FOCUS Report Lincoln Financial Advisors Corporation

X-17A-5 [Paper] - FOCUS Report

Published: 2004-03-31 09:41:03
Submitted: 2004-03-04
Period Ending In: 2003-12-31
scanned.pdf Scanned paper document


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                  04016082
                                                              UNITED STATES
                                                  SECURITIES AND EXCHANGE COMMISSION
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             Q&%                                     ANNUAL AUDITED                                                                            SEC FILE NUMBER
                                                          FORM X—17A:5                                                                        6—14685
                                                                               PART 1

                                                     FACING PAG
                        Information Required of Brokers and Dealers Pursuant to Section 17 of the
                                     Securities Exchange Act of 1934 and Rule 17a—5 Thereunder

REPORT FOR THE PERIOD BEGINNING                                   01—01—03                         AND ENDING                      12—31—03
                                                                     MM/DDYY                                                         MMODYY




                                                    A. REGISTRANT IDENTIFICATION

NAME OF BROKER—DEALER:                                                                                                                    OFFICIAL USE ONLY
             Lincoin Financial Advisors Corporation

ADDRESS OF PRINCIPAL PLACE OF BUSINESS: (Do not use P.O. Box No.)                                                                   hoooznznznnrzrrznn____—_—
                       1300 South Clinton Street, Suite 150
                                                                             (No. and Street)

                     Fort Wayne, Indiana 46802—3506
                          (City)                                    (State)                                                          (Zip Code)


NAME AND TELEPHONE NUMBER OF PERSON TO CONTACT IN REGARD TO THIS REPORT
      Matthew E. Lynch                                         (860) 466—1316
                                                                                                                          (Area Code — Telephone No.)


                                                  B. ACCOUNTANT IDENTIFICATION
INDEPENDENT PUBLIC ACCOUNTANT whose opinion is contained in this Report*
             Ernst & Young LLP
                                                        (Name — ofindividual, state last, first, middle name)

             110 West Berry Street, Suite 2300                 Fort Wayne                                         IN                                46802
 (Address)                                                          (City)                                      (State)                             (Zip Code)

CHECK ONE:
             x Certified Public Accountant                                                                                         PR@CE@QE@
             D0 Public Accountant
             Q Accountant not resident in United States or any of its possessions.                                                  MAR 3 1 2004

                                                                    FOR OFFICIAL USE ONLY                                      ‘       THOW;.A.)N
                                                                                                                                       I"Il




*Claims for exemption from the requirement that the annual report be covered by the opinion of an independent public accountant
must be supported by a statement of facts and circumstances relied on as the basis for the/exemption. See section 240.17a—5(e)(2).




                                    Onareane whn are io resbpond to the collection of information contained


                                           ® —




            OATH OR AFFIRMATION


            1,                Matthew E. Lynch                                                                 , swear (or affirm) that, to the
           best of my knowledge and belief the accompanying financial statements and supporting schedules pertaining to the firm of
                                      _Lincoln Financial Advisors Corporation                                                            , as of
                      December 31,                    , 20 03       , are true and correct. | further swear (or affirm) that neither the company
           nor any partner, proprieior, principal officer or director has any proprietary interest in any account classified solely as that of

           a customer, except as follows:




                                   22
                                                                                               HdsPZ           @%nature
                                                                                              Chiet Financial Officer
                                                                                                                                     .




‘dulo0Boo_ 8o 4210
                                                                                                                     Title




        This report** contains (check all applicable boxes):
                      (a)     Facing page. ‘
><><><><D><><><><><




                      (b)     Statement of Financial Condition.
                      (c)     Statement of Operations.
                      (d)     Statement of Cash Flows.
                       (e)    Statement of Changes in Stockholders‘ Equity or Partners‘ or Sote Proprietor‘s Capital.
                        (f)   Statement of Changes in Liabilities Subordinated to Claims or Creditors.
                      (g)     Computation of Net Capital.
                      (h)     Computation for|Determination of Reserve Requirements Pursuant to Rule 15¢c3—3.
                      (1)     information Relating to the Possession or control Requirements Under Rule 1503—3.
                      (} )    A Reconciliation, including appropriate explanation, of the Computation of Net Capital Under Rule 15¢3—1 and the
                              Computation for Determination of the Reserve Requirements Under Exhibit A or Rule 15c3—3.
       C (k)                  A Reconciliation between the audited and unaudited Statements of Financial Condition with respect to methods of con—
                              solidation.
       x              (1)     An Oath or Affirmation.
       Q               (m)    A copy of the SIPC Supplemental Report.
       x              (n}     A report describing any material inadequacies found to exist or found to have existed since the date of the previous audit.
       O               (o)    Schedule of Segregation Requirements and Funds in Segregation for Customers Trading on U.S. Commodity Exchanges.
       O               (p)    Statement of Secured Amount and Funds Held in Separate Accounts for Foreign Futures and Options Customers Pursuant to
                              Commission Regulation 30.7.



