuance of options, and warrants, the Company uses the Black-Scholes option pricing model, which is affected by the Company’s stock price as well as assumptions regarding a number of subjective variables. These variables include, but are not limited to the Company’s expected stock price volatility over the term of the awards, and actual and projected employee stock option exercise behaviors. No tax benefits were attributed to the stock-based compensation expense because a valuation allowance was maintained for all net deferred tax assets.

Cost of Underwriting Capital

The Company incurs fees on financing arrangements entered into to supplement underwriting capacity and working capital for the broker-dealer subsidiary. These fees are recorded as cost of underwriting capital as incurred.

 
9

 
 
MERRIMAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—CONTINUED
(unaudited)

1. Significant Accounting Policies — continued

Income Taxes

The Company uses the asset and liability method of accounting for income taxes. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are determined based on temporary differences between the financial statement carrying amounts and the tax basis of assets and liabilities using enacted tax rates in effect in the years in which temporary differences are expected to reverse. A valuation allowance is recorded to reduce deferred tax assets to an amount whose realization is more likely than not. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the consolidated statements of operations in the period that includes the enactment date.

New Accounting Pronouncements
 
In June 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2011-05, “Comprehensive Income (Topic 220): Presentation of Comprehensive Income,” that will require a company to present components of net income and other comprehensive income in one continuous statement or in two separate, but consecutive statements. There are no changes to the components that are recognized in net income or other comprehensive income under current GAAP. This guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011, with early adoption permitted. The Company does not expect the adoption of ASU 2011-05 to have a material effect on its consolidated financial statements.
 
In May 2011, the FASB issued ASU No. 2011-04, “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.” The amendments in this ASU generally represent clarification of Topic 820, but also include instances where a particular principle or requirement for measuring fair value or disclosing information about fair value measurements has changed. This update results in common principles and requirements for measuring fair value and for disclosing information about fair value measurements in accordance with GAAP and International Financial Reporting Standards (“IFRS”). The amendments are effective for interim and annual periods beginning after December 15, 2011 and are to be applied prospectively. Early application is not permitted. We do not expect the adoption of ASU 2011-04 to have a material impact on our consolidated financial statements.

 
10

 
 
MERRIMAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—CONTINUED
(unaudited)
 
2. Fair Value of Assets and Liabilities

Fair value is defined as the price at which an asset would sell for or an amount paid to transfer a liability in an orderly transaction between market participants at the measurement date (the exit price). Where available, fair value is based on observable market prices or parameters or derived from such prices or parameters. Where observable prices or parameters are not available, valuation models are applied. These valuation techniques involve some level of management estimation and judgment, the degree of which is dependent on the price transparency for the instruments or the market on which they are primarily traded, and the instruments’ complexity. Assets and liabilities recorded at fair value in the consolidated statements of financial condition are categorized based upon the level of judgment associated with the inputs used to measure their fair value.

A description of the valuation techniques applied to the Company’s major categories of assets and liabilities measured at fair value on a recurring basis follows.

Corporate Equities

Corporate equities are comprised primarily of exchange-traded equity securities that the Company takes selective proprietary positions based on expectations of future market movements and conditions.

Also, as compensation for investment banking services, the Company frequently receives common stock of the client as an additional compensation to cash fees. The common stock is typically issued prior to a registration statement is effective. The Company classifies these securities as “not-readily marketable securities” as they are restricted stock and may be freely traded only upon the effectiveness of a registration statement covering them or upon the satisfaction of the requirements to qualify under the exemption to Rule 144, including the requisite holding period. Once a registration statement covering the securities is declared effective by the SEC or the securities have satisfied the Rule 144 requirements, the Company classifies them as “marketable securities.”
 
Typically, the common stock is traded on stock exchanges and most are classified as Level 1 securities. The fair value is based on observed closing stock price at the measurement date.
 
Certain securities are traded infrequently and therefore do not have observable prices based on actively traded markets. These securities are classified as Level 3 securities, if pricing inputs or adjustments are both significant to the fair value measurement and unobservable. The Company determines the fair value of infrequently trading securities using the observed closing price at measurement date, discounted for the put option value calculated through the Black-Scholes model or similar valuation techniques. Valuation inputs used in the Black-Scholes model include interest rate, stock volatility, expected term and market price of the underlying stock. As of September 30, 2011 and December 31, 2010, the fair value of this type of securities included in securities owned in the statements of financial condition is $1,083,000 and $58,000, respectively. Had these securities been valued using observed closing prices, the total value of the securities would have been $1,150,000 and $75,000 as of September 30, 2011 and December 31, 2010, respectively.

 
11

 

MERRIMAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—CONTINUED
(unaudited)
 
2. Fair Value of Assets and Liabilities – continued

Stock Warrants
 
Also as partial compensation for investment banking services, the Company may receive stock warrants issued by the client. Stock warrants provide their holders with the right to purchase equity in a company. If the underlying stock of the warrants is freely tradable, the warrants are considered to be marketable. If the underlying stock is restricted, subject to a registration statement or to satisfying the requirements for a Rule 144 exemption, the warrants are considered to be non-marketable. Such positions are considered illiquid and do not have readily determinable fair values, and therefore require significant management judgment or estimation.
 
The fair value of the stock warrants is determined using the Black-Scholes model or similar valuation techniques. Valuation inputs used in the Black-Scholes model include interest rate, stock volatility, expected term and market price of the underlying stock. As these require significant management assumptions, they are classified as Level 3 securities.

Underwriters’ Purchase Options
 
The Company may receive partial compensation for its investment banking services also in the form of underwriters’ purchase options (“UPOs”). UPOs are identical to warrants other than with respect to the securities for which they are exercisable. UPOs grant the holder the right to purchase a “bundle” of securities, including common stock and warrants to purchase common stock. UPOs grant the right to purchase securities of companies for which the Company acted as an underwriter to account for any overallotment of these securities in a public offering. Such positions are considered illiquid and do not have readily determinable fair values, and therefore require significant management judgment or estimation.
 
The fair value of the UPO is determined using the Black-Scholes model or similar technique, applied in two stages. The first stage is to determine the value of the warrants contained within the “bundle” which is then added to the fair value of the stock within the bundle. Once the fair value of the underlying “bundle” is established, the Black-Scholes model is used again to estimate a value for the UPO. The fair value of the “bundle” as estimated by Black-Scholes in the first stage is used instead of the price of the underlying stock as one of the inputs in the second stage of the Black-Scholes. The use of the valuation techniques requires significant management assumptions and therefore UPOs are classified as Level 3 securities.

Preferred Stock

Preferred stock represents preferred equity in companies. The preferred stock owned by the Company is convertible at the Company’s discretion. For these securities, the Company uses the exchange-quoted price of the common stock equivalents to value the securities. They are classified within Level 2 or Level 3 of the fair value hierarchy depending on the availability of an observable stock price on actively traded markets.

 
12

 
 
MERRIMAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—CONTINUED
(unaudited)
 
2. Fair Value of Assets and Liabilities — continued
 
Assets and liabilities measured at fair value on a recurring basis are summarized below:

   
Assets at Fair Value at September 30, 2011
 
   
Level 1
   
Level 2
   
Level 3
   
Total
 
Assets:
                       
Corporate equities
  $ 1,268,219     $ -     $ 1,082,793     $ 2,351,012  
Stock warrants
    -       -       924,439       924,439  
Underwriters' purchase option
    -       -       8,436       8,436  
Preferred stock
    -       -       551       551  
Total securities owned
  $ 1,268,219     $ -     $ 2,016,219     $ 3,284,438  
Liabilities:
                               
Securities sold, not yet purchased
  $ 1,934     $ -     $ -     $ 1,934  
Total fair value liabilities
  $ 1,934     $ -     $ -     $ 1,934  
 
   
Assets at Fair Value at December 31, 2010
 
   
Level 1
   
Level 2
   
Level 3
   
Total
 
Assets:
                       
Corporate equities
  $ 1,241,760       -     $ 57,797     $ 1,299,557  
Stock warrants
    -       -       2,324,901       2,324,901  
Underwriters' purchase option
    -       -       1,518,465       1,518,465  
Preferred stock
    -       -       251       251  
Total securities owned
  $ 1,241,760     $ -     $ 3,901,414     $ 5,143,174  
 
 
13

 
 
MERRIMAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—CONTINUED
(unaudited)
 
2. Fair Value of Assets and Liabilities — continued

The following summarizes the change in carrying values associated with Level 3 financial instruments for the three months ended September 30, 2011 and 2010:

               
Underwriters'
             
   
Corporate
   
Stock
   
Purchase
    Preferred        
   
Equities
   
Warrants
   
Options
   
Stock
   
Total
 
Balance at June 30, 2011
  $ 570,515     $ 1,650,138     $ 21,109     $ 632     $ 2,242,394  
Purchases or receipt (a)
    -       178,273       -       -       178,273  
Sales or exercises
    444,000       (43,920 )     -       -       400,080  
Transfers into
    128,520
(b)
    -       -       -       128,520  
Gains / (losses)
    -       -       -       -          
Realized
    -       -       -       -       -  
Unrealized
    (60,242 )     (860,052 )     (12,673 )     (81 )     (933,048 )
Balance at September 30, 2011
  $ 1,082,793     $ 924,439     $ 8,436     $ 551     $ 2,016,219  
Change in unrealized gains
                                       
(losses) relating to instruments still held
                                       
at September 30, 2011
  $ (60,243 )   $ (638,098 )   $ (12,672 )   $ (80 )   $ (711,093 )


(a) Includes purchases of securities and securities received for services
 
(b) Principally reflects transfers from Level 1, due to reduced trading activity, and therefore price transparency, on the underlying instruments

               
Underwriters'
             
   
Corporate
   
Stock
   
Purchase
    Preferred        
   
Equities
   
Warrants
   
Options
   
Stock
   
Total
 
Balance at June 30, 2010
  $ 42,791     $ 1,348,710     $ 408,941     $ 619     $ 1,801,061  
Purchases or receipt
    -       -       -       -       -  
Sales or exercises
    -       -       -       -       -  
Transfers into
    37,890
(a)
    -       -       -       37,890  
Transfers out of
    -       -       -       -       -  
Gains (losses)
                                       
Realized
    -       -       -       -       -  
Unrealized
    63,274       (364,267 )     (62,511 )     (381 )     (363,885 )
Balance at September 30, 2010
  $ 143,955     $ 984,443     $ 346,430     $ 238     $ 1,475,066  
Change in unrealized gains
                                       
(losses) relating to instruments still held
                                       
at September 30, 2010
  $ 63,274     $ (364,267 )   $ (62,511 )   $ (381 )   $ (363,885 )
 

(a) Principally reflects transfers from Level 1, due to reduced trading activity, and therefore price transparency, on the underlying instruments
 
 
14

 
 
MERRIMAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—CONTINUED
(unaudited)
 
2. Fair Value of Assets and Liabilities — continued

The following summarizes the change in carrying values associated with Level 3 financial instruments for the nine months ended September 30, 2011 and 2010:
 
               
Underwriters'
             
   
Corporate
   
Stock
   
Purchase
    Preferred        
   
Equities
   
Warrants
   
Options
   
Stock
   
Total
 
Balance at December 31, 2010
  $ 57,797     $ 2,324,901     $ 1,518,465     $ 251     $ 3,901,414  
Purchases or receipt (a)
    2,955       554,119       -       -       557,074  
Sales or exercises
    832,189       (413,741 )     (881,804 )     -       (463,356 )
Transfers out of
    (10,658 )(b)     -       -       -       (10,658 )
Gains (losses):
    -       -       -       -       -  
Realized
    (292,278 )     (13,342 )     -       -       (305,620 )
Unrealized
    492,788       (1,527,498 )     (628,225 )     300       (1,662,635 )
Balance at September 30, 2011
  $ 1,082,793     $ 924,439     $ 8,436     $ 551     $ 2,016,219  
Change in unrealized gains
                                       
(losses) relating to instruments still held
                                       
at September 30, 2011
  $ 202,185     $ (1,005,043 )   $ (56,723 )   $ 300     $ (859,281 )
 

(a) Includes purchases of securities and securities received for services
 
(b) Principally reflects transfer to Level 1, due to availability of market data and therefore more price transparency

               
Underwriters'
             
   
Corporate
   
Stock
   
Purchase
    Preferred        
   
Equities
   
Warrants
   
Options
     Stock    
Total
 
Balance at December 31, 2009
  $ 21,731     $ 1,575,481     $ -     $ -     $ 1,597,212  
Purchases or receipt (a)
    96,890       316,184       462,399       -       875,473  
Sales or exercises
    -       (409,528 )     -       -       (409,528 )
Transfers into
    248,637 (b)      -       -       434 (b)      249,071  
Transfers out of
    (21,731 )(c)     -       -       -       (21,731 )
Losses:
                                       
Realized
    -       -       -       -       -  
Unrealized
    (201,572 )     (497,694 )     (115,969 )     (196 )     (815,430 )
Balance at September 30, 2010
  $ 143,955     $ 984,443     $ 346,430     $ 238     $ 1,475,066  
Change in unrealized losses
                                       
relating to instruments still held
                                       
at September 30, 2010
  $ (201,572 )   $ (497,694 )   $ (115,969 )   $ (196 )   $ (815,431 )
 

(a) Includes purchases of securities and securities received for services
 
(b) Principally reflects transfers from Level 1, due to reduced trading activity, and therefore price transparency, on the underlying instruments
 
(c) Principally reflects transfer to Level 1, due to availability of market data and therefore more price transparency
 
 
15

 
 
MERRIMAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—CONTINUED
(unaudited)

2. Fair Value of Assets and Liabilities — continued

Net gains and losses (both realized and unrealized) for Level 3 financial assets are a component of principal transactions in the consolidated statements of operations.
 
Transfers within the Fair Value Hierarchy
 
The Company assesses our financial instruments on a quarterly basis to determine the appropriate classification within the fair value hierarchy, as defined by ASC 820. Transfers between fair value classifications occur when there are changes in pricing observability levels. Transfers of financial instruments among the levels occur at the end of the reporting period. There were no significant transfers between our Level 1 and Level 2 classified instruments during the three and nine months ended September 30, 2011.

3. Issuance of Notes

Subordinated Notes Payable

On September 29, 2010, the Company borrowed $1,000,000 from nine individual lenders, all of whom were directors, officers or employees of the Company at the time of issuance, pursuant to a series of unsecured promissory notes (Subordinated Notes). The Subordinated Notes are for a term of three years and provide for interest comprising two components: (i) six percent (6.0%) per annum to be paid in cash monthly; and (ii) eight percent (8.0%) per annum to be accrued and paid in cash upon maturity. Additional consideration was paid to the lenders at closing comprising a number of shares of common stock of the Company equal to: (A) 30% of the principal amount lent; divided by (B) $3.01 per share. The total effective interest on the note is approximately 21.73%. Proceeds were used to supplement underwriting capacity and working capital for MC.

