Back to GetFilings.com

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the fiscal year ended December 31, 2001 Commission File Number 0-23644

INVESTMENT TECHNOLOGY GROUP, INC.
(Exact name of registrant as specified in its charter)

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 / /

DOCUMENTS INCORPORATED BY REFERENCE:

        Proxy Statement relating to the 2002 Annual Meeting of Stockholders (incorporated, in part, in Form 10-K Part III).

2001 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS

QuantEX is a registered trademark of the Investment Technology Group, Inc. companies.
POSIT is a registered service mark of the POSIT Joint Venture.
SmartServer, SPI, SPI SmartServer, VWAP SmartServer, ITG ACE, TCA, ITG WebAccess,
ITG/Opt, ResRisk, Inference Group and AlterNet are trademarks of the Investment Technology
Group, Inc. companies.

FORWARD-LOOKING STATEMENTS

        In addition to the historical information contained throughout this Annual Report on Form 10-K, there are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). All statements regarding our expected future financial position, results of operations, cash flows, dividends, financing plans, business strategies, competitive positions, plans and objectives of management for future operations, and concerning securities markets and economic trends are forward-looking statements. Although we believe our expectations reflected in such forward-looking statements are based on reasonable assumptions, there can be no assurance that such expectations will prove to have been correct. Important factors that could cause actual results to differ materially from the expectations reflected in the forward-looking statements herein include, among others, the actions of both current and potential new competitors, rapid changes in technology, fluctuations in market trading volumes, financial market volatility, evolving industry regulations, risk of errors or malfunctions in our systems or technology, cash flows into or redemptions from equity funds, effects of inflation, customer trading patterns, the success of our new products and services offerings as well as general economic and business conditions, internationally or nationally, securities, credit and financial market conditions, and adverse changes or volatility in interest rates.

ii

PART I

Item 1. Business

        Investment Technology Group, Inc. ("ITG" or the "Company") was formed as a Delaware corporation under the name Jefferies Group, Inc. ("Jefferies Group") on July 22, 1983 and its principal subsidiaries include: (1) ITG Inc. and AlterNet Securities, Inc. ("AlterNet"), United States ("U.S.") broker-dealers in equity securities, (2) Investment Technology Group Limited ("ITG Europe"), an institutional broker-dealer in Europe, which was 50% owned prior to our May 2, 2001 purchase of the remaining 50% ownership interest in the ITG Europe joint venture we did not already own, (3) ITG Australia Limited ("ITG Australia"), an institutional broker-dealer in Australia, (4) ITG Canada Corp. ("ITG Canada"), an institutional broker-dealer in Canada, (5) KTG Technologies Corporation ("KTG"), a direct access provider in Canada, (6) ITG Software, Inc., our intangible property management subsidiary in California, (7) ITG Software Solutions, Inc., our software development and maintenance subsidiary in California and (8) Inference Group LLC ("Inference"), an asset management subsidiary. We provide equity trading services and transaction research to institutional investors and brokers in the U.S., Canada, Australia and Europe.

        We are a full service trade execution firm that uses technology to increase the effectiveness and lower the cost of trading. With an emphasis on ongoing research, we offer the following services to our clients:

•

POSIT: an electronic stock crossing system.



•

QuantEX: a Unix-based decision-support, trade management and order routing system.



•

SmartServers: server-based implementation of trading strategies.



•

Electronic Trading Desk: an agency-only trading desk offering clients the ability to efficiently access multiple sources of liquidity.



•

ITG Platform: a PC-based order routing and trade management system.



•

ITG ACE and TCA: a set of pre- and post-trade tools for systematically estimating and measuring transaction costs.



•

ITG/Opt: a computer-based equity portfolio selection system.



•

ITG WebAccess: a browser-based order routing tool.



•

Research: research, development, sales and consulting services.

        We generate revenues on a "per transaction" basis for all orders executed. Orders are delivered to us from our "front-end" software products, QuantEX, ITG Platform and ITG WebAccess, as well as other vendors' front-ends and direct computer-to-computer links to customers. Orders may be executed on or through (1) POSIT, (2) the New York Stock Exchange ("NYSE"), (3) the American Stock Exchange, (4) certain regional exchanges, (5) the Nasdaq National Market, (6) market makers, (7) electronic communication networks ("ECNs"), systems which trade equity securities and (8) alternative trading systems ("ATSs").

POSIT

        POSIT was introduced in 1987 as a technology-based solution to the trade execution needs of quantitative and passive investment managers. It has since grown to also serve the active trading and broker-dealer communities. There are 551 clients currently using POSIT, including corporate and government pension plans, insurance companies, bank trust departments, investment advisors, broker-dealers and mutual funds.

1

        POSIT is an electronic stock crossing system through which clients enter buy and sell orders to trade single stocks and portfolios of equity securities among themselves in a confidential environment. Orders may be submitted to the system directly via QuantEX, ITG Platform, ITG WebAccess or other computer-to-computer links, or indirectly via ITG Electronic Trading Desk personnel. We also work in partnership with vendors of other popular trading systems, allowing users the flexibility to route orders directly to POSIT from trading products distributed by Bridge Information Systems, BRASS, Bloomberg and others.

        POSIT currently accepts orders for a universe of approximately 21,000 different equity securities, but may be modified, as the need arises, to include additional equity securities. At the end of the submission window the POSIT algorithm is run. It optimizes the maximum possible number of buy and sell orders that match or "cross". Clients may specify conditions on their orders that must be satisfied, such as the requirement that the net cash resulting from buys and sells remain within specified constraints. A client may also specify a minimum number of shares to be executed for a given order. POSIT prices trades at the midpoint of the best bid and offer on the primary market for each security at the time of the cross, based on information provided directly to the system by a third-party data vendor. There are currently eight scheduled crosses every business day, at 9:40 a.m., 10:00 a.m., 10:30 a.m. and then hourly, on the hour, from 11:00 a.m. to 3:00 p.m. (Eastern Time). POSIT matches take place within a five-minute window after the match times above. Within such five-minute window (or within the thirty second period prior to the start of the window), the system generates a message to the system operator who informs the ITG sales and trading personnel that the match will run in thirty seconds. The operator manually starts the match thirty seconds following this announcement unless (i) there are technical difficulties or (ii) a decision is made to delay the match based on our assessment that substantial additional liquidity will result from the delay. We endeavor to run each match within the five-minute window but reserve the right to run a match outside of this window.

        POSIT provides the following significant benefits to clients:

•

Confidential matching of buy and sell orders eliminates market impact. In contrast, participants in traditional or other open markets are constantly subject to the risk that disclosure of an order will unfavorably affect price conditions.



•

The average execution size in POSIT is more than ten times larger than the average execution size on ECNs.



•

Access to the substantial pool of liquidity represented by aggregate POSIT orders in each match.



•

Clients pay a low transaction fee on completed transactions relative to the industry average of approximately 5 cents per share. POSIT generates revenue from transaction fees charged on each share crossed through the system.



•

Immediately after each cross, the system electronically provides clients with reports of match results. Clients may then submit the unexecuted portion of their orders to subsequent POSIT matches, choose to execute unmatched orders through other means or take advantage of the Electronic Trading Desk services (described below).

        In December 1997, we introduced a new version of POSIT that gives users the option of customizing their trading objectives and specifying additional constraints, while preserving the functionality of the existing POSIT system. This capability is referred to collectively as a "POSIT strategy." This capability allows orders that might otherwise be ineligible for POSIT to participate in the match. POSIT strategies include ResRisk, which allows users to control the risk of the unexecuted "residual" portfolio, and Pairs, which makes execution of one trade contingent on the execution of another, at or better than a given relative valuation. Portfolio funding, liquidation, restructuring and rebalancing are some of the types of transactions that are appropriate for execution using ResRisk. Risk arbitrage, statistical arbitrage and portfolio substitution trades are examples of transactions that

2

can be implemented using the Pairs strategy. We also implement custom applications upon request. We have obtained a patent on the technology underlying such POSIT strategies.

        Clients can also access POSIT through our brokerage subsidiary, AlterNet. AlterNet enables clients to execute trades in POSIT on a net basis, i.e.with the commission payable to us for the POSIT trade included in the price at which the client executes their POSIT trade. This feature is particularly attractive to our broker-dealer customers and AlterNet was created in response to broker-dealers' desires to have net pricing in POSIT.

        The following graph illustrates the average daily volume of shares crossed on POSIT since 1994:

QuantEX

        QuantEX is our Unix-based trade management system, an advanced tool for technologically sophisticated clients transacting large volumes of orders. QuantEX helps clients efficiently manage every step of the trading process: from decision-making to execution to tracking of trade list status. From a dedicated workstation at their desks, users can access fully-integrated real-time and historical data and analytics, route and execute orders electronically, and perform trade management functions. QuantEX is an integrated system that supports multiple trade-related activities that have traditionally required the use of several unrelated systems.

        QuantEX is a rule-based decision support system that allows traders to quantify their trading processes to create automated strategies. It is designed to implement each client's trading styles and strategies and to apply them to hundreds of stocks, portfolios or industry groups at once. With QuantEX, clients can flag precisely the same kinds of moment-to-moment opportunities they would ordinarily want to pursue, but do so much more efficiently and scientifically.

        Rule-based strategies can be based on a wide range of quantitative models. Passive traders can use QuantEX strategies to help minimize slippage from various benchmarks, reduce tracking errors and achieve desired sector balances. Active traders can build models to match a wide variety of trading approaches, such as pairs trading, market-neutral algorithms and index or risk arbitrage. QuantEX strategies can involve the human trader in each order decision, or can fully automate the trading process, depending on the client's preference.

