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UNITED STATES

FORM 10-Q

For the quarterly period ended September 30, 2003

or

For the transition period from                      to

Commission file number 000-32717

Instinet Group Incorporated

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

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

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

     As of November 7, 2003 there were 330,966,188 share of the registrant’s common stock outstanding.

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Instinet Group Incorporated

FORM 10-Q QUARTERLY REPORT
For the Quarter Ended September 30, 2003

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

Forward-Looking Statements

We have made forward-looking statements in this report on Form 10-Q that are based on our management’s beliefs and assumptions and on information currently available to our management. From time to time, we may also include oral or written forward-looking statements in other materials released to the public. 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. The forward-looking statements contained in this report speak only as of the date hereof, and we do not undertake any obligation to update any of them publicly in light of new information or future events.

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 could cause our results to differ materially from those expressed or suggested in forward-looking statements, including those discussed below under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Quantitative and Qualitative Disclosures About Market Risk,” and under the caption “Certain Factors that May Affect Our Business” in our Annual Report on Form 10-K.

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Part I. FINANCIAL INFORMATION

Item 1. Financial Statements

Instinet Group Incorporated
Consolidated Statements of Operations
(In thousands, except per share amounts)
(Unaudited)

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

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Instinet Group Incorporated
Consolidated Statements of Financial Condition
(In thousands, except per share amounts)
(Unaudited)

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

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Instinet Group Incorporated
Consolidated Statement of Cash Flows
(In thousands)
(Unaudited)

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

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Instinet Group Incorporated
Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
(Unaudited)

NOTE 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 also operates an alternative trading system business consisting of the Instinet and Island ECNs and their clearing broker, Instinet Clearing Services.

     In the second quarter of 2003, the Company began formulating a business restructuring plan that includes separating the Company’s management and business operations into two distinct business lines: 1) Instinet, the Institutional Broker, our value-added brokerage, which includes services we provide to the Company’s non-broker-dealer institutional customers as well as Lynch, Jones & Ryan, the Company’s commission recapture subsidiary and 2) the ECN or alternative trading system (“ATS”), which will be known as “INET.” During the quarter, we continued to make progress on this plan. The aim of this restructuring is to have each business pursue its own distinct interests, add strategic clarity to each business and allow better identification of the costs of each business.

     The Company is approximately 63% owned by subsidiaries of Reuters Group PLC (“Reuters”).

NOTE 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. These financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and, in the opinion of management, reflect all adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of the financial position, results of operations and cash flows for the periods presented in conformity with generally accepted accounting principles. These unaudited financial statements should be read in conjunction with the Company’s audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K, as filed with the SEC.

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 the 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.

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Instinet Group Incorporated
Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
(Unaudited)

EARNINGS (LOSS) PER SHARE

     Basic earnings (loss) per share (“EPS”) is calculated by dividing net earnings by the weighted average number of common shares outstanding. Common shares outstanding include common stock and treasury stock for which no future service is required as a condition to the delivery of the underlying common stock. Diluted EPS includes the determinants of basic EPS and, in addition, reflects the dilutive effect of the common stock deliverable pursuant to stock options and to treasury stock for which future service is required as a condition to the delivery of the underlying common stock. The dilutive effect is included in the calculation of weighted average shares for periods that we have net income.

The computations of basic and diluted EPS are set forth below:

SOFT DOLLAR AND COMMISSION RECAPTURE

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

INVESTMENTS

     Investments with no ready market 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

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Instinet Group Incorporated
Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
(Unaudited)

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 that 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.

STOCK-BASED COMPENSATION

     The Company accounts for stock-based compensation to employees and directors using the intrinsic value method of accounting in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.” Therefore, no compensation expense was recognized for those stock options that had no intrinsic value on the date of grant.

     Had the Company recognized compensation expense over the relevant service period under the fair-value method of SFAS No. 123 with respect to stock options granted, the Company’s pro forma net income (loss) and EPS would have been as follows:

     The Company granted approximately 10,002 stock options during the nine months ended September 30, 2003. These options generally vest over service periods of three to four years.

