UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

(Mark One)

   For the fiscal year ended March 31, 2003

or

   For the transition period from             to

Commission File No. 1-8529

LEGG MASON, INC.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code:  (410) 539-0000

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:  NONE

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).    Yes  x    No  ¨

As of September 30, 2002, the aggregate market value of the registrant’s voting stock, consisting of the registrant’s common stock and the exchangeable shares discussed below, held by non-affiliates was $2,571,640,000.

As of May 23, 2003, the number of shares outstanding of the registrant’s common stock was 65,069,442. In addition, on that date a subsidiary of the registrant had outstanding 2,256,745 exchangeable shares which are convertible on a one-for-one basis at any time into shares of common stock of the registrant.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s definitive proxy statement dated June 18, 2003 are incorporated by reference into Part III.

PART I

General

We are a holding company that, through our subsidiaries, is principally engaged in providing the following services to individuals, institutions, corporations, governments and government agencies:

We currently operate through four business segments: Asset Management, Private Client, Capital Markets and Other.

In our asset management business, we provide asset management services to institutional and individual clients and investment advisory services to company-sponsored investment funds. As of March 31, 2003, our subsidiaries had an aggregate of $192.2 billion of assets under management. We classify our asset management business into three groups: Mutual Funds, Institutional and Wealth Management.

In our Mutual Funds business, we sponsor domestic and international equity, fixed income and money market mutual and closed-end funds and other proprietary funds. We have two asset management subsidiaries that primarily focus on managing proprietary investment funds:

Our Institutional asset management subsidiaries provide a wide range of asset management services and products to domestic and international institutional clients. Our Institutional asset management subsidiaries are:

Our Wealth Management subsidiaries provide customized discretionary investment management services and products to high net worth individuals and families, endowments and foundations and institutions. Our Wealth Management subsidiaries are:

Our Private Client and Capital Markets business segment activities are primarily conducted through Legg Mason Wood Walker, Incorporated (“Legg Mason Wood Walker”), our principal broker-dealer subsidiary. Legg Mason Wood Walker is a full service broker-dealer, investment advisor and investment banking firm operating primarily in the Eastern and Southern regions of the United States.

Our Other business segment consists primarily of the operations of Legg Mason Real Estate Services, Inc., our real estate finance and mortgage banking subsidiary. Legg Mason Real Estate Services is primarily engaged in commercial mortgage banking and servicing and discretionary and non-discretionary management of commercial real estate-related assets.

See “Item 7. Management’s Discussion and Analysis of Results of Operations and Financial Condition—Fiscal 2003 Compared with Fiscal 2002—Results by Segment” for the net revenues and pre-tax earnings of each of our business segments. See Note 17 of Notes to Consolidated Financial Statements in Item 8 of this Report for the net revenues and pre-tax earnings generated by Legg Mason in each of the four principal geographic areas in which we conduct business.

Legg Mason, Inc. was incorporated in Maryland in 1981 to serve as a holding company for Legg Mason Wood Walker and other subsidiaries. The predecessor company to Legg Mason Wood Walker was formed in 1970 under the name Legg Mason & Co., Inc. to combine the operations of Legg & Co., a Maryland-based broker-dealer formed in 1899, and Mason & Company, Inc., a Virginia-based broker-dealer formed in 1962. Our subsequent growth has occurred through internal expansion as well as through the acquisition of asset management, broker-dealer and commercial mortgage banking firms.

Additional information about Legg Mason is available on our website at http://www.leggmason.com. We make available, free of charge, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and our proxy statements. Investors can find this information under the “Inside Legg Mason-About—Investor Relations” section of our website. These reports are available through our website as soon as reasonably practicable after we electronically file the material with, or furnish it to, the Securities and Exchange Commission. The information on our website is not incorporated by reference into this Report.

Unless the context otherwise requires, all references in this Report to “we,” “us,” “our” and “Legg Mason” include Legg Mason, Inc. and its predecessors and subsidiaries.

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Revenues by Source

This table shows certain information about our revenues by source.

LEGG MASON, INC. AND SUBSIDIARIES

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Asset Management Business Segment

Our Asset Management business segment provides asset management services to institutional and individual clients and investment advisory services to company-sponsored investment funds. Operating in offices primarily located in the United States, and also located in the United Kingdom, Canada and Singapore, our asset management subsidiaries provide a broad array of investment management products and services. Our investment products include proprietary mutual funds ranging from money market and fixed income funds to equity funds managed in a wide variety of investing styles, non-United States funds and numerous unregistered, alternative investment products.

As of March 31, 2003, our subsidiaries had an aggregate of $192.2 billion of assets under management, of which approximately 31% was in equity related products and approximately 69% was in fixed income related products. During the year ended March 31, 2003, our assets under management grew by 9%, primarily as a result of growth in assets managed by Western Asset Management Company and Western Asset Management Company Limited.

Our asset management business has had steady growth over the last ten years, both in absolute terms and in terms of the percentage of our revenues and profits that it generates. During that period, our assets under management have grown from $13.1 billion to $192.2 billion and our investment advisory and related fee revenues, which include distribution fees that are included in the Private Client business segment, have grown from $79.6 million to $860.3 million. This growth in our asset management business has occurred through both internal growth and strategic acquisitions of asset management businesses. It is our strategy to continue to grow the asset management business, both in absolute terms and as percentages of our total revenues and profits.

We conduct our asset management business primarily through 15 subsidiaries. Each of these subsidiaries generally focuses on a different aspect of the asset management business in terms of the types of assets managed (primarily equity or fixed income), the types of products and services offered, the investment styles utilized, the distribution channels used and the types and geographic locations of its clients. These subsidiaries are generally operated as individual businesses, in many cases with certain administrative functions being provided by the parent company and other affiliates, that market their products and services under their own brand names. Consistent with this approach, we have in place revenue sharing agreements with Legg Mason Funds Management, Legg Mason Capital Management, Royce & Associates, Western Asset Management Company and Western Asset Management Company Limited, Brandywine Asset Management, Batterymarch Financial Management, Private Capital Management, Bartlett & Co., Barrett Associates and Berkshire Asset Management and/or certain of their key officers. Pursuant to these revenue sharing agreements, a specified percentage of the subsidiary’s revenues is required to be distributed to us, and the balance of the revenues is retained to pay operating expenses, including salaries and bonuses, with specific expense and compensation allocations being determined, subject to our approval, by the subsidiary’s management.

We classify our asset management business into three groups: Mutual Funds, Institutional and Wealth Management. Mutual Funds encompasses the subsidiaries that are primarily engaged in providing investment advisory services to proprietary mutual and closed-end funds and the proprietary funds operations of our other asset managers. Our Institutional managers are subsidiaries that focus on providing asset management services for institutional clients. Our Wealth Managers are subsidiaries that focus on providing asset management services for high net worth individuals and family groups. There is overlap among the three groups of subsidiaries as many of our Institutional subsidiaries and Wealth Managers also manage mutual funds that are included in Mutual Funds and each subsidiary may provide asset management services to other types of clients. These groups are described in more detail below.

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Our assets under management mix is as follows: Mutual Funds—$35.9 billion, Institutional—$136.8 billion and Wealth Management—$19.5 billion. Mutual Funds includes all assets in our proprietary investment funds and all separate accounts managed by our Mutual Funds subsidiaries. Institutional includes all non-proprietary investment fund assets managed by our Institutional managers. Wealth Management includes all non-proprietary investment fund assets managed by our Wealth Managers. In addition, assets managed by other subsidiaries that are not part of our Asset Management business segment are included in Institutional or Wealth Management as appropriate.

For the fiscal years ended March 31, 2003, 2002 and 2001, our Asset Management segment produced net revenues of $648.1 million, $557.9 million and $445.0 million, respectively. Our net revenues by group within Asset Management for the fiscal year ended March 31, 2003 was as follows: Mutual Funds—$200.0 million; Institutional—$328.1 million and Wealth Management—$120.0 million. In reporting our net revenues by Asset Management group, we include in each group all revenues of the subsidiaries within the group, including revenues earned for providing investment advisory services to proprietary funds. Revenues for the Mutual Funds group also include revenues for certain administrative, marketing, sales and distribution services (excluding those distribution and service fee revenues that are included in our Private Client business segment) provided to proprietary retail mutual funds. Revenues for the Institutional group also include revenues for certain administrative, marketing, sales and distribution services provided to proprietary institutional mutual funds and offshore funds.

Mutual Funds

In our Mutual Funds group, we sponsor domestic and international equity, fixed income and money market mutual funds, closed-end funds and other proprietary funds. Our mutual funds business primarily consists of two families of proprietary mutual and closed-end funds, the Legg Mason Funds and the Royce Funds. The Legg Mason Funds are 21 separate mutual funds that invest in a wide range of domestic and international equity and fixed income securities utilizing a number of different investment styles. The Royce Funds are 14 mutual funds and three closed-end funds that invest primarily in small-cap domestic company stocks using a value investment approach. Of our $35.9 billion in Mutual Funds assets as of March 31, 2003, $24.2 billion were in these two proprietary fund families.

The Legg Mason Funds consist of 21 separate mutual funds. Of these funds, three are money market funds, seven invest primarily in taxable or tax-free fixed income securities, nine invest primarily in domestic equity securities and two invest primarily in international equity securities. Investment objectives for the Legg Mason Funds range from capital appreciation to current income. Equity investment strategies may emphasize large-cap, mid-cap or small-cap investing. The largest of the Legg Mason Funds is Legg Mason Value Trust, Inc., which has received recognition for its investment performance over the last twelve calendar years.

Legg Mason Funds Management, Inc. is the primary equity investment advisor to the Legg Mason Funds. Legg Mason Funds Management serves as investment advisor to four of the equity funds in the Legg Mason Funds family, including Legg Mason Value Trust, Inc. Legg Mason Funds Management also subadvises the mutual fund managed by the joint venture described below and investment products sponsored by Perigee and Legg Mason Investments. Legg Mason Funds Management’s investment process uses a variety of qualitative and quantitative techniques to develop an estimate of the worth of a business over the long term. The objective is to identify companies where the value of the business is significantly higher than the current stock price. With one of our employees, we own 50% of a joint venture that serves as investment manager of one equity fund, Legg Mason Opportunity Trust, within the Legg Mason Funds family.