        QuantEX analyzes lists of securities based on the individual user's trading strategy. QuantEX provides clients access to our proprietary research, including pre-trade, post-trade and intra-day analytical tools. QuantEX has access to the ITG Data Center, which is a comprehensive historical database that provides a variety of derived analytics based upon raw historical data. Our support specialists translate the trading criteria developed by the client into a set of rules for trading securities, which are then loaded into QuantEX. QuantEX applies the client's proprietary trading rules to a

3

continuous flow of current market information on the list of securities selected by the user to generate real-time decision support. A user's rules can be based on a wide range of quantitative models or strategies, such as liquidity measures, technical indicators, price benchmarks, tracking to specific industries and sectors, pairs or other long or short strategies, index arbitrage, risk measurements and liquidity parameters for trade urgency, size or timing. These rules typically serve as a guide in support of a client's trading decisions. In addition, QuantEX supports the ability to implement these trading decisions automatically via an auto-trading strategy.

        As such, QuantEX can automate the complex trade management requirements typical of investment strategies that trade large volumes of securities through multiple sources of liquidity. Orders can be electronically routed to multiple markets, including the NYSE, the American Stock Exchange and certain regional stock exchanges, the Nasdaq National Market, POSIT, our SmartServers, the Electronic Trading Desk, over-the-counter market-makers, and selected broker-dealers, ECNs and ATSs. We intend to create links to additional ATSs and other liquidity sources where appropriate. Trades routed through QuantEX are automatically tracked and summarized. Each order can be monitored by source of execution, by trade list, by portfolio or globally with all other orders placed. QuantEX's built-in trade allocation features provide a facility for automated back-office clearance and settlement. QuantEX supports the Financial Information eXchange ("FIX") messaging protocol and can link to other FIX compliant systems.

        QuantEX also allows our clients to access our ISIS facility, an equity pre-and post-trade analysis system. Via the ISIS facility, QuantEX users can request both aggregate and stock-by-stock liquidity reports for a portfolio trade prior to and during execution. Clients can generate standard reports or use a report writer to design custom reports. Certain elements of these reports can also be displayed directly on the QuantEX execution page and referenced in QuantEX strategies. These pre-trade analyses help QuantEX users make decisions about how best to trade a portfolio, for example by helping identify the most difficult trades for special handling. The ISIS post-trade reporting facility allows QuantEX users to compare actual executed prices to user-selected benchmark prices in order to help assess trade execution quality. Available benchmarks include the volume-weighted average price, closing price and opening price.

        Our support specialists install the system, train users and provide ongoing support for the use of QuantEX's order routing and analysis capabilities. Our specialists are knowledgeable about portfolio management and trading as well as the system's hardware and software. Our support team works closely with each client to develop trading strategies and rules, explore new trading approaches, provide system integration services and implement system upgrades and enhancements.

        Revenues are generated through commissions and transaction fees charged for each trade electronically routed through QuantEX to the many destinations available from the application. We do not derive royalties from the sale or licensing of the QuantEX software. As of December 31, 2001, there were 148 installations of QuantEX at 52 client sites.

SmartServers

        SmartServers are automated trading destinations that accept orders from client workstations and execute them using a computerized trading strategy. All SmartServers are physically located at ITG, and are accessed electronically by clients via the ITG Platform or QuantEX, via direct connections or via our Electronic Trading Desk. Each SmartServer is an automated trading agent pre-programmed with a particular trading style. By using these agents, traders can focus their attention on a subset of their orders, letting the SmartServer trade the rest of the orders on the list.

        Currently, we provide two strategy-based servers: the VWAP SmartServer and the SPI SmartServer. The VWAP SmartServer is designed to allow clients to direct their orders to us to be executed in a manner designed to closely track a security's volume-weighted average price, or VWAP,

4

throughout the trading day. The VWAP SmartServer analyzes liquidity and market conditions continuously throughout the day and determines the appropriate order size and order price to approximate the VWAP. Clients may choose to execute relative to the VWAP price for the entire trading day, or for some subset of that trading day.

        The SPI SmartServer is designed to improve trading performance of small- and medium-size orders that are traditionally executed as market orders. The SPI SmartServer analyzes momentum, volatility, and indicators to decide how and when to trade an order to improve upon the results expected from a market order. Clients may choose a time horizon for each order, anywhere from 5 to 30 minutes, whereby the SPI SmartServer monitors the market and determines the timing, pricing, and size of outgoing orders using real-time market data.

Electronic Trading Desk

        The Electronic Trading Desk is a full-service agency execution group that specializes in the use of our proprietary products, including extensive use of POSIT for trade execution. For clients that do not send orders electronically to POSIT, our account executives receive orders for POSIT matches by telephone, fax or e-mail. The desk accepts orders until a POSIT match begins and after completion of the match execution reports are given to clients.

        In addition to order management services for POSIT, the Electronic Trading Desk provides agency execution services. QuantEX, ITG Platform and ITG WebAccess clients deliver lists of orders electronically to our desk and, as orders are executed by the desk, reports are automatically delivered electronically to the client's terminal. Trading desk personnel are thereby able to assist customers with decision support analyses generated by ITG Platform, QuantEX or ITG WebAccess and with the execution of trades. Clients give our traders single stock orders or lists of orders to work throughout the day as well as unfilled orders that remain due to order imbalances in POSIT matches.

        For order completion outside of POSIT match windows, the Electronic Trading Desk utilizes numerous sources of liquidity to complete trades. The trading desk will actively seek the contra side of client orders by soliciting interest among other clients, use QuantEX to route the orders to multiple markets, including primary exchanges, regional exchanges, over-the-counter market makers, ECNs and ATSs, or use our active order traders to execute the trade with floor brokers or over-the-counter brokers.

        The Portfolio Trading Group of our desk focuses on agency-only list and program trading. By employing a step-by-step process that leverages technology and access to multiple sources of liquidity, the Portfolio Trading Group seeks to systematically achieve high quality executions for the client. A client program is evaluated with a pre-trade analysis to determine aggregate portfolio characteristics, liquidity ranking and market impact, and to quantify risk. The group implements a number of sophisticated trading strategies using QuantEX to meet execution objectives on an agency basis. After the execution is completed, we provide the client with comprehensive reports analyzing execution results utilizing ITG Research products.

ITG Platform

        ITG Platform provides clients with seamless connectivity from their desktop to a variety of execution destinations, such as POSIT, the Electronic Trading Desk, our SmartServers, the NYSE, the American Stock Exchange and certain regional stock exchanges, the Nasdaq National Market, other over-the-counter market makers, selected ECNs and ATSs. We intend to create links to additional liquidity sources where appropriate. Orders may be corrected or cancelled electronically, and all reports are delivered electronically back to the ITG Platform. ITG Platform also supports special trading interfaces as needed by POSIT strategies and SmartServers. Allocation information can be associated with executions in the ITG Platform and delivered to us electronically. ITG Platform has access to

5

historical data through the ITG Data Center, including a wide array of analytics, such as average historical share volumes, dollar volumes, volatility and historical spread statistics. ITG Platform also provides clients enhanced list trading capabilities, access to ECN order types and, in some cases, access to real time Nasdaq Level II data as well as the ability to communicate with us via the Internet or through private networks.

        ITG Platform was intended for broad distribution to institutional clients, so it was designed to run in conventional PC environments alongside other applications, and be inexpensive to install, maintain and support.

        Many technical features support these goals:

•

Other applications can link to ITG Platform using the FIX data messaging protocol or the "drag and drop" method.



•

ITG Platform incorporates a spreadsheet package, so users can extend their trade blotter with custom calculations.



•

Custom execution reports can be created to fit each user's requirements.



•

ITG Platform can access Bridge and ILX quote data if those systems are used by the client. In addition, we provide the Primark Speed Feed to selected clients.



•

New versions of ITG Platform are distributed automatically to client sites and are easily installed with little or no user intervention required.

        As of December 31, 2001, there were 443 installations of ITG Platform at 206 client sites.

ITG Pre-trade Agency Cost Analysis ("ACE") and Post-trade Transaction Cost Analysis ("TCA")

        Accessed through the Internet, ITG ACE and TCA are equity pre- and post-trade analysis systems. ITG ACE and TCA users can request both aggregate and stock-by-stock liquidity reports for a trade portfolio prior to, during and following execution. Clients can generate standard reports built into the browser-based applications. Reports can be viewed, printed or saved to a file.

        ITG ACE helps users make decisions about the expected cost of trading. It also helps determine how best to trade a portfolio, for example by identifying the most difficult trades for special handling and by providing a reference point for evaluating principal trade pricing. The TCA post-trade reporting facility allows users to compare actual executed prices to user-selected benchmark prices in order to help assess trade execution quality. Available benchmarks include the volume-weighted average price, closing price, pre-trade midquote and last trade, among others.

ITG/Opt

        ITG/Opt is a computer-based equity portfolio selection system that employs advanced optimization techniques to help investors construct portfolios that meet their investment objectives. Special features of the system make it particularly useful to "long/short" and taxable investors, as well as any investor seeking to control transaction costs. ITG/Opt is usually delivered as a "turnkey" system that includes software and, in some cases, hardware and data. Included in the service is telephone and on-site support to assist in training and integrate the system with the user's other investment systems and databases, with the goal of tightly coupling ITG/Opt to the client's workflow. In addition to its core portfolio construction capabilities, ITG/Opt has powerful backtesting and batch scheduling features that permit efficient researching of new or refined investment strategies. The system, which is targeted at highly sophisticated investment applications, is offered primarily to our largest clients. Typically, portfolios that are constructed using ITG/Opt are executed via ITG, using one or more execution services, such as QuantEX, the Electronic Trading Desk and POSIT.

6

ITG WebAccess

        ITG WebAccess allows users to take advantage of ITG's advanced trading services from anywhere through the Internet. ITG WebAccess is a browser-based order routing tool for sending orders to POSIT and the Electronic Trading Desk.

ITG Research

        In addition to its role in the company's overall research and development effort, Research provides both sales and consulting services to our clients and prospective clients. Taken together, these activities are a key component of our overall relationship development and maintenance activities.

        In its sales capacity, Research introduces our clients and prospective clients to the full range of products and services offered by our company and provides information about features, pricing and technical/functional specifications. The sales process includes development of an in-depth understanding of client practices and requirements and the design and presentation of integrated solutions based on our products.

