INSTINET GROUP INC - 10-K Annual Report

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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 000-32717

INSTINET GROUP INCORPORATED
(Exact Name of Registrant as Specified in Its Charter)

DELAWARE 13-4134098
(State or Other Jurisdiction of (IRS Employer
Incorporation or Organization) Identification No.)

3 TIMES SQUARE 10036
NEW YORK, NY (Zip Code)
(Address of Principal Executive Offices)

212-310-9500
(Registrant's Telephone Number, Including Area Code)

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

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 of this
Form 10-K. [ ]

The number of shares of Common Stock outstanding as of March 20, 2002 was
248,738,970 shares. As of March 20, 2002, the aggregate market value of voting
stock held by non-affiliates of the registrant was approximately $272,356,973,
based upon the Nasdaq National Market closing price for such shares on that
date. For purposes of this calculation, the Registrant has assumed that its
directors and executive officers are affiliates.

Portions of the Instinet Group Incorporated Proxy Statement for the 2002
Annual Meeting of Stockholders are incorporated by reference in Part III hereof.

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INSTINET GROUP INCORPORATED

ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001

TABLE OF CONTENTS

Unless otherwise indicated or the context otherwise requires, references to
the "company," "we," "us," and "our" mean Instinet Group Incorporated and its
subsidiaries.

We have made forward-looking statements in this Annual Report on Form 10-K
for 2001, including in the sections entitled Business, Certain Factors that May
Affect Our Business, Management's Discussion and Analysis of Financial Condition
and Results of Operations and Quantitative and Qualitative Disclosures about
Market Risk, that are based on our management's beliefs and assumptions and on
information currently available to our management. Forward-looking statements
include information concerning our possible or assumed future results of
operations, business strategies, financing plans, competitive position,
potential growth opportunities and the effects of competition and regulation.
Forward-looking statements include all statements that are not historical facts.
You can identify these statements by the use of forward-looking terminology,
such as the words believes, expects, anticipates, intends, plans, estimates, may
or might or other similar expressions.

Forward-looking statements involve significant risks, uncertainties and
assumptions. Although we believe that the expectations reflected in the
forward-looking statements are reasonable, actual results may differ materially
from those expressed in these forward-looking statements. You should not put
undue reliance on any forward-looking statements. You should understand that
many important factors, in addition to those discussed in the section entitled
Certain Factors that May Affect Our Business and elsewhere in this annual
report, could cause our results to differ materially from those expressed or
suggested in forward-looking statements.

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PART I

ITEM 1. BUSINESS

INTRODUCTION

We are the largest global electronic agency securities broker and have been
providing investors with electronic trading solutions for more than 30 years.
Our services enable buyers and sellers worldwide to trade securities directly
and anonymously with each other, gain price improvement for their trades and
lower their overall trading costs. Through our electronic platforms, our
customers also can access over 40 securities markets throughout the world,
including Nasdaq, the NYSE, and stock exchanges in Frankfurt, Hong Kong, London,
Paris, Sydney, Tokyo, Toronto and Zurich. We also provide our customers with
access to research generated by us and by third parties, as well as various
informational and decision-making tools. Our customers primarily consist of
institutional investors, such as mutual funds, pension funds, insurance
companies and hedge funds, as well as broker-dealers. Our revenues consist
primarily of transaction fees generated by our securities brokerage and related
services. In 2001, we had revenues of $1.5 billion and earned net income of
$144.8 million.

Our global electronic agency securities brokerage business centers almost
exclusively on serving the needs of institutional investors and broker-dealers
in the global markets for equity securities. In the United States, our customers
include approximately 1,000 institutional investors and 720 broker-dealers as of
December 31, 2001. We have operations in Europe and Asia, where we had
approximately 900 customers as of December 31, 2001, and are continuing to grow
our global presence. During 2001, our customers used our systems to execute
106.0 million transactions globally, of which 98.3 million transactions were in
U.S. equity securities. Those U.S. transactions represented approximately 65.9
billion shares of Nasdaq-quoted stocks and 11.0 billion shares of U.S.
exchange-listed stocks. More than 80% of our customers' transactions in U.S.
equity securities using our electronic trading systems were executed within our
internal liquidity pool. We also offer our customers technology (known as
order-routing technology) that directs their equity securities transactions to
either our own liquidity pool or one of the various markets to which we are
connected to obtain better execution. . In addition to our core execution
services, we offer our customers services that enhance their ability to achieve
their trading objectives, including extended hours trading, crossing services,
block trading and portfolio trading, as well as global clearing and settlement
of trades. We are also one of the largest independent providers of research and
other brokerage services through soft dollar or other similar arrangements.

We have built our business on a model that incorporates the following four
core values:

- Independence and Neutrality -- As an agency broker, we do not trade
securities for our own account or maintain inventories of securities for
sale. As a result, unlike exchange specialists, market makers and other
market participants that trade for their own account, we have no direct
interest in, or in maintaining, the trading spread (the difference between
the price offered by a buyer and that asked by a seller) in the Nasdaq
market or on an exchange. We avoid conflicts with our customers that
interfere with their obtaining better pricing for their trades.

- Anonymity -- Our systems do not require the identity of the ultimate
buyer or seller to be disclosed to the counterparty or other market
participants at any point in the trading process. We believe that
anonymous trading can reduce the potential market impact of large
transactions and transactions by certain investors whose trading activity,
if known, may be more likely to influence other market activity, and may
contribute to improved pricing for our customers.

- Equal and Direct Access -- We provide all of our customers, without
regard to their size or volume of trading, with equal and direct access to
markets. Direct market access can increase the speed at which trades are
executed and level the playing field among market participants. This
enhanced market access also allows our customers to have available
real-time information on the demand for and supply of one or more
securities, a concept commonly referred to as transparency.

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- Customer Empowerment -- We use and develop, and may acquire, technology
to empower our customers to achieve their trading objectives. Our trading
services and tools give our customers flexibility in choosing their level
of direct participation in carrying out their trades.

As a result of these core values, we believe that we provide our customers
with valuable benefits that help them achieve their trading objectives at
reduced costs and with greater speed and efficiency.

While our global institutional equities business continues to be our core
business, we have developed several other services. Our global electronic
platform for trading fixed income securities provided brokerage and execution
services to approximately 115 banks and broker-dealers as of December 31, 2001.
We also provide correspondent clearing services to a few securities brokers in
the United States.

In an effort to expand the scope of our business and complement our
existing services, in recent years, we have acquired a number of companies. In
October 1999, we acquired Montag Popper & Partner GmbH, a German fixed income
voice broker. In February 2000, we acquired Lynch, Jones & Ryan, a leading
provider of specialized brokerage, research and commission recapture services to
pension plan sponsors and managers. In October 2001, we acquired ProTrader
Group, L.P., a provider of advanced trading technologies and electronic
brokerage services.

We were founded in 1969 and, although continuously headquartered in New
York since then, were a wholly owned subsidiary of Reuters Group PLC from May
1987 until our initial public offering in May 2001. Reuters currently owns
approximately 83.3% of our outstanding common stock. We opened a London office
in 1988 and currently also have offices in Frankfurt, Hong Kong, Paris, Tokyo,
Toronto and Zurich.

INDUSTRY BACKGROUND

GROWTH IN EQUITY TRADING VOLUME

Over the past decade, the volume of trading in the world's major stock
markets has grown dramatically. For example, from January 1, 1991 to December
31, 2001, average daily trading volume in the Nasdaq market increased at a
compound annual rate of 25% from 162.9 million shares to 1.9 billion shares,
while on U.S. exchanges, average daily trading volume increased at a compound
annual rate of 20%, from 189.0 million shares to 1.5 billion shares. In 2001,
this growth rate has slowed and there was significant volatility in the U.S.
markets over the year.

This overall growth in volumes over the past decade was due to a number of
factors, including strong economic conditions and increased issuances of equity
securities in the United States and record high returns in U.S. equity markets
through much of the period. Favorable market conditions had increasingly allowed
companies to raise capital through initial public offerings, resulting in
significant growth in the overall NYSE and Nasdaq market capitalization from
approximately $3.7 trillion and $521.4 billion, respectively, as of December 31,
1991 to approximately $11.7 trillion and $2.9 trillion, respectively, as of
December 31, 2001, despite a decrease in the overall NYSE and Nasdaq market
capitalization from 2000 to 2001. Increased personal wealth and disposable
income, greater availability of self-directed investment programs (including
employer-sponsored programs) and a trend towards more self-directed individual
investing had all contributed to increased public interest in investing in
equity securities. This trend resulted in a greater allocation of investment
funds to equity securities which increased trading volume. In addition,
technological innovation, including the emergence of the Internet and market
acceptance of electronic brokers, reduced transaction costs and further
stimulated trading activity. The decline in the growth rate and volatility of
U.S. market volumes in 2001 was due to a number of factors including a weakened
and uncertain economic climate (which was exacerbated by the events of September
11th), reduced capital raising activities and increased unemployment rates.

The overall growth in non-U.S. markets has paralleled that of the U.S.
markets in the past decade and continues to grow. From January 1, 1996 to
December 31, 2001, average daily trading volume on the London Stock Exchange
increased from 870.2 million shares to 2.3 billion shares, and on the Tokyo
Stock Exchange from approximately 405 million shares to 829 million shares. A
number of factors have contributed to this growth, including increased
availability of market information, a growing trend toward public (rather than
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governmental) ownership of companies in Europe and Asia, greater access to
equity investing and advances in trading technology. Additionally, growing
interest in the opportunities available in global markets, as well as a
heightened focus on diversification, have also resulted in increased
cross-border trading.

U.S. MARKET STRUCTURE

Until 1968, stock markets operated primarily in a physical
environment -- on a trading floor -- through an auction conducted by open
outcry. The NYSE continues to operate an auction system on a physical trading
floor, with orders for each listed stock being routed on the floor of the
exchange, either electronically or physically, to a designated dealer, known as
a specialist. In 1971, the Nasdaq system, a new electronic marketplace without a
physical trading floor, was introduced as an outgrowth of the traditional and
inefficient telephone-based over-the-counter market. Nasdaq dealers, known as
market makers, are linked together via a screen-based electronic communications
system, known as the Nasdaq quote montage.

While both of these trading markets have accommodated historical trading
patterns and volumes, they have substantial shortcomings, the most significant
of which is limited access. Neither market enables buyers and sellers to deal
directly with each other. Instead, trading is conducted indirectly through
intermediaries -- the specialists, in the case of the NYSE, and the market
makers, in the case of Nasdaq. Access to these intermediaries is further
restricted. For example, in the case of the NYSE, only a member owning a "seat"
on the exchange (or a brokerage firm to which that member has granted the use of
his seat) may trade with or through a specialist. Until 1997, when the SEC
adopted its Nasdaq order handling rules, only market makers had access to the
Nasdaq quote montage. In some cases, investors access a NYSE member firm or
Nasdaq market maker through the intervention of yet another securities brokerage
firm. Indirect access reduces the speed with which a desired trade is executed.
In some cases, this delay may prevent an investor from trading at the last
published price of which the investor had knowledge when placing an order for
the trade. In addition, an investor with indirect access often has more limited
pricing information than others with direct access (such as market makers or the
specialists). An SEC report issued in January 2001 determined that indirect
access and market fragmentation were primary causes for the longer execution
times and significantly larger effective and realized spreads in Nasdaq-quoted
stocks than those in NYSE-listed stocks. Market fragmentation refers to a market
environment in which prices are determined and orders are executed in a number
of different places (physical or electronic) rather than a single place.

Other shortcomings are also apparent. Paper or telephone-based trading,
which continues to be used where access to electronic systems is limited, also
reduces the speed of execution and increases potential for errors and disputes.
These factors lead to increased costs and market and execution risk for both
broker-dealers and traders. Sophisticated trading strategies, such as those
involving the execution of trades in more than one security or using multiple
types of financial instruments, are particularly difficult to accomplish without
rapid, direct and anonymous electronic market access.

Regulatory and technological developments over the past five years have led
to gradual increases in competition for trading shares that are listed on the
NYSE or quoted on Nasdaq. Alternative methods of trading NYSE-listed stocks by
non-NYSE members without recourse to the exchange trading floor -- the so-
called third market -- have emerged alongside the traditional structure of the
NYSE. Off-exchange trading by all broker-dealers, including NYSE members and
member firms, has been permitted in those stocks listed or traded on the NYSE
after April 26, 1979. In May 2000, the NYSE rescinded its Rule 390, which had
required all NYSE members and member firms to execute transactions in stocks
listed or traded on or before April 26, 1979, only on the floor of the NYSE,
subject to some exceptions. Because these stocks accounted for approximately 50%
of average daily trading volume in 2001, the abolition of Rule 390 may
eventually lead to increased competition in trading NYSE-listed stocks that were
previously subject to the rule. See also "-- Regulation."

Competition has also developed for trading in Nasdaq-quoted stocks. Most
significantly, in 1997, the SEC's order handling rules for market makers and
exchange specialists took effect. These rules provided a specified role for
ECNs, or electronic systems that widely disseminate to third parties orders
entered into them by a market maker or specialist and permit execution of those
orders against each other. The order handling

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rules deal specifically with the processing of limit orders, which are orders
with an associated limit price above which a buyer, or below which a seller,
will not trade. In particular, the rules prohibit a market maker or exchange
specialist from displaying its own limit order for a security through an ECN at
a more favorable price than its published quote unless the ECN publishes its
best-priced market maker and exchange specialist orders in that security and
permits execution against those orders through Nasdaq. Similarly, a market maker
that receives a limit order better than its own published quote, must generally
either execute the order, incorporate the limit order price into its published
quote or pass the order on to an ECN for public display and execution access.

The emergence of ECNs and later ATSs -- a term that refers generally to all
systems, including ECNs, that bring together the orders of buyers and sellers of
securities through automated means -- has provided efficient means of access to
market centers and has resulted in a shift in liquidity, or trading activity,
from the major established market centers to the ATSs. According to Nasdaq, ECNs
alone accounted for 30.9% of the total Nasdaq trade volume in 2001.

Following the adoption of the order handling rules, in 1998 the SEC adopted
Regulation ATS, which regulates the operation of ATSs (including all recognized
ECNs) registered as broker-dealers. ATSs may register as national securities
exchanges. To date, two ATSs have applications pending for exchange status, and
one ATS has already been approved to serve as a facility of an exchange. With
exchange status, an ATS gains direct access to the National Market System and
the Intermarket Trading System, enabling it to publicly display orders in U.S.
exchange-listed stocks and make those orders available for execution. As an
exchange, an ATS also becomes a self-regulatory organization, no longer subject
to NASD regulation.

Recently, the NASD has implemented or proposed a number of rule changes for
the Nasdaq market that move Nasdaq from a quote-driven display system to an
order-driven execution system that will directly compete with ECNs. First, in
part as a reaction to the growing competitive pressures from ECNs, in July 2001,
the NASD implemented SuperSoes as its new platform for the trading of the most
widely held Nasdaq-quoted stocks (Nasdaq National Market stocks). SuperSoes
substantially expanded the functionality of SOES -- Nasdaq's existing small
order execution system available only for small orders from public
customers -- by incorporating many features common among ECNs, as well as
improving the speed of order execution. In addition, unlike SOES, SuperSoes may
be used by market makers when trading for their own accounts. Full participation
in SuperSoes is mandatory for all market makers in any SuperSoes-eligible
securities in which they make markets. We believe a number of SuperSoes'
features disadvantage ECNs with significant internal liquidity pools, so that
only one ECN to date has chosen to participate in SuperSoes both for order-entry
and for display of its best-priced orders in the Nasdaq market ("full"
participation), with the remainder choosing instead order-entry only
participation. Without full participation in SuperSoes, ECNs must rely on
SelectNet to display and provide access to their customers' orders in the Nasdaq
market. (SelectNet is an older order delivery and negotiation system that
electronically facilitates, but does not automatically provide, order
executions.) In addition, SuperSoes' pricing structure is disadvantageous to
order-entry only participants. SuperSoes, in light of its features and
functionality, may have shifted, and may continue to shift, some order flow away
from ECNs.

Second, on January 10, 2001, the SEC approved the NASD's rules changes
creating a new trading platform for the Nasdaq market, known as SuperMontage.
These new rules will significantly change the way the Nasdaq market operates,
including changing the information displayed on, and the method of operation of,
the Nasdaq quote montage. The new structure will combine a computer display
containing more bid and offer information about trading interest in individual
Nasdaq-quoted stocks than is currently displayed, together with new rules
establishing the execution priority of quotes and orders submitted to Nasdaq.
Nasdaq has announced that it expects to implement this structure beginning
around the third quarter of 2002. The NASD rules as approved by the SEC were
significantly modified, and we believe improved, from the proposals previously
submitted by the NASD. The SEC conditioned its approval of the SuperMontage
proposal on the NASD establishing an alternative facility that market makers and
ECNs can use to meet their order display obligations. The SEC is also
considering making non-exclusive Nasdaq's role as a collector and distributor of
data (known as a securities information processor) regarding quotations in
Nasdaq-quoted stocks. Nasdaq's current role as the exclusive information
processor gives it financial and other competitive advantages.
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In addition, Nasdaq is in the process of becoming a for-profit exchange,
independent from the NASD. On March 15, 2001, Nasdaq submitted its application
for registration as a national securities exchange to the SEC. By operating as
an exchange with SuperMontage as its trading platform, Nasdaq is continuing to
evolve as a direct competitor of ATSs. Nasdaq is currently considering the fee
structure it would introduce as an independent, for-profit exchange. We are
unable to predict what fee changes Nasdaq might propose or eventually implement,
but Nasdaq's fee structure may have a significant impact on the competitive
landscape for ECNs.

The SEC has noted that even if Nasdaq gains status as an exchange, the NASD
will continue to be required to collect bids, offers and quotation sizes for
parties seeking to trade U.S. exchange-listed stocks -- which would then include
Nasdaq stocks -- other than on an exchange. As a result, the SEC has indicated
that the NASD must have an alternative display facility (ADF) operational by the
time Nasdaq is granted exchange status. Accordingly, on December 7, 2001, the
NASD submitted to the SEC proposed changes to the NASD's rules to reflect
Nasdaq's anticipated approval as an exchange, its resultant separation from the
NASD and the creation of an ADF. The NASD has indicated that in creating the
ADF, it intends to provide a facility that will display quotes and collect trade
data, while keeping its obligations to operate a market to a minimum. Other than
providing access to the Intermarket Trading System -- a system that links market
centers that trade U.S. exchange listed equity securities, the NASD's proposed
ADF would not provide for order execution or routing services, so that ADF
market participants themselves would be required to provide NASD member
broker-dealers with electronic access, either directly or indirectly, to their
quotations. It is unclear when and in what form the ADF might be implemented and
whether the ADF, as currently contemplated, would prove to be a viable
marketplace. For a further discussion of SuperSoes, SuperMontage and the NASD's
proposed ADF, see "-- Regulation" and "Certain Factors that May Affect Our
Business -- We Operate in a Highly Regulated Industry and Regulatory Changes
Could Adversely Affect Our Business."

The introduction of decimalization in April 2001 -- the quoting of stock
prices in dollars and cents rather than in dollars and fractions of a dollar
(such as 1/8 or 1/16) -- has also had an impact on the U.S. securities markets
and increased competition for ATSs. Decimalization may assist investors in
obtaining price improvement because improvement in smaller increments is
possible. Because decimalization narrows the average trading spreads, it has had
a significant negative impact on the profitability of traditional broker-
dealers. As a result, some market makers are moving from a business model in
which they trade as principal for their own account to an agency business model.
The SEC's recently expanded interpretation of Section 28(e) of the Exchange Act
allowing institutional investors to obtain soft dollar credits from certain
transactions executed through broker-dealers on a "riskless" principal basis,
rather than only on an agency basis, may further encourage this trend.
Decimalization has also caused traditional broker-dealers to execute their
customers' orders internally rather than route them to external market centers
for execution, because the additional price risk they incur to fill orders
internally has decreased to as little as a penny a share.

IMPACT OF TECHNOLOGICAL DEVELOPMENTS

Innovations in technology, particularly the growth of the Internet, have
increased the speed of communications and the availability of information,
facilitated the globalization of commerce, and simultaneously decreased the cost
of electronic commerce. New methods have developed to enable institutional
investors to access and participate in the equity securities markets more easily
and less expensively. Electronic markets have substantially reduced the need for
intermediation, such as by NYSE members and NYSE specialists or Nasdaq market
makers, because direct access is effectively unlimited and technology enhances
the ability to determine the best price at which a trade can be executed. These
developments, combined with the regulatory changes discussed above that allowed
for the emergence of ATSs, have led to dramatic growth in electronic trading and
provide us with significant opportunities.

Technological developments have also affected investing by individuals.
Technological advances have created new and inexpensive means for individual
investors to access markets directly on-line. As technology continues to improve
and regulatory and customer scrutiny of execution and trading services
intensifies, we believe that individual investors will increasingly demand
institutional-quality services.

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INTERNATIONAL SECURITIES MARKETS

Until the early 1990s, equity markets outside the United States were
generally less developed than those in the United States, with relatively low
trading volumes and less advanced trading systems. Thereafter, technological and
regulatory changes, other competitive pressures, and increased globalization
contributed to increasing trading activity and major structural changes in the
established European exchanges, which generally moved to an electronic model. In
this model, an electronic system receives and matches orders that are routed
through the system. Intermediaries provide execution services to their customers
primarily by providing connectivity to the exchange system. In addition, in
Europe there has been an increasing trend towards consolidation of exchanges,
encouraged by technology and the adoption of the euro. We believe that while
economic and financial difficulties and disruptions in Asia since 1997 have made
trends in Asian securities markets less predictable, similar competitive,
demographic and technological developments will lead over time to an evolution
in Asia comparable to that in Europe over the last decade.

FIXED INCOME MARKETS

The markets for fixed income securities are among the largest in the world.
According to the Bank for International Settlements quarterly review issued in
December 2001, approximately $29.5 trillion of fixed income securities were
outstanding as of June 30, 2001, representing $14.8 trillion of U.S. fixed
income securities and $14.7 trillion of non-U.S. fixed income securities. In
addition, approximately $300 billion of U.S. government securities are traded
among primary dealers and investors each day. In Europe, the introduction of the
euro has created a single fixed income securities market which, together with
the United States and Japan, make up the three largest markets in the world in
terms of size.

The fixed income markets are far less transparent than the equity markets.
Less information is available to investors regarding supply and demand, pricing
and trading volume. General acceptance of electronic fixed income trading
platforms has varied considerably across the markets and among the different
fixed income instruments.

OUR COMPETITIVE STRENGTHS

WE ARE A MARKET LEADER WITH STRONG BRAND AWARENESS

We pioneered an electronic screen-based trading system and have been
providing investors with electronic trading solutions for more than 30 years. We
have been a market leader in the trading of Nasdaq-quoted stocks for many years
and accounted for 14.0% of the total trading volume in that market in 2001. For
an explanation of how we calculate our trading volumes, see "Management's
Discussion and Analysis of Financial Condition and Results of Operations -- Key
Statistical Information -- Nasdaq Volume Calculations." Our substantial share
trading volume, particularly in Nasdaq-quoted stocks, attracts significant
customer attention and order flow. CNBC and CNNfn broadcast live daily from our
sales trading centers in the pre-and post-market hours. As a result, we have
strong name and brand recognition among institutional investors.

WE DELIVER COMPELLING BENEFITS TO OUR CUSTOMERS

We believe that our core values of independence and neutrality, anonymity,
equal and direct access and customer empowerment enable our customers to obtain
superior execution of their trades, including better pricing and reduced
transaction costs than are generally achievable using traditional trading
channels. For example, we believe that one of the biggest concerns of
institutional investors in securities trading today is the market impact of the
disclosure of their identity and trading intentions. Customers, therefore, often
seek to break up orders to hide their overall intentions, but if the market
becomes aware of a large investor seeking to sell securities, the price of those
securities may drop before the investor's position can be fully liquidated.
Similarly, market awareness of a large investor seeking to buy a large amount of
securities may result in an increase in the price of the securities before the
order can be fully executed. By allowing our customers to trade directly but
anonymously, we reduce the potential for this market impact, which we believe
can result in better pricing for the customer.
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We believe that we allow our customers to obtain significant price
improvement and reduced transaction costs in executing their trades. In a report
published in January 2002 based on data for the 12 months ended September 30,
2001, Plexus Group, an independent market research group, ranked Instinet first
in execution quality in Nasdaq-listed stocks when compared to a universe of the
12 most-active full-service brokers for which Plexus has data. Instinet also
tied for first in execution quality in U.S. exchange-listed stocks when compared
to the same universe of brokers.

WE OFFER A BROAD RANGE OF SERVICES

As an electronic agency broker, in addition to trade execution, we offer
our customers a wide variety of other services. Companies acting solely as ECNs
are generally limited to small order electronic execution and order routing. Our
broader business model extends beyond these functions, and we provide service
offerings tailored to our customers' diverse trading needs. These service
offerings include a variety of trading services, research, and clearing and
settlement, all of which add value for our customers. For example, we provide
services such as:

- simultaneous execution of multiple orders of securities (known as
portfolio trading);

- trading of large orders (referred to as block trading);

- automatically matching orders at specified levels (known as crossing);

- extended hours trading;

- technical assistance to customers in inputting orders; and

- managing the execution of orders for customers over time (often referred
to as working orders).

We also are one of the largest global independent providers of research and
other brokerage services through soft dollars or other similar arrangements.

WE OPERATE GLOBALLY

Our customers use our systems to trade securities in over 30 non-U.S.
securities markets, and we are members of 9 non-U.S. exchanges. As of December
31, 2001, approximately 750 customers in Europe and approximately 150 customers
in Asia had access to the INSTINET(R) trading system. The number of transactions
in non-U.S. equity securities executed through our systems has grown from
approximately 0.3 million transactions in 1996 to 7.7 million transactions in
2001.

In addition, we are a substantial independent provider of research and
other brokerage services through soft dollar and similar arrangements outside
the United States, and we offer a fixed income platform in Europe. We led, and
are the largest investor in, the consortium that owns 38.9% of virt-x, an
electronic order-driven equities market for pan-European securities.

WE HAVE A PROVEN ABILITY TO INNOVATE AND ADAPT

Throughout our 30-year history, we have been an innovator in using
technology to enhance securities trading, have seized market opportunities and
have adapted to numerous changes in our operating and regulatory environment
while continuing to grow. Some of our most significant developments include the
following:

- At a time when most investors were paying fixed commissions to trade in
NYSE-listed stocks, we pioneered an electronic screen-based trading
system that allowed customers to trade without paying fixed commissions.

- After the abolition of fixed commissions in 1975 placed significant price
pressure on our business, we established the first service to display
real-time information showing NYSE and regional exchange quotes together
on an electronic screen and provided our customers direct access to trade
NYSE-listed or regional exchange-listed stocks through the regional
exchanges.

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- In 1984, we created an electronic marketplace in which market makers and
institutional investors could trade directly among themselves and obtain
automated execution of trades inside the publicly quoted spreads for
those stocks. In 1989, we enhanced this service by enabling our customers
to interact and trade anonymously on our system.

- In the late 1990s, we adapted to cost and pricing pressures in our
equities business, to the introduction of the SEC's order handling rules,
which substantially changed activity for Nasdaq participants, and to the
adoption by the SEC of Regulation ATS, which imposed new requirements on
our activities. We enhanced and modified our services, lowered our prices
and changed our cost structure to adjust to these changes in our
operating environment.

- In response to the increasing volumes in cross-border trading and the
fragmentation of securities markets, we offered our customers ways to
access multiple liquidity pools. We introduced the first integrated
electronic trading platform to permit direct electronic access to
equities markets across Europe, together with facilities to negotiate and
trade directly and anonymously with other customers.

- We introduced one of the first order management tools that allowed
customers to manage, deliver and execute baskets of securities in the
Nasdaq market. We also introduced tools that allow customers to use our
technology to enter alternative pricing for trades (commonly referred to
as discretionary pricing) or for alternative trade sizes (commonly
referred to as reserve book features), which had in the past required a
high degree of manual intervention.

- We have been an innovator in developing extended hours trading and
crossing capabilities starting in 1995 and 1986, respectively. These new
services responded to globalization and continuous availability of
information about markets and issuers, and the resulting demand by
investors to trade equity securities after traditional exchanges and
markets are closed.

WE HAVE AN ESTABLISHED TECHNOLOGY INFRASTRUCTURE

We developed one of the earliest electronic businesses in any field of
commerce and introduced the first screen-based system through which
institutional investors could trade Nasdaq-quoted stocks directly with each
other. Our technology enables all of our customers to access the liquidity pool
within our own electronic trading system in order to trade these securities with
one another. In addition, our customers can use our electronic platforms to
connect to other markets in order to trade indirectly with other participants in
those markets. We believe that our ability to use technology effectively to
improve our services has been a key component in the development of our
business.

OUR STRATEGY

We are focused on using technology to deliver services that empower our
customers to reduce their total transaction costs, gain price improvement on
their trades and better achieve their trading objectives. Our objective is to
take advantage of growth opportunities that are arising in the securities
industry as a result of changing technology, regulation and market demands. We
believe that our strong global competitive position, breadth and scale of
operations, unique business model, and proven ability to innovate and use
technology give us an advantage in this pursuit. We also continue to explore
ways to take advantage of the synergies between us and Reuters, as well as our
respective capabilities, as part of our effort to provide value-added products
and services to our customers in a cost effective manner.