In addition to Legg Mason Funds Management and the joint venture, a number of our other subsidiaries manage Legg Mason Funds. Western Asset Management Company is investment advisor to four taxable fixed income funds and two taxable money market funds; Legg Mason Trust, fsb serves as investment advisor to three tax-exempt fixed income funds and one tax-exempt money market

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fund; Batterymarch Financial Management serves as investment advisor to two international funds; Brandywine Asset Management serves as investment advisor to two equity funds; and Bartlett & Co. and Barrett Associates (since May 1, 2003) each serve as investment advisor to one equity fund.

The Royce Funds consist of 14 mutual funds and three closed-end funds that invest primarily in small-cap domestic company stocks. The investment objective of each of these funds is long-term appreciation of capital using a value approach. The funds differ in their approaches to investing in small or micro-cap companies and the universe of securities from which they can select. Further, two of the funds are used as funding vehicles for insurance products.

Royce & Associates, LLC is investment advisor to all of the Royce Funds. In addition, Royce & Associates also manages other accounts that invest primarily in small-cap domestic company stocks, using a value approach. Royce & Associates’ stock selection process seeks to identify companies with strong balance sheets and the ability to generate free cash flow. Royce & Associates pursues securities that are priced below their estimate of current worth. We acquired Royce & Associates in October 2001.

Our proprietary mutual funds are distributed through a number of channels. Legg Mason Wood Walker is the principal underwriter for the Legg Mason Funds. The Legg Mason Funds are primarily distributed to retail investors through our Private Client Group financial advisors and through our funds marketing departments. The Royce Funds are primarily distributed through non-affiliated funds supermarkets, non-affiliated wrap programs, direct distribution and our Private Client Group financial advisors. In addition, two of the portfolios in the Royce Funds are distributed only through insurance companies. For the fiscal years ended March 31, 2003, 2002 and 2001, we received from our proprietary mutual funds and offshore investment funds approximately $137.0 million, $160.0 million, and $170.3 million, respectively, in asset-based distribution and service fees, of which $112.7 million, $132.5 million and $141.1 million, respectively, are included in the Private Client business segment.

Our Mutual Funds group also includes the Western Asset Funds, a proprietary family of mutual funds that are marketed primarily to institutional investors. Western Asset Management Company sponsors these funds and manages them using a team approach under the supervision of Western Asset’s investment committee. The funds primarily invest in fixed income securities. Western Asset also manages two closed-end funds. The Western Asset Funds, and the institutional and financial intermediary classes of the Legg Mason Funds, are marketed to institutional investors primarily through our institutional funds marketing department.

Our Mutual Funds group also includes five groups of proprietary funds that are sponsored and managed by our Institutional managers, Mutual Funds managers and Private Capital Management and are offered and sold only outside the U.S. to non-U.S. persons. The Legg Mason Global Offshore Funds, a family of 12 Netherlands Antilles domiciled funds, are managed by Western Asset, Legg Mason Funds Management, Private Capital Management and Batterymarch Financial Management. Domiciled in Ireland, the Legg Mason Global Fund plc, is a family of five funds managed by Western Asset, Legg Mason Funds Management, Legg Mason Investments and Royce & Associates that are primarily offered to investors in Europe. The Legg Mason Worldwide family of funds includes two funds domiciled in Luxembourg that are managed by Batterymarch Financial Management. Perigee manages a group of 17 funds that are sold in Canada. Finally, Legg Mason Investments manages 8 unit trusts in the United Kingdom.

Institutional

Our Institutional managers provide a wide range of asset management services and products to domestic and international institutional clients. These subsidiaries manage a range of domestic, international and global equity, balanced, fixed income and cash management portfolios for their institutional clients. Our domestic and international institutional clients include pension and other

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retirement funds, corporations, insurance companies, endowments and foundations and governments. Our seven Institutional asset management subsidiaries are described below.

As of March 31, 2003 and 2002, our Institutional asset management subsidiaries managed assets with a value of $135.8 billion and $118.5 billion, respectively (excluding assets with a value of $13.2 billion and $12.0 billion, respectively, in proprietary funds managed by these subsidiaries). These amounts also exclude $1.0 billion and $0.8 billion, respectively, of institutional assets managed by subsidiaries, primarily Legg Mason Real Estate Services, outside of our Asset Management business segment. Over 80% of the assets managed by our Institutional managers are in fixed income assets managed by Western Asset and Western Asset Limited. The growth in assets managed by our Institutional subsidiaries during the fiscal year primarily resulted from growth in fixed income accounts managed by Western Asset and Western Asset Limited, supplemented by growth in assets at Batterymarch, and partially offset by declines in assets managed by our other Institutional subsidiaries.

Western Asset Management Company is a leading fixed income asset manager for institutional clients. Among the services Western Asset provides are management of separate accounts and management of mutual funds, closed-end funds and other structured investment products. Based in Pasadena, California, Western Asset offers over 30 fixed income asset management products, including its “core” and “core plus” products. Western Asset targets four key areas in managing fixed income portfolios—sector allocation, issue selection, duration exposure and term structure weighting. For global portfolios, country/currency allocation is a fifth key area.

Western Asset Management Company Limited contains the United Kingdom operations of Western Asset Management Company. Based in London, Western Asset Limited manages non-United States dollar currency and fixed income assets for many of the international clients of Western Asset.

Perigee Investment Counsel Inc. is an institutional investment manager in Canada. The types of clients for whom Perigee provides investment management services include: pension plans for public and private sector entities, managed on both a separate account and pooled basis; third party mutual funds; government sponsored funds; insurance companies; trusts and foundations; and individual investors, whose portfolios are managed separately or on a pooled basis. Perigee offers products managed in a number of different equity and fixed income investment styles.

Brandywine Asset Management, LLC manages equity portfolios for institutional and, through wrap accounts, high net worth individual clients and manages global and international fixed income accounts for institutional clients. Brandywine, based in Wilmington, Delaware, pursues one equity investment approach—value investing—and is known for its “classic” or “deep” value equity management style.

Batterymarch Financial Management, Inc. manages U.S., international and emerging markets equity portfolios for institutional clients. Based in Boston, Massachusetts, Batterymarch primarily uses a quantitative approach to asset management. The firm’s investment process for U.S. and international portfolios is designed to enhance the fundamental investment disciplines by using quantitative tools to process fundamental data.

Legg Mason Capital Management, Inc. manages equity portfolios primarily for institutional accounts. Legg Mason Capital Management and Legg Mason Funds Management are generally operated as a single business, and Legg Mason Capital Management manages client portfolios using the same management style and approaches that are used by Legg Mason Funds Management to manage its proprietary funds.

Legg Mason Investments Holdings Limited primarily manages, for investors in the United Kingdom, unit and investment trusts, which are similar to open and closed-end funds in the United States, and has increasingly focused on distribution of asset management products rather than management

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of assets. Legg Mason Investments utilizes a team-oriented, research-driven approach to investment management and generally employs a growth investment style.

Wealth Management

Our Wealth Managers provide customized discretionary investment management services and products to high net worth individuals and families, endowments and foundations and institutions. Our Wealth Managers seek to provide portfolio management, client service and other financial services in a disciplined manner that is tailored to meet our clients’ particular needs and objectives. This group includes five asset management subsidiaries, our trust company subsidiary and a joint venture, all of which are described in more detail below.

As of March 31, 2003 and 2002, our Wealth Management subsidiaries managed assets with a value of $17.0 billion and $17.6 billion, respectively (excluding assets with a value of $0.9 billion on each date in proprietary funds managed by these subsidiaries). These amounts also exclude $2.5 billion and $2.8 billion, respectively, of wealth management assets managed by subsidiaries outside of our Asset Management business segment. A majority of the assets managed by our Wealth Managers are managed by Private Capital Management. The growth in assets under management by Private Capital Management during the fiscal year was offset by declines in assets managed by most of the other subsidiaries in this group.

Private Capital Management, L.P. manages equity assets for high net worth individuals and families, institutions, endowments and foundations in separate accounts and limited partnerships. Based in Naples, Florida, Private Capital Management’s value-focused investment philosophy is based on an analysis of a company’s free cash flow. In executing this philosophy, Private Capital Management seeks to build a portfolio consisting primarily of securities of mid-cap companies that possess several basic elements, including significant free cash flow, a substantial resource base, and a management team with the ability to correct problems that Private Capital Management believes have been excessively or inappropriately discounted by the public markets. We acquired Private Capital Management in August 2001.

Bartlett & Co. manages balanced, equity and fixed income portfolios for high net worth individual and institutional clients and follows a value investment philosophy. Bartlett operates out of offices in Cincinnati, Ohio and Indianapolis, Indiana. Bartlett’s research and stock selection criteria emphasize a variety of fundamental factors, and they seek to invest in companies that generally possess some combination of the following characteristics: financial strength, potential for growth of earnings and dividends, attractive profitability characteristics, sustainable competitive advantage, and shareholder-oriented management.

Barrett Associates, Inc., (82% owned as of March 31, 2003), is an equity asset manager for high net worth individuals and family groups, endowments and foundations. Based in New York, New York, Barrett Associates’ focus is to build wealth for their clients through the selection of stocks of high quality companies. Barrett delivers services through separately managed portfolios for individuals and institutions as well as through their proprietary mutual fund, the Barrett Growth Fund. In May 2003, the business and operations of another Wealth Management subsidiary, Gray Seifert & Co., Inc., were transferred to Barrett to reduce costs, where they operate as the Seifert Group within Barrett.

Berkshire Asset Management, Inc. provides equity, balanced, and intermediate duration high quality fixed income asset management services to individuals and institutions through separate accounts and limited partnerships. Based in Wilkes-Barre, Pennsylvania, Berkshire seeks to invest in high quality businesses that are selling at prices below Berkshire’s estimate of intrinsic value.