        Consulting encompasses a set of value-added services for the benefit of our clients. These services break down into three main categories: product support, development of customized trading strategies and provision of quantitative analysis. The products supported by Research are QuantEX, ITG ACE, TCA, ITG Platform, POSIT, and ITG/Opt. Support activities include trading strategy design and implementation, system integration, training and coordination of technical support. Strategy development involves building customized QuantEX strategies that automate the trading styles of specific clients. Quantitative analysis covers a broad range of activities such as transaction cost analysis, investment strategy simulations and provision of historical time series of proprietary analytics. As part of its analysis activities, Research publishes and distributes studies on topics of interest to our clients. In the same way users of fundamental research compensate the traditional brokerage houses that provide such research (i.e., directing commissions to such brokerage houses), our clients reward the company for these value-added research services.

ITG Europe

        In the fourth quarter of 1998, we entered into a 50/50 joint venture with Société Générale, and founded ITG Europe. On November 18, 1998, ITG Europe launched a new agency brokerage operation that includes the operation of a European version of the POSIT system. On May 2, 2001, we purchased Société Générale's entire interest in ITG Europe for $18.5 million. The acquisition was recorded under the purchase method of accounting. The purchase price has been allocated to assets acquired and liabilities assumed based upon estimated fair market values at the date of acquisition. Goodwill and other intangibles amounting to $16.7 million are being amortized on a straight-line basis over their useful lives, which range from 9 to 34 years.

ITG Australia

        In 1997, we entered into a 50/50 joint venture with Burdett, Buckeridge & Young ("BBY") and founded ITG Australia Limited, an international brokerage firm that applies our cost-saving execution and transaction research technologies to Australian equity trading. In November of 2000, we acquired the remaining interest in ITG Australia (from BBY and certain employees of ITG Australia) that we did not already own, bringing our ownership interest up to 100%. The purchase price has been allocated to assets acquired and liabilities assumed based upon estimated fair market values at the date of acquisition. The $5.0 million cost exceeded the estimated fair value of the net assets acquired by $3.7 million. The excess of the purchase price over the estimated fair value of the net assets acquired has been allocated to intangible assets and is being amortized on a straight-line basis over a twenty-year period.

7

ITG Canada

        In April 2000, we announced the formation of our Canadian subsidiary, ITG Canada Corp., which functions as an institutional broker-dealer in Canada. ITG Canada provides Canadian institutions access to many of the ITG products provided to our U.S. customer base including a version of QuantEX developed for the Canadian markets. E*Trade Technologies Corporation is also a licensed distributor of QuantEX in Canada. On June 29, 2001, the POSIT joint venture entered into an agreement to license a Canadian version of the POSIT system to the Toronto Stock Exchange ("TSE"). This Canadian version of POSIT will operate as a facility of the TSE for TSE listed securities and is expected to be launched in the second quarter of 2002.

        On September 28, 2001, we acquired the KastenNet business of Kasten Chase Applied Research Limited for $7.4 million Canadian dollars (approximately $4.7 million U.S. dollars). The acquisition was recorded under the purchase method of accounting. KastenNet is a direct access provider that employs proprietary technology to connect its clients, Canadian broker-dealers, to the TSE. We acquired the assets of KastenNet via KTG, a new wholly-owned subsidiary of ITG. The purchase price has been allocated to assets acquired and liabilities assumed based upon estimated fair market values at the date of acquisition. A software license we acquired amounting to $4.2 million U.S. dollars is being amortized on a straight-line basis over a fifteen-year period.

ITG Hong Kong

        In June 2001, we announced the formation of ITG Hong Kong Ltd. Operations are expected to commence in the second half of 2002.

Inference Group LLC

        Inference is our asset management subsidiary. Inference serves as the general partner of Edge Fund I L.P. ("Edge Fund"), which manages a portion of our assets. As of December 31, 2001, Edge Fund was invested in a prime money market fund, which is included in cash and cash equivalents in our consolidated statement of financial position. We are the only limited partner in Edge Fund.

        Inference also manages Inference Arbitrage Fund I Ltd. ("Inference Fund"), an investment vehicle available to third party investors. In May 2001, ITG invested $10.0 million in Inference Fund on the same terms as third party investors in connection with the launch of Inference Fund. As of December 31, 2001, this investment is included at its $9.4 million fair value in investments in limited partnerships in our consolidated statement of financial position.

Regulation

        Certain U.S. and non-U.S. subsidiaries are subject to various securities regulations and capital adequacy requirements promulgated by the regulatory and exchange authorities of the countries in which they operate. In the US, the Securities and Exchange Commission ("SEC") is the federal agency responsible for the administration of the federal securities laws, with the regulation of broker-dealers primarily delegated to self-regulatory organizations ("SROs"), principally the National Association of Securities Dealers, Inc. ("NASD") and national securities exchanges. In addition to federal oversight, securities firms are also subject to regulation by state securities administrators in those states in which they conduct business. Furthermore, non-US subsidiaries are subject to regulation by central banks and regulatory bodies in those jurisdictions where each subsidiary is authorized to do business. The SROs, central banks and regulatory bodies conduct periodic examination of broker-dealers in accordance with the rules they have adopted and amended from time to time.

8

        ITG's principal regulated subsidiaries are discussed below.

•

ITG Inc. is a U.S. broker-dealer registered with the SEC, NASD, National Futures Association, Ontario Securities Commission ("OSC"), all 50 states, Puerto Rico and the District of Columbia. ITG Inc.'s principal regulator is the NASD.



•

AlterNet is a U.S. broker-dealer registered with the SEC, NASD and 12 states. AlterNet's principal regulator is the NASD.



•

ITG Canada is a Canadian broker-dealer registered with the Investment Dealers' Association ("IDA") and OSC.



•

ITG Australia, an Australian broker-dealer, is a participating organization of the Australian Stock Exchange Limited.



•

ITG Europe refers to Investment Technology Group Limited ("ITGL") and/or its wholly owned subsidiary Investment Technology Group Europe Limited ("ITGEL"). ITGL and ITGEL are authorized by the Central Bank of Ireland under Section 10 of the Investment Intermediaries Act, 1995. ITGEL London Branch is regulated by the Financial Services Authority for the conduct of investment business in the United Kingdom. ITGL is a member of the London Stock Exchange ("LSE"), Deutsche Boerse and Euronext.

        Broker-dealers are subject to regulations covering all aspects of the securities business, including sales methods, trade practices among broker-dealers, use and safekeeping of clients' funds and securities, capital structure of securities firms, record-keeping and conduct of directors, officers and employees. Additional legislation, changes in the interpretation or enforcement of existing laws and rules may directly affect the mode of operation and profitability of broker-dealers. The SEC, self-regulatory organizations, state securities commissions and foreign regulatory authorities may conduct administrative proceedings, which can result in censure, fine, the issuance of cease-and-desist orders or the suspension or expulsion of a broker-dealer, its officers or employees. The principal purpose of regulation and discipline of broker-dealers is the protection of clients and the securities markets, rather than the protection of creditors and stockholders of broker-dealers.

        ITG Inc. and AlterNet are required by law to belong to the Securities Investor Protection Corporation. In the event of a U.S. broker-dealer's insolvency, the Securities Investor Protection Corporation fund provides protection for client accounts up to $500,000 per customer, with a limitation of $100,000 on claims for cash balances. ITG Canada is required by Canadian law to belong to the Canadian Investors Protection Fund ("CIPF"). In the event of a Canadian broker-dealer's insolvency, CIPF provides protection for client accounts up to 1,000,000 Canadian dollars per customer.

Regulation ATS

        From the formation of the POSIT joint venture until the adoption of Regulation ATS, POSIT had operated under a "no-action" letter from the SEC staff that it would not recommend that the SEC commence an enforcement action if POSIT were operated without registering as an exchange. We are currently operating POSIT and SmartServers as part of our broker-dealer operations in accordance with Regulation ATS. Accordingly, POSIT and SmartServers are not registered with the SEC as an exchange. There can be no assurance that the SEC will not in the future seek to impose more stringent regulatory requirements on the operation of alternative trading systems such as POSIT and SmartServers. In addition, certain of the securities exchanges have actively sought to have more stringent regulatory requirements imposed upon automated trade execution systems. There can be no assurance that Congress will not enact additional legislation applicable to alternative trading systems.

9

Net Capital Requirement

        As registered broker-dealers, both ITG Inc. and AlterNet are subject to the SEC's uniform net capital rule. The net capital rule is designed to measure the general integrity and liquidity of a broker-dealer and requires that at least a minimum part of its assets be kept in a relatively liquid form.

        The net capital rule requires a broker-dealer doing business with the public to maintain certain minimum net capital standards. ITG Inc. is required to maintain net capital equal to the greater of $250,000 or 2% of its aggregate debit balances, as defined. As of December 31, 2001, ITG Inc. had net capital of $136.1 million, which exceeded minimum net capital requirements by $135.8 million.

        AlterNet is required to maintain net capital equal to the greater of $100,000 or 6²/3% of its aggregate indebtedness, as defined. As of December 31, 2001, AlterNet had net capital of $1.0 million, which was $0.9 million in excess of required net capital.

        Although we believe that the combination of our existing net regulatory capital and operating cash flows will be sufficient to meet regulatory capital requirements for each of ITG Inc. and AlterNet, a shortfall in net regulatory capital would have a material adverse effect on our business and our results of operations.

        In addition, ITG Canada, ITG Australia and ITG Europe had regulatory capital in excess of the minimum requirements applicable to each company as of December 31, 2001 of approximately $5.3 million, $1.3 million and $13.8 million, respectively.

License and Relationship with Barra

        In 1987, Jefferies & Company, Inc. and BARRA Inc. ("Barra") formed a joint venture for the purpose of developing and marketing POSIT. In 1993, Jefferies & Company, Inc. assigned all of its rights relating to the joint venture and the license agreement, discussed below, to us.