          **For conditions of confidential treatment of certain portions of this filing, see section 240.17a—5(e)(3).


     SECURITIES AND EXCHANGE COMMISSION

                   WASHINGTON, D.C.


              ANNUAL AUDITED REPORT

              DATE—DECEMBER 31, 2003


   LINCOLN FINANCIAL ADVISORS CORPORATION
               (Name of Respondent)


   1300 South Clinton Street,Fort Wayne,IN_46802—3506
           (Address of principal executive office)


                    Matthew E. Lynch
                    Senior Vice President
       and Chief Financial and Administrative Officer
          Lincoln Financial Advisors Corporation
                 1300 South Clinton Street
               Fort Wayne, IN 46802—3506

(Name and Address of person authorized to receive notices and
communications from the Securities and Exchange Commission)


Financial Statements and Supplementary Information

LINCOLN FINANCIAL ADVISORS CORPORATION

 Years ended December 31, 2003 and 2002 with Report of Independent Auditors




wR 0310—0481195


                                          Lincoln Financial Advisors Corporation

                             Financial Statements and Supplementary Information


                                              Years ended December 31, 2003 and 2002




                                                                       Contents

Report of IndependeMt AUGITOTS ...)2..22.002.00200000eee 0e es eavee es revrrvrr esb en n e ns rarb n tb r ns eb e n en seb en eb e eb rere en e ree s 1


Audited Financial Statements

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StAatEMENtS Of IMACOM@...........2020202222»2222riserssseresesar6ereeessresrseriresrerresesresesssessesrrrersesrrrererrssrseererrrrree se aere 3
Statements of Changes in StOCKAOIG&T‘ $ EQUItY .....2.2.22.02022200200eee e es rererrvsrer es rer es rrersrrerrrrvereresrrveseees 4
StateMeNtS Of CASH FIOWS ...,...,2,22222222020v2veevsvsrvvervrresrvare se es ervrersererseseeserrassietrererrrrrressrr es es es e earreerreed 5
Nficrelsthrnleriisictonto e 6



Supplementary Information

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SCREUUIG II.......22..02222sr2rvervreverrsrrrssesesssrierrrevecsrrtereeverrrreecreeressetseserreeraesrervesserrrerrerrsrerrerrrreresserrrecerrare              13
SCREUUI@ III ......2222.0002022sivvrrsrvsereerrrrreserressetresseersserseerssseseerrecsessrrssrrsesrresersssresrrrrissrerrrrrrrrrerssrrrerrer es               14
Statement Pursuant to SEC Rule 17@—5(0@)(4) .......2.0202200200002verrreesrestrrrresvrtrrererrerertrrrrrserrrrerrrrrsrr ks                                     15
Report of Independent Auditors on Internal Accounting
   Controls Required by SEC RUlG@ 17@—5......,.022000002002000669r e e es es r e trrrerrrrerrrertrer e es ersrrrerrrerererr es 16


E-” ERNST& YOUNG                                           & Ernst & Young uir           ® Phone: (260) 424—2233
                                                             National City Center          Fax:   (260) 425—4899
                                                             Suite 2300                    www.ey.com
                                                             110 West Berry Street
                                                             Fort Wayne, Indiana 46802




                                  Report of Independent Auditors

  Board of Directors
  Lincoln Financial Advisors Corporation

  We have audited the accompanying statements of financial condition of Lincoln Financial
  Advisors Corporation (an indirect, wholly owned subsidiary of Lincoln National Corporation) as
  of December 31, 2003 and 2002, and the related statements of income, changes in stockholder‘s
  equity and cash flows for the years then ended. These financial statements are the responsibility
  of management of Lincoln Financial Advisors Corporation. Our responsibility is to express an
  opinion on these financial statements based on our audits.

