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, 2002 COMMISSION FILE NUMBER 000-32717

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

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. [X] Yes [ ] 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. [ ]

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

As of June 30, 2002, the aggregate market value of voting and non-voting
common equity held by non-affiliates of the registrant was approximately
$259,002,123, 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 2003
Annual Meeting of Stockholders are incorporated by reference in Part III hereof.

The number of shares of Common Stock outstanding as of March 20, 2003 was
330,716,108 shares.
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INSTINET GROUP INCORPORATED

ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002

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 2002, 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, manage
their orders 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. Our customers primarily
consist of institutional investors, such as mutual funds, pension funds,
insurance companies and hedge funds, as well as market professionals, including
broker-dealers.

We have been operating in an increasingly challenging business, economic
and regulatory environment. During the past three years, the major U.S. market
indices have experienced a severe decline and significant volatility. The weak
and uncertain economic climate, increased unemployment rates, reduced capital
raising, decreased market capitalization,ongoing geopolitical and global
conflicts, coupled with the current corporate governance and accounting issues,
have contributed to a decreased pace of global economic growth. This has
resulted in significantly lower equity prices, decreased corporate activity,
increased market volatility, decreased trading volumes and a generally more
difficult business environment. In addition, intense price competition from
other liquidity providers and trading venues, together with recent SEC
regulations and interpretive initiatives, have prompted us to reduce our prices
significantly, which has resulted in decreased revenues and losses from
operations. As a result, our revenues decreased from $1.4 billion in 2001 to
$1.1 billion. We had a net loss of $735.2 million in 2002, primarily due to a
$552.0 million charge for goodwill impairment, a restructuring charge and a
writedown in our investments. In the past, we have implemented various cost
reduction plans and in December 2002, we began implementing a cost reduction
plan that targets a further reduction in operating costs of $100 million, on an
annualized basis, by the end of 2003.

During the first two months of 2003, the U.S. markets continued to weaken
and trading volumes continued to decline. The average daily trading volumes in
Nasdaq-quoted and U.S. exchange-listed stocks decreased 8% from 3.6 billion
shares in the fourth quarter of 2002 to 3.3 billion shares during the first two
months of 2003. Our average daily trading volumes have also decreased. Our
average daily trading volumes in Nasdaq-quoted and U.S. exchange-listed stocks
have decreased 13% from 575 million shares in the fourth quarter of 2002 to 504
million shares during the first two months of 2003. This decrease in trading
volumes has had a negative effect on our transaction fee revenue. In addition,
in March 2003 we announced a reduction of 12% in our global staffing levels
resulting from attrition and the elimination of positions. We expect that these
staff reductions will result in an estimated $20 million reduction in our
operating costs, on an annualized basis, by the end of 2003. This staff
reduction is part of our continued focus on cost reduction and is in addition to
the $100 million cost reduction target previously announced.

On September 20, 2002, we completed our acquisition of Island Holding
Company, Inc., the parent company of The Island ECN, Inc., a leading electronic
securities marketplace. We now operate two of the largest alternative trading
systems (ATSs) trading Nasdaq-quoted stocks. In 2002, the Instinet ATS alone
accounted for approximately 15% of the total trading volume in the Nasdaq
market. Following the merger, in the fourth quarter of 2002, our two ATSs
accounted for approximately 30% of the total trading volume in Nasdaq-quoted
stocks. Like our Instinet ATS, the Island ATS has assembled a large liquidity
pool of orders to buy and sell securities, which orders are published in its
marketplace. Island's proprietary technology enables it to offer low cost, rapid
and reliable order display and matching services to its customers.

Our global electronic agency securities brokerage business centers almost
exclusively on serving the needs of institutional investors and market
professionals, including broker-dealers, in the global markets for equity
securities. As of December 31, 2002, we had over 1,300 institutional investor
customers and approximately 1,290 broker-dealer customers in the United States.
Our Instinet ATS, which also has operations outside the United States, had
approximately 890 customers in Europe and Asia as of December 31, 2002 and
continues
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to maintain a global presence. During 2002, our customers used our two ATSs to
execute a combined volume of 156.0 million transactions globally (including
Island volumes after September 20, 2002), of which 148.4 million transactions
were in U.S. equity securities. Those U.S. transactions represented
approximately 81.9 billion shares of Nasdaq-quoted stocks and 15.7 billion
shares of U.S. exchange-listed stocks. More than 80% of our customers'
transactions in U.S. equity securities using the electronic trading systems of
our two ATSs are generally executed within our internal liquidity pools. We also
offer our customers, through our Instinet ATS, technology (known as smart
order-routing technology) that directs their equity securities transactions to
access either our Instinet 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 one of the largest independent providers of research and other
brokerage services through soft-dollar or other similar arrangements. We are
also one of the largest providers of commission recapture services, which enable
pension plan and other fund sponsors to recapture a portion of the gross
transaction fees that the fund managers pay us. In addition, we provide
correspondent clearing services to several securities brokers in the United
States.

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 62.6% of our outstanding common stock. We recently opened an
office in Jersey City, New Jersey and also currently have offices in London,
Frankfurt, Hong Kong, Paris, Tokyo, Toronto and Zurich.

CORE VALUES

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 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.

- 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.

ACQUISITIONS AND DIVESTITURES

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
addition to our acquisition of Island in September 2002, we acquired
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Harborview LLC, a NYSE floor brokerage firm, in January 2003. In October 2001,
we acquired ProTrader, a provider of advanced trading technologies and
electronic brokerage services, and 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.

On May 3, 2002, we closed our fixed income business, which we began
developing in 1998 and started trading in the spring of 2000, and also closed
Montag Popper & Partner GmbH, a German fixed income broker-dealer, that we
acquired in October 1999 as part of the development of our global fixed income
business. Against the background of a global economic slowdown and the uneven
pace of acceptance of electronic fixed income trading platforms, however, our
fixed income business was unable to reach a critical mass.

We believe our acquisition of Island will result in better execution
opportunities for our customers, a stronger technology and trading platform, an
alternative to other offerings, cost savings and a stronger management team,
which will ultimately bring together our complementary capabilities in the
global equity markets and create a company better able to serve our customers'
needs. We continue to develop and have begun to implement a plan to maximize our
current operational and organizational functions by integrating Island into our
business, increasing efficiencies and reducing costs. Our current target is to
achieve savings of approximately $100 million of operating costs, on an
annualized basis, by the end of 2003 through our integration efforts. We expect
these savings to result from, among other things, the consolidation of our
clearing operations, headcount reductions, consolidation of office space and
maximizing infrastructure efficiencies. We will also focus on integrating our
personnel, facilities, and key technologies. In the fourth quarter of 2002, we
reduced our workforce by approximately 250 employees both in the U.S. and our
international operations and consolidated our office space within the New York
City area. In January 2003, we also completed the conversion of Island's trading
activity from I-Clearing Corp. to Instinet Clearing Services, Inc. We continue
to develop our plan and evaluate our integration goals and the time parameters
necessary to achieve these goals.

INDUSTRY BACKGROUND

EQUITY TRADING VOLUME

Over the past five years, the major U.S. market indices have experienced
substantial growth followed by a severe decline and significant volatility. For
example, the Dow Jones Industrial Average increased from 7,965 in January 1998,
reached a peak of 11,723 in January 2000, dropped to a low of 7,286 in October
2002 and increased to 8,342 by the end of December 2002. The Nasdaq Composite
experienced similar volatility increasing from 1,574 in January 1998 to a peak
of 5,133 in March 2000, then experienced a severe decline to 1,336 by the end of
December 2002.

This trend comes after a period of tremendous growth in the global equity
markets. This historical growth resulted from a number of factors, including
strong economic conditions and increased issuances of equity securities and
record high returns, particularly in the U.S. equity markets. A trend towards
more self-directed individual investing and public interest in investing in
equity securities also contributed to this growth. In addition, technological
innovation, including increased reliance on the Internet and electronic brokers,
reduced transaction costs and further stimulated trading activity. In non-U.S.
markets, increased availability of market information, a growing trend toward
public (rather than governmental) ownership of companies in Europe and Asia,
greater access to equity investing and advances in trading technology
contributed to increased trading volumes.

Since 2002, the trend of growth in some U.S. markets has slowed, while
other markets have experienced no growth or downward trends. In 2002, Nasdaq
market volumes decreased slightly but had significant declines during the first
quarter of 2003. However, since 2002, the U.S. exchanges have maintained
moderate growth. For example, the average daily trading volume in the Nasdaq
market increased from 1.8 billion shares to 1.9 billion shares from 2000 to 2001
but decreased to 1.8 billion shares in 2002. As of the end of February 2003, the
average daily trading volume in the Nasdaq market decreased further to 1.3
billion shares. On U.S. exchanges, there was continued modest growth over this
period with average daily trading volumes of
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1.2 billion shares, 1.5 billion shares and 1.8 billion shares for 2000, 2001 and
2002, respectively. As of the end of February 2003, the average daily trading
volume on U.S. exchanges remained at 1.8 billion shares. A number of factors
have produced these recent trends, including a weakened and uncertain economic
climate; increased unemployment rates; reduced capital-raising activities;
decreased market capitalization; ongoing geopolitical and global conflicts; and
current corporate governance and accounting issues, which have generally
resulted in a decline in public confidence in the securities markets.

Similar to the U.S. markets, non-U.S. markets have also experienced
considerable volatility and a significant decline in stock prices since 2001.
However, during this period, non-U.S. markets have maintained moderate growth in
volumes. A number of factors have contributed to these trends, including a
weakened and uncertain economic climate, reduced capital raising activities and
an uncertain global political climate.

U.S. MARKET STRUCTURE

Until 1969, when Instinet was founded, 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
this seat) may trade with or through a specialist. Until 1997, when the SEC
order handling rules became effective, 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
specialists).

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 an
exchange or quoted on Nasdaq. To fulfill its statutory mandate to foster this
competition while integrating the trading of stocks on different venues into the
National Market System (referred to as the NMS), the SEC has required the
national securities exchanges and associations (referred to as self-regulatory
organizations, or SROs) trading those stocks to jointly operate and participate
in NMS systems for the consolidation, dissemination and sale of market data in
U.S. exchange-listed stocks (the Consolidated Tape Association and Consolidated
Quotation System) and Nasdaq-quoted stocks (the Nasdaq -- UTP Plan), as well as
an intermarket order routing system for U.S. exchange-listed securities (the
Intermarket Trading System, or ITS).

For exchange-listed stocks, the so-called third market -- the trading of
exchange-listed stocks by non-exchange members without recourse to the exchange
trading floor-has emerged. In addition, regional exchanges, such as the
Cincinnati Stock Exchange and Pacific Exchange have grown in relative
importance.
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For Nasdaq-quoted stocks, 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 orders
entered into them by a market maker or specialist to third parties and permit
execution of those orders against each other. The order handling 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 the facilities, or pursuant to the rules,
of a self-regulatory organization. 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 electronic communications networks (ECNs) and, later,
alternative trading systems (ATSs) -- a term that refers generally to systems,
including ECNs, other than traditional exchanges or Nasdaq, 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, away from the major established market
centers towards the ATSs.

Following the adoption of the order handling rules, in 1998 the SEC adopted
Regulation ATS, which regulates the operation of ATSs registered as
broker-dealers. Under Regulation ATS, an ATS may seek to register with the SEC
as a national securities exchange. To date, The Island ATS has submitted a draft
application for registration as a national securities exchange, and another ATS
has already been approved to serve as a facility of an exchange. With exchange
status, an ATS gains direct access to ITS, enabling an ATS to access publicly
displayed orders in all ITS participant markets trading U.S. exchange-listed
stocks and make its own orders available for execution through ITS. It also
becomes a participant in other NMS systems, affording it a role in their
governance, a share of the revenues generated by the sale of consolidated market
data to vendors and market participants, and direct connectivity to those
systems. As an exchange, an ATS also becomes an SRO or SRO facility, no longer
subject to regulation by the NASD or another SRO.

Recently, the NASD has implemented 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 directly competes with ECNs. The most significant of these
rule changes resulted in the creation of SuperMontage, a new trading platform
for the Nasdaq market. The SEC approved SuperMontage on January 10, 2001, and
Nasdaq completed its implementation on December 2, 2002. Any ECN or market maker
using Nasdaq facilities to display quotations in Nasdaq-quoted stocks or to
access quotations on Nasdaq is now required to use SuperMontage. SuperMontage
significantly altered the way the Nasdaq market operates. The new structure
combines a computer display containing more bid and offer information about
trading interest in individual Nasdaq-quoted stocks than was previously
displayed and new rules establishing the execution priority of quotes and orders
submitted to Nasdaq. Unlike its predecessor, SuperSoes, SuperMontage also
includes functionality that facilitates participation by ECNs on the platform.
On January 31, 2003, the SEC approved a 90-day pilot program to enable
broker-dealers not registered as market makers to enter non-marketable limit
orders directly on SuperMontage for execution. This pilot program allows Nasdaq
for the first time to compete with the Instinet and Island ATSs and other market
centers in attracting orders that provide liquidity from non-market maker
broker-dealers. We are unable to predict the extent to which Nasdaq will be
successful in attracting liquidity-providing orders from these broker-dealers,
but to the extent it is, this pilot program may result in our receiving fewer
orders that provide liquidity in Nasdaq-quoted stocks and therefore executing
fewer orders in our liquidity pools in these stocks.

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 would be
continuing to evolve as a direct competitor of ATSs. If Nasdaq is registered as
an exchange, we are unable to predict what changes to its operations it might
propose or eventually implement. We are also unable to predict what impact
Nasdaq's registration as an exchange may have on our business.
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Even if Nasdaq gains status as an exchange, the NASD will continue to have
an obligation to collect quotations and transaction reports from NASD member
firms seeking to trade U.S. exchange-listed stocks -- which would then include
Nasdaq stocks -- other than on an exchange. This was a factor in the SEC's
decision to condition its approval of SuperMontage on the NASD establishing an
alternative facility to SuperMontage that market makers and ECNs could use to
meet their quotation display, order access and trade reporting obligations. On
July 27, 2002, the SEC approved the NASD's proposal for the Alternative Display
Facility (ADF) as a nine-month pilot program restricted to Nasdaq-quoted stocks.
The ADF pilot displays quotes and collects trade reports, but keeps the NASD's
obligations to operate a market to a minimum. The ADF pilot does not provide for
order execution or routing services. As a result, ADF pilot participants
themselves are required to provide NASD member broker-dealers with electronic
access to their quotations. The NASD's pending proposal for ADF trading of U.S.
exchange-listed stocks would provide ADF participants the choice of meeting
their order access obligations through ITS or by providing other market
participants with electronic access to their quotes themselves.

Another pending change to the Nasdaq market structure, in recognition of
Nasdaq's growing role as a competitor, is the expected replacement in 2004 of
Nasdaq as exclusive collector and distributor of consolidated data (known as an
exclusive securities information processor, or exclusive SIP), regarding
quotations and trades in Nasdaq-quoted stocks. This role has given Nasdaq
financial and other competitive advantages. The replacement is also expected to
be an exclusive SIP but may not compete directly with us.

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 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. We believe
decimalization has led to traditional broker-dealers executing a higher
percentage of their customers' orders internally (a practice known as
"internalization") instead of routing 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.

The securities markets and the brokerage industry in which we operate are
highly regulated. Many of the regulations applicable to us may have the effect
of limiting our activities, including activities that might be profitable, or
causing us to modify our business model in ways that may adversely affect our
revenues. Accordingly, new regulations or interpretations may be adopted that
could constrain our ability and our customers' ability to transact business
through us and could have a material adverse effect on our business, financial
condition and operating results.

In addition, the SEC regularly considers a variety of regulations or
interpretative initiatives with respect to the structure of the equity
securities markets, including initiatives intended to reduce fragmentation,
integrate ECNs and ATSs into the national market systems and create a national
consolidated limit order book. Future SEC rulemakings or interpretations in this
area could adversely affect our business, financial condition and operating
results. 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 structure
may have a significant impact on our equities business. See "Certain Factors
that May Affect Our Business -- Risks Related to Our Industry."

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

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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 a challenging competitive environment.

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.

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. Recent economic and
financial difficulties and disruptions in Asia have made trends in Asian
securities markets less predictable. However, we believe that, except for the
trend in Europe towards the consolidation of exchanges, similar competitive,
demographic and technological developments will lead over time to an evolution
in Asian markets generally comparable to that in Europe over the last decade.

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 18.6% of the total trading volume in that market in 2002. Our
trading volumes include Island volumes subsequent to the merger, which was
completed on September 20, 2002. Following the merger, in the fourth quarter of
2002, our two ATSs accounted for approximately 30% of the total trading volume
in Nasdaq-quoted stocks. 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 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 and market professionals.

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, through reduced fees for taking liquidity
and rebates for providing liquidity 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

8

market impact, which we believe can result in better pricing for the customer.
In addition, we believe that our services enable our customers to manage their
orders more effectively as well as provide efficient access to multiple
liquidity pools other than our liquidity pools.

We believe that we provide our customers with the opportunity for price
improvement and reduced transaction costs in executing their trades. In a report
published in January 2003 based on data for the 12 months ended September 30,
2002, Plexus Group, an independent market research group, ranked Instinet first
in execution quality in Nasdaq-listed stocks as well as U.S. exchange-listed
stocks when compared to a universe of the 12 most-active full-service brokers
for which Plexus has data.

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, 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);

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

- extended hours trading;

- directing orders to either our own liquidity pools or one of the various
markets to which we are connected (known as smart order-routing);

- technical assistance to customers in inputting orders; and

- management of 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 and
one of the largest providers of commission recapture services to pension plan
sponsors and managers.

WE OPERATE GLOBALLY

Our customers use our Instinet ATS to trade securities in approximately 30
non-U.S. securities markets, and we are a member of 11 non-U.S. exchanges. As of
December 31, 2002, approximately 735 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 Instinet's systems
has grown from approximately 1.5 million transactions in 2000 to 7.6 million
transactions in 2002.

In addition, outside the United States, we are an independent provider of
research and other brokerage services through soft dollar and similar
arrangements and a significant provider of commission recapture services to
pension plan sponsors and managers.

WE HAVE A PROVEN ABILITY TO INNOVATE AND ADAPT

Throughout our more than 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.
9

- 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.

- 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
SEC's adoption 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.

- In 2002, we introduced NEWPORT(TM), a unique, patent pending execution
management system for portfolio trading that allows customers to organize
and manipulate database components supporting the system's interface, in
addition to permitting the customization of the display features.

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 pools
within our own electronic trading systems in order to trade these securities
with one another or to access one of the various markets to which we are
connected. We continue to develop and enhance our technology to provide our
customers efficient access to our two ATS systems and to most other liquidity
pools, resulting in enhanced order execution capabilities. In addition, we
continue to provide our customers with enhanced technology to improve our
customers' order management and execution capabilities. 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 delivering services that empower our customers to reduce
their total transaction costs, gain price improvement on their trades, manage
their orders and better achieve their trading objectives. Our objective is to
take advantage of growth opportunities that may arise in the securities industry
as a result of changing technology, regulation, competition and increased
trading activity through electronic trading systems in global equity markets. 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.
10

The principal elements of our strategy include:

Maintain and Expand Our Liquidity. We continue to seek ways to
maintain and expand our trading volumes in the global equity markets,
particularly in the U.S. markets for Nasdaq-quoted and U.S. exchange-listed
stocks. Over the past two years, volatility, declines in trading volumes
and intense competition, particularly for U.S. broker-dealer customers,
have resulted in a difficult operating environment. We remain focused, in
this challenging climate, on maintaining and strengthening our liquidity by
enhanced pricing and service offerings for these broker-dealer customers,
and by leveraging our technological capabilities. We believe that this
focus on liquidity and technology results in better executions for all of
our customers. For our Instinet ATS, following our pricing initiatives in
late 2001 and the first quarter of 2002, in March 2002, we introduced a new
service initiative for U.S. broker-dealer customers that includes faster
response times, enhanced functionality, reduced fees for taking liquidity
and new rebates for providing liquidity. We also continue to assess our
pricing for all of our customers. As part of our continued effort to
operate as a low-cost provider to increase our efficiency, we have
implemented a cost reduction plan to reduce our fixed cost base and
continue to evaluate further cost reduction initiatives.

We continued our efforts to maintain and expand our liquidity with our
acquisition of Island in September 2002, which, among other things,
resulted in an increase in our consolidated market share in both
Nasdaq-quoted stocks and U.S. exchange-listed stocks. Our two ATSs,
Instinet and The Island ECN, currently operate independently. As we
evaluate the potential integration of the two trading platforms, we
continue to develop our technology to enhance the ability of customers of
each of our ATSs to access the liquidity in the other ATS. For example, in
November 2002, we introduced technology that offers Instinet customers the
option, for certain orders, to send automatically parts of orders that
cannot be filled on the Instinet system to the Island system at no
additional cost to the customer. In addition, we are developing technology
that will enable customers of the Island ATS to connect directly to our
smart order-routing technology through Inlet, Island's proprietary market
data and order handling platform. We anticipate deploying this new
technology to our customers during the second quarter of this year.