The principal elements of our strategy include the following:

Extend our global brokerage offering. We intend to continue to develop our
global agency brokerage business by aligning our existing resources and focusing
our initiatives on developing products and services tailored to our various
customer categories, based upon our customers' specific needs and their diverse
business models. These services include portfolio trading, block trading,
crossing, enhanced technology and research. We believe these services will
enable our customers to improve their execution performance. We are also
increasing our focus on our soft dollar and plan sponsor service programs, as
part of our efforts to enhance our global brokerage offering.
9

We believe that international markets offer a significant growth
opportunity for our institutional equities business. We are expanding our
European equities business, introducing services that add value for our
customers, while managing our costs to allow us to respond to anticipated future
pricing pressure. We are also continuing to develop our Asian institutional
equities business. In addition, international markets present high potential
growth for our fixed income business. We are continuing to focus our fixed
income securities activities on the specific needs of our existing customer
base. We are also exploring possible alliances and expansion opportunities in
the United States, Europe and Asia to further develop our customer base and our
capabilities for fixed income trading. For example, we are currently negotiating
with two major banks that, subject to the signing of definitive agreements, we
expect will provide liquidity and product support to our fixed income
activities. In return, the banks would have the right to acquire an ownership
stake in the fixed income broker-dealer operations that are presently 100% owned
by us. We are also continuing to evaluate our fixed income business and explore
various strategic options.

Maintain and expand our Nasdaq liquidity pool. At the same time we
continue to develop our global agency brokerage business, we intend to maintain
and expand our Nasdaq liquidity pool. Recently, we have experienced a decline in
our Nasdaq market share, primarily due to lower volumes from our broker-dealer
customers. As a result, in September 2001, we reduced our pricing, implementing
a new pricing schedule for our U.S. broker-dealer customers, and adjusted
certain pre-set volume levels at which we offer those customers lower per share
transaction fees and also established a pilot program to test pricing incentives
for liquidity providers. In March 2002, we aggressively reduced pricing,
implementing a new pricing plan to offer further pricing incentives to our U.S.
broker-dealer customers, reducing prices paid by broker-dealers trading
Nasdaq-quoted stocks by approximately 60% and simplifying the pricing schedule
by adjusting certain pre-set volume levels at which we offer those customers
lower per share transaction fees. We expect these pricing initiatives will
result in better executions for all of our customers. In anticipation of the
impact of price reductions on our revenue from U.S. broker-dealer customers, we
have taken action to reduce costs, including the cutback of staff levels in a
number of areas, and we continue to evaluate further cost initiatives. We are
also continuing to improve our integration with our customers' trading systems.
We expect that focusing on increasing liquidity, improving system and network
efficiencies and implementing our cost reduction program will enable us to
maintain and expand our Nasdaq liquidity pool.

Continue to enhance our technology. We plan to continue to improve our
technology by offering new trading products and functionality both to provide
improved services and to contain costs. Recently, we introduced smart
order-routing technology for trading in Nasdaq-quoted stocks, which provides our
customers with enhanced order execution capabilities. We are also developing a
new, more flexible platform for our communications with, and connections to, our
customers. We have introduced new trading functionality to improve our
customers' performance and efficiency when executing large, complex orders. In
addition, we have developed and are currently testing two new products to
enhance execution quality, both in U.S. equities and in overseas markets, and to
improve our customers' investment and trading performance. The first product,
based on the technology we acquired through our acquisition of ProTrader, is a
trading application, aimed primarily at active fund managers and hedge funds,
which will enable us to enhance our customer interface and order-routing
technology. The second product is a new program trading application that we have
developed in conjunction with passive and quantitative fund managers in the
United States and Europe which will enhance our customers' ability to execute
transactions involving multiple stocks, such as baskets and portfolios of
stocks -- commonly referred to as portfolio trade transactions -- in global
markets.

Pursue select acquisitions and strategic alliances. We plan to continue to
supplement our internal growth through select acquisitions of businesses or
technologies that will enable us to strengthen our current businesses, enter new
markets, provide services that we do not currently offer or advance our
technology. We will also continue to enter into strategic alliances and make
further strategic investments in companies that we believe are well-positioned
to capitalize on potential changes in the industry. As a result, we engage in
discussions on a regular basis regarding various types of transactions,
including possible acquisitions or investments, some of which could be material
to us. We may agree to pay the consideration in connection with a transaction in
cash, our securities or some combination of the two. Some acquisition
transactions that involve our securities could have a dilutive effect on our
earnings per share. It is also possible that the number

10

of shares of our common stock that may be issued in connection with a
transaction could constitute a material portion of our then outstanding common
stock not held by Reuters, even if not material compared to the total amount of
common stock outstanding. See "Certain Factors that May Affect Our
Business -- Future Sales of Our Shares Could Adversely Affect the Market Price
of Our Common Stock." At present, we have no agreements or understandings for
any material acquisitions or investments.

OUR BUSINESS

OUR GLOBAL INSTITUTIONAL EQUITIES BUSINESS

We offer our customers a broad range of trade, execution and ancillary
services, enabling them to trade equity securities directly with each other
through our platform, as well as with other investors in over 40 securities
markets throughout the world. The size, nature and geographic distribution of
our customers have generated a distinct pool of liquidity on our electronic
platform. We also offer our customers order-routing technology that directs
their equity transactions among the various markets to which we are connected to
obtain better execution. On a worldwide basis, in 2001, our customers used our
platform to complete a total of 106.0 million transactions, representing an
average of approximately 427,500 transactions each trading day.

We are one of the largest ATSs participating in Nasdaq. We accounted for
14.0% of the total trading volume in Nasdaq-quoted stocks during 2001 (although
that figure fluctuated significantly during the year). Our average daily trading
volume in Nasdaq-quoted stocks has increased at a compound annual rate of 25%
from 85.7 million shares in 1996 to 265.7 million shares in 2001. For an
explanation of how we calculate our Nasdaq trading volumes, see "Management's
Discussion and Analysis of Financial Condition and Results of Operations -- Key
Statistical Information -- Nasdaq Volume Calculations."

Our share of the total trading volume in U.S. exchange-listed stocks has
increased from 1.8% in 1996 to 3.1% in 2001. Our average daily trading volume in
U.S. exchange-listed stocks increased during that period at a compound annual
rate of 39% from 8.7 million shares in 1996 to 44.4 million shares in 2001. Our
transactions in non-U.S. stocks during that period increased from approximately
0.3 million transactions in 1996 to 7.7 million transactions in 2001,
representing a compound annual growth rate of 95%.

Customers

Institutional investors (including mutual funds, hedge funds, pension
funds, banks, insurance companies and investment portfolio managers) and market
professionals (broker-dealers, including Nasdaq market makers) are the core of
our customer base. We provide our equities trading services to approximately
2,600 customers, of which approximately 750 are in Europe and 150 are in Asia.
In the United States, our customers include approximately 1,000 institutional
investors and 720 broker-dealers.

Our customers fall into the following broad categories:

Institutional Investors:

- ACTIVE INSTITUTIONS, which generally include mutual funds and asset
managers that make stock specific equity investment decisions based on
fundamental company research;

- PASSIVE AND QUANTITATIVE INSTITUTIONS, which include mutual funds and
asset managers with a passive or quantitative approach to investing;

- PLAN SPONSORS, which generally include pension fund managers; and

- HEDGE FUNDS.

11

Market Professionals:

- MARKET MAKERS, which include broker-dealers and agency traders;

- DIRECT ACCESS, which includes smaller institutions and professional
non-institutional traders who seek to manage their own trading activity
by accessing the markets directly instead of through market professionals
or institutional investors; and

- PROGRAM DRIVEN TRADERS, which include customers who execute a variety of
arbitrage strategies and use automated computer processes to trade.

We have developed and are continuing to develop product and service
offerings tailored to these customer categories, based upon their specific
needs. Due to the diverse business models of our customers, some of our
customers may fall into several of these categories. In this case, we provide
our tailored services to each aspect of the customer's business model, rather
than assigning the customer to one particular category. We believe that by
offering our customers a tailored package of value-added services and
functionality, together with anonymous trading, access to our liquidity pool and
connections to other trading platforms, we can enhance our customers' ability to
achieve their trading objectives in this complex economic environment.

Services

We offer our customers a broad range of trade execution and other services
including the following:

Core Execution Services. We enable our customers to view market
information and execute trades directly with each other over our electronic
platform, and to trade with other investors in over 40 securities markets
worldwide. Direct trading between our customers over our platform creates a deep
liquidity pool, in particular for Nasdaq-quoted stocks and exchange-traded funds
(an index fund representing a basket of stocks that trades on the exchange, with
pricing throughout the day). Customers can also access market makers or other
ECNs through us using our smart order-routing technology. Our recently
introduced automated market interaction system automatically routes our
customers' transactions in Nasdaq-quoted stocks to either our own liquidity pool
or one of the various markets to which we are connected to obtain better
execution.

In the case of stocks listed on the NYSE or any other exchange, we
primarily provide connections to the exchange and, in the case of the NYSE, the
specialist for each listed stock, although our customers can trade directly with
each other over our platform.

For non-U.S. securities that are not traded in U.S. markets, although our
customers can trade directly with each other over our platform, we primarily
provide direct connections to the principal non-U.S. exchanges on which those
securities are listed. We are members of 9 non-U.S. exchanges and provide our
customers with direct access to those exchanges to execute their trades. For
more than 20 additional non-U.S. markets, we provide access through local
exchange members, with which some of whom we have clearing arrangements.

Negotiating Orders. Our technology allows our customers to communicate
anonymously both with all customers and with specific customers who have placed
an order. As a result, customers can determine whether there is interest by
another customer in a potential transaction and negotiate the volume and price
of that transaction, all directly and anonymously through our system, without
requiring any intermediation from anyone or displaying any of the communications
or negotiations to other customers. This capability facilitates the execution of
large orders and also allows customers to manage the delivery and execution of
their orders by themselves to minimize the market impact of a large order and
obtain price improvement. We have recently introduced new trading functionality
to improve our customers' performance and efficiency when executing these large,
complex orders.

Sales Trading Assistance. We have a dedicated group of sales and trading
professionals who provide our customers with various types of sales and trading
assistance. They provide technical assistance in the use of our screen-based
trading system. Customers can also place orders by telephone with our sales and
trading professionals, who enter the orders into our system on the customers'
behalf. These professionals can also work orders to manage the execution of a
large order over time for a customer to attempt to reduce the market
12

impact and achieve price improvement. For example, they may divide a large order
into a series of smaller orders that are entered over a period of time, possibly
at different prices. In addition, a dedicated team of sales and trading
professionals is available to assist our customers with their portfolio trading.

As of December 31, 2001, we had 344 sales and trading professionals, of
which 184 were located in North America, 124 in Europe and 36 in Asia. In
Europe, for those areas where we do not have a local presence, our sales traders
in London are responsible for providing brokerage services to those customers
and coverage of those markets. Recently, we streamlined our local presence
coverage in Europe, centralizing more of our European brokerage services in
London. London also has a specialized desk to service European portfolio
traders. In Asia, we provide coverage of our Japanese customers and the Japanese
market through our Tokyo office, with the remainder of Asia and Australia
serviced through our Hong Kong office. We also have coverage in each of our
offices in the United States, Canada, Europe and Asia to assist customers who
wish to place orders in a different region (for example, a European
institutional investor seeking to trade a U.S. or Japanese equity security).
These cross-region trades are also covered by our sales and trading
professionals for that market, thereby affording our customers in other regions
access to local market expertise. Because we have offices worldwide, we also are
able to provide sales and trading assistance to our customers 24 hours a day
without requiring additional sales and trading professionals to be staffed in
any one office on a continuous basis throughout the day.

Extended Hours Trading. Our customers can input orders for a security and
execute the trade with other customers in our liquidity pool before, during and
after normal market hours. This service has allowed us to expand globally to
include customers and markets in Europe and Asia, whose trading hours do not
coincide with those in the United States. It also permits us to make the
liquidity pool generated by our customers available on a 24-hour basis. Extended
hours trading has been a particularly important innovation for our customers
when material information about a market or company is released or reported
after that market or the principal market for that company's securities is
closed. When a pre- or post-market, price-moving event occurs, market
participants can interact directly at their election to discover a price, which
could be significantly different from the closing price, at which they can trade
following dissemination of news regarding the event. For example, after Adelphia
Communications Corp. announced raising a gross $1.5 billion from offerings of
common stock and securities on January 16, 2002, 7.5 million Adelphia shares
traded through our system between the close on January 15, 2002 and the open on
January 16, 2002. This represented approximately 197% of average daily trading
volume of Adelphia common stock during the prior 90-day period.

Crossing. Through our GLOBAL INSTINET CROSSING(TM), we enable customers to
enter buy or sell orders in U.S. traded securities for execution in a "crossing
session." In a crossing session, we electronically aggregate all orders to buy
or sell at a pre-specified time; match (or "cross") them with other orders to
sell or buy, respectively, and automatically execute them at a pre- determined
benchmark price. A crossing trade will be executed only if there is a
counterparty for that order (or portion of an order). Our crossing service
provides an electronic platform with enhanced liquidity for block trades and
better pricing outside regular trading hours than traditional brokerage or other
intermediaries might provide, together with the reduced trading risk of a
pre-determined benchmark price. We have two crossing sessions each trading day,
both of which occur outside of regular trading hours, the more significant of
which is in the evening. Following the close of the market each day, we have one
crossing session for orders priced at that day's closing price. On average in
2001, during each evening crossing session we received buy and sell orders from
370 customers for approximately 107 million shares of which trades were executed
for approximately 10 million shares. Before the market opens, we have another
crossing session using the volume-weighted average price for that trading day.
In addition, we now offer our customers access to a crossing system for Japanese
equity securities through JapanCross Securities Co., Ltd., our 50-50 joint
venture with Nikko Salomon Smith Barney Ltd. JapanCross, which began operating
in November 2001, enables customers worldwide to enter orders to buy or sell
Japanese equity securities in a pre-market crossing session at the
volume-weighted average price for that trading day.

Portfolio Trading. Our trading services also include portfolio trading,
which allows a customer to execute multiple orders in a number of different
securities simultaneously, including both orders to buy and sell shares of stock
as well as securities that are based on an index or basket of stocks. This
portfolio trading
13

capability, combined with our global access, also enables our customers to
manage and execute portfolios of securities denominated in a number of different
currencies. Our Trading Research Group provides portfolio managers and traders
with tools that track and evaluate trading costs by strategy, broker, market or
stock. We are also continuing to further develop technology to enhance our
client's ability to implement their trade strategies on a global basis. We are
currently testing a new program trading application that has been developed in
conjunction with passive and quantitative fund managers in the United States and
Europe, which will enhance our customers' ability to execute portfolio trade
transactions. This new trading application will continue to use our existing
execution, smart order-routing and clearing capabilities, as well as Reuters
market data infrastructure. In addition, our system will allow for interaction
between multiple traders at one customer site, the automation of trading using
algorithms created by the customer, customization of the interface by the
customer and integration with other systems commonly used by these customers. We
believe these features will help our customers to manage their order flow in a
more efficient manner. We anticipate deploying this new product to our customers
during the third quarter of this year.

Enhanced Customer Interface (Portal). Based upon the technology we
acquired through our acquisition of ProTrader, we have developed a trading
application that will enable us to enhance our customer interface and
order-routing technology. This new trading application will continue to use our
existing infrastructure while giving our customers a broader view and broader
access to multiple markets. Our customers will now have the ability to view
information for a single stock in multiple markets, increasing their ability to
execute their orders in multiple markets for better execution. We believe this
enhanced functionality will help our customers to manage their order flow in a
more efficient manner. We anticipate deploying this new product to our customers
during the second quarter of this year.

Soft Dollar Program. Institutional investors often allocate a portion of
their gross brokerage transaction fees for the purchase of proprietary and
independent third-party research products, as well as other brokerage services.
The amounts so allocated for those purposes are commonly referred to as soft
dollar revenues. We are one of the largest independent providers of research and
other brokerage services through soft dollar or other similar arrangements and
have offered soft dollar programs for over 15 years. We offer soft dollar
programs in order to increase the amount of business our institutional customers
conduct through us, thereby increasing our transaction volumes and the depth of
our liquidity pool. We are currently increasing our focus on these programs, as
part of our efforts to enhance our global brokerage offering and maintain and
expand our liquidity pool. In particular, we are developing tailored packages of
independent third-party research products for our various customer categories.

In 2001, more than one-third of our customers obtained proprietary and
third-party research services from us on a soft dollar basis. The portion of our
transaction fee revenue representing soft dollar revenues is offset
dollar-for-dollar by expenses we incur in paying for research from independent
third parties. We made $154.4 million in soft dollar payments to independent
research providers on behalf of our customers in 2001.

Research. Consistent with our agency brokerage approach, we believe our
clients can benefit from greater availability of research provided by
independent research providers who have no actual or potential conflicts of
interest with respect to the companies they analyze. In addition to the
independent third-party research that we provide to our customers through our
soft dollar programs (described above), we also offer proprietary research tools
and services, including those of our subsidiary, Lynch, Jones & Ryan, as well as
co-branded research. Our customers, primarily institutional investors, generally
use soft dollars or other similar arrangements to pay for these products and
services as well.

Our proprietary research is designed to enable our clients to design
efficient portfolio and trading strategies. Our proprietary research tools and
services for our customers include the following:

- INVESTMENT STRATEGY GROUP produces quantitative research, in the form of
both models and customized analysis, as well as general market
commentary.

- TECHNICAL ANALYSIS GROUP produces packaged and customized technical
analysis, as well as daily market commentary.

14

- REDBOOK publishes fundamental research on retail and related sectors. Its
REDBOOK RETAIL SALES AVERAGE is recognized as a leading indicator of
economic activity.

- THE GREAT LAKES REVIEW focuses on uncovering stock opportunities among
lesser-known companies in the Midwest.

In September 2001, we sold our Research and Analytics (R&A) product, an
integrated equity workstation that provides users with real-time quotes and news
as well as advanced analytics, to Reuters. The sale of R&A has enabled us to
focus on our core service offerings and reduce our costs associated with
providing the R&A product to our customers. We can continue to make available
soft-dollar payment options to our customers in connection with their use of the
R&A product.

Our co-branded research focuses on several different aspects of specific
industries and these research products include market studies, surveys and
detailed industry and company analysis. We are continuing to explore additional
co-branding relationships with other established research providers that have
expertise in specific sectors, products or companies.

Plan Sponsor Services. As part of our transactional services to pension
plans and other funds through their sponsors, such as corporations, unions,
state and local governments, endowments and foundations, we enable pension plan
and other fund sponsors to recapture a portion of the gross transaction fees
that the fund managers pay us. As of December 31, 2001, we provided these
services to approximately 1,200 pension plans and other funds. In addition, we
provide our plan sponsor customers with services that assist them when they
transfer from one money manager to another. For example, our crossing, portfolio
trading and trading research services can help these customers manage this
transition.

ProTrader. Through our recently acquired ProTrader subsidiary, we provide
advanced trading technologies and electronic brokerage services primarily to
professional non-institutional traders, active fund managers and hedge funds.

OUR FIXED INCOME SECURITIES BUSINESS

We offer dealers and market makers in the United States and Europe a
platform for trading primarily U.S. and European bonds. We offer approximately
270 U.S. government bonds, 30 U.S. federal agency bonds, 260 euro-denominated
government bonds, 20 Eurobonds and 290 German mortgage bond (Pfandbriefe)
products, as of December 31, 2001. Our subsidiary, Montag Popper, a German fixed
income broker, provides us with a presence in an important market in Europe. In
addition, we are exploring possible alliances and expansion opportunities in the
United States, Europe and Asia to further develop our capabilities for fixed
income trading. We are also continuing to evaluate our fixed income business and
explore various strategic options.

Customers

As of December 31, 2001, our fixed income business had over 115 customers,
with over 35 in the United States (including 23 of the 24 primary dealers in
U.S. government securities) and over 80 in Europe, representing a total of
approximately 1,000 traders.

Services

We perform the same trading role for our fixed income customers as for our
equities customers, with an electronic fixed income trading platform that
operates separately from our equities platform and that permits similar direct
access, anonymous trading and the opportunity for reduced transaction costs. Our
fixed income platform is available to customers in both the United States and
Europe. We support our electronic trading capability with broker desks staffed
with sales and trading professionals based in New York, London, Paris and
Frankfurt. We offer simultaneous communication of trade execution data to our
customer's trading desks and clearing and settlement information to their
middle- and back-offices, commonly referred to as "straight-through processing."
Straight-through processing can reduce costs and errors associated with our
customers' manual keyboard entry of execution data into their recordkeeping,
risk management and settlement systems.
15

Our customers can access our platform using either our graphical user interface
or our application program interface (API). The API can be integrated with our
customers' order management system or trading engine, allowing our customers
greater ease in submitting their orders electronically. When we introduced the
API, we also enhanced the capacity and performance of our fixed income platform,
which gives us the ability to manage increasing order flows and trade volumes
from our customers.

In addition to trading in single instruments, we enable our customers to
execute swaps in U.S. government securities and spread trades in
euro-denominated government bonds (both of which are the simultaneous purchase
of one bond and sale of another bond to take advantage of expected relative
changes in bond yields). We also offer basis trading (joint trading of a bond
together with a number of futures contracts, which is generally used to
neutralize market risk) in the United States and Europe.

OUR CORRESPONDENT CLEARING BUSINESS

We provide correspondent clearing services to a few securities brokers in
the United States. We offer transaction processing, clearing and settlement of
trades, recordkeeping and financing to our correspondent customers, as well as
various products and services oriented toward the institutional investor
community.

CLEARING AND SETTLEMENT OPERATIONS

We provide clearing and settlement services in nearly all of the markets in
which we execute trades for customers. Our clearing and settlement operations
are similar in design and function to other clearing brokers. We self-clear
through our subsidiary, Instinet Clearing Services (ICS), which uses our
proprietary CLEARING INFORMATION SYSTEM(TM) (CIS) to handle customer ticketing,
processing of allocations and communications with industry clearing agents,
depositories and books and records processing providers. For processing of books
and records, ICS uses Automatic Data Processing, Inc. (ADP) in the United
States, Nomura Institute's I-Star system in Japan and ACT Fiscal for all other
non-U.S. business. We also clear and settle for customers who have a contract
with ICS. With respect to these trades, we are responsible for a variety of
activities that take place after a securities trade has been executed, including
confirmation of trades before settlement, submitting executed transaction
information to industry clearing and settlement utilities, managing failed
trades, communicating trade and settlement data including allocations to
customers, management of corporate actions and updating and maintaining
Instinet's books and records.

STRATEGIC ALLIANCES AND INVESTMENTS

To enhance our core service offerings in our global electronic agency
securities business, we have made a number of strategic investments in companies
with operations or technology that we believe will enable investors and issuers
to better achieve their trading objectives. During the past three years, we have
acquired beneficial ownership interests in the following companies:

- 13.8% of TP GROUP LDC, a consortium that owns 38.9% of virt-x, an
electronic order-driven equities market for pan-European securities.

- 7.8% of W.R. HAMBRECHT + CO., INC., a U.S.-based investment banking firm
that enables issuers to conduct auction-based securities offerings via
the Internet through its OPENIPO(R). In addition, we have an option to
buy additional shares in the event WR Hambrecht becomes a publicly-traded
company.

- 9.6% of the voting interest of ARCHIPELAGO HOLDINGS, LLC, the parent
company of an ECN that has received approval for registration as a U.S.
stock exchange. In March 2002, Archipelago, LLC merged with REDIBook ECN
LLC, another ECN. We beneficially own approximately 4.8% of the voting
interest of the surviving entity.

- 48.5% of VENCAST, INC., a U.S.-based company that offers opportunities
for capital raising by, and investing in equity securities of, private
companies via the Internet.

16

- 47.9% of TRADEWARE S.A., a European-based provider of integrated order
routing solutions to broker-dealers in Europe. We also have warrants,
exercisable after October 1, 2002, that if fully exercised, would
increase our beneficial ownership to 57.3%.

- 12.8% of STARMINE INC., a U.S.-based provider of independent ratings of
Wall Street equity analysts.

EXCHANGE MEMBERSHIPS

Overall, we are a member of 18 exchanges in North America, Europe and Asia,
and we continue to develop our direct connections to non-U.S. exchanges. The
following chart shows our various exchange memberships:

EXCHANGE MEMBERSHIPS

- ---------------

(1) On October 25, 2001, the SEC approved the merger of the equities division of
the Pacific Exchange with Archipelago, LLC to create a fully electronic
national securities exchange under the name Archipelago Exchange (ArcaEx).
In March 2002, Archipelago merged with REDIBook, another ECN.

(2) The Paris, Amsterdam and Brussels Stock Exchanges merged on September 22,
2000 to form Euronext N.V. On February 6, 2002, Lisbon Stock Exchange also
joined Euronext. We currently provide customers with access to Euronext for
trades in French and Dutch stocks.

MARKETING AND COMMUNICATIONS

Our marketing and communications strategy is focused on three goals:

- strengthening corporate brand awareness;

- attracting new customers; and

- retaining our existing customers and cross-selling value-added services
to them.

We pursue these goals through a combination of marketing communications
through media (for example, in exchange for information about our extended hours
liquidity pool, CNBC and CNNfn broadcast live daily segments from our trading
floor in the pre- and post-market hours explaining market activity), print and
broadcast advertising, interactive marketing on our own Internet website and
other on-line channels, sponsorship of customer events, direct one-on-one
marketing, traditional public relations, a variety of alliances and co-marketing
programs and the production of client premiums and promotional items. Through
our website, prospective customers can get detailed information on our services,
as well as news about us and our market environment. We also distribute Instinet
Research's proprietary reports to a variety of journalists. We design our
advertising campaigns and other communications activities to educate the
marketplace regarding the nature of our agency brokerage business and our
services.

17

OUR TECHNOLOGY AND INTELLECTUAL PROPERTY

TECHNOLOGY

Our sophisticated and proprietary technology connects us to our customers,
automates traditionally labor-intensive securities transactions, provides us
with a platform to support our operations, and is an important part of our
compliance activities. We believe that our ability to use technology effectively
to expand and enhance our services has been a key component in the development
of our business.

Our systems provide customers with efficient service and have a proven
track record of adaptability as usage has increased and service and product
offerings have expanded. Our systems are designed to be interoperable and
flexible. For example, our core matching systems use an architecture that allows
us to independently develop and evolve the functionality of the systems in
different areas as business needs and opportunities demand.

To enhance the capacity and reliability of our systems, we have two core
data centers located in Jersey City, New Jersey and Bedford, Massachusetts,
which support our client connectivity, as well as our trading and execution
systems, clearing and settlement operations and customer interfaces. These two
data centers provide redundancy for our critical applications, systems and
services, allowing us to continue to operate from either site should the other
site fail. Prior to September 11, 2001, we had three core data centers; however,
as a result of the September 11th terrorist attacks, we lost one of them, which
had been located in the World Trade Center. If one of our two remaining data
centers were to be damaged, disabled or otherwise fail or experience
difficulties, it may be more difficult for us to continue operating without
disruption to our services. In order to mitigate this risk, we are installing
additional power, telecommunications and hardware at our remaining two core data
centers in order to replace the functionality and capabilities that the World
Trade Center facility provided. Our goal is to be able to support our client
connectivity and critical systems and services from these two facilities, with
each one being able to provide independent support. We also have two subsidiary
data centers and distribution points in London serving European clients.

Our central order matching engines for our institutional equities trading
platform, including our crossing services, and fixed income platform, which
provide order management functions, use sophisticated technologies including
Linux, Sun Enterprise Servers, Tibco's Rendezvous and Java and Enterprise Java
Beans (EJB).

Currently, our customers can access our trading systems through INSTINET(R)
display screens, direct links to our systems from those of our customers using
the FIX or other protocols, or our proprietary software. Most of the methods of
connecting to our trading systems are by means of dedicated networks provided by
Radianz. We are currently seeking to develop technology that will allow us to
replace our proprietary systems of communications and connectivity with an
Internet-based system that will shift communications and connectivity
requirements to our customers.

In the future, we expect to continue to make significant investments in
systems technology to upgrade services for the development of our business.

In order to deal with increasing demands on our execution and clearing
capacity in our equity securities trading system due to greater service levels
and external circumstances such as decimalization, we have a team of employees
dedicated to managing our capacity. We believe that it will be important not
only to add capacity in the future, but to make this capacity more flexible to
handle the complexity of changing circumstances. We have a test network to
simulate complex system trading scenarios and to carry out various performance
tests on our capacity. In addition, we have other ongoing capacity projects
relating to clearing and other areas.

INTELLECTUAL PROPERTY

To protect our proprietary technology and intellectual property rights, we
rely primarily on patent, copyright, trade secret and trademark law. We
principally use material, software and technology that we have developed and
that are protected by our own intellectual property rights. However, we also use
software, as well as other material and technology that is protected primarily
by intellectual property rights belonging to third parties. We have taken
measures to register and protect our tradename, logos, trademarks and service

18

marks both in the United States and in various countries throughout the world.
Notwithstanding the precautions we take to protect our intellectual property
rights, it is possible that third parties may copy or otherwise obtain and use
our proprietary technology without authorization or otherwise infringe on our
proprietary rights.

COMPETITION

The financial services industry generally, and the securities brokerage
business in which we engage in particular, is very competitive, and we expect
competition to intensify in the future. We expect to face competition from a
number of different sources varying in size, business objectives and strategy.
In our various businesses, we compete with the following entities and types of
entities, among others:

- market makers and other traditional broker-dealers (including many of our
own customers) acting as agent or principal;

- traditional and electronic trading methods in use on U.S. and
international exchanges, including NYSE specialists and the electronic
matching systems of international exchanges;

- Nasdaq's trading services that enable NASD members to trade
electronically in Nasdaq-quoted stocks, such as SelectNet, SuperSoes and
the planned SuperMontage structure;

- the NYSE's Institutional XPress(TM), NYSE Openbook(TM) and NYSE
Direct(TM) products;

- ECNs, ATSs, electronic brokers and other electronic trading systems,
including but not limited to Bloomberg Tradebook, the Island ECN, eSpeed
and Archipelago (in March 2002, Archipelago merged with REDIBook);

- automated trade execution services developed by third party vendors for
commercialization in a wide range of financial products markets;

- trading system software companies; and

- consortia comprised of leading financial institutions and service
providers, such as BrokerTec Global LLC and EuroMTS.