Legg Mason Focus Capital, Inc. primarily serves equity investors and features three products: Focus Global Equity, Whole Market Equity and Core Equity Income Plus. Focus Capital

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believes that the market reflects all available public information, and that active management adds value to an index over time by distinguishing information which is reflected accurately from that which is distorted.

Legg Mason Trust, fsb is a federally chartered unitary thrift institution with authority to exercise trust powers. Legg Mason Trust provides services as a trustee for trusts established by our individual and employee benefit plan clients and manages fixed income and equity assets. Through various subsidiaries, Legg Mason provides brokerage and asset management services for a significant portion of the assets held in Legg Mason Trust’s accounts.

Bingham Legg Advisers LLC is a joint venture that is equally owned by Legg Mason and Bingham McCutchen LLP, a Boston-based law firm. Because Bingham Legg is a joint venture, we do not include the assets it manages within our assets under management. Bingham Legg limits its focus to clients with a minimum of $1 million to invest and then seeks to provide them a high level of personal service.

Each Wealth Management subsidiary retains its own investment style and regional operations, seeking to generate ongoing growth in its core business through direct new business efforts in its market. In addition to these core efforts, we offer a wealth management program, directAdvantage,^SM which is designed to provide our Private Client Group financial advisors with a single platform through which they can deliver the full range of our wealth management investment advisory services to our brokerage clients. The directAdvantage initiative is a fee-based program enabling brokerage clients to pay a single, asset-based fee and receive custody, recordkeeping, consolidated reporting, transaction execution, and investment advisory services.

Private Client Business Segment

Our Private Client business segment distributes a wide range of financial products through its branch distribution network, including equity and fixed income securities, proprietary and non-affiliated mutual funds and annuities. This business segment is conducted primarily through Legg Mason Wood Walker.

Private Client Securities Business

For the fiscal years ended March 31, 2003, 2002 and 2001, our revenues derived from securities transactions for individual investors (excluding interest on margin accounts) constituted approximately 64%, 66% and 78%, respectively, of our total revenues from securities transactions and 22%, 24% and 29%, respectively, of our net revenues. Despite a significant decline in the percentage of revenues contributed by our Private Client securities business as a result of difficult market conditions and an increase in Asset Management revenues, we believe that this business will continue to be a significant source of our revenues in the foreseeable future, although the percentage of net revenues it provides may continue to decrease primarily as a result of increases in Asset Management revenues. We charge retail commissions on both exchange and over-the-counter (“OTC”) transactions in accordance with an internal schedule. We grant discounts from the schedule in certain cases. When we execute OTC transactions with an individual client, we allocate commissions to Private Client which are included in the Revenues by Source table as Principal Transactions. We also offer account arrangements under which a single fee is charged based on a percentage of the assets held in a customer’s account and no charge is imposed on a transaction-by-transaction basis. This single fee covers all execution and advisory services, including advisory services provided by our asset management subsidiaries and selected independent advisory firms. In addition, we provide asset allocation and advisor performance and selection consultation services. We have entered into dealer-sales agreements with a number of major distributors that offer mutual fund shares through broker-dealers. We also sell shares of our proprietary mutual funds though our retail sales network. See “Asset Management Business Segment—Mutual Funds.”

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Brokerage Offices

This table shows, as of March 31, 2003, information with respect to our retail securities brokerage offices.

Margin Accounts, Interest Income and Free Credit Balances

We effect customers’ securities transactions on either a cash or margin basis. In a cash transaction, the customer pays the price for the securities in cash. In a margin transaction, the customer pays less than the full cost of the securities purchased and borrows the balance of the purchase price from us. The loan is secured by the securities purchased or other securities owned by the customer. The amount of the loan is subject to the margin regulations (Regulation T) of the Board of Governors of the Federal Reserve System, New York Stock Exchange, Inc. (“NYSE”) margin requirements and our internal policies. In some instances, our internal policies are more stringent than Regulation T or NYSE requirements. In permitting a customer to purchase securities on margin, we are subject to the risks that a market decline could reduce the value of our collateral below the amount of the customer’s indebtedness and that the customer might be unable otherwise to repay the indebtedness.

We charge interest on amounts borrowed by customers (debit balances) to finance their margin transactions. The rate of interest we charge is the prime rate plus or minus an additional amount

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that varies depending upon the amount of the customer’s average debit balance. Interest revenue derived from these sources constituted approximately 2%, 4% and 8%, of our net revenues for the 2003, 2002 and 2001 fiscal years, respectively. We also earn interest on securities we own and on operating and segregated cash balances.

We finance customers’ margin account borrowings primarily through free credit balances (excess funds held by customers in their brokerage accounts). We pay interest on free credit balances in Legg Mason Wood Walker customers’ accounts when the funds will be used for reinvestment at a future date. In fiscal year 2003, we paid interest on approximately 95% of Legg Mason Wood Walker’s retail customer free credit balances.

Insurance Brokerage and Financial Planning

Substantially all of our financial advisors are licensed to sell insurance. Our subsidiary, Legg Mason Financial Services, Inc., acts as general agent for several life insurance companies and sells fixed and variable annuities and insurance. We also offer, through Legg Mason Wood Walker, financial planning services to individuals. See “Revenues by Source” for information regarding revenues generated by insurance brokerage activities.

Other Services

At March 31, 2003, Legg Mason Wood Walker served as a non-bank custodian for approximately 378,000 IRAs, 29,000 Simplified Employee Pension Plans and 12,000 Qualified Plans.

Registrations and Exchange Memberships

Legg Mason Wood Walker is registered as a broker-dealer with the Securities and Exchange Commission (“SEC”), is a member of the NYSE, the National Association of Securities Dealers, Inc. (“NASD”), the American Stock Exchange (“AMEX”) and the Securities Investors Protection Corporation (“SIPC”), and is registered as a futures commission merchant with the Commodity Futures Trading Commission. In addition, Legg Mason Wood Walker is a member of the Philadelphia, Boston and Chicago stock exchanges.

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Capital Markets Business Segment

Our Capital Markets business segment is conducted primarily through Legg Mason Wood Walker. This segment consists of our:

Institutional Sales

In our institutional sales business, we execute equity and fixed income securities transactions for institutional investors such as banks, mutual funds, insurance companies and pension and profit-sharing plans. These investors typically purchase and sell securities in large quantities that require special marketing and trading expertise. We believe that we receive a significant portion of our institutional brokerage commissions as a consequence of providing research opinions and services regarding specific corporations and industries and other matters affecting the securities markets. See “Research.”

We execute transactions for institutional investors as a broker or as a principal. We generally offer discounts from our commission schedule to our institutional customers. The size of these discounts varies with the size of particular transactions and other factors. For the fiscal years ended March 31, 2003, 2002 and 2001, the revenues we derived from securities transactions for institutional investors constituted approximately 36%, 34% and 22%, respectively, of our total revenues from securities transactions and 13%, 12% and 8% of our net revenues.

Trading

We are a market maker in equity securities that are traded on the Nasdaq Stock Market. As of March 31, 2003, we made markets in equity securities of approximately 276 corporations, including corporations for which we have acted as a managing or co-managing underwriter. We also are an active market maker and distributor of municipal bonds, particularly bonds issued by municipalities located in the Mid-Atlantic and Southern regions.

Our trading activities are also conducted with other dealers, and with institutional and individual customers of our branch office system. We designate an amount from trading activities representing a commission to the Private Client business segment when the transaction involves a retail client. In trading equity and debt securities, we maintain positions in the securities to service our customers and accordingly expose our capital to the risk of fluctuations in market value. We realize profits and losses from market fluctuations in these securities, although we generally seek to avoid substantial market risk, and may engage in hedging transactions to reduce risk. Trading profits (or losses) depend upon the skills of the employees engaged in trading activities, the amount of capital allocated to positions in securities and the general level of activity and trend of prices in the securities markets.

Among our traders, 49 are involved in trading corporate equity and debt securities, 18 are involved in trading municipal securities, 7 are involved in trading mortgage-backed securities, and 6 are involved in trading government securities.

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Investment Banking

Corporate and Municipal Finance

For the fiscal years ended March 31, 2003, 2002 and 2001, the revenues we derived from investment banking activities constituted approximately 7%, 7% and 5%, respectively, of our net revenues. At March 31, 2003, we had 109 professionals engaged in investment banking activities, including 75 in corporate finance and 34 in municipal finance.

We participate as an underwriter in public offerings of corporate debt and equity issues and municipal securities. We also manage or co-manage some of these offerings.

The following tables show, for the periods indicated, (i) the total number and dollar amount of corporate stock and bond and municipal bond offerings we managed or co-managed, and (ii) the total number and dollar amount of our underwriting participations in both those offerings and offerings managed by others.

Underwriting involves both economic and litigation risks. An underwriter may incur losses if it is unable to resell the securities it is committed to purchase, or if it is forced to liquidate its commitments at less than the agreed purchase price. In addition, an underwriter is subject to substantial potential liability for material misstatements or omissions in prospectuses and other communications with respect to underwritten offerings. See “Item 3. Legal Proceedings.” Furthermore, because underwriting commitments require a charge against net capital, we could find it necessary to limit our underwriting participations to remain in compliance with regulatory net capital requirements. See “Net Capital Requirements.”

Other Investment Banking Activities

Our investment banking activities also include debt and equity private placements and advice with respect to merger and acquisition transactions, and provision of financial advisory services to corporate and municipal clients.

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Syndicate

Our corporate syndicate department performs underwriting and marketing for initial public offerings of debt and equity (common and preferred), secondary public offerings of companies whose securities are already traded, and public offerings of closed-end funds.

Merchant Banking

Legg Mason Merchant Banking, Inc. manages and sponsors private equity funds. As of March 31, 2003, Legg Mason Merchant Banking, Inc. managed Legg Mason Capital Partners, L.P., a $41 million private equity fund formed in September 1996, Legg Mason Capital Partners II, L.P., a $100 million private equity fund formed in February 2000, and Legg Mason Mezzanine Fund, L.P., a $75 million private mezzanine debt fund formed in February 2003.