Extend Our Global Brokerage and Technology Offering. We intend to
continue to develop our global institutional agency brokerage business by
enhancing our pricing and service options, as well as continuing to
innovate and use technology to reduce our customers' transaction costs and
provide better pricing for their trades. Specifically, we intend to
continue to enhance our technology and improve our customer service and
professional sales and trading assistance efforts. We also seek to increase
customer awareness of the value of the benefits we provide as a result of
our core values of independence and neutrality, anonymity, equal and direct
access and customer empowerment. Both in the U.S. and internationally, we
will continue to align our existing resources and focus our initiatives on
developing products and services tailored to our various customer
categories, based upon our customers' specific needs and their diverse
business models, with the aim of improving our customers' execution
performance. These services include portfolio trading, block trading,
crossing, trading software, soft dollar and plan sponsor services, and
professional sales and trading assistance. We believe that these efforts
will also contribute to maintaining and expanding our trading volumes in
the global equity markets. We have recently introduced a number of new
products and services to enhance our customers' order management and trade
execution. Our new Direct-FIX technology, introduced in February 2002, is
an upgrade of our basic connectivity which combines faster connectivity
with improved trading functionality. In October 2002, we introduced a new
block trading functionality that we believe will improve our customers'
performance and efficiency when executing large, complex orders. In the
first half of 2002, we deployed two new customer interface products,
INSTINET TRADING PORTAL (SM) and NEWPORT(TM). Instinet Trading Portal is
aimed primarily at active fund managers and hedge funds and enhances our
customer interface with smart order-routing technology and sophisticated
order functionality, while Newport is an execution management application
for portfolio trading that is designed to improve our customers' ability to
execute program trades and implement trade strategies on a global basis
while reducing their transaction costs. We plan to continue to roll these
products out to new customers.

11

In pursuit of our strategy, we periodically engage in discussions 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
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. 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, order management
and ancillary services, enabling them to trade equity securities directly with
each other through our platforms, 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 distinct pools of liquidity on our
two electronic platforms. We also offer our customers smart 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
2002, our customers used our two platforms to complete a total of 156.0 million
transactions, representing an average of approximately 619,000 transactions each
trading day.

With our acquisition of Island in September 2002, we operate two of the
largest ATSs trading Nasdaq-quoted stocks. Our two ATSs accounted for 18.6% of
the total trading volume in Nasdaq-quoted stocks during 2002 (although that
figure fluctuated significantly during the year). This trading volume includes
all of Instinet's trading volume for 2002 and only Island's trading volume
subsequent to the merger, which was completed on September 20, 2002. Following
the merger, in the fourth quarter of 2002, our two ATSs accounted for
approximately 30% of the total trading volume in Nasdaq-quoted stocks. Our
average daily trading volume in Nasdaq-quoted stocks increased 22.4% from 265.7
million shares in 2001 to a combined volume of 325.2 million shares in 2002,with
almost all of that increase resulting from the addition of Island's volumes.

Including Island's trading volumes subsequent to September 20, 2002, our
two ATSs together accounted for 3.4% of the total trading volume in U.S.
exchange-listed stocks during 2002. Our average daily trading volume in U.S.
exchange-listed stocks increased 40.1% from 44.4 million shares in 2001 to a
combined volume of 62.2 million shares in 2002, with approximately half of that
increase resulting from the addition of Island's volumes.

Instinet's transaction volume in non-U.S. stocks was approximately 7.6
million transactions in 2002.

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" and
"Calculation of Instinet ATS and Island ATS Combined Volumes."

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. As of December 31, 2002, our Instinet ATS provided equities
trading services to approximately 2,865 customers, of which approximately 735
were in Europe and 150 in Asia. In the United States, our Instinet customers
included approximately 1,250 institutional investors and 730 broker-dealers as
of December 31, 2002. In the United States, Island provided equities trading
services to approximately 620 customers, most of which were broker-dealers, as
of December 31, 2002.

12

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.

MARKET PROFESSIONALS:

- TRADITIONAL BROKER-DEALERS, which include market makers, agency traders
and broker-dealers serving institutional and retail customers;

- DIRECT ACCESS BROKERS-DEALERS, who provide smaller institutions, retail
customers and individual professional traders electronic access to the
markets; and

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

- INDIVIDUAL PROFESSIONAL TRADERS, who seek to manage their own trading
activity by accessing the markets directly instead of through market
intermediaries or institutional investors.

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 order
management and execution functionality, together with anonymous trading, access
to our liquidity pool and efficient connections to other trading platforms, we
can enhance our customers' ability to achieve their trading objectives.

Services

We offer our customers a broad range of trade execution, order management
and other services through our two ATSs, Instinet and Island, including the
following:

Core Execution Services. Each of our two ATSs provides the
automated matching of buy and sell orders for both Nasdaq-quoted securities
and U.S. exchange-listed securities. Through each of our Instinet and
Island electronic trading platforms, we enable our customers to enter
orders and execute trades directly with one another. Direct trading between
our customers over each of our platforms 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 an exchange, with
pricing throughout the day).

Using the Instinet trading platform, customers are able to trade with
other investors in over 40 securities markets worldwide and access market
makers or other ECNs using our smart order-routing technology. For
customers who trade in Nasdaq-quoted stocks, the Instinet trading platform
provides an automated market interaction system, which 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. For customers who trade in NYSE-listed stocks or
stocks listed on any other exchange, the Instinet platform primarily
provides 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 the Instinet platform. We anticipate extending our
automated market interaction system to include U.S. exchange-listed stocks
by the end of the second quarter of this year.

13

For non-U.S. securities that are not traded in U.S. markets, Instinet
primarily provides direct connections to the principal non-U.S. exchanges
on which those securities are listed, although customers can also trade
directly with each other over the Instinet platform. Instinet is a member
of 11 non-U.S. exchanges and provides customers with direct access to those
exchanges to execute their trades. For more than 20 additional non-U.S.
markets, Instinet provides access through local exchange members.

We are currently in the process of developing a plan to potentially
integrate the core technologies of the matching engines of our two ATSs and
to identify operating efficiencies so that our customers who trade through
both of our trading platforms will be able to benefit from all of our
value-added services. As part of our integration efforts, we have deployed
technology that offers Instinet customers the option, for certain orders,
to send automatically parts of orders that cannot be filled on the Instinet
system to the Island system at no additional cost. If the order is not
executed there, the order will be posted on the Instinet trading platform
or routed to another market center for execution, based upon the customers'
instructions. This enhanced functionality is only available to customers
using our INSTINET TRADING PORTAL (SM) and NEWPORT(TM) trading applications
and only to customers who access the Instinet trading platform through
Direct-FIX. In addition, we are developing technology that will enable
Island customers to connect directly to our smart order-routing technology
through Inlet, Island's proprietary market data and order handling
platform. We anticipate deploying this new technology to our customers
during the second quarter of this year.

Negotiating Orders. Our Instinet trading platform utilizes technology
that 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. Instinet
also offers trading functionality that is designed to improve our
customers' performance and efficiency when executing these large, complex
orders. Instinet recently deployed a new order management application that
allows our customers to manage the delivery and execution of their block
orders by identifying potential counterparties for the order, and
negotiating directly with them, without diminishing their ability to expose
the order anonymously to the market as a whole. This new trading
application enables our customers to minimize the market impact of a large
order and reduce their transaction costs while continuing to use our
existing infrastructure. We believe this enhanced functionality will help
our customers to manage their order flow in a more efficient manner.

Sales Trading Assistance. Each of our two ATSs has a dedicated group
of sales and trading professionals who provide our customers with various
types of sales and trading assistance and provide technical assistance in
the use of our screen-based trading systems. Customers using the Instinet
trading platform can also place orders by telephone with our sales and
trading professionals, who enter the orders into our system on behalf of a
customer, and in some cases will work those orders in an attempt to reduce
their market 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, Instinet has a
dedicated team of sales and trading professionals available to assist its
customers with their portfolio trading and perform execution quality
analysis to assist Instinet's customers in their review of transaction
costs. Also, Instinet's Technical Analysis Group produces packaged and
customized technical analysis, as well as daily market commentary to enable
customers using the Instinet trading platform to design efficient portfolio
and trading strategies.

As of December 31, 2002, our two ATSs together had 285 sales and
trading professionals, of which 157 were located in North America, 92 in
Europe and 36 in Asia. In Europe, Instinet sales traders in London are
responsible for providing brokerage services to all of its customers and
coverage of all of the markets where our Instinet trading platform
operates. Recently, Instinet streamlined its local presence coverage in
Europe, centralizing most of its European brokerage services in London.
London also has a
14

specialized desk to service European portfolio traders. In Asia, Instinet
provides coverage for its Japanese customers and the Japanese market
through its Tokyo office, with the remainder of Asia and Australia serviced
through our Hong Kong office. Instinet also has coverage in each of its
offices in the United States, Canada, Europe and Asia to assist customers
who wish to place orders through the Instinet trading platform 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 Instinet's sales and trading professionals for that market,
thereby affording our customers in other regions access to local market
expertise. Because Instinet has offices worldwide, we also are able to
provide sales and trading assistance to our Instinet 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. Each of our Instinet and Island trading
platforms allows customers to input orders for a security and execute the
trade with other customers in our liquidity pool before, during and after
normal market hours. This permits Instinet to make the liquidity pool
generated by its customers available on a 24-hour basis, while Island
customers have access to its liquidity pool until 8:00 p.m., New York City
time. This service has also allowed our Instinet trading platform to expand
globally to include customers and markets in Europe and Asia, whose trading
hours do not coincide with those in the United States. 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 Microsoft Corp. announced that it would be issuing its first
dividend in the company's history on January 17th, 2003, 12.5 million
Microsoft shares traded through our two ATSs between the close on January
16, 2003 and the open on January 17, 2003. This represented approximately
31% of average daily trading volume of Microsoft Corp. during the prior
90-day period.

Crossing. Through our INSTINET CROSSING(R) provided to customers
using the Instinet trading platform, 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. Our Instinet
trading platform has 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 2002, during each evening crossing session, our Instinet trading
platform received buy and sell orders from 290 customers for approximately
101 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 offer Instinet 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 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.
We also offer our Instinet customers access to a crossing system for
foreign currencies through The INSTINET FX CROSS(SM), our strategic
alliance with Citibank, N.A. The Instinet FX Cross, which began operating
in December 2002 for our North American clients, enables clients to execute
large currency transactions anonymously at a transparent market price. The
Instinet FX Cross currently offers two crossing sessions per day in 12
currencies, to be executed at the CitiFX Benchmark rate, against Citibank,
N.A. the counterparty.

Portfolio Trading. The trading services of our Instinet ATS also
include portfolio trading, which allows a customer using our Instinet
trading platform to execute multiple orders in a number of different

15

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 capability, combined with Instinet's global access,
also enables Instinet customers to manage and execute portfolios of
securities denominated in a number of different currencies. Instinet's
Trading Research Group performs transaction cost analysis to assist
portfolio managers and traders in their effort to track and evaluate
trading costs. In addition, in April 2002, Instinet deployed a technology
to enhance its customers' ability to execute portfolio trade transactions
and implement their trade strategies on a global basis. This patent pending
execution management application, NEWPORT(TM), was developed in conjunction
with passive and quantitative fund managers in the United States and Europe
and uses Instinet's existing execution, smart order-routing and clearing
capabilities, as well as Reuters market data infrastructure. In addition,
this system facilitates collaboration 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 help Instinet customers to manage their orders in a more efficient
manner and reduce their operational and transaction costs. As of December
31, 2002, we deployed Newport(TM) to 50 Instinet customers in the United
States and Europe and $29 billion in value (meaning the number of shares
traded multiplied by the price of the shares) was transacted through the
Newport platform since its introduction.

Enhanced Customer Interface (INSTINET TRADING PORTAL(SM)). Based upon
the technology we acquired through our acquisition of ProTrader, our
Instinet ATS developed a trading application primarily for its active asset
managers and hedge funds that enables these customers to enhance its
customer interface and smart order-routing technology when using the
Instinet trading platform. This new trading application uses Instinet's
existing infrastructure while giving customers a broader view and broader
access to multiple markets. With Instinet Trading Portal, Instinet
customers 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 helps these customers to manage their orders in a more
efficient manner. In addition, as an Internet-based product, Instinet
Trading Portal is designed to substantially reduce communication and field
service costs associated with our traditional customer display screens. By
the end of the fourth quarter of 2002, Instinet Trading Portal was deployed
at over 600 Instinet customer sites,and over 1.4 billion shares were traded
through Instinet Trading Portal in 2002.

Inlet. Inlet is Island's proprietary Java-based, Internet-based
market data and order handling platform that permits its customers to place
orders in Island's marketplace. Currently, Inlet can only send orders to
the Island ATS. As part of our integration efforts, we are developing
technology that will allow Inlet to connect directly to the smart
order-routing technology of our Instinet trading platform.

Soft Dollar Program. Institutional investors often allocate a portion
of their gross brokerage transaction fees for the purchase of independent
third-party research products, as well as other brokerage services. The
amounts allocated for those purposes are commonly referred to as soft
dollar revenues. Our Instinet ATS is one of the largest independent
providers of research and other brokerage services through soft dollar or
other similar arrangements, and has offered soft dollar programs for over
15 years. Instinet offers soft dollar programs in order to increase the
amount of business institutional customers conduct through the Instinet
trading platform, thereby increasing its transaction volumes and the depth
of its liquidity pool. We continue to focus on these programs, as part of
our efforts to enhance our global brokerage offering and maintain and
expand our liquidity pool. In particular, Instinet is continuing to develop
tailored packages of independent third-party research products for its
various customer categories. We also offer customers using the Instinet
trading platform proprietary research tools and services. These services
include Redbook, which publishes fundamental research on retail and related
sectors and whose REDBOOK RETAIL SALES AVERAGE is recognized as a leading
indicator of economic activity, and THE GREAT LAKES REVIEW, which focuses
on uncovering stock opportunities among lesser-known companies in the
Midwest, which is offered by our subsidiary, Lynch, Jones & Ryan. In
addition, Instinet continues to make available soft-dollar payment options
to its customers in connection with their use of the Research

16

and Analytics (R&A) product, an integrated equity workstation that provides
users with real-time quotes and news as well as advanced analytics which is
owned by Reuters.

In 2002, more than one-third of Instinet's U.S. customers obtained
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. Instinet made $129.2 million in soft dollar
payments to independent research providers on behalf of all customers using
the Instinet trading platform in 2002.

Plan Sponsor Services. As part of the transactional services our
Instinet ATS provides to pension plans and other funds through their
sponsors, such as corporations, unions, state and local governments,
endowments and foundations, Instinet enables pension plan and other fund
sponsors to recapture a portion of the gross transaction fees that their
fund managers pay us. As of December 31, 2002, Instinet provided these
services to approximately 1,350 pension plans and other funds. In addition,
Instinet provides its plan sponsor customers with services that assist them
when they transfer from one money manager to another. For example,
Instinet's crossing, portfolio trading and trading research services can
help these customers manage this transition.

ProTrader. Through our ProTrader subsidiary, we provide advanced
trading technologies and electronic brokerage services primarily to
professional non-institutional traders, active fund managers, direct access
brokers and hedge funds who use the Instinet trading platform. As of
December 31, 2002, Protrader provided these services to approximately 950
customers.

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. In February 2003, we
replaced portions of CIS with a new system for the processing of trades for our
U.S. broker-dealer customers. This new system will improve the efficiency of CIS
by providing increased capacity to process significantly higher volumes of
trades for these customers. For processing of books and records, ICS uses
Automated 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 are
currently evaluating our relationship with ADP and continuing to explore
relationships with other established processing vendors. As part of our cost
saving initiatives and integration efforts in connection with our acquisition of
Island, on January 10, 2003, we completed the conversion of Island's trading
activity from I-Clearing Corp. to Instinet Clearing Services, Inc.

We also clear and settle for broker-dealer 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
confirming 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,
managing corporate actions and updating and maintaining Instinet's books and
records.

17

BUSINESS INVESTMENTS

We have made a number of investments in companies with operations or
technology to enhance our core service offerings in our global electronic agency
securities business. We have beneficial ownership interests in the following
companies:

- 7.0% of WR 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. WR Hambrecht has also issued warrants that, if fully exercised,
would dilute our ownership interest to 6.36%.

- 4.8% of the voting interest of ARCHIPELAGO SECURITIES, LLC, the parent
company of an ECN that has received approval to operate as a facility of
a U.S. stock exchange. In March 2002, Archipelago, LLC merged with
REDIBook ECN LLC, another ECN.

- 47.9% of TRADEWARE S.A., a European-based provider of integrated order
routing solutions to broker-dealers in Europe. We also have warrants
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.

- 50% of JAPANCROSS SECURITIES CO., LTD., a 50-50 joint venture with Nikko
Salomon Smith Barney Ltd. established to provide a crossing service for
Japanese equity securities.

- 9.8% of e-XCHANGE ADVANTAGE CORPORATION, a partnership with The Nasdaq
Stock Market, formed to develop securities electronic trading systems and
tools.

- 1.7% of THE NASDAQ STOCK MARKET, INC., a company that operates an
electronic stock market in the U.S.

We also owned 13.8% of TP GROUP LDC, a consortium that owned 38.9% of
virt-x, an electronic order-driven equities market for pan-European securities.
On February 3, 2003, SWX Holding AG, a subsidiary of SWX Swiss Exchange, the
Swiss market body, acquired 92% of virt-x. TP Group LDC received L13.6 million
in connection with the sale and was subsequently liquidated. We expect to
receive approximately $3.0 million as part of the liquidation in April 2003.

18

EXCHANGE MEMBERSHIPS

Overall, through our Instinet and Island subsidiaries, we are a member of
21 exchanges in North America, Europe and Asia, and we continue to develop our
direct connections to non-U.S. exchanges. Our Island subsidiaries are members of
the Cincinnati Stock Exchange and the Philadelphia Stock Exchange. The following
chart shows Instinet's various exchange memberships, which are through our
Instinet subsidiaries only, unless otherwise indicated:

EXCHANGE MEMBERSHIPS

NORTH AMERICA

American Stock Exchange
Archipelago Exchange
Bermuda Stock Exchange
Boston Stock Exchange
Chicago Board Options Exchange
Chicago Stock Exchange
Cincinnati Stock Exchange*
New York Stock Exchange
Philadelphia Stock Exchange*
Toronto Stock Exchange

EUROPE

Euronext(1)
Frankfurt Stock Exchange
London Stock Exchange
Helsinki Stock Exchange
Milan Stock Exchange
OFEX plc
Stockholm Stock Exchange
Swiss Stock Exchange
virt-x

ASIA-PACIFIC REGION

Hong Kong Stock Exchange
Tokyo Stock Exchange

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

* Indicates membership of both Instinet and Island

(1) 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:

- Creating positive awareness of our key products and services, including
our sales and trading expertise, liquidity pools and our sophisticated
trading tools.

- Attracting new customers.

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

We pursue these goals through a combination of marketing communications
strategies. These include media (for example, offering a daily broadcast to CNBC
of market activity information), print and broadcast advertising, interactive
marketing on our own websites and other online channels, sponsorships of
customer events, direct one-to-one marketing, traditional public relations and a
variety of alliances and co-marketing programs and the production of clients
newsletters, 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.

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.

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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.

We have four core data centers that enhance the capacity and reliability of
our Instinet and Island trading platforms. Our two core data centers for
Instinet are located in Jersey City, New Jersey and Bedford, Massachusetts.
These two data centers support client connectivity, as well as trading and
execution systems, clearing and settlement operations and customer interfaces.
They also provide redundancy for Instinet's critical applications, systems and
services, allowing Instinet to continue to operate from either site should the
other site fail. Island is supported by two data centers located in Secaucus,
New Jersey and New York, New York. These two data centers support client
connectivity, trading and execution systems, as well as customer interfaces. If
one of our four data centers were to be damaged, disabled or otherwise fail or
experience difficulties, it might be more difficult for us to continue operating
without disruption to our services. In order to mitigate this risk, we have
installed additional power, telecommunications and hardware at the two core data
centers that support the Instinet trading platform. In addition, we are
reconfiguring our network infrastructure in order to be able to support both
Instinet and Island client connectivity and critical systems and services from
any of these four facilities, with each one being able to provide independent
support. We anticipate that this reconfiguration will be completed by the third
quarter of 2003. We also have two subsidiary data centers and distribution
points in London serving Instinet's clients in Europe.

Our Instinet ATS uses a range of sophisticated technologies, including
Linux, Tibco's Rendezvous, Oracle, Java and Enterprise Java Beans (EJB), for the
various components of its systems, including its central order matching engines
for its institutional equities trading platform, as well as its crossing
services and order management functions. Our Island ATS also uses a number of
technologies including Linux, Windows, Java, Microsoft SQL for the various
components of its trading system.

Currently, our customers can access Instinet's trading platform through
INSTINET(TM) display screens, direct links to our systems from those of our
customers using the Financial Information Exchange (FIX) protocol, or other
protocols, or our proprietary software. Recent products that Instinet has
developed to access its marketplace include:

- Instinet Trading Portal (SM), our new trading application primarily for
our active asset managers and hedge funds. Instinet Trading Portal's
Internet-based deployment strategy is designed to substantially reduce
communication and field service costs associated with our traditional
customer display screens.

- Newport(TM), a patent pending program-trading solution aimed primarily at
passive and quantitative fund managers. Newport allows 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, which improves our customers' ability to execute program
trades in global markets.