The total proceeds of $1,000,000 raised in the transaction above is accounted for as an issuance of debt with stock. The total proceeds of $1,000,000 have been allocated to these individual instruments based on the relative fair values of each instrument. Based on such allocation method, the value of the stocks issued in connection with the Subordinated Notes was $206,000, which was recorded as a discount on the debt and applied against the Subordinated Notes. As of December 31, 2010, the Subordinated Notes of $809,000, net of $191,000 discount, remained outstanding and is included in notes payable to related parties in the Company’s consolidated statements of financial condition.

As of September 30, 2011, $823,000 of the Subordinated Notes, net of $137,000 discount, remain outstanding and is included in notes payable to related parties in the Company’s consolidated statements of financial condition. The remaining Subordinated Notes held by parties no longer related to the Company of $34,000, net of $6,000 discount, are included in notes payable in the Company’s consolidated statements of financial condition. The discount on the note is amortized over the term of the loan using the effective interest method. For the three and nine months ended September 30, 2011, the Company incurred $35,000 and $105,000 in interest on the Subordinated Notes, respectively. Total interest of $85,000 remain outstanding as of September 30, 2011 and is included in accrued expenses and other in the consolidated statements of financial condition.

2010 Chez Secured Promissory Note

On November 17, 2010, the Company borrowed $1,050,000 from Ronald L. Chez, our Co-Chairman of the Board of Directors, pursuant to a secured promissory note (2010 Chez Secured Promissory Note). The 2010 Chez Secured Promissory Note is secured by certain accounts receivable which were purchased by the Company from MC with the proceeds of the transaction being used for such purchase. The 2010 Chez Secured Promissory Note is due and payable in two tranches as the accounts receivable became due, with $950,000 due on January 19, 2011 and $100,000 due on February 28, 2011. It provides for interest of 29.2% per annum and additional consideration comprising two components (i) 50,000 shares of the Company’s Series D Preferred Stock (which is convertible into 7,142 shares of our Common Stock); and (ii) a cash fee of $15,000. The proceeds were used to supplement underwriting capacity for MC. As of December 31, 2010, the 2010 Chez Secured Promissory Note of $330,000 remained outstanding and is included in notes payable to related parties in the Company’s consolidated statements of financial condition.

 On January 21, 2011, the 2010 Chez Secured Promissory Note was amended to extend the maturity date to April 15, 2011 and change the 50,000 Series D Convertible Preferred Stock consideration to cash compensation of $21,000. For the three months ended September 30, 2011, the Company incurred $0 in fees in relation to this note, and for the nine months ended September 30, 2011, the Company incurred $42,000 in fees, composed of $15,000 and $21,000 in cash fees, and $6,000 of interest at 29.2% per annum. On March 24, 2011, all principal and related fees were paid and no balance remains outstanding.
 
 
16

 

MERRIMAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—CONTINUED
(unaudited)
 
3. Issuance of Notes — continued

Unsecured Promissory Notes

On November 1, 2010, the Company issued $300,000 in unsecured promissory notes (Unsecured Promissory Notes) to four of its Series D Convertible Preferred Stock investors with a maturity date of the earlier of January 31, 2011 or the consummation of a qualified financing, as defined. The Unsecured Promissory Notes provide for interest of twelve percent (12%) per annum to be paid in cash at maturity. Additional consideration was paid to the lenders at closing comprising a number of shares of common stock of the Company equal to 55% of the principal amount lent divided by $3.01 per share.

The total proceeds of $300,000 raised in the transaction above is accounted for as an issuance of debt with stock. The total proceeds of $300,000 have been allocated to these individual instruments based on the relative fair values of each instrument at the time of issuance. Based on such allocation method, the value of the stock issued in connection with the Unsecured Promissory Notes was $106,000, which was recorded as a discount on the debt and applied against the Unsecured Promissory Notes. As of December 31, 2010, Unsecured Promissory Notes of $260,000, net of $40,000 discount, remain outstanding and is included in notes payable in the Company’s consolidated statements of financial condition.

On January 31, 2011, the Company amended its Unsecured Promissory Notes to extend their maturity dates from January 31, 2011 to December 31, 2011. The interest rate from the amendment date to the maturity date was increased to 13%. Furthermore, the additional common stock consideration was cancelled and returned to the Company, as such $65,000 of previously amortized discount on debt was reversed during the three months ended March 31, 2011. As of September 30, 2011, $300,000 of the Unsecured Promissory Notes remains outstanding and is included in notes payable in the Company’s consolidated statements of financial condition. For the three and nine months ended September 30, 2011, the Company incurred $10,000 and $29,000 in interest in relation to this note, respectively. Total interest of $35,000 remains outstanding as of September 30, 2011 and is included in accrued expenses and other in the consolidated statements of financial condition.
 
 
17

 
 
MERRIMAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—CONTINUED
(unaudited)

3. Issuance of Notes — continued

Secured Promissory Notes

In April 2011, the Company raised $2,770,000 from 24 investors, of which 11 were directors, officers, consultants or employees of the Company at the time of issuance, pursuant to a series of secured promissory notes (Secured Promissory Notes). The Secured Promissory Notes are for a term of three years and provide for interest of ten percent (10.0%) per annum to be paid in cash quarterly. Additional consideration was paid to the lenders at closing comprising warrants to purchase shares of the common stock of the Company at a price per share equal to 85% of the Company’s stock price at the closing date (the Warrants). 86 Warrants were issued for each $1,000 invested. A total of 238,220 Warrants were issued. The Warrants issued to directors, officers, consultants and employees (Insider Warrants) of the Company provide that the Insider Warrants will not be exercisable unless first approved by the Company’s stockholders. These notes are secured by a security interest in and right of setoff against all of such the Company’s right, title and interest in, to all of the capital stock of Merriman Capital Inc., together with all proceeds, rents, profits and returns of and from any of the foregoing. Also, beginning on the date which is one year from the issuance date, if there is an equity financing of the Company resulting in gross proceeds of at least $15,000,000 in new money, holders shall have the option to put 50% of Secured Promissory Notes originally purchased back to the Company, for an amount equal to the principal plus accrued but unpaid interest, on 30 days written notice. The Secured Promissory Notes were issued in two tranches, one closed on April 7, 2011 for $2,470,000 and the other closed on April 21, 2011 for $300,000.

The total proceeds raised in the transaction above was accounted for as an issuance of debt with warrants. The total proceeds of $2,770,000 have been allocated to these individual instruments based on the relative fair values of each instrument at the time of issuance. Based on the fair value allocation method, the value of the warrants issued in connection with the Secured Promissory Notes received was $420,000, which was recorded as a discount on the debt and applied against the Secured Promissory Notes.

As of September 30, 2011, $1,421,000 of the Secured Promissory Notes, net of $209,000 discount, remain outstanding and are included in notes payable in the Company’s consolidated statements of financial condition. The remaining Secured Promissory Notes issued to Insiders of $991,000, net of $149,000 discount, are included in notes payable to related parties in the Company’s consolidated statements of financial condition. For the three and nine months ended September 30, 2011, the Company incurred $70,000 and $132,000 in interest in relation to this note, respectively. As of September 30, 2011, $72,000 of interest and remains outstanding and is included in accrued expenses and other in the consolidated statements of financial condition.

2011 Chez Secured Promissory Note

On April 7, 2011, the Company’s Co-Chairman of the Board of Directors, Ronald L. Chez, invested $330,000 in a three year secured promissory note (2011 Chez Secured Promissory Note) at an interest rate of six percent (6%) per annum payable quarterly. This note is secured by a security interest in and right of setoff against all of such the Company’s right, title and interest in, to all of the capital stock of Merriman Capital Inc., together with all proceeds, rents, profits and returns of and from any of the foregoing. Also, beginning on the date which is one year from the issuance date, if there is an equity financing of the Company resulting in gross proceeds of at least $15,000,000 in new money, holders shall have the option to put 50% of Secured Promissory Notes originally purchased back to the Company, for an amount equal to the principal plus accrued but unpaid interest, on 30 days written notice.

As of September 30, 2011, $330,000 of the 2011 Chez Secured Promissory Note remains outstanding and is included in notes payable to related parties in the Company’s consolidated statements of financial condition. For the three and nine months ended September 30, 2011, the Company incurred $5,000 and $10,000 in interest in relation to this note, respectively. As of September 30, 2011, $5,000 of interest remains outstanding and is included in accrued expenses and other in the consolidated statements of financial condition.

Temporary Subordinated Loan

During the first quarter of 2011, the Company issued a loan in the form of temporary subordinated loans to supplement the Company’s net capital and enable it to underwrite initial public offerings, in accordance with Rule 15c3-1 of the Securities Exchange Act of 1934. All temporary subordinated loan transactions are disclosed separately in Note 11 – Related Party Transactions.
 
 
18

 
 
MERRIMAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—CONTINUED
(unaudited)

4. Stockholders’ Equity

Series D Convertible Preferred Stock

On September 8, 2009, the Company issued 23,720,916 shares of Series D Convertible Preferred Stock along with 5-year warrants to purchase 3,388,677 shares of the Company’s common stock with an exercise price of $4.55 per share on a post-reverse split basis. The investor group consisted of 56 individuals and entities, including certain officers, directors and employees of the Company, as well as outside investors.

The Series D Convertible Preferred Stock was issued in a private placement exempt from registration requirements pursuant to Regulation D of the Securities Act of 1933. Seven shares of Series D Preferred are convertible into one share of common stock of the Company. For the three months ended September 30, 2011, 1,453,487 shares of Series D Convertible Preferred Stock were converted to 207,640 shares of common stock, and for the nine months ended September 30, 2011, 2,494,922 shares of Series D Convertible Preferred Stock were converted to 356,415 shares of common stock. Holders of the Series D Convertible Preferred Stock are entitled to a 6% annual dividend payable monthly in arrears. The Company is prohibited from paying any dividends on the Common Stock until all accrued dividends on the Series D Convertible Preferred Stock are first paid. For the three and nine months ended September 30, 2011, total Series D Convertible Preferred Stock dividends were $129,000 and $407,000 respectively. As of September 30, 2011, the Company has an outstanding cash dividends payable of $42,000 which are included in accounts payable in the consolidated statements of financial condition.
 
The holders of Series D Convertible Preferred Stock are entitled to a “liquidation preference payment” of $0.43 per share of Series D Convertible Preferred Stock plus all accrued but unpaid dividends on such shares prior and in preference to any payment to holders of the Common Stock upon a merger, acquisition, sale of substantially all the assets, or certain other liquidation events of the Company. Any proceeds after payment of the “liquidation preference payment” shall be paid pro rata to the holders of the Series D Convertible Preferred Stock and Common Stock on an as converted to Common Stock basis.
 
The Series D Convertible Preferred Stock has antidilution protection, including a full ratchet provision for certain new issuances of company stock, as specified in the Certificate of Designation of Series D Convertible Preferred Stock.
 
The holders of the Series D Convertible Preferred Stock are entitled to elect four of the nine authorized members of our Board of Directors. Additionally, they have certain “protective provisions,” as set forth in the Certificate of Designation, requiring us to obtain their approval before the Company can carry out certain actions.

The warrants issued in connection with the Series D Convertible Preferred Stock will expire five years from the date of the transaction. Holders of the Series D Convertible Preferred Stock may convert them into shares of the Company’s common stock at any time in amounts no less than $100,000 unless all of the shares held by the holder are for a lesser amount. The Series D Convertible Preferred Stock will automatically convert at the discretion of the Company upon 10-day notice given when the average closing price of the Company’s common stock over a 30-day period is at or above $21.00 per share on a post-reverse split basis and when the average trading volume for the immediately prior four-week period is 4,286 shares or more, provided that the shares have been effectively registered with the Securities and Exchange Commission or all of the Series D Convertible Preferred Stock may be sold under Rule 144 of the 1933 Exchange Act.
 
 
19

 
 
MERRIMAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—CONTINUED
(unaudited)

4. Stockholders’ Equity — continued

Potentially Dilutive Securities

Our Board of Directors has the authority to issue up to 300,000,000 shares of common stock and to issue options and warrants to purchase shares of our common stock without stockholder approval in certain circumstances.

The table below represents a list of potentially dilutive securities outstanding as of September 30, 2011:

 
       
 
Potentially Dilutive Securities Outstanding
   
Weighted-Average Exercise Price or Converion Price
 
Series D convertible preferred stock warrants
    3,388,677     $ 4.55  
Conversion of Series D preferred stock
    2,794,743       -  
Stock options
    1,271,712       5.59  
Warrants issued in connection with Secured Promissory Notes
    238,220       2.25  
Other outstanding warrants
    759,286       4.47  
Common stock payable for legal settlement
    2,374       -  
     Potentially dilutive securities
    8,455,012     $ 3.13  

5. Stock-Based Compensation Expense

Stock Options

 As of September 30, 2011, there were 2,155,915 shares authorized for issuance under the Option Plans, and 87,551 shares authorized for issuance outside of the Option Plans. As of September 30, 2011, 370,442 shares were available for future option grants under the Option Plans. There were no shares available for future option grants outside of the Option Plans. Compensation expense for stock options during the three and nine months ended September 30, 2011 was $49,000 and $665,000, respectively. Compensation expense for stock options during the three and nine months ended September 30, 2010 was $258,000 and $1,254,000, respectively.