        The technology used to operate POSIT is licensed to us pursuant to a perpetual license agreement between ITG Inc. and the POSIT joint venture. The license agreement grants ITG Inc. the exclusive right to use certain proprietary software necessary to the continued operation of POSIT and a non-exclusive license to use proprietary software that operates in conjunction with POSIT. Under the license agreement, ITG Inc. pays quarterly royalties to the POSIT joint venture equal to specified percentages of the transaction fees we charge on each share crossed through POSIT. For the years ended December 31, 2001, 2000, and 1999, Barra earned aggregate royalty income in respect of POSIT of $23.7 million, $20.2 million, and $16.9 million, respectively, under the license agreement.

        The license agreement permits Barra on behalf of the joint venture to terminate the agreement upon certain events of bankruptcy or insolvency or upon an uncured breach by ITG Inc. of certain covenants, the performance of which are all within our control. Although we do not believe that we will experience difficulty in complying with our obligations under the license agreement, any termination of the license agreement resulting from an uncured default would have a material adverse effect on us.

        Under the license agreement and the terms of the joint venture, Barra continues to provide certain support services to ITG Inc. in connection with the operation of POSIT, including software updates and the availability of experienced personnel. Barra also provides support for the development and maintenance of POSIT.

        Under the terms of the joint venture, Barra generally has the right to approve any sale, transfer, assignment or encumbrance of our interest in the joint venture. The POSIT joint venture may earn a royalty from licensing the POSIT technology to other businesses. The joint venture licensed to ITG

10

Australia and ITG Europe the right to use the POSIT technology for crossing Australian and European equity securities.

Competition

        The automated trade execution and analysis services offered by us compete with services offered by leading brokerage firms and transaction processing firms, and with providers of electronic trading and trade order management systems and financial information services. POSIT also competes with various national and regional securities exchanges and execution facilities, the Nasdaq National Market, ATSs and ECNs for trade execution services. Many of our competitors have substantially greater financial, research and development and other resources. We believe that our services compete on the basis of access to liquidity, transaction cost and market impact cost reduction, timeliness of execution and probability of trade completion. Although we believe that POSIT, QuantEX, ITG Platform, the Electronic Trading Desk and our Research services have established certain competitive advantages, our ability to maintain these advantages will require continued investment in the development of our services, additional marketing activities and customer support services. There can be no assurance that we will have sufficient resources to continue to make this investment, that our competitors will not devote significantly more resources to competing services or that we will otherwise be successful in maintaining our current competitive advantages. In addition, we cannot predict the effect that changes in regulation may have on the competitive environment.

Research and Product Development

        We believe that fundamental changes in the securities industry have increased the demand for technology-based services. We devote a significant portion of our resources to the development and improvement of these services. Important aspects of our research and development effort include enhancements of existing software, the ongoing development of new software and services and investment in technology to enhance our efficiency. The software programs incorporated into our services are subject, in most cases, to intellectual property protection. Research and development costs were $19.7 million, $16.5 million, and $9.7 million for the years ended December 31, 2001, 2000, and 1999, respectively.

Dependence on Proprietary Intellectual Property; Risks of Infringement

        Our success is dependent, in part, upon our proprietary intellectual property. We generally rely upon patents, copyrights, trademarks and trade secrets to establish and protect our rights in our proprietary technology, methods and products. A third party may still try to challenge, invalidate or circumvent the protective mechanisms that we select. We cannot assure that any of the rights granted under any patent, copyright or trademark that we may obtain will protect our competitive advantages. In addition, the laws of some foreign countries may not protect our proprietary rights to the same extent as the laws of the U.S.

        In the past several years, there has been a proliferation of so-called "business method patents" applicable to the computer and financial services industries. There has also been a substantial increase in the number of such patent applications filed. Under current law, U.S. patent applications remain secret for 18 months and may, depending upon where else such applications are filed, remain secret until issuance of a patent. In light of these factors, it is not economically practicable to determine in advance whether our products or services may infringe the present or future patent rights of others. We believe that factors such as technological and creative skills of our personnel, new product developments, frequent product enhancements, name recognition and reliable product maintenance are essential to establishing and maintaining a state-of-the-art technological system. There can be no assurance that we will be able to protect our technology from disclosure or that others will not develop

11

technologies that are similar or superior to our technology. It is likely that from time to time, we will receive notices from others of claims or potential claims of intellectual property infringement or we may be called upon to defend a joint venture partner, customer, vendee or licensee against such third party claims. Responding to these kinds of claims, regardless of merit, could consume valuable time, result in costly litigation or cause delays, all of which could have a material adverse effect on us. Responding to these claims could also require us to enter into royalty or licensing agreements with the third parties claiming infringement. Such royalty or licensing agreements, if available, may not be available on terms acceptable to us.

Employees

        As of December 31, 2001, we employed 588 personnel globally.

Proposed Acquisition of Hoenig Group Inc.

        On February 28, 2002, we announced that we had entered into an agreement to acquire all of the outstanding common stock of Hoenig Group Inc. ("Hoenig") for cash consideration of approximately $115.0 million. Hoenig is expected to have approximately $48.0 million of cash and cash equivalents at the closing date. Hoenig is an agency broker-dealer that provides trade execution, independent research and consulting services to alternative investment funds and money managers globally. The acquisition is expected to close by June 30, 2002.

Item 2. Properties

U.S. Operations

        Our principal offices are located at 380 Madison Avenue in New York, New York. We currently lease the entire 4^th floor and a portion of the 5^thand 7^th floors or approximately 84,300 square feet of office space. A portion of the 7^th floor is currently being sublet. The fifteen-year lease terms for the 4^th and 5^th floors and the thirteen-year lease term for the 7^th floor expire in January 2013.

        We maintain a research, development and technical support services facility in Culver City, California where we occupy approximately 78,000 square feet of office space. We lease the California facility pursuant to lease agreements that expire in December 2005.

        Additionally, we maintain a backup and regional office in Boston, Massachusetts where we occupy approximately 21,300 square feet of office space. The ten-year lease term for this space expires in April 2005.

        Inference maintains an office in Waltham, Massachusetts where we occupy approximately 2,850 square feet of office space. The lease agreement expires in April 2003.

International Operations

        We have a research facility in Herzliya, Israel where we occupy approximately 8,000 square feet of office space. We lease the Israel space pursuant to a seven-year lease agreement that expires in December 2008.

        We have a trading facility in Toronto, Canada where we occupy approximately 5,600 square feet of office space. In addition, KTG, our new Canadian subsidiary, has approximately 5,000 square feet of office space. We lease ITG Canada's space pursuant to a seven-year lease agreement that expires in December 2007 and KTG's lease will expire in February 2003.

12

        We have trading facilities in Dublin, Ireland and London, England where we occupy approximately 4,000 and 5,000 square feet of office space, respectively. We lease the Dublin space pursuant to a seventeen-year lease agreement that expires in July 2018 and we lease the London space pursuant to a five-year lease agreement that expires in July 2005.

        We have trading facilities in Melbourne and Sydney, Australia where we occupy approximately 4,600 and 2,700 square feet of office space, respectively. We lease the Melbourne space pursuant to a three-year lease agreement that expires in June 2003 and we lease the Sydney space pursuant to a five-year lease agreement that expires in February 2006.

        During 2001, we opened a trading facility in Hong Kong where we occupy approximately 5,100 square feet of office space. The lease agreement expires in June 2004.

Item 3. Legal Proceedings

        In 1998, we received a "30-day letter" proposing certain adjustments which, if sustained, would result in a tax deficiency of approximately $9.6 million plus interest. The adjustments proposed relate to (i) the disallowance of deductions taken in connection with the termination of certain compensation plans at the time of our initial public offering in 1994 and (ii) the disallowance of tax credits taken in connection with certain research and development expenditures. On September 18, 2000, we entered into a closing agreement with the Internal Revenue Service ("IRS") with respect to the compensation plan deductions, whereby the IRS agreed that the deductions taken were allowable deductions. This agreement eliminates approximately $7.6 million of the $9.6 million potential tax deficiency raised by the IRS in 1998. We are continuing to pursue the resolution of the research and development tax credit issue and we believe that the ultimate resolution will not be material to the financial position or results of operations of our company.

        We are not currently a party to any other material legal proceeding.

Item 4. Submission of Matters to a Vote of Security Holders

        There were no matters submitted to a vote of security holders during the fourth quarter ended December 31, 2001.

13

PART II

Item 5. Market for Registrant's Common Stock and Related Stockholder Matters

Common Stock Data

        Our common stock trades on the New York Stock Exchange under the symbol "ITG". Effective December 7, 2001, our outstanding shares of common stock split three-for-two. High and low closing sales prices have been retroactively restated to reflect such split.

        The following table sets forth, for the periods indicated, the range of the high and low closing sales prices per share of our common stock as reported on the New York Stock Exchange.

        On March 22, 2002, the closing sales price per share for our common stock as reported on the New York Stock Exchange was $51.62. On March 22, 2002, we believe that our common stock was held by approximately 9,300 stockholders of record or through nominees in street name accounts with brokers.

        Our dividend policy is to retain earnings to finance the operations and expansion of our businesses. We do not anticipate paying any cash dividends on our common stock in the foreseeable future.

Item 6. Selected Financial Data

        The selected Consolidated Statement of Income data and the Consolidated Statement of Financial Condition data presented below as of and for each of the years in the five-year period ended December 31, 2001, are derived from our consolidated financial statements, which financial statements have been audited by KPMG LLP, our independent auditors. Earnings per share information prior to 1999 has been retroactively restated to reflect our spin-off from Jefferies Group. See Note 1, Organization and Basis of Presentation, in the Notes to Consolidated Financial Statements. In addition, earnings per share information for all periods has been retroactively restated to reflect our

14

three-for-two stock split in December 2001. Such selected financial data should be read in connection with the consolidated financial statements contained in this report.