- Direct-FIX technology, an upgrade that offers enhanced trade reporting
functionality, access to our smart order-routing technology and access to
our market data. This upgrade combines faster connectivity with richer
trading functionality than its predecessor and is more cost-effective for
us.

Most of the methods of connecting to Instinet's trading platform are by
means of dedicated networks provided by Radianz, a joint venture between by
Reuters and Equant Finance B.V. However, we also provide Internet-based
connectivity to those customers who choose not to use Radianz. We are continuing
to replace our proprietary communications and connectivity systems with various
other methods of connectivity, including Internet-based systems and technology
provided by third party vendors, that will shift communications and connectivity
requirements to our customers. The availability of alternative methods of
connectivity will also provide Instinet customers with multiple options for
access to Instinet's trading platform.

Customers can access Island's trading platform either directly, through the
use of Island's proprietary technology, or through third-party trading platforms
for which Island has developed various products to allow
20

those trading platforms to access its trading platform. Products that Island has
developed to access its trading platform include:

- Inlet(R), a proprietary Java-based, Internet-based, market data and order
handling platform that permits subscriber customers to place orders in
Island's trading platform.

- OUCH(R), a proprietary protocol that provides subscriber customers with a
fast, efficient means of entering orders in Island's trading platform.
OUCH(R) allows investors to access the Island trading platform, either
directly or through a third-party trading platform, to place orders and
monitor order and trade information. All orders, whether entered by
direct OUCH(R) users or users of Island's other connectivity products,
are entered into Island's trading platform through the OUCH(R) protocol.

- FIX Connectivity, a product that allows subscriber customers and vendors
that have adopted the FIX protocol to connect to Island's trading
platform quickly without incurring significant additional technology
costs.

IslandNet(R) is a managed network service that provides simplified
connectivity to Island's trading platform and fully-redundant access over a
private network to its full range of products, including OUCH(R), FIX products
and Inlet(R). Island has also partnered with other leading providers of
front-end trading platforms, network services and trade and order management
systems to expand access to Island's matching services and data information.
These third-party systems generally connect to Island's trading platform through
OUCH(R) or FIX and then redistribute this connectivity to their customers.

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

We are considering the potential integration of the core technologies of
the matching engines of our two ATSs and continue to identify operating
efficiencies so that our customers who trade through both of our trading
platforms will be able to benefit from all of our value-added services. As part
of our integration efforts, we have deployed technology that offers Instinet
customers the option, for certain orders, to automatically send parts of orders
that cannot be filled on the Instinet system to the Island system at no
additional cost. If the order is not executed there, the order will be posted on
the Instinet trading platform or routed to another market center for execution,
based upon the customers' instructions. This enhanced functionality is only
available to customers using our INSTINET TRADING PORTAL (SM) and NEWPORT(TM)
trading applications and only to customers who access the Instinet trading
platform through Direct-FIX. In addition, we are developing technology that will
enable Island customers to connect directly to our smart order-routing
technology through Inlet(R), Island's proprietary market data and order handling
platform. We anticipate deploying this new technology to our customers during
the second quarter of this year.

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 trade name, logos, trademarks and service
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.
21

COMPETITION

The financial services industry generally, and in particular, the
securities brokerage business in which we engage is very competitive, and we
expect competition to remain intense 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, exchange specialists, 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 SuperMontage and Primex systems, which enable NASD members to
trade electronically in Nasdaq-quoted stocks;

- 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, 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;

- commercial banks and other financial institutions; and

- trading system software companies.

In our institutional equity securities business, both Instinet and Island
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;

- functionality and ease of use of our trading platforms; and

- reputation.

Instinet also competes based upon 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 that may 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.

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. To maintain our customer base and attempt to
counter this pressure, we have aggressively reduced pricing for our U.S. broker-
dealer customers and introduced reduced fees for taking liquidity and rebates
for providing liquidity. In addition, we seek to continue to innovate and use
technology on a global basis to reduce transaction costs; increase customer
awareness of the value of price improvement and the benefits we provide as a
result of our
22

core values of independence and neutrality, anonymity, equal and direct access
and customer empowerment; maintain and expand our Nasdaq liquidity pool and the
related benefits; and provide value-added brokerage and other services, tailored
for our various types of customers.

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 remain intense 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 in 2002, may persist.

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

- Competitors who apply for and receive status as securities exchanges or
facilities of an exchange will be able to benefit from their exclusive
participation in the various NMS systems. As a result, these competitors
may have an advantage over us in attracting business in, and generating
revenues from, their activity in U.S. exchange-listed and Nasdaq-quoted
stocks. In addition, there may be other potential competitive advantages
associated with securities exchange status, including a role in the
governance of NMS systems, a share of the revenues generated by the sale
of consolidated market data to vendors and market participants, and
direct connectivity to NMS systems, including ITS, which enables an ATS
to access publicly displayed orders in all ITS participant markets
trading U.S. exchange-listed stocks and make its own orders available for
execution through ITS. In addition, as exchanges, these competitors would
become SROs or SRO facilities, no longer subject to regulation by the
NASD or another SRO. One competitor, Archipelago, has already been
approved and is operating as a facility of a U.S. stock exchange.

- 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.

- 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."

- 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 or be subject to securities industry
regulations 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 size 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

23

companies, information and media companies, and other companies that are
not currently in the securities business.

- 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.

- As a result of decimalization and other factors, some market makers
continue to move 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
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. These developments may increase our competition, particularly in
the provision of soft dollar programs.

We compete with Nasdaq as a trading venue for Nasdaq-quoted stocks. We own
an equity interest of less than 2% in Nasdaq. The NASD operates the ADF, through
which Instinet meets its quotation display and order access requirements in
Nasdaq-quoted stocks, regulates and polices the Nasdaq market, and regulates the
activities of our U.S. broker-dealer subsidiaries through its own subsidiary,
NASDR. The NASD also holds a controlling stake in 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 allow the ADF to
provide quotation and trade data to Nasdaq in its current role as exclusive SIP.
NASD and Nasdaq (through NASD and as exclusive SIP) receive a share of the fees
Nasdaq collects from market participants to whom it disseminates these data.
This role has given Nasdaq certain financial and other competitive advantages.
In recognition of Nasdaq's growing role as a competitor, however, it is expected
to be replaced as the exclusive SIP in 2004. See "-- Industry Background" and
"-- Regulation."

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

REGULATION

As a securities broker, an operator of two systems considered ATSs and ECNs
under SEC regulations 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 subsidiaries that are
registered or licensed in the various jurisdictions. Instinet Corporation, The
Island ECN, Inc., Island Execution Services, Inc., The Island Futures Exchange,
Instinet Clearing Services, Inc., Lynch, Jones & Ryan, Inc., ProTrader
Securities Limited Partnership and Harborview LLC are each registered as U.S.
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 rulemaking or the initiation of proceedings could
adversely affect our business, financial results and condition, prospects and
reputation.

24

Regulation covers all aspects of our brokerage business, including:

- registration of offices and personnel;

- conduct of personnel;

- access to our ATSs;

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

- trading practices;

- record keeping;

- capital structure;

- capacity, integrity and security standards for our trading systems;

- 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 SROs 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 and clearing subsidiaries are registered with the SEC as
broker-dealers, and our brokerage subsidiary, Instinet Corporation, is also
registered with the SEC as an investment advisor. The SEC has delegated much of
the regulation of broker-dealers to SROs, 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 and the ADF. These rules regulate the conduct of our
U.S. broker-dealer subsidiaries and their activities in Nasdaq-quoted and U.S.
exchange-listed 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 business. Instinet Corporation,
Instinet Clearing Services, Inc., The Island ECN, Inc., Island Execution
Services, Inc., Lynch, Jones & Ryan, Inc., ProTrader Securities Limited
Partnership and Harborview LLC are also subject to regulation by the 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.

25

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 SROs.

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, 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 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 the facilities, or pursuant to
the rules, of a SROs. 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
a quote montage operated by a SROs.

When the order handling rules were introduced, Instinet was the first and
only existing ECN, and the best bids and offers from the Instinet 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 our Instinet ATS
and the Island ATS over a number of years verifying and extending the Instinet
ATS's and the Island ATS's status as ECNs in compliance with these rules. The
most recent "no-action" letters for each of the Instinet ATS and the Island ATS
are valid until July 6, 2003. The Division continues to condition its
"no-action" positions upon, among other things, specified limitations on the
fees we charge brokers who are not subscribers to our systems for executing
orders on our systems displayed on an SRO through the SRO's facilities or
according to the SRO's rules (fees commonly known as "access fees"). The
Division also conditions its positions upon our representation that the trade
execution and communication systems of each of our ATSs is able to handle
anticipated present and future peak trading volumes. In connection with its
annual examination of the capacity of market participants, the Division has in
the past raised issues regarding the adequacy of our capacity, our testing of
capacity limits and our plans for increasing capacity, which we believe we have
addressed. The Division also has in the past raised issues regarding our access
fees. We expect that the Division will continue to extend its "no-action"
positions, but we cannot assure you that it will do so or that its applicable
rules or the enforcement of those rules will not change.

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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 the best-priced buy and sell orders displayed
within our systems to subscribers through an SRO and providing
broker-dealers with access to these orders via an SRO's facilities or
according to an SRO's rules;

- limitations on the fees charged to broker-dealers for accessing system
orders displayed through an SRO, and compliance with SRO rules relating
to these fees;

- the establishment of written standards for granting access to trading on
our systems, and not unreasonably prohibiting or limiting access to the
services offered by our systems by applying these access standards in an
unfair or discriminatory manner;

- the establishment of and application of 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.

Exchange Registration and the Island Exchange Application

As a consequence of their compliance with the requirements of Regulation
ATS, neither the Instinet ATS nor the Island ATS is currently required to
register as a national securities exchange under applicable U.S. securities
laws. However, if the Island ATS and the Instinet ATS are integrated over time,
it is possible that our combined future share of the average daily trading
volume in specified securities or classes of securities could result in an SEC
determination that exchange registration is necessary. In addition, Island
submitted an application in draft with the SEC staff for registration as a
national securities exchange on June 28, 1999. If the SEC were to require either
or both of our two ATSs to register as a national securities exchange, or if any
of our subsidiaries were to voluntarily register as a national securities
exchange, we could become subject to substantial additional regulation. Among
other consequences, we might also be required to comply with fair representation
or ownership requirements.

Under our amended and restated corporate agreement with Reuters, in the
event the SEC seeks to require either or both of our ATSs to register as a
national securities exchange, we have agreed to take all commercially reasonable
actions to mitigate the effect of such actions on Reuters rights, including the
implementation of appropriate changes in our corporate structure and operations,
although we would not be required to take any action that would have a material
adverse effect on any material part of our business or its consolidated
financial condition or results of operations. In addition, neither of our ATSs
nor any of our subsidiaries may voluntarily register as a national securities
exchange without the prior written consent of Reuters if such registration would
materially affect Reuters ability to exercise its voting and other rights
related to its ownership of our common shares.

Quote Display and Order Execution Access in Exchange-Listed Stocks;
Intermarket Trading System

Under Regulation ATS, an ATS meeting certain trading volume thresholds
during four calendar months in any six calendar month period in securities for
which it displays quotation data must provide to an SRO its best bid and offer
data for those securities and must provide other broker-dealers execution access
to such quotes. Both of our ATSs currently provide all of their quotation data
for Nasdaq-quoted stocks to various SROs in order to comply with Regulation ATS.
Until recently, neither of our ATSs had met the trading

27

volume thresholds for any U.S. exchange-listed stocks. In Fall 2002, however,
both our Instinet ATS and our Island ATS reached the trading volume thresholds
in four of the prior six calendar months in exchange-traded funds reflecting the
Dow Jones Industrial Average Index (known as Diamonds), the Standard & Poor's
500 Index (or SPYs) and the Nasdaq-100 Index (known as QQQs). The NASD provides
its ATS members the ability to meet their Regulation ATS quote display and order
access requirements for U.S. exchange-listed stocks through its Nasdaq
Intermarket system, also commonly referred to as CAES/ITS. On November 4, 2002,
Instinet began providing its quotation data for SPYs and QQQs through CAES/ITS
and on December 2, 2002, began providing its quotation data for Diamonds through
CAES/ITS. Instead of providing its quotation data for U.S. exchange-listed
stocks to an SRO, however, Island discontinued the display of order information
for these stocks, although it still permits subscribers to trade these stocks on
a non-displayed basis, in accordance with Regulation ATS.

Under current SRO regulations, ATSs that provide quotation data for U.S.
exchange-listed stocks to an SRO, including our Instinet ATS, are subject to the
rules of the ITS Plan. The ITS Plan imposes limitations and provides remedies
with respect to transactions by members of ITS participant markets that involve
a "trade-through" of bids and offers. A trade-through occurs when a market
participant trades at a price that is inferior to a price displayed in another
participating market. The ITS Plan also imposes certain requirements when market
participants "lock" the market -- display bids and offers at prices that equal
offers and bids from other market participants -- or "cross" the
market -- display bids that exceed offers or display offers that are less than
bids of another market participant -- for a particular security. Quotations in
U.S. exchange-listed stocks displayed on our Instinet ATS and Island ATS
frequently "lock" or "cross" other markets.

On September 23, 2002, an SEC order became effective that granted a
temporary de minimis exemption from the ITS trade-through rule for the trading
of SPYs, QQQs and Diamonds. This temporary de minimis exemption, which ends on
June 4, 2003, enables ATSs and other market participants to effect
trade-throughs up to three cents away from the current best bid and offer in
these three stocks. This temporary de minimis exemption has facilitated the
ability of our Instinet ATS to continue to display quotations in and maintain
its market share and liquidity pool in SPYs, QQQs, and Diamonds. Without the de
minimis exception, our Instinet ATS would be required either to discontinue the
display of order information in SPYs, QQQs, and Diamonds or to continue its
participation in CAES/ITS or another SRO's, market with restrictions on its
ability to execute trades that would result in trade-through and to display
aggressively priced orders. Either alternative could have a significant adverse
effect on Instinet's ability to attract orders to its liquidity pool and
maintain and grow its market share and liquidity pool in the affected stocks.

Because of its concerns regarding the ITS Plan restrictions,
notwithstanding the temporary de minimis exemption from the trade-through rules,
effective September 23, 2002, Island discontinued the display of order
information for QQQs, Diamonds and SPYs, although it still permits subscribers
to trade those stocks on a non-displayed basis. This has resulted in a decline
in Island's market share in these stocks, which may have a negative impact on
our financial results or our business. Island is currently exploring
alternatives to enable it to provide quotation data for U.S. exchange-listed
stocks in compliance with the requirements of Regulation ATS, including limited
participation in CAES/ITS or another SRO's market.

We have been engaged in discussions with the SEC regarding issues relating
to the ITS Plan rules and their application to our two ATSs, but we are unable
to predict the outcome of these discussions.

SuperMontage

On January 10, 2001, the SEC approved the NASD's rule changes creating
SuperMontage, a new trading platform for the Nasdaq market. Nasdaq completed its
implementation of SuperMontage on December 2, 2002. Any ECN or market maker
using Nasdaq facilities to display quotations in Nasdaq-quoted stocks or to
access quotations on Nasdaq is now required to use SuperMontage. SuperMontage
significantly altered the way the Nasdaq market operates. SuperMontage combines
a computer display containing more bid and offer information about trading
interest in individual Nasdaq-quoted stocks than was previously displayed and
new rules establishing the execution priority of quotes and orders submitted to
Nasdaq. Unlike its predecessor, SuperSoes, SuperMontage also includes
functionality that facilitates participation by ECNs on the platform.

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Neither of our two ATSs currently displays its quotations in Nasdaq-quoted
stocks on SuperMontage. The Instinet ATS does provide its subscribers with the
ability to route orders for execution on SuperMontage. Our Instinet ATS
currently displays its quotations on the NASD's Alternative Display Facility,
while our Island ATS displays its quotations on the Cincinnati Stock Exchange.
If either of our ATSs were to display quotations on SuperMontage, the system's
execution priority rules contain provisions that could disadvantage us by
comparison to market makers and any ATS that does not charge fees to
broker-dealers for accessing orders in its trading system through Nasdaq.

In addition, on January 31, 2003, the SEC approved a 90-day pilot program
to enable broker-dealers not registered as market makers to enter non-marketable
limit orders directly on SuperMontage for execution. This pilot program allows
Nasdaq for the first time to compete with the Instinet and Island ATSs and other
market centers in attracting orders that provide liquidity from non-market maker
broker-dealers.

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 is continuing to
evolve as a direct competitor of ATSs. If Nasdaq is approved as an exchange, we
are unable to predict what changes to its operations it might propose or
eventually implement. We are also unable to predict what impact Nasdaq's
registration as an exchange may have on our business.

Alternative Display Facility and Securities Information Processor

Even if Nasdaq gains status as a securities exchange, the NASD will
continue to have an obligation to collect quotations and trade reports from NASD
member firms seeking to trade U.S. exchange-listed stocks -- which would then
include Nasdaq-listed stocks -- other than on an exchange. This was a factor in
the SEC's decision to condition its approval of SuperMontage on the NASD
establishing an alternative facility to SuperMontage that market makers and ECNs
could use to meet their quotation display, order access and trade reporting
obligations. On July 27, 2002, the SEC approved the NASD's proposal for the ADF
as a nine-month pilot program restricted to Nasdaq-quoted stocks. The ADF pilot
displays quotes and collects trade reports, but keeps the NASD's obligations to
operate a market to a minimum. The ADF pilot does not provide for order
execution or routing services. As a result, ADF market participants themselves
are required to provide NASD member broker-dealers with electronic access to
their quotations. The NASD's pending proposal for ADF trading of U.S.
exchange-listed stocks would provide ADF participants the choice of meeting
their order access obligations through ITS or by providing other market
participants with electronic access to their quotes themselves. On October 14,
2002, Instinet began utilizing the ADF pilot to meet its quotation display and
order access requirements under SEC rules, and since December 2, 2002, when
SuperMontage became fully implemented, has met these requirements for all
Nasdaq-quoted stocks through the ADF pilot. In February 2003, Instinet also
began to use the ADF pilot to meet its trade reporting obligations. We continue
to review and consider the implications of our participation in the ADF for our
business. Island currently uses the Cincinnati Stock Exchange, not the ADF, to
meet its quotation display, order access and trade reporting obligations in
Nasdaq-quoted stocks.

Another pending change to the Nasdaq market structure, in recognition of
Nasdaq's growing role as a competitor, is the anticipated replacement in 2004 of
Nasdaq as the exclusive SIP. This role has given Nasdaq financial and other
competitive advantages. The replacement is also expected to be an exclusive SIP
but may not compete directly with us.

Market Data Revenues

In the past, the Island ATS has earned market data revenues by
participating in market data revenue-sharing programs and other revenue-sharing
programs provided by Nasdaq and the CSE. Market data revenues consist of a
portion of the fees that the SROs and Nasdaq receive for selling quotation and
transaction data to independent market data providers and market participants
such as broker-dealers. On

29

July 2, 2002, the SEC announced that it had abrogated proposals that were
submitted by several markets, including Nasdaq and the CSE, to continue certain
of their market data revenue-sharing programs. As a result, the Nasdaq and the
CSE revenue-sharing programs from which Island has earned most of its market
data revenues were suspended, and Island suspended its market data
revenue-sharing program. The Nasdaq market data revenue-sharing program for U.S.
exchange-listed stocks, which had represented a substantial portion of Island's
market data revenues, was subsequently reinstated. The CSE has submitted a
proposal to share a reduced proportion of the market data revenues it receives
(50% instead of 75%) in Nasdaq-quoted stocks. The SEC, however, has not taken
any action on this or any other market data revenue-sharing programs for
Nasdaq-quoted stocks, and we cannot assure you that the SEC will approve any of
them. In addition, we cannot assure you that the market data revenue-sharing
programs for U.S. exchange-listed stocks will continue or remain in their
current form.

NASD Fees

The NASD has also partially implemented proposed changes in its fee
structure, including the introduction of a fee based on all NASD members'
transactions in U.S. exchange-listed and Nasdaq-quoted stocks regardless of
where those transactions occur. The NASD's new trading activity fee requires
NASD member clearing firms to report and remit payment to the NASD on a monthly
basis based on the trading activity cleared and settled by the firm on behalf of
itself and other NASD members. We are unable to predict what impact these fee
changes and required reporting will have on our business, financial condition or
operating results. However, the NASD has established an exemption from the
trading activity fee for NASD members that act as agent on behalf of another
NASD member. As a result of the exemption, both of our ATSs have experienced a
reduction in their transaction- based NASD regulatory fees. Because the NASD's
proposed fee structure is still subject to review by the SEC, we are unable to
predict what impact the final provisions of the fee structure will have.

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 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. We believe that
decimalization has led to traditional broker-dealers executing a higher
percentage of their customers' orders internally (a practice known as
internalization) instead of routing 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. Increased
internalization by traditional broker-dealers has also reduced, and could
continue to reduce, our order flow.

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 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 SEC interpretation may create greater competition for our
soft dollar business.
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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.