In our institutional equity securities business, we compete on the basis of
a number of factors, including:

- total transaction cost;

- amount and frequency of price improvement;

- the depth and breadth of our liquidity pool;

- our speed and quality of connectivity to other trading markets;

- anonymity, attributable to customer orders;

- reputation; and

- the quality and availability of our value-added brokerage and research
services.

We have experienced intense price competition in our equity securities
business in recent years. We believe that the downward pressure on prices will
continue as a result of the following factors:

- continuing advances in technology;

- price competition;

- increased customer awareness and regulatory scrutiny of execution costs;
and

- continuing unbundling of financial services.

To maintain our customer base and attempt to counter this pressure, we have
aggressively reduced pricing for our broker-dealer customers. In addition, we
seek to continue to innovate and use technology on a global

19

basis to reduce costs; increase customer awareness of the value of price
improvement and the benefits we provide as a result of our core values of
independence and neutrality, anonymity, equal and direct access and customer
empowerment; provide value-added brokerage and other services, tailored for our
various types of customers, and maintain and expand our Nasdaq liquidity pool
and the related benefits.

In our fixed income business, we face competition from traditional
broker-dealers, electronic brokers, ATSs and other electronic trading systems,
and also from other competitors and potential competitors referred to above. We
compete on the basis of a number of factors, including:

- our business model that offers value-added services, such as broker desk
support;

- speed and quality of connectivity to customers; and

- quality, cost and speed of execution.

In our correspondent clearing business, we face competition from
traditional clearing firms. Our main competitive factors are price competition
and quality of execution.

Many of the financial service providers with which we compete are
substantially larger than we are and have substantially greater financial,
technical, marketing and other resources. Outside the United States, in addition
to our U.S. competitors with international capabilities, we compete with banks
and other financial institutions that are well-capitalized and larger than we
are and may have long-standing, well-established and, in some cases, dominant
positions in their trading markets.

Competition may intensify for the following principal reasons:

- As the profitability of broker-dealers has come under significant
pressure due to the general economic downturn, as well as the impact of
decimalization, they have increasingly focused on price in their
selection of trading services. If this trend continues, the price
competition we have experienced in recent years, and in particular in the
fourth quarter of 2001 and into 2002, will likely persist.

- Commercial banks and other financial institutions have expanded their
product offerings to include many of the financial services traditionally
provided by broker-dealers. We expect competition from commercial banks
to increase as a result of regulatory initiatives in the United States to
remove or relax restrictions on combining commercial banks and other
types of financial service providers.

- Consolidations and alliances among broker-dealers and ECNs and between
commercial banks and broker-dealers have resulted, and we believe will
continue to result, in increasingly large and well-capitalized financial
service providers. Consolidation has occurred between multi-service
financial institutions and market makers (including exchange specialists)
that could result in better capitalized market makers that compete
directly with us and our agency brokerage model.

- ECNs who apply for and receive status as securities exchanges under
Regulation ATS will be able to benefit from direct connectivity to the
Intermarket Trading System. As a result, these ECNs will have a
competitive advantage over us in attracting business in U.S.
exchange-listed stocks. In addition, there may be other potential
competitive advantages associated with securities exchange status. One
ECN, Archipelago, has already been approved to serve as a facility of a
U.S. stock exchange.

- Nasdaq and the NYSE have announced plans to become for-profit entities
(and Nasdaq has applied to become a national securities exchange) and to
introduce services in order to attract order flow and trading volume.
Implementation of these plans would put them in direct competition with
us for order flow, liquidity and trading commissions.

- Multi-service competitors are able to cross-subsidize their agency
brokerage and market making activities, with which we directly compete,
with their revenues and profits from their other activities in which we
do not engage, such as principal trading and investment banking.

- As a result of decimalization, some market makers are moving from a
business model in which they trade as principal for their own account to
an agency business model in which they charge commissions rather than
profit from the "bid-ask" spread. The SEC's recently expanded
interpretation of
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Section 28(e) of the Exchange Act allowing institutional investors to
obtain soft dollar credits from certain transactions executed through
broker-dealers on a "riskless" principal basis, rather than only on an
agency basis, may further encourage this trend. These developments may
increase our competition, particularly in the provision of soft dollar
programs.

- Regulatory changes, such as NASD and Nasdaq rule changes, have altered,
and may continue to alter, the competitive landscape in which we operate.
Sometimes these changes give our competitors competitive advantages over
us. See "-- Industry Background" and "-- Regulation."

- Increased profit levels in the financial services industry have
strengthened many of our existing competitors and attracted new
competitors to that industry.

- New competitors have emerged, including companies who provide use of
order routers or similar technology, that may not need to have any
securities industry experience and potentially may compete against us
effectively with lower overhead costs. Some of these competitors may also
be better positioned than we are to exploit recent developments in
Internet-related technology and to build more attractive or flexible
competing products that could capture some of our business.

- A variety of existing companies may seek to expand their own businesses
to compete against us because of the ongoing growth of the securities
markets, the relationships between information and trading, and the
importance of technology in creating efficient trading systems. These
potential competitors could include companies that provide trading
services for products and services other than securities, software
companies, information and media companies, and other companies that are
not currently in the securities business.

We compete with Nasdaq as a trading venue for Nasdaq-quoted stocks. We own
an equity interest of less than 1% in Nasdaq. The NASD regulates the activities
of our U.S. broker-dealer subsidiaries through its own subsidiary, NASDR, and
also operates and regulates Nasdaq. The NASD is thus able to propose, and often
obtain, SEC approval of rule changes that we believe can be to Nasdaq's
competitive benefit as a securities marketplace and our competitive
disadvantage. In addition, we are required to provide quotation data to Nasdaq
in its current role as an exclusive securities information processor, and Nasdaq
then collects a fee from market participants to whom it disseminates these data.
The SEC conditioned its approval of the SuperMontage proposal on January 10,
2001 on the NASD establishing an alternative facility that market makers and
ECNs can use to meet their order display obligations. The SEC is also moving
toward making Nasdaq's role as a securities information processor non-exclusive
in the future, Nasdaq's current exclusive role provides it financial and other
competitive advantages. See "-- Industry Background" and "-- Regulation."

On December 7, 2001, the NASD submitted to the SEC proposed changes to the
NASD's rules to reflect Nasdaq's anticipated approval as an exchange, its
resultant separation from the NASD and the creation of an alternative display
facility to display quotations and collect trade data for parties (such as ECNs)
trading outside a registered securities exchange. Other than providing access to
the Intermarket Trading System, the NASD's proposed ADF would not provide for
order execution or routing services, so that ADF market participants themselves
would be required to provide NASD member broker-dealers with electronic access,
either directly or indirectly, to their quotations. It is unclear when and in
what form the ADF might be implemented and whether the ADF, as currently
contemplated, would prove to be a viable marketplace. We are unable to predict
accurately at this time the impact the NASD's proposed ADF would have on our
business.

For a further discussion of the risks relating to our competitive
environment, see "Certain Factors that May Affect Our Business -- We Face
Substantial Competition That Could Reduce Our Market Share and Harm Our
Financial Performance."

REGULATION

As a securities broker, an ATS, an ECN and an operator of a clearing
business for our own customers and third parties, we are subject to extensive
regulation in the United States and in certain other jurisdictions in which we
operate. This regulatory framework generally applies directly to our affiliates
that are registered or
21

licensed in the various jurisdictions. Instinet Corporation, Instinet Clearing
Services, Inc., Instinet Fixed Income Inc., Lynch, Jones & Ryan, Inc. and
ProTrader Securities, Limited Partnership are each registered as broker-dealers
with, and are subject to regulation by, the SEC and other entities, as described
below.

The purpose of these regulations is to generally safeguard the integrity of
the markets and to protect the interests of investors participating in those
markets, rather than the interests of securities firms or their creditors or
stockholders. As a result, these regulations cannot be expected to protect or
further the interests of our company and may have the effect of limiting or
curtailing our activities, including activities that might be profitable.
Furthermore, additional rule-making or the initiation of proceedings could
adversely affect our business, financial results and condition, prospects and
reputation.

Regulation covers all aspects of our brokerage business, including:

- registration of offices and personnel;

- conduct of personnel;

- acceptance, execution, clearing and settlement of customer orders;

- trading practices;

- record keeping;

- capital structure;

- sales practices and advertising; and

- handling of customer funds and securities and supervision of accounts in
connection with our wholesale business.

In addition, our business may be significantly affected by regulation that
extends to the structure of the markets for equities securities.

The various governmental authorities and industry self-regulatory
organizations that supervise and regulate us generally have broad enforcement
powers. If we fail to remain in regulatory compliance, we could be censored or
fined. Alternatively, regulators could issue cease-and-desist orders against us,
prohibit us from engaging in some of our businesses, or suspend or expel us or
any of our officers or employees from the securities industry. We face the risk
of significant intervention by regulatory authorities, including extensive
examination and surveillance activity. In the case of non-compliance or alleged
non-compliance with regulations, we could be subject to investigations and
judicial or administrative proceedings that may result in substantial penalties.
In the case of non-compliance, we could also, in some situations, be subject to
civil lawsuits, by customers, in some cases for substantial damages. Our ability
to comply with all applicable laws and rules is largely dependent on our
establishment and maintenance of compliance, audit and reporting systems, as
well as our ability to attract and retain qualified compliance and other
personnel.

OUR U.S. ACTIVITIES

The securities industry in the United States is subject to extensive
regulation under both federal and state laws. The SEC is the federal agency
responsible for the administration of the federal securities laws. Our U.S.
brokerage, clearing and fixed income brokerage subsidiaries are registered with
the SEC as broker-dealers, and our primary brokerage subsidiary is also
registered with the SEC as an investment advisor. Much of the regulation of
broker-dealers has been delegated by the SEC to self-regulatory organizations,
including the NASD, which has been designated by the SEC as our principal
regulator. The NASD adopts rules (subject to approval by the SEC) that regulate
the broker-dealer industry and govern the market structure of Nasdaq. These
rules regulate the conduct of our U.S. broker-dealer subsidiaries and their
activities in Nasdaq-quoted stocks. The NASD, through its subsidiary, NASDR,
also conducts periodic examinations of the operations of those subsidiaries. Our
U.S. broker-dealer and clearing subsidiaries also are registered as
broker-dealers in a number of states and are subject to regulation by state
securities administrators in states in which they conduct

22

business. Instinet Clearing Services, Inc., Lynch, Jones & Ryan and ProTrader
Securities, Limited Partnership are also subject to regulation by the regional
exchanges of which they are members.

In addition, our U.S. broker-dealer subsidiaries are members of the
Securities Investor Protection Corporation (SIPC). SIPC provides certain
protection for customers' accounts in the event of the liquidation of a
broker-dealer. SIPC is funded through assessments on registered broker-dealers,
including us.

This regulatory environment is also subject to change. Our business,
financial condition and operating results may be adversely affected as a result
of new or revised regulations or rules imposed by the SEC, other U.S. regulatory
authorities or self-regulatory organizations, such as the NASD. Our business,
financial condition and operating results also may be adversely affected by
changes in the interpretation or enforcement of existing laws and rules by the
SEC, other regulatory authorities and self-regulatory organizations.

Over the last five years, the SEC and the NASD have proposed a number of
regulatory changes in an effort to shape or respond to developments in the
securities markets and market structure that have resulted from advances in
technology and the growth of electronic trading. Because a substantial part of
our business involves electronic trading and relies heavily on technological
advances, these proposals may have a direct and substantial impact on us.

The Order Handling Rules

Starting in 1994, the SEC and the U.S. Department of Justice conducted
anti-trust investigations of the NASD and the Nasdaq market, including the
market makers, addressing concerns of fraud, price fixing and collusion. In
December 1997, 30 major brokerage firms and the Department of Justice entered
into a settlement of these anti-trust proceedings. In a report discussing
deficiencies in the NASD's oversight of the Nasdaq market and the NASD's failure
to enforce broker-dealer compliance with NASD rules and the requirements of the
federal securities laws, the SEC specifically noted that we were not a subject
of the Department of Justice investigation or the SEC report. In response to the
findings of these investigations and consistent with the recommendations in the
SEC Market 2000 Report issued in 1994, the SEC adopted the order handling rules
for market makers and exchange specialists in 1996. These rules took effect with
respect to Nasdaq-quoted stocks in 1997.

The order handling rules prohibit a market maker or exchange specialist
from displaying a limit order for a security through an ECN that is better than
its published quote unless the ECN publishes its best-priced market maker and
exchange specialist orders in that security and permits execution against those
orders through Nasdaq. Similarly, a market maker that receives a limit order
better than its own published quote, must generally either execute the order,
incorporate the limit order price into its published quote or pass the order on
to an ECN for public display and execution access. Regulation ATS, discussed
below, requires display of institutional orders that represent the best price on
the Nasdaq quote montage.

When the order handling rules were introduced, we were the first and only
existing ECN, and the best bids and offers from our trading system were directly
displayed for the first time in the Nasdaq quote montage. The order handling
rules, however, facilitated the proliferation of ECNs by providing a role for
ECNs in the display and execution of orders. As additional ECNs came into
existence, their quotes were also displayed in the Nasdaq quote montage, which
has produced greater price transparency for investors in the market for
Nasdaq-quoted stocks and resulted in greater competition for us.

Since the introduction of the order handling rules, the SEC's Division of
Market Regulation has issued a series of "no-action" letters to us over a number
of years verifying and extending our status as an ECN in compliance with these
rules. The most recent "no-action" letter is valid until March 31, 2002. The
Division continues to condition its "no-action" position upon, among other
things, our representation that we have sufficient capacity to handle reasonably
anticipated peak volumes of trading. The Division also conditions its position
upon specified limitations on the fees we charge brokers for access to our
trading system. We expect that the Division will continue to extend its
"no-action" position, but we cannot assure you that it will do so or that its
applicable rules or the enforcement of those rules will not change. In
connection with its annual examination of the capacity of market participants,
the Division has from time to time raised issues regarding

23

the adequacy of our capacity, our testing of capacity limits and our plans for
increasing capacity, which we believe we have addressed.

Regulation ATS

In December 1998, following the issuance of the order handling rules, the
SEC promulgated new rules relating to the regulation of certain ATSs. The SEC
expanded its interpretation of the definition of "exchange" under the U.S.
securities laws to encompass a range of electronic brokerage activities,
including those conducted by us. At the same time, Regulation ATS permits
systems to register as broker-dealers, rather than as national securities
exchanges with the SEC, if they comply with the regulation.

The requirements of Regulation ATS applicable to us include:

- mandatory public display of, and public access to, best-priced orders
displayed within the system;

- the establishment and application of fair access and capacity, integrity
and security standards; and

- additional notice, recordkeeping, reporting, confidential treatment and
other requirements.

We have modified and enhanced our trading systems to comply with Regulation ATS
and continue to review and monitor our systems and procedures for compliance.

SuperSoes

In part as a reaction to the growing competitive pressures from ECNs, in
July 2001, the NASD implemented SuperSoes as its new platform for the trading of
the most widely held Nasdaq-quoted stocks (Nasdaq National Market stocks).
SuperSoes substantially expanded the functionality of SOES -- Nasdaq's existing
automatic execution system available only for small orders from public
customers -- by incorporating many trading features common among ECNs. (SOES
remains the trading system for Nasdaq SmallCap stocks, which are not eligible to
be traded on SuperSoes.) Unlike SOES, SuperSoes may be used by market makers
when trading for their own accounts. SuperSoes also improves the speed of
executions and provides the ability to enter large orders, obtain automatic
executions of orders, and interact with both publicly displayed orders and
non-publicly displayed (reserve) orders. Full participation in SuperSoes is
mandatory for all market makers in any SuperSoes-eligible securities in which
they make markets. Although ECNs may elect to participate in SuperSoes either
only for order-entry or also for display of its best priced orders in the Nasdaq
market ("full" participation), only one ECN to date has chosen full
participation. There are a number of disadvantages to full participation for
ECNs, particularly those with significant internal liquidity pools, one of the
most significant of which is the manner in which the automatic execution
functionality of SuperSoes is designed, generally exposing ECNs -- but not
market makers -- to the risk of multiple executions against the same order.
Without full participation in SuperSoes, ECNs must rely on SelectNet to display
and provide access to their customers' orders in the Nasdaq market. (SelectNet
is an older order delivery and negotiation system that electronically
facilitates, but does not automatically provide, order executions.) In addition,
SuperSoes' pricing structure is disadvantageous to order-entry only
participants. SuperSoes, in light of its features and functionality, may have
shifted, and may continue to shift, some order flow away from ECNs.

SuperMontage

On January 10, 2001, the SEC approved the NASD's rule changes creating a
new trading platform for the Nasdaq market, generally known as SuperMontage.
These new rules will significantly change the nature of trading in Nasdaq-quoted
stocks, including changing the information required to be displayed on, and the
method of operation of, the Nasdaq quote montage. When implemented, SuperMontage
will combine a computer display containing more bid and offer information about
trading interest in individual Nasdaq-quoted stocks than is currently displayed,
together with new rules establishing the execution priority of quotes and orders
submitted to Nasdaq. The execution priority rules also contain provisions that
could disadvantage us by comparison to market makers and any ECN that does not
charge broker fees for accessing orders in its trading system through Nasdaq. We
are unable to predict the impact that the implementation of

24

SuperMontage will have on our business, but it could cause us to receive fewer
orders and execute fewer orders in our liquidity pool for Nasdaq-quoted stocks,
leading to a reduction in our liquidity pool.

Nasdaq Exchange Application

Nasdaq is in the process of becoming a for-profit exchange, independent
from the NASD. On March 15, 2001, Nasdaq submitted its application for
registration as a national securities exchange to the SEC. By operating as an
exchange with SuperMontage as its trading platform, Nasdaq continues to move
from a quote-driven display system to an order-driven execution system that will
directly compete with us and other ATSs. Nasdaq is currently considering the fee
structure it would introduce as an independent, for-profit exchange. We are
unable to predict what fee changes Nasdaq might propose or eventually implement,
but Nasdaq's fee structure may have a significant impact on our equity
securities business.

Alternative Display Facility, NASD Fees and Securities Information Processor

The SEC conditioned its approval of SuperMontage on the NASD establishing
an alternative facility that market makers and ECNs can use to meet their order
display obligations. The SEC has also noted that even if Nasdaq gains status as
an exchange, the NASD will continue to be required to collect bids, offers and
quotation sizes for parties seeking to trade U.S. exchange-listed
stocks -- which would then include Nasdaq stocks -- other than on an exchange.
As a result, the SEC has indicated that the NASD must have an alternative
display facility (ADF) operational by the time Nasdaq is granted exchange
status. Accordingly, on December 7, 2001, the NASD submitted to the SEC proposed
changes to the NASD's rules to reflect Nasdaq's anticipated approval as an
exchange, its resultant separation from the NASD and the creation of an ADF. The
NASD has indicated that in creating the ADF, it intends to provide a facility
that will display quotes and collect trade data, while keeping its obligations
to operate a market to a minimum. Other than providing access to the Intermarket
Trading System, the NASD's proposed ADF would not provide for order execution or
routing services, so that ADF market participants themselves would be required
to provide NASD member broker-dealers with electronic access to their
quotations. It is unclear when and in what form the ADF might be implemented and
whether the ADF, as currently contemplated, would prove to be a viable
marketplace. We continue to review the NASD's ADF proposal and consider its
possible implications for our business and our potential participation in the
ADF.

The SEC is also considering the establishment of a securities information
processor for data regarding quotations in Nasdaq-quoted stocks independent from
Nasdaq. Nasdaq's current role as the exclusive information processor gives it
financial and other competitive advantages. It is uncertain what form this new
securities information processor might take and what effect it might have on our
business.

The NASD has also proposed changes in its fee structure that would impose a
fee on all transactions in Nasdaq-quoted stocks regardless of where those
transactions occur. In addition, in order to assess this fee, the NASD would
require NASD members not using Nasdaq's Automated Confirmation Transaction (ACT)
service to otherwise report all of their transactions in Nasdaq-quoted stocks.
We are unable to predict what impact these fee changes and required reporting
would have on our business.

Decimalization

The introduction of decimalization in April 2001 has also had an impact on
the U.S. securities markets and increased competition for ATSs. Decimalization
may assist investors in obtaining price improvement because improvement in
smaller increments is possible. Because decimalization narrows the average
trading spreads, it has also had a significant negative impact on the
profitability of traditional broker-dealers. As a result, we have received, and
may continue to receive, fewer orders from our broker-dealer customers.
Decimalization has also caused, and may continue to cause, traditional
broker-dealers to execute their customers' orders internally rather than route
them to external market centers, other than our own, for execution, because the
additional price risk they incur to fill orders internally has decreased to as
little as a penny a share. Increased internal trading by traditional
broker-dealers has also reduced, and could continue to reduce, our order flow.

25

In addition, the decline in broker-dealer profitability has resulted in
some market makers moving from a business model in which they trade as principal
for their own account to an agency business model. The SEC's recently expanded
interpretation of Section 28(e) of the Exchange Act, discussed below, may
further encourage this trend, which may increase our competition.

Section 28(e)

Section 28(e) of the Exchange Act creates a limited safe harbor that allows
investment advisers to cause their client accounts to pay more than the lowest
available commission rate, as long as the adviser determines in good faith that
the commission is reasonable in relation to the value of the research and
brokerage services the broker provides to the adviser. In December, 2001, the
SEC issued an expanded interpretation of Section 28(e) allowing institutional
investors to obtain soft dollar credits from certain transactions executed
through broker-dealers on a "riskless" principal basis, rather than only on an
agency basis (which is how Instinet executes transactions). Coupled with the
move of some market makers from a business model in which they trade as
principal for their own account to an agency business model as a result of
decimalization, this new SEC interpretation may create greater competition for
our soft dollar business.

Abolition of Rule 390

In addition to our activity in Nasdaq-quoted stocks, we provide our
customers with access to U.S. exchange-listed stocks, including connectivity to
the NYSE and its exchange specialists. NYSE Rule 390 was abolished, in May 2000.
This rule had required that all NYSE members and member firms execute
transactions in stocks listed or traded on or before April 26, 1979, during
market hours only on the floor of the NYSE, subject to exceptions. Rule 390 had
prevented NYSE members from executing some transactions with their customers
completely in-house, but it also prevented them from exposing orders in other
market centers such as ours. As a result, we are able to execute trades
involving all NYSE-listed stocks on behalf of all of our customers. Because
these stocks accounted for approximately 50% of average daily trading volume in
2001, abolition of Rule 390 may eventually lead to increased competition in
trading NYSE-listed stocks that were previously subject to the rule.

Order Routing and Execution Disclosure Rules

On January 30, 2001, SEC rules became effective (and were fully implemented
by the end of November 2001) that require many market participants, including
us, to make detailed public disclosure in electronic form of certain statistical
measures of execution quality for orders in equity securities. Market centers
must disclose information, categorized by security, size and type of order about
the time frames in which orders are executed and on the prices offered by
participants relative to each other and the marketplace. The rules also require
securities brokers, including us, to provide detailed disclosure in electronic
form regarding their order routing practices. In September 2001, the SEC issued
an interpretation that provides an exemption from this order routing disclosure
as long as the average number of customer non-directed orders routed by the
security broker during the calendar quarter is 500 or less. To date, Instinet
Clearing Services, Inc. has satisfied the requirements of the exemption.

We cannot predict what impact these rules and the consequent disclosures
will have on the number and size of orders we receive from customers.

Regulation of Clearing Activities

We are a self-clearing broker in the United States through our subsidiary
Instinet Clearing Services, Inc. We also have a correspondent clearing business
in which we provide clearing services in the United States for broker-dealers
that are not affiliated with us. Brokers that clear their own trades are subject
to substantially more regulatory requirements than brokers that rely on others
to perform those functions. Errors in performing clearing functions, including
clerical, technological and other errors related to the handling of funds and
securities held by us on behalf of customers and broker-dealers, could lead to
civil penalties imposed by applicable regulatory authorities as well as losses
and liability in related lawsuits and proceedings brought by

26

our customers, the customers of our wholesale customers and others. Any
liability that arises as a result of our clearing operations could have a
material adverse effect on our business, financial condition and operating
results.

In addition, securities industry regulators in the United States are
currently reviewing the extent to which clearing firms should be held
accountable for the improper activities of the broker-dealers for which they
provide clearing services. We cannot assure you that our procedures will be
sufficient to protect us from liability for the acts of broker-dealers that use
our correspondent clearing services under current laws and regulations. We can
also not assure you that securities industry regulators will not enact more
restrictive laws or regulations or change their interpretations of current laws
and regulations in a manner that would increase our potential liability.

Net Capital Requirements

The SEC and the NASD, as well as other regulatory agencies and securities
exchanges within and outside the United States, have stringent rules with
respect to the maintenance of specific levels of net capital by regulated
broker-dealers. These rules include the SEC's net capital rule, to which our
U.S. broker-dealer subsidiaries are subject. The failure by one of these
subsidiaries to maintain its required net capital may lead to suspension or
revocation of its registration by the SEC and its suspension or expulsion by the
NASD and other U.S. or international regulatory bodies, and ultimately could
require its liquidation. In addition, a change in the net capital rules, the
imposition of new rules or any unusually large charge against the net capital of
one of our broker-dealer subsidiaries could limit its operation, particularly
those, such as correspondent clearing, that are capital intensive. A large
charge to the net capital of one of these subsidiaries could result from an
error or other operational failure or a failure of a customer to complete one or
more transactions, including as a result of that customer's insolvency or other
credit difficulties, and we cannot assure you that we would be able to furnish
the affected subsidiary with the requisite additional capital to offset that
charge. The net capital rules could also restrict our ability to withdraw
capital from our broker-dealer subsidiaries, which could limit our ability to
pay cash dividends, repay debt or repurchase shares of our outstanding stock. A
significant operating loss or any unusually large charge against net capital
could adversely affect our ability to maintain our present levels of business,
or to expand, which could have a material adverse effect on our business,
financial condition and operating results.

Other U.S. Regulation

The SEC and NASD are currently considering, and we are periodically in
discussions with them regarding, other regulatory issues. These currently
include:

- the continuing ability of ECNs to charge access fees and the levels of
those fees;

- the criteria for customers' access to an ECN's system;

- data dissemination requirements; and

- the capacity, scalability and back-up of our trading systems.

The SEC had also indicated that it is reviewing issues concerning the
Intermarket Trading System. The NYSE had advocated the redesign or elimination
of the Intermarket Trading System, which links market centers that trade listed
equity securities, allowing an order to trade a security that is listed on two
or more markets to be executed in the market displaying the best price. The NYSE
had also suggested that, if the Intermarket Trading System is maintained, access
should be limited to exchanges and self-regulatory organizations, such as the
NYSE and Nasdaq. The NYSE could also seek to withdraw from the Intermarket
Trading System. Changes in the Intermarket Trading System, such as restrictions
on our access to the system, the withdrawal of the NYSE from the system or the
elimination of the system in its entirety, could adversely affect our ability to
attract business in NYSE-listed stocks.

We are unable to predict the outcome of the various deliberations and
discussions on the evolution of the U.S. equities market structure and
regulatory framework, although these issues or other issues of market

27

structure may have a significant impact on our equities business. In this
regard, we may consider it desirable to modify our regulatory position to
advance our business strategy. Potential steps could include the creation of new
subsidiaries regulated in the United States or abroad, the establishment of
linkages that would enable us to act as a facility of a regulated exchange,
display some or all of our orders in Nasdaq-quoted stocks on another exchange or
the ADF, report some or all of our Nasdaq trades to another exchange or the ADF,
or efforts to register as an exchange to conduct some or all of our business. On
January 23, 2001, the SEC approved new rules requiring the reporting to the NASD
of transactions in specified fixed income securities. These rules will become
effective once the NASD's new price reporting and dissemination system for the
corporate bond market (TRACE) is in place. We anticipate that TRACE will be
implemented by July 1, 2002. If we extend our fixed income trading platform to
include corporate bonds, we will become subject to these reporting rules.

In December 2000, Congress passed the Commodity Futures Modernization Act,
which allows single stock futures to be traded on the exchanges and adds
guidelines for the SEC's role in regulating some equity based derivative
securities. This act also streamlines the regulation of U.S. futures exchanges
and limits the jurisdiction of the CFTC. If we were to seek to expand into the
execution of options and futures trades, then we would be subject to this
additional regulation.

We expect that our business, especially our communications with and
connectivity to customers, will increasingly rely on the Internet and other
electronic communications gateways. We intend to expand use of these gateways.
Although to date the use of the Internet has been relatively free from
regulatory restraints, the SEC, certain self regulatory organizations and
certain states are beginning to address the regulatory issues that may arise in
connection with the use of the Internet for securities and financial services
transactions. Accordingly, new regulations or interpretations may be adopted
that constrain our ability and our customers' ability to transact business
through the Internet or other electronic communications gateways and could have
a material adverse effect on our business, financial condition and operating
results.

Regulation of the Non-U.S. Securities Industries and Investment Service
Providers

The financial services industry, including the securities brokerage
business, is heavily regulated outside of the United States. We are required to
comply with regulatory controls of each specific country in which we or our
subsidiaries conduct business, as well as the regulations of each exchange of
which we or our subsidiaries are members. As we expand our international
operations, we may be required to comply with requirements that are inconsistent
with our existing international activities. As a result, the varying compliance
requirements of these different regulatory jurisdictions and other factors may
affect our business or limit our ability to expand our international operations.