Other Business Segment

Our Other businesses are principally our real estate service and mortgage banking business and unallocated corporate revenues and expenses. The real estate service and mortgage banking business is conducted through Legg Mason Real Estate Services, Inc. (“LMRES”).

Real Estate Services

LMRES is engaged in the commercial mortgage banking business. The firm originates, structures, places and services commercial mortgages on income-producing properties for insurance companies, pension funds and other investors. LMRES is also engaged in the business of discretionary and non-discretionary management of commercial real estate-related assets for institutional clients. In addition, LMRES provides real estate consulting services, specializing in sports arena and facility feasibility, analysis and financing, as well as in providing corporate real estate services and equity sales. LMRES’ headquarters are located in Philadelphia, Pennsylvania, and it has offices located in the Mid-Atlantic and Southeastern regions of the United States.

As of March 31, 2003 and 2002, the commercial mortgage servicing portfolio of LMRES was $9.1 billion and $8.6 billion, respectively.

Research

Legg Mason Wood Walker employs 50 equity analysts who develop investment recommendations and market information with respect to companies and industries. Legg Mason Wood Walker’s research has focused on the identification of securities of financially sound, well-managed companies that appear to be undervalued in relation to their long-term earning power or the value of their underlying assets. Our equity research also focuses on companies in certain business sectors, including:

These research services are supplemented by research services purchased from outside firms.

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Our clients do not pay for research services directly, although we are often compensated for our research services by institutional clients through the direction of brokerage transactions to Legg Mason Wood Walker for execution. We believe that our research activities are important in attracting and retaining institutional and individual brokerage clients.

Securities Brokerage Operations

Our Securities Brokerage Operations personnel are responsible for the processing of securities transactions; receipt, identification and delivery of funds and securities; internal financial controls; office services; custody of customers’ securities; and the handling of margin accounts. At March 31, 2003, we had approximately 270 full-time employees performing these functions.

There is considerable fluctuation during any year and from year to year in the volume of transactions we must process. We record transactions and post our books on a daily basis. Our operations personnel monitor day-to-day operations to determine compliance with applicable laws, rules and regulations. Any failure to keep current and accurate books and records can render Legg Mason Wood Walker subject to disciplinary action by governmental and self-regulatory authorities, as well as to claims by its clients.

Legg Mason Wood Walker executes and clears securities transactions as a member of the NYSE and various regional exchanges, and is a participant in both The Depository Trust Company and National Securities Clearing Corporation. Legg Mason Wood Walker also provides clearing services to affiliated and unaffiliated broker-dealers.

We believe that our internal controls and safeguards are adequate, although fraud and misconduct by customers and employees and the possibility of theft of securities are risks inherent in the financial services industry. As required by the NYSE and certain other authorities, we carry a fidelity bond covering loss, theft, embezzlement or misplacement of securities, and forgery of checks and drafts.

Employees

At March 31, 2003, we had approximately 5,290 employees. None of our employees is covered by a collective bargaining agreement. We consider our relations with our employees to be satisfactory. However, competition for experienced financial services personnel, especially financial advisors and investment management professionals, is intense and from time to time we may experience a loss of valuable personnel.

We recognize the importance to our Private Client business of hiring and training financial advisors. We train new financial advisors who are required to take examinations recognized by the NYSE, the NASD and various states in order to be registered and qualified, and maintain ongoing training for financial advisors.

Competition

We are engaged in an extremely competitive business. Our competition includes, with respect to one or more aspects of our business, numerous national, regional and local asset management firms and broker-dealers, and commercial banks and thrift institutions. Many of these organizations have substantially more personnel and greater financial resources than we have. Discount brokerage firms oriented to the individual investor market, including firms affiliated with banks and mutual fund organizations and on-line brokerage firms, have devoted substantial funds to advertising and direct solicitation of customers in order to increase their share of commission dollars and other securities-related income. In many instances, we are competing directly with these organizations. We also compete for investment funds with banks, insurance companies and investment companies. The principal competitive

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factors relating to our business are the quality of advice and services provided to investors and the price of those services.

Competition in our business periodically has been affected by significant developments in the financial services industry. See “Factors Affecting the Company and the Financial Services Industry—Industry Changes and Competitive Factors.”

Regulation

The financial services industry in the United States is subject to extensive regulation under both Federal and state laws. The SEC is the Federal agency charged with administration of the Federal securities laws. Financial services firms are also subject to regulation by securities exchanges, other self-regulatory authorities and state securities commissions in those states in which they conduct business. In addition, financial services firms are subject to regulation by various foreign governments, securities exchanges, central banks and regulatory bodies, particularly in those countries where they have established offices.

Our asset managers and proprietary mutual funds are subject to extensive regulation. Our U.S. asset managers are registered as investment advisors with the SEC and are also required to make notice filings in certain states. Virtually all aspects of the asset management business are subject to various federal and state laws and regulations. These laws and regulations are primarily intended to benefit the asset management clients and generally grant supervisory agencies and bodies broad administrative powers, including the power to limit or restrict an investment advisor from conducting its asset management business in the event that it fails to comply with such laws and regulations. Possible sanctions that may be imposed for a failure include the suspension of individual employees, limitations on the asset managers engaging in the asset management business for specified periods of time, the revocation of registrations, other censures and fines. A regulatory proceeding, regardless of whether it results in a sanction, can require substantial expenditures and can have an adverse effect on the reputation of an asset manager.

Broker-dealers are subject to regulations that cover all aspects of the securities business, including:

Additional legislation, changes in rules promulgated by the SEC and self-regulatory authorities, or changes in the interpretation or enforcement of existing laws and rules, may directly affect the mode of operation and profitability of broker-dealers. Much of the regulation of broker-dealers has been delegated to self-regulatory authorities, principally the NASD and the securities exchanges. These self-regulatory organizations conduct periodic examinations of member broker-dealers in accordance with rules they have adopted and amended from time to time, subject to approval by the SEC. The SEC, self-regulatory authorities and state securities commissions may conduct administrative proceedings that can result in censure, fine, suspension or expulsion of a broker-dealer, its officers or employees. These administrative proceedings, whether or not resulting in adverse findings, can require substantial expenditures and can have an adverse impact on the reputation of a broker-dealer. The principal purpose of regulation and

discipline of broker-dealers is the protection of customers and the securities markets, rather than protection of creditors and stockholders of the regulated entity.

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Our broker-dealer subsidiaries are required by Federal law to belong to the SIPC. When the SIPC fund falls below a certain amount, members are required to pay annual assessments of up to 1% of adjusted gross revenues, as defined. As a result of adequate fund levels, each of our broker-dealer subsidiaries was required to pay the minimum annual assessment of $150 in fiscal year 2003. The SIPC fund provides protection for securities held in customer accounts up to $500,000 per customer, with a limitation of $100,000 on claims for cash balances.

Net Capital Requirements

Every registered broker-dealer is subject to the Uniform Net Capital Rule (“Rule 15c3-1”) promulgated by the SEC. Rule 15c3-1, which is designed to measure the financial soundness and liquidity of broker-dealers, specifies minimum net capital requirements. Since Legg Mason, Inc. is not itself a registered broker-dealer, it is not directly subject to Rule 15c3-1. However, our broker-dealer subsidiaries are subject to Rule 15c3-1, and a provision of Rule 15c3-1 requires that a broker-dealer notify the SEC prior to the withdrawal of equity capital by a parent company if the withdrawal would exceed the greater of $500,000 or 30 percent of the broker-dealer’s excess net capital.

Rule 15c3-1 provides that a broker-dealer doing business with the public shall not permit its aggregate indebtedness to exceed 15 times its net capital or, alternatively, that it not permit its net capital to be less than 2% of its aggregate debit items (primarily receivables from customers and broker-dealers) computed in accordance with Rule 15c3-3. As of March 31, 2003, our broker-dealer subsidiaries had aggregate net capital of $363.4 million, which exceeded the minimum net capital requirements by $342.8 million.

Under NYSE Rule 326, Legg Mason Wood Walker, as a member organization that carries customer accounts, would be required to reduce its business activities if its net capital, as defined, was less than 4% of aggregate debit items, as defined, and would be precluded from expanding its business if its net capital was less than 5% of aggregate debit items. As of March 31, 2003, Legg Mason Wood Walker’s net capital was 36% of its aggregate debit items.

Compliance with applicable net capital rules could limit the operations of our broker-dealer subsidiaries, particularly operations such as underwriting and trading activities that require use of significant amounts of capital. A significant operating loss or an extraordinary charge against net capital could adversely affect the ability of our broker-dealers to expand or even maintain their present levels of business. See Note 16 of Notes to Consolidated Financial Statements in Item 8 of this Report.

Factors Affecting the Company and the Financial Services Industry

The financial services industry is characterized by frequent changes, the effects of which have been difficult to predict. In addition to an evolving regulatory environment, the industry has been subject to radical changes in pricing structure, alternating periods of contraction and expansion and intense competition from within and outside the industry.

Importance of Investment Performance

We believe that investment performance is one of the most important factors for the growth of assets under management for a company in the asset management business like us. Poor investment performance could impair the revenues and growth of a company like ours because:

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If our revenues decline without a commensurate reduction in our expenses, our net income will be reduced. If our revenues decline at an asset management subsidiary with a revenue sharing agreement, our net income from that subsidiary will be reduced.

Assets Under Management May Be Withdrawn

Investment advisory and administrative contracts are generally terminable at will or upon relatively short notice, and mutual fund investors may redeem their investments in the funds at any time without prior notice. Institutional and individual clients can terminate their relationships with an asset manager, reduce the aggregate amount of assets under management, or shift their funds to other types of accounts with different rate structures for any number of reasons, including investment performance, changes in prevailing interest rates, loss of key investment management personnel and financial market performance. In a declining stock market, the pace of mutual fund redemptions and withdrawal of assets from other accounts could accelerate. Poor performance relative to other investment management firms tends to result in decreased purchases of fund shares, increased redemptions of fund shares, and the loss of institutional or individual accounts. The decrease in revenues that could result from any such event could have a material adverse effect on our business.