Nasdaq Market Data-Related Rule Changes

Instead of using consolidated market data for Nasdaq-quoted stocks for
closing price calculations and meeting certain market data-related regulatory
requirements, Nasdaq has undertaken to obtain, and in some cases already
obtained, SEC approval to establish Nasdaq-specific market data for these
purposes. For example, Nasdaq has sought to obtain SEC approval of a rule change
seeking to establish a Nasdaq official closing price and is actively marketing
its use instead of the consolidated closing price for market participants'
closing price-related activities. In addition, Nasdaq has received approval to
require market participants using Nasdaq facilities to execute or report trades
to use the Nasdaq best bid instead of the consolidated best bid in meeting their
short sale regulatory requirements.

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 or clear
trades for other broker-dealers 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 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 continues
to review 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
31

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:

- data dissemination requirements;

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

- rules affecting market interaction and sharing of regulatory costs in the
trading of Nasdaq-quoted securities.

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 structure
may have a significant impact on our equities business. In this regard, we may
consider it desirable to modify the regulatory position for either or both of
our two ECNs 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
registered national securities exchange, the display of some or all of our
orders in Nasdaq-quoted stocks on another exchange, the reporting of additional
trades to the ADF or to another exchange, or efforts to register as an exchange
to conduct some or all of our business.

Our business, especially our communications with and connectivity to
customers, increasingly relies on the Internet and other electronic
communications gateways. We are in the process of expanding use of these
gateways. Although to date the use of the Internet has been relatively free from
regulatory restraints, the SEC, certain SROs 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 could 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
32

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 (EU) is
regulated by a number of agencies in each member state. European Union
legislation, however, allows investment firms like us to obtain single
authorization, or "passport", which is generally valid throughout the European
Union and which in particular allows for remote membership of regulated markets
or exchanges. Because our largest international operations are in the United
Kingdom, our principal European regulator is the Financial Services Authority
and we currently "passport" out of the UK into most EU member states.

European legislation governing investment services (Investment Services
Directive) is currently being amended and the European Commission has proposed
new rules for investment firms operating ATSs. These new rules are likely to be
based on the ATS standards already agreed upon and published by the Committee of
European Securities Regulators (CESR) in July 2002. The seven main CESR
standards require investment firms to notify regulators that they are operating
an ATS; to ensure that users are treated fairly; to provide price transparency;
to monitor user compliance with the rules of the system; to assist regulators in
preventing market manipulation; to have adequate systems capacity; and to
explain their arrangements for clearing and settlement. The Investment Services
Directive is expected to be adopted in 2004 and to take effect in either 2005 or
2006. However, it is anticipated that the UK FSA will implement the CESR
standards prior to the implementation of the Investment Services Directive,
probably in 2004. We are unable at this time to predict how these proposed
changes will affect our business.

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 could result in censure, fine, the prevention of activities or
our suspension or expulsion from their country or exchange 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
continuing weak and uncertain economic climate, increased unemployment rates,
reduced capital raising activities, decreased market capitalization, ongoing
geopolitical and global conflicts and the current corporate governance and
accounting issues have led to decreasing trading volumes and intensified price
competition and generally a more difficult business
33

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 trade execution, brokerage, 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 is fixed. The continuing decline in trading
volumes 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 declines better than we could.

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.

Consolidation and alliances within the industry have resulted, and may
continue to result, in increasingly intense competition. 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.

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, operates the ADF, and regulates and
polices the Nasdaq market. The NASD, either directly or through its
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.

Nasdaq has applied to register as a national securities exchange, and
another of our competitors has been approved to serve as a facility of an
existing exchange. Competitors that receive status as a national securities
exchange or operate as a facility of an exchange will be able to gain certain
benefits from their exclusive participation in the various NMS systems. These
benefits may give these competitors an advantage over us in attracting business
in, and generating revenues from, their activity in U.S. exchange-listed and
Nasdaq-quoted stocks. In addition, by operating as an exchange independent from
the NASD with SuperMontage as its trading platform, Nasdaq is continuing to
evolve as a direct competitor of ATSs, including Instinet and Island, which
could negatively impact our business, financial condition and operating results.

We have experienced intense price competition in our equity securities
business in recent years. 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, we
have aggressively reduced pricing for our U.S. broker-dealer customers and
introduced reduced fees for taking liquidity and rebates for providing
liquidity. These pricing changes have caused the transaction fee revenue we
receive from this customer group to decline significantly and could cause the
transaction fee revenue Instinet receives from this customer group to continue
to decline, even if their volumes increase. As a result of our reduced pricing
for our U.S. broker-dealer customers, we have experienced a decline in revenue
and volatility in our market share. As a result of these pricing changes, we
have taken, and will continue to take, actions to reduce costs,
34

which may include reducing our staff levels, consolidating our facilities, and
reducing operational and transaction-related expenses, among other alternatives.
In part, as a result of these pricing changes, we reported a net loss of $735.2
million, or $2.71 per share, for 2002. We expect intense competition to
continue, and if it does so or intensifies, we could lose further market share
and revenue.

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

General

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 ATS and an 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, or causing us to modify our business model in ways that may
adversely affect our revenues.

ATS Status and Exchange Registration

As a result of our compliance with the requirements of Regulation ATS,
neither of our two ATSs currently is required to register as a national
securities exchange. It is possible that in the future the SEC could make a
determination that exchange registration is necessary. Our Island ATS filed an
application in draft form for registration as a national securities exchange
with the SEC. If the SEC were to require either or both of our two ATSs to
register as a national securities exchange, or if any of our subsidiaries were
to voluntarily register as a national securities exchange, we could become
subject to substantial additional regulation, which might reduce our operational
flexibility in ways that could have a material adverse effect on our business.
Among other consequences, we might also be required to comply with fair
representation or ownership requirements. These requirements could adversely
affect our operations and could also result in material limitations or
restrictions on Reuters equity interest in us or Reuters ability to exercise its
voting and other governance rights in the manner contemplated by our amended and
restated corporate agreement with Reuters. In addition, we cannot assure you
that Reuters would not withhold its consent to the voluntary registration of our
ATSs or any of our subsidiaries as a national securities exchange, even if our
management determines that exchange registration would be beneficial to us or
one of our subsidiaries.

Quote Display and Order Execution Access in Exchange-Listed Stocks; Intermarket
Trading System

The requirements of Regulation ATS requiring ATSs to display quotation data
and provide order execution access for securities for which certain trading
volume thresholds have been met, as well as the rules of the ITS Plan for ATSs
that provide quotation data for U.S. exchange-listed stocks to an SRO, could
have a significant adverse effect on our business, financial condition and
operating results, including the following:

- Our Instinet ATS's provision of quotes in SPYs, QQQs and Diamonds through
CAES/ITS could have a significant negative impact on our trading volumes
in those stocks.

- We cannot assure you that the SEC will extend the temporary de minimis
exemption from the trade-through rules of the ITS Plan beyond June 4,
2003 or extend it to any other U.S. exchange-listed stocks in which we
may cross the Regulation ATS trading volume thresholds. Without the de
minimis exception, our Instinet ATS would be required either to
discontinue the display of order information in SPYs, QQQs, and Diamonds
or to continue its participation in CAES/ITS or another SRO's market with
restrictions on its ability to execute trades that would result in
trade-through and to display aggressively priced orders. Either
alternative could have a significant adverse effect on the ability of our
Instinet ATS to attract orders to its liquidity pool and maintain and
grow its market share and liquidity pool in the affected stocks.

- Our Island ATS's discontinuation of the display of order information in
SPYs, QQQs and Diamonds has resulted in a decline in Island's market
share in these stocks. Island is currently exploring

35

alternatives to enable it to provide quotation data for U.S.
exchange-listed stocks in compliance with the requirements of Regulation
ATS, including limited participation in CAES/ITS or another SRO's market.
However, we cannot assure you that it will find a viable mechanism to
participate in an SRO market in these stocks or that it will do so in a
manner that will avoid an adverse effect on our business, financial
condition and operating results.

- We cannot assure you that either of our two ATSs will not reach the ATS
trading volume thresholds in other U.S. exchange-listed stocks, requiring
us either to provide quotes and comply with ITS Plan rules or discontinue
the display of order information.

We have been engaged in discussions with the SEC regarding issues relating
to the ITS Plan rules and their application to our two ATSs but have been unable
to reach a satisfactory resolution of the relevant commercial and regulatory
issues. We intend to continue to work on solutions to these issues and to
discuss them with the SEC; however, we are unable to predict the outcome of
these discussions.

STRUCTURAL DEVELOPMENTS IN THE MARKETS IN WHICH WE OPERATE MAY PLACE US AT A
COMPETITIVE DISADVANTAGE

The structure of the Nasdaq stock market is currently undergoing a
fundamental change, which may place us at a competitive disadvantage, adversely
affecting our business, financial condition and operating results.

Nasdaq has moved from a quote-driven display system to an order-driven
execution system that directly competes with ECNs and ATSs. SuperMontage,
Nasdaq's new trading platform which Nasdaq completed implementing on December 2,
2002, incorporates enhanced functionality, including the display of more
quotation information than was previously displayed. We are unable to predict
how successful SuperMontage will be as a direct competitor to our ATSs, but it
could cause us to receive fewer orders and execute fewer orders in our liquidity
pools for Nasdaq-quoted stocks, leading to a reduction in our liquidity pools.
In addition, Nasdaq's current pilot program to enable broker-dealers not
registered as market makers to enter non-marketable limit orders directly on
SuperMontage for execution allows Nasdaq for the first time to compete with the
Instinet and Island ATSs and other market centers in attracting orders that
provide liquidity from non-market maker broker-dealers. We are unable to predict
the extent to which Nasdaq will be successful in attracting liquidity-providing
orders from these broker-dealers, but to the extent it is, this pilot program
may result in our receiving fewer orders that provide liquidity in Nasdaq-quoted
stocks and therefore executing fewer orders in our liquidity pools in these
stocks.

Since the full implementation of SuperMontage on December 2, 2002, our
Instinet ATS has met its quotation display and order access requirements for all
Nasdaq-quoted stocks through the NASD's ADF. In February 2003, Instinet also
began to use the ADF to meet its trade reporting obligations. The ADF has only
been approved as a pilot program for nine months and the approval is limited to
Nasdaq-quoted stocks only. As the ADF is a relatively new system, we cannot
assure you that the ADF will continue to provide a fully operational alternative
to SuperMontage or that the ADF will prove to be a commercially viable facility.
We also cannot assure you that its functionality will prove acceptable to our
customers. In addition, the rules, fees and functionality of the ADF could place
us at a commercial disadvantage to our competitors. For example, the ADF does
not provide for order execution or routing services. As a result, ADF market
participants themselves are required to provide NASD member broker-dealers with
electronic access, either directly or indirectly, to their quotations, which
could create additional costs for those participants, including our Instinet
ATS. The current ADF fee structure also contains certain features that could
cause fees to fall disproportionately on ECNs that do not meet certain trade
reporting thresholds, further increasing costs for some participants (including
our Instinet ATS). We are unable to predict accurately at this time the impact
the ADF or our Instinet ATS's participation in it will have on our business. The
ADF's rules, fees and functionality remain subject to change and further
approval by the SEC, and we cannot predict the final features of the ADF.

We cannot assure you that the decision of our Instinet ATS to use
SuperMontage only for order routing, and the decision of our Island ATS not to
use SuperMontage at all, will not have a significant negative impact
36

on the order flow of our two ATSs or their other business related to
Nasdaq-quoted stocks. In addition, if at any time our Instinet ATS were to be
unable to use the ADF or our Island ATS were unable to use the Cincinnati Stock
Exchange to meet their regulatory requirements, we would be required to consider
possible alternatives, including participation in SuperMontage. We cannot assure
you that any of these alternatives would not have a significant material adverse
effect on our business. In particular, if either of our ATSs were to display
quotations on SuperMontage, the system's execution priority rules contain
provisions that could disadvantage us by comparison to market makers and any ECN
that does not charge fees to broker-dealers for accessing orders in its trading
system through Nasdaq.

OUR BUSINESS MAY BE AFFECTED BY SEC ACTIONS RELATING TO ECNS

General

The SEC regularly considers a variety of regulations or interpretative
initiatives with respect to the structure of the equity securities markets,
including initiatives intended to reduce fragmentation, integrate ECNs and ATSs
into the NMS and create a national consolidated limit order book. Future SEC
rulemakings or interpretations in this area could adversely affect our business,
financial condition and operating results.

Access Fees

The SEC is currently considering, and we are periodically in discussions
with it regarding, other important issues, such as the fees (including
subscriber and non-subscriber access fees) ECNs charge, the levels of those
fees, the circumstances in which access fees may be charged and the criteria for
customers' access to an ECN's system and the requirements of Regulation ATS. For
example, the SEC has, at times, approved rules or issued interpretations that
directly govern how we determine prices for different types of customers and
services. We are currently in a dispute with certain of our customers regarding
the application of these rules or interpretations to our past pricing policies.
We are unable to predict the outcome of this dispute. See also "Legal
Proceedings." Future SEC rules or interpretations regarding any of these issues
could have a significant and material adverse impact on our equity securities
business. We are currently discussing the application of those rules and
interpretations with the SEC, and we are unable to predict the outcome of these
discussions. We also continue to evaluate our services and the fees we charge
for them. The Instinet ATS implemented a new pricing policy that took effect on
August 1, 2002, and the Island ATS implemented a new pricing policy that took
effect on September 5, 2002. A further change in pricing became effective on
October 21, 2002.

The Island ECN has received a subpoena from the SEC for information
regarding Island's access policies, including pricing, in connection with an
investigation by the SEC of possible non-compliance with certain provisions of
Regulation ATS by certain ECNs. The Island ECN has submitted its complete
response to the subpoena. We currently do not know the intended scope or primary
objectives of this investigation and cannot predict its outcome, but it could
have a significant adverse effect on our equity securities business.

Market Data Revenue

In July 2002, the SEC abrogated certain market data revenue sharing
programs. Market data revenues represented approximately 5% and 14% of Island's
total revenues for 2001 and the first three months of 2002, respectively. For
the first three months of 2002, these revenues were offset in part by market
data rebates that Island paid to some of its customers. Since then, the SEC has
not taken any action on SRO proposals to reinstate market data revenue sharing
programs in Nasdaq-quoted stocks. In addition, we cannot assure you that the
market data revenue sharing programs for U.S. exchange-listed stocks will
continue or remain in their current form. As a result, we cannot assure you that
our Island ATS will continue to earn market data revenues or, if it does, what
the level of those revenues will be in the future. If our Island ATS is unable
to resume earning market data revenue for Nasdaq-quoted stocks or continue
earning market data revenue for U.S. exchange-listed stocks, this could
adversely affect our business, financial condition and operating results. We
also cannot predict the impact of the suspension of Island market data revenue
rebates sharing on our business, financial condition and operating results.

37

In addition, the Island ECN received a subpoena from the SEC for
information regarding trading and market rebate practices with respect to some
of Island's market data revenue rebate programs, in connection with an
investigation by the SEC of customer trading practices in some exchange-traded
funds. The Island ECN has submitted its complete response to the subpoena. We
currently do not know the intended scope or primary objectives of this
investigation and cannot predict its outcome, but it could have a significant
adverse effect on our equity securities business.

REGULATORY CHANGES COULD ADVERSELY AFFECT OUR BUSINESS

The securities industry generally has been and is subject to continuous
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
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:

- 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 NASD has also partially implemented proposed changes in its fee
structure, including the introduction of a new trading activity fee and
related reporting requirements for transactions in U.S. exchange-listed
and Nasdaq-quoted stocks regardless of where those transactions occur. We
are unable to predict what impact these fee changes and required
reporting will have on our business, financial condition or operating
results. Although an exemption from the trading activity fee was
established for NASD members that act as agent on behalf of another NASD
member, which has reduced the fees of our two ATSs, we can not assure you
that this exemption will continue to be available. Because the NASD's
proposed fee structure is still subject to review by the SEC, we are
unable to predict what impact the final provisions of the fee structure
will have.

- The SEC's Division of Market Regulation has issued a series of
"no-action" letters to our Instinet ATS and our Island ATS over a number
of years verifying and extending the status our two ATSs as ECNs. The
most recent "no-action" letters for each of our two ATSs are valid until
July 6, 2003. The Division's "no-action" positions are subject to our
continuing to satisfy certain conditions, including those regarding our
systems capacity, fair access for participants and a limitation on our
maximum access fees. See "Risks Related to Our Business -- Insufficient
Systems Capacity or Systems Failures Could Harm Our Business." Our recent
acquisition of The Island ECN may also affect the Division's view of both
businesses. We are in discussions with the Division from time to time
regarding these issues, and we cannot assure you that the Division will
continue to extend its "no-action" positions. An adverse change in any of
the Division's positions could interfere with the ability of the Instinet
ATS and the Island ATS to act as an ECN or participate in the ADF,
CAES/ITS, CSE, or other markets and thereby have a material adverse
effect on our business, financial condition and operating results.

Nasdaq has sought to obtain, and in some cases already obtained, SEC
approval of several rule changes that would have the result of establishing
Nasdaq-specific market data for use in closing price calculations and for
meeting certain regulatory requirements in Nasdaq-quoted stocks. We are unable
to predict the impact of the approval and implementation of these proposals,
including whether they will result in market participants directing a greater
percentage of order flow to Nasdaq as opposed to either of our two ATSs.

38

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 our business, financial condition and operating results.

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.

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
business, 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

39

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

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 has occurred in the past), 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.

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. 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.

WE MAY HAVE DIFFICULTY MANAGING OUR ACQUISITION OF ISLAND AND OUR OTHER
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.
We cannot assure you that we will realize, when anticipated or at all, the
benefits we expect as a result of our acquisitions, including our acquisition of
Island. Achieving the benefits of our acquisitions will depend on many factors,
including the successful and timely integration and, in some cases, the
consolidation of products, technology, operations and administrative functions,
of two companies that have previously operated separately. Considering the
highly technical and complex nature of our and Island's products, these
integration efforts may be difficult and time consuming. In addition, we may
choose not to integrate some portions of Instinet's and Island's business, which
may result in lower cost savings.

- Acquisitions entail numerous other risks, including the following:

- difficulties in the assimilation of acquired operations and products;

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

- failure of our combined management to oversee and manage newly acquired
companies effectively;

- assumption of unknown material liabilities;

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

- failure to achieve financial or operating objectives;

- failure to implement adequate compliance and risk management methods for
new operations;

- 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.

40

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 1,264 shares
per transaction in 1998 to 658 shares per transaction in 2002 (including Island
shares per transaction subsequent to September 20, 2002). 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. There can
be no assurance that this trend will not continue.

COSTS RELATED TO OUR INVESTMENTS IN TECHNOLOGY MAY CONTINUE TO ADVERSELY AFFECT
OUR PROFITABILITY AND NET INCOME

We have incurred significant costs associated with our efforts to
strengthen, expand and diversify our business and enhance our technology since
1998. Any technological innovations may require significant expenditures over
long periods of time, so that our operating margins and profitability could 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, 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. We also cannot assure
you that our recent management changes and headcount reductions will not 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.

INSUFFICIENT SYSTEMS CAPACITY OR SYSTEMS FAILURES COULD HARM OUR BUSINESS

We are heavily dependent on the capacity and reliability of the our
proprietary software, 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. We also cannot assure you that our recent
headcount reductions as part of our cost-cutting initiatives will not impact our
ability to respond to system problems. Each of Instinet's and Island's status as
a SEC-recognized ATS 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.

41

To accommodate potential increases in order message volume and trading
volume, including as a result of our acquisition of Island, the trading
practices of new and existing clients, the development of new and enhanced
trading system functionalities, sub-penny pricing, and regulatory changes, 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 and order messages will be accurate or that our systems will always be
able to accommodate actual trading volumes and order messages without failure or
degradation of performance. System failure or degradation could result in
regulatory inquiries or proceedings, and could also lead our customers to file
formal complaints with industry regulatory organizations, 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 in the past raised
issues regarding the adequacy of our capacity, our testing of capacity limits
and our plans for increasing capacity. The inability of our systems to
accommodate an increasing volume of transactions and order messages could also
constrain our ability to expand our businesses.

From time to time, we experience periods of extremely high trading volume
in the equity securities markets. On a few occasions during these periods, the
volume order messages and trading activity has caused a slowing of our order
execution, 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 execute orders, and 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 been addressing each of these areas and upgrading our systems as
necessary, but we cannot assure you that a similar slowing of our order message
and trade allocation systems will not occur again in the future. We use new
technologies to upgrade our established systems, and the development of these
new technologies entails technical, financial and business risks. We cannot
assure you that we will successfully implement new technologies or adapt our
existing technology and transaction processing systems to customer requirements
or emerging industry standards. Our core data centers support our trading and
execution systems, clearing and settlement operations and customer interfaces.
If one of our 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.

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 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.

42

WE MAY HAVE DIFFICULTY MANAGING OUR JOINT VENTURES AND ALLIANCES SUCCESSFULLY

From time to time we consider 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.

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
correspondent clearing operations and the activities of our ProTrader and Island
subsidiaries, 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. In
addition, although we maintain insurance policies consistent with those
maintained by others in the securities industry, we cannot assure you that our
insurance policies will provide adequate coverage.

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.

43

Based on management's experience and current industry trends, we anticipate
that our available cash resources 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.

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
44

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 have moved a portion
of our business from our proprietary networks to non-proprietary networks and
the Internet. 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 risk 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.