  We conducted our audits in accordance with auditing standards generally accepted in the United
  States. Those standards require that we plan and perform the audit to obtain reasonable
  assurance about whether the financial statements are free of material misstatement. An audit
  includes examining, on a test basis, evidence supporting the amounts and disclosures in the
  financial statements. An audit also includes assessing the accounting principles used and
  significant estimates made by management, as well as evaluating the overall financial statement
  presentation. We believe that our audits provide a reasonable basis for our opinion.

  In our opinion, the financial statements referred to above present fairly, in all material respects,
  the financial position of Lincoln Financial Advisors Corporation at December 31, 2003 and
  2002, and the results of its operations and its cash flows for the years then ended in conformity
  with accounting principles generally accepted in the United States.

  Our audits were conducted for the purpose of forming an opinion on the basic financial
  statements taken as a whole. The supplementary information contained in the accompanying
  schedules is presented for purposes of additional analysis and is not a required part of the basic
  financial statements, but is supplementary information required by rule 17a—5 under the
  Securities and Exchange Act of 1934, Such information has been subjected to the auditing
  procedures applied in our audits of the basic financial statements and, in our opinion, is fairly
  stated in all material respects in relation to the basic financial statements taken as a whole.


                                                               CEamaA +                        LLP
  February 16, 2004




                                   A Member Practice of Ernst & Young Global                                1


                             Lincoln Financial Advisors Corporation


                                  Statements of Financial Condition



                                                                          December 31
                                                                       2003             2002
    Assets
    Cash and cash equivalents                                   $ 54,481,989      $ 50,194,770
    Investmentiin common stock                                        91,700           124,100
    Receivables:
      Commissions and fees                                          15,844,277        13,306,190
      Affiliates:                                                     4,976,682        2,017,372
    Deferred income tax benefit                                         18,469           431,308
    Other assets                                                       193,825            69,234
    Property and equipment:
      Computer software costs                                         1,663,149        1,421,987
      Leasehold improvements                                           258,268          232,495
                                                                     1,921,417         1,654,482
  Less accumulated depreciation                                     (1,020,122)         (905,449)
Net property and equipment                                             901,295          749,033
Total assets.                                                   $76,508,237       $ 66,892,007

Liabilities and stockholder‘s equity
Payable to %endors                                              $       25,000    $       15,431
Payable to affiliates                                               12,338,101         2,023,948
Deferred revenue                                                     3,025,749         2,336,938
Accrued commissions                                                 10,891,526         9,690,576
Accrued compensation and benefits                                    1,715,065        ©2,121,356
Breakpoint reserve                                                   3,803,872                 —
Other liabilities                                                    7,458,946         2,913,760
Total liabilities                                                   39,258,259        19,102,009

Stockholder’;s equity:
  Common stock, $100 par value:
    Authorized, issued and outstanding shares—135,000                500,000           500,000
  Additional paid—in capital                                         399,511           347,450
  Donated capital                                                  8,713,454         8,614,603
     Retained earnings                                            27,637,013        38,327,945
Total stockholder‘s equity                                        37,249,978        47,789,998
Total liabilities and stockholder‘s equity                      $76,508,237       $ 66,892,007

See accompanying notes.

2


                          Lincoln Financial Advisors Corporation

                                  Statements of Income



                                                           Year ended December 31
                                                             2003            2002
Revenues:
  Commissions and fees                                   $ 177,771,046   $ 169,321,009
 Interest and dividends                                        693,299       1,099,895
Total revenues                                             178,464,345     170,420,904

Expenses:
  Commissions and agency expenses                           $3,943,299      79,602,774
  Service charges from affiliates                           18,012,507       4,252,642
  Salaries, wages and benefits                              10,011,478       9,109,364
  Licenses and fees                                            881,133         992,087
  Professional services                                      2,955,376       2,879,041
  Office expenses                                            1,362,905       1,246,296
  Other general and administrative expenses                  4,177,028       6,130,667
Total expenses                                             121,343,726     104,212.871
Income before income taxes                                  57,120,619      66,208,033
Income taxes                                                23,157,359      26,832,506
Net income                                               $ 33,963,260 $     39,375,527

See accompanying notes.