The following table is a summary of the Company’s stock option activity for the nine months ended September 30, 2011:

   
Shares
   
Weighted- Average Exercise Price
 
Outstanding at December 31, 2010
    1,665,083     $ 5.85  
Granted
    277,892       2.44  
Exercised
           
Cancelled
    (671,263 )     (4.91 )
                 
Outstanding at September 30, 2011
    1,271,712     $ 5.59  
                 
Exercisable at September 30, 2011
    589,396     $ 6.54  
                 
                 
Vested and expected to vest as of September 30, 2011
    1,183,316          
 
 
20

 
 
MERRIMAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—CONTINUED
(unaudited)

5. Stock-based Compensation Expense — continued

The following table summarizes information with respect to stock options vested and outstanding at September 30, 2011:

     
Options Outstanding at September 30, 2011
   
Vested Options at
September 30, 2011
 
Range of Exercise Price
   
Number
   
Weighted- Average Remaining Contractual Life (Years)
   
Weighted- Average Exercise Price
   
Aggregate Intrinsic Value
   
Number
   
Weighted- Average Exercise Price
   
Aggregate Intrinsic Value
 
$0.0000 - $3.4999       735,791       7.33     $ 2.71     $       317,897     $ 2.95     $  
$3.5000 - $6.9999       107,767       7.32       5.86             54,945       5.67        
$7.0000 - $10.4999       366,463       8.10       8.43             168,473       8.43        
$10.5000 - $13.9999       24,385       6.28       11.43             15,099       11.70        
$14.0000 - $27.9999       21,377       1.64       22.23             17,092       21.07        
$28.0000 - $48.9999       12,053       1.24       32.91             12,014       32.92        
$49.0000 - $84.4999       3,876       1.89       64.59             3,876       64.59        
                                                           
        1,271,712       7.36     $ 5.59     $       589,396     $ 6.54     $  
 
As of September 30, 2011, total unrecognized compensation expense related to unvested stock options was $1,934,000. This amount is expected to be recognized as expense over a weighted-average period of 2.40 years.

The weighted average fair value of each stock option granted for the three and nine months ended September 30, 2011 was $1.54 and $2.05, respectively. The weighted average fair value of each stock option granted for the three and nine months ended September 30, 2010 was $4.25 and $2.63, respectively. The fair value of each option award is estimated on the date of grant using the Black-Scholes stock option pricing model, with the following assumptions for the nine months ended September 30, 2011 and 2010:

 
   
Nine Months Ended September 30,
 
   
2011
   
2010
 
Expected Volatility
    123.39 %     135.77 %
Average expected term (years)
    3.70       2.66  
Risk-free interest rate
    1.47 %     1.42 %
Dividend yield
    -       -  
 
 
21

 
 
MERRIMAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—CONTINUED
(unaudited)

 5. Stock-based Compensation Expense — continued

Restricted Stock

At the date of grant, the recipients of restricted stock have most of the rights of a stockholder other than voting rights, subject to certain restrictions on transferability and a risk of forfeiture. The fair value of restricted stock is equal to the market value of the shares on the date of grant. The Company recognizes the compensation expense for restricted stock on a straight-line basis over the requisite service period. Compensation expense for restricted stock during the three and nine months ended September 30, 2011 was $48,000 and $61,000, respectively. Compensation expense for restricted stock during the three and nine months ended September 30, 2010 was $164,000 and ($80,000), respectively. The Company had a negative stock compensation expense for the nine months ended September 30, 2010 due to cancellation of restricted stock that had been granted to an employee who was terminated during the first quarter of 2010.

The following table is a summary of the Company's restricted stock activity for the nine months ended September 30, 2011:

   
Restricted Stock Outstanding
   
Weighted- Average Grant Date Fair Value
   
Aggregate Intrinsic Value
 
Balance as of December 31, 2010
    10,831     $ 6.68     $ 23,828  
Granted
    199,606       2.05          
Vested
    (5,994 )     (4.34 )        
Cancelled
    (23,682 )     (3.39 )        
                         
Balance as of September 30, 2011
    180,761     $ 2.04     $ 316,332  
                         
                         
Vested and expected to vest as of September 30, 2011
    139,343                  

The weighted average fair value of the restricted stock granted under the Company's stock option plans for the three and nine months ended September 30, 2011 was $2.04 per share. The weighted average fair value of the restricted stock granted under the Company's stock option plans for the three and nine months ended September 30, 2010 was $2.77 and $2.87 per share, respectively. The fair value of the restricted stock award is estimated on the date of grant using the intrinsic value method.

As of September 30, 2011, total unrecognized compensation expense related to restricted stock was $240,000. This expense is expected to be recognized over a weighted-average period of 0.68 years.

Board of Directors Compensation

In 2009, the Company formed a Strategic Advisory Committee of the Board of Directors chaired by Mr. Ronald Chez, the lead investor in the Series D Convertible Preferred Stock strategic transaction. During the first year, the Chairman of the Committee was compensated with five-year warrants to purchase 42,857 shares of the Company’s common stock at $4.55 on a post-reverse split basis, to be issued pro rata on a monthly basis from September 2009 to September 2010. On January 21, 2011, the Company entered into an amended agreement with Mr. Chez to prohibit the exercise of the 42,857 warrants without prior shareholder approval. The Company intends to submit these warrants for shareholder approval in the next shareholder meeting. No other compensation was provided for his service on the Committee.

Due to the modification of the terms of the warrants, the Company recorded a decrease in the stock-based compensation expense of $37,000 and $127,000 for the three and nine months ended September 30, 2011, respectively. As of September 30, 2011, the Company recorded accrued expenses of $59,000 as the Company’s best estimate of the services performed by Mr. Chez as the chairman of the Strategic Advisory Committee until the warrants are approved by the shareholders.
 
 
22

 
 
MERRIMAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—CONTINUED
(unaudited)
 
6. Discontinued Operations

Panel Intelligence LLC

In December 2008, management determined that the sale of Panel would reduce investments required to develop Panel’s business and generate capital necessary for the Company’s core business. The sale of Panel was completed in January 2009. Management determined that the plan of sale criteria in ASC 360, “Property, Plant and Equipment”, had been met. As a result, the revenue and expenses of Panel have been reclassified and included in discontinued operations in the consolidated statements of operations. For the three and nine months ended September 30, 2010, income from discontinued operations related to Panel was $0 and $33,000, respectively. For the three and nine months ended September 30, 2011, income from discontinued operations related to Panel was $0.

Institutional Cash Distributors

On January 16, 2009, the Company entered into an agreement to sell the assets of Institutional Cash Distributors (ICD), a division of MC, for $2,000,000 to a group of investors who were also its employees in order to raise capital. In the second quarter of 2010, ICD, LLC, formed by the new group of investors, started supporting its operations fully and as such, did not require significant assistance from MC. The Company discontinued the support of the ICD business, and did not have significant involvement going forward. The Company determined that the criteria for discontinued operations under guidance ASC 205, “Discontinued Operations”, have been met as of June 30, 2010. As a result, the revenue and expenses of ICD have been included in discontinued operations in the consolidated statements of operations.

As of December 31, 2010 and September 30, 2011, there were no assets or liabilities held for sale by the Company that related to ICD that were included in the Company’s consolidated statements of financial condition.

For the three and nine months ended September 30, 2011, income from discontinued operations related to ICD was $0. For the three and nine months ended September 30, 2010, income from discontinued operations related to ICD was $0 and $62,000, respectively.

7. Income Taxes

At the end of each interim reporting period the Company calculates an effective tax rate based on the Company’s estimate of the tax provision (benefit) that will be provided for the full year, stated as a percentage of estimated annual pre-tax income (loss). The tax provision for the interim period is determined using this estimated annual effective tax rate. For the nine months ended September 30, 2011 and 2010, we recorded $6,000 of income tax expense and $4,000 of income tax benefit, respectively. The increase in federal and state income taxes in 2011 was primarily due to state tax notices received.

Historically and currently, the Company has recorded a valuation allowance on the deferred tax assets, the significant component of which relates to net operating loss carryforwards. Management continually evaluates the realizability of its deferred tax assets based upon negative and positive evidence available. Based on the evidence available at this time, the Company continues to conclude that it is not “more likely than not” that the Company will be able to realize the benefit of our deferred tax assets in the future.

The Company does not have any unrecognized tax benefits or any associated accrued interest or penalties. The Company’s policy is to account for interest, if any, as interest expense and penalties as income tax expense.
 
 
23

 
 
MERRIMAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—CONTINUED
(unaudited)


8. Earnings (Loss) per Share

The following is a reconciliation of the basic and diluted net income (loss) available to common stockholders and the number of shares used in the basic and diluted net income (loss) per common share computations for the periods presented:

   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2011
   
2010
   
2011
   
2010
 
Loss from continuing operations
  $ (1,842,526 )   $ (4,512,696 )   $ (4,425,344 )   $ (6,699,450 )
                                 
Income from discontinued operations
                      95,104  
                                 
Net loss
  $ (1,842,526 )   $ (4,512,696 )   $ (4,425,344 )   $ (6,604,346 )
Convertible preferred stock, series D dividends
    (129,433 )     (146,400 )     (407,212 )     (446,100 )
Net loss attributable to common shareholders - basic and diluted
  $ (1,971,959 )   $ (4,659,096 )   $ (4,832,556 )   $ (7,050,446 )
                                 
Weighted-average number of common shares -basic
    2,652,285       2,030,584       2,485,935       1,931,781  
Assumed exercise or conversion of all potentially dilutive common shares outstanding
                       
Weighted-average number of common shares -diluted
    2,652,285       2,030,584       2,485,935       1,931,781  
                                 
                                 
Basic and diluted net income (loss) per share:
                               
Loss from continuing operations
  $ (0.69 )   $ (2.22 )   $ (1.78 )   $ (3.47 )
Income from discontinued operations
                      0.05  
                                 
Net loss per share
  $ (0.69 )   $ (2.22 )   $ (1.78 )   $ (3.42 )
                                 
Net loss per share attributable to common shareholders
  $ (0.74 )   $ (2.29 )   $ (1.94 )   $ (3.65 )
 
 
24

 
 
MERRIMAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—CONTINUED
(unaudited)
 
8. Earnings (Loss) per Share — continued

Basic earnings (loss) per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding, excluding shares of non-vested stock. Diluted income per share is calculated by dividing net income by the weighted average number of common shares used in the basic income per share calculation plus the number of common shares that would be issued assuming exercise or conversion of all potentially dilutive common shares outstanding, including non-vested stock. Diluted loss per share is unchanged from basic loss per share because the addition of common shares that would be issued assuming exercise or conversion would be anti-dilutive. Interest and dividends are also not considered since including them in the calculation of diluted loss per share would be anti-dilutive.

Shares used in the diluted net income per share computation include the dilutive impact of the Company’s stock options and warrants. The impact of the Company’s stock options and warrants on shares used for the diluted income per share computation is calculated based on the average share price of the Company’s common stock for each period using the treasury stock method. Under the treasury stock method, the tax-effected proceeds that would be hypothetically received from the exercise of all stock options and warrants with exercise prices below the average share price of the Company’s common stock are assumed to be used to repurchase shares of the Company’s common stock.

9. Regulatory Requirements

Merriman Capital, Inc. is a broker-dealer subject to Rule 15c3-1 of the SEC, which specifies uniform minimum net capital requirements, as defined, for their registrants. As of September 30, 2011, Merriman Capital, Inc. had regulatory net capital, as defined, of $2,497,000, which exceeded the amount required by $2,147,000. MC complies with the alternative net capital requirement allowed in Appendix E of Rule 15c3-1. MC is exempt from Rules 15c3-3 and 17a-13 under the Securities Exchange Act of 1934 because it does not carry customer accounts, nor does it hold customer securities or cash.

Under its rules, FINRA may prohibit a member firm from expanding its business or paying dividends if resulting net capital would be less than 5 percent of aggregate debit balances. Advances to affiliates, repayment of subordinated debt, dividend payments and other equity withdrawals by MC are subject to certain notification and other provisions of the SEC and FINRA rules. In addition, MC is subject to certain notification requirements related to withdrawals of excess net capital.
 
 
25

 
 
MERRIMAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—CONTINUED
(unaudited)

 10. Contingencies

Litigation

The Company is involved in the following lawsuits:

Don Arata and Gary Thornhill, et al. v. Merriman Capital, Inc. and Merriman Holdings, Inc.

In July 2008, MC and the Company were served with complaints filed in the San Francisco County, California Superior Court by several plaintiffs who invested money with Del Biaggio and related entities. In March 2009, MC and the Company were served with an amended consolidated complaint on behalf of 39 plaintiffs which consolidated several similar pending actions filed by the same law firm. Plaintiffs allege, among other things, fraud based on Cacchione’s alleged assistance to Del Biaggio in connection with the fraudulent investments and MC’s failure to discover and stop the continuing fraud. Plaintiffs in this lawsuit seek damages of over $9 million. MC and the Company responded to the amended consolidated complaint in June 2009 denying all liability. On May 9, 2011, the case was settled by mutual agreement. (The Davis, Cook, Bachelor, Hengehold and Thornhill cases, originally filed as separate claims, are now part of the consolidated cases.) In June 2011, the Company amended the settlement agreement and accrued additional litigation settlement expenses. The Company has appropriately accrued for settlement in this case as of September 30, 2011. On November 3, 2011, the Company further amended the settlement agreement to postpone the due date of the final payment until November 21, 2011.
 
Trustee for the Bankruptcy estates of William James “Boots” Del Biaggio and BDB Management, LLC v.  Merriman Capital, Inc. and D. Jonathan Merriman.

On September 2, 2011, a complaint was filed in FINRA arbitration against the Issuer’s subsidiary, Merriman Capital, Inc. by the bankruptcy estates of William James “Boots” Del Biaggio III and BDB Management, LLC.  The complaint alleges various causes of action arising from alleged unauthorized trading and cross collateralization in plaintiff’s accounts at Merriman Capital and seeks damages of $7.2 million.  Issuer believes that it has valid defenses and intends to contest these claims vigorously.  On November 2, 2011, Issuer caused an answer to the complaint to be filed on behalf of Merriman Capital and D. Jonathan Merriman, denying the allegations and asserting, among other things, the right to set off damages caused to Merriman Capital and the Issuer by Del Biaggio, who is currently serving an eight year sentence in federal prison for fraud, in an amount well in excess of plaintiff’s alleged damages.
 
Additionally, from time to time, the Company is involved in ordinary routine litigation incidental to our business.

Change of Control Agreements

In May 2011, the Company and its broker dealer subsidiary, Merriman Capital, Inc., entered into a series of Change of Control Agreements with six members of management whereby the Company or MC agreed to make payments to the individuals in the event there is a change of control. Each Change in Control Agreement was structured as a “double trigger” which means that, in order to be entitled to the payment, there must be (i) a change in control, followed by (ii) a termination or constructive termination of the individual within twelve months of the change in control.

The individuals with whom the Company entered into Change of Control Agreements, together with the amount due to such individual, are as follows: (i) D. Jonathan Merriman, Co-Chairman and CEO of the Company, who is entitled to a payment equal to three times his base salary plus one time his most recent year’s bonus (Merriman’s bonus compensation structure was recently revised to be based on revenue generation); (ii) Alex Seiler, CEO of MC, who is entitled to a payment equal to (A) five times base salary, if triggered in the initial 12 months of the agreement, and (B) an amount equal to three times base salary plus one times most recent year’s bonus, if triggered after the initial 12 months of the agreement; (iii) Jack Thrift, CFO of the Company and MC, who is entitled to a payment equal to two times his base salary; (iv) Michael Marrus, Head of Investment Banking of MC, who is entitled to a payment equal to one times his base salary; (v) Paul Kent, Head of Equity Capital Markets, who is entitled to a payment equal to one times his base salary; and (vi) Michael Doran, General Counsel of MC, who is entitled to a payment equal to one times his base salary.