In many countries, the laws and regulations applicable to the securities
and financial services industries are uncertain and evolving. In these
countries, it may be difficult for us to determine the exact requirements of
local laws and regulations in every market, particularly because legal and
regulatory developments generally trail technological advances. Our inability to
remain in compliance with regulatory requirements in a particular jurisdiction
could have a materially adverse effect on our operations in that market and on
our reputation generally.

The securities industry in the member states of the European Union is
regulated by agencies in each member state. The European Union, however,
requires the mutual recognition of regulatory agencies. This allows providers of
investment services, like us, to obtain single authorization which is generally
valid throughout the European Union. Because our largest international
operations are in the United Kingdom, our principal regulator is the Financial
Services Authority. The conduct of our business is also regulated by agencies in
each of the other member states in which we provide investment services,
including Germany and France. The provision of investment services is also
regulated by other agencies in other jurisdictions outside of the European Union
in which we operate, such as the Swiss Federal Banking Commission, the
Securities and Futures Commission in Hong Kong and the Financial Supervisory
Authority in Japan.

Any of these non-U.S. regulatory agencies, as well as many non-U.S.
exchanges of which we are a member, may conduct administrative proceedings
against us which can result in censure, fine, the prevention
28

of activities or our suspension or expulsion from their country as an investment
services provider. The applicable regulations cover minimum financial resource
requirements and conduct of business rules for all authorized investment
businesses.

New regulations, changes in existing regulations or changes in the
interpretation or enforcement of existing regulations outside the United States
may adversely affect or limit our business or operations and adversely affect
our financial condition and operating results.

CERTAIN FACTORS THAT MAY AFFECT OUR BUSINESS

You should carefully consider the risks described below before making a
decision to invest in our company. There may be additional risks that we do not
currently know of or that we currently deem immaterial based on the information
available to us. All of these risks may impair our business operations.

RISKS RELATED TO OUR INDUSTRY

ECONOMIC, POLITICAL AND MARKET FACTORS BEYOND OUR CONTROL COULD REDUCE DEMAND
FOR OUR SERVICES AND HARM OUR BUSINESS

We earn revenues primarily from securities brokerage and related services
and expect to continue to do so. The demand for these services is directly
affected by domestic and international factors that are beyond our control,
including economic, political and market conditions; unforeseen market closures
or other disruptions in trading; the availability of short-term and long-term
funding and capital; the level and volatility of interest rates; currency
exchange rates; and inflation. Any one or more of these factors may contribute
to reduced activity and prices in the securities markets generally. The recent
economic downturn, as well as the September 11 terrorist attacks, which closed
the U.S. equity markets for four days, have led to decreasing trading volumes
and prices, decreased capital formation and a more difficult business
environment for us. These conditions may continue or worsen, which could have a
material adverse effect on our business, financial condition and operating
results.

DECREASES IN TRADING VOLUMES OR PRICES COULD HARM OUR BUSINESS AND PROFITABILITY

Declines in the volume of securities trading and in market liquidity
generally result in lower revenues from our brokerage, research and related
activities. In addition, our revenues from trading outside the United States are
determined on the basis of the value of transactions (rather than the number of
shares traded), which are adversely affected by price declines. Our
profitability would be adversely affected by a decline in our revenues because a
significant portion of our costs are fixed. The recent decline in trading
volumes and prices has had, and may continue to have, a significant adverse
effect on our business, financial condition and operating results. Our
competitors with more diversified business lines might withstand these decreases
better than we would.

WE OPERATE IN A HIGHLY REGULATED INDUSTRY, WHICH MAY LIMIT OUR ACTIVITIES

The securities markets and the brokerage industry in which we operate are
highly regulated. 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. We are subject to regulation as a securities
broker, as an alternative trading system (ATS) and electronic communications
network (ECN), and as an operator of a clearing business for our own customers
and third parties. Many of the regulations applicable to us may have the effect
of limiting our activities, including activities that might be profitable.

REGULATORY CHANGES COULD ADVERSELY AFFECT OUR BUSINESS

The securities industry has been subject to several fundamental regulatory
changes, including changes in the rules of the SEC and of self-regulatory
organizations such as the NYSE and the NASD. In the future, the

29

industry may become subject to new regulations or changes in the interpretation
or enforcement of existing regulations. We cannot predict the extent to which
any future regulatory changes may adversely affect our business. Although
regulatory changes can affect all aspects of our business, the markets for
equity securities have been subject to the most significant regulatory changes.
Our activities as an agency broker in equity securities are the principal source
of our revenues and profits.

Recent and proposed regulatory changes that have had or could have a
significant effect on our equity securities business include the following:

- Nasdaq's expanded SuperSoes order execution system has caused, and may
continue to cause, us to receive fewer orders in Nasdaq-quoted stocks,
which are the largest component of our equity securities business. In
addition, SuperSoes has resulted, and may continue to result, in fewer of
the orders we receive being executed.

- The NASD's recent rule changes creating a new trading platform for
Nasdaq, generally referred to as SuperMontage, which are currently
expected to be implemented beginning around the third quarter of 2002,
could also cause us to receive fewer orders in Nasdaq-quoted stocks and
also could cause fewer of the orders we receive to be executed in our
liquidity pool. We are unable to predict accurately at this time the
impact these changes will have on our business.

- The NASD's recent proposal for the creation of an alternative display
facility (ADF) to display quotations and collect trade data for parties
(such as ECNs) trading outside a registered securities exchange does not
generally provide for order execution or routing services. As a result,
ADF market participants themselves would be required to provide NASD
member broker-dealers with electronic access, either directly or
indirectly, to their quotations. It is unclear when and in what form the
ADF might be implemented and whether the ADF, as currently contemplated,
would prove to be a viable marketplace. We are unable to predict
accurately at this time the impact the NASD's proposed ADF would have on
our business.

- The introduction of decimalization in April 2001 -- the quoting of stock
prices in dollars and cents rather than in dollars and fractions of a
dollar (such as 1/8 or 1/16) -- has had, and may continue to have, a
negative effect on the profitability of our broker-dealer customers,
which has resulted, and may continue to result, in our receiving fewer
orders from those customers. Decimalization has also reduced, and may
continue to reduce, our order flow by increasing the likelihood that
traditional broker-dealer firms will try to execute orders internally
rather than route them to external market centers for execution. In
addition, the negative effect on broker-dealer profitability has
resulted, and may continue to result, in some market makers moving from a
business model in which they trade as principal for their own account to
an agency business model, which may increase our competition.

- The SEC's recently expanded interpretation of Section 28(e) of the
Exchange Act allowing institutional investors to generate "soft dollar"
credits -- by allocating a portion of their gross brokerage transaction
fees for research and other brokerage services -- from certain
transactions executed through broker-dealers on a "riskless" principal
basis, rather than only on an agency basis (which is how Instinet
executes transactions), could increase competition for those customers in
our equity brokerage business.

- The SEC has implemented rules requiring many market participants,
including us, to make detailed public disclosure regarding orders in
equity securities and order routing practices. We cannot predict what
impact these rules will have on the number and size of orders we receive
from customers.

- The NYSE's rule change to allow its member firms to execute transactions
in NYSE-listed stocks during market hours off the floor of the NYSE could
reduce our order flow in NYSE-listed stocks if traditional broker-dealers
execute orders in market centers other than ours.

- Changes in the Intermarket Trading System, such as restrictions on our
access to the system, requirements to use the system to publish
quotations, the threatened withdrawal of the NYSE from the

30

system or the elimination of the system in its entirety, could adversely
affect our ability to attract business in NYSE-listed stocks.

- The SEC and the NASD are currently considering, and we are periodically
in discussions with them regarding, other important issues, such as the
continuing ability of ECNs to charge access fees, the levels of those
fees and the criteria for customers' access to an ECN's system. We are
unable to predict the outcome of these deliberations and discussions, but
these issues may have a significant impact on our equity securities
business.

- The NASD has proposed changes in its fee structure that would impose a
fee on all transactions in Nasdaq-quoted stocks regardless of where those
transactions occur. In addition, in order to assess this fee, the NASD
would require NASD members not using Nasdaq's Automated Confirmation
Transaction (ACT) service to otherwise report all of their transactions
in Nasdaq-quoted stocks. We are otherwise unable to predict what impact
these fee changes and required reporting would have on our business.

The SEC's Division of Market Regulation has issued a series of "no-action"
letters to us over a number of years verifying and extending our status as an
ECN. The most recent "no-action" letter is valid until March 31, 2002. The
Division's "no-action" position is subject to our continuing to satisfy certain
conditions, including those regarding our systems capacity and a limitation on
our maximum fees. See "-- Risks Related to Our Business -- Insufficient Systems
Capacity or Systems Failures Could Harm Our Business." We cannot assure you that
the Division will continue to extend its "no-action" position. An adverse change
in the Division's position could interfere with our ability to act as an ECN and
thereby have a material adverse effect on our business, financial condition and
operating results.

INTERNATIONAL REGULATION COULD ADVERSELY AFFECT OUR BUSINESS

The financial services industry, including the securities brokerage
business, is heavily regulated in many jurisdictions outside the United States.
We are required to comply with the regulatory regime of each country in which we
conduct business, as well as the regulations of each exchange of which we are a
member. The varying requirements of these jurisdictions may adversely affect our
business or limit our ability to expand our international operations. We may not
be able to obtain the necessary regulatory approvals for planned expansion; if
approvals are obtained, they may impose restrictions on our business; or we may
not be able to continue to comply with the terms of the approvals or applicable
regulations. In addition, in many countries, the regulations applicable to the
securities and financial services industries are uncertain and evolving, and it
may be difficult for us to determine the exact regulatory requirements. Our
inability to remain in compliance with regulatory requirements in a particular
jurisdiction could have a materially adverse effect on our operations in that
market and on our reputation generally. Changes in regulations or changes in the
interpretation or enforcement of existing regulation outside the United States
may adversely affect or limit our business or operations and adversely affect
our financial condition and operating results.

WE FACE SUBSTANTIAL COMPETITION THAT COULD REDUCE OUR MARKET SHARE AND HARM OUR
FINANCIAL PERFORMANCE

The financial services industry generally, and the securities brokerage
business in which we engage in particular, is very competitive, and we expect
competition to intensify in the future. Many of the financial service providers
with which we compete are well-capitalized and substantially larger than we are
and 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. Some of them may be able
to respond more quickly to new or evolving opportunities, technologies and
customer requirements than we can and may be able to undertake more extensive
promotional activities. Outside the United States, in addition to our U.S.
competitors with international capabilities, we compete with non-U.S. banks and
other financial institutions that may also have long-standing, well-established
and, in some cases, dominant positions in their trading markets. If we are not
able to compete successfully in the future, our business, financial condition
and operating results could be adversely affected.

31

We compete with Nasdaq as a trading venue for Nasdaq-quoted stocks. The
NASD regulates the activities of our U.S. broker-dealer subsidiaries, has a
significant ownership interest in Nasdaq and owns the NASDR, which regulates and
polices the Nasdaq market. The NASD, either directly or through these
subsidiaries, is thus able to propose, and often obtain, SEC approval of rule
changes that we believe can be to Nasdaq's competitive benefit as a securities
marketplace and our competitive disadvantage.

A number of our competitors have applied for status as a national
securities exchange, and one has been approved to serve as a facility of an
exchange. Competitors that receive status as national securities exchanges, or
that enter into arrangements to operate as facilities of national securities
exchanges, will gain direct access to the National Market System and the
Intermarket Trading System, which will enable them to publicly display orders in
NYSE-listed stocks and make those orders available for execution. In addition,
these exchanges will become self-regulatory organizations, no longer subject to
NASD regulations. Nasdaq has also applied for status as a for-profit exchange.
By operating as an exchange with SuperMontage as its trading platform, Nasdaq is
continuing to evolve as a direct competitor of ATSs, including Instinet, which
could negatively impact our business, financial condition and operating results.
Nasdaq is currently considering the fee structure it would introduce as an
independent, for-profit exchange. We are unable to predict what fee changes
Nasdaq might propose or eventually implement, but Nasdaq's fee structure may
have a significant impact on our equity securities business.

We have experienced intense price competition in our equity securities
business in recent years, particularly from other ECNs. In addition, some of our
competitors may have more modern technology and a broader range of services and,
therefore, may be able to offer brokerage services to customers at lower prices
than we can. As a result of this price competition, we have experienced a
decline in both market share and revenue and have aggressively reduced pricing
for our U.S. broker-dealer customers. We anticipate that these pricing changes
will cause the transaction fee revenue we receive from this customer group to
decline significantly, even if their volumes increase, which may result in a net
operating loss in the first quarter of 2002. As a result of these pricing
changes, we have taken, and will continue to take, actions to reduce costs,
which may include reducing our staff levels and restructuring some of our
non-core businesses, among other alternatives. We expect intense competition to
continue, and if it does so or intensifies, we could lose further market share
and revenue.

OUR INABILITY TO MANAGE THE RISKS OF INTERNATIONAL OPERATIONS EFFECTIVELY COULD
ADVERSELY AFFECT OUR BUSINESS

We have operations in Europe and Asia, and there are a number of risks
inherent in doing business in international markets, including the following:

- less developed technological infrastructures and generally higher costs,
which could result in lower customer acceptance of our services or
customers having difficulty accessing our electronic marketplace;

- less automation in clearing and settlement systems, resulting in higher
expenses and increased operational difficulties (including an increased
risk of transactional errors and failure to complete customers'
transactions);

- difficulties in recruiting and retaining personnel, and managing
international operations;

- reduced protection for intellectual property rights;

- seasonal reductions in business activity during the summer months; and

- potentially adverse tax consequences.

Our inability to manage these risks effectively could adversely affect our
business, financial condition and operating results.

32

Our international operations also expose us to the risk of fluctuations in
currency exchange rates. If our risk management strategies relating to exchange
rates prove ineffective, we could suffer losses that would adversely affect our
financial condition and operating results.

REGULATORY NET CAPITAL REQUIREMENTS COULD ADVERSELY AFFECT OUR ABILITY TO
CONTINUE TO CONDUCT OR EXPAND OUR BUSINESS OPERATIONS OR TO PAY DIVIDENDS

Our broker-dealer subsidiaries are subject to stringent rules with respect
to the maintenance of specific levels of net capital by regulated
broker-dealers, including the SEC's net capital rule. The failure by one of
these subsidiaries to maintain its required net capital may lead to suspension
or revocation of its registration by the SEC and its suspension or expulsion by
the NASD or other U.S. or international regulatory bodies, and ultimately could
require its liquidation. In addition, changes in net capital regulation or a
significant operating loss or any unusually large charge against the net capital
of one of our broker-dealer subsidiaries could limit its operations,
particularly those, such as correspondent clearing, that are capital intensive.
A large charge to the net capital of one of these subsidiaries could result from
an error or other operational failure or a failure of a customer to complete one
or more transactions, including as a result of that customer's insolvency or
other credit difficulties. Our inability to maintain our present levels of
business or to expand as a result of the net capital rules could have a material
adverse effect on our business, financial condition and operating results. The
net capital rules also could restrict our ability to withdraw capital from our
broker-dealer subsidiaries, which could limit our ability to pay cash dividends,
repay debt or repurchase shares of our outstanding stock.

RISKS RELATED TO OUR BUSINESS

INSUFFICIENT SYSTEMS CAPACITY OR SYSTEMS FAILURES COULD HARM OUR BUSINESS

We are heavily dependent on the capacity and reliability of the computer
and communications systems supporting our operations. Heavy use of our computer
systems during peak trading times or at times of unusual market volatility could
cause our systems to operate slowly or even to fail for periods of time. Our
status as an SEC-recognized ECN requires that our trade execution and
communications systems be able to handle anticipated present and future peak
trading volumes. In addition, the status of our subsidiaries as SEC-registered
broker-dealers and NASD members is conditioned in part on their ability to
process and settle trades. If any of our systems do not operate properly or are
disabled, that ability could be compromised and we could suffer financial loss,
liability to clients, regulatory intervention or reputational damage.

To accommodate estimated potential increases in trading volume, including
as a result of the growth in our business and regulatory changes such as
decimalization, we have made and will continue to make significant investments
in additional hardware and software. We cannot assure you that our estimates of
future trading volumes will be accurate or that our systems will always be able
to accommodate actual trading volumes without failure or degradation of
performance. 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 altogether. In connection with its
annual examination of the capacity of market participants, the SEC's Division of
Market Regulation has from time to time raised issues regarding the adequacy of
our capacity, our testing of capacity limits and our plans for increasing
capacity. See "Business -- Regulation -- Our U.S. Activities -- The Order
Handling Rules." The inability of our systems to accommodate an increasing
volume of transactions could also constrain our ability to expand our
businesses.

In the past, we have experienced periods of extremely high trading volume
in the equity securities markets. On a few occasions during these periods, the
volume of trading activity has caused a slowing of our trade allocation and
related systems. Sustained periods of high trading volumes in the past have
enabled us to identify specific areas of vulnerability in our transaction
processing systems. These or similar events could interfere with our customers'
ability to settle trades through us or prevent us from satisfying our
responsibilities to clearing and settlement organizations and could result in
financial exposure or regulatory action. We have

33

been addressing each of these areas and upgrading our systems as necessary, but
we cannot assure you that a similar slowing of our trade allocation systems will
not occur again in the future.

As a result of the September 11 terrorist attacks, we lost one of our three
core data centers, which had been located in the World Trade Center. The
remaining two core data centers support our trading and execution systems,
clearing and settlement operations and customer interfaces. If one of these
remaining data centers were to be damaged, disabled or otherwise fail or
experience difficulties, it may be more difficult for us to continue operating
without disruption to our services.

Our electronic systems could be adversely affected by general power or
telecommunications failures, computer viruses or natural or other disasters
(including terrorist attacks). They are also vulnerable to damage or failure due
to human error and sabotage (both external and internal). The loss of support
services from third parties could also have a material adverse effect on our
electronic systems.

SHIFTS IN OUR BUSINESS MIX MAY DECREASE OUR PROFITABILITY AND NET INCOME

Changes in the mix of customers we serve (large institutional investors,
portfolio managers, hedge funds and broker-dealers) and in the use of our
trading system by our customers can materially affect our profitability and net
income. A substantial portion of our trading volume is derived from our
broker-dealer customers. In the second half of 2001, we experienced a
significant decline in volumes from these customers, resulting in lower market
share, particularly for Nasdaq-quoted shares. A shift in our customer mix toward
fewer broker-dealers or a further decline in the use of our trading system by
broker-dealers could reduce the depth and breadth of our liquidity pool, which
could reduce its attractiveness to our customers and adversely affect our
trading volumes, operating results and financial condition.

IF WE FAIL TO INTRODUCE NEW SERVICES AND SERVICE ENHANCEMENTS AND ADAPT OUR
TECHNOLOGY IN A TIMELY MANNER, WE MAY BE UNABLE TO COMPETE EFFECTIVELY

Our business environment is characterized by rapid technological change,
changing and increasingly sophisticated customer demands and evolving industry
standards. If we are unable to anticipate and respond to the demand for new
services, products and technologies on a timely and cost-effective basis and to
adapt to technological advancements and changing standards, we will be less
competitive, which could have a material adverse effect on our business,
financial condition and operating results. In addition, new services that we may
develop and introduce may not achieve market acceptance.

DECREASES IN OUR AVERAGE TRANSACTION SIZE HAVE REDUCED, AND MAY CONTINUE TO
REDUCE, OUR PROFITABILITY ON A PER TRANSACTION BASIS

In recent years, although the number of customer transactions in U.S.
equity securities that have been executed through our systems has increased, the
average size of those transactions has declined, decreasing from 1,575 shares
per transaction in 1996 to 782 shares per transaction in 2001. This decline has
caused our average revenue per transaction to decrease. As a result, our
profitability and margins on a per transaction basis have decreased. We expect
average revenue per transaction to continue to decline in the future.

OUR INABILITY TO ADJUST OUR COST STRUCTURE IF REVENUES DECLINE SUDDENLY COULD
ADVERSELY AFFECT OUR RESULTS

Our expense structure is based on historical expense levels and historical
and expected levels of demand for our services. If demand for our services and
our resulting revenues should decline suddenly (as occurred in the second half
of 2001), we may be unable to adjust our fixed cost base on a timely basis,
which could have a material adverse effect on our operating results and
financial condition.

34

COSTS RELATED TO OUR NEW BUSINESS DEVELOPMENT EFFORTS AND INVESTMENTS IN
TECHNOLOGY MAY CONTINUE TO ADVERSELY AFFECT OUR PROFITABILITY AND NET INCOME

Our net income declined in 1999 from 1998 and has remained below the 1998
level. These results are due in part to the significant costs associated with
our efforts to strengthen, expand and diversify our business and enhance our
technology since 1998. Our new business activities, the expansion of our
services and technological innovations may require significant expenditures over
long periods of time before they generate substantial revenues or net income.
Unless and until these activities generate revenues proportionate to these
expenditures, our operating margins and profitability will be adversely
affected.

WE DEPEND ON OUR EXECUTIVE OFFICERS AND KEY PERSONNEL

Our future success depends, in significant part, upon the continued service
of our executive officers, particularly Douglas M. Atkin, our President and
Chief Executive Officer, as well as various key sales, trading and technical
personnel. The loss of these key people could have a material adverse effect on
our business, financial condition and operating results.

Our future success also will depend in significant part on our ability to
recruit and retain highly skilled and often specialized individuals as
employees, particularly in light of the rapid pace of technological advances.
The level of competition in our industry for people with these skills is
intense, and from time to time we have experienced losses of key employees.
Significant losses of key personnel, particularly to other firms with which we
compete, could have a material adverse effect on our business, financial
condition and operating results.

WE MAY HAVE DIFFICULTY MANAGING OUR GROWTH EFFECTIVELY

We have experienced significant growth in our business activities over the
last five years including:

- our expansion in international markets;

- the launch of our fixed income business; and

- other new business initiatives, such as our correspondent clearing
operations.

This growth has placed, and is expected to continue to place, a significant
strain on our management and resources.

Our growth has required increased investment by us in facilities,
personnel, and financial and management systems and controls. It also has
required expansion of our procedures for monitoring and assuring our compliance
with applicable regulations, and we have needed to integrate, train and manage a
growing employee base. Our expansion in recent years has increased our need for
internal audit and monitoring processes that are more robust and broader in
scope than those we have historically required. We may not be successful in
implementing all of the processes that are necessary. Unless our growth results
in an increase in our revenues that is proportionate to the increase in our
costs associated with this growth, our operating margins and profitability will
be adversely affected.

FINANCIAL OR OTHER PROBLEMS EXPERIENCED BY THIRD PARTIES, INCLUDING CUSTOMERS,
TRADING COUNTERPARTIES, CLEARING AGENTS AND EXCHANGES, COULD HAVE AN ADVERSE
EFFECT ON OUR BUSINESS

We are exposed to credit risk from third parties that owe us money,
securities or other obligations. These parties include our customers, trading
counterparties, clearing agents, exchanges and other financial intermediaries.
These parties may default on their obligations to us due to bankruptcy, lack of
liquidity, operational failure or other reasons. Although we believe we have no
obligation to do so, we generally settle trades with a counterparty even if our
customer fails to meet its obligations to us.

We are exposed to substantial credit risk from both parties to a securities
transaction during the period between the transaction date and the settlement
date. This period is three business days in the U.S. equities markets and can be
as much as 30 days in some international markets. In addition, we have credit
exposure

35

that extends beyond the settlement date in the case of a party that does not
settle in a timely manner by failing either to make payment or to deliver
securities. Adverse movements in the prices of securities that are the subject
of these open transactions can increase our credit risk. Credit difficulties or
insolvency or the perceived possibility of credit difficulties or insolvency of
one or more large or visible market participants could also result in
market-wide credit difficulties or other market disruptions whereby a large
number of market participants may not settle transactions or otherwise perform
their obligations. Credit losses could adversely affect our financial condition
and operating results.

WE MAY HAVE DIFFICULTY MANAGING OUR ACQUISITIONS SUCCESSFULLY

To achieve our strategic objectives, we have acquired or invested in, and
in the future may seek to acquire or invest in, other companies or businesses.
Acquisitions entail numerous risks, including the following:

- difficulties in the assimilation of acquired operations and products;

- diversion of management's attention from other business concerns;

- assumption of unknown material liabilities;

- a failure to integrate successfully any operations, personnel, services
or products that we acquire;

- failure to achieve financial or operating objectives;

- impairment of certain acquired intangible assets, which would reduce
future reported earnings; and

- potential loss of customers or key employees of acquired companies.

Failure to manage our acquisitions to avoid these risks could have a material
adverse effect on our business, financial condition and operating results.

WE MAY HAVE DIFFICULTY MANAGING OUR JOINT VENTURES AND ALLIANCES SUCCESSFULLY

We seek to expand or enhance some of our operations from time to time by
forming joint ventures or alliances with various strategic partners throughout
the world. Entering into joint ventures and alliances entails risks, including

- difficulties in developing and expanding the business of newly formed
joint ventures;

- exercising influence over the activities of joint ventures in which we do
not have a controlling interest; and

- potential conflicts with our joint venture or alliance partners.

Unsuccessful joint ventures or alliances could have a material adverse effect on
our business, financial condition and operating results.

OUR COMPLIANCE SYSTEMS MIGHT NOT BE FULLY EFFECTIVE

Our ability to comply with all applicable laws and rules is largely
dependent on our establishment and maintenance of compliance, audit and
reporting systems and procedures, as well as our ability to attract and retain
qualified compliance, audit and risk management personnel. We cannot assure you
that these systems and procedures are fully effective. We also cannot assure you
that our recent headcount reductions as part of our cost-cutting initiatives
will not reduce the effectiveness of these systems and procedures. We face the
risk of significant intervention by regulatory authorities, including extensive
examination and surveillance activity. In the case of actual or alleged
non-compliance with regulations, we could be subject to investigations and
judicial or administrative proceedings that may result in substantial penalties
or civil lawsuits, including by customers, for damages, which can be
substantial. Any of these could adversely affect our business, reputation,
financial condition and operating results and, in extreme cases, our ability to
conduct our business or portions thereof.

36

OUR RISK MANAGEMENT METHODS MIGHT NOT BE FULLY EFFECTIVE

Our policies and procedures to identify, monitor and manage our risks may
not be fully effective and may vary among our various businesses and
subsidiaries worldwide. Some of our risk management methods depend upon
evaluation of information regarding markets, customers or other matters that are
publicly available or otherwise accessible by us. That information may not in
all cases be accurate, complete, up-to-date or properly evaluated. The new
business initiatives that we have recently launched or acquired, such as our
fixed income and correspondent clearing operations and the activities of our
ProTrader subsidiary, may require different oversight procedures than those we
have employed in the past. We cannot assure you that our recent headcount
reductions as part of our cost-cutting initiatives will not reduce the
effectiveness of our risk management policies and procedures. If our policies
and procedures are not fully effective or we are not always successful in
monitoring or evaluating the risks to which we are or may be exposed, our
business, reputation, financial condition and operating results could be
materially adversely affected.

WE MAY NOT BE ABLE TO OBTAIN ADDITIONAL FINANCING IF WE NEED IT

Our business is dependent upon the availability of adequate funding and
regulatory capital under applicable regulatory requirements. Historically, we
have satisfied these needs from internally generated funds and from lines of
credit made available to us by commercial banking institutions. Prior to our
initial public offering, Reuters had issued non-binding, short-term letters to
certain of these institutions confirming its ownership of us and indicating that
if we were to default under the relevant facility, Reuters would consider,
without any obligation, requests by these institutions for compensation. Reuters
has withdrawn these letters and advised us that it will not issue any additional
letters in the future, and we will thus not have the benefits of these letters.

Based on management's experience and current industry trends, we anticipate
that our available cash resources (including the remaining proceeds from our
recent initial public offering) will be sufficient to meet our presently
anticipated working capital and capital expenditure requirements for at least
the next 12 months. However, if for any reason we need to raise additional
funds, we may not be able to obtain additional financing when needed on terms
favorable to us. In addition, so long as Reuters owns a majority of our common
stock, we will need Reuters consent to incur net indebtedness (indebtedness for
borrowed money less cash on hand) in excess of an aggregate of $400 million,
excluding any indebtedness incurred by us in the ordinary course of our
brokerage or similar business or in connection with our clearing of securities
trades or our obligations to securities exchanges or clearing systems. We cannot
assure you that we will receive Reuters consent to incur indebtedness above this
amount in the future if we need to do so for any reason.

WE DEPEND ON THIRD PARTY SUPPLIERS FOR KEY SERVICES

We rely on a number of third parties to supply elements of our trading,
clearing and other systems, as well as computers and other equipment, and
related support and maintenance. We cannot assure you that any of these
providers will be able to continue to provide these services in an efficient,
cost-effective manner or that they will be able to adequately expand their
services to meet our needs. If we are unable to make alternative arrangements
for the supply of critical services in the event of an interruption in or the
cessation of service by an existing service provider, our business, financial
condition and operating results could be materially adversely affected.

In particular, we depend largely on the services of Radianz for the
telecommunications network that connects us with our customers. Radianz, a joint
venture between Reuters and Equant Finance B.V. that is 51% owned by Reuters,
provides these services to us pursuant to an agreement it has entered into with
Reuters. We are not a party to this agreement. Therefore, although we have
rights under this agreement, we must rely on Reuters to enforce this agreement
in the event of any breach by Radianz, but Reuters has no legal obligation to do
so. Disruptions in Radianz' network services to us, including as a result of the
termination of the agreement between Reuters and Radianz, or its inability to
continue to support our business, would have a material adverse effect on our
business, financial condition and operating results.

37

OUR CLEARING OPERATIONS COULD EXPOSE US TO POTENTIAL LIABILITY

Errors in performing clearing functions, including clerical, technological
and other errors related to the handling of funds and securities held by us on
behalf of customers and broker-dealers, could lead to civil penalties imposed by
applicable regulatory authorities, as well as losses and liability in related
lawsuits brought by customers and others. Any liability that arises as a result
of our clearing operations could have a material adverse effect on our business,
financial condition and operating results.