RISKS RELATING TO OUR RELATIONSHIP WITH RELATED PARTIES

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 62.6% of our common stock. Under
our amended and restated certificate of incorporation, for as long as it
continues to beneficially own more than 50% of our common stock, Reuters will
control many matters that require a stockholder vote. These matters include the
election of directors and the removal of directors without cause, 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, five of
45

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.

Our amended and restated certificate of incorporation and our amended and
restated 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.

We have agreed not to take any action voluntarily that would reduce Reuters
ownership of our then-outstanding voting stock to less than 51% of our capital
stock or then-outstanding voting stock without Reuters consent. 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.

CERTAIN OTHER OF OUR STOCKHOLDERS HAVE SIGNIFICANT CONTRACTUAL RIGHTS AND MAY
EXERCISE THOSE RIGHTS IN A MANNER THAT MAY NOT BENEFIT OUR PUBLIC STOCKHOLDERS

Some former Island stockholders associated with TA Associates, Bain Capital
and Silver Lake Partners will have the right to nominate a total of three
members to our board of directors as long as they each own 8,000,000 shares of
our common stock that they received as consideration in our acquisition of
Island. If the size of our board of directors is increased beyond its current
size, then in most instances these stockholders would have the right to appoint
additional directors. The right of these stockholders to nominate directors is
based on the number of shares of our common stock issued to them as a result of
the acquisition that they continue to own in the future and not the percentage
of our outstanding common stock represented by those shares. If we issue a
significant number of additional shares in the future, then these Island
stockholders may retain the right to nominate directors to our board in a manner
disproportionate to their overall ownership of our outstanding common stock.

REUTERS AND CERTAIN OTHER STOCKHOLDERS 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 or some former Island
stockholders 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 or those stockholders of control over our
management and affairs.

46

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

Reuters and the Island stockholders are not prohibited from engaging in our
lines of business, including brokerage 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.

SOME OF OUR AGREEMENTS WITH REUTERS MAY NOT BE 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 arm's-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.

RISKS ASSOCIATED WITH PURCHASING OUR COMMON STOCK

CERTAIN PROVISIONS OF OUR CERTIFICATE OF INCORPORATION, BYLAWS 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 amended and restated certificate of incorporation and amended and
restated bylaws 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
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, 2002, there were 330,714,705 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. We have also granted Reuters
(and its transferees) rights

47

to demand registration of their shares and to include their shares in future
registration statements. 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 connection with our acquisition of ProTrader Group, L.P. in October of
2001, we issued 5,017,058 common shares to former ProTrader stockholders. All of
these shares may now be sold without restriction.

On September 23, 2002, we filed a registration statement on Form S-8 under
the Securities Act with respect to up to 1,553,151 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 increase
the size of its option plan and include additional shares in the Form S-8 under
the Securities Act. We may file a registration statement permitting resale of
these shares by affiliates.

In connection with our acquisition of Island, we issued 80,658,829 common
shares to former Island stockholders along with warrants and options to purchase
an additional 5,793,455 of our common shares. Many of these shares may now be
sold without restriction. In addition, we have agreed to provide some Island
securityholders with registration rights that would facilitate their future
sales of our common shares received as a result of the acquisition of Island.

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.

Sales of substantial amounts of our common shares in the public market
could adversely affect the market price of those shares. A decline in the market
price of our common shares could adversely affect its access to the equity
capital markets. In addition, any issuance of shares by us could dilute our
earnings per share.

WEBSITE ACCESS

We make our annual report on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K, and all amendments to those reports available, free
of charge, on the "Investor Relations" section of our Internet website at
http://www.Instinet.com as soon as reasonably practicable after we
electronically file this material with, or furnish this material to, the
Securities and Exchange Commission.

ITEM 2. PROPERTIES

We lease all of our office space, most of which is located in New York City
and Jersey City, New Jersey. Our principal offices are 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." We also lease office space at
Harborside Plaza 10, Jersey City, New Jersey, where our clearing, technology
operations, disaster recovery and certain support functions, including finance,
business services, human resources, are currently located. We may relocate
additional employees to our New Jersey offices in 2003. 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 are involved in various legal proceedings (including
those described below) arising in the ordinary course of business. We are also
subject to periodic regulatory audits and inspections. While any litigation
contains an element of uncertainty, it is the opinion of management after
consultation with counsel, that the outcomes of such proceedings or claims are
unlikely to have a material adverse effect on the business, financial condition
or operating results of the company.
48

THE ISLAND ECN, INC. V. ARCHIPELAGO L.L.C.; B-TRADE SERVICES LLC; REDIBOOK ECN
L.L.C.

On September 20, 2002, Island commenced an arbitration proceeding against
respondents Archipelago L.L.C. ("Archipelago"); B-Trade Services LLC
("B-Trade"); and REDIBook ECN L.L.C. ("REDIBook") before the NASD. Island
alleges that each respondent entered into a subscriber agreement with Island
which prescribed certain fees and, despite Island's demand that each respondent
abide by the terms of its contract, each respondent has refused to pay such
fees. Island asserts breach of contract, quantum meruit, unjust enrichment and
account stated causes of action against respondents and seeks total damages in
the amount of at least approximately $11,100,000 of which approximately
$1,900,000 is due from B-Trade, $5,100,000 from Archipelago and $4,000,000 from
REDIBook. Archipelago and REDIBook have served an answer and counterclaims upon
Island in which they deny the substantive allegations of Island's statement of
claim, assert certain affirmative defenses and allege counterclaims against
Island alleging that Island engaged in unfair, discriminatory pricing practices
against these respondents and asserting claims involving breach of contract,
breach of obligation of good faith, and attempted monopolization and conspiracy
to restrain trade under the Sherman Act. These counterclaims allege damages of
no less than $30 million before trebling, for a total of no less than $90
million treble damages pursuant to the federal antitrust laws. Archipelago is
also seeking attorney's fees. Respondent B-Trade separately also answered
Island's statement of claim by denying each of Island's substantive allegations,
asserting affirmative defenses, and alleging a breach of contract counterclaim
against Island. B-Trade's counterclaim seeks at least $2.75 million in damages.
Island intends to pursue vigorously its claims and oppose respondents'
counterclaims.

ARCHIPELAGO SECURITIES, L.L.C. V. INSTINET GROUP INCORPORATED

On February 19, 2003, Archipelago Securities, L.L.C. commenced a separate
action against Instinet before the NASD, in which it alleged that Instinet also
engaged in unfair, discriminatory pricing practices against it and asserted
claims involving a breach of contract, a breach of obligation of good faith, and
attempted monopolization and conspiracy to restrain trade under the Sherman Act.
Archipelago in its claim seeks no less than $41 million before trebling for a
total of no less than $123 million trebled damages. Instinet intends to defend
vigorously this proceeding by opposing Archipelago's claims and asserting
certain affirmative defenses and its own counterclaims against Archipelago
Securities L.L.C.

NEXTRADE HOLDINGS, INC. V. PROTRADER GROUP, LP, PROTRADER SECURITIES CORP.,
PROTRADER TECHNOLOGIES LP, PROTRADER TRADING LLC, AND PROTRADER.COM LP

On February 4, 2003, NexTrade Holdings, Inc. commenced an action against
certain ProTrader subsidiaries in the United States District Court, Middle
District of Florida, Tampa Division. The complaint alleges that these
subsidiaries adopted and used the mark "ProTrader" to identify themselves and
their goods and services in the securities industry and, in so doing, these
subsidiaries have infringed plaintiff's exclusive rights in its federally
registered trademark "Pro-Trade(R)" in violation of sec.32(1) of the Lanham Act.
The complaint further alleges that these subsidiaries' use of the ProTrader mark
is likely to cause confusion, mistake or deception among purchasers of software,
services and goods bearing the name "ProTrader," which allegedly constitutes
false designation of origin and unfair competition in violation of sec.43(a) of
the Lanham Act. The complaint also alleges that these subsidiaries' use
constitutes trademark infringement in violation of Florida state statutes and
its common law, and unfair competition based on trademark infringement in
violation of the common law of Florida. Finally, the complaint alleges fraud in
the inducement based on defendants' alleged deceitful negotiations to resolve
the dispute. Plaintiff seeks to recover all of these subsidiaries' profits,
gains and advantages resulting from the unauthorized use of the "ProTrader"
mark, damages sustained by the plaintiff of no less than $15 million before
trebling and that such damages be trebled, and exemplary and punitive damages of
not less than $90 million. Defendants intend to vigorously contest plaintiff's
claims.

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, 2002.
49

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:

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

* adjusted for cash dividend

On March 20, 2003, the last reported sales price for our common stock on
the Nasdaq National Market was $3.54. As of March 20, 2003, there were
approximately 8,500 holders of record of our common stock.

The equity compensation plan information required to be furnished pursuant
to this item is incorporated by reference from the Equity Compensation Plan
Information section of the Proxy Statement.

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. As a result of our
reorganization, all of our international operations are now conducted by our own
subsidiaries. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Our Reorganization and Initial Public Offering."

In connection with our acquisition of Island, we paid a $1.00 per common
share cash dividend to our stockholders of record as of September 19, 2002,
which represented a distribution of $248.7 million, of which $206.9 million was
paid to Reuters. We paid this dividend on October 3, 2002.

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

50

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.

(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 Group, LP 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.

(8) In connection with our merger with Island on September 20, 2002,
we assumed two hedge option agreements with Ameritrade Holding Corporation.
These hedge option agreements were originally entered into between Island
and Datek Online Holdings Corp. (which Ameritrade acquired on September 9,
2002) and hedged Ameritrade's obligations under a stock appreciation rights
(SARs) plan. The SARs were granted to various directors, officers and
employees of Datek and, upon exercise, entitled the holders to receive cash
in an amount equal to the excess of the market value of our common shares
over the exercise price of the SAR. In connection with our merger with
Island, Ameritrade accelerated the SARs, in accordance with the terms of
the SAR plan. Pursuant to an option exercise agreement dated as of October
18, 2002 we entered into with Ameritrade and Datek, we sold 1,651,238
shares of our common stock to Ameritrade for an exercise price of $0.91 per
share in a series of private placements pursuant to Regulation D of the
Securities Act in November and December 2002.
51

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, 2002, 2001 and 2000 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, 1999 and 1998 set forth below was derived from our audited
consolidated financial statements that are not included in this annual report.
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 and 1998.

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

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

(2) Historical amounts may be restated due to updates of volume information from
Nasdaq.

(3) For a description of how we calculate our Nasdaq share volumes,
see -- "Nasdaq Volume Calculations" and "Calculation of Instinet ATS and
Island ATS Volume Combined Volumes'

(4) Island's results, subsequent to September 20, 2002, are consolidated with
our results for the periods described.

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

We have been operating in an increasingly challenging business, economic
and regulatory environment. During the past three years, the major U.S. market
indices have experienced a severe decline and significant volatility. The weak
and uncertain economic climate, increased unemployment rates, reduced capital
raising, decreased market capitalization, ongoing geopolitical and global
conflicts, coupled with the current corporate governance and accounting
concerns, have contributed to a decreased pace of global economic growth. This
has resulted in significantly lower equity prices, decreased corporate activity,
increased market volatility, decreased trading volumes, and a generally more
difficult business environment. In addition, intense competition from other
liquidity providers and trading venues, together with recent SEC regulations and
interpretive initiatives, have prompted us to reduce our prices significantly,
which has resulted in decreased revenues and losses from operations. Our
transaction fee revenues have declined from a record $1.4 billion in 2001 to
$1.1 billion in 2002 and our net income decreased from $144.8 million to a loss
of $735.2 million, primarily due to a $552.0 million charge for goodwill
impairment, a restructuring charge and a write down in our investments. In the
past, we have implemented various cost reduction plans and in December 2002, we
began implementing a cost reduction plan that targets a further reduction in
operating costs of $100 million, on an annualized basis, by the end of 2003. Our
transaction fees earned from our customers trading equity securities have
represented a substantial part of our revenues and accounted for approximately
99% of our transaction fee revenues in 2002 and 2001.

During the first two months of 2003, the U.S. markets continued to weaken
and trading volumes continued to decline. The average daily trading volumes in
Nasdaq-quoted and U.S. exchange-listed stocks decreased 8% from 3.6 billion
shares in the fourth quarter of 2002 to 3.3 billion shares during the first two
months of 2003. Our average daily trading volumes have also decreased. Our
average daily trading volumes in Nasdaq-quoted and U.S. exchange listed stocks
have decreased 13% from 575 million shares in the fourth quarter of 2002 to 504
million shares during the first two months of 2003. This decrease in trading
volumes has had a negative effect on our transaction fee revenue. In addition,
in March 2003, we announced a reduction of 12% of our global staffing levels,
approximately 175 positions, resulting from attrition and the eliminations of

54

positions. We expect that these staff reductions will result in an estimated $20
million reduction in our operating costs, on an annualized basis, by the end of
2003. This staff reduction is part of our continued focus on cost reduction and
is in addition to the $100 million cost reduction target previously announced.

ACQUISITION OF ISLAND AND SPECIAL DIVIDEND

On September 20, 2002, we completed our acquisition of Island. We now
operate two of the largest alternative trading systems (ATSs) trading
Nasdaq-quoted stocks. We believe this transaction brings together complementary
capabilities in the global equity markets, creating a company better able to
serve customer needs. We expect the merger to deliver synergies as a result of
expanded liquidity and cost savings in technology, clearing, facilities and
compensation. Under the terms of the acquisition agreement, we issued 80,658,886
shares of our common stock to Island stockholders and converted options,
warrants and stock appreciation rights to holders of Island options, warrants
and stock appreciation rights outstanding at September 20, 2002.

Subsequent to the acquisition, we incurred various non-cash charges related
to the amortization of identified intangible assets and the conversion of
existing Island equity options. In addition, we incurred charges to enable us to
achieve on-going cost synergies.

In connection with our acquisition of Island, we paid a $1.00 per common
share cash dividend to our stockholders of record as of September 19, 2002,
which represented a distribution of $248.7 million, of which $206.9 million was
paid to Reuters. We paid this dividend on October 3, 2002.

BUSINESS ENVIRONMENT

Over the past five years, the major U.S. market indices experienced
substantial growth followed by a severe decline and significant volatility. For
example, the Dow Jones Industrial Average increased from 7,965 in January 1998,
reached a peak of 11,723 in January 2000, dropped to a low of 7,286 in October
2002 and increased to 8,342 by the end of December 2002. The Nasdaq composite
experienced similar volatility, increasing from 1,574 in January 1998 to a peak
of 5,133 in March 2000, then experienced a severe decline to 1,336 by the end of
December 2002.

This trend comes at the end of a period of tremendous growth in the global
equity markets. Our transaction fee revenues grew at a compound annual growth
rate of 20% from $821.8 million in 1998 to $1.4 billion in 2001. This growth in
revenues was primarily driven by increases in share volumes in the equity
securities markets and by our expanded international business. For example, the
total number of shares of U.S. exchange-listed and Nasdaq-quoted stocks traded
increased at a compound annual rate of 27% from 403.7 billion in 1998 to 832.3
billion in 2001.

However, beginning in the second half of 2001 through 2002, the growth rate
of the volume of trading in the U.S. markets began to slow, and in 2002, Nasdaq
market volumes declined, although the U.S. exchanges still maintained moderate
growth. We believe the slowdown in trading volumes and the downward pressure on
share prices, has been caused in part by an overall decline in the global
economy, particularly in the U.S. The growth rate in the total number of shares
of U.S. exchange-listed and Nasdaq-quoted stocks traded decreased to 9% from
2001 to 2002. As a result of these market and competitive pressures, we
significantly reduced our prices in 2002 which contributed to a decrease in our
transaction fee revenues to $1.1 billion in 2002 (For the year-to-year growth
rates, see "Selected Financial Data.").

The international equity markets have experienced similar volatility and
downward share prices as the U.S. markets. Our international equity transaction
volume increased at a compound annual rate of 55%, from 1.3 million transactions
in 1998 to 7.6 million transactions in 2002 (For the year-to-year growth rates,
see "Selected Financial Data."). Our transaction fee revenue earned from
non-U.S. equities has grown over the past five years from $139.2 million to a
peak of $267.5 million in 2000. However, these fees declined to $212.4 million
in 2002 primarily due to price declines in non-U.S. securities. Our net
transaction fee revenue earned from non-U.S. equities (a non-GAAP financial
measurement), which excludes revenues directly related to soft dollar and
commission recapture, has grown over the past five years from $107.9 million in
1998

55

to a peak of $207.7 million in 2000. However, these fees began to decline in
2001, and in 2002, declined to $154.3 million, primarily due to price reductions
in non-U.S. securities. Our revenues from international transactions are
determined on the basis of the value of transactions, rather than the number of
shares traded.

In addition, we continue to operate in an increasingly challenging business
environment due to recent significant regulatory changes. The securities markets
and the brokerage industry in which we operate are highly regulated. Many of the
regulations applicable to us may have the effect of limiting our activities,
including activities that might be profitable, or causing us to modify our
business model in ways that may adversely affect our revenues.

OUR MARKET SHARE

Our share trading volume in U.S. exchange-listed and Nasdaq-quoted stocks
has increased at a compound annual rate of 23% from 33.7 billion in 1998 to 76.9
billion in 2001. Our share trading volume grew 27% to 97.6 billion in 2002,
which included 16.9 billion from Island. (See -- "Calculation of Instinet ATS
and Island ATS Combined Volumes."(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 from 8.4% in 1998 to 10.8% in 2002. Our Instinet ATS alone accounted
for approximately 15% of the total trading volume in the Nasdaq quoted stock in
2002. Following our acquisition of Island, our two ATSs accounted for
approximately 30% of the total trading volume in Nasdaq-quoted stocks for the
three months ended December 31, 2002.

We experienced a decline in our Nasdaq market share beginning in the second
half of 2001. This was primarily attributable to lower volumes from our
broker-dealer customers, increased price competition and the introduction of
Nasdaq's SuperSoes system in the third quarter of 2001.

The following graph depicts our share volume and our transaction fee
revenues, on a quarterly basis, from 1998 to 2002:

[GRAPH]

56

PRICING CHANGES

To respond to the intense price competition and our declining market share,
particularly for Nasdaq-quoted trading, 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. 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. We will continue to monitor future price
competition and evaluate our pricing structure as part of our ongoing efforts to
maintain and expand the liquidity pools of our two ATSs. These price changes
have significantly affected our average U.S. equity transaction fee revenue per
share, which decreased 40.8% from $0.0076 in 2001 to $0.0045 2002. Our average
U.S. net equity transaction fee revenue per share (a non-GAAP financial
measurement) decreased 53.8% from $0.0065 in 2001 to $0.0030 in 2002.

BUSINESS EXPANSION, COST REDUCTION INITIATIVES & BUSINESS REALIGNMENT

Our expenses grew significantly from 1998 to 2001, primarily due to
increased transactions by our customers, as well as increased expenses related
to our efforts to expand and diversify our activities, which has caused
reductions in our margins. 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 began providing correspondent clearing
services to a few brokers in the United States. 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. These internal development efforts resulted in
significant costs, which we expensed as incurred.

In response to the various regulatory and competitive changes in our
business and in the marketplace, in 2000, 2001 and 2002, we engaged in various
cost reduction plans and re-aligned our core business focus, resulting in
restructuring charges:

- In December 2000, we announced that based upon a review of market
conditions and an evaluation of possible alternate strategies, we decided
to terminate our retail brokerage efforts. As a result, we recorded a
charge of $7.5 million in 2000 and $4.0 million in 2001. Between 1998 and
2001, we incurred total expenses of $76.9 million related to our retail
brokerage initiative, including these restructuring charges.

- In July 2001, in order to address the declines in our margins, 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 charge of $24.4 million. Employee headcount
levels were reduced by 226. The departments primarily affected were
various operational areas in technology support, 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 also aggressively managed discretionary spending in areas
such as marketing costs, professional fees and travel costs.

- In March 2002, in order to offset the impact of reduced revenues due to
our price reductions to U.S. broker-dealer customers, we announced that
we would reduce our annualized fixed operating costs by approximately
$120 million compared to our annualized fixed cost run rate in the fourth
quarter of 2001. This program was substantially completed by the end of
the first half of 2002 at a cost of $58.4 million. It included reducing
staff levels by 489. The departments primarily affected were various
operational areas in technology support functions, clearing operations,
sales and trading, and administrative functions in our U.S. and
international offices. We closed the Houston, Los Angeles and San Jose
trading offices of our ProTrader subsidiary, consolidated our European
trading and clearing

57

operations, significantly reduced the size of our offices in Switzerland,
U.K. and France, and consolidated our office space in the U.S.

- In May 2002, we closed our fixed income trading platform. Against the
background of a global economic slowdown and the uneven pace of
acceptance of electronic fixed income trading platforms, the business had
been unable to reach a critical mass. As part of this shutdown, we
recorded a discontinued operations charge, net of tax, of $22.7 million
in 2002. Between 1998 and 2002, we incurred a charge of $168.7 million
related to our fixed income business, including this restructuring
charge.

- In December 2002, we announced that we had commenced a cost-reduction
plan to reduce operating costs by $100 million on an annualized basis
(compared to the level in the third quarter of 2002, as if Island was
included for the full quarter) by the end of 2003 in order to achieve
cost synergies in connection with our acquisition of Island. As part of
this plan, we reduced our workforce by 300, or approximately 17% of our
global full-time employees, consolidated office space within the New York
City area and closed most of the remaining offices of our ProTrader
subsidiary. A charge of $62.4 million was recorded in 2002 in connection
with these measures.