Each Change of Control Agreement is for an initial term of four years, and after the first one year period and each successive one year period renews automatically for a further one year period unless terminated by either party. Each Change of Control Agreement also provides for acceleration of vesting of all options and restricted stock and payment of health and other benefits for one year.

As of October 17, 2011, all change in control agreements were terminated either through voluntary termination or resignation from the Company. In doing so, any potential remuneration arising in connection with those agreements have been forgiven.
 
 
26

 
 
MERRIMAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—CONTINUED
(unaudited)

11. Related Party Transactions

Subordinated Notes Payable to Related Parties

As mentioned in Note 3, on September 29, 2010, the Company borrowed $1,000,000 from nine individual lenders, all of whom were directors, officers or employees of the Company at the time of issuance, pursuant to a series of Subordinated Notes. The effective interest rate on the note is 21.73% with a maturity date of September 29, 2013. As of September 30, 2011, the Subordinated Notes of $823,000, net of $137,000 discount, remain outstanding and is included in notes payable to related parties in the Company’s consolidated statements of financial condition. For the three and nine months ended September 30, 2011, the Company incurred $34,000 and $101,000 as fees on the Subordinated Notes held by related parties. Total interest of $82,000 remain outstanding as of September 30, 2011 and is included in accrued expenses and other in the consolidated statements of financial condition. As of December 31, 2010, the Subordinated Notes of $809,000, net of $191,000 discount, remained outstanding and is included in notes payable to related parties in the Company’s consolidated statements of financial condition.

2010 Chez Secured Promissory Note

On November 17, 2010, the Company borrowed $1,050,000 from Ronald L. Chez, our Co-Chairman of the Board of Directors, pursuant to the 2010 Chez Secured Promissory Note. The 2010 Chez Secured Promissory Note is secured by certain accounts receivable which were purchased by the Company from the Company’s broker dealer subsidiary with the proceeds of the transaction being used for such purchase. It provides for interest of 29.2% per annum and additional consideration comprising two components (i) 50,000 shares of the Company’s Series D Preferred Stock; and (ii) a cash fee of $15,000. The 2010 Chez Secured Promissory Note is due and payable in two tranches as the accounts receivable become due, with $950,000 due on January 19, 2011 and $100,000 due on February 28, 2011. As of December 31, 2010, the 2010 Chez Secured Promissory Note of $330,000 remained outstanding and is included in notes payable to related parties in the Company’s consolidated statements of financial condition.

On January 21, 2011, the 2010 Chez Secured Promissory Note was amended to extend the maturity date to April 15, 2011 and change the 50,000 Series D Convertible Preferred Stock consideration to cash compensation of $21,000. For the three months ended September 30, 2011, the Company incurred $0 in fees in relation to this note, and for the nine months ended September 30, 2011, the Company incurred $42,000 in fees, composed of $15,000 and $21,000 in cash fees, and $6,000 of interest at 29.2% per annum. On March 24, 2011, all principal and related fees have been paid and no balance remains outstanding.

Temporary Subordinated Loan

On January 31, 2011, the Company borrowed $2,800,000 from Ronald L. Chez, Co-Chairman of the Board of Directors. The loan was in the form of a temporary subordinated loan in accordance with Rule 15c3-1 of the Securities Exchange Act of 1934. The Company compensated Mr. Chez $56,000 in fees for this loan and is included in cost of underwriting capital in the consolidated statements of operations. On February 7, 2011, the loan and fees were paid in full and no balance remains outstanding as of September 30, 2011.
 
 
27

 
 
MERRIMAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—CONTINUED
(unaudited)

11. Related Party Transactions – continued

Secured Promissory Notes

As mentioned in Note 3 above, in April 2011, the Company raised a total of $2,770,000 from 24 investors, of which $1,270,000 was from 11 directors, officers, consultants or employees of the Company (collectively, the Insiders) at the time of issuance, pursuant to a series of Secured Promissory Notes. The Secured Promissory Notes are for a term of three years and provide for interest of ten percent (10.0%) per annum to be paid in cash quarterly. Additional consideration was paid to the lenders at closing comprising warrants to purchase shares of the common stock of the Company at a price per share equal to 85% of the Company’s stock price at the closing date. 86 Warrants were issued for each $1,000 invested. The Insider Warrants will not be exercisable unless first approved by the Company’s stockholders. As collateral security for these Secured Promissory Notes, the Company grants the holders, a security interest in and right of setoff against all of such the Company’s right, title and interest in, to all of the capital stock of Merriman Capital Inc., together with all proceeds, rents, profits and returns of and from any of the foregoing. Also, beginning on the date which is one year from the issuance date, if there is an equity financing of the Company resulting in gross proceeds of at least $15,000,000 in new money, holders shall have the option to put 50% of Secured Promissory Notes originally purchased back to the Company, for an amount equal to the principal plus accrued but unpaid interest, on 30 days written notice.

As of September 30, 2011, $991,000 of the Secured Promissory Notes issued to Insiders, net of $149,000 of discount, remains outstanding and is included in notes payable to related parties in the Company’s consolidated statements of financial condition. For the three and nine months ended September 30, 2011, the Company incurred $29,000 and $55,000, respectively, in interest in relation to this note issued to Insiders, $31,000 of which remain outstanding as of September 30, 2011 and is included in accrued expenses and other in the consolidated statements of financial condition.

2011 Chez Secured Promissory Note
 
On April 7, 2011, the Company’s Co-Chairman of the Board of Directors, Ronald L. Chez, invested $330,000 in a three year secured promissory note (2011 Chez Secured Promissory Note) at an interest rate of six percent (6%) per annum payable quarterly. As collateral security for these Secured Promissory Notes, the Company grants the holders, a security interest in and right of setoff against all of such the Company’s right, title and interest in, to all of the capital stock of Merriman Capital Inc., together with all proceeds, rents, profits and returns of and from any of the foregoing. Also, beginning on the date which is one year from the issuance date, if there is an equity financing of the Company resulting in gross proceeds of at least $15,000,000 in new money, holders shall have the option to put 50% of Secured Promissory Notes originally purchased back to the Company, for an amount equal to the principal plus accrued but unpaid interest, on 30 days written notice.

As of September 30, 2011, $330,000 of the 2011 Chez Secured Promissory Note remains outstanding and is included in notes payable to related parties in the Company’s consolidated statements of financial condition. For the three and nine months ended September 30, 2011, the Company incurred $5,000 and $10,000 in interest in relation to this note, respectively. As of September 30, 2011, $5,000 of interest remains outstanding and is included in accrued expenses and other in the consolidated statements of financial condition.

Strategic Advisory Committee

In September 2009, the Company formed a Strategic Advisory Committee of the Board of Directors chaired by Ronald L. Chez, the lead investor in the Series D Convertible Preferred Stock strategic transaction. During the first year of his term as the Chair of the Committee, Mr. Chez was compensated with warrants to purchase 42,857 shares of the Company’s common stock at $4.55 per share on a post-reverse split basis, to be issued prorata on a monthly basis from September 2009 to September 2010. On January 21, 2011, the Company entered into an amended agreement with Mr. Chez to prohibit the exercise of the 42,857 warrants without prior shareholder approval. The Company intends to submit these warrants for shareholder approval in the next shareholder meeting. No other compensation was provided for his service on the Committee.

Due to the modification of the terms of the warrants, the Company recorded a decrease in the stock-based compensation expense of $37,000 and $127,000 for the three and nine months ended September 30, 2011, respectively. As of September 30, 2011, the Company recorded accrued expenses of $59,000 as the Company’s best estimate of the services performed by Mr. Chez as the chairman of the Strategic Advisory Committee until the warrants are approved by the shareholders.
 
 
28

 
 
MERRIMAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—CONTINUED
(unaudited)

12. Segment Reporting

Effective January 1, 2011, the Company’s business results are categorized into the following three segments: MC, Riverbank and OTCQX. The MC segment includes a broad range of services, such as capital raising and financial advisory services for corporate clients, and brokerage and equity research services for our institutional investor clients. The Riverbank segment includes capital raising services through a network of independent investment bankers and OTCQX includes assistance to corporate issuers in listing on OTCQX, the premier OTC Market tier, along with other services that facilitate the access to institutional capital markets.
 
 
The accounting policies of the segments are consistent with those described in the Significant Accounting Policies in Note 1. The Company evaluates segment results based on revenue and segment income. There are no revenue generating activities between segments.
 
Segment asset disclosures are not provided as no significant assets are separately determinable for Riverbank or OTCQX.

Revenue and expenses directly associated with each segment are included in determining segment income, which is also the internal performance measure used by management to assess the performance of each business in a given period.

Corporate items and eliminations include the effects of eliminating transactions between operating segments, and certain non-allocated amounts. Corporate items and eliminations is not an operating segment. Rather, it is added to operating segment totals to reconcile to consolidated totals on the financial statements. Certain amounts included in corporate items and eliminations cost are not allocated to operating segments because they are excluded from the measurement of their operating performance for internal purposes. These include Board of Directors compensation, interest on general borrowings, litigation settlement costs and other charges.

Management believes that the following information provides a reasonable representation of each segment’s contribution to revenue and loss or operating results:

   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2011
   
2010
   
2011
   
2010
 
Revenues
                       
MC
  $ 3,857,677     $ 4,215,540     $ 15,422,574     $ 19,493,128  
Riverbank
    7,696       -       3,184,377       -  
OTCQX
    214,601       40,176       406,975       312,892  
Total segment revenues
    4,079,974       4,255,716       19,013,926       19,806,020  
Consolidation items and elimination
    6,564       (18,890 )     (568 )     (23,656 )
Consolidated revenues
  $ 4,086,538     $ 4,236,826     $ 19,013,358     $ 19,782,364  
                                 
Segment loss
                               
MC
  $ (1,787,301 )   $ (3,104,319 )   $ (4,155,342 )   $ (4,495,752 )
Riverbank
    (6,945 )     -       84,620       -  
OTCQX
    95,406       (15,285 )     57,500       141,042  
Total segment loss
    (1,698,840 )     (3,119,604 )     (4,013,222 )     (4,354,710 )
Consolidation items and elimination
    (143,686 )     (1,393,092 )     (412,122 )     (2,344,740 )
Consolidated loss from continuing operations
  $ (1,842,526 )   $ (4,512,696 )   $ (4,425,344 )   $ (6,699,450 )
 
 
29

 

MERRIMAN HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—CONTINUED
(unaudited)

13. Subsequent Events

Change in Control Agreements

As of October 17, 2011, all change in control agreements were terminated either through voluntary termination or resignation from the Company. In doing so, any potential remuneration arising in connection with those agreements have been forgiven.

Changes in Listing Platform

On October 26, 2011 the Company notified the NASDAQ Capital Market of its intention to voluntarily delist its common stock from the NASDAQ Capital Market and to list it on the OTCQX U.S. Premier (OTCQX) market, operated by OTC Markets, Inc. (OTCM-QX). The Company will remain a reporting company under the Securities Exchange Act of 1934, as amended.
 
The company expects that the last day of trading of its common stock on The NASDAQ Capital Market will be on or about November 17, 2011, with trading to commence on QX the next trading day.
 
Secured Promissory Note Exchange Offer

During November 2011, the Company began offering an opportunity for the holders of the $3,000,000 of Secured Promissory Notes and warrants to convert into common stock and new warrants as follows:

 
1)  
For the Secured Promissory Notes, a number of new shares of common stock of the Company equal to (i) the total amount of principal plus accrued but unpaid interest of the Secured Promissory Notes submitted for cancellation divided by (ii) an amount equal to 80% of the average closing price per share of the Company’s common stock as quoted on the exchange on which it principally trades for the 30 day period ending two days prior to the first closing date (the “AP”); plus

 
2)  
For the warrants, 1.25 new warrants for each warrant converted, with each new warrant carrying an exercise price equal to 110% of the AP

The closing of the sale and purchase of the securities contemplated hereby shall take place without unreasonable delay on one or more dates, following the full execution of the agreements by the Secured Promissory Note holders.

As of November 10, 2011, holders of approximately $1,860,000, or 62%, of the principal amount of this senior debt elected to convert their notes into shares of common stock and warrants to purchase common stock.    If all of the holders of the Secured Promissory Notes agree to convert their notes into common stock, the Company will reduce its annual interest cost by approximately $287,000.
 
Unsecured Promissory Note Exchange Offer

During November 2011, the Company began offering an opportunity for the holders of the $300,000 of Unsecured Promissory Notes to convert into common stock and warrants as follows:

 
1)  
A number of new shares of common Stock of the Company equal to (i) the total amount of principal plus accrued but unpaid interest of the Unsecured Promissory Notes submitted for cancellation divided by (ii) an amount equal to 80% of the average closing price per share of the Company’s common stock as quoted on the exchange on which it principally trades for the 30 day period ending two days prior to the first closing date (the “AP”); plus
 
 
2)  
Warrants to purchase shares of common stock of the Company with a strike price equal to 110% of the AP and in amount with an aggregate exercise price equal to 25% of the principal and interest amount of Unsecured Promissory Notes exchanged.

The closing of the sale and purchase of the securities contemplated hereby shall take place without unreasonable delay on one or more dates, following the full execution of the agreements by the Secured Promissory Note holders.

As of November 10, 2011, none of the holders of the principal amount of this debt have elected to convert their notes into shares of common stock and warrants.  If all of the holders of the Unsecured Promissory Notes agree to convert their notes into common stock, the Company will reduce its annual interest cost by approximately $39,000.

Modifications to Series D Convertible Preferred Certificate of Designation and Issuance of Additional Shares

The Company issued Series D Convertible Preferred Stock during September 2009.  The Series D certificate of designation requires that at least 50% of the holders of the Series D Convertible Preferred Stock agree to any amendments to the agreement.  During November 2011, more than 50% of the holders of the outstanding Series D Convertible Preferred Stock of the Company agreed to amend certain provisions of the Series D certificate of designation.  Accordingly, the following amendments will be applicable to all of the outstanding Series D Convertible Preferred Stock; an amendment to require that until such time as the directors declare a dividend, any unpaid and undeclared dividends accumulate, compound and will not be payable, and an amendment to decrease the “full ratchet” anti-dilution provision of the Series D certificate of designation to an amount to equal two times the AP, as applicable to the conversion of the Secured Promissory Notes and Unsecured Promissory Notes described above.  This amendment to the Series D certificate of designation will reduce the Company’s annual Series D Convertible Preferred Stock dividend requirement by approximately $500,000 annually, unless such dividends are declared by the board of directors.
  