Fluctuating Securities Volume and Prices

There are substantial fluctuations in volume and price levels of securities transactions in the financial services industry. These fluctuations can occur on a daily basis and over longer periods as a result of national and international economic and political events, broad trends in business and finance, and interest rate movements. Reduced volume and prices generally result in lower brokerage and investment banking revenues, trading losses as both principal and underwriter, and loss or reduction in incentive and performance fees. Periods of reduced volume will adversely affect profitability because fixed costs remain relatively unchanged. To the extent that purchases of securities are permitted to be made on margin, securities firms also are subject to risks inherent in extending credit. These risks are particularly high during periods of rapidly declining markets because a market decline could reduce collateral value below the amount of a customer’s indebtedness. The business cycles of our different operations and subsidiaries may occur contemporaneously. Consequently, the effect of an economic downturn may have a magnified negative effect on our business. In a period of reduced margin usage by clients, our interest profit may be adversely affected. In the past, heavy trading volume has caused clearance and processing problems for securities firms, and this could occur in the future. In addition, securities firms face risk of loss from errors that can occur in the execution and settlement process. See “Securities Brokerage Operations.”

A large portion of our revenues is derived from investment advisory contracts with clients. Under these contracts, the investment advisory fees we receive are typically based on the market value of assets under management. Accordingly, a decline in the prices of securities generally may cause our revenues and income to decline by:

If our revenues decline without a commensurate reduction in our expenses, our net income will be reduced. If our revenues decline at an asset management subsidiary with a revenue sharing agreement, our net income from that subsidiary will be reduced.

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Industry Changes and Competitive Factors

The financial services businesses in which we are engaged are extremely competitive. Competition includes numerous national, regional and local asset management firms and broker-dealers, and commercial bank and thrift institutions. Many of these organizations have substantially more personnel and greater financial resources than we do. Discount brokerage firms oriented to the individual investor market, including firms affiliated with banks and mutual fund organizations and on-line brokerage firms, have devoted substantial funds to advertising and direct solicitation of customers in order to increase their share of commission dollars and other securities-related income. We also compete for investment funds with banks, insurance companies and investment companies.

The financial services industry has had considerable consolidation as numerous financial services firms have either been acquired by other financial services firms or ceased operations. In many cases, this has resulted in firms with greater financial resources than ours. In addition, a number of heavily capitalized companies that were not previously engaged in the financial services business have made investments in and acquired financial services firms. Increasing competitive pressures in the financial services industry require firms of our size to offer to their customers many of the services that are provided by much larger firms that have substantially greater resources than we do. A sizable number of new asset management firms and mutual funds have been established in the last ten years, increasing competition in that area of our activities. In addition, access to mutual funds distribution channels has become increasingly competitive.

An increasing number of firms that offer discount brokerage services to individual investors have been established in recent years. Included in these firms are on-line brokerage firms and affiliates of banks and mutual fund organizations. These firms generally effect transactions at substantially lower commission rates on an “execution only” basis, including through the Internet, without offering other services, like investment and financial advice and research, that are provided by “full-service” brokerage firms such as ours. Some of these discount brokerage firms have increased the range of services that they offer. Increases in the number of discount brokerage firms or services provided by these firms may adversely affect us.

In addition, some full-service brokerage firms provide customers discount services, including on-line trading over the Internet. Our Private Client business may be adversely affected by the demand for and availability of on-line securities trading.

Certain institutions, notably commercial banks and thrift institutions, have become a competitive factor in the financial services industry by offering investment banking and corporate and individual financial services traditionally provided only by securities firms. Commercial banks, generally, are expanding their securities activities and their activities relating to the provision of financial services, and are deriving more revenue from these activities. In addition, in November 1999, legislation was passed that effectively repealed certain laws that separated commercial banking, investment banking and insurance activities. This legislation allows commercial banks, securities firms and insurance firms to affiliate, which may lead to additional consolidation and increasing competition in markets traditionally dominated by investment banks and brokerage firms. Continued expansion of the type and extent of competitive services that banks and other institutions offer or further repeal or modification of administrative or legislative barriers may adversely affect firms such as us that are heavily oriented to individual investors.

Acquisitions

As part of our business strategy, we review possible acquisitions in the ordinary course and regularly engage in discussions with respect to potential acquisitions, some of which may be material. Acquisitions involve a number of risks and present financial, managerial and operational challenges, including:

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An acquisition increases the risk that any business may lose customers or employees, including key employees of the acquired business. An acquired business could underperform relative to our expectations and we may not realize the value we expect from the acquisition. Adverse market conditions or poor investment or other performance by an acquired company may adversely affect revenue and, in the case of an asset manager, its assets under management and performance fees. We could also experience financial or other setbacks if an acquired company has problems of which we are not aware. Future acquisitions may further increase our leverage or, if we issue equity securities to pay for the acquisitions, dilute the holdings of our existing stockholders.

Regulatory Matters

Our business is subject to regulation by various regulatory authorities that are charged with protecting the interests of broker-dealers’ and investment advisors’ customers. See “Regulation.” Our business and results of operations can be adversely affected by Federal, state and foreign regulatory issues and proceedings, including, without limitation, the effects that the current regulatory proceedings and investigations into research analyst conflicts in the financial services industry may have on our investment banking, institutional sales or retail brokerage businesses, all of which have historically received support from our equity research department; the effects on Legg Mason of the current brokerage industry-wide regulatory inquiry into whether retail customers have received the full benefit of available reductions in mutual fund load fees; and the effects of the performance and potential regulatory issues in the investment trust business in the United Kingdom.

Recent financial scandals have led to insecurity and uncertainty in the financial markets. In response to these scandals, the Sarbanes-Oxley Act of 2002 effected significant changes to corporate governance, accounting requirements and corporate reporting. This law generally applies to all companies, including us, with equity or debt securities registered under the Securities Exchange Act of 1934.

Effect of Net Capital Requirements

The SEC and the NYSE have stringent rules with respect to the net capital requirements of securities firms. A significant operating loss or extraordinary charge against net capital may adversely affect the ability of our broker-dealer subsidiaries to expand or even maintain their present levels of business. See “Net Capital Requirements.”

Litigation

Many aspects of our business involve substantial risks of liability. In the normal course of business, our subsidiaries have been named as defendants or co-defendants in lawsuits seeking substantial damages. We are also involved from time to time in governmental and self-regulatory agency investigations and proceedings. There has been an increased incidence of litigation in the financial services industry in recent years, including customer claims as well as class action suits seeking substantial damages. See “Item 3. Legal Proceedings.”

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Importance of Key Personnel

We are dependent on the continued services of our management team, including our Chief Executive Officer, and a number of our key asset management and securities personnel. The loss of such personnel without adequate replacement could have a material adverse effect on us. Additionally, we need qualified managers and skilled employees with financial services experience in order to operate our business successfully. If we are unable to attract and retain qualified individuals or our costs to do so increase significantly, our operations would be materially adversely affected.

Operational Risks

There is considerable fluctuation during any year and from year-to-year in the volume of transactions we must process. We record transactions and post our books on a daily basis. Operations personnel monitor day-to-day operations to determine compliance with applicable laws, rules and regulations. Failure to keep current and accurate books and records can render us liable to disciplinary action by governmental and self-regulatory authorities, as well as to claims by our clients.

We depend on our headquarters and operations center for the continued operation of our business. A disaster directly affecting our headquarters or operations center may have a material adverse impact on our ability to continue to operate our business without interruption. Although we have disaster recovery programs in place, there can be no assurance that these will be sufficient to mitigate the harm that may result from such a disaster. In addition, insurance and other safeguards might only partially reimburse us for our losses.

International Operations

A number of our subsidiaries operate in Canada and the United Kingdom on behalf of international clients. We also have offices in Spain, Singapore and Switzerland. Our international operations require us to comply with the legal requirements of foreign jurisdictions and expose us to the political consequences of operating in foreign jurisdictions. Our foreign business operations are also subject to the following risks:

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We lease all of our office space. Our headquarters, Baltimore sales office and certain other functions are located in an office building in which we are the major tenant. In that building, we currently occupy approximately 377,000 square feet with annual base rent of approximately $7.8 million. The initial term of the lease will expire in 2009, with two renewal options of eight years each.

Our brokerage operations and technology functions are housed in a separate office building in which we are the sole tenant, currently occupying approximately 120,000 square feet with annual base rent of approximately $1.9 million. The initial term of the lease will expire in 2011, with two renewal options of five years each.

Information concerning the location of our retail sales offices is contained in Item 1 of this Report. See Note 9 of Notes to Consolidated Financial Statements in Item 8 of this Report for a discussion of our lease obligations.

Our subsidiaries are the subject of customer complaints, have been named as defendants or codefendants in various lawsuits alleging substantial damages and have been involved in certain governmental and self-regulatory agency investigations and proceedings. These proceedings arise primarily from securities brokerage, asset management and investment banking activities. Some of these proceedings relate to public offerings of securities in which one or more of our subsidiaries participated as a member of the underwriting syndicate. We are also aware of litigation against certain underwriters of offerings in which one or more of our subsidiaries was a participant, but where the subsidiary is not now a defendant. In these latter cases, it is possible that a subsidiary may be called upon to contribute to settlements or judgments. While the ultimate resolution of pending litigation and other matters cannot be currently determined, in the opinion of our management, after consultation with legal counsel, these actions are expected to be resolved with no material adverse effect on our financial condition. However, if during any period a potential adverse contingency should become probable or resolved, the results of operations in that period could be materially affected. See Note 9 of Notes to Consolidated Financial Statements in Item 8 of this Report.

None.

Information (not included in our definitive proxy statement for the 2003 Annual Meeting of Stockholders) regarding certain of our executive officers is as follows:

Peter L. Bain, age 44, was elected Executive Vice President of Legg Mason in July 2001, and was named head of our wealth management investment advisory group in June 2000. From 1995 to 2000, Mr. Bain was a Managing Director of Berkshire Capital Corporation, a privately held investment bank, and from 1997 to 2000 he was a member of the Management Committee of that company. Mr. Bain is responsible for the strategic direction of our wealth management investment advisory subsidiaries and for ongoing acquisition strategy in the wealth management market sector.