CASH AND CASH EQUIVALENTS

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

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Instinet Group Incorporated
Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
(Unaudited)

SECURITIES OWNED

     Securities owned are recorded on a trade date basis and are carried at their market value with unrealized gains and losses reported in investments on the Consolidated Statements of Operations. Securities owned, with the exception of shares in stock exchanges, have maturities of less than 3 years and consist of the following:

SECURITIES BORROWED AND LOANED

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

RECEIVABLE FROM AND PAYABLE TO BROKER-DEALERS

     Receivable from broker-dealers is primarily comprised of fails to deliver with broker-dealers. 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 are primarily comprised of institutional debit balances and payable to customers represent free credit balances in customer accounts.

COMMISSIONS AND OTHER RECEIVABLES, NET

     Commissions and other receivables are reported net of a provision for doubtful accounts of $26,494 and $22,002 as of September 30, 2003 and December 31, 2002, respectively.

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Instinet Group Incorporated
Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
(Unaudited)

     As of September, 30, 2003, included in commissions and other receivables is approximately $31,143 from Archipelago L.L.C., B-Trade Services LLC and REDIBook ECN L.L.C of which approximately $17,233 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.

     On October 21, 2003, the Company was granted a motion for summary judgment with respect to The Island ECN, Inc. v. B-Trade Services LLC claim, resulting in an award of $1,979 (which includes interest), plus taxable costs and fees (see Note 12).

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 counterparties, 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 (loss) income on the Consolidated Statements of Financial Condition.

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 they are incurred. These activities have not resulted in a material impact to the Company’s operations to date.

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Instinet Group Incorporated
Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
(Unaudited)

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 Consolidated Statements of Financial Condition.

RESTRUCTURING

     The Company has accounted 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 Employment Benefits,” and SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS No. 146, which the Company adopted January 1, 2003, eliminates the future use of EITF 94-3 for restructuring initiatives. The adoption of SFAS No. 146 has not had a material effect on the Company’s financial condition, results of operations or cash flows.

NOTE 3. INVESTMENTS

     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. The carrying value of the Company’s investments is as follows:

NOTE 4. COLLATERAL ARRANGEMENTS

     As of September 30, 2003 and December 31, 2002, the fair value of collateral held by the Company that can be sold or repledged totaled $614,429 and $777,286, respectively. Such collateral is generally obtained under resale and securities borrowing agreements. Of this collateral, $604,302 and $699,037 had been sold or repledged generally to cover short sales or effect deliveries of securities as of September 30, 2003 and December 31, 2002, respectively. In addition, securities in customer accounts with a fair value of $85,579 and $47,549 could be sold or repledged by the Company as of September 30, 2003 and December 31, 2002, respectively.

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Instinet Group Incorporated
Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
(Unaudited)

NOTE 5. NET CAPITAL REQUIREMENTS

     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 September 30, 2003 and December 31, 2002, Instinet Clearing Services, Inc., which is the counterparty to each of the customer transactions in U.S. securities executed through Instinet Corporation, had net capital of $99,186 and $163,084, which was $91,424 and $160,179 in excess of its required net capital of $7,762 and $2,905, 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 September 30, 2003 and December 31, 2002, these subsidiaries had met their local capital adequacy requirements.

NOTE 6. INTANGIBLE ASSETS

     Information regarding the Company’s identifiable intangible assets is as follows:

     Intangible assets arose in connection with the Company’s acquisitions of ProTrader Securities LP in October 2001 and Island Holding Company, the parent company of the Island ECN, Inc. (collectively, “Island”) in September 2002. The intangible assets are amortized on a straight-line basis over their respective estimated useful lives of up to 7 years.

     Amortization expense was $6,292 and $2,898 for the three months ended September 30, 2003 and 2002, respectively, and $18,877 and $7,940 for the nine months ended September 30, 2003 and 2002, respectively. Estimated amortization expense for each of the next 5 years is as follows:

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Instinet Group Incorporated
Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
(Unaudited)

NOTE 7. COMMITMENTS AND CONTINGENCIES

     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, management believes, after consultation with counsel, that the outcomes of such proceedings or claims are unlikely to have a material adverse effect on the Company.