Securities industry regulators in the United States are currently reviewing
the extent to which clearing firms will be held accountable for the improper
activities of broker-dealers for which they provide clearing services. In our
correspondent clearing activities, our procedures may not be sufficient to
protect us from liability for the acts of broker-dealers or other wholesale
customers that use our correspondent clearing services under current laws and
regulations. Securities industry regulators may also enact more restrictive laws
or regulations or change their interpretations of current laws and regulations.

EMPLOYEE MISCONDUCT OR ERRORS COULD HARM US AND ARE DIFFICULT TO DETECT AND
DETER

Employee misconduct could subject us to financial losses or regulatory
sanctions and seriously harm our reputation. It is not always possible to deter
employee misconduct, and the precautions we take to prevent and detect this
activity may not be effective in all cases. Misconduct by our employees could
include hiding unauthorized activities from us, improper or unauthorized
activities on behalf of customers or improper use of confidential information.

Employee errors in recording or executing transactions for customers can
cause us to enter into transactions that customers may disavow and refuse to
settle. These transactions expose us to risk of loss, which can be material,
until we detect the errors in question and unwind or reverse the transactions.
As with any unsettled transaction, adverse movements in the prices of the
securities involved in these transactions before we unwind or reverse them can
increase this risk.

OUR QUARTERLY RESULTS MAY FLUCTUATE SIGNIFICANTLY

We have experienced, and may continue to experience significant seasonality
in our business. This seasonal trend may continue for the foreseeable future and
similar trends may affect our business, financial condition and operating
results in the future. As a result of this and the other factors and risks
discussed in this section and under "Management's Discussion and Analysis of
Financial Condition and Results of Operations," period-to-period comparisons of
revenues and operating results are not necessarily meaningful, and the results
of any quarter are not necessarily indicative of results for any future period.

WE MAY NOT BE ABLE TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS

We rely primarily on trade secret, copyright, trademark and patent law to
protect our proprietary technology. However, it is possible that third parties
may copy or otherwise obtain and use our proprietary technology without
authorization or otherwise infringe on our rights. We may also face claims of
infringement that could interfere with our ability to use technology that is
material to our business operations.

In addition, in the future, we may have to rely on litigation to enforce
our intellectual property rights, protect our trade secrets, determine the
validity and scope of the proprietary rights of others or defend against claims
of infringement or invalidity. Any such litigation, whether successful or
unsuccessful, could result in substantial costs to us and diversions of our
resources, either of which could negatively affect our business.

USE OF THE INTERNET TO ACCESS OUR SERVICES COULD EXPOSE US TO RISKS OF FAILURE
OF INTERNET PERFORMANCE AND ADVERSE CUSTOMER REACTION

Our business has traditionally been conducted with our customers through
the use of proprietary networks for the execution of trades and the
communication of information. To achieve better economies of distribution or to
improve the delivery of our services to our customers, we may seek to move a
portion of our business from our proprietary networks to non-proprietary
networks and the Internet. This may subject us to
38

additional costs. In addition, existing and prospective customers may react
unfavorably to these changes due to their concerns regarding the security,
reliability, cost, ease of use, accessibility and quality of service of the
Internet or other systems.

THE SERVICES WE PROVIDE TO PROFESSIONAL NON-INSTITUTIONAL TRADERS MAY INCREASE
OUR EXPOSURE TO PRIVATE SECURITIES LITIGATION

Many aspects of the securities brokerage business, including on-line
trading services, involve substantial risks of liability. In recent years, there
has been an increasing incidence of litigation involving the securities
brokerage industry, including class action suits that generally seek substantial
damages, including in some cases punitive damages. The services we provide to
professional non-institutional traders through our ProTrader subsidiary may
subject us to a greater risk of customer complaints, litigation and potential
liability, including with respect to suitability and delays or errors in
execution or settlement. Any litigation brought in the future could have a
material adverse effect on our business, financial condition and operating
results. See "Business -- Legal and Administrative Proceedings."

RISKS RELATING TO OUR RELATIONSHIP WITH REUTERS

REUTERS HAS SIGNIFICANT CONTROL OVER US AND MAY NOT ALWAYS EXERCISE ITS CONTROL
IN A WAY THAT BENEFITS OUR PUBLIC STOCKHOLDERS

Reuters beneficially owns approximately 83.3% of our common stock. For as
long as it continues to beneficially own more than 50% of our common stock,
Reuters will control all matters that require a stockholder vote. These matters
include the election of directors and the removal of directors without cause, as
well as mergers, acquisitions and other business combinations. In addition,
Reuters exercises a significant amount of influence over corporate matters, such
as payment of dividends and stock issuances, and over our management, business
activities and operations. Currently, four of our directors are also officers,
former officers or directors of Reuters. In addition, if we are deemed to supply
news services at a time when Reuters beneficially owns more than 50% of our
common stock, we will be required to adhere to certain principles relating to
integrity, independence, reliability and freedom from bias which apply to
Reuters generally. If applicable, these principles may influence how we conduct
our business. In addition, to the extent that these principles apply, they may
affect Reuters ability to enter into a transaction that would effect a change of
control of our company. See the information incorporated in this annual report
by reference from the "Certain Business Relationships" section of the Proxy
Statement.

Our certificate of incorporation and our corporate agreement with Reuters
also include provisions that provide Reuters with rights, including when it
beneficially owns less than a majority of our voting stock, that may be less
favorable to you and us than the corporate law governing these matters would be
in the absence of these provisions. These provisions include the right, when
Reuters beneficially owns between 35% and 50% of our voting stock, to block some
issuances of equity securities and some dispositions and acquisitions of assets
or businesses exceeding specified thresholds.

In addition, we have agreed with Reuters not to take any action that would
violate a stock exchange rule or similar requirement applicable to Reuters, or
that would result in adverse tax consequences for Reuters as a result of its
relationship with us. Reuters' substantial ownership position could also limit
our ability to enter into a transaction that involves a change of control, which
might adversely affect the market price of our common stock.

39

REUTERS MAY HAVE INTERESTS THAT CONFLICT WITH THE INTERESTS OF OUR OTHER
STOCKHOLDERS AND US AND MAY CAUSE US TO FOREGO OPPORTUNITIES

Various conflicts of interest between Reuters and us may arise in the
future in a number of areas relating to our business and relationships,
including the following:

- potential competitive business activities;

- potential acquisitions of businesses or properties;

- incurrence of indebtedness;

- tax matters;

- financial commitments;

- marketing functions;

- indemnity arrangements;

- service arrangements; and

- the exercise by Reuters of control over our management and affairs.

Individuals who are officers or directors of us and either Reuters or one
of its other subsidiaries may have fiduciary duties to both companies. Our
certificate of incorporation includes provisions confirming Reuters right to
engage in activities that compete with us and relating to the allocation of
business opportunities between Reuters and us. The resulting situation may be
more advantageous to Reuters than the corporate law governing those
opportunities would be in the absence of those provisions.

Reuters is not prohibited from engaging in our lines of business, including
brokerage, fixed income and research, and may directly or indirectly compete
with us in the future. Bridge Trading, a Reuters subsidiary, is a broker-dealer
that competes with us, primarily in the area of NYSE-listed stocks and in the
soft dollar business. In addition, we have granted a license to Reuters to use
some software and technology related to our fixed income securities platform,
which would permit Reuters to compete with us in some fixed income products.

OUR AGREEMENTS WITH REUTERS ARE NOT THE RESULT OF ARMS-LENGTH NEGOTIATIONS
BETWEEN INDEPENDENT PARTIES

We have entered into a number of commercial agreements with Reuters. Some
of these agreements were negotiated in the context of a parent-subsidiary
relationship and therefore are not the result of arms-length negotiations
between independent parties. Accordingly, we cannot assure you that the terms of
those agreements, including pricing and other material terms, are as
advantageous to us as the terms we could have negotiated with unaffiliated third
parties. See the information incorporated in this annual report by reference
from the "Certain Business Relationships" section of the Proxy Statement.

RISKS ASSOCIATED WITH PURCHASING OUR COMMON STOCK

CERTAIN PROVISIONS OF OUR CERTIFICATE OF INCORPORATION, BY-LAWS AND DELAWARE
CORPORATE LAW COULD MAKE A TAKE-OVER MORE DIFFICULT, COULD ADVERSELY AFFECT THE
MARKET PRICE OF OUR COMMON STOCK OR DEPRIVE YOU OF A PREMIUM OVER OUR MARKET
PRICE

Our certificate of incorporation and by-laws and the laws of Delaware (the
state in which we are organized) contain provisions that might make it more
difficult for someone to acquire control of us in a transaction not approved by
our board of directors. These provisions could also discourage proxy contests
and make it more difficult for you and other stockholders to elect directors
other than the candidates nominated by our board. For example, our certificate
of incorporation authorizes our board of directors to determine the rights,
preferences, privileges and restrictions of unissued series of preferred stock,
without any vote or action

40

by our stockholders. Thus, the board can authorize and issue shares of preferred
stock with voting or conversion rights that could adversely affect the voting or
other rights of holders of our common stock. In addition, the issuance of
preferred stock may have the effect of delaying, deferring, or preventing a
change of control of our company, because the terms of the preferred stock that
might be issued could potentially prohibit our consummation of any merger,
reorganization, sale of substantially all of our assets, liquidation or other
extraordinary corporate transaction without the approval of our stockholders.

The existence of these provisions could adversely affect the market price
of our common stock. Although these provisions do not have a substantial
practical significance to investors while Reuters controls us, these provisions
could have the effect of depriving stockholders of an opportunity to sell their
shares at a premium over prevailing market prices should Reuters voting power
decrease to less than 50%. See the information incorporated in this annual
report by reference from the "Certain Business Relationships" section of the
Proxy Statement.

FUTURE SALES OF OUR SHARES COULD ADVERSELY AFFECT THE MARKET PRICE OF OUR COMMON
STOCK

As of December 31, 2001, there were 248,351,000 shares of our common stock
outstanding. Of this amount, 206,900,000 shares are owned beneficially by our
parent, Reuters. Reuters will be able to sell its shares in the public markets
from time to time, subject to certain limitations on the timing, amount, and
method of such sales imposed by SEC regulations. If Reuters were to sell a large
number of its shares, the market price of our stock could decline significantly.
In addition, the perception in the public markets that sales by Reuters might
occur could also adversely affect the market price of our common stock.

In May 2001, we filed a registration statement on Form S-8 under the
Securities Act with respect to up to 33,715,500 shares of our common stock that
are reserved for issuance pursuant to our stock option plan. As a result, shares
received by employees upon exercise of their options will be eligible for resale
by the holders in the public markets, subject to certain lock-up agreements and
Rule 144 limitations applicable to affiliates. We may file a registration
statement permitting resale of these shares by affiliates.

In the future, we may issue our securities in connection with acquisitions
or investments. The amount of our common stock issued in connection with an
acquisition or investment could constitute a material portion of our then
outstanding common stock not held by Reuters.

ITEM 2. PROPERTIES

We lease all of our office space, most of which is located in New York
City, including that of our principal offices located at 3 Times Square, New
York, New York. We sublease the space for our principal offices from an
affiliate of Reuters. For further information about this lease, see "Certain
Relationships and Related Transactions." As of December 18, 2001, we also lease
office space at Harborside Plaza 10, Jersey City, New Jersey, to which we intend
to relocate our clearing, disaster recovery and certain support functions
beginning in the fourth quarter of 2002 as a result of the office space lost by
us at One World Trade Center on September 11, 2001. In addition we have lease
agreements for office space outside the United States in Frankfurt, Hong Kong,
London, Paris, Tokyo and Zurich. For further information about our leased
properties, see "Notes to Consolidated Financial Statements."

ITEM 3. LEGAL PROCEEDINGS

From time to time, we and our subsidiaries are involved in various legal
proceedings arising in the ordinary course of business. We are also subject to
periodic regulatory audits and inspections. Neither we nor our subsidiaries are
currently a party to any litigation or regulatory examination or inspection that
we believe could have a material adverse effect on our business, financial
condition or operating results.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY SHAREHOLDERS

No matters were submitted to security holders for a vote during the fourth
quarter ended December 31, 2001.

41

PART II

ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Our common stock commenced trading on the Nasdaq National Market on May 18,
2001 under the symbol "INET." Prior to that date, there was no public market for
our common stock. The following table sets forth, for the periods indicated, the
high and low closing prices per share for our common stock as reported on the
Nasdaq National Market and the dividend declared per share of our common stock:

On March 20, 2002, the last reported sales price for our common stock on
the Nasdaq National Market was $6.68. As of March 20, 2002, there were
approximately 11,000 holders of record of our common stock.

DIVIDENDS

Prior to our reorganization in 2000, most of our international operations
and some of our other activities were conducted by other companies within the
Reuters Group. In order to fund these operations, we paid dividends to Reuters,
which then made capital contributions to those companies. During 1998 and 1999,
we paid dividends to Reuters of $52.0 million and $100.0 million, respectively,
and Reuters subsequently made capital contributions to those companies of $51.5
million and $44.3 million, respectively. As a result of our reorganization in
2000, all of our international operations are now conducted by our own
subsidiaries and the capital contributions made by Reuters in 1998 and 1999 have
been recorded as capital contributions to us in those years. Because we are now
able to fund our international operations directly, we did not pay any dividends
to, or receive any capital contributions from, Reuters in 2000. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Our Reorganization."

We intend to retain our future earnings for use in our business and do not
anticipate paying any cash dividends in the foreseeable future. Any decision to
declare and pay dividends in the future will be made at the discretion of our
board of directors, after taking into account our financial results, capital
requirements and other factors they may deem relevant. So long as Reuters
continues to beneficially own more than 50% of our outstanding common stock, it
will be able to exercise control over our payment of dividends.

RECENT SALES OF UNREGISTERED SECURITIES

The following information relates to securities issued or sold by the
Registrant since June 27, 2000, the date of the Registrant's inception. During
that time, the Registrant has issued unregistered securities in the transactions
described below. Securities issued in such transactions were offered and sold in
reliance upon the exemption from registration under Section 4(2) of the
Securities Act, relating to offers of securities by an issuer not involving any
public offering or in reliance upon the exemption from registration under
Regulation S under the Securities Act, relating to offers of securities outside
the United States to persons who are not citizens or residents of the United
States. The offers and sales of securities described below were made without an
underwriter and the certificates representing the securities bear a restrictive
legend permitting the transfer of the securities only upon their registration
under, or pursuant to an exemption from the registration requirements of, the
Securities Act.

(1) On July 25, 2000, Instinet Group LLC and Instinet Corporation
executed a Contribution Agreement pursuant to which Instinet Corporation
contributed 100 shares of common stock of Instinet Global Holdings, Inc. to
Instinet Group LLC in exchange for 32,486 limited liability company
interests of Instinet Group LLC.

42

(2) On July 31, 2000, Instinet Group LLC and Reuters Holdings
Switzerland SA executed a Subscription Agreement pursuant to which Reuters
Holdings Switzerland SA contributed $167,300,000 to Instinet Group LLC in
exchange for 10,064,564 limited liability company interests in Instinet
Group LLC.

(3) On July 31, 2000, Instinet Group LLC and Instinet Corporation
executed an Asset Contribution Agreement pursuant to which Instinet
Corporation contributed substantially all of its assets and liabilities to
Instinet Group LLC in exchange for 169,236,283 limited liability company
interests in Instinet Group LLC.

(4) On September 29, 2000, Instinet Group LLC and Reuters C Corp.
(formerly known as Instinet Corporation) executed a Contribution Agreement
pursuant to which Reuters C Corp. contributed to Instinet Group LLC (a) all
of its rights and interest in 100 shares of common stock of Instinet Fixed
Income Inc. and all of its liabilities related to Instinet Fixed Income
Inc. in exchange for 1,348,371 limited liability company interests in
Instinet Group LLC and (b) all of its rights and interest in three Class A
shares of Hambrecht Instinet Ltd. in exchange for a payment of $3.00.

(5) On September 29, 2000, Instinet Group LLC and Reuters Holdings
Switzerland SA executed a Contribution Agreement pursuant to which Reuters
Holdings Switzerland SA contributed 12,000 shares of common stock of
Instinet Investments (Bermuda) Ltd. to Instinet Group LLC in exchange for
1,679,335 limited liability company interests in Instinet Group LLC.

(6) On September 29, 2000, Instinet Group LLC and Reuters Holdings
Switzerland SA executed a Contribution Agreement pursuant to which Reuters
Holdings Switzerland SA contributed 100,057,300 shares of common stock of
Instinet Holdings Limited to Instinet Group LLC in exchange for 28,315,789
limited liability company interests in of Instinet Group LLC.

(7) On October 1, 2001, we acquired ProTrader pursuant to an Interest
Purchase Agreement dated as of July 23, 2001, as amended as of October 1,
2001 (the "Purchase Agreement"), between us and David G. Jamail, David R.
Burch, Overunder, LLC, John A. McEntire IV, John Bunda, Laura Horne, Currin
Van Eman and Shayne Young (together, the "ProTrader Sellers"). Pursuant to
the Purchase Agreement, we paid the ProTrader Sellers a purchase price of
$100 million in cash and an aggregate of 5,017,058 shares of our common
stock, valued at $50 million. We sold 4,629,427 shares to the ProTrader
Sellers on October 1, 2001 in a private placement pursuant to Regulation D
of the Securities Act. We sold the remaining 387,631 shares to one of the
ProTrader Sellers on January 3, 2002 in a private placement pursuant to
Regulation D of the Securities Act.

ITEM 6. SELECTED FINANCIAL DATA
(IN THOUSANDS, EXCEPT VOLUME, SHARE AND PER SHARE DATA AND GROWTH
RATES)

The following selected consolidated financial data should be read together
with our financial statements and the related notes included elsewhere in this
annual report and the discussion under "Management's Discussion and Analysis of
Financial Condition and Results of Operations." The information as of and for
the years ended December 31, 2001, 2000 and 1999 set forth below was derived
from our audited consolidated financial statements and related notes included
elsewhere in this annual report. The information as of and for the years ended
December 31, 1998 and 1997 set forth below was derived from our audited
consolidated financial statements that are not included in this annual report.

43

The historical financial information may not be indicative of our future
performance and does not reflect what our financial position and results of
operation would have been had we operated as a separate, stand-alone entity
during 2000, 1999, 1998 and 1997.

- ---------------

(1) The expenses in various categories in this table include costs incurred by
us in developing our fixed income securities business and a retail brokerage
capability. These costs totaled $49.3 million in 2001, $118.8 million in
2000, $51.1 million in 1999, and $13.4 million in 1998. Although we will
continue to incur costs for our fixed income business, we expect that they
will decline as a percentage of revenues in the future. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Overview."

44

(2) Calculated based on the number of common shares that would have been held by
Reuters after giving effect to a return of capital payment of $150 million
to Reuters and our conversion from a limited liability company to a
corporation, which is pushed back for EPS calculation purposes.

- ---------------

(1) Includes costs incurred by us in developing our fixed income securities
business and a retail brokerage capability, which totaled totaled $49.3
million in 2001, $118.8 million in 2000, $51.1 million in 1999, and $13.4
million in 1998. Although we will continue to incur costs for our fixed
income business, we expect that they will decline as a percentage of
revenues in the future. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Overview."

45

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

This annual report contains forward-looking statements that involve risks
and uncertainties. Our actual results could differ materially from those
anticipated in forward-looking statements for many reasons, including the risks
described in "Certain Factors that May Affect Our Business" and elsewhere in
this annual report. You should read the following discussion with "Selected
Financial Data" and our financial statements and related notes included
elsewhere in this annual report.

OVERVIEW

Over the past five years, our revenues have grown at a compound annual rate
of 21%, from $584.3 million in 1996 to $1.5 billion in 2001. For the
year-to-year growth rates, see "Selected Financial Data."

This growth in revenues has been primarily driven by increases in share
volumes in the equity securities markets and by our expanded international
business, although in 2001, there has been significant volatility in the U.S.
markets and the rate of growth of the volume of trading in the U.S. markets has
slowed. For example, the total number of shares of U.S. exchange-listed and
Nasdaq-quoted stocks traded has increased at a compound annual rate of 26% from
263.8 billion in 1996 to 832.6 billion in 2001. Our trading volume in U.S.
exchange-listed and Nasdaq-quoted stocks increased at a compound annual rate of
26% over the same period. For the year-to-year growth rates, see "Selected
Financial Data." Our share of the total trading volume in U.S. exchange-listed
and Nasdaq-quoted stocks, while fluctuating over the period, increased slightly
from 9.1% in 1996 to 9.2% in 2001. Our transaction fees earned from our
customers trading equity securities have represented, and continue to represent,
a substantial part of our revenues and accounted for 94.5% of our revenues in
2001.

International equity markets have also grown substantially, and in 1988, we
began expanding our presence in these markets. Our international equity
transaction volume has increased at a compound annual rate of 95%, from 272,000
transactions in 1996 to 7.7 million transactions in 2001. For the year-to-year
growth rates, see "Selected Financial Data." Our net transaction fee revenue
earned from non-U.S. equities, which excludes revenues directly related to soft
dollar and commission recapture, has grown over the past five years from 8.4% of
our total net transaction fee revenue from our customers trading equity
securities in 1996 to 17.3% in 2000. However, this amount decreased to 16.7% in
2001, primarily due to price declines in non-U.S. securities markets despite our
increased volumes in those markets. Our revenues from international transactions
are determined on the basis of the value of transactions (rather than the number
of shares traded).

We experienced a decline in our Nasdaq market share from 15.2% in the first
half of 2001 to 13.5% in the third quarter and 11.7% in the fourth quarter,
primarily attributable to lower volumes from our broker-dealer customers. We had
strong volume growth from this group during the first half of 2001. Since then,
the profitability of those broker-dealers has come under significant pressure
due to lower overall trading volumes and reduced investment banking activities
as a result of the weak and uncertain economic conditions in the second half of
2001, as well as the impact of decimalization. These factors, together with the
introduction of Nasdaq's SuperSoes system during the third quarter of 2001,
contributed to this decline in our market share in Nasdaq-quoted trading. Our
volumes in Nasdaq-quoted stocks from other customer groups have varied in
proportion with overall market volumes. In order to address these issues, in
September 2001, we reduced our pricing, implementing a new pricing schedule for
our U.S. broker-dealer customers and adjusted certain pre-set volume levels at
which we offer those customers lower per share transaction fees. These changes
resulted in an 11% decline in our average pricing. We also established a pilot
program to test pricing incentives for liquidity providers during the second
half of 2001.

In March 2002, we implemented a new pricing plan to offer further pricing
incentives to our U.S. broker-dealer customers, reducing prices paid by
broker-dealers trading Nasdaq-quoted stocks by approximately 60% and simplifying
the pricing schedule by further adjusting certain pre-set volume levels. These
initiatives were in response to intense price competition that we have
experienced in the fourth quarter of 2001 and into 2002, particularly for
Nasdaq-quoted trading. Our market share in 2002, however, has remained
relatively stable, comparable to our fourth quarter 2001 level. We will continue
to monitor future price competition and evaluate our pricing structure as part
of our ongoing efforts to maintain and expand our Nasdaq liquidity pool.
46

As a result of these various pricing changes, we expect transaction fee revenue
we receive from this customer group to decline significantly, even if their
volumes increase, which may result in a net operating loss in the first quarter
of 2002.

Our net income increased from $119.4 million in 1996 to $144.8 million in
2001.

In May 2001, we completed an initial public offering of 36.8 million shares
at an offering price of $14.50 per share. We received net proceeds of
approximately $487 million in the offering after deducting our offering
expenses.

COST REDUCTION INITIATIVES

In order to address the decline in our margins, in July 2001, we announced
a review of spending initiatives with the aim of reducing our underlying
operating cost structure by approximately $70 million annually compared to our
total expenses in the first half of 2001. This program was completed in 2001 at
a pre-tax cost of $24.4 million. Employee headcount levels were reduced by 226.
The departments primarily affected were various operational areas in technology
support functions, sales and trading, administrative functions and clearing
operations in our U.S. and international offices. We closed our office in
Sydney, Australia, consolidated our European trading and clearing operations,
significantly reducing the size of our Zurich office, and in the U.S., closed
the Greenwich, Detroit and Seattle trading offices of our ProTrader subsidiary.
We have also aggressively managed discretionary spending in areas such as
marketing costs, professional fees to advisors and travel costs.

In addition, given the anticipated impact of price reductions on revenue
from our U.S. broker-dealer customers, we have taken further action to reduce
costs. We intend to reduce our annualized operating costs by approximately $120
million through a number of measures, including continued efforts to improve
system and network efficiencies, the evaluation and potential restructuring of
some of our non-core businesses, a reduction in staff levels and reductions in
related facilities cost. We expect to substantially realize these cost
reductions by the end of the second quarter of 2002. We expect these savings
will work to balance the impact of our price reductions. Based on current
estimates, we anticipate incurring a pre-tax restructuring charge of
approximately $55 million during the first half of 2002, although we continue to
evaluate further cost reduction initiatives, which may result in further
charges. We expect to achieve these reductions without diminishing our ability
to provide high quality service to our customers, without diminishing our
capacity to design, develop and deploy innovative new technology, and without
diminishing our internal risk, compliance and accounting controls.

BUSINESS DEVELOPMENT AND EXPANSION

In recent years, we have been expanding and diversifying our activities
through internal development and acquisitions:

In February 2000, we acquired Lynch, Jones & Ryan, a leading provider of
specialized brokerage, research and commission recapture services to pension
plan sponsors and managers. Institutional investors often allocate a portion of
their gross brokerage transaction fees for the purchase of proprietary and
independent third-party research products. The amounts so allocated for those
purposes are commonly referred to as soft dollar revenues. We also enable
pension plan and other fund sponsors to recapture a portion of the gross
transaction fees that their fund managers pay us through commission recapture
programs, which are another form of institutional discount brokerage. We offer
these soft dollar and commission recapture programs in order to increase the
amount of business our institutional customers conduct through us, thereby
increasing our transaction volumes and the depth of our liquidity pool. Over the
past five years, our expenses for payments we make to third-party research
providers and for commission recapture payments, which are equal in amount to
the corresponding soft dollar revenues and revenues that are subject to
commission recapture, increased at a compound annual rate of 49% from $30.3
million in 1996 to $220.1 million in 2001. The amount shown for 2001 includes
$78.0 million attributable to Lynch, Jones & Ryan.

47

In order to expand the services we provide our institutional and
professional investors, in October 2001, we acquired ProTrader, a provider of
advanced trading technologies and electronic brokerage services. This
acquisition will enhance our customer interface and order routing technology,
which we intend to roll out in the first half of 2002. The acquisition excluded
ProTrader's proprietary trading business. The $150 million purchase price
consisted of $100 million in cash and 5,017,058 shares of our common stock
valued at $50 million. The shares issued in this transaction are eligible for
resale subject to applicable limitations under the Securities Act of 1933. We
granted registration rights with respect to these shares and on March 27, 2002
filed with the SEC a registration statement for the resale of these shares.

In 1998, we began developing a fixed income securities platform, which we
launched in the spring of 2000 in the United States and Europe. In October 2000,
we also began providing correspondent clearing services to a few brokers in the
United States. These new businesses have not generated significant revenues to
date. With the emergence of Internet-based retail brokerage as a significant and
growing portion of the equity marketplace, we initially planned to develop our
own Internet-based retail brokerage operation and, starting in 1998, designed
and developed a platform for this business. In December 2000, based on a review
of market conditions and an evaluation of possible alternate strategies, we
decided not to launch our own on-line retail brokerage operation. In addition,
we are also continuing to evaluate our fixed income business and explore various
strategic options.

We have accomplished our diversification efforts and related expansion
primarily through internal development and through acquisitions. These internal
development efforts have resulted in significant costs, which we have expensed
as incurred. Beginning in late 1998 through 2001, we incurred expenses of
approximately $155.8 million related to the development of our fixed income
securities platform. Over the same period, we incurred expenses of approximately
$76.9 million in creating a retail brokerage capability. Included in this amount
are restructuring charges, totaling $11.5 million, that resulted from the change
in our strategy related to retail brokerage.

OPERATING MARGINS

Partly as a result of our internal development and expansion efforts, our
expenses have increased at a faster rate than our revenues. As a percentage of
revenues, total expenses have increased from 63.5% in 1996 to 83.1% in 2001. Our
restructuring costs also contributed to this increase in 2001. In addition, the
required accounting for our soft dollar and commission recapture businesses has
a dilutive effect on our operating margins. The portion of our transaction fee
revenue representing soft dollar revenues and commission recapture is offset
dollar-for-dollar by expenses we incur in paying for research from independent
third parties and in making payments representing commission recapture to
pension plan and other plan sponsors.

The following table shows the impact of our new business development
efforts, our soft dollar and commission recapture businesses and our
restructuring costs on our total expenses as a percentage of revenues. Although
we will continue to incur costs for our fixed income business, we expect that
they will decline as a percentage of revenues in the future. If our soft dollar
business continues to increase at a faster rate than our other revenues, it will
also continue to have an increasingly dilutive effect on our operating margins.
In addition, our anticipated restructuring charge for 2002 will have a negative
impact on our margins.

48

The growth in our expenses also has reflected the increasing number of
transactions by our customers, since our expenses are generally related to
transaction volumes rather than share volumes. The number of transactions has
increased at a faster rate than share trading volumes due to a decline in the
average number of shares per transaction, both in the markets generally and in
our business. This decline has resulted from a decrease in investors' costs per
transaction, coupled with the fact that investors can often better achieve their
trading objectives by executing a larger number of smaller transactions. In
addition, although our revenues have increased substantially as discussed above,
the decline in transaction size, combined with the increase in the number of
transactions and increased competition in the markets in which we operate, has
resulted in lower average revenue per transaction. Although our average cost per
transaction has also declined, average revenue per transaction has decreased at
a faster rate, resulting in pressure on our margins. We expect that both our
average cost per transaction and our average revenue per transaction will
continue to decline, but at approximately equivalent rates.