                          Lincoln Financial Advisors Corporation

                     Statements of Changes in Stockholder‘s Equity


                                                               Year ended December 31
                                                                 2003         2002

Common stock—
  balance at beginning and end of year                     $       500,000    $      500,000

Additionalpaid—in capital—
  Balance at beginning of year                                    347,450            125,000
  Nonqualified employee stock option tax benefit                         =—          222,450
  Executive stock option tax benefit                               52,061                  —
Balance at end of year                                            399,511            347,450

Donated capital:
 Balance at beginning of year                                    8$,614,603        11,348,917
  Additions, net of income taxes                                27,998,851         31,765,686
  Dividends paid                                               (27,900,000)       (34,500,000)
Balance at end of year                                           8,713,454          8,614,603

Retained earnings:
  Balance at beginning of year                                 38,327,945         34,698,226
  Net income                                                   33,963,260         39,375,527
  Minimum pension liability                                        945,808          (945,808)
  Comprehensive income                                          34,909,068         38,429,719
 Dividends paid                                                (45,600,000)       (34,800,000)
Balance at end of year                                         27,637,013         38,327,945
Stockholder‘s equity at end of year                        $ 37,249,978       $ 47,789,998


See accompanying notes.


                          Lincoln Financial Advisors Corporation

                                  Statements of Cash Flows

                                                                 Year ended December 31
                                                                   2003              2002
Operating activities
Net income                                                   $    33,963,260     $ 39,375,527
Adjustments to reconcile net income to net
  cash provided by operating activities:
    Deferred income tax expense (benefit)                            412,839          (82,630)
    Change in unrealized appreciation of common stock                 32,400                 —
    Depreciation                                                     114,673          154,337
    Changes in operating assets and liabilities:
      Receivables:
        Commission and fees                                        (2,538,087)      1,780,176
        Affiliates                                                (2,959,310)       3,151,731
      Other assets                                                   (124,591)        (34,958)
      Payable to affiliates                                       10,314,153       (5,482,955)
      Deferred revenue                                                688,811         (57,650)
      Payable to vendors                                                9,569           (9,901)
      Accrued commissions                                           1,200,950        (581,583)
      Accrued compensation and benefits                              (406,291)        148,142
     Breakpoint reserve                                             3,803,872                 —
     Other liabilities                                              5,490,994         996,981
Cash provided by operating activities                             50,003,242       39,357,217

Investing activities
Sale of mutual fund                                                         =         166,748
Purchase of leasehold improvements                                   (25,773)         (78,855)
Purchase of computer software                                       (241,162)        (272,024)
Cash used in investing activities                                   (266,935)        (184,131)

Financing activities
Donated capital                                                   27,998,851       31,765,686
Nonqualified employee stock option tax benefit                              =         222,450
Executive stock option tax benefit                                    52,061                 —
Dividends paid to stockholder from donated capital               (27,900,000)     (34,500,000)
Dividends paid to stockholder from retained earnings             (45,600,000)     (34,800,000)
Cash used in financing activities                                (45,449,088)     (37,311,864)

Increase in cash and cash equivalents                              4,287,219        1,861,222
Cash and cash equivalents at beginning of year                    50,194,770       48,333,548
Cash and cash equivalents at end of year                     $    54,481,989     $ 50,194,770

See accompanying notes.


                          Lincoln Financial Advisors Corporation

                               Notes to Financial Statements




1. Organization and Accounting Policies

Description of Business

Lincoln Financial Advisors Corporation ("LFA") is a registered broker—dealer and investment
advisor engaged principally in the distribution of securities, including certain mutual funds,
limited partnerships and individual issue equity and fixed income securities. LFA is licensed to
engage in broker—dealer and investment advisor activity throughout the United States. Effective
November 1, 2002, the ownership of 100% of the stock of LFA was transferred from Lincoln
Life and Annuity Distributors, Inc. ("LLAD®") to The Lincoln National Life Insurance Company
("LNL"), which is a wholly owned subsidiary of Lincoln National Corporation ("LNC").

The financial statements have been prepared in conformity with accounting principles generally
accepted in the United States. These financial statements comply with the requirements of the
Securities and Exchange Commission ("SEC") pertaining to the Financial and Operational
Combined Uniform Single ("FOCUS") Report.