15

        The following graph represents the number of shares ITG Inc. executed as a percentage of the market volume in the U.S. market since 1994.⁵

ITG U.S. Share Volume as Percentage of U.S. Market Volume

¹

Numbers are as of December 31^st of each year.

²

Total customers and POSIT customers include those U.S. customers who have generated revenues in excess of $1,000 in such year.

³

QuantEX and ITG Platform customers and customer installations include those customers and installations that have either (a) traded 100,000 shares in the last quarter of such calendar year or (b) traded shares on at least 12 different days during such quarter.

⁴

Share and earnings per share information have been retroactively restated to reflect the Company's spin-off from Jefferies Group in 1999 and the three-for-two stock split in December 2001.

⁵

The percentages on the graph are total ITG shares executed divided by the "market" volume. Total ITG shares executed includes total POSIT shares, shares executed by the Electronic Trading Desk and shares executed via Client Site Direct Access products. Market volume includes shares executed by and as provided by the New York Stock Exchange and the Nasdaq National Market. Market volume excludes ITG shares executed.

16

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

        The following discussion and analysis should be read in conjunction with our consolidated financial statements, including the notes thereto.

General

        In 2001, as we continued to expand globally, the Company's business structure was organized into two reportable segments: U.S. operations and international operations. The U.S. operations segment provides agency equity trading services and transaction research to institutional investors and brokers in the U.S. The international operations segment includes our agency brokerage businesses in Australia, Canada and Europe and our start-up brokerage operations in Asia, as well as a research facility in Israel.

Revenues:

        We generate substantially all of our revenues from the following three products and services:

•

POSIT: a confidential electronic stock crossing system;



•

Electronic Trading Desk: an agency-only trading desk;



•

Client Site Direct Access;



•

QuantEX: a Unix-based front-end software system providing market analysis, trade management and electronic connectivity to POSIT and multiple trade execution destinations;



•

ITG Platform: a PC-based front-end software system providing market analysis, trade management and electronic connectivity to POSIT and multiple trade execution destinations.

        Revenues primarily consist of commissions from customers' use of our trade execution and analytical services. Because these commissions are paid on a per-transaction basis, revenues fluctuate from period to period depending on the volume of securities traded through our services. We record as POSIT revenue any order that is executed on the POSIT system regardless of the manner in which the order was submitted to POSIT. ITG collects a commission from each side of a trade matched in POSIT. We record as Electronic Trading Desk revenue any order that is handled by our trading desk personnel and executed at any trade execution destination other than POSIT. We record as Client Site revenue any order that is sent by our clients, through ITG's Client Site systems but without assistance from the Electronic Trading Desk, to any third party trade execution destination. Other revenues include (a) interest income/expense, (b) market gains/losses and financing costs resulting from temporary positions in securities assumed in the normal course of our agency trading business, (c) fees for development and other services provided to our unconsolidated international affiliates prior to our acquisition of the remaining interests in ITG Australia and ITG Europe, (d) realized gains and losses in connection with our cash management and strategic investment activities and (e) income from positions taken by ITG Canada arising from customer facilitations which are a customary practice in the Canadian marketplace.

Expenses:

        Expenses consist of compensation and employee benefits, transaction processing, software royalties, occupancy and equipment, telecommunications and data processing services, net (gain)/loss on long-term investments, spin-off costs and other general and administrative expenses. Compensation and

17

employee benefits expenses include base salaries, bonuses, employment agency fees, part-time employee compensation, fringe benefits, including employer contributions for medical insurance, life insurance, retirement plans and payroll taxes, less the portion of salaries that is capitalized as part of our software development activities. Transaction processing expenses consist of floor brokerage and clearing fees and connection fees for use of certain third party execution services. Software royalties are payments to our POSIT joint venture partner, Barra. Occupancy and equipment expenses include rent, depreciation, amortization of leasehold improvements, maintenance, utilities, occupancy taxes. Telecommunications and data processing services include costs for computer hardware, infrastructure enhancements, data center equipment, market data services and voice, data, telex and network communications. Net (gain)/loss on long-term investments includes equity gain/loss on joint venture investments. Spin-off costs include legal, accounting, consulting and various other expenses in connection with the spin-off from Jefferies Group and related transactions. Other general and administrative expenses include amortization of software, goodwill and other intangible assets, legal, audit, tax, consulting and promotional expenses.

        In November 2000, we completed the purchase from BBY and certain employees of ITG Australia of the remaining 50% interest in ITG Australia that we did not already own, bringing our ownership up to 100%. The acquisition was accounted for under the purchase method of accounting. The $5.0 million cost exceeded the estimated fair value of the net assets acquired by $3.7 million. The excess of the purchase price over the estimated fair value of the net assets acquired has been allocated to goodwill and is being amortized on a straight-line basis over a twenty-year period.

        In the fourth quarter of 1998, we entered into a 50/50 joint venture with Société Générale, and founded ITG Europe. On November 18, 1998, ITG Europe launched a new agency brokerage operation that included the operation of a European version of the POSIT system. On May 2, 2001, we purchased Société Générale's entire interest in ITG Europe for $18.5 million. The acquisition was recorded under the purchase method of accounting. The purchase price has been allocated to assets acquired and liabilities assumed based upon estimated fair market values at the date of acquisition. Goodwill and other intangibles amounting to $16.7 million are being amortized on a straight-line basis over their estimated useful lives, which range from 9 to 34 years.

        On September 28, 2001, we acquired the KastenNet business of Kasten Chase Applied Research Limited for $7.4 million Canadian dollars (approximately $4.7 million U.S. dollars). The acquisition was recorded under the purchase method of accounting. KastenNet is a direct access provider that employs proprietary technology to connect its clients, Canadian broker-dealers, to the Toronto Stock Exchange. We acquired the assets of KastenNet via KTG Technologies Corporation, a new wholly-owned subsidiary of ITG. The purchase price has been allocated to assets acquired and liabilities assumed based upon estimated fair market values at the date of acquisition. A software license we acquired amounting to $4.2 million U.S. dollars is being amortized on a straight-line basis over a fifteen-year period.

        The consolidated financial statements include the results of operations of the above businesses from their respective dates of acquisition. At December 31, 2001 and 2000, accumulated amortization related to goodwill and other intangibles totaled $6.3 and $5.2 million, respectively.

18

Results of Operations

        The table below sets forth certain items in the statement of income expressed as a percentage of revenues for the periods indicated:

Year Ended December 31, 2001 Compared to Year Ended December 31, 2000

Earnings Per Share

        Basic earnings per share for 2001 and 2000 were $1.65 and $1.37, respectively. Diluted earnings per share increased $0.28, or 21%, from $1.34 to $1.62. Earnings per share have been retroactively restated to reflect a three-for-two stock split in December 2001.

Revenues

        Total revenues increased $67.0 million, or 22%, from $310.4 million to $377.4 million. Revenues from U.S. operations increased $44.2 million, or 14%, from $306.8 million to $351.0 million. Revenues from international operations increased seven fold or $22.8 million from $3.6 million to $26.4 million. There were 248 U.S. trading days in 2001 and 252 U.S. trading days in 2000, reflecting the four-day closure of the U.S. financial markets from September 11 through September 14, 2001. Revenues per trading day increased by $290,000, or 24%, from $1,232,000 to $1,522,000. Consolidated revenues per average number of employees decreased $123,000, or 15%, from $843,000 to $720,000, due to a total headcount increase of 145 primarily resulting from our consolidation of ITG Australia in November 2000 and ITG Europe in May 2001 as well as the start-up of ITG Canada in the second quarter of 2000. U.S. revenues per average number of employees decreased $38,000, or 4%, from $912,000 to $874,000. The increase in headcount outpaced the increase in revenues from international operations as ITG Europe and ITG Canada are still in their early stage of development.

19

        Consolidated POSIT revenues increased $31.5 million or 20% reflecting higher share volume and the consolidation of ITG Australia and ITG Europe included in 2001. ITG Europe contributed $8.2 million and ITG Australia contributed $1.3 million to consolidated POSIT revenues in 2001. International POSIT revenues included in the consolidated financial statements in 2000 amounted to $0.1 million. The number of shares crossed on the U.S. POSIT system increased 1.39 billion, or 18%, from 7.86 billion in 2000 to 9.25 billion in 2001. The number of shares crossed on the U.S. POSIT system per trading day increased 6.2 million, or 20%, from 31.1 million in 2000 to 37.3 million in 2001.

        Electronic Trading Desk revenues increased 34% due to both an increase in U.S. share volume in 2001 and the inclusion of $12.9 million of revenues from ITG Australia, ITG Canada and ITG Europe for which only $497,000 of revenues were reported in 2000.

        Client Site revenues increased 23% resulting from a 68% increase in share volume in 2001, partially offset by a 27% decrease in average Client Site revenue per share. The decrease in average Client Site revenue per share reflects, in part, growth in our lower priced routing only services, where we do not incur transaction processing costs.

        Other revenues decreased 41% primarily as a result of the gain of $4.3 million, or 84% of the decrease, recognized in 2000, from the sale of our investment in Versus Technologies, Inc. Also contributing to the decrease was a reduction of $3.1 million, from $4.5 million in 2000 to $1.4 million in 2001, in connection with fees for development and other services provided to our unconsolidated international affiliates, prior to our acquisition of the remaining interests in ITG Australia and ITG Europe, and a $2.4 million writedown on our venture capital investment in the Angel Investors II, L.P. fund as a result of a decrease in fair value. This was partially offset by (i) an increase in interest and investment income as a result of higher average invested balances partially offset by a decrease in average interest rates, (ii) a $1.2 million gain on the sale of our investment in Advanced Investment Technology, Inc., an asset management company, and (iii) inclusion of revenues from KTG of $0.7 million (following the September 28, 2001 acquisition of the KastenNet business of Kasten Chase).

Expenses

        Total expenses excluding income tax expense for 2001 increased $43.9 million, or 22%, from $197.4 million to $241.3 million.