Extension of Time to Pay Don Arata and Gary Thornhill, et al. v. Merriman Capital, Inc. and Merriman Holdings, Inc. Litigation Settlement

On November 3, 2011, the Company further amended the settlement agreement to postpone the due date of the final payment until November 21, 2011.
 
 
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ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report on Form 10-Q, including this Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements regarding future events and our future results that are based on current expectations, estimates, forecasts, and projections about the industries in which we operate and the beliefs and assumptions of our management. Words such as “may,” “should,” “expects,” “anticipates,” “targets,” “goals,” “projects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “predicts,” “potential” or “continue,” variations of such words, and similar expressions are intended to identify such forward-looking statements. In addition, any statements that refer to projections of our future financial performance, our anticipated growth and trends in our businesses, and other characterizations of future events or circumstances, are forward-looking statements. Readers are cautioned that these forward-looking statements are only predictions and are subject to risks, uncertainties, and assumptions that are difficult to predict. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. Readers are referred to risks and uncertainties identified underRisk Factors” beginning on Page 51 and elsewhere herein. We undertake no obligation to revise or update publicly any forward-looking statements for any reason. Numbers expressed herein may be rounded to thousands of dollars.

Overview

Merriman Holdings, Inc. (formerly Merriman Curhan Ford Group, Inc.) is a financial services company that primarily provides investment banking, sales and trade execution, and equity research through our primary operating subsidiary, Merriman Capital, Inc. (MC).

MC is an investment bank and securities broker-dealer focused on fast-growing companies and institutional investors. Our mission is to be the leader in researching, advising, financing, trading and investing in fast-growing companies under $1 billion in market capitalization. We originate differentiated equity research, brokerage and trading services primarily to institutional investors, as well as investment banking and advisory services to our fast-growing corporate clients.

We are headquartered in San Francisco, with an additional office in New York, NY. As of September 30, 2011, we had 62 employees. Merriman Capital, Inc. is registered with the Securities and Exchange Commission (SEC) as a broker-dealer and is a member of Financial Industry Regulatory Authority (FINRA) and the Securities Investors Protection Corporation (SIPC).
 
 
31

 
 
Executive Summary

Our total revenues were $4,087,000 for the three months ended September 30, 2011, which represented a 4% decrease over the same period in 2010. This decrease was primarily attributable to a decline in our commission business and to unrealized losses from our warrant portfolio. Our commission revenues for the same period decreased 3% year-over-year, due primarily to lower trading volume. Investment banking revenue increased by 68% year over year primarily due to an increase in banking transactions. Additionally, for the three months ended September 30, 2011, we incurred a net loss of $910,000 from principal transactions, $934,000 of which was due to net unrealized losses on our investment portfolio and $24,000 of which was attributable to net gains from our trading and proprietary operations. This compared to a net loss of $309,000 for the same period in 2010, which was comprised of a net loss of $234,000 from our investment portfolio and a net loss of $75,000 from our trading and proprietary operations. For the three months ended September 30, 2011, net loss from operations was $1,840,000 or $0.69 per share.
 
Business Environment

Uncertainty in the global macro environment affected capital markets and continued to cause a paralysis in equity portfolios during the third quarter of 2011. U.S. equity indices ended the second quarter down sharply as compared to the end of the second quarter of 2011. The flow of funds into U.S. equity funds was negative for the quarter ended September 30, 2011 as investors withdrew approximately $100 billion from stock and mixed equity funds. IPO activity in the U.S. decreased to approximately a quarter of the level in Q2 2011. However, more than half of the capital raised through IPO activity during the third quarter of 2011 was for companies which had a financial sponsor, or private equity firm, bringing it to market.

During the first nine months of 2011, approximately half of all IPO offerings were completed by companies in the following industrial classifications; technology, media, telecom, energy and consumer. Merriman Holdings, Inc. services companies in these industries. As the Company continues to examine the opportunities in 2011, we note that the current backlog of companies filing for an IPO includes a preponderance of companies in these industries as well.

More and more securities offerings are being completed within the exemptive provisions of the Securities Acts. The Company anticipates that this trend will continue as fast-growing companies navigate the most advantaged path to accessing capital markets in the future. We continue to assist companies in private securities transactions and through offerings on the OTCQX.
 
 
32

 
 
Liquidity and Capital Resources

MC, as a broker-dealer, is subject to Rule 15c3-1 of the Securities Exchange Act of 1934, which specifies uniform minimum net capital requirements, as defined, for their registrants. As of September 30, 2011, Merriman Capital, Inc. had regulatory net capital, as defined, of $2,497,000, which exceeded the amount required by $2,147,000.

As of September 30, 2011, liquid assets consisted primarily of cash and cash equivalents of $3,535,000 and marketable securities of $2,452,000, totaling $5,987,000.  For the nine months ended September 30, 2011, the Company had negative cash flows from operations of $3,567,000.

During 2011, the Company began the process of eliminating profitless revenue activities and certain discretionary spending.  During the quarter ended September 30, 2011, the Company significantly reduced its operating expenses by eliminating certain non- productive personnel, administrative positions and technology related costs.  Subsequent to September 30, 2011, the Company reduced its emphasis on the profitless research operations and increased it focus on its OTCQX and advisory businesses.  Additionally, the Company continues to review all expenses to assess their revenue generating potential or risk mitigation effectiveness.  As of September 30, 2011, the Company had 62 full time employees.  The headcount of  the Company as of November 10, 2011 decreased to 29 full time employees.

During November 2011, the Company began offering an opportunity for the holders of the $3,000,000 of Secured Promissory Notes and warrants to convert into common stock and new warrants as follows:

 
1)  
For the Secured Promissory Notes, a number of new shares of common stock of the Company equal to (i) the total amount of principal plus accrued but unpaid interest of the Secured Promissory Notes submitted for cancellation divided by (ii) an amount equal to 80% of the average closing price per share of the Company’s common stock as quoted on the exchange on which it principally trades for the 30 day period ending two days prior to the first closing date (the “AP”); plus

 
2)  
For the warrants, 1.25 new warrants for each warrant converted, with each new warrant carrying an exercise price equal to 110% of the AP

The closing of the sale and purchase of the securities contemplated hereby shall take place without unreasonable delay on one or more dates, following the full execution of the agreements by the Secured Promissory Note holders.

As of November 10, 2011, holders of approximately $1,860,000, or 62%, of the principal amount of this senior debt elected to convert their notes into shares of common stock and warrants to purchase common stock.    If all of the holders of the Secured Promissory Notes agree to convert their notes into common stock, the Company will reduce its annual interest cost by approximately $287,000.

During November 2011, the Company began offering an opportunity for the holders of the $300,000 of Unsecured Promissory Notes to convert into common stock and warrants as follows:

 
1)  
A number of new shares of common Stock of the Company equal to (i) the total amount of principal plus accrued but unpaid interest of the Unsecured Promissory Notes submitted for cancellation divided by (ii) an amount equal to 80% of the average closing price per share of the Company’s common stock as quoted on the exchange on which it principally trades for the 30 day period ending two days prior to the first closing date (the “AP”); plus
 
 
2)  
Warrants to purchase shares of common stock of the Company with a strike price equal to 110% of the AP and in amount with an aggregate exercise price equal to 25% of the principal and interest amount of Unsecured Promissory Notes exchanged.

The closing of the sale and purchase of the securities contemplated hereby shall take place without unreasonable delay on one or more dates, following the full execution of the agreements by the Secured Promissory Note holders.

The closing of the sale and purchase of the securities contemplated hereby shall take place without unreasonable delay on one or more dates, following the full execution of the agreements by the Secured Promissory Note holders.

As of November 10, 2011, none of the holders of the principal amount of this debt have elected to convert their notes into shares of common stock and warrants.  If all of the holders of the Unsecured Promissory Notes agree to convert their notes into common stock, the Company will reduce its annual interest cost by approximately $39,000.

The Company issued Series D Convertible Preferred Stock during September 2009.  The Series D certificate of designation requires that at least 50% of the holders of the Series D Convertible Preferred Stock agree to any amendments to the agreement.  During November 2011, more than 50% of the holders of the outstanding Series D Convertible Preferred Stock of the Company agreed to amend certain provisions of the Series D certificate of designation.  Accordingly, the following amendments will be applicable to all of the outstanding Series D Convertible Preferred Stock; an amendment to require that until such time as the directors declare a dividend, any unpaid and undeclared dividends accumulate, compound and will not be payable, and an amendment to decrease the “full ratchet” anti-dilution provision of the Series D certificate of designation to an amount to equal two times the AP, as applicable to the conversion of the Secured Promissory Notes and Unsecured Promissory Notes described above.  This amendment to the Series D certificate of designation will reduce the Company’s annual Series D Convertible Preferred Stock dividend requirement by approximately $500,000 annually, unless such dividends are declared by the board of directors.

Finally, management believes that it has the ability to delay or reduce expenditures if necessary in order to continue to operate the business for the foreseeable future.  Additionally, management is pursuing raising strategic capital. Failure to generate sufficient cash flows from operations, reduce spending or raise additional capital would have a material adverse effect on the Company’s ability to achieve its intended business objectives.
 
 
33

 

Results of Operations

The following table sets forth the results of operations for the three and nine months ended September 30, 2011 and 2010:

   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
   
September 30,
   
September 30,
 
   
2011
   
2010
   
2011
   
2010
 
Revenues:
                       
Commissions
  $ 3,834,121     $ 3,959,937     $ 10,821,486     $ 11,402,663  
Principal transactions
    (910,382 )     (309,422 )     (417,399 )     (133,261 )
Investment banking
    900,879       537,187       8,051,512       8,099,497  
Other
    261,920       49,124       557,759       413,465  
Total revenues
    4,086,538       4,236,826       19,013,358       19,782,364  
Operating expenses:
                               
Compensation and benefits
    3,229,605       4,863,982       15,152,508       15,462,360  
Brokerage and clearing fees
    326,236       361,413       1,087,182       1,131,584  
Professional services
    421,576       456,533       1,342,679       1,195,094  
Occupancy and equipment
    483,834       479,205       1,407,554       1,451,045  
Communications and technology
    491,197       476,941       1,499,666       1,563,417  
Depreciation and amortization
    20,755       99,746       117,160       302,600  
Travel and entertainment
    200,411       303,956       747,028       955,525  
Legal services and litigation settlement expense
    104,322       855,286       549,681       1,867,878  
Cost of underwriting capital
    -       8,000       97,625       968,576  
Other
    492,228       874,232       1,130,565       1,587,580  
Total operating expenses
    5,770,164       8,779,294       23,131,648       26,485,659  
Operating loss
    (1,683,626 )     (4,542,468 )     (4,118,290 )     (6,703,295 )
                                 
Other income
    15,000       -       26,601       29,319  
Interest expense, net
    (171,137 )     (3,530 )     (327,548 )     (29,759 )
Loss from continuing operations before income taxes
    (1,839,763 )     (4,545,998 )     (4,419,237 )     (6,703,735 )
Income tax (expense) benefit
    (2,763 )     33,302       (6,107 )     4,285  
Loss from continuing operations
    (1,842,526 )     (4,512,696 )     (4,425,344 )     (6,699,450 )
Income from discontinued operations
    -       -       -       95,104  
Net loss
  $ (1,842,526 )   $ (4,512,696 )   $ (4,425,344 )   $ (6,604,346 )
Preferred stock cash dividend
    (129,433 )     (146,400 )     (407,212 )     (446,100 )
Net loss attributable to common shareholders
  $ (1,971,959 )   $ (4,659,096 )   $ (4,832,556 )   $ (7,050,446 )
 
 
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Our total revenues during the third quarter of 2011 decreased by $150,000, or 4% compared to the same period in 2010. Of the total decrease in revenues, commissions were lower by $126,000 while principal transactions contributed to an additional $601,000 decrease. However, investment banking revenues were $364,000, or 68% higher during the third quarter of 2011 as compared to the same period in 2010. Other revenues also increased by 433%, or $213,000 mostly due to the expansion of our OTCQX advisory services as we sponsored more companies in the OTCQX Markets.

Investment Banking Revenue

The following table sets forth our revenue and transaction volumes from our investment banking activities for the three and nine months ended September 30, 2011 and 2010:
 
   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2011
   
2010
   
2011
   
2010
 
Revenue:
                       
Capital raising
  $ 700,879     $ 262,187     $ 6,212,891     $ 7,282,788  
Financial advisory
    200,000       275,000       1,838,621       816,709  
                                 
Total investment banking revenue
  $ 900,879     $ 537,187     $ 8,051,512     $ 8,099,497  
                                 
Transaction Volumes:
                               
Public offerings:
                               
Capital underwritten participations
  $ 41,400,000     $ 104,275,000     $ 346,963,946     $ 342,775,000  
Number of transactions
    1       1       8       5  
Private placements:
                               
Capital raised
  $ 6,942,000     $ -     $ 650,611,923     $ 94,369,150  
Number of transactions
    1       -       11       7  
Financial advisory:
                               
Transaction amounts
  $ 101,000,000     $ 15,000,000     $ 160,000,000     $ 43,028,500  
Number of transactions
    1       1       3       4  
 
Our investment banking revenue was $901,000, or 22% of our total revenue during the third quarter of 2011, representing a 68% increase from the same quarter in 2010, which were all generated by MC. The increase in the investment banking revenues generated by MC in the third quarter of 2011 was primarily due to more transactions during the third quarter of 2011 and higher fees generated per transaction as compared to the third quarter of 2010. There were no investment banking revenues generated by Riverbank during the third quarter of 2011.
 
During the three months ended September 30, 2011 and 2010, there were no investment banking clients that accounted for more than 10% of our total revenue.

 
35

 
 
Commissions and Principal Transactions Revenue
 
Our broker-dealer activity includes the following:
 
 
Commissions - Commissions include revenue resulting from executing trades in exchange-listed securities, over-the-counter securities and other transactions as agent.
 
 
Principal Transactions - Principal transactions consist of a portion of dealer spreads attributed to our securities trading activities as principal in NASDAQ-listed and other securities, and include transactions derived from our activities as a market-maker. Additionally, principal transactions include gains and losses resulting from market price fluctuations that occur while holding positions in our securities trading inventory.
 