F. Barry Bilson, age 50, was elected Senior Vice President of Legg Mason in October 1998. Mr. Bilson was Vice President-Finance of Legg Mason from June 1984 through October 1998. Mr. Bilson has served in various financial management capacities since joining us in 1981, and presently has responsibility for business development projects. Mr. Bilson is a certified public accountant.

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Charles J. Daley, Jr., age 41, became Senior Vice President and Treasurer of Legg Mason in January 2002 and Senior Vice President, Chief Financial Officer and Treasurer of Legg Mason Wood Walker in December 2001. He had been Vice President of Legg Mason since July 1999 and of Legg Mason Wood Walker since 1997. From 1988 through September 1997, he served as Assistant Controller of Legg Mason and of Legg Mason Wood Walker. Mr. Daley is a certified public accountant.

Mark R. Fetting, age 48, was elected Executive Vice President of Legg Mason in July 2001. From June 2000 until July 2001, he served as a Senior Advisor to Legg Mason. From 1991 to 2000, Mr. Fetting was Division President and Senior Officer of Prudential Financial Group, Inc., a financial services company. Mr. Fetting has responsibility for our mutual funds business. Mr. Fetting is a director of 21 funds within the Legg Mason mutual funds complex and 14 funds within the Royce & Associates mutual funds complex.

Thomas P. Mulroy, age 42, was elected Executive Vice President of Legg Mason in July 2002 and an Executive Vice President of Legg Mason Wood Walker in November 2000. He became a Senior Vice President of Legg Mason in July 2000 and Legg Mason Wood Walker in August 1998. From 1986 through 1998, Mr. Mulroy held various positions in Legg Mason Wood Walker’s equity capital markets operations. Mr. Mulroy has responsibility for Legg Mason Wood Walker’s equity institutional sales, trading and research.

Robert G. Sabelhaus, age 55, was elected Executive Vice President of Legg Mason in July 2001 and Executive Vice President of Legg Mason Wood Walker in August 1993. Mr. Sabelhaus is an executive officer in the private client brokerage division of Legg Mason Wood Walker.

Timothy C. Scheve, age 45, became a Senior Executive Vice President of Legg Mason in July 2000 and of Legg Mason Wood Walker in November 2000. He had been Executive Vice President of Legg Mason and of Legg Mason Wood Walker since January 1998. Mr. Scheve has served in various financial and administrative capacities since joining us in 1984, and presently has primary responsibility for our administrative functions.

Elisabeth N. Spector, age 55, became a Senior Vice President of Legg Mason in January, 1994. She has general responsibilities in business strategy.

Joseph A. Sullivan, age 45, became a Senior Vice President of Legg Mason in July 2000 and of Legg Mason Wood Walker in August 1994. He manages Legg Mason Wood Walker’s fixed income capital markets operations and has responsibility for the oversight of the taxable and municipal fixed income banking, trading, institutional sales, and research departments of Legg Mason Wood Walker. He is a former member of the Board of Directors of the Bond Market Association.

Edward A. Taber, III, age 59, became a Senior Executive Vice President of Legg Mason in July 1995. He has overall responsibility for our institutional investment management activities. Mr. Taber is a director of the Western Asset Funds, Inc., a mutual fund consisting of six portfolios.

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PART II

Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters.

Shares of Legg Mason, Inc. common stock are listed and traded on the New York Stock Exchange (symbol LM). As of March 31, 2003, there were 2,655 holders of record of Legg Mason’s common stock. Information with respect to our dividends and stock prices is as follows:

Equity Compensation Plan Information

The following table provides information about our equity compensation plans as of March 31, 2003.

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plan participants upon their deferral of compensation or dividends paid on phantom stock units. When amounts are deferred, participants receive a number of phantom stock units equal to the deferred amount divided by 90% to 95% of the fair market value of a share of Common Stock.

Set forth below is a brief description of the material terms of our equity compensation plans that have not been approved by our stockholders. For all of our phantom stock plans and retention plans described below, we issue to a trust shares of our Common Stock that are available for distributions under the plans.

Legg Mason Wood Walker, Incorporated Private Client Group Deferred Compensation Plan (“PCG Plan”)

Under the PCG Plan, financial advisors in our Private Client Group were eligible to earn deferred bonuses in each calendar year based upon several performance measures. Deferred bonuses under the PCG Plan were deemed invested in either an interest account or a “phantom stock” account. Amounts deemed invested in phantom stock accounts were credited as a number of phantom stock units based on a unit price equal to the market price for a share of Legg Mason Common Stock. The number of phantom stock units credited to an account will be adjusted over the deferral period to account for any stock

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dividends, stock splits and similar events. Dividends paid on Common Stock are credited to phantom stock accounts by adding a number of phantom stock units based on a unit price equal to 95% of the market price for a share of Common Stock. Amounts deemed invested in interest accounts are annually credited with interest. Deferred bonuses under the PCG Plan vest at the end of the sixth calendar year after they are credited, and are subject to forfeiture if the recipient’s employment with us terminates prior to the vesting date, other than a termination as a result of death, disability or retirement. Vested deferred bonuses are distributed to the recipient, at the election of the recipient, upon either (i) the date they vest or (ii) the date the recipient’s employment with us terminates. Upon a distribution, the participant receives (in a lump sum or in periodic installments, at the participant’s election) a number of shares of Common Stock equal to the number of phantom stock units that are to be distributed, or cash in the amount of the balance of the interest account to be distributed. Commencing in calendar year 2002, we ceased issuing bonuses under the PCG Plan; however, this Plan still applies to deferred bonuses that have yet to vest.

Legg Mason Wood Walker, Incorporated Financial Advisor Retention Plan, formerly named the Legg Mason Wood Walker, Incorporated Financial Advisor Deferred Compensation Plan (the “FA Plan”)

In calendar year 2002, the PCG Plan was replaced with the FA Plan. Under the FA Plan, financial advisors in our Private Client Group are eligible to earn in each calendar year the right to receive future retention bonuses based upon several performance measures. When the right to receive a future retention bonus is awarded, the retention bonus is deemed invested in either an interest account or a “phantom stock” account. Amounts deemed invested in phantom stock accounts are credited as a number of phantom stock units based on a unit price equal to the market price for a share of Legg Mason Common Stock. The number of phantom stock units credited to an account will be adjusted over the period until the bonus is payable to account for any stock dividends, stock splits and similar events. Dividends paid on Common Stock are credited to phantom stock accounts by adding a number of phantom stock units based on a unit price equal to 95% of the market price for a share of Common Stock. Amounts deemed invested in interest accounts are annually credited with interest. Retention bonuses under the FA Plan are payable at the end of the sixth calendar year after the rights to receive them are granted, and rights to receive bonuses are subject to forfeiture if the recipient’s employment with us terminates prior to the end of that sixth year, other than a termination as a result of death, disability or retirement. When retention bonuses are paid, the recipient receives a number of shares of Common Stock equal to the number of phantom stock units that are to be distributed, or cash in the amount of the balance of the interest account to be distributed.

Legg Mason Wood Walker, Incorporated Key Employee Phantom Stock Agreements (the “Key Employee Agreements”)

Under the Key Employee Agreements, certain employees, as part of their recruitment by our Private Client Group, are offered deferred compensation bonuses credited within the first year of their employment. Deferral amounts under the Key Employee Agreements are deemed invested in “phantom stock” units based on a unit price equal to the market price for a share of Legg Mason Common Stock. The number of phantom stock units credited to an account will be adjusted over the deferral period to account for any stock dividends, stock splits and similar events. Dividends paid on Common Stock are credited to phantom stock accounts by adding a number of phantom stock units based on a unit price equal to 95% of the market price for a share of Common Stock. A portion of the deferred amounts under the Key Employee Agreements vests each year over a period of five years, and deferred amounts are subject to forfeiture if the recipient’s employment with us terminates prior to the vesting date, other than a termination as a result of death or disability. Vested deferred amounts are distributed to the recipient, at the election of the recipient, upon (i) the date they vest, (ii) the date the entire deferred amount vests, or (iii) the date the recipient’s employment with us terminates. Upon a distribution, the participant receives (in a lump sum or in periodic installments, at the participant’s election) a number of shares of Common Stock equal to the number of phantom stock units that are to be distributed.

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Legg Mason Wood Walker, Incorporated Professional Branch Manager Phantom Stock Agreements (the “Branch Manager Agreements”)

Under the Branch Manager Agreements, certain of the branch managers in our Private Client Group may elect to defer up to $12,000 of compensation in any calendar year. We “match” dollar-for-dollar all amounts deferred under the Branch Manager Agreements. Deferred and match amounts under the Branch Manager Agreements are deemed invested in “phantom stock” units based on a unit price equal to the market price for a share of Common Stock. The number of phantom stock units credited to an account will be adjusted over the deferral period to account for any stock dividends, stock splits and similar events. Dividends paid on Common Stock are credited to phantom stock accounts by adding a number of phantom stock units based on a unit price equal to 95% of the market price for a share of Common Stock. Phantom stock units resulting from the Legg Mason “match” vest six full years after they are credited, and are subject to forfeiture if the recipient’s employment with us terminates prior to the vesting date, other than a termination as a result of death, disability or retirement. Vested deferred amounts are distributed to the recipient, at the election of the recipient, upon either (i) the date they vest or (ii) the date the recipient’s employment with us terminates. In a distribution, the participant receives (in a lump sum or in periodic installments, at the participant’s election) a number of shares of Common Stock equal to the number of phantom stock units that are to be distributed.