We continue to evaluate further cost initiatives, which may result in future
charges.

FIXED AND VARIABLE COST BASE

As a result of the initiatives described above, we have begun to achieve a
reduction in our expenses. Our total expenses, which included the charges for
cost reduction initiatives, were $1.8 billion in 2002, $1.2 billion in 2001 and
$1.1 billion in 2000; however, our fixed-cost base (a non-GAAP financial
measure) decreased to $642.1 million in 2002, from $809.7 million in 2001 and
$792.0 million in 2000. Island contributed $16.9 million to our fixed expenses
in 2002. Our fixed-cost base excludes non-operating expenses (goodwill
impairment and restructuring costs) and variable costs (soft dollar and
commission recapture, broker-dealer rebates and brokerage, clearing and exchange
fees).

Our variable expenses are generally related to transaction volumes as well
as share volumes. Our average number of shares per transaction has declined
primarily due to a change in our customer mix and increased trades, particularly
from our broker-dealer clients.

GOODWILL IMPAIRMENT

During the third quarter of 2002, we experienced a decline in our market
capitalization, particularly towards the end of the quarter. Due to this
significant decrease, Instinet's book value exceeded its fair market value. We
believe that this significant decline in market value reflected the ongoing
challenging business environment, declining business fundamentals, the
commoditization of some of our services, the launch of significant competitive
products and a difficult regulatory environment. These events prompted us to
perform a goodwill impairment test.

In accordance with SFAS No. 142, "Goodwill and Other Intangible Assets"
("SFAS 142"), based on the results of a valuation analysis prepared by an
independent specialist, we determined that our existing goodwill had been
completely impaired and as a result, we recorded a pre-tax goodwill impairment
loss of $552.0 million, the remaining carrying value of our goodwill, as of
September 30, 2002. This was a non-cash charge and resulted in no reduction in
tangible book value. We recorded a related tax benefit of approximately $26.0
million related to this charge.

OTHER BUSINESS 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, for $50.0 million, in order to expand our services
to certain customer groups.

58

In October 2001, we acquired ProTrader, a provider of advanced trading
technologies and electronic brokerage services. This acquisition was intended to
enhance our customer interface and order routing technology. 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.

On January 7, 2003, pursuant to an existing option purchase agreement, we
purchased Harborview LLC, a NYSE floor brokerage firm for $594,000. We believe
that this acquisition will reduce our execution costs and enhance our execution
capabilities.

OUR REORGANIZATION AND INITIAL PUBLIC OFFERING

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 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.

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.

MANAGEMENT CHANGES

We have had several executive management changes beginning in 2002:

In April 2002, Douglas M. Atkin, President and Chief Executive
Officer, resigned from Instinet. Mark Nienstedt, then Chief Financial
Officer, was appointed to serve as Instinet's acting President and Chief
Executive Officer. Kenneth K. Marshall, then Chief Operating Officer, also
announced his retirement and Jean-Marc Bouhelier was appointed Chief
Operating Officer.

Subsequent to the acquisition of Island in September 2002, Edward J.
Nicoll, then Chairman of Island, was appointed Chief Executive Officer and
Director of Instinet. In November 2002, John F. Fay was appointed Chief
Financial Officer of Instinet. Mark Nienstedt continued as Instinet's
President until his resignation on February 10, 2002; however, Mr.
Nienstedt continues to serve as director and officer of Instinet. Effective
January 2003, Andre Villeneuve retired as Instinet's Executive Chairman of
the Board of Directors and Ian Strachan was appointed to succeed him as
non-executive Chairman of the Board.

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.

NON-GAAP FINANCIAL MEASUREMENT

In evaluating our financial performance and results of operations,
management reviews certain financial measures that are not in accordance with
generally accepted accounting standards in the United States ("non-GAAP").
Non-GAAP measurements do not have any standardized meaning and are therefore
unlikely to be comparable to similar measures presented by other companies.
Management uses non-GAAP financials

59

measures in evaluating our operating performance. In light of the use by
management of these non-GAAP measurements to assess our operational performance,
we believe it is useful to provide information with respect to these non-GAAP
measurements so as to share this perspective of management. These non-GAAP
financials measures should be considered in the context with our GAAP results. A
reconciliation of our non-GAAP measurements are provided below:

- Our transaction fees earned from our customers trading equity securities
have represented, and continue to represent, a substantial part of our
revenues. GAAP requires us to add our soft dollar and commission
recapture expenses and broker-dealer rebates, dollar-for-dollar, to
related equity transaction fee revenues, which has a dilutive effect on
our operating margins. Therefore, when evaluating our revenues from
equity transactions, management reviews our net equity transaction fee
revenue, based on U.S. securities and non-U.S. securities. Our net equity
transaction fee revenues are calculated by subtracting the soft dollar
and commission recapture expenses as well as broker-dealer rebates from
the related equity transaction fees, as well as non-equity related
revenues, and is calculated as follows:

- Our expense structure includes a certain level of fixed costs, as well as
a variable cost base that fluctuates with customer transaction volumes as
well as share volumes. If demand for our brokerage

60

services declines and we are unable to respond by adjusting our fixed
cost base, our operating results could be materially adversely affected.
Therefore, we have undertaken cost reduction initiatives to reduce our
fixed cost base. We estimate our fixed cost base by subtracting line
items that we have determined to be predominantly variable in nature.
Some of these variable line items may contain a fixed component.
Similarly, some of our fixed expense line items may contain a variable
component. Management does not adjust for the variable or fixed component
within each line item when analyzing our fixed cost base. Our fixed cost
base is calculated as follows:

REVENUES

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

Transaction fees accounted for the significant portion of our revenues in
2002. These fees are commission and other revenues earned on our customers' use
of our various brokerage and related services, and fluctuate based upon share
volumes and pricing changes. These services include ECN transaction revenues,
service bureau transaction fees, market data, communication, clearing and other
brokerage services. 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. ECN
transaction fee revenues include commissions charged to broker-dealers who
consume liquidity from our ECNs. The commissions we charge to liquidity
consumers more than offset the amount we pay broker-dealers who liquidity to our
ECNs.

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.

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 on 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 realized and
unrealized gains and losses from our marketable securities.

61

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.

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, as well as 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.

Broker-dealer rebates represents were commission rebates to broker-dealers
who provide liquidity to our ECNs as part of our pricing incentives for
broker-dealers. We charge commissions to broker-dealers who consume liquidity,
which is recorded as transaction fee revenue. The commissions we charge to
liquidity consumers more than offset the amount we pay to broker-dealers who
provide liquidity to our ECNs.

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.

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, 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 2003 as
we leverage 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."

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. Goodwill amortization was recorded
until January 1, 2002, when we adopted new accounting rules, which require that
goodwill no longer be amortized to earnings. In 2002, we wrote off all of our
goodwill.

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. We expect these costs to decrease in 2003 as we have consolidated our
office space in the New York City area.

Professional fees include fees paid to consultants as well as legal and
accounting fees.

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.

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Other expenses consist primarily of interest costs related to securities
lending activities by our clearing operations, administrative expenses,
provision for bad debt, 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., foreign income
taxes, valuation allowances against losses that may not be realized and the
effect of certain non-deductible expenses.

CRITICAL ACCOUNTING POLICIES

Our accounting policies related to our strategic alliances and long term
investments ("investments") and goodwill are the most critical accounting
policies that requires us to make estimates and use judgments that could affect
our results.

INVESTMENTS

Our investments are stated at estimated fair value as determined in good
faith by management. Generally, we will 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 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 to any estimation technique. The fair value
estimates presented herein are not necessarily indicative of an amount that 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.

In 2002, we wrote down our investments in WR Hambrecht + Co., Archipelago
Holding LLC, The Nasdaq Stock Market, Inc. and Knight Roundtable Europe Ltd., by
$45.2 million, based upon management's best judgment of each investment's fair
market value.

GOODWILL

SFAS 142 requires that management perform a detailed review of the carrying
value of the Company's tangible and intangible assets. In this process,
management is required to make estimates and assumptions in order to determine
the fair value of the Company's assets and liabilities and projected future
earnings using various valuation techniques. Management uses its best judgment
and information available to it at the time to perform this review, as well as
the services of an expert valuation specialist. Because management's assumptions
and estimates are used in the valuation, actual results may differ.

In accordance with SFAS 142, based on the results of a valuation analysis
prepared by an independent specialist, we determined that our existing goodwill
had been completely impaired and as a result, we recorded a pre-tax goodwill
impairment loss of $552.0 million in 2002. In addition, based upon a review of
the discounted cash flows of our ProTrader subsidiary, we incurred a goodwill
impairment charge of $15.7 million upon our adoption of SFAS 142.

See Note 2 to the consolidated financial statements for a summary of our
significant accounting policies.

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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 -- "Nasdaq Volume Calculations" and "Calculation of Instinet ATS and
Island ATS Volume Combined Volumes"

(3) Our net equity transaction fee revenues are calculated by subtracting the
soft dollar and commission recapture expenses and broker-dealer rebates from
the related equity transaction fees. GAAP requires us to add our soft dollar
and commission recapture expenses and broker-dealer rebates,
dollar-for-dollar, to related equity transaction fee revenues.

(4) Our average U.S. net equity transaction fee revenue is calculated by
dividing our net U.S. equity transaction fee revenue for the buy and sell
side of each transaction by our total U.S. share volume.

(5) Island's results, subsequent to September 20, 2002, are consolidated with
our results for the periods described.

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(6) In 2002, our average U.S. net equity transaction fee revenue has fluctuated
significantly as was $0.0018, $0.0025, $0.0036 and $0.0055 for the three
months ended December 31, 2002, September 30, 2002, June 30, 2002 and March
31, 2002, respectively.

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.
Historical amounts may be restated due to updates of volume information from
Nasdaq.

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.

CALCULATION OF INSTINET ATS AND ISLAND ATS COMBINED VOLUMES

Our two ATSs, Instinet and The Island ECN, currently operate independently;
however, we disclose the volumes from our two ATSs on a combined basis.
Currently, Instinet customers have the option, for certain orders, to
automatically send parts of orders that cannot be filled on the Instinet system
to the Island system. In calculating our combined volumes, we eliminate one side
of these routed orders.

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RESULTS OF OPERATIONS

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

DECEMBER 31, 2002 VERSUS DECEMBER 31, 2001

Overview

Net income decreased from $144.8 million for 2001 to a net loss of $735.2
million for 2002 primarily due to a $552.0 million charge for goodwill
impairment, a restructuring charge and a write down in our investments.

66

Our revenues decreased 29.0% from $1.5 billion for 2001 to $1.1 billion for
the comparable period in 2002, primarily as a result of lower average pricing,
which more than offset revenues related to our increased share volumes and
acquisition of Island.

Expenses increased 50.6% from $1.2 billion for 2001 to $1.8 billion for
2002. Our expenses for 2002 included a goodwill impairment charge of $552.0
million and restructuring charges of $120.8 million. Our expenses for 2001
included a restructuring charge of $24.4 million. Excluding these charges (a
non-GAAP financial measurement), our expenses decreased 3.6% from $1.2 billion
in 2001 to $1.1 billion for 2002. In addition, Island contributed $60.3 million
of expenses in 2002.

Revenues

Transaction fee revenue decreased 24.3% from $1.4 billion in 2001 to $1.1
billion in 2002. Transaction fee revenue excluding revenues directly related to
soft dollar and commission recapture as well as broker-dealer rebates, declined
39.3% from $1.2 billion in 2001 to $724.9 million in 2002. These decreases were
primarily due to a decline in average pricing as a result of our pricing
changes. Our average transaction fee revenue per U.S. share, decreased 40.8%
from $0.0076 in 2001 to $0.0045 in 2002. Our average net transaction fee revenue
per U.S. share (a non-GAAP financial measure), which excludes revenues directly
related to soft dollar and commission recapture as well as broker-dealer
rebates, decreased 53.8% from $0.0065 in 2001 to $0.0030 in 2002. On a quarterly
basis, our average net U.S. equity transaction fee revenue has fluctuated
significantly and was $0.0018, $0.0025, $0.0036 and $0.0055 for the three months
ended December 31, 2002, September 30, 2002, June 30, 2002 and March 31, 2002,
respectively.

Primarily due to the acquisition of Island in September 2002, our various
pricing changes, and the introduction of our broker-dealer rebates, we increased
our trading volumes and market share in Nasdaq quoted and U.S. exchange-listed
stocks between 2001 and 2002, however, the decrease in our average pricing more
than offset the effect of the increases in our trading volumes. Our trading
volumes in Nasdaq-quoted stocks increased 24.4% and our trading volumes in U.S
exchange-listed stocks increased 42.3% in 2002, compared to 2001. Island
contributed 90.8% or 14.6 billion shares, of the increase in Nasdaq-quoted
stocks and 50.3% or 2.3 billion shares, of the increase in U.S. exchange-listed
stocks. Our share of volume in Nasdaq-quoted stocks, while fluctuating during
the period, increased from 14.0% in 2001 to 18.6% in 2002, and our share of
volume in U.S. exchange-listed stocks increased from 3.1% in 2001 to 3.4% in
2002. Our Instinet ATS alone accounted for 15.3% of the total trading volume in
the Nasdaq quoted stocks for 2002. Following our acquisition of Island, our two
ATSs accounted for 29.7% of the total trading volume in Nasdaq-quoted stocks for
the three months ended December 31, 2002. Our average number of transactions per
day in Nasdaq-quoted and U.S. exchange-listed stocks decreased 15.9% from
782,025 in 2001 to 657,771 in 2002.

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, decreased 1.2% from $220.1 million
in 2001 to $217.3 million in 2002, primarily due to a decrease in our soft
dollar revenues due to reduced use of this service partly offset by increased
use of the commission recapture services provided by our Lynch, Jones and Ryan
subsidiary.

Our transaction fee revenue earned from U.S. equity transactions decreased
25.8% from $1.2 billion in 2001 to $865.8 million in 2002. Our transaction fee
revenue earned from non-U.S. equities declined 17.4% from $257.2 million in 2001
to $212.4 million in 2002. This amount represented 18.1% of our total equity
transaction fee revenue in 2001, and 19.7% in 2002. Our net transaction fee
revenue earned from U.S. equity transactions (a non-GAAP financial measurement),
which excludes revenues directly related to soft dollar and commission recapture
and broker-dealer rebates, decreased 42.6% from $994.8 million in 2001 to $570.7
million in 2002 due to the decrease in our average pricing resulting from lower
rates for U.S. broker-dealer customers following the price reductions we
initiated for this group in March 2002. Our net transaction fee revenue earned
from non-U.S. equities (a non-GAAP financial measurement), which excludes
revenues directly related to soft dollar and commission recapture and
broker-dealer rebates, declined 22.4% from $198.8 million in 2001 to $154.3
million in 2002. This amount represented 16.7% of our total net equity
transaction fee revenue in 2001, and 21.3% in 2002. This increase was primarily
due to a greater decrease in

67

our U.S. net equity transaction fees as a result of our price changes versus our
non-U.S. net equity transaction fees.

Interest revenue decreased 18.6% from $49.3 million in 2001 to $40.1
million in 2002. This decrease was primarily due to a decrease in interest
rates, which affects the revenue generated by our stock borrowing activities
related to our clearing services, as well as a decrease in our interest bearing
cash and cash equivalents.

Investments revenue decreased from a gain of $17.4 million in 2001 to a
loss of $59.1 million in 2002. The loss was primarily due to write downs of
$45.2 million where management made a determination that the fair value of
investments was impaired and $12.1 million for investments accounted for under
the equity method, offset by gains on our securities owned, including $2.7
million on our sale of shares in the Toronto Stock Exchange upon its
demutualization and initial public offering in November 2002.

Expenses

Compensation and benefits expense decreased 30.7% from $406.3 million in
2001 to $281.8 million in 2002. This decrease was primarily due to a decrease in
our worldwide headcount, particularly in our U.S. offices, the closure of our
fixed income business as part of our cost reduction initiatives, as well as a
decline in incentive compensation due to our lower revenues. Our average
headcount was 2,083 in 2001 and 1,672 in 2002. Our total headcount decreased
from 2,132 employees as of December 31, 2001 to 1,474 employees (including 133
employees from Island) as of December 31, 2002. In addition, employees have also
been given incentives through the issuance of stock options. The Company's
policy is not to reflect an expense for stock options granted to employees.

Soft dollar and commission recapture expense decreased 1.2% from $220.1
million in 2001 to $217.3 million in 2002. This expense is offset
dollar-for-dollar by soft dollar revenues and revenues that are subject to
commission recapture. This decrease was primarily due to a decrease in our soft
dollar costs due to lower volumes partly offset by expanded use of our
commission recapture services offered by our Lynch Jones & Ryan subsidiary.

Broker-dealer rebates were $124.4 million in 2002. As noted above, as part
of our pricing incentives for broker-dealers, we now offer commission rebates to
broker-dealers who provide liquidity, which is recorded as an expense, and
charge commissions to broker-dealers who consume liquidity, which is recorded as
transaction fee revenue. The commissions we charge to liquidity consumers more
than offset the amount we pay to broker-dealers who provide liquidity to our
ECNs.

Brokerage, clearing and exchange fees increased 2.3% from $146.2 million in
2001 to $149.5 million in 2002. This increase was due to higher brokerage and
exchange fees as a result of our new order routing technology (which allows us
to route trades to other ECNs, which in turn, charge us fees for this service),
our acquisition of Island and fees charged to our ProTrader subsidiary. Partly
offsetting these increases were a reduction in our regulatory fees and lower
U.S. clearing costs as a result of implementing certain technology efficiencies,
such as trade compression.

Communications and equipment expense decreased 19.4% from $156.0 million in
2001 to $125.7 million in 2002. This decrease was due in large part to lower
core communications costs, which decreased 23.1% from $77.9 million in 2001 to
$62.8 million in 2002, reflecting the benefit of improved network and systems
efficiencies. Our equipment and software costs for upgrading our existing
systems and other enhancements decreased 21.2% from $38.0 million in 2001 to
$30.0 million in 2002 primarily due to decreased spending in this area. Our
exchange data access charges also decreased 19.7% from $19.8 million in 2001 to
$15.9 million, primarily due to the sale of our Research and Analytics product
to Reuters in September 2001.

Depreciation and amortization expense decreased 2.9% from $80.8 million in
2001 to $78.4 million in 2002. This decrease was primarily due a reduction in
depreciation of our capitalizable assets, which decreased as part of our cost
reduction initiatives, offsetting a slight increase due to our acquisition of
Island. In addition, we ceased amortizing goodwill as a result of our adoption
of SFAS 142 on January 1, 2002. Offsetting this

68

decrease in goodwill amortization was amortization related to our intangible
assets, which we acquired in connection with our acquisition of Island and
ProTrader.

Occupancy expense increased 11.2% from $49.9 million in 2001 to $55.5
million in 2002, primarily due to increased property insurance, maintenance and
one time costs associated with our move to new corporate headquarters in New
York and our acquisition of Island. Partly offsetting these increases was a
decrease in rent expense due to consolidation of our office space in the New
York metropolitan area.

Professional fees decreased 38.5% from $40.0 million in 2001 to $24.6
million in 2002. This decrease was primarily due to reduced use of technical and
management consultants, partly offset by an increase in our legal expenses and
our acquisition of Island.

Marketing and business development decreased 22.8% from $22.1 million in
2001 to $17.1 million in 2002. This decrease was due to a scaling back of our
branding campaign as a result of our cost reduction initiatives.

Other expenses increased 8.2% from $54.5 million in 2001 to $59.0 million
in 2002. This increase was primarily due to an increase in our provision for bad
debts due to loans we made, payments to Reuters in connection with the sale of
our R&A product in order to allow our customers to receive this service and
support from Reuters instead of us, and interest costs related to our securities
lending and other clearing activities. Partly offsetting these increases were
decreases in our travel expenses as part of our cost reduction initiatives, a
one-time refund of value added tax previously paid to certain non-U.S. tax
authorities and interest expense related to a loan Reuters provided to us to
fund our acquisition of Lynch Jones & Ryan in February 2000. This loan was
repaid in June 2001.

Provision for Income Taxes

Our tax provision on income/(loss) from continuing operations decreased
from a charge of $122.2 million in 2001 to a benefit of $53.1 million in 2002 as
a result of our loss from continuing operations before income taxes and
cumulative effect of change in accounting principle. Our effective income tax
rate decreased from 41.9% in 2001 to 7.11% in 2002. This decrease resulted from
the permanent impairment of goodwill that was not deductible for tax purposes,
restructuring charges, write-down in our investments, operating losses in tax
jurisdictions where utilization of tax losses is doubtful and other valuation
allowances.

Cumulative Effect of Change in Accounting Principle

The cumulative effect of a change in accounting principle related to
goodwill, net of tax, was $18.6 million in 2002. We adopted SFAS 142 on January
1, 2002. SFAS 142 requires that goodwill no longer be amortized to earnings, but
instead be reviewed for impairment. Impairment is deemed to exist when the
carrying value of goodwill exceeds its implied fair value. This methodology
differs from our previous policy, as permitted under accounting standards
existing before SFAS 142, of using undiscounted cash flows of the businesses
acquired over its estimated life. Upon adoption of SFAS 142, we incurred
goodwill impairment before tax of $15.7 million related to our acquisition of
ProTrader and $3.3 million related to our acquisition of Montag Popper & Partner
GmbH, a fixed income broker-dealer in Germany. Decreased customer transaction
volumes led to operating losses, closure of several trading offices and
restructuring of our ProTrader subsidiary. In addition, after a review of market
conditions we determined our fixed income operations could not reach critical
mass and therefore the carrying value of goodwill related to our acquisition of
Montag was impaired and written off.