Also a contributor to our reduced margins has been the growth in our
headcount levels as we expanded and diversified our activities. We grew from
1,063 employees as of December 31, 1997 to 2,210 as of December 31, 2000. Our
headcount levels decreased to 1,975 (excluding the effect of the ProTrader
acquisition) as of December 31, 2001, as a result of our cost reduction
initiatives. Including the effect of our ProTrader acquisition, our headcount
levels decreased to 2,132. This growth has been the principal contributor to the
increase in our compensation and benefits expense and occupancy expense.

SEASONALITY

We have experienced, and may continue to experience, significant
seasonality in our business. As a result of this and other factors described
above, period-to-period comparisons of our revenues and operating results are
not necessarily meaningful, and the results for any quarter are not necessarily
indicative of results for any future period.

OUR REORGANIZATION

Effective September 30, 2000, we, together with Reuters, reorganized our
operations to combine all of our operations under one holding company structure.
Prior to the reorganization, while most of our U.S. business was conducted by
our own direct or indirect subsidiaries, most of our international operations
and some of our other activities were conducted by other companies affiliated
with us within the Reuters

49

Group. In order to fund these international operations, we paid dividends to
Reuters, which then made corresponding capital contributions to the appropriate
companies. In the reorganization, Reuters transferred various assets,
liabilities and ownership interests in those companies to us.

On May 9, 2001, we converted our company from a Delaware limited liability
company into a Delaware corporation, based on a conversion ratio of 1.033209
shares per membership interest.

REVENUES

Our revenues consist of transaction fees, interest and investment income.

Transaction fees accounted for over 95% of our revenues in 2001. These fees
are commission and other revenues earned on our customers' use of our various
brokerage and related services and fluctuate based upon transaction volumes and
pricing changes. Transaction fees also include soft dollar revenues and revenues
that are subject to commission recapture, which offset dollar-for-dollar the
expenses we incur in paying for research from independent third parties and for
commission recapture payments to pension plan and other fund sponsors.

For transactions in U.S. equity securities, we generally base our fees on a
per share basis. Our broker-dealer customers are subject to a fee schedule that
provides for a per share amount that declines based upon pre-set volume levels.
Our institutional customers pay a per share amount based upon the customer's
level of usage of our services. For transactions in non-U.S. equity securities,
we generally base our fees on the transaction value per trade as is customary in
the international markets in which we operate, and also take into account the
customer's level of trading activity. As described above under "-- Overview," we
have aggressively reduced pricing for our U.S. broker-dealer customers. As a
result, we expect transaction fee revenue we receive from this customer group to
decline significantly, even if their volumes increase.

For transactions in fixed income securities, we generally base our fees on
the transaction value per trade, taking into account the customer's level of
trading activity.

Clearing fees are earned on a per ticket basis. A ticket refers to one or
more customer transactions grouped together for clearing purposes. In some
cases, a single transaction is cleared using more than one ticket.

Interest income is interest earned on the cash provided as collateral on
stock borrowing transactions related to our clearing business, our interest
earning assets, which primarily consist of fixed income securities, and our cash
balances.

Investment income consists of realized and unrealized gains and losses,
dividends and other income earned on a series of strategic alliances and
long-term investments we have made in other companies, as well as unrealized
gains and losses from our marketable securities.

OPERATING EXPENSES

Employee compensation and benefits expense includes salaries, incentive
compensation and related employee benefits and taxes. Salaries and benefits
account for just over half of our employee compensation and benefits expense.
Many employees receive annual incentive compensation based on our overall
operating results as well as their individual performance. As a result, a
portion of this expense fluctuates based on our operating results. Some
employees, such as sales employees, receive periodic incentive compensation
based on new customer acquisitions and revenues. As part of our cost reduction
initiatives, we have been reducing our headcount, which we expect will result in
lower compensation expense in the future.

Communications and equipment expense consists primarily of costs for our
network connections with our customers; costs for maintenance of our core
network and other systems development efforts; costs for software, computers and
other equipment; and fees for access to stock market data. Communications and
equipment expense generally fluctuates based upon long-term trends in our
business activity. Certain elements of this expense, which we incur in
anticipation of certain transaction volume levels, have both a fixed and
variable nature. Once we incur these expenses initially, we may not incur them
going forward on a recurring,
50

annual basis. As a result of the importance of our systems to the viability of
our business, we continue to invest heavily in areas such as system capacity and
reliability, increased functionality and performance, and security. We also must
modify our systems from time to time to comply with various regulatory
requirements, such as the SEC order handling rules, Regulation ATS and the
introduction of decimalization. The expenses we incur for these modifications
may vary substantially from period to period. We expect our communications and
equipment expense to decrease slightly in 2002 as a result of us leveraging the
benefit of our improved network and systems efficiencies, as well as reduced
costs from Radianz, which provides us with network communications services. See
"Certain Relationships and Related Transactions."

Soft dollar and commission recapture expense consists primarily of expenses
we incur to purchase research products from third parties for our customers in
connection with our soft dollar research business. In addition, starting in 2000
with the acquisition of Lynch, Jones & Ryan, this expense includes commission
recapture payments to pension plan and other fund sponsors. Our soft dollar and
commission recapture expense fluctuates based upon the level of our customers'
demand for these services and overall market transaction volumes. As we continue
to expand our soft dollar services, we expect this expense to increase with
commensurate increases in soft dollar revenues and plan sponsor transaction fee
revenue.

Brokerage, clearing and exchange fees include fees paid to clearing
entities for clearing and settlement services, fees paid to floor brokers and
exchanges for trade execution, and fees paid to third-party vendors for data
processing services. These costs generally fluctuate based on transaction
volumes. As the percentage of our business accounted for by our international
transaction volumes continues to increase, we anticipate higher brokerage and
clearing expenses. In the international markets in which we operate, these costs
tend to be higher than in the U.S. markets.

Depreciation and amortization expense results primarily from the
depreciation of the fixed assets we purchase, as well as the amortization of
goodwill resulting from our acquisitions. In accordance with SFAS No. 142
(described below under "Recently Issued Accounting Standards"), which became
effective January 1, 2002, we will no longer amortize our goodwill to earnings,
but perform an impairment test on an annual basis. At this time, we are
currently evaluating the full impact of this statement on our financial position
and results of operations, however at a minimum, amortization of existing
goodwill of approximately $8 million, on an annual pre-tax basis, will cease
upon adoption.

Professional fees include fees paid to consultants engaged to support our
strategic development of existing and new businesses and our technology, as well
as legal and accounting fees.

Occupancy expense includes the costs of leasing, furnishing and maintaining
our office and operations space, primarily in the New York metropolitan area.
Occupancy expense is primarily affected by increases or decreases in the number
of employees and expansion or contraction of our services and related support
functions.

Marketing and business development expense consists primarily of media,
print and other advertising expenses incurred to create brand awareness, promote
our services and introduce new products. It also includes travel and client
entertainment expenses.

Other expenses consist primarily of interest costs related to securities
lending activities by our clearing operations, administrative expenses, interest
expense related to the use of our credit facilities and borrowings from Reuters,
if any, as well as other general office costs.

Provision for income taxes includes taxes related to our income in each
country or jurisdiction in which we operate. The difference between our
effective tax rate and the U.S. statutory tax rate may differ period to period,
but primarily results from state and local taxes in the U.S. and the effect of
certain non-deductable expenses.

CRITICAL ACCOUNTING POLICIES

Our financial statements have been prepared pursuant to the rules and
regulations of the SEC and, in our opinion, reflect all adjustments, consisting
only of normal recurring adjustments, necessary for a fair statement

51

of the our financial position, results of operations and cash flows for the
periods presented in conformity with generally accepted accounting principles.
The preparation of our financial statements requires us to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities as of the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period.

Our accounting policy related to our strategic alliances and long term
investments ("investments") is the most critical accounting policy that requires
us to make estimates that could affect our results. Our investments are stated
at estimated fair value as determined in good faith by management. Generally, we
will initially value these investments at cost as a proxy for fair value, and
require that changes in value be established by meaningful third-party
transactions or a significant impairment in the financial condition or operating
performance of the issuer, unless meaningful developments occur that otherwise
warrant a change in the valuation of an investment. Factors considered in
valuing individual investments include, without limitation, available market
prices, type of security, purchase price, purchases of the same or similar
securities by other investors, marketability, restrictions on disposition,
current financial position and operating results, and other pertinent
information.

We use our best judgment in estimating the fair value of these investments.
There are inherent limitations in any estimation technique. The fair value
estimates presented herein are not necessarily indicative of an amount which we
could realize in a current transaction. Because of the inherent uncertainty of
valuation, these estimated fair values do not necessarily represent amounts that
might be ultimately realized, since such amounts depend on future circumstances,
and the differences could be material.

See Note 3 to the consolidated financial statements for a summary of our
significant accounting policies.

52

KEY STATISTICAL INFORMATION

The following table presents key transaction volume information, as well as
certain other operating information.

- ---------------

(1) U.S. shares consist of shares of U.S. exchange-listed and Nasdaq-quoted
stocks.

(2) For a description of how we calculate our Nasdaq share volumes, see below.

(3) Our net equity transaction fee revenues are calculated by subtracting the
soft dollar and commission recapture expenses for equity transactions from
the related transaction fees. The required accounting for our soft dollar
and commission recapture businesses requires us to record transaction fee
revenue on a gross basis by adding the related dollar-for-dollar expenses to
those equity transaction fee revenues.

53

NASDAQ VOLUME CALCULATIONS

For purposes of calculating our published share volumes, we count the
number of shares that are traded through us as broker once. We do not count both
sides of the transaction, although we usually receive transaction fees from
parties on both sides of the transaction. As a result, we treat a transaction of
10,000 shares on our system as a single 10,000 share transaction for purposes of
calculating our share volumes.

We use the Nasdaq share volumes published by Nasdaq as resulting from the
NASD's transaction reporting rules for our calculations, including our
percentage of Nasdaq share volume, where Nasdaq share volume is the denominator.

Because of the structure of the Nasdaq market, the sale of shares by one
investor and purchase of those shares by another investor can require a series
of transactions, most often through one or more market makers, all of which are
reported to Nasdaq and included by Nasdaq in total transaction volume.

For example, in a 10,000 share purchase and sale involving two market
makers, the 10,000 share sale by Investor 1 to Market Maker 1 would be reported
to Nasdaq as a 10,000 share transaction by Market Maker 1. The sale in turn by
Market Maker 1 of the same 10,000 shares to Market Maker 2 would also be
reported to Nasdaq by Market Maker 1 as a 10,000 share transaction. Finally, the
purchase in turn of the same 10,000 shares by Customer 2 from Market Maker 2
would be reported to Nasdaq by Market Maker 2 as a third 10,000 share
transaction. Total Nasdaq trading volume would thus be 30,000 shares.

We could act as agency broker in any one or more of these three
transactions and would count any transaction in which we acted once in our
published trading volume. If, for example, we acted as broker in the transaction
between Market Maker 1 and Market Maker 2, we would act as broker for both
parties, but our trading volume would be a total of 10,000 shares.

As another example, in a 10,000 share purchase and sale involving a single
market maker, the 10,000 share sale by Investor 1 to Market Maker would be
reported by Market Maker to Nasdaq as a 10,000 share transaction, and the
purchase in turn by Investor 2 from Market Maker would be reported by Market
Maker to Nasdaq as a second 10,000 share transaction. Total Nasdaq trading
volume would thus be 20,000 shares. We could again act as agency broker in
either or both of these two transactions and would count any transaction in
which we acted once in our published trading volume. If, for example, we acted
as broker in the transaction between Investor 1 and Market Maker, we would
report our trading volume as 10,000 shares.

As a final example, we (or another broker) could act as agency broker for
two investors in the purchase and sale by them of 10,000 shares of a
Nasdaq-quoted stock. In this case, we act as agency broker for both parties but
would report a single 10,000 share transaction to Nasdaq, total Nasdaq trading
volume would be 10,000 shares, and our published trading volume would be 10,000
shares.

54

RESULTS OF OPERATIONS

The following table sets forth our consolidated statements of income data
for the periods presented as a percentage of total revenue:

- ---------------

(1) The expenses in various categories in this table include costs incurred by
us in developing our fixed income securities business and a retail brokerage
capability. See "-- Overview."

DECEMBER 31, 2001 VERSUS DECEMBER 31, 2000

Overview

Net income decreased 2.3% from $148.2 million in 2000 to $144.8 million in
2001. Our revenues grew 4.3% from $1.4 billion in 2000 to $1.5 billion in 2001
primarily as a result of increased U.S. trading volumes in the first half of
2001, notwithstanding the effects of the market closures from the events of
September 11. This growth offset a 4.3% decline in our net transaction fee
revenue earned from our customers trading non-U.S. equities primarily as a
result of declines in share prices in non-U.S. securities markets despite our
increased volumes in those markets. Our revenues from trading outside the United
States are determined on the basis of the value of transactions, rather than the
number of shares traded.

This revenue growth was offset by the 6.3% increase in expenses from $1.17
billion in 2000 to $1.24 billion in 2001. This increase in expenses was
primarily due to increased expenses related to our soft dollar and commission
recapture businesses as a result of increased customer demand for this service,
a restructuring charge related to our cost reduction initiatives and higher
compensation and benefits expense, offset by a reduction in our professional
fees and marketing and business development expenses.

55

Expenses increased despite an overall decrease in our business development
costs in connection with our efforts to expand and diversify our activities. Our
expenses related to the development of our fixed income securities platform,
which we launched in March 2000, decreased from $62.2 million in 2000 to $44.6
in 2001. Our expenses related to the creation of a retail brokerage capability
decreased from $56.6 million in 2000 to $4.7 million in 2001. Included in the
2000 and 2001 amounts are restructuring charges of $7.5 million and $4.0
million, respectively. All charges related to our change in strategy related to
our retail brokerage capability were incurred as of March 31, 2001.

Revenues

Transaction fee revenue increased 3.0% from $1.39 billion in 2000 to $1.43
billion in 2001. This increase was due to higher trading volumes primarily in
the first half of 2001 both domestically and internationally, reflecting growth
in trading volumes in the global securities markets.

Our soft dollar revenues and our revenues that are subject to commission
recapture, which are offset dollar-for-dollar by our soft dollar research
payments and commission recapture expenses, increased 22.2% from $180.0 million
in 2000 to $220.1 million in 2001 primarily a result of increased customer
demand for our soft dollar services as well as our purchase of Lynch, Jones &
Ryan in February 2000.

Our net transaction fee revenue earned from non-U.S. equities, which
excludes revenues directly related to soft dollar and commission recapture,
declined 4.3% from $207.7 million in 2000 to $198.8 million in 2001. This amount
represented 17.3% of our total net equity transaction fee revenue in 2000, and
16.7% for the comparable period in 2001. This decrease was primarily due to
declines in share prices in non-U.S. securities markets despite our increased
transaction volumes in those markets. Our revenues from trading outside the
United States are determined on the basis of the value of transactions, rather
than the number of shares traded.

Our trading volumes in Nasdaq-quoted and U.S. exchange-listed stocks
increased 14.8% and 18.2%, respectively, primarily in the first half of 2001.
Our share of volume in Nasdaq-quoted stocks increased from 13.0% in 2000 to
14.0% in 2001, and our share of volume in U.S. exchange-listed stocks increased
from 3.0% in 2000 to 3.1% in 2001. Our average number of transactions in
Nasdaq-quoted and U.S. exchange-listed stocks per day increased 23.0% from
347,690 in 2000 to 427,544 in 2001.

Interest revenue increased 26.2% from $40.5 million in 2000 to $51.1
million in 2001. This increase was primarily due to revenue generated by our
clearing services, as well as interest from our fixed income investments and
higher cash balances as a result of our initial public offering in May 2001.

Investment income increased 95.2% from $9.1 million in 2000 to $17.7
million in 2001. This increase was primarily due to mark-to-market gains of
$18.6 million in shares we own in the Euronext, London and Hong Kong stock
exchanges as a result of their demutualizations, as well as unrealized gains of
$0.9 million on our fixed income investments. Partly offsetting these gains was
a net write-down of $1.6 million related to our strategic alliances and
long-term investments. We wrote-up our investment in Archipelago by a net amount
of $16.9 million due to the November 2001 merger announcement between
Archipelago and REDIBook and based on valuations of independent third parties
involved in this transaction. Offsetting this gain was a net write-down of $17.7
million of our strategic alliances and long-term investments in businesses which
are in the area of capital raising, in particular WR Hambrecht + Co. and
Vencast. In accordance with our accounting policy, we initially value
investments at cost as a proxy for fair value and require that changes in value
be established by meaningful third-party transactions or a significant
impairment in the issuer.

Expenses

Compensation and benefits expense increased 5.1% from $412.4 million in
2000 to $433.4 million in 2001. This increase was primarily due to higher salary
costs partly offset by a decrease in our incentive compensation. Our headcount
increased in 2001 as compared to the comparable period in 2000, reaching 2,267
employees as of March 31, 2001, but then declining as of December 31, 2001 to
1,975 employees as part of our cost reduction initiatives, excluding the effect
of our ProTrader acquisition in October 2001. As of

56

December 31, 2001, after giving effect to the ProTrader acquisition, our
employee headcount was 2,132. Our acquisition of ProTrader contributed to the
increase in our compensation and benefits expense as a percentage of revenues
from 28.7% in 2000 to 29.0% in 2001.

Communications and equipment expense increased 6.4% from $153.7 million in
2000 to $163.6 million in 2001. This increase was due in large part to higher
costs related to our core communications, which increased 33.9% from $58.2
million in 2000 to $77.9 million in 2001. Of this amount, $58.7 million related
to network communications services that Radianz began providing to us in June
2000. We outsourced these services and transferred employees to Radianz at that
time. In addition, our office communication expense increased 38.9% from $10.9
million in 2000 to $15.2 million in 2001 primarily due to the move to our new
corporate headquarters. Partly offsetting these increases was a decrease in our
equipment, hardware and software costs for upgrading our existing systems. These
costs decreased 17.9% from $52.6 million in 2000 to $43.2 million in 2001
reflecting the benefit of improved network and systems efficiencies. A total of
$4.3 million of the decrease relates to decreased development expenses related
to our fixed income business and creation of a retail brokerage capability. Our
exchange data access charges also decreased 14.7% from $32.0 million in 2000 to
$27.3 million in 2001 primarily due to the sale of R&A to Reuters in the fourth
quarter of 2001. Primarily as a result of increased core communications costs,
communications and equipment expense increased as a percentage of our revenues
from 10.7% in 2000 to 10.9% in 2001.

Soft dollar and commission recapture expense increased 22.2% from $180.0
million in 2000 to $220.1 million in 2001. This expense is offset
dollar-for-dollar by soft dollar revenues and revenues that are subject to
commission recapture. This increase was primarily due to our acquisition of
Lynch, Jones & Ryan in February 2000, as well as an increase in the overall use
of our soft dollar services by our customers and increased market transaction
volumes. Primarily as a result of our purchase of Lynch, Jones & Ryan, this
expense increased as a percentage of our revenues from 12.6% in 2000 to 14.7% in
2001.

Brokerage, clearing and exchange fees increased 6.7% from $137.4 million in
2000 to $146.7 million in 2001. This increase resulted from higher domestic and
international brokerage and exchange fees as well as higher domestic clearing
fees primarily due to an increase in the number of transactions. Partly
offsetting this increase was a decrease in our international clearing fees due
to lower rates charged by our clearing banks. Primarily as a result of higher
brokerage and exchange fees, as a percent of revenue brokerage, clearing and
exchange fees increased from 9.6% in 2000 to 9.8% in 2001.

Depreciation and amortization expense increased 8.2% from $77.7 million in
2000 to $84.1 million in 2001. This increase was primarily due to an increase in
depreciation as a result of our additional purchases of fixed assets and
amortization of leasehold improvements, in connection with our move to our new
corporate headquarters in New York. As a percentage of our revenues,
depreciation and amortization expense increased from 5.4% in 2000 to 5.6% in
2001.

Professional fees decreased 56.3% from $95.3 million in 2000 to $41.6
million in 2001. This decrease was primarily due to reduced use of technical and
management consultants as a result of our cost reduction initiatives, as well as
reduced legal expenses. These fees were higher in 2000 as we were preparing for
our reorganization and initial public offering. A total of $24.5 million of the
decrease in professional fees was attributable to reduced use of consultants for
the creation of a retail brokerage capability and for our fixed income business.
Professional fees decreased as a percentage of our revenues from 6.6% in 2000 to
2.8% in 2001.

Occupancy expense increased 38.0% from $38.3 million in 2000 to $52.8
million in 2001. This increase was primarily due to higher lease payments and
related expenses for our new corporate headquarters in New York.

Marketing and business development expense decreased 31.2% from $32.7
million in 2000 to $22.5 million in 2001. This decrease was due primarily to a
decreased level of advertising as a result of our cost reduction initiatives as
well as the change in strategy related to our retail brokerage capability.

Other expenses increased 30.1% from $42.9 million in 2000 to $55.8 million
in 2001. This increase was primarily due to our interest costs related to our
securities lending activities, allowance for doubtful accounts,
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payments to Reuters in connection with our sale of our R&A product in order to
allow customers to continue to receive this service and support from Reuters
instead of us, and our charitable donations and other costs associated with the
events of September 11. Partly offsetting this increase was a decrease in our
travel costs as a result of our cost reduction initiatives.

Loss of fixed assets at World Trade Center and recovery of fixed assets
lost relates to losses of $20.4 million we incurred in our offices at the World
Trade Center as a result of the events of September 11. We recovered $21.0
million from our insurance carrier.

Our tax provision decreased 7.7% from $116.4 million in 2000 to $107.4
million in 2001. Our effective income tax rate decreased from 44.0% in 2000 to
42.6% in 2001. The reduction in the rate for 2001 is primarily due to lower
state and local income taxes.

YEAR ENDED DECEMBER 31, 2000 VERSUS DECEMBER 31, 1999

Overview

Net income increased 8.9% from $136.1 million in 1999 to $148.2 million in
2000. Our revenue grew 48.0% from $969.4 million in 1999 to $1.4 billion in 2000
primarily as a result of increased trading volumes on a global basis.

This revenue growth was offset by the 59.2% increase in expenses from
$735.1 million in 1999 to $1.2 billion in 2000. A portion of this increase is
related to increased business development costs in connection with our efforts
to expand and diversify our activities. Our expenses related to the development
of our fixed income securities platform, which we launched in March 2000,
increased from $36.7 million in 1999 to $62.2 million in 2000. Our expenses
related to the creation of a retail brokerage capability increased from $14.4
million in 1999 to $56.6 million in 2000. Included in this amount is a
restructuring charge of $7.5 million in the fourth quarter of 2000 as a result
of the change in our strategy related to retail brokerage. Excluding the effect
of these costs, our expenses increased 53.7% from $684.0 million in 1999 to
$1,051.6 million in 2000. This increase in expenses was primarily due to:

- additional staffing as a result of our growth, in particular in the
United States;

- increased expenses related to our soft dollar and commission recapture
businesses, primarily as a result of our acquisition of Lynch, Jones &
Ryan in February 2000; and

- increased communications and equipment and brokerage, clearing and
exchange fees expenses primarily as a result of the significant increase
in transaction volumes.

Revenues

Transaction fee revenue increased 47.9% from $937.0 million in 1999 to $1.4
billion in 2000. This increase was due to significantly higher trading volumes
both domestically and internationally, reflecting growth in trading volumes in
the global securities markets. Our soft dollar revenues and our revenues that
are subject to commission recapture, which are offset dollar-for-dollar by our
soft dollar research payments and commission recapture expenses, increased
101.2% from $89.5 million in 1999 to $180.0 million in 2000, primarily as a
result of our acquisition of Lynch, Jones & Ryan. Transaction fee revenue earned
from our international operations increased 41.1% from $232.0 million in 1999 to
$327.4 million in 2000, and represented 23.6% of our transaction fee revenue in
2000. Our net transaction fee revenue earned from non-U.S. equities, which
excludes revenues directly related to soft dollar and commission recapture,
increased 43.6% from $144.7 million in 1999 to $207.7 million in 2000. This
amount represented 17.1% of our total net equity transaction fee revenue in 1999
and 17.3% in 2000. This growth reflects our continued expansion in the
international marketplace.

Our trading volumes in Nasdaq-quoted and NYSE-listed stocks increased 63.0%
and 57.1% in 2000, respectively. Our share of volume in Nasdaq-quoted stocks
remained unchanged at 13.0% in 1999 and 2000, and our share of volume in
NYSE-listed stocks increased from 2.4% in 1999 to 3.0% in 2000. With declining

58

transaction sizes, our average number of transactions in Nasdaq-quoted and
NYSE-listed stocks per day increased 83.6% from 178,183 in 1999 to 327,131 in
2000.

Interest revenue increased 69.2% from $23.9 million in 1999 to $40.5
million in 2000. This increase was primarily due to the impact of rising
interest rates on our money market investments, as well as revenue on stock
borrowing transactions generated by our clearing services.

Investment income increased 5.7% from $8.6 million in 1999 to $9.1 million
in 2000. This increase was primarily due to mark-to-market gains on the shares
of the London Stock Exchange we received in the Exchange's demutualization in
July 2000, which were partially offset by a decrease in the market value of the
fixed income securities we own.

Expenses

Compensation and benefits expense increased 60.2% from $257.5 million in
1999 to $412.4 million in 2000. This increase was primarily due to the addition
of new employees, particularly in the United States, to support our rapid
growth, as well as an increase in incentive compensation due to growth in our
revenues. Our headcount increased from 1,594 employees as of December 31, 1999
to 2,210 employees as of December 31, 2000. A total of $23.7 million of the
increase in our compensation and benefits expense related to higher expenses in
our fixed income business and for the creation of a retail brokerage capability,
while our acquisition of Lynch, Jones & Ryan resulted in $19.4 million of
additional compensation and benefits expense. These expenses relating to our new
businesses and the acquisition of Lynch, Jones & Ryan contributed significantly
to the increase in our compensation and benefits expense as a percentage of
revenues from 26.6% in 1999 to 28.7% in 2000.

Communications and equipment expense increased 66.5% from $92.3 million in
1999 to $153.7 million in 2000. This increase was in part due to higher costs
related to our core communications, which increased 87.5% from $31.0 million in
1999 to $58.2 million in 2000. In addition, our equipment and software costs for
upgrading our existing systems to increase capacity and for other enhancements
to and maintenance of those systems increased 55.7%, from $33.8 million in 1999
to $52.6 million in 2000. Our costs for exchange data access also increased
51.4% from $21.1 million in 1999 to $32.0 million in 2000. The increase in our
costs for exchange data access was primarily due to higher charges for our
international business because we often agree to bear these charges for
international customers with high trading volumes. A total of $8.2 million of
the increase in communications and equipment expense related to higher
development expenses in our fixed income business and for the creation of a
retail brokerage capability, particularly in the area of equipment, hardware and
software purchase costs. Primarily because of our systems upgrading costs,
communications and equipment expense increased as a percentage of our revenues
from 9.5% in 1999 to 10.7% in 2000.

Soft dollar and commission recapture expense increased 101.2% from $89.5
million in 1999 to $180.0 million in 2000. This expense is offset
dollar-for-dollar by soft dollar revenues and revenues that are subject to
commission recapture. This increase was primarily due to the acquisition of
Lynch, Jones & Ryan in February 2000, as a result of which we incurred costs of
$57.9 million for soft dollar and commission recapture payments to pension plan
and other fund sponsors in 2000. As a result, this expense also increased as a
percentage of our revenues from 9.2% in 1999 to 12.6% in 2000. Our third-party
research products expense also increased as a result of an increase in the
overall use of our soft dollar services by our customers.

Brokerage, clearing and exchange fees increased 74.1% from $79.0 million in
1999 to $137.4 million in 2000. This increase resulted primarily from higher
clearing fees, which more than doubled both domestically and internationally.
The increase in domestic clearing fees was in large part due to our acquisition
of Lynch, Jones & Ryan. As a result, brokerage, clearing and exchange fees
increased as a percentage of our revenues from 8.2% in 1999 to 9.6% in 2000. The
increase in international clearing fees was in large part due to costs
associated with our membership in additional securities exchanges, offset in
part by lower brokerage fees internationally as we reduced the use of floor
brokers for those exchanges, and higher transaction volumes.

Depreciation and amortization expense increased 9.1% from $71.2 million in
1999 to $77.7 million in 2000. This increase was primarily due to an increase in
depreciation as a result of our additional purchases of

59

fixed assets and amortization of leasehold improvements, as well as goodwill
amortization on our acquisition of Lynch, Jones & Ryan, which added $2.7 million
in goodwill amortization expense. As a percentage of our revenues, depreciation
and amortization expense decreased from 7.4% in 1999 to 5.4% in 2000.

Professional fees increased 51.8% from $62.7 million in 1999 to $95.3
million in 2000. This increase was primarily due to increased use of technical
consultants for systems and equipment enhancements, upgrades and maintenance, as
well as strategic and business consultants. A total of $12.4 million of the
increase in professional fees related to the creation of a retail brokerage
capability. As a percentage of our revenues, professional fees increased from
6.5% in 1999 to 6.6% in 2000.

Occupancy expense increased 41.2% from $27.1 million in 1999 to $38.3
million in 2000. This increase was primarily due to higher lease expenses as a
result of the expansion of our New York office space to accommodate our
increased headcount.

Marketing and business development increased 39.4% from $23.4 million in
1999 to $32.7 million in 2000. This increase was due in part to marketing and
business development expenses related to the creation of a retail brokerage
capability, which accounted for $4.9 million of the increase. In addition, our
new corporate branding campaign commenced in July 1999.