Use of Estimates

The preparation of the financial statements of LFA requires management to make estimates and
assumptionsithat affect amounts reported in the financial statements and the accompanying notes.
Such estimates and assumptions could change in the future as more information becomes known,
which could|impact the amounts reported and disclosed herein.

Commission Revenue and Expense

Commission revenue for customers‘ securities transactions and related commission expenses are
recorded on ‘a settlement—date basis, which does not deviate materially from a trade—date basis.
Asset—based commissions and related commission expenses are recorded as earned based on a
contractual percentage of customer deposits. Wrap fee income, also referred to as assets under
management fee income, is received one quarter in arrears. An accrual is recorded for fee
income, and:a corresponding accrual is recorded for the commission expense to be paid on the
fee income. ;

Cash and Cash Equivalents

Cash and cash equivalents, which are carried at cost, include all highly liquid debt instruments
purchased with a maturity of three months or less and therefore, the recorded value approximates
fair value. Cash of $3,400,000 and $500,000 as of December 31, 2003 and 2002, respectively,
has been segregated in a special bank account for the benefit of customers under Rule 15c3—3 of
the Securities Exchange Act of 1934,. The increase in cash in the restricted account of
$2,900,000 in 2003 is for customers due Breakpoint refunds (see Note 5 "Breakpoint Reserves").

6


                          Lincoln Financial Advisors Corporation

                        Notes to Financial Statements (continued)




1. Organization and Accounting Policies (continued)

Investments in Common Stock

Investment in common stock is stated at fair value with unrealized appreciation (depreciation)
included in Interest and Dividends on the Statements of Income. Fair value is determined based
on quoted market prices of these securities. Cost of common stock at December 31, 2003 and
2002 is $83,100 and $124,100, respectively.

Income Taxes

LFA has elected to file consolidated federal and state income tax returns with LNL and LNC.
Pursuant to an intercompany tax sharing agreement with LNC, LFA provides for income taxes on
a separate return filing basis. The tax sharing agreement also provides that LFA will receive
benefit for net operating losses, capital losses and tax credits which may not be usable on a
separate return basis to the extent such items may be utilized in the consolidated income tax
returns of LNC.

Deferred Revenue

Cash received in advance for financial planning contracts is recorded as deferred revenue until
delivery of the financial plan to the respective customer.

Property and Equipment

All fixed assets, including furniture and fixtures, leasehold improvements data processing
equipment and computer software are carned on the basis of cost, and depreciation is computed
thereon based on the estimated service lives of the assets using the straight—line method.

Reclassification


Certain amounts in the 2002 financial statements have been reclassified to conform with the 2003
presentation. These reclassifications had no effect on shareholders‘ equity, net income or net
capital previously reported.


                           Lincoln Financial Advisors Corporation

                         Notes to Financial Statements (continued)




2. Donated Capital

LFA receives commissions and expense allowances ("Compensation") for sales of variable
insurance products by registered representatives of certain affiliated Companies. All of this
Compensation relates to variable annuity and variable life products manufactured by LNL. This
Compensation does not represent revenues to LFA as LFA provides essentially no services,
outside of ilicensing services for registered representatives, in support of these sales. LFA
receives this Compensation as variable insurance products Compensation which can only be paid
to, and recéived by, an entity registered as a broker—dealer with the National Association of
Securities Dealers (CNASD"). Because this Compensation does not represent revenues of LFA,
the amounts received, net of applicable income taxes, have been recorded as donated capital.
These transactions increased (decreased) donated capital as follows:

                                                                  Year ended December 31
                                                                       2003             2002

    Commissions and expense allowances                          $ 47,076,676     $ 50,809,798
    Federal income taxes                                          (15,076,307)     (17,104,600)
    State income taxes                                             (4,001,518)         (1,939,512)
                                                                $ 27,998,851     $ 31,765,686


3. Federal Income Taxes

Income tax expense consists of the following:

                                                                  Year ended December 31
                                                                       2003            2002

   Federal _                                                    $ 18,292,974     $ 21,207,553
   State                                    ‘                      4,864,385        5,624,953
   Total       _                                                $ 23,157,359     $ 26,832,506

Income tax expense differs from the Federal tax rate of 35% as a result state taxes.