        The following table itemizes expenses by category (in thousands):

        Compensation and employee benefits:    Salaries, bonuses and related employee benefits increased primarily due to growth in our employee base of 145 employees or 33% from 443 at December 31, 2000 to 588 at December 31, 2001. A total of 63 employees, or approximately 43% of the increase, related to the consolidation of ITG Europe, and the addition of employees arising from the KastenNet acquisition and the start-up of our operation in Hong Kong. Additionally, 35% percent of the increase related to new staff in technology, product development, sales and trading and production

20

infrastructure. Total compensation and employee benefits as a percentage of revenues increased from 24.9% in 2000 to 27.5% in 2001. This 2.6% increase is mainly attributable to the consolidation of the international operations, primarily the operations of ITG Europe and ITG Canada which are still at an early stage of their lifecycle, while the U.S. percentage increased primarily due to four fewer trading days during 2001. Average compensation and employee benefits expenses per (average) headcount decreased $12,000, or 6%, from $210,000 to $198,000.

        Transaction processing:    Transaction processing as a percentage of revenues decreased from 14.2% to 13.1%. This includes transaction costs incurred by ITG Australia, ITG Canada and ITG Europe that were not included in 2000. U.S. transaction costs as a percentage of revenues decreased from 14.3% in 2000 to 12.8% in 2001. Despite our share volume growth, U.S. clearing and execution costs as a percentage of revenues declined primarily from rate reductions negotiated with our clearing vendor. This was partially offset by ECN execution costs which, in the U.S., increased $4.2 million or 43% from $9.8 million in 2000 to $14.0 million in 2001 reflecting higher ECN volume, which more than doubled from 2000. The impact of higher ECN execution volume was partially offset by significant cost savings achieved through rate reductions and from a higher share of executions being made through lower unit cost ECN providers.

        Software royalties:    Because software royalties are contractually fixed as a percentage of POSIT revenues, the increase is entirely attributable to an increase in POSIT revenues.

        Occupancy and equipment:    Depreciation and amortization on furniture, fixtures and equipment, and office rent were the main contributors to the $3.7 million increase in 2001 compared to 2000. The international operations accounted for $2.2 million, or 59% of the increase, following the opening of additional offices in June 2000 in Toronto, Canada and the inclusion of space utilized by ITG Australia and ITG Europe subsequent to consolidation of these entities in November 2000 and May 2001, respectively. The U.S. operations represented $1.5 million, or 41% of the increase, primarily from incremental depreciation and amortization, U.S. headcount increases and upgrades of infrastructure.

        Telecommunications and data processing services:    Telecommunications and data processing services as a percentage of revenues remained flat at 4.0%. The additional costs were due to the inclusion of ITG Australia, ITG Canada and ITG Europe, which had only an immaterial impact in 2000. ITG Canada's operations began in June 2000, and ITG Australia and ITG Europe were consolidated in November 2000 and May 2001, respectively.

        Net (gain) loss on long-term investments:    In 2001, we recognized a gain of $1.9 million through our ITG Europe joint venture relating to the sale of 100,000 shares of stock that ITG Europe held in the LSE which were received at the time of the LSE demutualization in the year 2000. The reported gain on long-term investments of $0.3 million was net of our $1.6 million share of ITG Europe's operating loss prior to consolidation in May 2001. In 2000, we recognized a loss on long-term investments primarily resulting from the start-up costs of our Vostock joint venture with SoundView Technology Group, Inc. combined with losses on our ITG Europe joint venture relating to the development and marketing costs of our European expansion. Vostock was developed to provide an on-line auction market for secondary share offerings to supplement the traditional distribution methods for secondary offerings. The Vostock product was never launched and we and SoundView have ceased our expenditures on Vostock.

        Other general and administrative:    The increase in other general and administrative expenses reflects a $2.0 million increase in consulting fees for software development initiatives, the addition of $2.5 million of costs incurred by ITG Australia, ITG Canada, ITG Europe and ITG Hong Kong, as well as a $0.5 million increase in software amortization for certain products that were released in the fourth quarter of 2000. In 2001, we made a charitable contribution to the New York Times 9/11 Neediest Fund in the amount of $1.1 million following the tragic events of September 11, 2001.

21

Income Tax Expense

        The decrease in the effective tax rate from 43.7% in 2000 to 42.0% in 2001 was primarily due to decreases in state and local income taxes.

Year Ended December 31, 2000 Compared to Year Ended December 31, 1999

Earnings Per Share

        Basic earnings per share for 2000 and 1999 were $1.37 and $0.99, respectively. Diluted earnings per share increased $0.39, or 41%, from $0.95 to $1.34. Diluted earnings per share for 2000 and 1999, excluding non-recurring charges (net of tax benefits) of $3.9 million, in 1999, incurred in connection with our spin-off from Jefferies Group, were $1.34 and $1.03, respectively. Earnings per share have been retroactively restated to reflect a three-for-two stock split in December 2001.

Revenues

        Total revenues increased $78.4 million, or 34%, from $232.0 million to $310.4 million. Revenues from U.S. operations increased $76.6 million, or 33%, from $230.2 million to $306.8 million. Revenues from international operations increased $1.7 million, or 89%, from $1.9 million to $3.6 million. There were 252 trading days in both 1999 and 2000. Revenues per trading day increased by $311,000, or 34%, from $921,000 to $1,232,000. Revenues per average number of employees increased $50,000, or 6%, from $793,000 to $843,000.

        The number of shares crossed on the POSIT system increased 1.3 billion, or 21%, from 6.5 billion to 7.8 billion which drove the $25.2 million or 19% POSIT revenue increase from $129.4 million in 1999 to $154.6 million in 2000. The number of shares crossed on the POSIT system per day increased 5.4 million, or 21%, from 25.7 million to 31.1 million. Client Site revenues increased 49% reflecting an increase in share volume of 2.4 billion or 77%, from 3.1 billion in 1999 to 5.5 billion in 2000. The increase in share volume was partially offset by an 18% decrease in average Client Site revenue per share in 2000 attributable, in part, to growth in executions by our clients through ECNs. Electronic Trading Desk revenues increased 41% primarily from an increase in share volume of 1.0 billion or 50% from 2.0 billion in 1999 to 3.0 billion in 2000, partially offset by an 8% decrease in the average revenue per share in 2000 attributable, in part, to growth in executions by our clients through ECNs. Other revenues increased primarily due to (a) a gain recorded on the sale of our remaining investment in Versus Technologies, Inc., (b) increases in investment income arising from larger average interest-earning balances and improved rates of return and (c) international development fee income, which were partially offset by interest costs incurred on accelerated settlement of transactions in the normal course of business.

Expenses

        Total expenses excluding income tax expense for 2000 increased $48.2 million, or 32%, from $149.2 million to $197.4 million.

22

        The following table itemizes expenses by category (in thousands):

        Compensation and employee benefits:    Salaries, bonuses and related employee benefits increased primarily due to growth in our employee base of 125 employees or 39% from 318 to 443, payment of additional compensation necessary to attract and retain quality personnel and increased bonus expense due to our performance-based compensation plan. Approximately 44% of the increase in employees were staffed in technology, product development and production infrastructure and 38% of the increase in employees related to the addition of Canada and Australia. Average compensation and employee benefits expenses per (average) headcount increased $33,000, or 19%, from $177,000 to $210,000.

        Transaction processing:    Transaction processing as a percentage of revenues increased from 13.9% to 14.2% of revenues. ECN costs increased $8.4 million from $1.4 million in 1999 to $9.8 million in 2000. Additionally, clearing costs increased by $4.6 million in 2000 from $14.8 million in 1999 to $19.4 million in 2000 as a result of share volume increases and a decrease in the average ticket size. Partially offsetting the increases were decreases in Super DOT costs, primarily specialist charges, due to a pricing change which eliminated NYSE specialist charges for trades executed within 5 minutes as compared to 2 minutes in 1999.

        Software royalties:    Because software royalties are contractually fixed as a percentage of POSIT revenues, the increase is wholly attributable to an increase in POSIT revenues.

        Occupancy and equipment:    The increase in headcount and infrastructure enhancements resulted in increased equipment purchases and the associated depreciation and maintenance expenses. In addition, rent expense increased due to the expansion of our research and development facility in Culver City, California, and our New York headquarters, as well as the opening of additional offices during 2000 in Toronto, Canada and Waltham, Massachusetts.

        Telecommunications and data processing services:    Increases in our client base and employee base resulted in additional client data services, including market data line connections, increased communication charges to link clients to ITG in New York and Boston, and for infrastructure improvements to accommodate volume growth and the move to decimalization. Telecommunications and data processing services as a percentage of revenues decreased slightly to 4.0% in 2000 from 4.1% in 1999.

        Net loss on long-term investments:    The increase in loss on long-term investments in 2000 over 1999 primarily resulted from the recorded losses incurred by our European joint venture, a $944,000 loss from our Vostock joint venture with Wit SoundView and the effect of the deferred gain on the sale of the LongView Group, realized in 1999, after having been held in escrow for one year.

23

        Other general and administrative:    The increase in other general and administrative expenses reflects an increase in legal, accounting and consulting professional fees along with increased spending on business development. These expenses were partially offset by lower software amortization for certain products that were released in late 1998, which had increased the related expense in 1999.

Income Tax Expense

        The decrease in the effective tax rate from 45.2% in 1999 to 43.7% in 2000 was due to decreases in state and local income taxes partially offset by higher nondeductible foreign losses in 2000.

Dependence on Major Customers

        During 2001, revenue from our 10 largest customers accounted for approximately 29.6% of our consolidated revenue while revenue from each of our three largest customers accounted for 4.8%, 4.6%, and 3.9%, respectively, of consolidated revenue. During 2000, revenue from our 10 largest customers accounted for approximately 31.4% of our consolidated revenue while revenue from each of our three largest customers accounted for 6.4%, 5.1%, and 4.5%, respectively, of consolidated revenue. During 1999, revenue from our 10 largest customers accounted for approximately 33.0% of our consolidated revenue while revenue from each of our three largest customers accounted for 5.8%, 4.7% and 4.7%, respectively, of consolidated revenue. Customers may discontinue use of our services at any time. The loss of any significant customers could have a material adverse effect on our results of operations. In addition, the loss of significant POSIT customers could result in lower share volumes of securities submitted to POSIT systems around the world, which may adversely affect the liquidity of systems.