The following table sets forth our revenue and several operating metrics, which we utilize in measuring and evaluating performance of our trading activity:
 
   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2011
   
2010
   
2011
   
2010
 
                         
Commissions:
                       
Institutional equities
  $ 3,834,121     $ 3,959,937     $ 10,821,486     $ 11,402,663  
                                 
Total commissions revenue
  $ 3,834,121     $ 3,959,937     $ 10,821,486     $ 11,402,663  
                                 
Principal transactions:
                               
Customer principal transactions, proprietary trading and market making
  $ 23,706     $ (74,909 )   $ 288,142     $ 837,575  
Investment portfolio
    (934,088 )     (234,513 )     (705,541 )     (970,836 )
                                 
Total principal transactions revenue
  $ (910,382 )   $ (309,422 )   $ (417,399 )   $ (133,261 )
                                 
Transaction Volumes:
                               
Number of shares traded
    147,998,878       178,819,198       430,726,103       542,839,680  
 
Commissions amounted to $3,834,000, or 94% of our total revenue during the third quarter of 2011, representing a 3% decrease in such revenue from the same period in 2010. The decrease was mostly attributable to lower trading volume. All commission revenues were generated by MC.

 
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Principal transactions revenue consists of four different activities - customer principal trades, market making, trading for our proprietary account, and realized and unrealized gains and losses in our investment portfolio. As a broker-dealer, we account for all of our marketable security positions on a trading basis and as a result, all security positions are marked to fair market value each day. Returns from market making and proprietary trading activities tend to be more volatile than acting as agent or principal for customers. For the three months ended September 30, 2011, we incurred a net loss of $910,000 from principal transactions, $934,000 of which was due to net unrealized losses on our investment portfolio and $24,000 of which was attributable to net gains from our trading and proprietary operations. This compared to a net loss of $309,000 for the same period in 2010, which was comprised of a net loss of $234,000 from our investment portfolio and a net loss of $75,000 from our trading and proprietary operations

During the third quarter of 2011, there was one brokerage customer that accounted for more than 10% of our total revenue and two in the third quarter of 2010.

Compensation and Benefits Expenses
 
Compensation and benefits expense represents the largest component of our operating expenses and includes incentive compensation paid to sales, trading, research and investment banking professionals, as well as discretionary bonuses, salaries and wages, and stock-based compensation. Incentive compensation varies primarily based on revenue production. Discretionary bonuses paid to research analysts also vary with commission revenue production, but also includes other qualitative factors and is determined by management. Salaries, payroll taxes and employee benefits vary based primarily on overall headcount.

The following table sets forth the major components of our compensation and benefits for the three and nine months ended September 30, 2011 and 2010:

   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2011
   
2010
   
2011
   
2010
 
Incentive compensation and discretionary bonuses
  $ 1,185,304     $ 2,027,627     $ 8,332,437     $ 7,240,040  
Salaries and wages
    1,612,601       1,960,080       4,999,836       5,485,457  
Stock-based compensation
    59,646       442,876       598,151       1,277,656  
Payroll taxes, benefits and other
    372,054       433,399       1,222,084       1,459,207  
                                 
Total compensation and benefits
  $ 3,229,605     $ 4,863,982     $ 15,152,508     $ 15,462,360  
                                 
Total compensation and benefits as a  percentage of core business revenue
    65 %     107 %     78 %     78 %
Cash compensation and benefits as a  percentage of core business revenue
    63 %     97 %     75 %     71 %

Compensation and benefits expense decreased by $1,634,000, or 34%, from the third quarter of 2010 to the third quarter of 2011. Of the total compensation and benefits for the three months ended September 30, 2011, ($14,000) was for personnel at Riverbank. The negative expense is caused by the true up of the distribution to Riverbank personnel based on the membership agreement. For the three months ended September 30, 2011 and 2010, $115,000 and $55,000 was incurred by OTCQX, respectively. MC incurred total compensation and benefits of $3,135,000 and $4,498,000 for the three months ended September 30, 2011 and September 30, 2010, respectively, or a decrease of $1,363,000 due mostly to the decrease in incentive compensation earned and lower stock-based compensation expense during the third quarter of 2011. This decrease was primarily due to lower average headcount from 84 during the third quarter of 2010 to 68 during the third quarter of 2011. Corporate items accounted for ($7,000) and $311,000 of total compensation and benefits for the three months ended September 30, 2011 and 2010, respectively. The decrease is primarily related to the decrease in stock compensation expense due to modification of warrants during 2011, which also resulted in a negative corporate compensation and benefits expense for the three months ended September 30, 2011.

 
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Cash compensation is equal to total compensation and benefits expense excluding stock-based compensation. Cash compensation and benefits expense as a percentage of core business revenue decreased to 63% of revenues during the third quarter of 2011 as compared to 97% in the same period in 2010. This decrease was primarily due to lower average headcount from 84 during the third quarter of 2010 to 68 during the third quarter of 2011.

Stock-based compensation expense decreased by 87% year over year. The decrease in stock-based compensation expense can be attributed to cancellations of options and restricted stock due to employee terminations during the quarter, and due to the lower fair value of the equity grants made during the year.

There was one sales professional that accounted for more than 10% of our total revenue during the three months ended September 30, 2011 and four in the same period of 2010.
 
Other Operating Expenses
 
Brokerage and clearing fees include trade processing expenses that we pay to our clearing broker and execution fees that we pay to floor brokers and electronic communication networks. Merriman Capital, Inc. is a fully-disclosed broker-dealer which has engaged a third party clearing broker to perform all of the clearance functions. The clearing broker-dealer processes and settles the customer transactions for Merriman Capital, Inc. and maintains the detailed customer records. These expenses are almost entirely variable, and are based on commission revenue and the volume of brokerage transactions. Our brokerage and clearing fees remained almost flat during the third quarter of 2011 compared to the same period in 2010 even though trading volume decreased. This is mostly due to our option trading business wherein our trade execution charges are relatively higher compared to equity trades.

Professional services expense includes audit and accounting fees, expenses related to investment banking transactions, and various consulting fees.

Communications and technology expense includes market data and quote services, voice, data and internet service fees, and data processing costs.

Depreciation and amortization expense primarily relate to the depreciation of our computer equipment and leasehold improvements. Depreciation and amortization are mostly fixed in nature. The decrease of $79,000, or 79% in the third quarter of 2011 over the same period in 2010 is a result of fewer purchases of equipment and leasehold improvements combined with full depreciation of certain assets, reducing the depreciable base of assets.

Travel and business development expenses are incurred by each of our lines of business and include business development costs by our investment bankers, travel costs for our research analysts to visit the companies that they cover and non-deal road show expenses. Non-deal road shows represent meetings in which management teams of our corporate clients present directly to our institutional investors. The decrease of $104,000, or 34%, year over year, is due to continued cost reduction measures as well as lower headcount.

Legal services and litigation settlement expenses were incurred in connection with our activities in prior years. The decrease of $751,000, or 88% is primarily due to the fact that most cases had been concluded towards the end of 2010. As such, lower legal fees were incurred in the third quarter of 2011.

Cost of underwriting capital includes expenses incurred directly related to underwriting deals, such as cost of borrowing to be able to underwrite offerings as required by FINRA rules. During the three months ended September 30, 2011, the Company had no borrowings under these types of arrangements, and accordingly, there was no cost of underwriting incurred.

 
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Other operating expense includes company events, recruiting fees, professional liability and property insurance, marketing, business licenses and taxes, office supplies, write-off of receivables, and other miscellaneous expenses. The decrease of $382,000 in the third quarter of 2011 over the third quarter of 2010 is mostly due to write off of certain unsuccessful deal related expenses during the third quarter of 2010 and none in the third quarter of 2011.
 
Income Taxes
 
At the end of each interim reporting period the Company calculates an effective tax rate based on the Company’s estimate of the tax provision (benefit) that will be provided for the full year, stated as a percentage of estimated annual pre-tax income (loss). The tax provision (benefit) for the interim period is determined using this estimated annual effective tax rate. For the nine months ended September 30, 2011 and 2010, we recorded $6,000 of income tax expense and $4,000 of income tax benefit, respectively. The increase in federal and state income taxes in 2011 was primarily due state tax notices received.

Historically and currently, the Company has recorded a valuation allowance on the deferred tax assets, the significant component of which relates to net operating loss carryforwards. Management continually evaluates the realizability of its deferred tax assets based upon negative and positive evidence available. Based on the evidence available at this time, the Company continues to conclude that it is not “more likely than not” that we will be able to realize the benefit of our deferred tax assets in the future.
 
The Company does not have any unrecognized tax benefits or any associated accrued interest or penalties. The Company’s policy is to account for interest, if any, as interest expense and penalties as income tax expense.
 
 
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Off-Balance Sheet Arrangements

We were not a party to any off-balance sheet arrangements during the three and nine months ended September 30, 2011 and 2010. In particular, we do not have any interest in so-called limited purpose entities, which include special purpose entities and structured finance entities.

Commitments

Change of Control Agreements

In May 2011, the Company and its broker dealer subsidiary, Merriman Capital, Inc., entered into a series of Change of Control Agreements with six members of management whereby the Company or MC agreed to make payments to the individuals in the event there is a change of control. Each Change in Control Agreement was structured as a “double trigger” which means that, in order to be entitled to the payment, there must be (i) a change in control, followed by (ii) a termination or constructive termination of the individual within twelve months of the change in control.

The individuals with whom the Company entered into Change of Control Agreements, together with the amount due to such individual, are as follows: (i) D. Jonathan Merriman, Co-Chairman and CEO of the Company, who is entitled to a payment equal to three times his base salary plus one time his most recent year’s bonus (Merriman’s bonus compensation structure was recently revised to be based on revenue generation); (ii) Alex Seiler, CEO of MC, who is entitled to a payment equal to (A) five times base salary, if triggered in the initial 12 months of the agreement, and (B) an amount equal to three times base salary plus one times most recent year’s bonus, if triggered after the initial 12 months of the agreement; (iii) Jack Thrift, CFO of the Company and MC, who is entitled to a payment equal to two times his base salary; (iv) Michael Marrus, Head of Investment Banking of MC, who is entitled to a payment equal to one times his base salary; (v) Paul Kent, Head of Equity Capital Markets, who is entitled to a payment equal to one times his base salary; and (vi) Michael Doran, General Counsel of MC, who is entitled to a payment equal to one times his base salary.

Each Change of Control Agreement is for an initial term of four years, and after the first one year period and each successive one year period renews automatically for a further one year period unless terminated by either party. Each Change of Control Agreement also provides for acceleration of vesting of all options and restricted stock and payment of health and other benefits for one year.

As of October 17, 2011, all change in control agreements were terminated either through voluntary termination or resignation from the Company. In doing so, any potential remuneration arising in connection with those agreements have been forgiven.

Other Commitments

The following table summarizes our significant commitments as of September 30, 2011, consisting of capital leases and future minimum lease payments under all non-cancelable operating leases and other non-cancelable commitments with initial or remaining terms in excess of one year.

   
Notes
Payable & Related
Interest
   
Operating Commitments
   
Operating
Leases
   
Total
 
2011
  $ 434,530     $ 1,033,922     $ 345,053     $ 1,813,505  
2012
    357,169       276,533       1,774,002       2,407,704  
2013
    1,586,239       16,139       1,327,563       2,929,941  
2014
    3,254,836       -       -       3,254,836  
                                 
Total commitments
  $ 5,632,774     $ 1,326,594     $ 3,446,618     $ 10,405,986  

 
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Loss from Discontinued Operations

Panel Intelligence LLC

In December 2008, management determined that the sale of Panel would reduce investments required to develop Panel’s business and generate capital necessary for the Company’s core business. The sale of Panel was completed in January 2009. Management determined that the plan of sale criteria in ASC 360, “Property, Plant and Equipment”, had been met. As a result, the revenue and expenses of Panel have been reclassified and included in discontinued operations in the consolidated statements of operations. For the three and nine months ended September 30, 2010, income from discontinued operations related to Panel was $0 and $33,000, respectively. For the three and nine months ended September 30, 2011, income from discontinued operations related to Panel was $0.

Institutional Cash Distributors

On January 16, 2009, the Company entered into an agreement to sell the assets of Institutional Cash Distributors (ICD), a division of MC, for $2,000,000 to a group of investors who were also its employees in order to raise capital. In the second quarter of 2010, ICD, LLC, formed by the new group of investors, started supporting its operations fully and as such, did not require significant assistance from MC. The Company discontinued the support of the ICD business, and will not have significant involvement going forward. The Company determined that the criteria for discontinued operations under guidance ASC Topic 205, “Discontinued Operations”, have been met as of June 30, 2010. As a result, the revenue and expenses of ICD have been included in discontinued operations in the consolidated statements of operations.

As of December 31, 2010 and September 30, 2011, there were no assets or liabilities held for sale by the Company that related to ICD that were included in the Company’s consolidated statements of financial condition.

For the three and nine months ended September 30, 2011, income from discontinued operations related to ICD was $0. For the three and nine months ended September 30, 2010, income from discontinued operations related to ICD was $0 and $62,000, respectively.

 
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Critical Accounting Policies and Estimates
 
The consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States, which require us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to the valuation of securities owned and deferred tax assets. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.
 
Securities Owned

Corporate Equities – are comprised primarily of exchange-traded equity securities that the Company takes selective proprietary positions based on expectations of future market movements and conditions. They are generally valued based on quoted prices from the exchange. To the extent these securities are actively traded, valuation adjustments are not applied and they are categorized in Level 1 of the fair value hierarchy. Certain securities are traded infrequently and therefore do not have observable prices based on actively traded markets. These securities are classified as Level 3 securities, if pricing inputs or adjustments are both significant to the fair value measurement and unobservable. The Company determines the fair value of infrequently trading securities using the observed closing price at measurement date, discounted for the put option value calculated through the Black-Scholes model or similar valuation techniques.

Stock Warrants – represent warrants to purchase equity in a publicly traded company. Such positions are considered illiquid and do not have readily determinable fair values, and therefore require significant management judgment or estimation. For these securities, the Company uses the Black-Scholes valuation methodology or similar techniques. They are classified within Level 3 of the fair value hierarchy.

Underwriters’ Purchase Options – represent the overallotment of units for a publicly traded company for which the Company acted as an underwriter. Such positions are considered illiquid and do not have readily determinable fair values, and therefore require significant management judgment or estimation. For these securities, the Company uses the Black-Scholes valuation methodology. They are classified within Level 3 of the fair value hierarchy.