                          Lincoln Financial Advisors Corporation

                         Notes to Financial Statements (continued)




3. Federal Income Taxes (continued)

Income taxes paid, including taxes paid on net additions to donated capital, amounted to
$42,796,865 in 2003 and $48,680,525 in 2002. Income tax expense includes a deferred tax
expense (benefit) of $412,839 and $(82,630) in 2003 and 2002, respectively. The deferred
income tax benefit consists principally of tax benefits associated with retirement benefit accruals.
Payable to affiliates includes federal income taxes (receivable) payable of $(2,322,166) and
$240,030 at December 31, 2003 and 2002, respectively.



4. Agreements and Transactions With Affiliates

Service charges are allocated to LFA by certain affiliates for corporate and administrative
services provided. Allocations include, but are not limited to, service charges related to human
resource administration, print and distribution and communication services. Total service charge
allocations were $3,979,799 and $4,252,642 in 2003 and 2002, respectively.

LFA receives Compensation, recorded as Commissions and fees revenue, on sales earned by its
registered representatives who are also agents of affiliated Lincoln agency companies. Since
these agency companies are not registered broker—dealers, they cannot receive this Compensation.
A portion of the Compensation received on this business is due to the efforts of these agency
companies and their agents, and LFA incurs no related expense. The expense allowances that
would otherwise have been paid to these affiliated agency companies if these companies were
registered broker—dealers, totaled $58,171,909 and $56,332,957 in 2003 and 2002, respectively.

Effective October 1, 2003, in order to be compliant with the NASD Notice to Members 03—63
regarding expense sharing agreements, and to better match expenses with related securities
revenue, LFA entered into a series of Master Services Agreements with its affiliated agency
companies.   In compliance with these agreements, LFA identified securities related expenses
historically paid and reported by affiliated Lincoln agency companies. These expenses include,
but are not limited to, officer compensation and benefits, compliance services and field office
occupancy and operations. These expenses are identified and charged to LFA on a monthly basis
by the affiliated agency companies. In 2003, LFA incurred $14,032,708 in expenses related to
these Master Services Agreements. They are reported in Service charges from affiliates on the
Statements of Income.


                          Lincoln Financial Advisors Corporation

                         Notes to Financial Statements (continued)




5. Breakpdint Reserve

In December 2002, NASD issued a Special Notice to Members ("Notice") which reminded
broker—dealers of their obligation to correctly apply breakpoint discounts to front—end sales load
mutual fund transactions. After issuing this Notice, the staffs of NASD, the SEC and the New
York Stock Exchange (NYSE) conducted examinations of broker—dealers to assess their ability to
deliver breakpoint discounts. A March 2003 report on those examinations states that most of the
43 broker—dealers examined failed to provide the appropriate breakpoint discount to customers in
a significant number of cases.

As a result of the above examinations, broker—dealers, including LFA, were directed to perform a
"self—assessment" in 2003 by NASD. As part of this self—assessment, LFA found that it did not
uniformlydeliver appropriate breakpoint discounts to its 2001 and 2002 Class A share mutual
fund investors. LFA has taken the necessary steps in 2003 to make appropriate refunds to its
eligible Class A mutual fund customers and properly account for overcharge liabilities as
instructed by NASD Notice to Members 03—47.

In December of 2003 and January 2004, 130,000 written notices were sent to potential refund
customers that, upon each response, LFA must research and promptly pay refunds if deemed
appropriate. A third—party consulting firm has been engaged by LFA to assist with the claim
refund admflnistration.   The breakpoint reserve liability at December 31, 2003 is $3,803,872,
which includes $2,867,572 for future claim refunds and $936,300 for administrative costs. LFA
has charged a total of $3,906,774 to expense in 2003 for anticipated customer refunds and the
associated costs of researching and administering these claims. LFA has segregated $2,900,000
needed to satisfy its breakpoint refund liability in a special reserve bank account for the exclusive
benefit of customers as required by SEC rule 15c—3—3.


6. Legal Matters

LFA is involved in various pending or threatened legal proceedings arising from the conduct of
business. In some instances, these proceedings include claims for unspecified or substantial
punitive damages and similar types of relief in addition to amounts for alleged contractual
liability or requests for equitable relief. The lawsuits allege a number of causes of action,
including (1); allegations that LFA registered representatives provided improper inducements to
persuade the, plaintiffs to undertake an unsuitable investment, (2) allegations by plaintiffs of
fraudulent misrepresentation associated with estate planning services and (3) allegations by a
former agent that LFA acted wrongfully to exclude him from participation in commissions.