Liquidity and Capital Resources

        Our liquidity and capital resource requirements result from our working capital needs, primarily consisting of compensation and benefits, transaction processing fees and software royalty fees. Historically, cash from operations has met all working capital requirements. A substantial portion of our assets are liquid, consisting of cash and cash equivalents or assets readily convertible into cash.

        We believe that our cash flow from operations and existing cash balances will be sufficient to meet our cash requirements. We generally invest our excess cash in money market funds and other short-term investments that generally mature within 90 days or less. Additionally, securities owned at fair value include highly liquid, state and municipal obligations, auction rate preferred stock and common stock. At December 31, 2001, cash equivalents and securities owned at fair value amounted to $299.4 million and net receivables from brokers, dealers and other, of $12.5 million were due within 30 days. At December 31, 2001, cash and cash equivalents included deposits at clearing firms totaling $3.5 million.

        We also invest a portion of our excess cash balances in cash enhanced strategies, which we believe should yield higher returns without any significant effect on risk. As of December 31, 2001, we had investments in limited partnerships investing in marketable securities and a venture capital fund amounting to $25.6 million in the aggregate. The limited partnerships employ either a hedged convertible strategy or a long/short strategy to capitalize on short term price movements.

        Cash flows from operating activities reached $125.2 million for the year ended December 31, 2001, an increase of $28.6 million from the prior year. The increase is primarily attributable to the growth in net income and other changes in working capital, partially offset by the decrease in the tax benefit from employee stock options, reflecting the exercise by employees of stock options with higher strike prices. Net cash used in investing activities was $44.3 million for the year ended December 31, 2001, an increase of $22.4 million from the prior year. This increase is primarily related to the $17.8 million purchases of (i) the remaining 50% stake in the ITG Europe joint venture and (ii) the assets of

24

KastenNet via KTG Technologies Corporation in Canada, net of cash acquired. In 2001, the Company also invested $11.0 million in limited partnerships. Net cash provided by financing activities was $20.8 million for the year ended December 31, 2001, an increase of $12.7 million from the prior year when the Company purchased $9.7 million worth of its common stock as part of the Company's share buy back program.

        For the year ended December 31, 2000, cash flows from operating activities were $96.6 million, a decrease of $9.4 million from the prior year, reflecting working capital changes. Net cash used in investing activities was $21.9 million, an improvement of $5.5 million from the prior year, reflecting lower investments in limited partnerships, partially offset by higher capital expenditures. Net cash provided by financing activities was $8.1 million for the year ended December 31, 2000, an improvement of $111.3 million from the prior year when the Company (i) paid a $74.6 million special cash dividend in connection with the spin-off from Jefferies Group and (ii) purchased $58.1 million worth of its common stock.

        As of December 31, 2001, the Company's contractual obligations and other commercial commitments consisted principally of minimum future rentals under non-cancelable operating leases as follows (dollars in thousands):

        On February 28, 2002, we announced that we had entered into an agreement to acquire all of the outstanding common stock of Hoenig for cash consideration of approximately $115.0 million. Hoenig is expected to have approximately $48.0 million of cash and cash equivalents at the closing date. The acquisition is expected to close by June 30, 2002. We anticipate funding the purchase price from our existing cash balances.

        Historically, all regulatory capital needs of ITG Inc. and AlterNet have been provided by cash from operations. We believe that cash flows from operations will provide ITG Inc. and AlterNet with sufficient regulatory capital. As of December 31, 2001, ITG Inc. and AlterNet had net excess regulatory capital of $135.8 million and $0.9 million, respectively. In addition, ITG Canada, ITG Australia and ITG Europe had regulatory capital in excess of the minimum requirements applicable to each company as of December 31, 2001 of approximately $5.3 million, $1.3 million and $13.8 million, respectively. Although we believe that the combination of our existing net regulatory capital and operating cash flows will be sufficient to meet regulatory capital requirements, a shortfall in net regulatory capital would have a material adverse effect on us.

Recent Accounting Pronouncements

        In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 141, "Business Combinations" ("SFAS No. 141") and SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142"), effective for fiscal years beginning after December 15, 2001 and immediately applicable to business combinations occurring after June 30, 2001. Under the new rules, all business combinations are accounted for using the purchase method. In addition, goodwill and some intangible assets deemed to have indefinite lives will no longer be amortized but will be subject to

25

annual impairment tests in accordance with the new standards. Other intangible assets will continue to be amortized over their useful lives.

        The adoption of SFAS No. 142 in the first quarter of 2002 will impact the goodwill associated with our completed acquisitions of ITG Australia and ITG Europe. The new rules were applied on our September 28, 2001 acquisition of the assets of KastenNet via KTG. Discontinuance of goodwill amortization is not expected to materially impact future earnings. We expect to perform the required impairment test of our goodwill in the second quarter of 2002, as of January 1, 2002. We do not anticipate that these tests will have a material effect on our consolidated financial statements.

        In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations" ("SFAS No. 143"), which is effective for fiscal years beginning after June 30, 2001. SFAS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated retirement costs. In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144"), which is effective for fiscal years beginning after December 31, 2001. SFAS No. 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets. The adoption of SFAS No. 143 and SFAS No. 144 in the first quarter of 2002 is not expected to have a material effect on our results of operations, financial position or cash flows.

Issues and Uncertainties

        While our management's expectations for the future are optimistic, the following issues and uncertainties, among others, should be considered in evaluating our growth outlook.

Financial Market Conditions and Economic Conditions

        Our business is materially affected by conditions in both domestic and foreign financial markets. The demand for our securities brokerage and related services are also directly affected by factors such as economic and political conditions that may lead to decreased trading activity and prices in the securities markets generally. The future economic environment will be subject to periodic economic downturns, such as recessions, which could also result in reduced trading volumes and prices, which could materially harm our business, financial condition and operating results.

Decreases in Trading Volumes or Market Prices

        Declines in the volume of securities trading and in market liquidity generally result in lower revenues from our POSIT, Client Site and Electronic Trading Desk products. In addition, our trading commissions outside the U.S. and Canada are based on the value of transactions (rather than volume based), which would be adversely affected by price declines. Our profitability would be adversely affected by a decline in trading revenues because a significant portion of our costs is fixed. For these reasons, decreases in trading volume or securities prices could have a material adverse effect on our operating results.

Regulation

General

        The securities markets and the brokerage industry in which we operate are subject to extensive regulation in the United States and other jurisdictions around the world. We face the risk of significant intervention by regulatory authorities in all jurisdictions in which we conduct business. In our case, the impact of regulation extends beyond "traditional" areas of securities regulation, such as disclosure and prohibitions on fraud and manipulation by market participants, to the regulation of the structure of markets.

26

        The securities industry has been subject to several fundamental regulatory changes. In the future, the industry may become subject to new regulations or changes in the interpretation or enforcement of existing regulations, which may adversely affect our business. The markets for equity securities have been subject to the most significant regulatory changes. We cannot predict the extent to which any future regulatory changes can affect our business.

Regulation ATS

        Before Regulation ATS went into effect on April 21, 1999, we operated POSIT pursuant to a "no-action" letter from the SEC staff which stated that it would not commence an enforcement action if POSIT were operated without registering as an exchange. We are currently operating POSIT and SmartServers as part of our broker-dealer operations in accordance with Regulation ATS. Accordingly, neither POSIT nor our SmartServers are registered with the SEC as an exchange. There can be no assurance that the SEC will not in the future seek to impose more stringent regulatory requirements on the operation of alternative trading systems such as POSIT and SmartServers. There can be no assurance that Congress will not enact additional legislation applicable to alternative trading systems.

Net Capital Requirement

        Each of our broker-dealer subsidiaries is subject to regulatory capital requirements promulgated by the regulatory and exchange authorities of the countries in which they operate. The failure by any of these subsidiaries to maintain its required regulatory capital may lead to suspension or revocation of its broker-dealer registration and its suspension or expulsion by U.S. or international regulatory bodies, and ultimately could require its liquidation.

Competition

        The financial services industry generally, and the securities brokerage business in which we engage in particular, is extremely competitive, and we expect it to remain so. The brokerage and related services offered by us compete with services provided by leading brokerage firms and transaction processing firms and with providers of electronic trading and trade order management systems and financial information services. POSIT also competes with various national and regional securities exchanges and execution facilities, the Nasdaq National Market, ATSs and ECNs for trade execution services. Many of our competitors have substantially greater financial, technical, marketing and other resources. Many of them offer a wider range of services, have broader name recognition and have larger customer bases than we do. Outside the United States, in addition to our U.S. competitors with international capabilities, we compete with non-U.S. financial service companies that may also have long-standing, well-established relations with their clients, some of which also hold dominant positions in their trading markets. We compete on the basis of a number of factors, including access to liquidity, transaction execution, our products and services, innovation, reputation and price.

Insufficient System Capacity or System Failures

        Our business relies heavily on the computer and communications systems supporting our operations. Peak trading times and times of unusual market volatility could cause our systems to operate slowly or even fail for periods of time. General power or telecommunications failures or natural disasters could cause blackouts in our systems. The presence of computer viruses can also cause failure of our systems. As our business expands, we will need to expand our systems to accommodate an increasing volume of transactions. If any of our systems do not operate properly or are disabled, we could incur financial loss, liability to clients, regulatory intervention or reputational damage. System failure or degradation could lead our customers to file formal complaints with industry regulatory organizations, initiate regulatory inquiries or proceedings, file lawsuits against us, trade less frequently through us or cease doing business with us.