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 4.4% 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.
69

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 8.3% increase in expenses from $1.1
billion in 2000 to $1.2 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, higher
compensation and benefits expense and a restructuring charge related to our cost
reduction initiatives, offset by a reduction in our professional fees and
marketing and business development expenses.

Expenses increased despite a decrease in our business development costs in
connection with our efforts to expand and diversify our activities. 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. Our loss from the discontinued
operations of our fixed income business decreased from $55.6 million in 2000 to
39.1 million in 2001.

Revenues

Transaction fee revenue increased 3.1% from $1.38 billion in 2000 to $1.42
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 transaction fee revenue earned from non-U.S. equities declined 3.8%
from $267.5 million in 2000 to $257.2 million in 2001. This amount represented
19.4% of our total equity transaction fee revenue in 2000, and 18.1% in 2001.
Our net transaction fee revenue earned from non-U.S. equities (a non-GAAP
financial measurement), 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% 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 29.7% from $38.0 million in 2000 to $49.3
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 91.9% from $9.1 million in 2000 to $17.4
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
70

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 7.1% from $379.3 million in
2000 to $406.3 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 2,123
employees as of March 31, 2001, but then declining as of December 31, 2001 to
1,852 employees as part of our cost reduction initiatives, excluding the effect
of our ProTrader acquisition in October 2001 and our discontinued fixed income
business. As of 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 26.6% in 2000 to 27.3% 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 14.8% in
2001.

Brokerage, clearing and exchange fees increased 7.4% from $136.2 million in
2000 to $146.2 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 9.5% in 2000 to 9.8% in 2001.

Communications and equipment expense increased 8.9% from $143.2 million in
2000 to $156.0 million in 2001. This increase was due in large part to higher
costs related to our core communications, which increased 40.3% from $58.2
million in 2000 to $81.6 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 35.4% from $10.9
million in 2000 to $14.8 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 13.9% from $44.2 million in 2000 to $38.0 million in 2001,
reflecting the benefit of improved network and systems efficiencies. Our
exchange data access charges also decreased 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 10.0% in 2000 to 10.5% in 2001.

Depreciation and amortization expense increased 8.9% from $74.2 million in
2000 to $80.8 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 5.2% in 2000 to 5.4% in
2001.

Occupancy expense increased 38.9% from $35.9 million in 2000 to $49.9
million in 2001. This increase was primarily due to higher lease payments and
related expenses for our new corporate headquarters in New York.

Professional fees decreased 55.7% from $90.2 million in 2000 to $40.0
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 $20.4 million of the
decrease in professional fees was

71

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 6.3% in 2000 to 2.7% in 2001.

Marketing and business development expense decreased 31.1% from $32.1
million in 2000 to $22.1 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 47.1% from $37.1 million in 2000 to $54.5 million
in 2001. This increase was primarily due to our interest costs related to our
securities lending activities, allowance for doubtful accounts, 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.

Provision for Income Taxes

Our tax provision decreased 10.1% from $136.0 million in 2000 to $122.2
million in 2001. Our effective income tax rate decreased from 42.5% in 2000 to
41.9% in 2001. The reduction in the rate for 2001 is primarily due to lower
state and local income taxes.

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
for a fair statement of 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.

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The following data sets forth as a percentage of revenue certain unaudited
consolidated quarterly income data.

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;

74

- changes in pricing;

- 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;

- general economic conditions; and

- seasonality.

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 should decline suddenly (as has
occurred in the past) and 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. In addition, we may continue to make
significant expenditures related to technological innovations over long periods
of time, so that our operating margins and profitability could be adversely
affected.

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 achieve 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 achieve 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. Our
financial liquidity is primarily determined by the performance of our business
and partly by the return on our investments. We maintain a highly liquid balance
sheet that can fluctuate significantly between financial statement dates. Our
cash equivalents and securities owned are primarily comprised of highly liquid
investments that can be sold in the secondary market, if necessary. We currently
anticipate that our existing cash resources and credit facilities, will be more
than sufficient to meet our anticipated working capital, capital expenditures
and regulatory capital requirements, operating losses, restructuring charges as
well as other anticipated requirements for at least the next twelve months. To
the extent that overall market volumes and our trading volumes decrease beyond
certain levels, we may be required to obtain additional financing from third
parties or Reuters.

We received net proceeds of $486.9 million during our initial public
offering in 2001. We used $150.0 million of these proceeds to repay our
indebtedness to Reuters, $100.0 million in connection with our acquisition of
ProTrader in October 2001 and used the remaining proceeds to pay a portion of a
special dividend of $248.7 million in connection with our acquisition of Island
in September 2002.

Cash and cash equivalents, together with assets readily convertible into
cash, accounted for 67.7%, 65.8% and 66.2% of our assets as of December 31,
2000, 2001 and 2002, respectively. Cash and cash equivalents decreased to $275.8
million as of December 31, 2002 from $703.7 million as of December 31, 2001,
primarily due to our dividend payment of $248.7 million in connection with our
acquisition of Island, decreases in our securities owned and purchases of fixed
assets and leasehold improvements. Decreases in our payables to broker-dealers
and payables to customers and increases in securities borrowed were partly
offset by a decrease in our receivables from broker-dealers. 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

75

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.

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.

- Commissions receivable represent commissions (transaction fees)
principally from broker-dealers.

- 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 various 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.

Changes in our total assets and liabilities, in particular, receivable from
broker-dealers and customers, securities borrowed, and 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 2000, 2001 and 2002 related to the purchase of data
processing and communications equipment, leasehold improvements and purchases of
furniture for our additional office facilities. We incurred losses of
approximately $20.3 million in 2001 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 in 2001 from our insurance carrier. Capital expenditures and
investments in new technology were financed primarily through income from
operations. Additionally, we made cash payments or acquired cash in excess of
net assets of $26.0 in 2002 in connection with our acquisition of Island and
ProTrader, $71.2 million in October 2001 and $5.3 million in January 2002 in
connection with our acquisition of ProTrader and $48.5 million in February 2000
in connection with our acquisition of Lynch, Jones & Ryan. Historically,
acquisitions of new businesses had generally been funded through subordinated
borrowings from Reuters. Since our initial public offering, acquisitions have
generally been funded from the proceeds from our initial public offering, cash
generated by our operations or through issuance of our common stock. We also
repurchased $1.5 million of our common stock in 2002 to satisfy future
conversions of restricted stock units into common stock under our Restricted
Stock Unit plan. We received $1.4 million related to the issuance of our common
stock to satisfy options exercised during 2002. Lastly, we paid a $248.7 million
special dividend in 2002 in connection with our acquisition of Island.

76

Our future cash payments associated with contractual obligations, which are
primarily leases for office space and equipment under non-cancelable operating
leases with third parties and Reuters, are summarized as follows:

Our aggregate minimum lease commitments after 2007 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 $(248.9) million,
$286.8 million and $50.4 million in 2002, 2001 and 2000, respectively. As noted
above, we made a $248.7 million dividend payment. 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.

As of December 31, 2002, we had access to $201.0 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, 2002,
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,
2002, we had access to $599.4 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, 2002, there
was $27.3 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, 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. 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, 2002, 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 executed through our subsidiary
Instinet Corporation (but not The Island ECN, which cleared its securities
transactions through another broker-dealer until January 10, 2003, after which
point it began clearing its transactions through ICS), had net capital of $168.1
million, which was $160.2 million in excess of its required net capital of $2.9
million.

We have an active securities borrowing and lending business, where we
borrow securities from one party and lend them to another, as well as to
facilitate the settlement process to meet our customers' needs. Under these
transactions, we either receive or provide collateral, generally cash. When we
borrow securities, we provide cash to the lenders as collateral and earn
interest on the cash. Similarly, when we loan securities, we receive cash as
collateral and pay interest to the borrower. The initial collateral advanced or
received approximates, or is greater than, fair value of the securities borrowed
or loaned. In the event the counterparty
77

is unable to meet its contractual obligations to return the pledged collateral,
we may be exposed to the market risk of acquiring the collateral at prevailing
market prices. We provided $608.5 million and $455.9 million as collateral for
securities borrowed as of December 31, 2002 and 2001, respectively. We also
received $453.3 million and $257.0 million as collateral for securities loaned
as of December 31, 2002 and 2001, respectively.

Included in commissions and other receivables is approximately $30 million
from Archipelago L.L.C., B-Trade Services LLC and REDIBook ECN L.L.C of which we
have commenced arbitration proceedings before the NASD for approximately $11
million. We have established an appropriate reserve against the disputed amount
based upon a review of the facts and circumstances surrounding the dispute.

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, 2002, these funds amounted to
$251.8 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. 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. Management does not believe adoption of this statement
will have a material impact upon our financial condition and results of
operations.

SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities," was issued in June 2002 and is effective for fiscal years beginning
after December 31, 2002. SFAS No. 146 addresses financial accounting and
reporting for costs associated with exit or disposal activities and nullifies
Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring)." SFAS No 146 requires that a
liability for a cost associated with an exit or disposal activity be recognized
when the liability is incurred. Under Issue 94-3, a liability for an exit cost
as defined in Issue 94-3 was recognized at the date of an entity's commitment to
an exit plan. Management does not believe adoption of this statement will have a
material impact upon our financial condition and results of operations.

SFAS No. 148, "Accounting for Stock-Based Compensation -- Transition and
Disclosure -- an amendment of FASB Statement No. 123," was issued in December
2002 and amends FASB Statement No. 123, "Accounting for Stock-Based
Compensation," to provide alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. In addition, this Statement amends the disclosure requirements of
Statement 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. The
Company's policy is not to expense stock options; therefore, management does not
believe adoption of this statement will have a material impact on our financial
condition and results of operations.

FIN No. 45, "Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Guarantees of Indebtedness of Others" was issued in
November 2002. FIN No. 45 elaborates disclosures to be made by a guarantor in
its interim and annual financial statements about its obligations under certain
guarantees that it has issued. It also clarifies that a guarantor is required to
recognize, at the inception of a guarantee, a liability for the fair value of
the obligation undertaken in issuing the guarantee. The initial recognition and
initial measurement provisions of FIN 45 are applicable on a prospective basis
to guarantees issued or

78

modified after December 31, 2002. The disclosure requirements are effective for
periods ending after December 15, 2002. Management is reviewing the potential
impact of adoption of this statement on its financial condition and results of
operations.

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.

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 of securities consisting of the
following:

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, 2002 and 2001, the fair value of the portfolio would
have declined by $1.5 million and $2.1 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 $275.8 and $703.7 million as of December 31, 2002
and 2001, respectively. We also had short-term borrowings of $27.3 and $69.3
million as of December 31, 2002 and 2001, 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

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; therefore, we have not hedged this exposure. In the future, we may
enter into derivative financial instruments as a means of hedging this risk.

79

We manage currency exposure related to our brokerage business on a
geographic basis. We generally match each of the non-U.S. subsidiary's
liabilities with assets denominated in the same local currency and manage each
subsidiary's balance sheet in 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 when translated into the
U.S. dollar, our reporting currency. We currently do not seek to mitigate this
exchange rate exposure, but we may in the future.

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.

The following is a breakdown of the currency denominations of our
securities owned (in millions):

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 $7.9
million and $4.3 million as of December 31, 2002 and 2001, respectively.

A portion of our revenues and expenses are denominated in non-U.S. dollar
currencies. Approximately 20.4% of our revenues and 10.1% of our expenses as of
December 31, 2002 and 24.3% of our revenues and 22.0% of our expenses as of
December 31, 2001 were so denominated. Our profits are therefore exposed to
foreign currency risk -- not a loss of funds but rather 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 $3.3 million and $4.3 million as of December 31, 2002 and 2001,
respectively. We do not hedge this exposure as it is for financial reporting
purposes.

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 $2.9
million and $5.6 million as of December 31, 2002 and 2001, respectively.

CREDIT RISKS

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

80

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.

We are also exposed to credit risks from third parties that owe us money,
securities or other obligations. These parties include our customers, trading
counterparties clearing agents, exchanges and other financial institutions.
These parties may default on their obligations due to bankruptcy, lack of
liquidity, operational failure or other reasons. Over the last three years, our
loss from a counterparty refusing to pay or was unable to settle with us have
been immaterial.

We are exposed to the credit worthiness of agencies with which we invest a
portion of our available cash, primarily U.S and non-U.S. government and agency
obligations, as well as corporate and municipal bonds. For investments maturing
within six months, our credit policy is that all investments have at least an
A1/P1 credit rating from Standard & Poors and Moody's Investors Service. We also
maintain counterparty concentration limits that specify the amount that we can
invest with any one counterparty.

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INSTINET GROUP INCORPORATED

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

82

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors
of Instinet Group Incorporated

In our opinion, the accompanying consolidated financial statements present
fairly, in all material respects, the financial position of Instinet Group
Incorporated and its subsidiaries at December 31, 2002 and 2001, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 2002, 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.

As discussed in Note 2 and 5 to the financial statements, on January 1,
2002 the Company has adopted the goodwill provisions of Statement of Financial
Accounting Standard No. 142, "Goodwill and Other Intangible Assets."

PricewaterhouseCoopers LLP

New York, New York
January 27, 2003

83

INSTINET GROUP INCORPORATED

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

The accompanying notes are an integral part of these consolidated financial
statements.
84

INSTINET GROUP INCORPORATED

CONSOLIDATED STATEMENTS OF OPERATIONS

The accompanying notes are an integral part of these consolidated financial
statements.
85

INSTINET GROUP INCORPORATED

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

The accompanying notes are an integral part of these consolidated financial
statements.
86

INSTINET GROUP INCORPORATED

CONSOLIDATED STATEMENTS OF CASH FLOWS

The accompanying notes are an integral part of these consolidated financial
statements.
87

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. The Company is approximately 63% 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.

- The Island ECN, Inc. ("Island"), a U.S. registered broker-dealer which
provides agency brokerage services primarily to broker-dealers, 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.

- 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 to broker-dealers and institutional customers in
Europe, Asia and Canada.

- ProTrader Securities LP. ("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. 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.

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. Soft dollar revenues and revenues subject to commission
recapture are offset dollar-for-dollar by soft dollar research payments and
commission recapture expenses.

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INSTINET GROUP INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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.

Investments are accounted for under the equity method if the Company has
the ability to exercise significant influence, but not control over the
investee. Significant influence is deemed to exist if the Company has ownership
of between 20% and 50%.

Realized and unrealized gains and losses from investments are included in
investment income on the Consolidated Statements of Operations.

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 amortization of $295,098 and $373,689 as of December 31, 2002
and 2001, respectively.

ACQUISITIONS AND GOODWILL

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 estimated fair value of the Company's reporting units. The
Company estimates fair value by using a discounted cash flow model or by using
the services of an external valuation specialist. 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 No. 142, "Goodwill and other Intangible Assets"
("SFAS 142"), 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.

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.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The Company's subsidiary, ProTrader Group, L.P. ("ProTrader"), has entered
into agreements whereby additional consideration would be paid to former owners
of trading offices it had purchased. The additional consideration is generally
based on actual trading volumes of the respective trading office and is
generally effective for a period of two years from the date of acquisition. In
accordance with EITF 95-8: "Accounting for Contingent Consideration Paid to
Shareholders of an Acquired Enterprise in a Purchase Business Combination", the
Company records these contingent payments as additional goodwill.

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 $1,126 and $6,001 at
December 31, 2002 and 2001. Amortization expense was $3,373, $5,136 and $4,431
for the years ended December 31, 2002, 2001 and 2000, respectively.

INCOME TAXES

The Company files a consolidated income tax return in the U.S. and combined
U.S. state and local income tax returns, where applicable.

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 Operations for changes
in deferred tax assets and liabilities.

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 No. 123, "Accounting for Stock-Based Compensation" ("SFAS 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 123 and
accordingly, records compensation expense over the vesting period.

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Had the Company determined compensation cost based on the estimated fair
value at the grant dates for its stock based plans under SFAS 123, the Company's
net income for the years ended December 31, 2002, 2001 and 2000 would have been
as follows:

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 Statements of Operations. 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.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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.

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 of $22,002 and $7,472 as of December 31, 2002 and 2001,
respectively.

Included in commissions and other receivables is approximately $30 million
from Archipelago L.L.C.., B-Trade Services LLC and REDIBook ECN L.L.C of which
approximately $11 million is under dispute. The Company has commenced
arbitration proceedings before the NASD and has established a reserve against
the disputed amount based upon a review of the facts and circumstances
surrounding the dispute. (Note 19)

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.

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 Operations 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.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

TREASURY STOCK

The Company's purchases of shares of its own common stock are recorded as
treasury stock under the cost method and are shown as a reduction to
stockholders' equity on the statement of financial condition.

RESTRUCTURING

The Company accounts for its cost reduction initiatives and resulting
restructuring charges in accordance with EITF 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)," SFAS No. 112,
"Employer's Accounting for Post Retirement Benefits," and SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets."

3. 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 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 an
advance to the Company of $150 million by Reuters.

In connection with the Company's initial public offering, the Company
converted from a limited liability company to a corporation in the state of
Delaware.

4. ACQUISITIONS ($ IN THOUSANDS)

ISLAND

On September 20, 2002, the Company acquired 100% of the outstanding common
stock of Island Holding Company, Inc., the parent company of The Island ECN,
Inc. (collectively, "Island"). Island's results of operations, since that date,
have been included in the Company's consolidated financial statements. Island is
a leading electronic securities marketplace, with a large liquidity pool of
orders to buy and sell securities that are published in its marketplace.
Island's proprietary technology enables it to offer low cost, rapid and reliable
order display and matching services to its customers. The Company believes this
acquisition will result in better execution opportunities for its customers, a
stronger technology and trading platform, an alternative to other offerings,
cost savings, and a stronger management team.

The aggregate purchase price was $555,349, consisting of $492,826
representing 80,658,886 shares of the Company's common stock, $20,141
representing additional common shares for the conversion of options, warrants
and stock appreciation rights, deferred tax liability of $32,560 related to
intangible assets and $9,822 representing direct costs of the acquisition. The
value of the common shares issued was determined based on the average closing
market price of the Company's common shares over the 2-day period before and
after June 10, 2002, the date the terms of the acquisition were agreed to and
announced.

The following table summarizes the estimated fair values of the assets
acquired and liabilities assumed at the date of acquisition. The allocation of
the excess purchase price over the estimated fair values of Island's

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

assets and liabilities was performed by an independent valuation specialist and
were as follows as of September 20, 2002:

PROTRADER

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 believed this acquisition would 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
Less liabilities assumed.................................... (8,616)
--------
Net assets acquired......................................... $152,806
========

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

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 ("Montag"), 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.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following unaudited supplemental pro forma information has been
prepared to give effect to acquisition of Island as of the beginning of the year
preceding the year in which the acquisition occurred. 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 for the Company's acquisition of
LJR and ProTrader.

5. GOODWILL ($ IN THOUSANDS)

The following table sets forth the changes in the carrying amount of
goodwill:

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.

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, as of December 31, 2001.
Goodwill amortization was $8,110 and $7,505 for the years ending December 31,
2001 and 2000, respectively.

The Company acquired approximately 92% of ProTrader in 2001, thereby
increasing goodwill by $70,583, and acquired the remaining 8% in 2002,
increasing its goodwill by $4,606. In addition, the Company recorded additional
goodwill of $23 related to contingency consideration paid to former owners of
trading offices purchased by its subsidiary ProTrader.

The Company completed its merger with Island on September 20, 2002, thereby
increasing its goodwill by $421,081. In addition, Island had existing goodwill
of $261.

In the first quarter of 2002, during the Company's adoption of SFAS 142 and
its transitional review test of goodwill, the Company identified indicators of
possible impairment of its recorded goodwill related to its ProTrader
acquisition. Such indicators were an overall decrease in customer transaction
volumes during the first quarter, which led to operating losses. As a result,
the Company closed several trading offices and restructured its operations in
the first quarter of 2002. In accordance with SFAS 142, based on the results of
a discounted cash flow analysis, the Company calculated a pre-tax level of
goodwill impairment of $15,750, which was represented by the shortfall of the
discounted cash flows versus the carrying amount of goodwill.

In May 2002, the Company closed its fixed income trading platform. Due to a
global economic slowdown and the uneven pace of acceptance of electronic fixed
income trading platforms, the business had been unable to reach a critical mass.
As a result, the Company's goodwill related to its acquisition Montag was
impaired. Therefore, the Company recorded a pre-tax impairment loss of $3,296,
the remaining carrying value of its goodwill for that business in May 2002.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

During the third quarter of 2002, the Company experienced a decline in its
market capitalization, particularly towards the end of the quarter. Due to this
significant decrease, the Company's book value exceeded its fair market value.
The Company believes that the significant decline in market value reflects the
ongoing challenging business environment, declining business fundamentals, the
commoditization of its services, the launch of significant competitive products
and a difficult regulatory environment. These events prompted the Company to
perform a goodwill impairment test.