10


                          Lincoln Financial Advisors Corporation

                         Notes to Financial Statements (continued)




6. Legal Matters (continued)

The ultimate outcome of these matters cannot presently be determined. However, in the opinion
of management, the ultimate disposition of pending litigation will not have a material adverse
effect on the Company‘s financial position, liquidity or results of operations. LFA intends to
vigorously defend the lawsuits and its position in arbitration cases.


7. Net Capital Requirements

LFA is subject to the Securities and Exchange Commussion Uniform Net Capital Rule ("Rule
15c3—1"), which requires the maintenance of minimum net capital and requires that the ratio of
aggregate indebtedness to net capital, both as defined by Rule 15c3—1 may not exceed 15 to 1.
Minimum net capital for LFA at December 31, 2003 was $2,617,217. At December 31, 2003,
LFA had net capital of $14,956,709, which was $12,339,491 in excess of its required net capital
of $2,617,217. LFA‘s net capital ratio was 2.63 to 1.



8. Subsequent Events

On January 2, 2004, LFA Management Corporation, a newly incorporated wholly owned
subsidiary of LFA, was capitalized by LFA with a $500,000 cash contribution.  LFA
Management Corporation was created to house various senior management personnel of LFA
who provide LFA with executive management services and corporate governance. LFA
Management Corporation and LFA have entered into a Master Services Agreement which
provides for a monthly management fee to be paid by LFA equal to LFA Management
Corporation‘s costs plus 1% of those costs. The service agreement between LFA and LFA
Management Corporation became effective January 1, 2004




                                                                                             11


SUPPLEMENTARY INFORMATION


                         Lincoln Financial Advisors Corporation

                                          Schedule I

                     Computation of Net Capital Under Rule 15c3—1
                       of the Securities and Exchange Commuission

                                    As of December 31, 2003


Net capital
Total stockholder‘s equity                                          37,249,978
Deduct total nonallowable assets and other deductions               22,293,269
Net capital                                                         14,956,709

Computation of aggregate indebtedness
Total aggregate indebtedness                                        39,258,259

Ratio: aggregate indebtedness to net capital                        262.5%

Computation of basic net capital requirement
Net capital requirement (greater of
  $250,000 or 6—2/3% of aggregate indebtedness)                      2,617,217

Excess net capital                                                  12,339,492

Excess net capital at 1,000%                                        11,030,883




                                                                             12


                          Lincoln Financial Advisors Corporation

                                            Schedule II

              Computation for Determination of Reserve Requirements
           Under Rule 15¢c3—3 of the Securities and Exchange Commission

                                     As of December 31, 2003



Credit balances
Free creditiand other credit balances                               $ 2,867,572
Total credit items                                                  $2,867,572

Debit balajnces
Secured customer debit balances
 Less 1% _                                                                    =
—Total debit items                                                  $         —

Excess of total credits over total debits                           $ 2,867,572
Required deposit                                                    $3,010,951




13


                          Lincoln Financial Advisors Corporation

                                          Schedule IH

              Information Relating to Possession or Control Requirements
            Under Rule 15¢c3—3 of the Securities and Exchange Commission

                                    As of December 31, 2003




Market valuation and number of items:


1. Customers‘ fully paid securities and excess margin securities not in
   LFA‘s possession or control as of December 31, 2003 (for which
   instructions to reduce to possession or control had been issued) but for
   which the required action was not taken by LFA within the
   time frames specified under Rule 15c3—3.

   A. Number of items.


2. Customers‘ fully paid securities and excess margin securities for which
   instructions to reduce to possession or control had not been issued as of
   December 31, 2003, excluding items arising from "temporary lags which
   result from normal business operations" as permitted under Rule 15c3—3.     $

   A. Number of items.




                                                                                   14


                        Lincoln Financial Advisors Corporation

                      Statement Pursuant to SEC Rule 17a—5(d)(4)

                                  As of December 31, 2003



There were no material differences between the Computation of Net Capital Pursuant to SEC
Rule 15c3—1 and the Computation for Determination of Reserve Requirements Pursuant to SEC
Rule 15c3—3 included in the accompanying supplementary information and the computation
included in| the LFA‘s corresponding unaudited Form X—17a—5, Part II filing as of December 31,
2003.