Legg Mason Wood Walker, Incorporated Producing Branch Manager Retention Plan (the “Branch Manager Plan”)

Under the Branch Manager Plan, certain branch managers in our Private Client Group are eligible to earn the right to receive deferred bonuses and retention bonuses. Rights to receive deferred and retention bonuses are awarded in tandem under the Branch Manager Plan following each fiscal year based on the income earned by eligible branch managers during the fiscal year. When the right to receive a deferred bonus and retention bonus is awarded, the bonuses are deemed invested in either an interest account or a “phantom stock” account. Amounts deemed invested in phantom stock accounts are credited as a number of phantom stock units based on a unit price equal to the market price for a share of Legg Mason Common Stock. The number of phantom stock units credited to an account will be adjusted over the period until the bonuses are payable to account for any stock dividends, stock splits and similar events. Dividends paid on Common Stock are credited to phantom stock accounts by adding a number of phantom stock units based on a unit price equal to 95% of the market price for a share of Common Stock. Amounts deemed invested in interest accounts are annually credited with interest. Deferred bonuses under the Branch Manager Plan are payable on the earlier of (i) the end of the sixth fiscal year after the rights to receive them are granted and (ii) the date the applicable recipient’s employment with us terminates. Retention bonuses under the Branch Manager Plan are payable at the end of the sixth fiscal year after the rights to receive them are granted, and rights to receive retention bonuses are subject to forfeiture if the applicable recipient’s employment with us terminates prior to the end of that sixth year, other than a termination as a result of death, disability or retirement. When bonuses are paid under the Branch Manager Plan, the recipient receives a number of shares of Common Stock equal to the number of phantom stock units that are to be distributed, or cash in the amount of the balance of the interest account to be distributed. We adopted the Branch Manager Plan during fiscal year 2003 and the first rights to receive bonuses under the Plan will be granted after March 31, 2003.

Howard, Weil, Labouisse, Friedrichs, Inc. Equity Incentive Plan (the “Howard Weil Plan”)

Under the Howard Weil Plan, certain employees of Howard, Weil, Labouisee, Friedrichs, Inc. (“Howard Weil”) were entitled to defer their receipt of compensation. The deferred amounts were deemed invested in Voting Stock of Howard Weil. When we acquired Howard Weil in 1987, the deferred amounts were funded by placing Howard Weil stock into a trust, and the stock in the trust was converted into Legg Mason Common Stock. Since the acquisition, no additional amounts have been deferred under the Howard Weil Plan. However, the Howard Weil Plan governs the distribution of shares from the trust to participants. In addition, dividends paid on the shares held in the trust are used to purchase additional

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shares of Legg Mason Common Stock in the open market, which are then credited to the accounts of participants.

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(Dollars in thousands except per share amounts)

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Business Description

Legg Mason, Inc. (the “Parent”), a holding company, and its subsidiaries (collectively with the Parent, “Legg Mason”) are principally engaged in providing asset management, securities brokerage, investment banking and related financial services to individuals, institutions, corporations and municipalities. Terms such as “we,” “us,” “our” and “company” refer to Legg Mason.

Legg Mason has operations principally in the United States of America, the United Kingdom and Canada and also has offices in Spain, Switzerland and Singapore. The financial services industry in which Legg Mason operates is very competitive and highly regulated. Our profitability is sensitive to a variety of factors, including the amount and composition of our assets under management, the volume of trading in securities, the volatility and general level of securities prices and interest rates, the level of customer margin and credit account balances and the demand for investment banking services. In addition, overall market conditions, the diversification of services and products offered, investment performance and client relations are significant factors in determining whether we are successful in retaining and attracting clients. In the past decade, we have experienced substantial expansion due to internal growth and the strategic acquisition of asset management firms that provided, among other things, a broader range of investment expertise, additional product diversification and increased assets under management.

Legg Mason currently operates through four business segments: Asset Management, Private Client, Capital Markets, and Other. The business segments are based upon factors such as the services provided and distribution channels utilized. Certain services that we offer are provided to clients through more than one of our business segments. As such, the same revenue category may be reflected in multiple segments. We allocate certain common income and expense items among our business segments based upon various methodologies and factors.

The Asset Management segment provides asset management services to institutional and individual clients and investment advisory services to company-sponsored investment funds. Investment advisory and related fees earned by Asset Management vary based upon factors such as the type of underlying investment product, the amount of assets under management and the type of services that are provided. In addition, performance fees may be earned on certain investment advisory contracts for exceeding performance benchmarks. Distribution fees earned on company-sponsored investment funds are reported in Private Client when sold through its branch distribution network.

The Private Client segment distributes a wide range of financial products through its branch distribution network, including equity and fixed income securities, proprietary and non-affiliated mutual funds and annuities. At March 31, 2003, Private Client’s financial advisors operated out of 136 retail branch offices. The primary sources of net revenues for Private Client are commissions and principal credits earned on equity and fixed income transactions in customer brokerage accounts, distribution fees earned from mutual funds, fees earned from fee-based brokerage and managed accounts and net interest from customers’ margin loan and credit account balances. Sales credits associated with underwritten offerings initiated in the Capital Markets segment are reported in Private Client when sold through its branch distribution network.

The Capital Markets segment consists of our equity and fixed income institutional sales and trading, corporate and public finance advisory and underwriting activities, as well as corporate structured financing activities. Fixed income institutional sales and trading include transactions in both corporate and municipal products. Although we maintain securities in inventory primarily to facilitate customer transactions, Capital Markets also realizes trading profits and losses from trading activities. Sales credits associated with underwritten offerings are reported in Capital Markets when sold through institutional distribution channels. The results of this business segment also include realized and unrealized gains and losses on investments acquired in connection with merchant and investment banking activities.

The Other segment consists principally of our real estate service and mortgage banking business and unallocated corporate revenues and expenses.

All references to fiscal 2003, 2002 or 2001 refer to our March 31 fiscal year then ended.

Business Environment

The weak U.S. and global financial market conditions experienced in the prior fiscal year continued during fiscal 2003 as the uncertainty surrounding the economic outlook remained. The equity markets were plagued by slow economic activity, corporate governance, regulatory and accounting issues, concerns over terrorism and the growing tension and ultimate war in the Middle East. Domestically, the Dow Jones Industrial Average, the Nasdaq Composite Index and the S&P 500 were down 23%, 28% and 26%, respectively, during the year ended March 31, 2003. The fixed income markets benefited during the year due to declining interest rates and the volatility of the equity markets. During fiscal 2003, the U.S. Federal Reserve lowered interest rates by 0.50% to 1.25%, the lowest level since 1961.

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The Sarbanes-Oxley Act of 2002 (the “Act”), as well as regulations established by the various market exchanges, were in response to the corporate governance and accounting scandals. The Act provides additional oversight to protect investors’ interests and addresses many issues including the independence of public accountants and boards of directors, and managements’ responsibility for fair and accurate disclosures. In addition, regulatory proceedings and investigations of the relationships between research analysts and investment banking operations at financial services companies have created uncertainty as to whether companies in the industry will be required to make significant changes in their research or investment banking operations. This difficult regulatory environment, coupled with the uncertain economic outlook, provided for a challenging business environment.

Despite the difficult market conditions, we were able to achieve strong results of operations, primarily as a result of the addition and subsequent growth of revenues from entities acquired during fiscal 2002, a robust fixed income environment and the benefit of a full year of cost savings and efficiency initiatives.

Results of Operations

Our financial position and results of operations are materially affected by the overall trends and conditions of the financial markets, particularly in the United States. Results of any individual period should not be considered representative of future results. Many of our activities have fixed operating costs that do not decline with reduced levels of business activity. Accordingly, sustained periods of unfavorable market conditions are likely to affect our profitability adversely.

The following table sets forth, for the periods indicated, items in the Consolidated Statements of Earnings as a percentage of net revenues and the increase (decrease) by item as a percentage of the amount for the previous period:

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FISCAL 2003 COMPARED WITH FISCAL 2002

Financial Overview

Net revenues, net earnings and diluted earnings per share were up 5% to $1.53 billion, 25% to $190.9 million and 24% to $2.78, respectively. On August 1, 2001, we acquired Private Capital Management, L.P. (“PCM”), a high net worth investment manager in Naples, Florida. At acquisition, PCM managed $8.6 billion of assets, primarily in small to mid-cap stocks. On October 1, 2001, we acquired Royce & Associates, Inc. (“Royce”), an investment manager located in New York City. At acquisition, Royce managed $4.7 billion of assets, primarily in small and micro-cap mutual funds. As of March 31, 2003, PCM and Royce managed $11.5 billion and $8.2 billion of assets, respectively. The benefit of a full year of results and growth of Royce and PCM increased net revenues by approximately $80.0 million (net of interest expense). Additionally, net earnings increased as a result of lower compensation costs as a percentage of net revenues, decreases in litigation-related costs and the benefit of a full year of cost savings initiatives implemented in the prior year.

Net Revenues

Investment advisory and related fees, including distribution fees from investment funds, increased 10% to $860.3 million, primarily as a result of additional investment advisory fees of $90.5 million from Royce and PCM and growth of $40.9 million from our fixed income institutional investment advisor. Excluding acquisitions, these increases were offset in part by declines in investment advisory and distribution fees from company-sponsored equity investment funds of $42.7 million and lower fees at certain non-U.S. based investment advisors of $10.2 million.

Investment Advisory Revenues and Assets Under Management

Securities brokerage revenues, including both commissions and principal transactions, increased 1 % to $474.9 million as a result of increases in the volume of both institutional and retail fixed income transactions, sales of annuities and the impact of a full year of commissions earned by PCM’s brokerage operations. These increases were offset in part by declines in listed retail equity transaction volume and sales of non-proprietary mutual funds. Investment banking revenues increased 7% to $109.0 million, primarily due to increases in new issue and underwriting revenues, and increased merger and advisory fees. Other revenues increased 8% to $62.3 million, primarily as a result of a $3.1 million increase in annual retirement account fees due to more accounts being charged a fee and increases in the fee rates, higher loan origination fees at our mortgage banking subsidiary and a $1.3 million realized gain on the sale of certain contracts in our bank brokerage network, offset in part by unrealized losses on firm investments.

Net interest profit declined 47% to $21.6 million primarily as a result of a decrease of $53.1 million in interest revenue due to lower average interest rates earned on customer account and firm investment balances, partially offset by a decrease in interest expense of $42.8 million as a result of lower average interest rates paid on customer credit account balances. In addition, interest expense increased $9.2 million as a result of acquisition-related debt. Net interest profit accounted for 7.0% of consolidated pre-tax profits, down significantly from 16.1% in the prior fiscal year.