27

Rapid Changes in Technology

        Due to the high demand for technology-based services in the securities industry, we are subject to rapid technological change and evolving industry standards. Also, customer demands become greater and more sophisticated as the dissemination of information to customers increases. If we are unable to anticipate and respond to the demand for new services, products and technologies in a timely and cost-effective manner and to adapt to the technological advancements and changing standards, we will be less able to compete effectively, which could have a material adverse effect on our business.

Credit Risk

        We are exposed to credit risk from third parties that owe us money, securities, or other obligations, including our customers and trading counterparties. These parties may default on their obligations to us due to bankruptcy, lack of liquidity, operational failure or other reasons. Substantially all of the clearing and depository operations for our broker-dealer subsidiaries are performed pursuant to clearing agreements with their clearing brokers, who review the credit risk of trading counterparties, as deemed necessary. Volatile securities markets, credit markets and regulatory changes increase our exposure to credit risk, which could adversely affect our financial condition and operating results.

License and Relationship with Barra

        We have a perpetual license with the POSIT joint venture, which is a joint venture we have with Barra. The license grants ITG Inc. the exclusive right to use certain proprietary software necessary to the continued operation of POSIT and a non-exclusive license to use proprietary software that operates in conjunction with POSIT. The license agreement permits Barra on behalf of the joint venture to terminate the agreement upon certain events of bankruptcy or insolvency or upon an uncured breach by ITG Inc., of certain covenants, the performance of which are all within our control. Although we do not believe that we will experience difficulty in complying with our obligations under the license agreement, any termination of the license agreement resulting from an uncured default would have a material adverse effect on us. The POSIT joint venture also licensed to ITG Australia Limited and ITG Europe the right to use the POSIT technology for crossing Australian and European equity securities. These licenses contain substantially the same default and termination provisions as the U.S. license.

Research and Product Development

        In connection with our research and product development activities, as well as capital expenditures to improve other aspects of our business, we incur substantial expenses that do not vary directly, at least in the short term, with fluctuations in securities transaction volumes and revenues. In the event of a material reduction in revenues, we may not be able to reduce such expenses quickly and, as a result, we could experience reduced profitability or losses. Conversely, sudden surges in transaction volumes can result in increased profit and profit margin. To ensure that we have the capacity to process projected increases in transaction volumes, we have historically made substantial capital and operating expenditures in advance of such projected increases, including during periods of low transaction volumes. In the event that such growth in transaction volumes does not occur, the expenses related to such investments could cause reduced profitability or losses.

Changes in Our Customer Base

        Changes in our customer base (which includes institutional investors, portfolio managers, hedge funds and broker-dealers) can materially affect our profitability and net income. A substantial portion of our revenue is derived from our 10 largest customers. The loss of any significant customer could have a material adverse effect on our results of operations. In addition, the loss of significant POSIT customers could result in lower share volumes of securities submitted to POSIT, which may adversely

28

affect the liquidity of the system, which could reduce its attractiveness to our customers and adversely affect our trading volumes, operating results and financial condition.

Dependence on Third Party Suppliers for Key Services

        We depend on a number of third parties to supply elements of our trading systems, computers and other equipment, and related support and maintenance. We cannot be certain that any of these providers will be able to continue to provide these services in an efficient and cost-effective manner or that they will be able to meet our expanding needs. If we are unable to make alternative arrangements for the supply of these services in the event of a disruption in the services, our business, financial condition and operating results could be materially harmed.

Risks of Infringement of our Intellectual Property Rights

        We rely upon patents, copyrights, trademarks and trade secrets to establish and protect our rights in our proprietary technology, methods and products. However, a third party may still try to challenge, invalidate or circumvent the mechanisms we select to protect our rights. In addition, the laws of some foreign countries may not protect our proprietary rights to the same extent as the laws of the U.S.

        In the past several years, there has been a proliferation of so-called "business method patents" applicable to the computer and financial services industries. Under current law, U.S. patent applications remain secret for 18 months and may, depending upon where else such applications are filed, remain secret until issuance of a patent. Thus it is not economically practicable to determine in advance whether our products or services may infringe the present or future patent rights of others. There can be no assurance that we will be able to protect our technology from disclosure or that others will not develop technologies that are similar or superior to our technology. It is likely that from time to time we may also face claims that use of technology material to our business operations infringes on rights of third parties or we may be called upon to defend a joint venture partner, customer or licensee against such third party claims, which could consume valuable time, result in costly litigation or cause delays, all of which could have a material adverse effect on our business.

29

Item 7A. Quantitative and Qualitative Disclosure About Market Risk

Market Price Risk

        As part of our company's full service equity trade execution business we do not engage in proprietary trading; however, at times we do hold positions overnight due to client or Company errors. Accordingly, we maintain policies and procedures regarding the management of our errors and accommodations proprietary trading accounts. It is our policy to attempt to trade out of all positions arising from errors and accommodations immediately while balancing our exposure to market risk, which can arise from liquidating such positions. Accordingly, certain positions may be liquidated over a period of time in an effort to minimize market impact.

        We have established approval policies that include review by a Supervisory Principal of any proprietary trading activity. Our operations department reviews all open trades intraday in an effort to ensure that any open issues are addressed and resolved by the close of the trading day. Additionally, our clearing broker notifies us of all known trade discrepancies on the day following the trade date.

        We employ a cash management strategy which seeks to optimize excess liquid assets by preserving principal, maintaining liquidity to satisfy capital requirements, minimizing risk and maximizing our after tax rate of return. For working capital purposes, we invest only in money market instruments. Cash balances that are not needed for normal operations are invested in a tax efficient manner in instruments with appropriate maturities and levels of risk to correspond to expected liquidity needs. We currently have investments in municipal bonds, auction rate preferred bonds and common stock. To the extent that we invest in marketable equity securities, we ensure portfolio liquidity by investing in marketable securities with active secondary or resale markets. We do not use derivative financial instruments in our investment portfolio. A portion of the investments under our cash management strategy are managed by Inference, our asset management subsidiary, which conducts its trading activities on our behalf in accordance with investment strategies reviewed with senior management and is subject to oversight by our Chief Financial Officer. At December 31, 2001 and 2000, our cash and cash equivalents and securities owned were approximately $299.4 million and $187.3 million, respectively.

        We will from time to time, make investments that are considered strategic. These investments require approval of executive management and/or the board of directors. This component of our cash management strategy is reevaluated periodically. At December 31, 2001 and 2000, investments in limited partnerships investing in marketable securities and a venture capital fund were approximately $25.6 million and $29.5 million, respectively.

Interest Rate Risk

        Our exposure to interest rate risk relates primarily to the interest-bearing portions of our investment portfolio. Our policy is to invest in high quality credit issuers, limit the amount of credit exposure to any one issuer and invest in tax efficient strategies. Our first priority is to reduce the risk of principal loss. We seek to preserve our invested funds by limiting default risk, market risk, and re-investment risk. We attempt to mitigate default risk by investing in high quality credit securities that we believe to be low risk and by positioning our portfolio to respond appropriately to reductions in the credit rating of any investment issuer or guarantor that we believe is adverse to our investment strategy.

        Our interest-bearing investment portfolio primarily consists of short-term, high-credit quality money market funds, highly liquid variable rate municipal securities and preferred stock. These investments totaled approximately $246.2 million and $156.3 million at December 31, 2001 and 2000, respectively. Our interest-bearing investments are not insured and because of the short-term high quality nature of the investments are not likely to fluctuate significantly in market value. For the years ended December 31, 2001 and 2000, we estimate that a hypothetical 100 basis point adverse change in

30

interest rates would have resulted in a $2.3 million and $1.3 million decline in the fair value of our portfolio, respectively.

Foreign Currency Risk

        We are seeking to expand globally in a variety of ways, including our operations in Canada, Australia, Europe and Hong Kong, and through the development of specially tailored versions of our services. Additionally, we maintain development facilities in Israel. Our investments and development activities in these countries expose us to currency exchange fluctuations between the U.S. Dollar and the British Pound Sterling, Australian Dollar, Canadian Dollar, Euro, Hong Kong Dollar and Israeli New Shekel. To the extent that our international activities recorded in local currencies increase in the future, our exposure to fluctuations in currency exchange rates will correspondingly increase. We have not engaged in foreign currency hedging activities. However, non-U.S. dollar cash balances held overseas are generally kept at levels necessary to meet current operating and capitalization needs. For the years ended December 31, 2001 and 2000, we estimate that a hypothetical 10% adverse change in foreign exchange rates would have resulted in a $2.6 million and $0.4 million loss in revenue from our foreign operations, respectively.

31

Item 8. Financial Statements and Supplementary Data

FINANCIAL REPORTS SECTION

32

INDEPENDENT AUDITORS' REPORT

Board of Directors
Investment Technology Group, Inc. and Subsidiaries:

        We have audited the accompanying consolidated statements of financial condition of Investment Technology Group, Inc. and subsidiaries (the "Company") as of December 31, 2001 and 2000, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2001. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

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

        In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Investment Technology Group, Inc. and subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America.

/s/ KPMG LLP

New York, New York
January 17, 2002

33

INVESTMENT TECHNOLOGY GROUP, INC.
Consolidated Statements of Financial Condition
(In thousands, except share amounts)

The accompanying Notes to these Consolidated Financial Statements are integral parts of these statements.

34

INVESTMENT TECHNOLOGY GROUP, INC.
Consolidated Statements of Income
(In thousands, except per share amounts)

(1)

Earnings per share have been retroactively restated to reflect a three-for-two stock split in December 2001.

The accompanying Notes to these Consolidated Financial Statements are integral parts of these statements.

35

INVESTMENT TECHNOLOGY GROUP, INC.
Consolidated Statements of Changes in Stockholders' Equity
For the Years Ended December 31, 2001, 2000 and 1999
(In thousands, except share amounts)

The accompanying Notes to these Consolidated Financial Statements are integral parts of these statements.

36

INVESTMENT TECHNOLOGY GROUP, INC.
Consolidated Statements of Cash Flows
(Dollars in thousands)