15          |                                                                              15


g.” ERNST& YOUNG                                          & Ernst & Young uur            & Phone: (260) 424—2233
                                                             National City Center          Fax:   (260) 425—4899
                                                             Suite 2300                    www.ey.com
                                                             110 West Berry Street
                                                             Fort Wayne, Indiana 46802




                  Report of Independent Auditors on Internal Accounting
                          Controls Required by SEC Rule 17a—5

  Board of Directors
  Lincoln Financial Advisors Corporation

  In planning and performing our audit of the financial statements and supplemental schedules of
  Lincoln Financial Advisors Corporation ("LFA") for the year ended December31l, 2003, we
  considered its internal control, including control activities for safeguarding securities, to
  determine our auditing procedures for the purpose of expressing our opinion on the financial
  statements and not to provide assurance on internal control.

  Also, as required by rule 17a—5(g)(1) of the Securities and Exchange Commission ("SEC"), we
  have made a study of the practices and procedures followed by LFA, including tests of such
  practices and procedures that we considered relevant to the criteria stated in rule 17a—5(g) in
  making the periodic computations of aggregate indebtedness and net capital under rule 17a—
  3(a)(11) and for determining compliance with the exemptive provisions of rule 15¢c3—3. Because
  LFA does not carry securities accounts for customers or perform custodial functions relating to
  customer securities, we did not review the practices and procedures followed by LFA in any of
  the following:

         1. Making quarterly securities examinations, counts, verifications and comparisons

         2. Recordation of differences required by rule 17a—13

         3. Complying with the requirements for prompt payment for securities under Section 8
            of Federal Reserve Regulation T of the Board of Governors of the Federal Reserve
            System

  The management of LFA is responsible for establishing and maintaining internal control and the
  practices and procedures referred to in the preceding paragraph. In fulfilling this responsibility,
  estimates and judgments by management are required to assess the expected benefits and related
  costs of internal controls and of the practices and procedures referred to in the preceding
  paragraph and to assess whether those practices and procedures can be expected to achieve the
  SEC‘s above—mentioned criteria. Two of the criteria of internal control and the practices and
  procedures are to provide management with reasonable, but not absolute assurance that assets for
  which LFA has responsibility are safeguarded against loss from unauthorized use or disposition,
  and that transactions are executed in accordance with management‘s authorization and recorded
  properly to permit the preparation of financial statements in accordance with accounting
  principles generally accepted in the United States. Rule 17a—5(g) lists additional criteria of the
  practices and procedures listed in the preceding paragraph.

                                  A Member Practice of Ernst & Young Global                                16


El FRNST& YOUNG                                       & Ermst & Young LLP

 Because of inherent limitations in any internal control or the practices and procedures referred to
 above, misstatements due to errors or fraud may occur and not be detected. Also, projections of
 any evaluation of internal control to future periods are subjectto the risk that internal control may
 become inadequate because of changes in conditions, or that the effectiveness of its design and
 operation may deteriorate.

 Our consideration of the internal control would not necessarily disclose all matters in internal
 control that might be material weaknesses under standards established by the American Institute
 of Certified Public Accountants. A material weakness is a condition in which the design or
 operation of one or more of the specific internal control components does not reduce to a
 relatively low level the risk that errors or fraud in amounts that would be material in relation to
 the financial statements being audited may occur and not be detected within a timely period by
 employees in the normal course of performing their assigned functions. However, we noted no
 matters involving internal control, including control activities for safeguarding securities, and its
 operation that we consider to be material weaknesses as defined above.

 We understand that practices and procedures that meet the criteria referred to in the second
 paragraph of this report are considered by the SEC to be adequate for its purposes in accordance
 with the Securities Exchange Act of 1934 and related regulations, and that practices and
 procedures that do not meet such criteria in all material respects indicate a material inadequacy
 for such purposes. Based on this understanding and on our study, we believe that LFA‘s
 practices and procedures were adequate at December 31, 2003 to meet the SEC‘s criteria.

 This report is intended solely for the information and use of the Board of Directors, management,
 the SEC and other regulatory agencies that rely on rule 17a—5(g) under the Securities Exchange
 Act of 1934 in their regulation of registered brokers and dealers, and is not intended to be and
 should not be used by anyone other than these specified parties.


                                                        favmat +                         LLP
 February 16, 2004




                                                                                                    17



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