Valuation of Securities Owned

Securities owned and securities sold, not yet purchased are reflected in the consolidated statements of financial condition on a trade-date basis. Related unrealized gains or losses are generally recognized in principal transactions in the consolidated statements of operations. The use of fair value to measure financial instruments is fundamental to our financial statements and is one of our most critical accounting policies.

The fair value of a financial instrument is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (the exit price). Instruments that we own (long positions) are marked to bid prices, and instruments that we have sold, but not yet purchased (short positions), are marked to offer prices. Fair value measurements are not adjusted for transaction costs. Fair values of our financial instruments are generally obtained from quoted market prices in active markets, broker or dealer price quotations, or alternative pricing sources with reasonable levels of price transparency. To the extent certain financial instruments trade infrequently or are non-marketable securities and, therefore, have little or no price transparency, we value these instruments based on management’s estimates.
 
Substantially all of our financial instruments are recorded at fair value or contract amounts that approximate fair value. Securities owned and securities sold, not yet purchased, are stated at fair value, with any related changes in unrealized appreciation or depreciation reflected in principal transactions in the consolidated statements of operations. Financial instruments carried at contract amounts include cash and cash equivalents and amounts due from and to brokers, dealers and clearing brokers.

 
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Fair Value Measurement—Definition and Hierarchy

The Company follows the provisions of ASC 820, “Fair Value Measurement and Disclosures” for our financial assets and liabilities. Under ASC 820, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., the “exit price”) in an orderly transaction between market participants at the measurement date.

Where available, fair value is based on observable market prices or parameters or derived from such prices or parameters. Where observable prices or inputs are not available, valuation models are applied. These valuation techniques involve some level of management estimation and judgment, the degree of which is dependent on the price transparency for the instruments or market and the instruments’ complexity. Assets and liabilities recorded at fair value in the consolidated statements of financial condition are categorized based upon the level of judgment associated with the inputs used to measure their fair value. The Company’s financial assets and liabilities measured and reported at fair value are classified and disclosed in one of the following categories:
 
Level 1 —Unadjusted, quoted prices are available in active markets for identical assets or liabilities at the measurement date. The types of assets and liabilities carried at Level 1 fair value generally are G-7 government and agency securities, equities listed in active markets, investments in publicly traded mutual funds with quoted market prices and listed derivatives.

Level 2 — Pricing inputs (other than quoted prices included in Level 1) are either directly or indirectly observable for the asset or liability through correlation with market data at the measurement date and for the duration of the instrument’s anticipated life. Fair valued assets that are generally included in this category are stock warrants for which market-based implied volatilities are available, and unregistered common stock.

Level 3 — Pricing inputs are both significant to the fair value measurement and unobservable. These inputs generally reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model. Fair valued assets that are generally included in this category are stock warrants for which market-based implied volatilities are not available.

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes the level in the fair value hierarchy within which the fair value measurement falls in its entirety is determined based on the lowest level of input that is significant to the fair value measurement in its entirety.

For further information on financial assets and liabilities that are measured at fair value on a recurring basis, and a description of valuation techniques, see Note 2 – Fair Value of Assets and Liabilities, of the Notes to the Consolidated Financial Statements in Item 1 of Part 1.

 
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Revenue Recognition
 
Investment banking revenue includes underwriting and private placement agency fees earned through our participation in public offerings, private placements of equity and convertible debt securities and fees earned as financial advisor in mergers and acquisitions and similar transactions. Underwriting revenue is earned in securities offerings in which we act as an underwriter and includes management fees, selling concessions and underwriting fees. Fee revenue relating to underwriting commitments is recorded when all significant items relating to the underwriting cycle have been completed and the amount of the underwriting revenue has been determined.

Syndicate expenses related to securities offerings in which we act as underwriter or agent are deferred until the related revenue is recognized or we determine that it is more likely than not that the securities offerings will not ultimately be completed. Underwriting revenue is presented net of related expenses. As co-manager for registered equity underwriting transactions, management must estimate our share of transaction-related expenses incurred by the lead manager in order to recognize revenue. Transaction-related expenses are deducted from the underwriting fee and therefore reduce the revenue that is recognized as co-manager. Such amounts are adjusted to reflect actual expenses in the period in which we receive the final settlement, typically 90 days following the closing of the transaction.

Merger and acquisition fees, and other advisory service revenue are generally earned and recognized only upon successful completion of the engagement. Unreimbursed expenses associated with private placement and advisory transactions are recorded as expenses as incurred.

Commissions revenue and related clearing expenses are recorded on a trade-date basis as security transactions occur. Principal transactions in regular-way trades are recorded on the trade date, as if they had settled. Profit and loss arising from all securities and commodities transactions entered into for the account and risk of our company are recorded on a trade-date basis.

OTCQX advisory services revenue is pro-rated monthly from the completion of the due diligence until the end of the engagement term.

Stock-based Compensation Expense

The Company measures and recognizes compensation expense based on estimated fair values for all stock-based awards made to employees and directors, including stock options, restricted stock and warrants. The Company estimates fair value of stock-based awards on the date of grant using the Black-Scholes option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense in the Company’s consolidated statements of operations over the requisite service periods. Because stock-based compensation expense is based on awards that are ultimately expected to vest, stock-based compensation expense has been reduced to account for estimated forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

To calculate stock-based compensation resulting from the issuance of options, and warrants, the Company uses the Black-Scholes option pricing model, which is affected by the Company’s stock price as well as assumptions regarding a number of subjective variables. These variables include, but are not limited to the Company’s expected stock price volatility over the term of the awards, and actual and projected employee stock option exercise behaviors. No tax benefits were attributed to the stock-based compensation expense because a valuation allowance was maintained for all net deferred tax assets.

 
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Deferred Tax Valuation Allowance

We account for income taxes in accordance with the provision of ASC 740, Income Taxes, which requires the recognition of deferred tax assets and liabilities at tax rates expected to be in effect when these balances reverse. Future tax benefits attributable to temporary differences are recognized to the extent that the realization of such benefits is more likely than not. We have concluded that it is not more likely than not that we will be able to realize the benefit of our deferred tax assets as of September 30, 2011 and 2010 based on the scheduling of deferred tax liabilities and projected taxable income. The amount of the deferred tax assets actually realized, however, could vary if there are differences in the timing or amount of future reversals of existing deferred tax liabilities or changes in the actual amounts of future taxable income. Should we determine that we will be able to realize all or part of the deferred tax asset in the future, an adjustment to the deferred tax asset will be recorded in the period such determination is made.

Related Party Transactions

Subordinated Notes Payable to Related Parties

As mentioned in Note 3, on September 29, 2010, the Company borrowed $1,000,000 from nine individual lenders, all of whom were directors, officers or employees of the Company at the time of issuance, pursuant to a series of Subordinated Notes. The effective interest rate on the note is 21.73% with a maturity date of September 29, 2013. As of September 30, 2011, the Subordinated Notes of $823,000, net of $137,000 discount, remain outstanding and is included in notes payable to related parties in the Company’s consolidated statements of financial condition. For the three and nine months ended September 30, 2011, the Company incurred $34,000 and $101,000 as fees on the Subordinated Notes held by related parties. Total interest of $82,000 remain outstanding as of September 30, 2011 and is included in accrued expenses and other in the consolidated statements of financial condition. As of December 31, 2010, the Subordinated Notes of $809,000, net of $191,000 discount, remained outstanding and is included in notes payable to related parties in the Company’s consolidated statements of financial condition.

2010 Chez Secured Promissory Note

On November 17, 2010, the Company borrowed $1,050,000 from Ronald L. Chez, our Co-Chairman of the Board of Directors, pursuant to the 2010 Chez Secured Promissory Note. The 2010 Chez Secured Promissory Note is secured by certain accounts receivable which were purchased by the Company from the Company’s broker dealer subsidiary with the proceeds of the transaction being used for such purchase. It provides for interest of 29.2% per annum and additional consideration comprising two components (i) 50,000 shares of the Company’s Series D Preferred Stock; and (ii) a cash fee of $15,000. The 2010 Chez Secured Promissory Note is due and payable in two tranches as the accounts receivable become due, with $950,000 due on January 19, 2011 and $100,000 due on February 28, 2011. As of December 31, 2010, the 2010 Chez Secured Promissory Note of $330,000 remained outstanding and is included in notes payable to related parties in the Company’s consolidated statements of financial condition.

On January 21, 2011, the 2010 Chez Secured Promissory Note was amended to extend the maturity date to April 15, 2011 and change the 50,000 Series D Convertible Preferred Stock consideration to cash compensation of $21,000. For the three months ended September 30, 2011, the Company incurred $0 in fees in relation to this note, and for the nine months ended September 30, 2011, the Company incurred $42,000 in fees, composed of $15,000 and $21,000 in cash fees, and $6,000 of interest at 29.2% per annum. On March 24, 2011, all principal and related fees have been paid and no balance remains outstanding.

Temporary Subordinated Loan

On January 31, 2011, the Company borrowed $2,800,000 from Ronald L. Chez, Co-Chairman of the Board of Directors. The loan was in the form of a temporary subordinated loan in accordance with Rule 15c3-1 of the Securities Exchange Act of 1934. The Company compensated Mr. Chez $56,000 in fees for this loan and is included in cost of underwriting capital in the consolidated statements of operations. On February 7, 2011, the loan and fees were paid in full and no balance remains outstanding as of September 30, 2011.

 
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Secured Promissory Notes

As mentioned in Note 3 above, in April 2011, the Company raised a total of $2,770,000 from 24 investors, of which $1,270,000 was from 11 directors, officers, consultants or employees of the Company (collectively, the Insiders) at the time of issuance, pursuant to a series of Secured Promissory Notes. The Secured Promissory Notes are for a term of three years and provide for interest of ten percent (10.0%) per annum to be paid in cash quarterly. Additional consideration was paid to the lenders at closing comprising warrants to purchase shares of the common stock of the Company at a price per share equal to 85% of the Company’s stock price at the closing date. 86 Warrants were issued for each $1,000 invested. The Insider Warrants will not be exercisable unless first approved by the Company’s stockholders. As collateral security for these Secured Promissory Notes, the Company grants the holders, a security interest in and right of setoff against all of such the Company’s right, title and interest in, to all of the capital stock of Merriman Capital Inc., together with all proceeds, rents, profits and returns of and from any of the foregoing. Also, beginning on the date which is one year from the issuance date, if there is an equity financing of the Company resulting in gross proceeds of at least $15,000,000 in new money, holders shall have the option to put 50% of Secured Promissory Notes originally purchased back to the Company, for an amount equal to the principal plus accrued but unpaid interest, on 30 days written notice.

As of September 30, 2011, $991,000 of the Secured Promissory Notes issued to Insiders, net of $149,000 of discount, remains outstanding and is included in notes payable to related parties in the Company’s consolidated statements of financial condition. For the three and nine months ended September 30, 2011, the Company incurred $29,000 and $55,000, respectively, in interest in relation to this note issued to Insiders, $31,000 of which remain outstanding as of September 30, 2011 and is included in accrued expenses and other in the consolidated statements of financial condition.

2011 Chez Secured Promissory Note
 
 
On April 7, 2011, the Company’s Co-Chairman of the Board of Directors, Ronald L. Chez, invested $330,000 in a three year secured promissory note (2011 Chez Secured Promissory Note) at an interest rate of six percent (6%) per annum payable quarterly. As collateral security for these Secured Promissory Notes, the Company grants the holders, a security interest in and right of setoff against all of such the Company’s right, title and interest in, to all of the capital stock of Merriman Capital Inc., together with all proceeds, rents, profits and returns of and from any of the foregoing. Also, beginning on the date which is one year from the issuance date, if there is an equity financing of the Company resulting in gross proceeds of at least $15,000,000 in new money, holders shall have the option to put 50% of Secured Promissory Notes originally purchased back to the Company, for an amount equal to the principal plus accrued but unpaid interest, on 30 days written notice.

As of September 30, 2011, $330,000 of the 2011 Chez Secured Promissory Note remains outstanding and is included in notes payable to related parties in the Company’s consolidated statements of financial condition. For the three and nine months ended September 30, 2011, the Company incurred $5,000 and $10,000 in interest in relation to this note, respectively. As of September 30, 2011, $5,000 of interest remains outstanding and is included in accrued expenses and other in the consolidated statements of financial condition.

Strategic Advisory Committee

In September 2009, the Company formed a Strategic Advisory Committee of the Board of Directors chaired by Ronald L. Chez, the lead investor in the Series D Convertible Preferred Stock strategic transaction. During the first year of his term as the Chair of the Committee, Mr. Chez was compensated with warrants to purchase 42,857 shares of the Company’s common stock at $4.55 per share on a post-reverse split basis, to be issued prorata on a monthly basis from September 2009 to September 2010. On January 21, 2011, the Company entered into an amended agreement with Mr. Chez to prohibit the exercise of the 42,857 warrants without prior shareholder approval. The Company intends to submit these warrants for shareholder approval in the next shareholder meeting. No other compensation was provided for his service on the Committee.

Due to the modification of the terms of the warrants, the Company recorded a decrease in the stock-based compensation expense of $37,000 and $127,000 for the three and nine months ended September 30, 2011, respectively. As of September 30, 2011, the Company recorded accrued expenses of $59,000 as the Company’s best estimate of the services performed by Mr. Chez as the chairman of the Strategic Advisory Committee until the warrants are approved by the shareholders.
 
 
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Subsequent Events

Change in Control Agreements
 
As of October 17, 2011, all change in control agreements were terminated either through voluntary termination or resignation from the Company. In doing so, any potential remuneration arising in connection with those agreements have been forgiven.

Changes in Listing Platform

On October 26, 2011 the Company notified the NASDAQ Capital Market of its intention to voluntarily delist its common stock from the NASDAQ Capital Market and to list it on the OTCQX U.S. Premier (OTCQX) market, operated by OTC Markets, Inc. (OTCM-QX). The Company will remain a reporting company under the Securities Exchange Act of 1934, as amended.
 
The company expects that the last day of trading of its common stock on The NASDAQ Capital Market will be on or about November 17, 2011, with trading to commence on QX the next trading day.
 
Secured Promissory Note Exchange Offer

During November 2011, the Company began offering an opportunity for the holders of the $3,000,000 of Secured Promissory Notes and warrants to convert into common stock and new warrants as follows:

 
1)  
For the Secured Promissory Notes, a number of new shares of common stock of the Company equal to (i) the total amount of principal plus accrued but unpaid interest of the Secured Promissory Notes submitted for cancellation divided by (ii) an amount equal to 80% of the average closing price per share of the Company’s common stock as quoted on the exchange on which it principally trades for the 30 day period ending two days prior to the first closing date (the “AP”); plus

 
2)  
For the warrants, 1.25 new warrants for each warrant converted, with each new warrant carrying an exercise price equal to 110% of the AP

The closing of the sale and purchase of the securities contemplated hereby shall take place without unreasonable delay on one or more dates, following the full execution of the agreements by the Secured Promissory Note holders.