Non-Interest Expenses

Compensation and benefits increased 2% to $897.5 million, primarily due to a full year’s impact of PCM and Royce, which resulted in an increase of $32.4 million in compensation-related expenses, and higher profitability-based asset management incentive expense, offset in part by a decline in sales and distribution fee commissions of $27.6 million. Compensation as a percentage of net revenues decreased to 58.7% in fiscal 2003 from 60.9% in fiscal 2002 primarily due to our Private Client and Capital Market segments. A substantial part of compensation expense fluctuates in proportion to the level of business activity. Other compensation costs, primarily salaries and benefits, are fixed and typically do not decline with reduced levels of business activity.

Communications and technology expense declined 7% to $92.0 million, primarily as a result of declines in costs for quote services, consulting fees and leased computer equipment.

Occupancy increased 5% to $65.2 million, primarily due to the impact of a full year of expenses of acquired entities, higher operating expenses at our corporate headquarters and the addition of office space leased by our fixed income institutional investment advisor.

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Amortization of intangible assets increased 32% to $24.9 million, primarily as a result of a $5.5 million increase related to a full year of amortization of asset management contracts acquired in the PCM acquisition. We adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets,” effective April 1, 2001, under which goodwill and indefinite life intangible assets are no longer amortized. See Note 6 of Notes to Consolidated Financial Statements.

Other expenses increased 4% to $140.3 million, primarily as a result of the impact of a full year of commissions paid to third party distributors of Royce funds, the addition of expenses of acquired entities and an increase of $2.1 million in reserves for recruiting-related advances to financial advisors. These increases were offset in part by a decline in litigation-related expenses of approximately $5.7 million and lower promotional expenses.

The provision for income taxes increased 17% to $117.4 million in fiscal 2003, primarily as a result of the increase in pretax earnings. The effective tax rate declined to 38.1% from 39.6% in the prior year due to lower average effective state income tax rates resulting from changes in state apportionment factors, $2.6 million in one-time net state income tax refunds and a lower average effective foreign tax rate as a result of realizing the tax benefits of U.K. net operating loss carryforwards. We do not expect that the changes in state apportionment factors will continue to further reduce effective state tax rates.

Results by Segment

Asset Management

Net revenues in Asset Management increased 16% to $648.1 million and pre-tax earnings increased 12% to $178.7 million, principally as a result of the impact of a full year of results and growth at PCM and Royce, as well as growth at our fixed income institutional investment advisor. Revenues from Asset Management tend to be more stable than those from Private Client and Capital Markets because they are less affected by changes in securities market conditions. Compensation as a percentage of net revenues increased to 48.3% in fiscal 2003 from 46.7% in fiscal 2002 and the pre-tax profit margin decreased to 27.6% in fiscal 2003 from 28.5% in fiscal 2002 because a higher percentage of revenues were generated by subsidiaries that retain a larger percentage of revenues, under revenue-sharing agreements, as incentive compensation. Asset Management represented 42.4% of consolidated net revenues in fiscal 2003, an increase from 38.4% in fiscal 2002. In fiscal 2003, PCM and Royce contributed an additional $90.5 million of investment advisory fees and $31.3 million of pre-tax earnings. In addition, investment advisory fees grew $40.9 million at our fixed income institutional investment advisor. These increases were offset in part by declines of $19.2 million in advisory fees from company-sponsored equity investment funds and $10.2 million in advisory fees from certain non-U.S. based investment advisors. In addition, net interest profit decreased $11.9 million primarily as a result of lower average interest rates earned on firm investment balances and an increase in acquisition-related debt. Included in the current fiscal year are charges of $2.8 million related to write-downs of previously acquired asset management contracts. Total assets under management were $192.2 billion as of March 31, 2003, an increase of $15.2 billion or 9% from March 31, 2002. As of March 31, 2003, approximately $132.1 billion or 68.7% of assets under management were in fixed income related products and $60.1 billion or 31.3% were in equity related products. Our assets under management mix was as follows: Institutional-$136.8 billion (71.2%); Mutual Funds-$35.9 billion (18.7%); and Wealth Management-$19.5 billion (10.1%).

Private Client

Despite a decline in Private Client’s net revenues of 5% to $588.6 million, pre-tax earnings increased 46% to $77.6 million. Compensation as a percentage of net revenues decreased to 58.1% in fiscal 2003 from 61.9% in fiscal 2002 as a result of lower effective commission payout rates and incentive compensation. The pre-tax profit margin increased to 13.2% in fiscal 2003 from 8.6% in fiscal 2002. Private Client represented 38.5% of consolidated net revenues in fiscal 2003, a decrease from 42.6% in the prior year. Net revenues declined primarily due to a decrease of $19.8 million in distribution fee revenues on company-sponsored investment funds, principally equity funds, and lower retail transaction volume. Improved pre-tax earnings and profit margin are attributable to a decline in non-interest expenses, driven by cost savings initiatives implemented last year, including the impact of branch consolidations, a reduction in the number of full-time employees and lower costs for communication services. Net interest profit in Private Client decreased 12% to $49.9 million, primarily due to a decline in average interest rates earned on firm investment balances.

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Capital Markets

Net revenues in Capital Markets increased 7% to $259.7 million, while pre-tax earnings increased 34% to $52.5 million. Compensation as a percentage of net revenues declined to 56.4% in fiscal 2003 from 60.6% in fiscal 2002 due to lower effective percentage payouts for incentive compensation on higher revenues. The pre-tax profit margin increased to 20.2% in fiscal 2003 from 16.2% in fiscal 2002. Capital Markets represented 17.0% of consolidated net revenues in fiscal 2003 and 16.7% in fiscal 2002. The increase in net revenues was primarily attributable to higher institutional fixed income transaction volume and trading profits, as well as increases in municipal banking fees, offset in part by a decline in corporate banking fees and unrealized losses related to warrants acquired in connection with private placements.

Other

Other consists principally of the results of our real estate service and mortgage banking business and unallocated corporate revenues and expenses. Net revenues and pre-tax earnings declined $1.2 million and $1.9 million, respectively, from the prior year, reflecting a reduction in net interest profit at our real estate service and mortgage banking subsidiary, partially offset by increased mortgage banking fees.

FISCAL 2002 COMPARED WITH FISCAL 2001

Financial Overview

In fiscal 2002, net revenues reached then-record levels and increased 7% to $1.45 billion, primarily as a result of an increase in investment advisory and related fees. Despite the increase in net revenues during fiscal 2002, net earnings declined 2% to $152.9 million from fiscal 2001 as a result of increased expenses, including profitability-based incentive compensation, the addition of expenses of acquired entities and litigation-related costs. In fiscal 2002, diluted earnings per share declined 3% to $2.24 from $2.30 in fiscal 2001.

The results for fiscal 2002 also include the effect of adopting SFAS No. 142, which resulted in an expense reduction of $7.8 million ($6.7 million net of tax). This expense reduction increased both basic and diluted earnings per share by $0.10 in fiscal 2002.

Net Revenues

Revenues from investment advisory and related activities rose $126.6 million or 19% to $780.6 million in fiscal 2002, primarily as a result of the acquisitions of PCM and Royce, which contributed $97.1 million to the increase. The remainder of the increase was primarily attributable to growth in assets under management in fixed income investment advisory accounts. Revenues from securities brokerage activities declined 3% to $469.8 million as a result of a decrease in retail securities transactions and non-affiliated mutual fund and variable annuity sales. These declines were offset in part by increases in fixed income and equity institutional securities transaction volume. Revenues from investment banking activities increased 55% to $102.2 million primarily due to a $34.2 million increase in new issue sales concessions and increased municipal banking fees. Other revenues increased 14% to $58.0 million primarily as a result of realized and unrealized gains on firm investments and an increase in loan origination fees, partially offset by the sale of a merchant banking related investment in the prior fiscal year.

Our net interest profit declined 62% to $40.8 million from $106.8 million in the prior fiscal year, primarily as a result of a decrease of $92.0 million in interest revenue, due to lower average interest rates earned on customer margin account and firm investment balances, and an increase in interest expense of $30.2 million as a result of an increase in acquisition-related debt. These decreases in net interest profit were partially offset by a decrease in interest expense of $69.3 million as a result of lower average interest rates paid on customer credit account balances. Net interest profit accounted for 16.1% of consolidated pre-tax profits, down significantly from 40.2% in the prior fiscal year.

Non-Interest Expenses

Compensation and benefits expense increased 10% to $883.4 million, primarily attributable to significantly higher profitability-based incentive compensation, which increased by $36.9 million, the addition of $28.2 million in expenses as a result of the acquisitions of PCM and Royce and an increase in vested deferred compensation of $10.8 million during fiscal 2002. These increases were offset in part by a decline in variable sales commissions of $10.6 million.

Communications and technology expense declined 4% to $99.0 million as a result of decreased costs for telephone usage, quote services and printing, offset in part by the addition of expenses of acquired entities.

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Occupancy costs increased 20% to $62.2 million in fiscal 2002 from $51.7 million in fiscal 2001 as a result of a full year impact of prior year expansion, including an operations center and new branch offices, as well as the addition of expenses of acquired entities.

Amortization of intangible assets increased $6.4 million or 52% to $18.8 million from the prior fiscal year, primarily attributable to $11.0 million of amortization of PCM’s asset management contracts, offset in part by the impact of adopting SFAS No. 142, under which goodwill and indefinite life intangible assets are no longer amortized. See Note 6 of Notes to Consolidated Financial Statements.

Other expenses increased 9% to $134.7 million, primarily attributable to an increase in litigation-related costs of $12.7 million (net of recoveries of $9.8 million). Fiscal 2002 net litigation-related costs were $15.1 million compared to $2.4 million in fiscal 2001.

The income tax provision decreased 9% to $100.3 million in fiscal 2002 due to lower pre-tax earnings and lower state income taxes. Legg Mason’s effective income tax rate was 39.6% in fiscal 2002, down from 41.2% in fiscal 2001 due to lower average effective state income tax rates and the impact of adopting SFAS No. 142, which eliminated non-deductible amortization of goodwill for book purposes.

Results by Segment

Asset Management