NOTE 8. COMPREHENSIVE LOSS

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

NOTE 9. CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE

     Pursuant to SFAS 142, the Company changed its accounting policy related to goodwill effective January 1, 2002. SFAS 142 requires that goodwill no longer be amortized to earnings, but instead be reviewed for impairment at least annually. Under SFAS 142, impairment is deemed to exist when the carrying value of goodwill is greater than its implied fair value.

     During the first quarter of 2002, the Company identified indicators of possible impairment of its recorded goodwill related to its ProTrader Group, LP (“ProTrader”) and Montag Pöpper & Partner GmbH (“Montag”) acquisitions. For ProTrader, such indicators were an overall decrease in customer transaction volumes, which primarily led to operating losses. As a result, the Company closed several trading offices and restructured its operations. Based on the results of a discounted cash flow analysis, the Company calculated a 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. Therefore, the Company’s goodwill related to its acquisition of Montag, a fixed income broker-dealer, was impaired and the Company recorded an impairment loss of $3,296, the remaining carrying value of its goodwill.

     The Company recorded goodwill impairment, net of taxes, of $18,642 or $0.07 a share, for the nine months ended September 30, 2002 as a change in accounting principle.

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Instinet Group Incorporated
Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
(Unaudited)

NOTE 10. RESTRUCTURING

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

     In July 2001, the Company announced a review of spending initiatives with the aim of reducing its underlying operating cost structure. During the year ended December 31, 2001, the Company incurred a charge of $24,400 and this restructuring was substantially complete during 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. As of September 30, 2003, the Company carried a liability of $8,994 associated with this restructuring on its Consolidated Statements of Financial Condition, which is reflected as follows:

     The Company expects to pay a significant portion of the 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 included reducing staff levels and related occupancy costs. During the year ended December 31, 2002, the Company incurred a charge of $62,405. As of September 30, 2003, the Company carried a liability of $23,120 associated with this restructuring on its Consolidated Statements of Financial Condition, which is reflected as follows:

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Instinet Group Incorporated
Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
(Unaudited)

     The Company expects to pay approximately $1,000 to $3,000 of the remaining liability by December 31, 2003.

NOTE 11. DISCONTINUED OPERATIONS

     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:

     The Company recorded a restructuring charge of $22,514 related to the closure of its fixed income platform for the year ended December 31, 2002. The Company has substantially paid this liability.

NOTE 12. SUBSEQUENT EVENTS

LEGAL PROCEEDINGS

     On October 21, 2003, the Company was notified that its motion for summary judgment had been granted by the panel in The Island ECN, Inc. v. B-Trade Services LLC. As part of that decision, the arbitration panel (i) sustained Island’s claims against B-Trade in their entirety resulting in an award to Island of $1,979 (which includes interest), plus taxable costs and fees, and (ii) dismissed B-Trade’s defenses and counter-claims against Island. This panel’s ruling completely resolves this matter in Island’s favor. Island’s claims against Archipelago L.L.C. and REDIBook ECN L.L.C. (and the respective counter-claims) are still pending in arbitration.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

     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.

Business Environment

     U.S. equity market volumes decreased during the third quarter of 2003 with Nasdaq share volume, a primary driver of our business, down 2% over the second quarter of 2003 and flat from the third quarter of 2002. Outside of the U.S., market conditions improved during the third quarter of 2003 over the second quarter of 2003 with international market consideration, or total trading value, increasing approximately 16% due primarily to a rebound in Asian markets. International market consideration also increased approximately 19% compared to the third quarter of 2002.

     Although our gross transaction fee revenues of $272.5 million for the third quarter of 2003 increased from $254.3 million in the comparable period in 2002, much of this gain was offset by an increase to $53.6 million from $39.0 million in broker-dealer rebate expense. Our average pricing for U.S. equities has leveled off the past several quarters but has decreased significantly this quarter compared to the comparable period in 2002. We believe this decrease is due primarily to reductions in our broker-dealer pricing during 2002 as well as an increase in lower priced broker-dealer volume as a percentage of total volume resulting primarily from our acquisition of Island effective September 20, 2002.