In accordance with SFAS 142, based on the results of a valuation analysis
prepared by an independent specialist, the Company has determined that its
existing goodwill had been completely impaired and as a result the Company
recorded a pre-tax goodwill impairment loss of approximately $552 million, the
remaining carrying value of its goodwill, as of September 30, 2002.

For comparative purposes, the following table reflects the Company's
results for the years ended December 31, 2001 and 2000, adjusted as though the
Company had adopted SFAS 142 on January 1, 2000:

6. INTANGIBLE ASSETS ($ IN THOUSANDS)

Information regarding the Company's identifiable intangible assets are as
follows:

Intangible assets arose in connection with the Company's acquisitions of
ProTrader in October 2001 and Island in September 2002. The intangible assets
are amortized on a straight-line basis over their respective

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

estimated useful lives as shown above. Amortization expense for the year ended
December 31, 2002 and 2001 was $14,232 and $2,358, respectively. Estimated
amortization expense for each of the next 5 years is:

7. 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 result from additional investments, sales, and unrealized and
realized gains and losses, as well as fluctuations in exchange rates for
investments made in non-U.S. dollars. A description of the Company's more
significant investments is as follows:

- WR Hambrecht + Co ("Hambrecht")-- In 1999 and 2000, the Company made
strategic investments totaling $27,500, now representing a 7.0% 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, the
Company carried its investment at estimated fair value of $16,450. In
December 2002, the Company wrote off its remaining value in Hambrecht due
to a significant decrease in the valuation of its shares as a result of a
recent round of financing, as well as the dramatic slowdown in investment
banking activity. In addition, as of December 31, 2002, the Company has
recorded a loan receivable from Hambrecht in the amount of $2,031. This
loan accrues interest at prevailing market rates and matures in February
2007 and June 2007.

- TP Group LDC -- Beginning in 1999, the Company made strategic
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. In November
2000, the Company made an additional investment and, as of December 31,
2002 and 2001, the Company carried its investment at estimated fair value
of $2,695 and $8,816, respectively.

- Archipelago Holdings LLC ("Archipelago") -- In 1999, the Company made an
investment of 15,528 GBP, now representing approximately 4.8% 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. In March 2002, Archipelago merged with REDIBook
ECN LLC, another ECN. As of December 31, 2002 and 2001, the Company
carried its investment at estimated fair value of $15,000 and $40,000,
respectively.

- The Nasdaq Stock Market, Inc ("Nasdaq") -- In 2000, the Company made an
investment of $15,475 in Nasdaq, and its subsidiaries, ProTrader and
Island, carried investments in Nasdaq totaling $2,817, together now
representing 1.7% interest. As of December 31, 2002 and 2001, the Company
carried its investment at estimated fair value of $14,792 and $15,736.

- Tradeware S.A. ("Tradeware") -- In 2000, the Company made strategic
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, 2002 and 2001, the Company
carried its investment at $3,254 and $4,492, respectively, as determined
under the equity method. In addition, as of December 31, 2002, the

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Company recorded a loan receivable from Tradeware in the amount of
$2,045. This loan accrues interest at prevailing market rates and matures
on December 31, 2004.

- JapanCross Securities Co. Ltd. ("Japan Cross") -- In 2001, the Company
made a series of strategic investments totaling $3,782, now representing
a 50% interest in Japan Cross, a joint venture which was established to
provide a crossing service for Japanese equity securities. As of December
31, 2002 and 2001, the Company carried its investment at $2,096 and
$3,782, respectively as determined under the equity method.

- Starmine Corporation ("Starmine") -- In February 2002, the Company made
an investment of $2,000 representing a 12.8% interest in Starmine.
Starmine provides independent ratings of Wall Street equity analysts. As
of December 31, 2002, the Company carried its investment at estimated
fair value of $2,000.

- e-Xchange Advantage Corporation ("e-Xchange") -- In July 2002, the
Company made an investment of $2,000 representing a 9.8% interest in
e-Xchange. e-Xchange formed a partnership with Nasdaq to develop
securities electronic trading systems and tools. As of December 31, 2002,
the Company carried its investment at estimated fair value of $2,000.

- Vencast, Inc. ("Vencast") -- In 2000 and 2001, the Company made
investments of 5,031 GBP and $1,500, respectively, in Vencast. Vencast
provided 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. In March 2002, Vencast ceased
operations and the Company wrote off its carrying value. In addition, as
of December 31, 2001, the Company had recorded a loan receivable from
Vencast in the amount of $3,000, which was subsequently written off.

- 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. At December 31, 2001, the Company carried its investment
at estimated fair value of $250. In June 2002, the Company wrote off its
investment in Roundtable.

8. RESTRUCTURING ($ IN THOUSANDS)

The Company has initiated several cost reduction programs, which have
resulted in restructuring charges. Information regarding the Company's
restructuring charges follows:

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 a charge of $4,000 and $7,500 for the years ended December 31,
2001 and 2000. All of the liability related to this restructuring charge had
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. This restructuring
was completed in 2001 at a cost of $24,400 in the year ended December 31, 2001
and included:

- Workforce Reduction -- the Company reduced its employee headcount 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 $21,000 related to its
workforce reduction during the second half of 2001.

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- Office Closures/Consolidation -- 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 $3,000 related to its office closures during the second
half of 2001.

As of December 31, 2002, the Company carried a liability of $3,273
associated with this restructuring on its Consolidated Statements of Financial
Condition, which is reflected as follows:

The Company expects to pay the remaining liability by December 31, 2003.

In March 2002, the Company announced that it would reduce its annualized
fixed operating costs in order to offset the impact of reduced revenues due to
its price reductions to U.S. broker-dealer customers. This restructuring
included reducing staff levels and related occupancy costs, improving system and
network efficiencies, and restructuring non-core businesses. During the year
ended December 31, 2002, the Company incurred a charge of $58,395, which
included:

- Workforce Reduction -- the Company reduced its employee headcount by 489.
The departments primarily affected were various operational areas in
technology support functions, clearing operations, sales and trading, and
administrative functions in its U.S. and international offices. The
Company recorded a pre-tax charge of $39,989 for the year ended December
31, 2002, related to its workforce reduction.

- Office Closures/Consolidation -- the Company closed the Houston, Los
Angeles and San Jose trading offices of its ProTrader subsidiary,
consolidated its European trading and clearing operations, significantly
reduced the size of its offices in Switzerland, U.K. and France, and
consolidated its office space in the U.S. given its lower headcount. The
Company recorded a pre-tax charge of $18,406 for the year ended December
31, 2002, related to its office closures.

As of December 31, 2002, the Company carried a liability of $29,543
associated with this restructuring on its Consolidated Statements of Financial
Condition, which is reflected as follows:

The Company expects to pay approximately $22 million of the remaining
liability by December 31, 2003.

In December 2002, the Company announced that it had commenced a
cost-reduction plan to reduce operating costs in order to achieve cost synergies
in connection with its acquisition of Island. This restructuring

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

included reducing staff levels and related occupancy costs. During the year
ended December 31, 2002, the Company incurred a charge of $62,405, which
included:

- Workforce Reduction -- the Company reduced its employee headcount by 300.
The departments primarily affected were various operational areas in
technology support functions, clearing operations, sales and trading, and
administrative functions in its U.S. and international offices. The
Company recorded a pre-tax charge of $26,356 related to its workforce
reduction.

- Office Closures/Consolidation -- the Company closed the Tampa, Dallas and
Chicago offices and consolidated the remaining office space at its
ProTrader subsidiary, and consolidated its office space in the New York
City area, given its lower headcount. The Company recorded a pre-tax
charge of $36,049 related to its office closures.

As of December 31, 2002, the Company carried a liability of $50,709
associated with this restructuring on its Consolidated Statements of Financial
Condition, which is reflected as follows:

The Company expects to pay approximately $13 million to $15 million of the
remaining liability by December 31, 2003.

9. DISCONTINUED OPERATIONS ($ IN THOUSANDS)

On May 3, 2002, the Company closed its fixed income trading platform. The
Company began developing its fixed income business in 1998 and started trading
in the spring of 2000. Against the background of a global economic slowdown and
the uneven pace of acceptance of electronic fixed income trading platforms, the
business had been unable to reach a critical mass. As a result of the closure,
the Company incurred the following charges:

A restructuring charge of $22,514 related to the closure of the Company's
fixed income platform is reflected for the year ended December 31, 2002. As of
December 31, 2002, the Company carried a liability of $221 associated with this
restructuring on its consolidated statements of financial condition, which is
expected to be substantially paid by June 30, 2003.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

10. STOCK-BASED PLANS ($ IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

RESTRICTED STOCK UNITS

In 2002, the Company granted Restricted Stock Units ("RSU") to certain
members of senior management in lieu of cash for a portion of each member's
calendar year 2001 bonus, including a Board member and the newly appointed Chief
Executive Officer. The RSUs are convertible into an equal number of shares of
the Company's common stock and generally vest either one or two years from the
date of grant. As of December 31, 2002, the Company has granted 208,807 RSUs.

WARRANTS

Under the terms of the merger agreement with Island, the Company converted
and issued 2,851,327 warrants to holders of Island warrants as substitutions for
Island warrants outstanding at September 20, 2002. The warrants have an exercise
price of $1.04 and expire in January 2011.

STOCK APPRECIATION RIGHTS ("SARS")

Under the terms of the merger agreement with Island, the Company converted
and issued 19,006 SARs as substitutions for SARs to holders of Island SARs
outstanding at September 20, 2002. The SARs have an exercise price of $0.91,
vest over 3 or 4 years and have a term of 7 years.

OPTIONS

Instinet Plan

Substantially all employees and certain directors of the Company and
certain employees of Radianz who were previously employees of the Company (Note
20) 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 and generally vest over 4 years.
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. The Company has authorized the
issuance of a maximum of 34,118 shares of common stock under the Instinet Plan.
Options expire on dates ranging from March 2003 to December 2011.

Under the terms of the merger agreement with Island, the Company converted
and issued 2,942,128 options to holders of Island options as substitutions for
Island options outstanding at September 20, 2002. These converted options are
subject to the provisions of the Island Stock Option plan, which vest over 3 or
4 years, have a terms of 5 to 10 years and carry exercise prices ranging from
$0.91 to $9.23.

101

INSTINET GROUP INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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

Additional information on options outstanding as of December 31, 2002 is as
follows:

In September 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. The Company recorded unearned
compensation of $22,553 and $718 for employees and non-employees, respectively,
as unearned compensation on the modification date as a separate component of
stockholders' equity.

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, at a conversion
rate of 1.033209. There was no change in the economic value per each option
granted.

In October 2002, the Company approved an adjustment to the exercise prices
of all outstanding options issued prior to September 19, 2002 to adjust for the
dividend to the Company's stockholders, in accordance with FIN 44, "Accounting
for Certain Transactions involving Stock Compensation an Interpretation of APB
No. 25." The exercise prices of these options were decreased by $0.98 per
option. The $0.98 adjustment reflects the change in the price of Company's
common stock between the close of business on Friday, September 20, 2002, the
last date on which the common stock price included the dividend, and the open of
business on Monday, September 23, 2002, the first date on which the common stock
began trading without the right to the dividend.
102

INSTINET GROUP INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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 Depository Shares ("ADS"). SAYE options are issued for terms of
4 or 6 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, 2002
and 2001:

- 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 4
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, 2002 and 2001:

103

INSTINET GROUP INCORPORATED

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:

OPTION EXPENSE

The Company applies APB Opinion No. 25, "Accounting for Stock Issued to
Employees", SFAS 123, and related accounting interpretations for all of its
stock-based plans referred to above. As a result, the Company has recorded as
compensation expense $4,254, $5,979 and $2,674 as of December 31 2002, 2001 and
2000, respectively.

OTHER

The weighted average estimated fair value of the Instinet Plan options
granted during the years ended December 31, 2002 and 2001 was $4.42 and $5.80
per option, respectively. The weighted average estimated fair value of the
Reuters Plan's ordinary share options granted during the years ended December
31, 2001 was

104

INSTINET GROUP INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

$8.58 per option. The fair value of each option granted is estimated, as of its
respective grant dates, using a Black-Scholes option-pricing model with the
following weighted average assumptions:

11. EARNINGS PER SHARE ($ AND SHARES IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

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.

Options and warrants to purchase 4,426 shares of common stock were not
included in the computation of diluted EPS for the year ended December 31, 2002
as the Company incurred losses during the period. Accordingly, the diluted EPS
computation does not include the anti-dilutive effect of these options and
warrants. Options to purchase 20,373 shares of common stock were not included in
the computation of diluted EPS for the year ended December 31, 2001 as the
exercise price for these options exceeded the average market price of the
Company's common stock for each of the respective periods. Accordingly, the
diluted EPS computation does not include the anti-dilutive effect of these
options. The number of common shares outstanding, both basic and diluted, for
the year ended December 31, 2000 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.

105

INSTINET GROUP INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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

12. 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:

106

INSTINET GROUP INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

13. 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 join 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 1 and 2 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 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. In 2002, Reuters modified its
post retirement benefits and a majority of accrued costs related to the post
retirement plans will be reversed over the next 19 years in accordance with
generally accepted accounting principles.

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 $15,750 and $42,577, respectively. The Company ceased the deferral plan at
the end of 2002.

Employees of Island are eligible to participate in Island's defined
contribution 401(k) plan upon meeting certain eligibility requirements. The
Company makes discretionary contributions based upon its results of operations.
In January 2003, the Company terminated the Island plan and transferred the
Island employees to the Instinet Plans.

107

INSTINET GROUP INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

14. INCOME TAXES ($ IN THOUSANDS)

The provision for income tax consisted of the following:

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

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

108

INSTINET GROUP INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

15. COMPREHENSIVE INCOME ($ IN THOUSANDS)

Comprehensive income includes net income and changes in stockholders'
equity except those resulting from investments by, or distributions to,
stockholders. Comprehensive income is as follows:

16. ALLOWANCE FOR DOUBTFUL ACCOUNTS ($ IN THOUSANDS)

The following table summarizes the activity in the Company's allowance for
doubtful accounts:

Other additions were acquired in connection with the Company's acquisition
of Island.

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

109

INSTINET GROUP INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

18. 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,
2002 and 2001, ICS, which is the counterparty to each of the customer
transactions in U.S. securities executed through ICorp (but not Island, which
clears its securities transactions through another broker-dealer), had net
capital of $163,084 and $259,990, which was $160,179 and $256,443 in excess of
its required net capital of $2,905 and $3,547, respectively. 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, 2002 and 2001, these subsidiaries had met
their local capital adequacy requirements.

19. COMMITMENTS AND CONTINGENCIES ($ IN THOUSANDS)

LITIGATION

From time to time, the Company is involved in various legal proceedings
arising in the ordinary course of business. The Company is also subject to
periodic regulatory audits and inspections. While any litigation contains an
element of uncertainty, it is the opinion of management after consultation with
counsel, that the outcomes of such proceedings or claims are unlikely to have a
material adverse effect on the business, financial condition or operating
results of the Company.

110

INSTINET GROUP INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

LEASES

The Company leases office space and equipment under non-cancellable
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:

Rental expense amounted to $26,818, $32,299 and $23,238 for the years ended
December 31, 2002, 2001 and 2000, respectively.

OTHER COMMITMENTS AND CONTINGENCIES

The Company has received letter of credit agreements totaling $99,813,
$174,800 and $343,313 for the years ended December 31, 2002, 2001 and 2000 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.

20. 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. All receivables and payables with
affiliates and the Parent are generally settled on a quarterly basis. 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, 2002, 2001 and 2000, the Company recorded as expense $11,814,
$13,849 and $12,321, respectively, related to these services.

Reuters provides certain operational and administrative support and other
general corporate services to the Company. For the years ended December 31,
2002, 2001 and 2000, the Company recorded as expense $28,864, $31,228 and
$41,239, respectively, related to these services.

In 2002, the Company entered into agreements with Bridge Trading, a wholly
owned subsidiary of Reuters, under which the Company pays fees for accounts or
orders introduced by Bridge Trading to the Company. Payments under these
agreements amounted to $415 for the year ended December 31, 2002.

In 2001, the Company leased office space for its corporate headquarters in
New York City from 3 Times Square Associates LLC, a joint venture between
Reuters and an independent third party. The lease expires in 2021 with a
one-time right to cancel the lease after 10 years. Payment related to this lease
agreement was $14,569 and $8,563 for the years ended December 31, 2002 and 2001.

Effective September 2001, the Company sold at book value its Research and
Analytical Product ("R&A") to Reuters in order to allow Instinet R&A users to
leverage Reuters investment in Bridge by allowing them to participate in a much
broader service, while still benefiting 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

111

INSTINET GROUP INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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 service and support from Reuters. For the
years ended December 31, 2002 and 2001, the Company has recorded $5,582 and
$1,757, respectively, as expense to Reuters for continuing to provide this
service.

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 years ended December
31, 2002 and 2001, and the period from July 2000 to December 31, 2000, the
Company incurred expenses of $30,042, $58,686 and $30,959, respectively, related
to the Radianz agreement.

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 an
interest 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.

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.

21. DIVIDEND ($ IN THOUSANDS)

In connection with the acquisition of Island, the Company paid a $1.00 per
common share cash dividend to its stockholders of record as of September 19,
2002, which represented a distribution of $248,739, of which $206,900 was
distributed to the Company's Parent. The Company paid this dividend on October
3, 2002.

22. TREASURY STOCK ($ IN THOUSANDS)

During 2002, the Company purchased 244,960 shares of its own common stock
at a cost of $1,532 in connection with its RSU plan (Note 10) and reissued
39,153 shares as RSUs became vested.

23. COLLATERAL ARRANGEMENTS ($ IN THOUSANDS)

As of December 31, 2002 and 2001, the fair value of collateral held by the
Company that can be sold or repledged totaled $777,286 and $607,069,
respectively. Such collateral is generally obtained under resale and securities
borrowing agreements. Of this collateral, $699,037 and $548,487 had been sold or
repledged generally to cover short sales or effect deliveries of securities as
of December 31, 2002 and 2001, respectively. In addition, securities in customer
accounts with a fair value of $47,549 and $76,462 could be sold or repledged by
the Company as of December 31, 2002 and 2001, respectively.

24. 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
112

INSTINET GROUP INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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.

25. 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, 2002, 2001 and 2000, 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.

26. SUBSEQUENT EVENTS

Effective January 1, 2003, the Company terminated its participation in the
Reuters 401(k) plan and formed the Instinet 401(k) plan.

On January 7, 2003, pursuant to an existing option purchase agreement, the
Company purchased Harborview LLC, a NYSE floor brokerage firm for $594,000.

113

INSTINET GROUP INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

27. 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.

114

INSTINET GROUP INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

115

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 2003 Annual Meeting of Stockholders to be filed with the Securities and
Exchange Commission pursuant to Regulation 14A within 120 days after December
31, 2002 (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.

ITEM 14. CONTROLS AND PROCEDURES

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

Within the 90 days prior to the date of this report, we carried out an
evaluation under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures. Based upon and as of the date of that evaluation, the Chief
Executive Officer and Chief Financial Officer concluded that the disclosure
controls and procedures are effective in all material respects to ensure that
information required to be disclosed in the reports we file and submit under the
Exchange Act are recorded, processed, summarized and reported as and when
required.

CHANGES IN INTERNAL CONTROLS

There have been no significant changes in our internal controls or other
factors that could significantly affect our internal controls subsequent to the
date of their evaluation. There were no significant deficiencies or material
weaknesses identified in the evaluation and therefore no corrective actions were
taken.

116

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a) Exhibit List

117

118

119

120

121

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

* Filed herewith

+ Management Compensation Arrangement

122

(b) The following reports on Form 8-K were filed for the last quarter
covered by this report, and subsequently through March 28, 2003:

123

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

Date: March 28, 2003.

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.

II-1

II-2

CERTIFICATIONS

I, Edward J. Nicoll, certify that:

1. I have reviewed this annual report on Form 10-K of Instinet Group
Incorporated;

2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under
which such statements were made, not misleading with respect to the period
covered by this annual report;

3. Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
annual report;

4. The registrant's other certifying officers and I are responsible
for establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:

a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report is
being prepared;

b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this annual report (the "Evaluation Date"); and

c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons performing
the equivalent function):

(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability
to record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and

(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have indicated in
this annual report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.

Date: March 28, 2003

By: /s/ EDWARD J. NICOLL
------------------------------------
Name: Edward J. Nicoll
Title: Chief Executive Officer

II-3

I, John F. Fay, certify that:

1. I have reviewed this annual report on Form 10-K of Instinet Group
Incorporated;

2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under
which such statements were made, not misleading with respect to the period
covered by this annual report;

3. Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
annual report;

4. The registrant's other certifying officers and I are responsible
for establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:

d) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report is
being prepared;

e) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this annual report (the "Evaluation Date"); and

f) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons performing
the equivalent function):

(c) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability
to record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and

(d) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have indicated in
this annual report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.

Date: March 28, 2003

By: /s/ JOHN FAY
------------------------------------
Name: John Fay
Title: Chief Financial Officer

II-4

EXHIBIT INDEX

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

* Filed herewith

+ Management Compensation Arrangement