Other expenses increased 9.5% from $32.3 million in 1999 to $35.4 million
in 2000. This increase was primarily related to a restructuring charge of $7.5
million related to our retail brokerage operation, as well as interest costs
associated with our subordinated borrowings from Reuters for our purchase of
Lynch, Jones & Ryan.

Restructuring cost of $7.5 million in 2000 related to a redeployment of our
retail brokerage efforts to our existing wholesale brokerage business based upon
review of market conditions and an evaluation of possible alternate strategies
for our web-based retail brokerage operation, which we began in 1998.

Provision for Income Taxes

Our tax provision increased 18.5% from $98.3 million in 1999 to $116.4
million in 2000. Our effective income tax rate increased from 41.9% in 1999 to
44.0% in 2000. The change in our effective tax rates was primarily due to a
greater percentage of our profits being attributable to the United States, as
well as those U.S. jurisdictions with high state and local tax rates.

60

QUARTERLY RESULTS

The following tables set forth certain unaudited consolidated quarterly
statement of income data, both in dollar amounts and as a percentage of total
revenues, and certain unaudited consolidated quarterly operating data for the
eight quarters ended December 31, 2001. In our opinion, this unaudited
information has been prepared on substantially the same basis as the
consolidated financial statements appearing elsewhere in this annual report and
includes all adjustments (consisting of normal recurring adjustments) necessary
to present fairly the unaudited consolidated quarterly data. The unaudited
consolidated quarterly data should be read together with the consolidated
financial statements and related notes included elsewhere in this annual report.
The results for any quarter are not necessarily indicative of results for any
future period.

- ---------------

(1) The expenses in various categories in this table include costs incurred by
us in developing our fixed income securities business and a retail brokerage
capability. See "-- Overview."

We have experienced, and expect to continue to experience, significant
fluctuations in quarterly operating results as a result of a variety of factors,
including:

- trading volumes;

- impact of competition;

- changes in interest rates;

- changes in foreign currency rates;

- changes in regulations;

- our ability to manage personnel and process trading activity;

- the amount and timing of capital expenditures;

- the incurrence of costs associated with acquisitions;

- changes in pricing;

- general economic conditions; and

- seasonality.

62

Our expense structure includes a certain level of fixed costs, as well as a
variable cost base that fluctuates with customer transaction volumes. In
addition, we incur certain costs in anticipation of certain transaction volume
levels. If demand for our brokerage services declines and we are unable to
respond by adjusting our fixed cost base on a timely basis, our operating
results could be materially adversely affected. In addition, we may continue to
make significant expenditures related to the expansion of our services, new
business activities and technological innovations. Many of our businesses may
require significant expenditures over long periods of time before they generate
substantial revenues or net income, and our results may be affected as a result.

Due to all of the foregoing factors, period-to-period comparisons of our
revenues and operating results are not necessarily meaningful, and these
comparisons cannot be relied upon as indicators of future performance. In
addition, we cannot assure you that we will be able to sustain the rates of
revenue growth that we have experienced in the past, that we will be able to
improve our operating results or that we will be able to sustain our
profitability on a quarterly basis. See "Certain Factors that May Affect Our
Business."

LIQUIDITY AND CAPITAL RESOURCES

We finance our business primarily through cash generated by our operating
activities. In addition, we have access to a number of credit facilities,
although our borrowings under these facilities have been traditionally low. The
net proceeds from our initial public offering are also a source of funding for
us. Prior to our reorganization, in order to fund our international operations,
we paid dividends to Reuters, which then made capital contributions to those
companies. See "-- Our Reorganization." For a discussion of our dividend policy
following the offering, see "Market for the Company's Common Equity and Related
Stockholders' Equity." We currently anticipate that the net proceeds from our
initial public offering, together with our cash resources and credit facilities,
will be more than sufficient to meet our anticipated working capital, capital
expenditures and regulatory capital requirements as well as other anticipated
requirements for at least the next twelve months. To the extent that we further
develop our correspondent clearing operations, we may need to obtain additional
financing. Our financial liquidity is primarily determined by the performance of
our business and partly by the return on our investments. Our cash equivalents
and securities owned are primarily comprised of highly liquid investments that
can be sold in the secondary market, if necessary. To the extent that market
volumes and our volumes decrease beyond certain levels, we may be required to
obtain additional financing from third parties or Reuters.

Cash and cash equivalents, together with assets readily convertible into
cash, accounted for 65.8%, 72.6% and 76.6% our assets as of December 31, 2001,
2000 and 1999, respectively. Cash and cash equivalents increased to $703.7
million as of December 31, 2001 from $415.2 million as of December 31, 2000
primarily due to the $486.9 million of net proceeds we received from our initial
public offering in May 2001, as well as increases in our securities loaned. This
increase was offset in part by an increase in our securities segregated under
federal regulations and securities borrowed. The increase in our securities
borrowed and loaned, as well as securities segregated under federal regulations
relates to our clearing business. Cash and cash equivalents increased to $415.2
million as of December 31, 2000 from $349.5 million as of December 31, 1999
primarily due to increased cash flows from our operating activities resulting
from increased balances in receivables from and payables to broker-dealers and
customers related to the higher transaction volumes resulting from the growth in
our business.

Assets readily convertible into cash consist primarily of the following
components as set forth on our Statement of Financial Condition:

- Receivables from broker-dealers principally represent amounts due on
securities transactions that have not been completed as of the settlement
date. The settlement date generally occurs within three business days of
the trade date for U.S. securities transactions, but can take as long as
30 days for non-U.S. equity transactions.

- Receivables from customers principally represent customer debit balances
and amounts due on securities transactions that have not been completed
as of the settlement date.

63

- Commissions receivable represent commissions (transaction fees)
principally from broker-dealers and are generally collected within 30
days.

- Securities owned consist principally of U.S. government and agency
securities, municipal bonds and corporate bonds in which we invest our
excess cash (for the purpose of this calculation, we have excluded the
shares we own in the London, Hong Kong and Euronext stock exchanges).

- Securities borrowed represent the amount of collateral deposited with
brokers securing marketable equity securities borrowed by us in
connection with covering customer securities transactions in our clearing
business.

Our initial public offering also resulted in an increase in our total
assets and stockholders' equity between December 31, 2001 and 2000. Higher
balances of securities borrowed and loaned related to our clearing business also
contributed to this increase. Offsetting these factors were the decreases in our
receivable from customers and broker-dealers. The growth in our transaction
volumes caused an increase in our total assets and liabilities between December
31, 2000 and December 31, 1999. Changes in our total assets and liabilities, in
particular, receivable from broker-dealers and customers, securities borrowed,
commissions receivable and payable to broker-dealers and customers, generally
lead to large fluctuations in our cash flows from operating activities from
period to period and within periods.

Capital expenditures in 2001, 2000 and 1999 related to the purchase of data
processing and communications equipment, leasehold improvements and purchases of
furniture for our additional office facilities to support our growth. We
incurred losses of approximately $20.3 million related to fixed assets at our
offices in the World Trade Center, as a result of the events of September 11. We
recovered $21.0 million from our insurance carrier. Capital expenditures and
investments in new technology were financed primarily through income from
operations. Additionally, we made cash payments in excess of net assets acquired
of $71.2 million in October 2001 in connection with our acquisition of
ProTrader, $48.5 million in February 2000 in connection with our acquisition of
Lynch, Jones & Ryan, and $3.9 million in October 1999 in connection with our
acquisition of the fixed income business of Montag Popper. Historically,
acquisitions of new businesses had generally been funded through subordinated
borrowings from Reuters. In the future, acquisitions will generally be funded
from the proceeds from our initial public offering and cash generated by our
operations. Our aggregate minimum lease commitments are $30.3 million in 2002,
$27.5 million in 2003, $22.3 million in 2004, $18.5 million in 2005, and $17.3
million in 2006. Our aggregate minimum lease commitments after 2006 are $203.9
million and relate to our 20 year lease for our headquarters in New York. We
anticipate that we will meet our 2002 capital expenditure needs out of operating
cash flows.

Cash provided by/(used in) financing activities totaled $286.8 million,
$50.4 million and ($55.7) million in 2001, 2000 and 1999, respectively. In May
2001, we made a return of capital of $150.0 million to Reuters. We funded that
return of capital through an intercompany advance from Reuters. We repaid that
advance in May 2001 out of the net proceeds we received from our initial public
offering. In addition, Reuters loaned us $49.0 million to fund our acquisition
of Lynch, Jones & Ryan in February 2000. This loan bore interest at an annual
rate based on six-month LIBOR plus 1.25% and was repaid in June 2001 We paid
dividends of $100.0 million to Reuters in 1999 and Reuters subsequently made
capital contributions of $44.3 million in 1999 to various of our international
operations as described in "-- Our Reorganization" above. We did not pay any
dividends to, or receive any capital contributions from, Reuters in 2001 or
2000.

As of December 31, 2001, we had access to $211.0 million of uncommitted
credit lines from commercial banking institutions to meet the funding needs of
our U.S. operations. These credit lines are collateralized by a combination of
customer securities and our marketable securities. As of December 31, 2001,
there were no borrowings outstanding under these credit lines. We currently pay
no annual fees to maintain these facilities. In addition, as of December 31,
2001, we had access to $769.8 million of uncommitted credit lines from
commercial banking institutions to meet the funding needs of our European and
Asian subsidiaries. These credit lines are uncollateralized, and we currently
pay no annual fees to maintain these facilities. As of December 31, 2001, there
was $69.3 million outstanding under these credit lines. Prior to our initial
public offering, Reuters had issued non-binding, short-term letters to certain
of these institutions confirming its ownership of us and indicating that if we
were to default under the relevant facility, Reuters would consider,
64

without any obligation, requests by these institutions for compensation. Reuters
has withdrawn these letters and advised us that it will not issue any additional
letters.

Our broker-dealer subsidiaries are subject to regulatory requirements
intended to ensure their respective general financial soundness and liquidity,
which require that they comply with certain minimum capital requirements. These
regulations, which differ in each country, generally prohibit a broker-dealer
subsidiary from repaying borrowings from us or our affiliates, paying cash
dividends, making loans to us or our affiliates or otherwise entering into
transactions that would result in a significant reduction in its regulatory net
capital position without prior notification or approval of its principal
regulator. See "Business -- Regulation." Our capital structure is designed to
provide each of our subsidiaries with capital and liquidity consistent with its
business and regulatory requirements. As of December 31, 2001, our U.S.
registered broker-dealer subsidiary Instinet Clearing Services, Inc., which is
the counterparty to each of our customer transactions in U.S. securities, had
net capital of $260.0 million, which was $256.4 million in excess of its
required net capital of $3.5 million.

In connection with our correspondent clearing business, we are required to
maintain segregated funds in a special reserve bank account for the exclusive
benefit of our customers. As of December 31, 2001, these funds amounted to
$310.7 million.

In addition, so long as Reuters owns a majority of our common stock, we
will need Reuters consent to incur net indebtedness (indebtedness for borrowed
money less cash on hand) in excess of an aggregate of $400.0 million and any
indebtedness incurred by us in the ordinary course of our brokerage or similar
business or in connection with the clearance of securities or obligations to
securities exchanges or clearing systems. We cannot assure you that we will
receive Reuters consent to incur indebtedness above this amount in the future if
we need to do so for any reason.

RECENTLY ISSUED ACCOUNTING STANDARDS

SFAS No. 141, "Business Combinations," was issued in June 2001 and is
effective for all business combinations initiated after June 30, 2001, as well
as all business combinations accounted for using the purchase method for which
the date of acquisition is July 1, 2001 or later. SFAS No. 141 requires that all
business combinations be accounted for under the purchase method of accounting.
Use of the pooling-of-interests method is no longer permitted. At this time, we
do not believe that adoption of this statement will have a material impact on
our financial condition and results of operations.

SFAS No. 142, "Goodwill and Other Intangible Assets," was issued in June
2001 and is effective for fiscal years beginning after December 15, 2001. SFAS
No. 142 requires that goodwill no longer be amortized to earnings, but instead
be periodically reviewed for impairment. The amortization of goodwill ceases
upon adoption of this statement, which in our case will be January 1, 2002. At
this time, we are currently evaluating the full impact of this statement on our
financial position and results of operations; however, at a minimum,
amortization of existing goodwill of approximately $8 million, on an annual
pre-tax basis, will cease upon adoption.

SFAS No. 143, "Accounting for Asset Retirement Obligations," was issued in
August 2001 and is effective for fiscal years beginning after June 15, 2002.
SFAS No. 143 provides accounting and reporting standards for obligations
associated with the retirement of tangible long-lived assets and the associated
asset retirement costs. At this time, management is reviewing the potential
impact, if any, that adoption of this statement may have on our financial
condition and results of operations.

SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets," was issued in October 2001 and is effective for fiscal years beginning
after December 15, 2001. SFAS No. 144 develops an accounting model for long
lived assets that are to be disposed of by sale, as well as addressing the
principal implementation issues. At this time, management is reviewing the
potential impact, if any, that adoption of this statement may have on our
financial condition and results of operations.

65

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk generally represents the risk of changes in value of a
financial instrument that might result from fluctuations in interest rates,
foreign exchange rates and equity prices. We have established policies,
procedures and internal processes governing our management of market risks in
the normal course of our business operations. Our Global Risk Management
Department is responsible for establishing this risk management framework, as
well as defining, measuring and managing our risks both for existing and planned
services, within ranges set by our management.

INTEREST RATE RISK

We invest a portion of our available cash in marketable securities,
classified as securities owned in our consolidated statements of financial
condition, to maximize yields while continuing to meet our cash and liquidity
needs and the net capital requirements of our regulated subsidiaries. We
maintain a short-term investment portfolio consisting mainly of U.S. government,
U.S. agency and municipal bonds, euro-denominated, Canadian and Japanese
government bonds, and corporate bonds. Our portfolio has an average maturity of
less than two years. The aggregate fair market value of this portfolio was
$206.8 million and $178.3 million as of December 31, 2001 and 2000,
respectively. These securities are subject to interest rate risk and will fall
in value if interest rates increase. If interest rates had increased immediately
and uniformly by 100 basis points, or 65 basis points in the case of municipal
bonds, as of December 31, 2001 and 2000, the fair value of the portfolio would
have declined by $2.1 million and $2.3 million, respectively. We generally hold
these securities until maturity and therefore would not expect our financial
condition, operating results or cash flows to be affected to any significant
degree by a sudden change in interest rates.

In addition, as a part of our brokerage business, we invest portions of our
excess cash in short-term interest earning assets (mainly cash and money market
instruments), which totaled $703.7 million and $415.2 million as of December 31,
2001 and 2000, respectively. We also had short-term borrowings of $69.3 million
and $117.1 million as of December 31, 2001 and 2000, respectively, on which we
are generally charged rates that approximate the U.S. Federal Funds rate or the
local equivalent rate. As a result, we do not anticipate that changes in
interest rates will have a material impact on our financial condition, operating
results or cash flows.

EXCHANGE RATE RISK

Historically, our exposure to exchange rate risk has been managed on an
enterprise-wide basis as part of Reuters risk management strategy. We are
currently evaluating our own exchange rate risk management strategy.

A portion of our operations consists of brokerage services provided outside
of the United States. Therefore, our results of operations could be adversely
affected by factors such as changes in foreign currency exchange rates or
economic conditions in the foreign markets in which we have operations. We are
primarily exposed to changes in exchange rates on the British pound and the
Euro. When the U.S. dollar strengthens against these currencies, the U.S. dollar
value of non-U.S. dollar-based revenues decreases. When the U.S. dollar weakens
against these currencies, the U.S. dollar value of non-U.S. dollar-based
revenues increases. Correspondingly, the U.S. dollar value of non-U.S.
dollar-based costs increases when the U.S. dollar weakens and decreases when the
U.S. dollar strengthens. Accordingly, changes in exchange rates may affect our
results. However, we do not believe that our exchange rate exposure will have a
material adverse effect on our financial condition, results of operations or
cash flows. In the future, we may enter into derivative financial instruments as
a means of hedging this risk.

We manage currency exposure related to our brokerage business on a
geographic basis. We generally match each of the non-U.S. subsidiaries'
liabilities with assets denominated in the same local currency. This generally
results in the net equity of the subsidiary being reported in its functional
currency and subject to the effect of changes in currency exchange rates. We
currently do not seek to mitigate this exchange rate exposure, but we may in the
future.

66

We may enter into forward foreign currency contracts to facilitate our
customers' settling transactions in various currencies, primarily the U.S.
dollar, British pound or Euro. These forward foreign currency contracts are with
third parties and with terms generally identical to our customers' transactions.
Because our customers' transactions are matched to the forward foreign exchange
contract, our exposure to exchange rate risk is not material.

Approximately $47.5 million and $17.8 million of our securities owned were
denominated in foreign currencies as of December 31, 2001 and 2000,
respectively. Of this amount, $20.9 million and $4.8 million were denominated in
euros as of December 31, 2001 and 2000, respectively; $5.7 million and $5.1
million were denominated in Canadian dollars as of December 31, 2001 and 2000,
respectively; $12.1 million and $6.8 million were denominated in British pounds
as of December 31, 2001 and 2000, respectively; $7.6 million was denominated in
Japanese yen as of December 31, 2001; and $1.2 million was denominated in the
Hong Kong dollar as of December 31, 2001. Our resulting exposure to exchange
rate risk is estimated as the potential loss in fair value resulting from a
hypothetical 10% adverse change in foreign exchange rates due to functional
versus reporting currency exposure and was $4.3 million and $1.6 million as of
December 31, 2001 and 2000, respectively.

A portion of our revenues and expenses are denominated in non-U.S. dollar
currencies. Approximately 24.3% of our revenues and 22.0% of our expenses as of
December 31, 2001, and 23.7% of our revenues and 25.3% of our expenses as of
December 31, 2000 were so denominated. Our profits are therefore exposed to
foreign currency risk -- not of a loss of funds but rather of a loss for
financial reporting purposes. We estimate this risk as the potential loss in
revenue resulting from a hypothetical 10% adverse change in foreign exchange
rates on the mix in our profits between our functional currency and the
respective reporting currencies of our subsidiaries. On this basis, the
estimated risk was approximately $4.3 million and $3.4 million as of December
31, 2001 and 2000, respectively.

EQUITY PRICE RISK

As an agency broker, we do not trade securities for our own account or
maintain inventories of securities for sale. However, we own marketable
securities of the London, Hong Kong and Euronext stock exchanges as a result of
their demutualizations, which exposes us to market price risk. This risk is
estimated as the potential loss in fair value resulting from a hypothetical 10%
adverse change in quoted market prices and amounted to approximately $5.6
million and $680,000 as of December 31, 2001 and 2000, respectively.

CREDIT RISK ON UNSETTLED TRADES

We are exposed to substantial credit risk from both parties to a securities
transaction during the period between the transaction date and the settlement
date. This period is three business days in the U.S. equities markets and can be
as much as 30 days in some international markets. In addition, we have credit
exposure that extends beyond the settlement date in the case of a party that
does not settle in a timely manner by failing either to make payment or to
deliver securities. We hold the securities that are the subject of the
transaction as collateral for our customer receivables. Adverse movements in the
prices of these securities can increase our credit risk. Over the last three
years, our loss from transactions in which a party refused or was unable to
settle and other credit losses have been immaterial.

67

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INSTINET GROUP INCORPORATED

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

68

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholders
of Instinet Group Incorporated

In our opinion, the consolidated financial statements listed in the
accompanying index present fairly, in all material respects, the financial
position of Instinet Group Incorporated and its subsidiaries at December 31,
2001 and 2000, and the results of their operations and their cash flows for each
of the three years in the period ended December 31, 2001, in conformity with
accounting principles generally accepted in the United States of America. These
financial statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of America, which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

PRICEWATERHOUSECOOPERS LLP

New York, New York
January 22, 2002

69

INSTINET GROUP INCORPORATED

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

The accompanying notes are an integral part of these consolidated financial
statements.
70

INSTINET GROUP INCORPORATED

CONSOLIDATED STATEMENTS OF INCOME

The accompanying notes are an integral part of these consolidated financial
statements.
71

INSTINET GROUP INCORPORATED

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
AND TOTAL COMPREHENSIVE INCOME

The accompanying notes are an integral part of these consolidated financial
statements.
72

INSTINET GROUP INCORPORATED

CONSOLIDATED STATEMENTS OF CASH FLOWS

The accompanying notes are an integral part of these consolidated financial
statements.
73

INSTINET GROUP INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. ORGANIZATION AND DESCRIPTION OF BUSINESS

Instinet Group Incorporated (the "Company" or "Instinet") is a Delaware
holding company which, through its operating subsidiaries, provides agency and
other brokerage services to broker-dealers, institutional customers, hedge funds
and professional traders through Instinet Global Holdings, Inc. ("IGHI"). The
Company is 83.3% owned by a subsidiary of Reuters Group PLC ("Reuters" or
"Parent"). The Company's primary operating subsidiaries are:

- Instinet Corp. ("ICorp."), a U.S. registered broker-dealer which provides
agency brokerage services to broker-dealers and institutional customers
primarily through its automated real-time trading system.

- Instinet Clearing Services, Inc. ("ICS"), a U.S. registered broker-dealer
which provides execution and clearing services to affiliates and
unaffiliated broker-dealers in the United States.

- Instinet Fixed Income, Inc., a U.S. registered broker-dealer which
provides agency brokerage services for banks and broker-dealers trading
U.S. government and agency securities.

- Lynch, Jones & Ryan, Inc. ("LJR"), a U.S. registered broker-dealer
offering specialized brokerage, research and commission recapture
services to pension plan sponsors and managers.

- Instinet International Corp., a Delaware holding company which, through
its locally registered broker-dealer subsidiaries, provides agency and
other brokerage services in equity and fixed income securities to
broker-dealers and institutional customers in Europe, Asia and Canada.

- ProTrader Securities Corp. ("ProTrader"), a U.S. registered broker-dealer
which provides direct access execution and advanced trading technology
primarily to professional and non-institutional traders, active fund
managers and hedge funds.

2. REORGANIZATION AND INITIAL PUBLIC OFFERING

Prior to September 30, 2000, Reuters ownership of the Company's global
agency brokerage operations was structured such that its U.S. operations were
owned through a U.S.-based holding company, and its European and Asian
operations were owned through European-based holding companies. Effective
September 30, 2000, Instinet reorganized its worldwide operations to combine all
of Instinet's operations under one holding company structure. The reorganization
was accounted for at historical cost in a manner similar to a pooling of
interests.

On October 5, 2000, the board of directors of Reuters created and
authorized a sub-committee to approve an initial public offering of Instinet. On
February 6, 2001, the sub-committee authorized the filing of a registration
statement with the Securities and Exchange Commission in connection with the
initial public offering. On May 9, 2001, the Company converted from a limited
liability company to a corporation in the state of Delaware and on May 23, 2001,
the Company completed its initial public offering. In that offering, the Company
sold 36,800,000 shares of common stock and received net proceeds of
approximately $487 million after deducting offering expenses and repayment of an
advance to the Company of $150 million by Reuters.

3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF PRESENTATION

The accompanying consolidated financial statements include the accounts of
the Company and its wholly owned subsidiaries. All significant transactions and
balances between and among the Company and its subsidiaries have been eliminated
in consolidation.

74

INSTINET GROUP INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

USE OF ESTIMATES

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities as of the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from these estimates.

TRANSACTION FEES

Transaction fees and related expenses arising from securities brokerage
transactions are recorded on a trade date basis.

SOFT DOLLAR AND COMMISSION RECAPTURE

Soft dollar and commission recapture expenses primarily relate to the
purchase of third party research products as well as payments made as part of
the Company's commission recapture services. The Company reports its transaction
fee revenue from these businesses separately from its soft dollar and commission
recapture expenses.

INVESTMENTS

Investments are stated at estimated fair value as determined in good faith
by management. Generally, management will initially value investments at cost
and require that changes in value be established by meaningful third-party
transactions or a significant impairment in the financial condition or operating
performance of the issuer, unless meaningful developments occur that otherwise
warrant a change in the valuation of an investment. Factors considered in
valuing individual investments include, without limitation, available market
prices, type of security, purchase price, purchases of the same or similar
securities by other investors, marketability, restrictions on disposition,
current financial position and operating results, and other pertinent
information.

Management uses its best judgment in estimating the fair value of these
investments. There are inherent limitations in any estimation technique. The
fair value estimates presented herein are not necessarily indicative of an
amount which the Company could realize in a current transaction. Because of the
inherent uncertainty of valuation, these estimated fair values do not
necessarily represent amounts that might be ultimately realized, since such
amounts depend on future circumstances, and the differences could be material.

Unrealized gains and losses from investments are included in investment
income on the consolidated statements of income.

DEPRECIATION AND AMORTIZATION OF FIXED ASSETS ($ IN THOUSANDS)

Depreciation of capitalized furniture and equipment is provided on a
straight-line basis using estimated useful lives of three to ten years.
Leasehold improvements are amortized on a straight-line basis over the lesser of
the lease term or the estimated useful life. Fixed assets are stated at cost,
net of accumulated depreciation and amortization of $373,689 and $300,286 as of
December 31, 2001 and 2000, respectively. Depreciation and amortization expense
was $75,978, $70,216 and $66,590 for the years ended December 31, 2001, 2000 and
1999, respectively.

75

INSTINET GROUP INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

ACQUISITIONS AND GOODWILL ($ IN THOUSANDS)

All business acquisitions have been accounted for under the purchase method
and, accordingly, the excess of the purchase price over the fair value of the
net assets acquired has been recorded as goodwill on the consolidated statements
of financial condition.

The carrying value of goodwill is reviewed on a periodic basis for
impairment based upon the undiscounted cash flows of the businesses acquired
over the remaining amortization period. Should the review indicate that goodwill
is impaired, the Company's carrying value of goodwill would be reduced by the
estimated shortfall of the discounted cash flows.

In accordance with SFAS 142 "Goodwill and other Intangible Assets,"
goodwill existing as of June 30, 2001 was amortized until December 31, 2001. For
goodwill arising from acquisitions after June 30, 2001, the Company did not
amortize goodwill but reviewed it for impairment in accordance with the
Company's impairment policy, noted above. After December 31, 2001, the Company
will review all goodwill for impairment in accordance with SFAS 142.

Pursuant to the purchase method, the results of operations, changes in
stockholders' equity and cash flows of acquired companies and businesses are
included in consolidated operations only for those periods following the date of
their acquisition.

INTANGIBLE ASSET

The identifiable intangible asset consists primarily of intellectual
property and related technology in connection with the Company's acquisition of
ProTrader in October 2001. The intangible asset is being amortized on a straight
line basis over its estimated useful life of 7 years. Intangible asset is stated
net of accumulated amortization of $2,358. Amortization expense was $2,358 for
the period ended December 31, 2001.

MARKETING AND BUSINESS DEVELOPMENT

Advertising costs are expensed when incurred.

SOFTWARE COSTS

Costs for internal use software, whether developed or obtained, are
assessed to determine whether they should be capitalized or expensed in
accordance with American Institute of Certified Public Accountants' Statement
("SOP") 98-1 "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use." Capitalized software costs, which are reflected as
fixed assets on the statements of financial condition, were $6,001 and $8,444 at
December 31, 2001 and 2000. Amortization expense was $5,136, $4,431 and $6,586
for the years ended December 31, 2001, 2000 and 1999, respectively.

INCOME TAXES

Prior to its reorganization (Note 2), the Company's U.S. operations were
included in the federal income tax returns filed by an affiliate in the United
States. The Company determined its provision for federal income taxes as if it
had filed separate income tax returns. After the reorganization, the Company
filed a separate federal income tax return. The Company filed separate income
tax returns in other countries and combined U.S. state and local income tax
returns with an affiliate.

The Company records deferred tax assets and liabilities for the difference
between the tax basis of assets and liabilities and the amounts recorded for
financial reporting purposes, using current tax rates. Deferred tax expenses and
benefits are recognized in the consolidated statements of income for changes in
deferred tax assets and liabilities.
76

INSTINET GROUP INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

STOCK-BASED COMPENSATION

The Company accounts for its stock-based compensation plans in accordance
with APB Opinion No. 25, Accounting for Stock Issued to Employees ("APB No.
25"), SFAS 123 Accounting for Stock-Based Compensation ("SFAS No. 123"), and
related accounting interpretations. The Company has chosen to account for stock
options granted to employees using the intrinsic value method prescribed in APB
No. 25 and accordingly compensation expense is measured as the excess, if any,
of the estimated fair value of the Company at the date of grant over the option
exercise price and is recorded over the vesting period. For options granted to
non-employees, the Company uses the fair value method prescribed in SFAS No. 123
and accordingly records compensation expense over the vesting period. See Note 7
for the pro forma disclosures required by SFAS No. 123.

CASH AND CASH EQUIVALENTS

The Company considers all highly liquid investments with original
maturities of three months or less to be cash equivalents.

SECURITIES OWNED ($ IN THOUSANDS)

Securities owned are recorded on a trade date basis and are carried at
their market value with unrealized gains and losses reported in investment
income on the consolidated statement of income. Securities owned, with the
exception of shares in stock exchanges, have maturities of less than 3 years and
consisted of the following:

SECURITIES BORROWED AND LOANED

Securities borrowed and loaned are recorded at the amount of cash
collateral advanced or received. Securities borrowed require the Company to
deposit cash with the lender. For securities loaned, the Company receives
collateral in the form of cash in an amount generally in excess of the market
value of the securities loaned. The Company monitors the market value of the
securities borrowed and loaned on a daily basis, with additional collateral
obtained or refunded, as necessary.

RECEIVABLE FROM AND PAYABLE TO BROKER-DEALERS

Receivable from broker-dealers are primarily comprised of fails to deliver.
Fails to deliver arise when the Company does not deliver securities on
settlement date. The Company records the selling price as a receivable due from
the purchasing broker-dealer. The receivable is collected upon delivery of the
securities. Payable to broker-dealers are primarily comprised of fails to
receive. Fails to receive arise when the Company does not receive securities on
settlement date. The Company records the amount of the purchase price as a
payable due to the selling broker-dealer. The liability is paid upon receipt of
the securities.

77

INSTINET GROUP INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

RECEIVABLE FROM AND PAYABLE TO CUSTOMERS

Receivable from customers primarily represent customer debit balances and
payable to customers represent free credit balances in customer accounts.

COMMISSIONS AND OTHER RECEIVABLES, NET ($ IN THOUSANDS)

Commissions and other receivables are reported net of a provision for
doubtful accounts. The following table summarizes the activity in the Company's
allowance for doubtful accounts:

SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL AND SECURITIES SOLD UNDER
AGREEMENTS TO REPURCHASE

Transactions involving purchases of securities under agreements to resell
and securities sold under agreements to repurchase are treated as collateralized
financing transactions and are recorded at their contracted resale amounts plus
accrued interest. It is the Company's policy to take possession of securities
with a market value in excess of the principal amount loaned plus the accrued
interest thereon, in order to collateralize reverse repurchase agreements.
Similarly, the Company is required to provide securities to counterparties in
order to collateralize repurchase agreements. The Company's agreements with
counterparties generally contain contractual provisions allowing for additional
collateral to be obtained, or excess collateral returned, when necessary. It is
the Company's policy to value collateral daily and to obtain additional
collateral, or to retrieve excess collateral from counter-parties, when deemed
appropriate.

FOREIGN CURRENCY TRANSLATION

Assets and liabilities of subsidiaries whose functional currency is not the
U.S. dollar are translated based on the end of period exchange rates from local
currency to U.S. dollars. Results of operations are translated at the average
exchange rates in effect during the period. The resulting gains or losses are
reported as comprehensive income on the consolidated statements of changes in
stockholders' equity.

DERIVATIVES

The Company may enter into forward foreign currency contracts to facilitate
customers' settling transactions in various currencies, primarily the U.S.
dollar, British pound or Euro. These forward foreign currency contracts are
entered into with third parties and with terms generally identical to its
customers' transactions, thereby mitigating exposure to currency risk. Forward
foreign currency contracts generally do not extend beyond 14 days and realized
and unrealized gains and losses resulting from these transactions are recognized
in the consolidated statements of income as transaction fees in the period
during which they are incurred. These activities have not resulted in a material
impact to the Company's operations to date.

4. GOODWILL AND ACQUISITIONS ($ IN THOUSANDS)

Instinet Corporation was acquired by Reuters in 1987. For purposes of
preparing the consolidated financial statements of the Company, the $96,893
excess over the fair value of the net assets acquired by Reuters was recorded by
the Company as goodwill.

78

INSTINET GROUP INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Goodwill arising from acquisitions of businesses, as well as the
acquisition of Instinet Corporation by Reuters, was amortized on a straight-line
basis over periods of 15 to 20 years until December 31, 2001. Goodwill is stated
at cost, net of accumulated amortization of $76,608 and $70,498 as of December
31, 2001 and 2000, respectively. Goodwill amortization was $8,110, $7,505 and
$4,616 for the years ending December 31, 2001, 2000 and 1999, respectively.

A description of the Company's significant acquisitions prior to December
31, 2001, including the date acquired, purchase price (including acquisition
costs) and goodwill recognized, is as follows:

- Montag Popper & Partner GmbH, a German fixed income broker-dealer, was
acquired in October 1999 for $5,989. The $3,881 excess of the purchase
price over the fair value of the net assets acquired was recorded as
goodwill.

- LJR was acquired in February 2000 for $49,500. The $48,500 excess of the
purchase price over the fair value of the net assets acquired was
recorded as goodwill.

- In October 2001, the Company acquired ProTrader, a U.S. registered
broker-dealer which provides direct access execution and advanced trading
technology primarily to professional and non-institutional traders,
active fund managers and hedge funds. The Company believes this
acquisition will enhance its customer interface and order routing
technology. The Company agreed to acquire ProTrader for $100 million in
cash and 5.02 million shares of Instinet common stock valued in aggregate
at $50 million, based on the average share price of Instinet stock for
the seven trading days prior to closing. Direct capitalizable costs
associated with this transaction were $2,806. On October 1, 2001, the
Company acquired approximately 92% and acquired the remaining 8% on
January 3, 2002.

The following table summarizes the estimated fair values of the assets
acquired and liabilities assumed:

Assets:
Current and long term assets.............................. $ 19,062
Intangible asset.......................................... 71,777
Goodwill.................................................. 70,583
--------
Total assets acquired............................. 161,422
Liabilities assumed......................................... (8,616)
--------
Net assets acquired......................................... $152,806
========

Of the consideration paid, approximately 50% of the excess purchase price
over net assets was assigned to an intangible asset, consisting of
intellectual property and the related technology of ProTrader, which was
recorded on their books at historical cost and the remaining amount to
goodwill. The amount of goodwill expected to be deductible for tax
purposes is $16,804.

Pursuant to the purchase method of accounting, the accompanying
consolidated statements of income reflect the results of operations of the
aforementioned entities and businesses subsequent to the date of acquisition.
Pro forma consolidated results after giving effect to the acquisition as of the
beginning of the year preceding the year in which the acquisition occurred would
not have been materially different from the reported amounts.

5. INVESTMENTS ($ IN THOUSANDS)

From time to time, the Company makes strategic alliances and long-term
investments in other companies. The changes in the carrying values at the end of
each period results from additional investments, sales, and unrealized and
realized gains and losses, as well as fluctuations in exchange rates for
investments

79

INSTINET GROUP INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

made in non-U.S. dollars. A description of the Company's more significant
investments, including date of investment, invested amount and percentage of
ownership are as follows:

- WR Hambrecht + Co ("Hambrecht") -- In 1999 and 2000, the Company made
investments totaling $27,500, now representing a 7.8% interest, in
Hambrecht. Hambrecht underwrites initial public offerings through its
auction-based securities offering via the Internet, performs research and
analysis, places and invests in private equity transactions, and offers
mergers and acquisition advisory services. As of December 31, 2001 and
2000, the Company carried its investment at estimated fair value of
$16,450 and $27,500, respectively.

- TP Group LDC -- In 1999 and 2000, the Company made investments, and also
sold certain portions of its investment, in TP Group LDC, now
representing a 13.8% interest. TP Group LDC is a consortium led by the
Company that owns 38.9% of virt-x, an electronic order driven equities
market for pan-European securities. As of December 31, 2001 and 2000, the
Company carried its investment at estimated fair value of $8,816 and
$6,907, respectively.

- Archipelago Holdings LLC ("Archipelago") -- In 1999, the Company made an
investment of 15,528 GBP, now representing a 9.6% voting interest, in
Archipelago. Archipelago, through its subsidiary, provides order entry
and execution capabilities using proprietary systems while providing
customers access to liquidity, including access to other electronic
communication networks. As of December 31, 2001 and 2000, the Company
carried its investment at estimated fair value of $40,000 and $23,137,
respectively.

- Vencast, Inc. ("Vencast") -- In 2000 and 2001, the Company made
investments of 5,031 GBP and $1,500, respectively, now representing a
48.5% interest, in Vencast. Vencast provides solutions by using the
Internet to facilitate the process of raising capital and investing for
the private equity industry. As of December 31, 2001, the Company carried
its investment at $2,373, as determined under the equity method. As of
December 31, 2000, the Company carried its investment at estimated fair
value of $7,496.

- The Nasdaq Stock Market, Inc. ("Nasdaq") -- In 2000, the Company made an
investment of $15,475 in Nasdaq and at December 31, 2001, ProTrader
carried an investment in Nasdaq of $261. As of December 31, 2001 and
2000, the Company carried its investment at estimated fair value, which
was unchanged from its original cost.

- Tradeware S.A. ("Tradeware") -- In 2000, the Company made investments of
4,000 euros, and in 2001, 66,925 Belgian francs and 1,500 euros, now
representing a 47.9% interest, in Tradeware. Tradeware is a European
based provider of integrated order routing solutions to broker-dealers in
Europe. As of December 31, 2001 and 2000, the Company carried its
investment at $4,492 and $3,723, respectively, as determined under the
equity method.

- Knight Roundtable Europe Ltd. ("Roundtable") -- In 2001, the Company made
an investment of $1,000 in Roundtable. Roundtable is a pan-European
broker consortium designed to compete for order flow from small investors
in the region. As of December 31, 2001, the Company carried its
investment at estimated fair value of $250.

- JapanCross Securities Co. Ltd. ("JapanCross") -- In 2001, the Company
made a series of investments totaling $3,782, now representing a 50%
interest in JapanCross, a joint venture which was established to provide
a crossing service for Japanese equity securities. As of December 31,
2001, the Company carried its investment at $3,782 as determined under
the equity method.

80

INSTINET GROUP INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

6. SHORT-TERM BORROWINGS ($ IN THOUSANDS)

Short-term borrowings represent amounts borrowed on uncommitted bank lines
of credit, which provide for borrowings for operational and general corporate
purposes which generally bear interest rates that approximate the Federal Funds
rate in the United States and euro or pound sterling LIBOR rates in Europe. The
following is a summary of short-term borrowings information:

Weighted average interest rates for U.S. dollar and non-U.S. dollar
denominated obligations are as follows:

7. STOCK-BASED COMPENSATION ($ IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

INSTINET PLAN

Substantially all employees and certain directors of the Company and
certain employees of Radianz who were previously employees of the Company (Note
12) participate in the Company's stock option plan ("Instinet Plan"), which was
adopted in February 2000. Under the Instinet Plan, options on the Company's
common shares are issued for terms of 7 years, vesting over 4 years, one quarter
on the first anniversary of grant and 1/36 on the last day of each month
thereafter. Subject to vesting and expiration provisions, participant exercise
rights occur upon an initial public offering or six and one-half years from the
original grant date. The options are exercisable at the estimated fair market
value of the shares on the date the options were issued. The terms for options
granted to employees and non-employees are the same.

81

INSTINET GROUP INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

A summary of the Instinet Plan stock option activity is as follows:

A summary of the Instinet Plan stock option information is as follows:

Options outstanding as of December 31, 2001 are as follows:

On September 2, 2000, the board of directors of the Company approved a
modification to the Instinet Plan changing the exercise terms. Accordingly, the
Company recorded as unearned compensation the difference between the exercise
price of the option and estimated fair market value of the Company as of the
date of modification for options granted to employees. For options granted to
non-employees, the Company recorded the estimated fair value of the option on
the date of modification as unearned compensation using the Black-Scholes option
pricing model with the following assumptions: dividend yield, 0%; expected
volatility, 68.48%; risk free interest rate, 5.95%; and expected life, in years,
7. The Company recorded $22,553 and $718 for employees and non-employees,
respectively, as unearned compensation and as a separate component of
stockholders' equity. These amounts are amortized in accordance with the
remaining vesting provision.

In May 2001, the Company adjusted the shares and exercise price of its
existing options as a result of its conversion from a limited liability company
to a corporation in connection with its initial public offering (Note 2) at a
conversion rate of 1.033209. There was no change in the economic value for each
option granted.

REUTERS PLANS

Certain employees of the Company participate in the following Reuters stock
option plans (collectively, the "Reuters Plans").

- Save As You Earn Plan ("SAYE Plan") -- Reuters introduces a new SAYE plan
each year. For U.S.-based employees, options are issued on Reuters
American Depositary Shares ("ADS"). SAYE

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

options are issued for terms of 4.5 or 6.5 years, vest over a 3 or 5 year
period, respectively, and are exercisable at the market price of the ADS
on the date of grant. The Company will contribute 20% of the exercise
price of the option to U.S.-based employees when exercised. For
non-U.S.-based employees, options are issued on Reuters ordinary shares.
Options are issued for terms similar to the U.S.-based employees,
however, they have an exercise price 20% less than the market price of
the ordinary shares on the date of grant. Accordingly, the Company
recorded as deferred compensation the intrinsic value of the stock
options awarded which is recognized over the vesting period. The
following table summarizes Reuters ADS and ordinary share options issued
under the Reuters SAYE Plan as of December 31, 2001 and 2000:

- Plan 2000 -- Reuters introduced the Plan 2000 option plan in 1998, under
which employees may be entitled to a single option award to acquire 2000
shares of Reuters ordinary shares. Options are issued for terms of 7
years, vest after a 3 year period and are exercisable at the market price
of the ordinary share on the date of grant. The following table
summarizes Reuters ordinary share options issued under the Reuters Plan
2000 as of December 31, 2001 and 2000:

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Reuters ADS option activity under the Reuters SAYE Plan is as follows:

Reuters ordinary shares option activity is as follows:

The Company applies APB Opinion No. 25, Accounting for Stock Issued to
Employees, SFAS No. 123, Accounting for Stock-Based Compensation, and related
accounting interpretations for all of its stock option plans referred to above,
and accordingly, the Company recorded as compensation expense the following:

The weighted average estimated fair value of the Instinet Plan options
granted during the years ended December 31, 2001 and 2000 was $5.80 and $10.93
per option, respectively. The weighted average estimated fair value of the
Reuters Plans ordinary share options granted during the years ended December 31,
2001 and 2000 was $8.58 and $9.04 per option, respectively. Had the Company
determined compensation cost based on the estimated fair value at the grant
dates for the Instinet Plan and Reuters Plans options under SFAS

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

No. 123, the Company's net income for the years ended December 31, 2001, 2000
and 1999 would have been as follows:

The fair value of each option granted is estimated as of its respective
grant dates using the Black-Scholes option pricing model with the following
weighted average assumptions:

8. EMPLOYEE BENEFIT PLANS ($ IN THOUSANDS)

The Company participates in various Reuters pension plans around the world.
The U.S. employees are eligible to participate in the Reuters 401(k) plan. The
majority of non-U.S. employees who joined the Company prior to April 1999 are
eligible to participate in Reuters Pension Fund ("RP Fund"). The majority of
non-U.S. employees who joined after April 1999 are eligible to participate in
the Reuters Retirement Plan ("RR Plan"). Each of these plans is supplemented by
non-qualified plans that allow for contributions above limits imposed by local
taxing authorities. Funding is provided by voluntary contributions from members
of the plans and contributions from the Company. U.S. employees can contribute
up to 13% of their annual base salary to the 401(k) plan and the Company
contributes 8.125% of the employees' annual base salary. For the RR Plan,
non-U.S. employees can contribute up to 4% of their annual base salary and the
Company contributes 7% of their annual base salary. For the RP Fund, non-U.S.
employees can contribute up to 6% of their annual base salary and the Company
contributes 10.025% of their annual base salary. All plans are administered by
third parties.

Certain employees of the Company also participate in a long-term
performance-based incentive compensation plan ("Long term plan"). Under the Long
term plan, a portion of the operating earnings of the Company exceeding certain
predetermined targets aggregated over a four-year period (a "Performance
Period") are distributed to participants. A new Performance Period is started
each January and as of December 31, 2001 and 2000, there were one and two Long
term plans in effect, respectively.

Substantially all employees of the Company are eligible to participate in
Reuters employee stock purchase plan ("ESP Plan") where employees can contribute
up to a predetermined limit of their salary

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

towards the purchase of Reuters common shares for non-U.S. employees or ADS for
U.S. employees. The Company may contribute 20% of the employees' contribution to
the plan.

Reuters also provides certain employees of the Company with post retirement
benefits such as healthcare and life insurance. Eligible employees are those who
retire from the Company at normal retirement age.

The Company's expenses related to the employee benefit plans referred to
above are as follows:

In addition, certain employees of the Company are eligible to participate
in the Instinet Management Deferral Plan (the "Deferral Plan"). Under the
Deferral Plan, employees can voluntarily defer a portion of their compensation
for a period of five years by investing in certain employer provided investment
options administered by ICS. The participating employees bear the entire risk of
each investment election. Deferred compensation as of December 31, 2001 and 2000
was $42,577 and $53,696, respectively.

9. NET CAPITAL REQUIREMENTS ($ IN THOUSANDS)

The Company's U.S. broker-dealer subsidiaries are subject to the SEC's
Uniform Net Capital Rule, which requires the maintenance of minimum net capital.
The subsidiaries have elected to use the alternative method, which requires that
they maintain minimum net capital equal to the greater of $250 or 2% of
aggregate debit items arising from customer transactions. As of December 31,
2001, ICS, which is the counterparty to each of our customer transactions, had
net capital of $260.0 million, which was $256.4 million in excess of its
required net capital of $3.5 million. Certain other U.S. broker-dealer
subsidiaries of the Company are also subject to capital adequacy requirements
and were in compliance with their respective requirements.

The Company's international broker-dealer subsidiaries are subject to
capital adequacy requirements promulgated by authorities of the countries in
which they operate. As of December 31, 2001 and 2000, these subsidiaries had met
their local capital adequacy requirements.

10. COMMITMENTS AND CONTINGENCIES ($ IN THOUSANDS)

LITIGATION

In the normal course of conducting its securities business, the Company has
been involved in various legal proceedings. In the opinion of management, after
consultation with legal counsel, the ultimate outcome of pending litigation
matters will not have a material adverse effect on the financial condition,
results of operations or liquidity of the Company.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

LEASES

The Company leases office space and equipment under noncancellable
operating leases with third parties and Reuters extending for periods in excess
of one year. Certain leases contain renewal options and escalation clauses.
Future minimum rental commitments under the Company's leases are as follows:

Year ending December 31, 2002............................... $ 30,338
Year ending December 31, 2003............................... 27,494
Year ending December 31, 2004............................... 22,316
Year ending December 31, 2005............................... 18,539
Year ending December 31, 2006............................... 17,253
Thereafter.................................................. 203,911

Rental expense amounted to $32,299, $23,238, and $16,222 for the years
ended December 31, 2001, 2000 and 1999, respectively.

OTHER COMMITMENTS AND CONTINGENCIES

The Company has received letter of credit agreements totaling $175,183,
$343,313 and $200,000 for the years ended December 31, 2001, 2000 and 1999 as
guarantees to various non-U.S. securities clearing and regulatory agencies, as
well as other corporate services and obligations. The Company pays an annual fee
of one half of one percent of the value of the letter of credit.

11. INCOME TAXES ($ IN THOUSANDS)

The provision for income tax consisted of the following:

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The temporary differences which have created deferred tax assets and
liabilities, are detailed below:

Management believes that it is more likely than not that the tax assets,
net of the valuation allowance will be realized. The valuation allowance relates
to operating losses in certain non-U.S. subsidiaries that may not be realized in
the future.

The following is a reconciliation of the provision for income taxes and the
amount computed by applying the U.S. Federal statutory rate to income before
income taxes.

12. RELATED PARTY TRANSACTIONS ($ IN THOUSANDS)

The Company transacts business and has extensive relationships with Reuters
and its related parties. Due to these relationships, it is possible that the
terms of these transactions are not the same as those that would result from
transactions among unrelated parties. A description of these transactions and
relationships is set forth below:

The Company receives Reuters data consisting of news and information which
is used by the Company as well as distributed to its customers. For the years
ended December 31, 2001, 2000 and 1999, the Company has recorded as expense
$13,849, $12,321 and $8,736, respectively, related to these services.

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INSTINET GROUP INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Reuters provides certain operational and administrative support and other
general corporate services to the Company. For the years ended December 31,
2001, 2000, and 1999, the Company recorded as expense $31,228, $41,239 and
$15,814, respectively, related to these services.

In June 2000, the Company sold at book value all of its equipment related
to its telecommunications network and transferred certain employees to Radianz,
a joint venture between Reuters and Equant Finance B.V., which was created to
provide internet protocol networks to the financial services industry. Equant
Finance B.V. is a provider of voice, data and internet services. Since June
2000, Radianz provides services related to the Company's core communications
network that prior to the sale would have been provided by the Company. The
Company, by the nature of a master agreement between Reuters and Radianz, is
subject to fee arrangements negotiated by Reuters. For the year ended December
31, 2001 and the period from July 2000 to December 31, 2000, the Company
incurred expenses related to the Radianz agreement of $58,686 and $30,959,
respectively.

The Company performs for Reuters certain technology enhancement related
services and provides trading information and use of the Company's technology
platform related to its fixed income trading systems at no cost to Reuters.

In February 2000, Reuters provided a subordinated loan to the Company of
$49,000 to fund the Company's purchase of LJR. This subordinated loan bore
interest at a rate based on six-month LIBOR plus 1.25% and was repaid in June
2001. For the years ended December 31, 2001 and 2000, the Company recorded
interest expense related to this loan of $1,640 and 3,250, respectively.

As of December 31, 2000, receivables from affiliates, net, included a
$30,000 non-interest-bearing, secured demand note receivable. As of December 31,
2001 and 2000, all other receivables and payables with affiliates and the Parent
arise from normal operating activities between the Company and Reuters and its
affiliates and are generally settled on a quarterly basis.

The Company leases office space for its corporate headquarters in New York
City from an affiliate of Reuters. The lease expires in 2021 with a one time
right to cancel the lease after 10 years. Payment related to this lease
agreement was $8,563 for the year ended December 31, 2001.

13. R&A SALE TO REUTERS ($ IN THOUSANDS)

Effective September 2001, the Company sold at book value its Research and
Analytics Product ("R&A") to Reuters in order to allow Instinet R&A users to
participate in a much broader service and still benefit from the information
currently available through R&A. Under the agreement, the Company sold to
Reuters all the assets, rights, claims, contracts, licenses, trade secrets and
confidential and proprietary business information, and substantially all of the
R&A employees used by it in the R&A product platform. In turn, Reuters agreed to
assume certain liabilities and obligations of the R&A business. The net book
value of the assets sold, which consisted of computer hardware, machinery and
equipment, was $7,868. The Company entered into a mutual services agreement with
Reuters under which the Company will continue to assist Reuters in supporting
the R&A business for up to 18 months. In addition, the Company and Reuters have
agreed to allow customers of the Company who have been using the R&A product to
continue to receive the service and support from Reuters. The Company incurred
expense of $1,757 related to this service for the period ended December 31,
2001.

14. SEGMENT/GEOGRAPHIC DATA ($ IN THOUSANDS)

The Company's activities as a provider of agency brokerage services
constitute a single business segment pursuant to SFAS No. 131, Disclosures about
Segments of an Enterprise and Related Information. The accompanying table
summarizes select data about the Company's domestic and international
operations. Because of the highly integrated nature of the financial markets in
which the Company competes and the
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

integration of the Company's worldwide business activities, the Company believes
that results by geographic region are not necessarily meaningful in
understanding its business.

15. RESTRUCTURING ($ IN THOUSANDS)

In 1998, the Company began to design and develop a web-based retail
brokerage operation. In December 2000, based upon a review of market conditions
and an evaluation of possible alternate strategies, the Company decided to
re-direct its retail brokerage efforts. As part of this redeployment, the
Company recorded restructuring charges of $4.0 million and $7.5 million for the
years ended December 31, 2001 and 2000, respectively, all of which has been paid
as of December 31, 2001.

In July 2001, the Company announced a review of spending initiatives with
the aim of reducing its underlying operating cost structure by approximately $70
million annually. This restructuring was completed in 2001 at a pre-tax cost of
$24.4 million and included:

- Workforce reduction -- the Company reduced its employee headcount levels
by 226. The departments primarily affected were various operational areas
in technology support functions, sales and trading, administrative
functions and clearing operations in its U.S. and international offices.
The Company recorded a pre-tax charge of approximately $21 million
related to its workforce reduction.

- Office closures -- the Company closed its office in Sydney, Australia and
consolidated its European trading and clearing operations, significantly
reducing the size of its Zurich office. In the U.S., the Company closed
the Greenwich, Detroit and Seattle trading offices of its ProTrader
subsidiary. The Company recorded a pre-tax charge of approximately $3
million related to its office closures.

As of December 31, 2001, the Company carries a liability of $6,779 related
to its restructuring on its consolidated statements of financial condition,
which it expects to utilize approximately $1,085 through cash payments for lease
expenses and $5,694 for severance costs through 2002.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

16. EARNINGS PER SHARE ($ AND SHARES IN THOUSANDS)

Basic earnings per share ("EPS") excludes dilution and is computed by
dividing net income by the weighted average number of common shares outstanding
for the period. Diluted EPS reflects the potential reduction in EPS that could
occur if securities or other contracts to issue common stock were exercised or
converted into common stock.

The Company has authorized the issuance of a maximum of 34,118 shares of
common stock under the Company's stock option plan. Options to purchase 21,104
shares of common stock at a weighted average exercise price of $16.03 per share
were outstanding as of December 31, 2001. However, options to purchase 20,373
shares of common stock were not included in the computation of diluted EPS for
the years ended December 31, 2001 and 2000, respectively, because the options
were anti-dilutive. The number of common shares outstanding, both basic and
diluted, for the years ended December 31, 2000 and 1999 reflects the number of
shares that would have been held by Reuters after giving effect to the return of
capital payment of $150,000 to Reuters and conversion of the Company from a
limited liability company to a corporation, which is pushed back for EPS
calculation purposes.

Earnings per share under the basic and diluted computations are as follows:

17. COLLATERAL ARRANGEMENTS ($ IN THOUSANDS)

As of December 31, 2001 and 2000, the fair value of collateral held by the
Company that can be sold or repledged totaled $607,069 and $307,424,
respectively. Such collateral is generally obtained under resale and securities
borrowing agreements. Of this collateral, $548,487 and $236,000 had been sold or
repledged generally to cover short sales or effect deliveries of securities as
of December 31, 2001 and 2000, respectively. In addition, securities in customer
accounts with a fair value of $76,462 and $104,810 could be sold or repledged by
the Company as of December 31, 2001 and 2000, respectively.

18. FAIR VALUE OF FINANCIAL INSTRUMENTS

Statement of Financial Accounting Standards No. 107, "Disclosure about Fair
Value of Financial Instruments," requires the disclosure of the fair value of
financial instruments, including assets and liabilities recognized on the
consolidated statements of financial condition. Management estimates that the
aggregate net fair value of all financial instruments recognized on the
consolidated statements of financial condition approximates their carrying
value, as such financial instruments are short term in nature and bear interest
at current market rates.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

19. CONCENTRATIONS OF CREDIT, MARKET AND OTHER RISKS

The Company is exposed to substantial credit risk from both parties to a
securities transaction during the period between the transaction date and the
settlement date. This period is three business days in the U.S. equities markets
and can be as much as 30 days in some international markets. In addition, the
Company may have credit exposure that extends beyond the settlement date in the
case of a party that does not settle in a timely manner by failing either to
make payment or to deliver securities. We hold the securities that are the
subject of the transaction as collateral for our customer receivables. Adverse
movements in the prices of these securities can increase our credit risk. The
majority of the Company's transactions and, consequently, the concentration of
its credit exposure are with broker-dealers and other financial institutions,
primarily located in the United States and the U.K. The Company seeks to control
its credit risk through a variety of reporting and control procedures, including
establishing credit limits and enforcing credit standards based upon a review of
the counter-parties' financial condition and credit ratings. The Company
monitors trading activity and collateral levels on a daily basis for compliance
with regulatory and internal guidelines and obtains additional collateral, if
appropriate. For the years ended December 31, 2001, 2000 and 1999, losses from
transactions in which a party refused or was unable to settle have been
immaterial.

The Company uses securities borrowed and loaned transactions to facilitate
the settlement process to meet its customers' needs. Under these transactions,
the Company either receives or provides collateral, generally cash or
securities. In the event the counterparty is unable to meet its contractual
obligations to return the pledged collateral, the Company may be exposed to the
market risk of acquiring the collateral at prevailing market prices.

The Company is subject to operational, technological and settlement risks.
These include the risk of potential financial loss attributable to operational
factors such as untimely or inaccurate trade execution, clearance or settlement
or the inability to process large volumes or transactions. The Company is also
subject to risk of loss attributable to technological limitations or computer
failures that may constrain the Company's ability to gather, process and
communicate information efficiently, securely and without interruption.

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INSTINET GROUP INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

20. QUARTERLY RESULTS (UNAUDITED)

The following tables set forth certain unaudited consolidated quarterly
statement of income data. The unaudited consolidated quarterly data should be
read together with the consolidated financial statements and related notes
included elsewhere in this annual report. The results for any quarter are not
necessarily indicative of results for any future period.

93

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.

PART III.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY

The information about Directors and Executive Officers required to be
furnished pursuant to this item is incorporated by reference from the "General
Information Concerning the Board of Directors," "Compensation of Directors," and
"Compensation of Executive Officers" sections of our definitive proxy statement
for our 2002 Annual Meeting of Stockholders to be filed with the Securities and
Exchange Commission pursuant to Regulation 14A within 120 days after December
31, 2000 (the "Proxy Statement").

ITEM 11. EXECUTIVE COMPENSATION

The information required to be furnished pursuant to this item is
incorporated by reference from the "Compensation of Executive Officers" section
of the Proxy Statement.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required to be furnished pursuant to this item is
incorporated by reference from the "Security Ownership of Directors, Nominees
and Executive Officers" section of the Proxy Statement.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required to be furnished pursuant to this item is
incorporated by reference from the "Certain Business Relationships" section of
the Proxy Statement.

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a) Exhibit List

- ---------------

* Filed herewith

(b) The following reports on Form 8-K were filed for the last quarter
covered by this report, and subsequently through March 26, 2002:

97

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

INSTINET GROUP INCORPORATED

By: /s/ PAUL A. MEROLLA
------------------------------------
Paul A. Merolla

March 27, 2002.

Pursuant to the requirements of the Securities Act of 1934, this report has
been signed by the following persons in the capacities and on the dates
indicated.

99

EXHIBIT INDEX

100

101

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* Filed herewith

102