As of November 10, 2011, holders of approximately $1,860,000, or 62%, or the principal amount of this senior debt elected to convert their notes into shares of common stock and warrants to purchase common stock.    If all of the holders of the Secured Promissory Notes agree to convert their notes into common stock, the Company will reduce its annual interest cost by approximately $287,000.

Unsecured Promissory Note Exchange Offer

During November 2011, the Company began offering an opportunity for the holders of the $300,000 of Unsecured Promissory Notes to convert into common stock and warrants as follows:

 
1)  
A number of new shares of common Stock of the Company equal to (i) the total amount of principal plus accrued but unpaid interest of the Unsecured Promissory Notes submitted for cancellation divided by (ii) an amount equal to 80% of the average closing price per share of the Company’s common stock as quoted on the exchange on which it principally trades for the 30 day period ending two days prior to the first closing date (the “AP”); plus
 
 
2)  
Warrants to purchase shares of common stock of the Company with a strike price equal to 110% of the AP and in amount with an aggregate exercise price equal to 25% of the principal and interest amount of Unsecured Promissory Notes exchanged.

The closing of the sale and purchase of the securities contemplated hereby shall take place without unreasonable delay on one or more dates, following the full execution of the agreements by the Secured Promissory Note holders.

As of November 10, 2011, none of the holders of the principal amount of this debt have elected to convert their notes into shares of common stock and warrants.  If all of the holders of the Unsecured Promissory Notes agree to convert their notes into common stock, the Company will reduce its annual interest cost by approximately $39,000.

Modifications to Series D Convertible Preferred Certificate of Designation and Issuance of Additional Shares

The Company issued Series D Convertible Preferred Stock during September 2009.  The Series D certificate of designation requires that at least 50% of the holders of the Series D Convertible Preferred Stock agree to any amendments to the agreement.  During November 2011, more than 50% of the holders of the outstanding Series D Convertible Preferred Stock of the Company agreed to amend certain provisions of the Series D certificate of designation.  Accordingly, the following amendments will be applicable to all of the outstanding Series D Convertible Preferred Stock; an amendment to require that until such time as the directors declare a dividend, any unpaid and undeclared dividends accumulate, compound and will not be payable, and an amendment to decrease the “full ratchet” anti-dilution provision of the Series D certificate of designation to an amount to equal two times the AP, as applicable to the conversion of the Secured Promissory Notes and Unsecured Promissory Notes described above.  This amendment to the Series D certificate of designation will reduce the Company’s annual Series D Convertible Preferred Stock dividend requirement by approximately $500,000 annually, unless such dividends are declared by the board of directors.
 
Extension of Time to Pay Don Arata and Gary Thornhill, et al. v. Merriman Capital, Inc. and Merriman Holdings, Inc. Litigation Settlement

On November 3, 2011, the Company further amended the settlement agreement to postpone the due date of the final payment until November 21, 2011.

 
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ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
 
Information concerning market risk is incorporated herein by reference to Item 7A of our Annual Report on Form 10-K and Form 10-K/A for the year ended December 31, 2010. There has been no material change in the quantitative and qualitative disclosure about market risk since December 31, 2010.

 
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ITEM 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

We have established disclosure controls and procedures to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to the officers who certify the Company's financial reports and to other members of senior management and the Board of Directors.

Based on the evaluation of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934), the Principal Executive Officer and Principal Financial Officer of the Company have concluded that the disclosure controls and procedures are effective as of September 30, 2011.

Changes in internal controls

There have been no changes in the Company's internal control over financial reporting (as defined in Rules 13a-15(d) and 15d-15(d) of the Exchange Act) that occurred during the fiscal quarter ended September 30, 2011, that materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.

 
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PART II. OTHER INFORMATION
 
ITEM 1. Legal Proceedings

Don Arata and Gary Thornhill, et al. v. Merriman Capital, Inc. and Merriman Holdings, Inc.

In July 2008, MC and the Company were served with complaints filed in the San Francisco County, California Superior Court by several plaintiffs who invested money with Del Biaggio and related entities. In March 2009, MC and the Company were served with an amended consolidated complaint on behalf of 39 plaintiffs which consolidated several similar pending actions filed by the same law firm. Plaintiffs allege, among other things, fraud based on Cacchione’s alleged assistance to Del Biaggio in connection with the fraudulent investments and MC’s failure to discover and stop the continuing fraud. Plaintiffs in this lawsuit seek damages of over $9 million. MC and the Company responded to the amended consolidated complaint in June 2009 denying all liability. On May 9, 2011, the case was settled by mutual agreement. (The Davis, Cook, Bachelor, Hengehold and Thornhill cases, originally filed as separate claims, are now part of the consolidated cases.) In June 2011, the Company amended the settlement agreement and accrued additional litigation settlement expenses. The Company has appropriately accrued for settlement in this case as of September 30, 2011. On November 3, 2011, the Company further amended the settlement agreement to postpone the due date of the final payment until November 21, 2011.
 
Trustee for the Bankruptcy estates of William James “Boots” Del Biaggio and BDB Management, LLC v.  Merriman Capital, Inc. and D. Jonathan Merriman.

On September 2, 2011, a complaint was filed in FINRA arbitration against the Issuer’s subsidiary, Merriman Capital, Inc. by the bankruptcy estates of William James “Boots” Del Biaggio III and BDB Management, LLC.  The complaint alleges various causes of action arising from alleged unauthorized trading and cross collateralization in plaintiff’s accounts at Merriman Capital and seeks damages of $7.2 million.  Issuer believes that it has valid defenses and intends to contest these claims vigorously.  On November 2, 2011, Issuer caused an answer to the complaint to be filed on behalf of Merriman Capital and D. Jonathan Merriman, denying the allegations and asserting, among other things, the right to set off damages caused to Merriman Capital and the Issuer by Del Biaggio, who is currently serving an eight year sentence in federal prison for fraud, in an amount well in excess of plaintiff’s alleged damages.
 
Additionally, from time to time, the Company is involved in ordinary routine litigation incidental to our business.

 
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ITEM 1A. Risk Factors

In addition to the factors set forth below and the other information set forth in this report, including reports we incorporate by reference, you should carefully consider the risk factors previously disclosed in response to Item 1A to Part 1 of our Annual Report on Form 10-K for the year ended December 31, 2010, filed on March 30, 2011, as amended by our Form 10-K/A filed on April 28, 2011.

We may not be able to continue operating our business
 
The Company incurred significant losses in the nine months ended September 30, 2011 and the year ended December 31, 2010. Even if we are successful in executing our plans, we will not be capable of sustaining losses such as those incurred in the nine months ended September 30, 2011, and in 2010. The Company’s ability to meet its financial obligations is highly dependent on market and economic conditions. We also recorded net losses in certain quarters within other past fiscal years.

Prior Claims on Assets in Liquidation

There can be no assurance that there will be any proceeds available in liquidation for holders of our Series D and Common Stock after payments to holders of our Secured Promissory Notes and our Unsecured Promissory Notes. If there are any proceeds available to stockholders in liquidation, holders of our Series D Preferred have a liquidation preference over our common stock.

The holders of Series D Convertible Preferred Stock are entitled to a “liquidation preference payment” of $0.43 per share of Series D Convertible Preferred Stock (or $3.01 per share on a Common Stock Equivalent basis) plus all accrued but unpaid dividends on such shares, prior and in preference to, any payment to holders of the Common Stock upon a merger, acquisition, sale of substantially all the assets, or certain other liquidation events of the Company.

Holders of Common Stock might receive nothing in liquidation, or receive much less than they would if there were no Secured Promissory Notes or Series D Convertible Preferred Stock outstanding.

Limitations on our access to capital and our ability to comply with net capital requirements could impair our ability to conduct our business
 
Liquidity, or ready access to funds, is essential to financial services firms. Failures of financial institutions have often been attributable in large part to insufficient liquidity. Liquidity is of importance to our trading business, and perceived liquidity issues may affect our customers and counterparties’ willingness to engage in brokerage transactions with us. Our liquidity could be impaired due to circumstances that we may be unable to control, such as a general market disruption or operational problems that affect our trading capability.

The Company has historically accessed capital markets to raise money through the sale of equity. Holders of our Series D Preferred Stock have certain rights and restrictive provisions which may affect our ability to continue to raise capital through the issuance of additional common stock.
 
MC, our broker-dealer subsidiary, is subject to the net capital requirements of the SEC and various self-regulatory organizations of which it is a member. These requirements typically specify the minimum level of net capital a broker-dealer must maintain, and also mandate that a significant part of its assets be kept in relatively liquid form. Any failure to comply with these net capital requirements could impair our ability to conduct our core business. Furthermore, MC is subject to laws that authorize regulatory bodies to prevent or reduce the flow of funds from it to Merriman Holdings, Inc. 

 Factors which could impede our ability to access additional capital include the recent extreme volatility in the equity markets and our recent operating results. If we are not able to access additional capital, we might not be able to meet our obligations in a timely manner, which would have a material adverse effect on the Company’s ability to achieve its intended business objectives.
 
Difficult market conditions could adversely affect our business in many ways.
 
Equity markets have recently been characterized by extreme volatility. Difficult market and economic conditions and geopolitical uncertainties have, in the past, adversely affected, and may in the future adversely affect, our business and profitability in many ways. Weakness in equity markets and diminished trading volume of securities could adversely impact our brokerage business, from which we have historically generated more than half of our revenue. Industry-wide declines in the size and number of underwritings and mergers and acquisitions also would likely have an adverse effect on our revenue. In addition, reductions in the trading prices for equity securities also tend to reduce the deal value of investment banking transactions, such as underwriting and mergers and acquisitions transactions, which in turn may reduce the fees we earn from these transactions. As we may be unable to reduce expenses correspondingly, this would have a material adverse effect on the Company’s ability to achieve its intended business objectives.
 
 
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We may experience significant losses if the value of our marketable security positions deteriorates.

We conduct active securities trading, market-making and investment activities for our own account, which subjects our capital to risks. These risks include market, credit, counterparty and liquidity risks, which could result in losses. These activities often involve the purchase, sale or short sale of securities as principal in markets that may be characterized as relatively illiquid, or that may be particularly susceptible to rapid fluctuations in liquidity and price. Losses resulting from such trading could have a material adverse effect on the Company’s ability to achieve its intended business objectives.
 
We have incurred losses for the period covered by this report in the recent past and may incur losses in the future.
 
The Company recorded net losses of $1,843,000 for the nine months ended September 30, 2011 and $5,338,000 for the year ended December 31, 2010. We also recorded net losses in certain quarters within other past fiscal years. We may incur losses in future periods.  
 
Reduced scale of operations and revenues, and changes to business plan

During 2011, the Company significantly reduced the scale of its operations and is actively creating a new business plan. The headcount of the firm was 77 at the beginning of the year and was 29 as of November 10, 2011. The historical business of the firm is outlined in our prior filings with the SEC. There is a risk that the firm will not be able to achieve profitability with this reduced level of productive personnel.

Currently, the Company is developing a business plan which will highlight its strengths in sponsoring corporate issuers to be listed on the OTCQX market, and on executing securities transactions for institutional customers. Although most elements of this plan have been finalized, many others elements have not yet been finalized as of November 10, 2011. There is a risk that the Company may not be able to determine a profitable new business model or that once conceived, that the firm will not be able to execute the business plan successfully due to various constraints, including those related to the current capital markets and the lack of adequate financial resources to transition the Company into the new business model.

Possible need for additional capital

As of September 30, 2011, the Company had approximately $7.4 million in current assets.  It also had approximately $3.5 million in current liabilities and approximately $1.0 million of equity at that time.  Additionally, as a broker-dealer firm, the Company is required to maintain a minimum level of net capital in order to conduct its business.  As of September 30, 2011, the Company had approximately $2.1 million of excess net capital.  Given the history of losses of the Company, the uncertain business environment, and the evolving business plans, there can be no assurance that the Company will have sufficient capital to continue to achieve its intended business objectives.
 
 
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ITEM 6.   Exhibits
3.8   Certificate of Amendment of Certificate of Designation implementing changes to dividend and antidilution provisions of Series D Preferred Stock, effective November 8, 2011.
     
31.1 
 
Certification of Principal Executive Officer Pursuant To Section 302 of the Sarbanes-Oxley Act of 2002.
     
31.2
 
Certification of Chief Financial Officer Pursuant To Section 302 of the Sarbanes-Oxley Act of 2002.
     
32.1 
 
Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
10.49
 
Form of Secured Promissory Note dated April 7, 2011. (Incorporated by reference to the Registrant’s Current Report on 8-K filed 4-13-11.)
     
10.50
 
Form of Chez Secured Promissory Note dated April 7, 2011. (Incorporated by reference to the Registrant’s Current Report on 8-K filed 4-13-11.)
     
10.51
 
Form of Warrant dated April 7, 2011 issued to investors who are not officers, directors, consultants or employees of the Company. (Incorporated by reference to the Registrant’s Current Report on 8-K filed 4-13-11.)
     
10.52
 
Form of Insider Warrant dated April 7, 2011, issued to investors who are officers, directors, consultants or employees of the Company. (Incorporated by reference to the Registrant’s Current Report on 8-K filed 4-13-11.)
     
10.53
 
Form of Secured Promissory Note dated April 21, 2011. (Incorporated by reference to the Registrant’s Current Report on 8-K filed 4-27-11.)
     
10.54
 
Form of Warrant dated April 21, 2011 issued to investors who are not officers, directors, consultants or employees of the Company. (Incorporated by reference to the Registrant’s Current Report on 8-K filed 4-27-11.)
     
10.55
 
Form of Insider Warrant dated April 21, 2011, issued to investors who are officers, directors, consultants or employees of the Company. (Incorporated by reference to the Registrant’s Current Report on 8-K filed 4-27-11.)
 
 
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SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
MERRIMAN HOLDINGS, INC.
 
       
November 14, 2011
By: 
/s/ D. JONATHAN MERRIMAN
 
   
D. Jonathan Merriman,
 
   
Chief Executive Officer
 
   
(Principal Executive Officer)
 
       
       
November 14, 2011
By: 
/s/ JACK A. THRIFT
 
   
Jack A. Thrift
 
   
Chief Financial Officer
 
   
(Principal Financial Officer) 
 
 
 
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