Strategic Developments

     In the second quarter of 2003, we began formulating a business restructuring plan that includes separating our management and business operations into two distinct business lines: 1) Instinet, the Institutional Broker, our value-added brokerage, which includes services we provide to our non-broker-dealer institutional customers as well as Lynch, Jones & Ryan, our commission recapture subsidiary and 2) the ECN or alternative trading system (“ATS”), which will be known as “INET.” During the quarter, we continued to make progress on our plan. The aim of this restructuring is to have each business pursue its own distinct interests, add strategic clarity to each business and allow better identification of the costs of each business.

     Our value-added broker serves institutions around the world. Its products and services are designed to improve both the trading efficacy and investment performance of our clients. Instinet, the Institutional Broker, plans to release to clients before year-end two key brokerage products for U.S. equity trading: Continuous Block Crossing, or CBX, and Proactive SmartRouter. CBX is a block-matching system with minimum order and trade-size parameters and penny price increments to better facilitate block trading. Proactive SmartRouter will enable clients, in addition to routing marketable orders to the best available execution option, to post orders in more than one venue at the same time.

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     Our ATS business is currently made up of two ATS’s — the Instinet ECN and the Island ECN, and their clearing broker, Instinet Clearing Services, Inc. We are in the process of integrating these two pools of liquidity into one single ATS, to be called “INET.” We expect that INET will be one of the largest liquidity pools in Nasdaq-listed equities and it will operate based on the Island technology platform. INET will also provide its clients with access to other U.S. trading venues utilizing Instinet’s SmartRouter technology.

     Additionally, we recently announced plans for INET to display its best bid and offer price in Nasdaq’s SuperMontage. INET will begin displaying orders on SuperMontage in January following the consolidation of the Island ECN and Instinet ECN.

     As a result of the business restructuring, we expect to record a restructuring charge in the fourth quarter of 2003 or concurrent with the implementation of the restructuring plan. Upon completion of the business restructuring, we currently anticipate we will provide separate financial disclosures for the VAB and the ATS as established by SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information” for the first quarter of 2004.

Pricing Change

     We recently announced that our two ECNs would offer a 25% price reduction for routing orders in over-the-counter securities to other trading venues through Instinet’s SmartRouter. Further, retroactive to October 1, 2003 and effective through the end of this year, the price was reduced by an additional 12% for a 37% reduction overall.

Market Share and Market Volumes

     During the three months ended September 30, 2003, trading volumes in the U.S. markets decreased to 231.8 billion shares from 239.1 billion for the comparable period in 2002. Total Nasdaq-listed share volume was 110.7 billion shares in the three months ended September 30, 2003, level compared to 110.2 billion shares in the comparable period in 2002. U.S. exchange-listed share volume was 121.1 billion shares in the three months ended September 30, 2003, down from 128.9 billion shares for the comparable period in 2002.

     Our overall market share increased to 14.7% or 34.2 billion of total U.S. market share volume, which comprised 26.5% or 29.3 billion of Nasdaq share volume, and 4.0% or 4.8 billion of U.S. exchange-listed share volume, in the three months ended September 30, 2003. In the comparable 2002 period, our overall market share was 11.1% or 26.5 billion of total U.S. market share volume, which comprised 20.0% or 22.6 billion of Nasdaq share volume, and 3.0% or 3.9 billion of U.S. exchange-listed share volume. We believe our market share in Nasdaq-listed stocks and share volume has increased significantly since the third quarter of 2002, due to our acquisition of Island in September 2002. However, our overall market share decreased from 15.5% in the three months ended June 30, 2003 primarily due to lower Nasdaq share volume.

Non-GAAP Financial Measurements

     In evaluating our financial performance and results of operations, management reviews certain financial measures that are not in accordance with generally accepted accounting principles in the United States (“non-GAAP”). Non-GAAP measurements do not have any standardized meaning and

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are therefore unlikely to be comparable to similar measures presented by other companies. Management uses non-GAAP financial 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 financial measures should be considered in context with our GAAP results.

     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: