A B WATLEY GROUP INC - 10-K Annual Report

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

Form 10-K
(Mark One)

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended September 30, 2001

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______ to ______

Commission file number: 1-14897

A.B. Watley Group Inc.
----------------------
(Name of registrant as specified in its charter)

Delaware 13-3911867
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

40 Wall Street, New York, New York 10005
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(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code: (212) 422-1100
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Securities registered pursuant to Section 12(b) of the Act:

None

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

Common Stock, $.001 par value
-----------------------------
(Title of Class)

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

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

The issuer's revenues for the fiscal year ended September 30, 2001 were
$25,471,902.

The aggregate market value of the voting stock held by nonaffiliates of
the registrant on January 11, 2002 (computed by reference to the closing price
of such stock on such date) was approximately $20,730,922. The number of shares
of common stock, par value $.001 per share, outstanding as of December 31, 2001
was 12,887,138 shares.

DOCUMENTS INCORPORATED BY REFERENCE

None

Forward Looking Statements: This Report contains certain statements that may be
deemed "forward-looking statements" within the meaning of Section 27A of the
Securities Act and Section 21E of the Exchange Act. All statements, other than
statements of historical facts, that address activities, events or developments
that the company intends, expects, projects, believes or anticipates will or may
occur in the future are forward-looking statements. Such statements are based on
certain assumptions and assessments made by management of the company in light
of its experience and its perception of historical trends, current conditions,
expected future developments and other factors it believes to be appropriate.
The forward-looking statements included in this Report are also subject to a
number of material risks and uncertainties, including but not limited to
economic, competitive, governmental and technological factors affecting the
company's operations, markets, services and prices, and other factors discussed
in the company's filings under the Securities Act and the Exchange Act.
Stockholders and prospective investors are cautioned that such forward-looking
statements are not guarantees of future performance and that actual results,
developments and business decisions may differ from those envisaged by such
forward-looking statements.

PART I

Item 1. Business

A.B. Watley Group Inc. ("company" or "Watley") is the parent company of A.B.
Watley, Inc., a New York registered broker-dealer that operates both
direct-access trading and third market institutional sales trading brokerage
businesses. A.B. Watley Group Inc. provides direct-access trading capabilities
and related software to both retail as well as corporate customers. As of
September 30, 2001, the brokerage firm had approximately 12,000 retail
customers. In August 2000 we began marketing our proprietary technology, which
we call a Direct-Access Vertical Exchange (DAVE), to the brokerage and banking
industries. These initiatives resulted in our licensing agreement with E*TRADE
Group, Inc. Historically, revenues have been generated primarily from retail and
institutional customer transactional fees. In the future, we anticipate
augmenting that revenue with licensing and related fees from corporate clients.

The primary goal of the firm is to become cash-flow positive as quickly as
possible. Having spent a great deal of money on developing and implementing our
technological infrastructure and trading software for our target markets, we are
now poised to both reduce costs and expand the core businesses on this efficient
superstructure.

Cost cutting initiatives will include aggressively reducing headcount,
renegotiating our clearing agreements at more favorable rates, reducing use of
software consultants and implementing more cost efficient methods of software
development. We expect to reduce our total headcount by 30% over the next
several months. We recently completed renegotiation of our clearing agreements
which will result in savings of approximately 38% based on current trading
levels. While we will continue to consider the possibility of self-clearing in
the future, it is not currently cost efficient to do so given our new clearing
agreements and current trading levels. Having completed our direct-access
trading platform, along with receiving acceptance from E*Trade in accordance
with the terms of our contract, we will greatly reduce our dependence on
software consultants. In fiscal year ended 2001, software consultants amounted
to approximately $4,000,000.

We will continue to pursue a two pronged approach to grow our business. Having
experienced a challenging year in 2001, we are focusing on our two core
competencies: servicing the most active trading segment of the online trading
community and actively pursuing additional software licensing clients.

On November 2, 2001, Watley acquired substantially all the assets of On-Site
Trading, Inc. ("On-Site") and assumed $1.8 million in liabilities. This
acquisition included On-Site's client's base, a limited liability corporation
(the "LLC"), two branches owned by On-Site, and agreements with 12 non-business
branch locations ("NBBL"). National Association of Securities Dealers ("NASD")
Rule 3010(g) defines "branch office" and includes several exemptions from branch
office registration requirements for non-branch business locations that meet
certain conditions under the Rule. The conditions include limitations on how the
NBBL is advertised to the public. The Securities and Exchange Commission has
further clarified what represents a branch versus an NBBL. Any office location
that (i) performs any function of an office of supervisory jurisdiction, (ii)
publicly displays signage, (iii) operates from public areas of buildings, such
as bank branches, even when such locations are temporarily staffed, or (iv)
advertises an address in any public media would still be required to register as
a branch office. Such locations hold themselves out to the public as being
places where the member conducts a securities business and thus, come within the
definition of a branch office. Watley acquired these assets for 1.875 million
shares of common stock. The liability portion is to be put toward On-Site's
liabilities to LLC and will be paid out over a three-year period.

Watley acquired a total of 1,700 accounts representing assets (account balances
and securities) of $84 million. The account breakdown is as follows; 1,200 of
those clients were being serviced from branches or non-business branch
locations. 500 of those 1,700 clients were what we call `remote' users, or
Internet-based users. As of December 31, 2001, average customer account balances
were $36,800, and average customer trades were 3,000 per day. The acquired
branches are located in Boca Raton, Florida and Great Neck, New York. Coupled
with the branch acquisitions, the additional non-business branch locations in
Encino CA, Chicago IL, Glen Cove NY, Naples FL, West Palm Beach FL, Bethesda MD,
Brooklyn NY, Cedarhurst NY, Melville NY, Birmingham AL, Red Bank NJ, and Beverly
Hills CA give Watley a national presence to leverage business growth and
marketing efforts. The distinction between the branches and the non-business
branch locations is for an NBBL the branch manager is responsible for all branch
expenses (rent, computer hardware, and communications) and in turn receives a
portion of the commissions paid by the branch customers. For owned branches the
company is responsible for all branch expenses and the branch manager is an
employee of the company. As such, the branch manager does not receive any of the
branch commissions.

The LLC was formed, and operates in 12 states, as a means for registered
professionals to engage in proprietary trading utilizing the LLC's funds in
securities transactions. The LLC engages exclusively in proprietary trading and
does not conduct business with the public. A $20,000 capital contribution is
required to become a Class B member. Intraday/Overnight buying power is
available to the Class B member to the extent that the aggregation of all
positions in all of the company's accounts are within the firm's Net Capital
requirements and is also limited in accordance with risk parameters set up by
the Class A member based on the Class B member's capital balance. The buying
power available to an LLC Class B member is generally higher than that available
to a broker-dealer customer. The registered professionals are the Class B
members of the LLC. The LLC is a registered broker-dealer and a member of the
PHLX. Watley is the Class A member of the LLC.

As our company integrates these assets and personnel. We intend to leverage the
marketing potential that this branch and non-business branch location network
represents to generate growth as well as additional cost savings by eliminating
redundant functions. We have has already identified and eliminated all major
redundancies and are working actively to integrate the business and achieve
additional cost savings. As we integrate the new client base completely, we have
commenced an internal initiative to migrate as many of the old On-Site user base
from the old Redi Trading platform using the clearing services of Spear, Leeds &
Kellogg ("Spear Leeds"), to our own UltimateTrader(R) II platform clearing
through Penson Financial Services, Inc. Our strategy is continue to provide the
Redi system to those users, with an aggressive marketing and pricing campaign to
convert as many as possible to the Watley platform to continue to reduce costs
and streamline operations. As we migrate these clients over, even greater
economies of scale will be realized.

The acquisition of assets of On-Site is on course to be a cash flow positive, or
accretive, acquisition. The selective acquisition of these types of businesses
will be an integral part of our plan moving forward and will allow us to achieve
greater economies of scale through our operations and highly scalable trading
platform.

The On-Site acquisition initiated our strategy to roll-up select, cash flow
positive and complementary brokerage businesses. We think that Watley has a
significant competitive advantage within the direct-access market segment in
that we are in a position to use equity as a viable acquisition currency if a
deal makes economic sense. There are a number of very attractive brokerage
companies with complementary client bases to ours that our company's structure
can incorporate intelligently into our current infrastructure goals. We are
actively engaged in negotiations with a number of them.

We are working to make software licensing a core revenue source in the future.
After our signing a contract with E*Trade Group, Inc. ("E*Trade") in November of
2000, we committed significant development resources in order to bring that
licensing endeavor to fruition. Having spent nearly six months in development to
integrate the data delivery and front-end presentation layer portions of our
software into their transaction engine, we entered into a testing environment in
July 2001. E*Trade launched our product into a production environment in
September. By the end of December 2001 we had billed E*Trade in excess of
$345,000 for both licensing and development work. Additionally, we have reached
an agreement that stipulates that we may serve as a development resource for
E*Trade on software development outside the scope of the original contractual
obligations regarding the delivered software. As the quality of our software is
constantly improving and we gain momentum and market acceptance, we hope to
obtain more licensing deals. Our primary target for licensing remains the online
brokerage community, clearing corporations and banks.

New Opportunities

Direct-access trading technology provides customers with the opportunity to
trade securities directly into various market centers, including exchanges and
Electronic Communication Networks (ECNs) without the intervention of a broker.
The absence of broker intervention is a key feature that differentiates us from
most online brokers. Other features of our service include:

o Integrated Product: real-time market data delivery and trade execution
software

o Speed: Average trade execution is less than 5 five seconds

o Market Transparency: Ability to view all market participants and market
centers in real-time

Generally, direct-access results in better trade execution as well as lower
transactional costs for the user.

Our services are delivered through DAVE, which is a combination of our
proprietary: (a) order entry and trade processing and (b) data delivery engines.
Today, customers can access DAVE through (i) UltimateTrader(R) II, our
proprietary client-server direct-access software application and (ii)
WatleyTrader, our proprietary web-based direct-access platform.

We believe our subsidiary, A.B. Watley, Inc., is one of the largest
direct-access brokerage firms in the U.S. A.B. Watley, Inc. is a registered
securities broker-dealer and member of the National Association of Securities
Dealers, Inc. Through this unit we provide real-time online financial brokerage
products and services to retail and institutional customers.

2

Industry Overview

Our industry has recently experienced a series of changes led by electronic and
online commerce. These changes have created significant market opportunities for
us along with other similar brokerage firms. Favorable market trends have
resulted from (i) growing market acceptance of online brokerage services; (ii)
pronounced market segmentation; (iii) a complementary regulatory environment;
and (iv) disparity in the scalability and quality of competing trading
technologies.

Growing Market Acceptance of Online Brokerage Services

Historically, individual investors accessed the financial markets through
full-commission brokers, who offered investment advice and placed trades. With
deregulation of brokerage commissions in 1975 and the resulting unbundling of
brokerage services, investors began to realize that they could separate
financial advisory services from securities trading. This brought about the
advent and subsequent proliferation of discount brokerage firms, which provided
an alternative investment approach by completing trades at a reduced cost.

The emergence of electronic brokerage services has provided investors with the
ability to further unbundle services and costs typically charged by
full-commission and traditional discount brokerage firms. By requiring personnel
to handle each transaction, most traditional brokerage firms restrict client
access to trading and information. Further, while full-commission and discount
brokerage firms are able to offer electronic trading services, their continued
reliance on personnel, branch offices and associated infrastructure prevents
them from capturing the same operating efficiencies that are achievable by
electronic trading.

The growth of discount brokerage firms and the increasing utilization of the
Internet to access a wide range of financial services underscore a fundamental
shift in market demographics. This shift has altered the way consumers manage
their personal financial assets. Based on industry research reports and the
rapid consumer acceptance of online transactions, we believe consumers are
increasingly taking direct control over their personal financial affairs, not
only because they are now able to do so, but also because they find it more
convenient and less expensive than relying on financial intermediaries.

3

Pronounced Market Segmentation

As the brokerage industry has matured, market segmentation has become more
pronounced. Segments within the industry are defined and identified based on a
variety of demographic factors. One of these factors is customer trading
activity. In July 2000, Robertson Stephens, Inc. stated in its Active Trading
report that active traders (all accounts trading 30-plus times a quarter),
represent approximately 54% of the 1.68 million average online daily trades yet
only 6.3%, or 800,100 of approximately 12.7 million total online accounts. This
translates into 910,000 trades per day from 800,100 accounts, or an average of
68 trades per account per quarter, versus the overall online industry average of
7 trades per quarter. Although these numbers are from the year 2000, and online
trading has slowed down in the year 2001, we believe that the percentages that
they represent continue to remain valid.

Since inception, we have targeted and served the most active 5-7% of trading
clients in the U.S. It is our belief that this group also happens to be among
the most profitable and historically under-serviced segment within the brokerage
community. This active trading segment is our primary target market.

There has been an active trader segment in the U.S. for many years. Active
trading is dependent upon the following core characteristics: (i) software
quality; (ii) software reliability; and (iii) access to efficient liquid market
centers. Until recently, access to that efficiency and liquidity was primarily
limited to institutions. Direct-access broadens the availability to all
investors. Moreover, this capability fuels the expansion of the active trader
segment.

We are positioned to provide this market segment with some of the most
sophisticated trading systems available. As recently as five years ago, a
website that offered online trading technology was considered state-of-the-art.
Today, our direct-access technology, featuring smart-order routing and
split-second trade execution empowers all investors. While many of our
competitors in the brokerage industry decide whether to adopt this leading edge
technology, we have created and grown our business model based on three core
elements that together represent the foundation of our trading platforms. These
core elements are maximum liquidity, transparency and speed.

A Complementary Regulatory Environment

In 1996, the SEC adopted rules that brought sweeping changes to the structure of
the over-the-counter market. These rule changes also brought potential benefits
to our business and to our competitors. They also brought significant benefits
to active trading clients. Known as "order handling rules", they allowed for the
creation and operation of ECN's. ECN's are open broadcasting systems that allow
anyone with a connection to the network to see all the bids and offers posted
into the system for any Nasdaq traded security. The order handling rules require
market makers to display certain limit orders in their quotations or to send
those orders to an ECN for display. The increased regulatory emphasis on
enforcing compliance with the duty of brokers to obtain the best execution for
their clients has fostered the growing importance of ECN's, which provide an
ever-increasing source of liquidity in the over-the-counter market.

Additional and more recent rule changes have facilitated the emergence of
direct-access trading technology and business models offering such technology.
The Securities and Exchange Commission has adopted two rules to improve public
disclosure of order execution and routing practices. Under Rule 11Ac1-5, market
centers that trade Nasdaq National Market System securities are required to make
available to the public monthly electronic reports that include uniform
statistical measures of execution quality. Under Rule 11Ac1-6, broker-dealers
that route customer orders in equity and option securities to certain
destinations for execution are required to make available on a quarterly basis
reports that, among other things, identify the venues to which customer orders
are routed for execution. In addition, broker-dealers will be required to
disclose to customers, on request, the venues to which their individual orders
were routed. By reporting execution activity, many expect that the brokerage
industry, in particular order-handing, will become more transparent to the
public. These rules are also intended to spur more vigorous competition among
market participants to provide the best possible prices for investor orders.

In light of the new disclosure rules being adopted, many industry analysts feel
that demand for direct-access execution capabilities and real-time market
information will continue to grow and potentially grow at an increasing rate. We
believe that these recent regulatory developments, coupled with the increased
availability of real-time information, advances in the Internet and networking
and communications technologies, have created significant investing
opportunities for active traders and investors. These recent changes also
represent significant market opportunities for online brokerage services.

Disparity in the Scalability and Quality of Competing Trading Technologies

The expansion of the online brokerage market has significantly impacted the
financial markets. The development of direct-access and our DAVE technology
represent the next wave of change. While the established online brokers have
used the Internet to make more efficient the communication with investors, our
proprietary direct-access technology allows investors to interact directly with
markets. In our opinion, this interactive capability represents a fundamental
change and will become the accepted standard in the financial markets.

4

Our direct-access platform is not only technologically advanced, but is also
highly scalable (see "Technology Summary"). The combination of technology and
scalability provides us with a competitive advantage versus the established
online brokers as well as the smaller PC-based direct-access competitors. Many
of the largest online brokers presently possess the scale to accommodate
increased customer adoption; however, few currently own and/or offer a
direct-access service. In addition, the PC-based direct-access brokers are at a
competitive disadvantage because their existing capabilities lack the
much-needed scalability. Our current technological architecture allows us to
deliver a direct-access product efficiently to thousands, and potentially,
hundreds of thousands of simultaneous highly active retail and institutional
clients.

The Future of Direct-Access Trading Technology and DAVE

Our services are delivered through DAVE, which is a combination of our
proprietary: (a) ticker plant; (b) order entry and trade processing and (c) data
delivery engines. Today, customers can access DAVE through (i) UltimateTrader(R)
II, our proprietary client-server direct-access software application; and (ii)
WatleyTrader, our proprietary web-based direct-access platform.

Benefits of our proprietary technology platform to us include significantly
increased scalability, reliability and manageability. We also expect our
technology platform to substantially increase operating margins by eliminating
almost all third-party software licensing and data services fees and
streamlining internal information management support.

State-of-the-Art Technology

In the latter part of 1998, we commenced a strategic upgrade of our entire
technology platform in order to support an anticipated increase in demand for
our direct-access online brokerage services. Since that time, we have developed
and launched DAVE, our state-of-the-art trading and market data system. Our
system is designed to accommodate substantial increases in both client demand
and the regulatory requirements resulting from decimalization, regulatory
reporting changes and T+1 settlement. Our current implementation of leading-edge
order entry and trade processing and data delivery technology ensures
scalability, flexibility, reliability and manageability to accommodate the "next
wave of change in the financial markets."

Features

Our technology model provides a number of significant and value-added benefits
to active investors:

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A.B. Watley Technology Benefits for the retail market
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System Feature Client Benefits
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o Direct Access to Exchanges & o Allows investors to execute
ECNs independently of third party market
makers for more efficient executions.
Provides ability to act as "market
maker" on par with institutional
traders.

o Superior Speed of Execution o Client-server order execution model
substantially reduces time elapsed
between investor order entry and
receipt of order by exchange/ECN.
Average order execution time for an
OTC market order is 2-7 seconds.

o Order Routing Discretion o Enables investors to actively
determine venue for order execution
among variety of alternatives (Island,
Instinet, other ECNs, NASDAQ, specific
market makers, NYSE DOT, our company
block trade desk). Provides critical
added ability to trade at the best
price.
- --------------------------------------------------------------------------------
o NASDAQ Level II Data o Enables access to complete range of
bid/ask, volume and market depth for
variety of execution markets.
- --------------------------------------------------------------------------------
o Realtime Data Analytics o Provides best available retail package
of realtime, streaming market data,
charts and technical analysis. This
suite of content includes intraday
charting, a variety of analytical
studies (e.g., RSI, moving averages,
MACD), time and sales, option quote
chains, regional exchange quotes and
news.
- --------------------------------------------------------------------------------
o High Utilization Capacity o Affords access to our company's
technology platform by entire client
base on simultaneous basis. Critical
given consistent high level of
concurrent utilization and spikes in
utilization due to highly volatile
market movements and shifts in market
liquidity.
- --------------------------------------------------------------------------------
5

Technology Summary

We have created an enterprise class ticker plant, data delivery (DD) system and
order and entry trade processing (OETP) system for the U.S. securities markets
that is state-of-the-art. Our Direct-Access Vertical Exchange, or DAVE, system
architecture is resident in a Sun Solaris UNIX operating environment and is
comprised of a number of best of breed component middleware parts, commercial
grade and proprietary databases and administered and continuously improved on by
seasoned professionals at the cutting edge of financial services technology.

For the market data delivery side of DAVE, we run proprietary database systems
in a combination of JAVA and C++. On the order entry and trade processing
portion, we run database systems provided by Oracle. Through a combination of
these components and proprietary business logic, the OETP (Order Entry and Trade
Processing) component system provides a platform to handle vast numbers of users
engaged in high-volume direct-access trading.

The DAVE: Open/Distributed Enterprise Architecture

[GRAPHIC]

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UltimateTrader ----
Client |
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| -------------
| ---- B2B
| | Partner
| INTERNET/ | -------------
| ---- INTRANET ---- |
| | | -------------
| | ---- 3rd Party
| | Application
| | -------------
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Web ---- |
-------------- |
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Multiple
Redundant
Internet
Connection
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|
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| |
-------------------------------- --------------------------------
Order Entry and Trade Processing Data Delivery System

Tuxedo Transaction Tuxedo Transaction
- -------- Monitoring MW Monitoring MW --------
Oracle ---- JMS Publish and Subscribe JMS Middleware ---- Oracle
Database Multiple SUN E-4500 Servers Multiple SUN E-4500 Servers Database
- -------- -------------------------------- -------------------------------- --------
/ \ \
/ \ \
----------------------- ----------------------- -----------------------
Service Bureau Exchange Interfaces Market News and Data
Back Office NYSE, NASDAQ, NASDAQ, CME, CBOT,
ECNs, Order Desk NYSE, OPRA
----------------------- ----------------------- -----------------------

Highly Scalable and Cost Efficient UNIX-based trading system

Our upgraded platform has been developed to run on UNIX computing platforms,
offering the benefit of expansion and scalability. This in turn allows for the
ready "cloning" of the technology platform with minimum modification and cost to
accommodate a substantial increase in customer demand in forms of data feeds and
transactions. UNIX also contributes significantly to the efficiency of the
platform by providing superior processing capacity, thereby requiring fewer
servers to process trading activity. Fewer UNIX servers also implies lower
server-related maintenance costs relative to NT servers.

6

System scalability has also been enhanced by the utilization of a Massive
Parallel Processing (MPP) architecture design. By managing transaction
processing on a "stateless" basis, our system enables increased processing power
in proportion to the addition of hardware. This increased processing power was
vital when the securities markets moved to decimalization (increasing market
data volume by two to three times). It will also be a very important aspect of
our readiness for when the markets move to a T+1 settlement environment
(necessitating realtime order entries to back-end or service bureau mainframes).

Open/Distributed Enterprise Architecture Highly Flexible

Both the OETP and DD systems utilize the C++/Java programming paradigm in
connection with object oriented application development and iterative
development cycles. As a result, the primary software components utilized in
both systems can be readily modified for future upgrades and projects. By
adopting an open architecture approach, moreover, our system can integrate
different protocols, application programming interfaces, third party
applications, operating systems and hardware without disrupting the enterprise
infrastructure.

The open architecture approach will also enable us to more easily integrate the
trading system with third party software developer applications, thereby
providing built-in potential scalability to alternative distribution channels
controlled by third parties. This principle was proven by the fact that we
effectively integrated with our first large licensing client, E*Trade.

Transaction Processing Architecture Highly Fault Tolerant

The transaction order-processing platform provides superior reliability by
incorporating three major commercial enterprise class software entities. We
achieve high availability with our databases by employing Oracle enterprise
products. Through the utilization of JMS (JAVA messaging service) we achieve
message delivery reliability. And through implementation of BEA Tuxedo
middleware we are ensured that we achieve high levels of transactional
integrity. In addition, effective recovery ability is provided through the
storage of information in the database prior to the transmission of any message,
data or transaction coupled with the ability to recall this data and restart
transactions seamlessly.

System Reduces Cost of Market Data Delivery

Upon completion and launch of our proprietary data delivery and software product
UltimateTrader II in September of 2000, we began the migration of our client
base to our own proprietary platform. This migration caused such costs to be
reduced from the $227.50 per month to approximately $13 per client per month.
The proprietary software and associated scale economies will allow us to be one
of the lowest cost providers of integrated real-time streaming market data.

The enhanced technology platform eliminates much of the effective cost of
large-scale data delivery by employing a "publish and subscribe" delivery method
that makes all market data available to all investors on an "as needed" basis.
Unlike request-reply processing, publish-subscribe is "decoupled", allowing for
asynchronous, anonymous and immediate communication without complicated
administrative overhead. In conjunction with our proprietary compression
methodology, this approach (i) ensured our ability to cope with surges in
real-time market data demand as the industry migrated into a decimalized
environment; and (ii) significantly reduced both the complexity of application
code and the bandwidth and hardware required for market data delivery. The
enhanced scalability of the Sun server platform further reduced the cost of data
delivery by markedly reducing the number of servers required to support a large
number of investors simultaneously receiving realtime information.

Furthermore, the new platform is capable of employing IP Multicasting and thus
can generate additional savings as the major Internet carriers deploy multicast
enabled networks. By employing IP Multicasting, the system can "broadcast" all
quotes while users subscribe to these quotes as needed - enabling information
delivery to be scaled to a nearly unlimited number of subscribers. This in turn
leads to another significant decrease in the bandwidth and in the number of
servers required to distribute market data to our clients.

7

Architecture Allows for Efficient Administration

Our system incorporates a highly effective system administration function that
provides a complete window on the entire Information Technology ("IT") platform,
thereby allowing system administrators to work proactively to solve system
problems before service may be affected. We utilize BMC Patrol for this critical
task and have been very pleased with the results. This feature, in conjunction
with the enhanced scalability of the Sun server platform, improves managerial
control and efficiency by reducing systems administration staff requirements.
Importantly, the remote administrative capabilities of the software enable us to
utilize any variety of co-location facilities for further cost and manpower
efficiencies and reliability.

Leading Technology Team

We presently maintain a dedicated in-house IT team with the proven expertise and
resources necessary to fully develop, test, modify, maintain and administer a
state-of-the-art online brokerage technology platform. Our technology team has
been completely integrated into our business model from inception, and consists
of 32 full-time IT professionals grouped into a development unit and a system
administration unit. Our team is led by the former Director of IT Strategies for
WorldCom. Also, several of our team members have gained experience with the U.S.
Navy, Morgan Stanley Dean Witter, Goldman Sachs, American Airlines
Sabre/Travelocity, EDS and State Farm Insurance.

Targeted Marketing Strategy for Both Retail and Business-to-Business Clients

Our marketing strategy is to simultaneously target the active trading segment of
the retail customer universe and corporate clients within the banking and
brokerage communities.

Active Trading Segment

In July 2000, Robertson Stephens stated in their Active Trading report that the
active trader market (all accounts trading 30-plus times a quarter), represents
54% of the 1.68 million average online daily trades but only 6.3%, or 800,100,
of the 12.7 million total online accounts. This translates into 910,000 trades
per day from 800,100 accounts. Based on these findings, we presently have a
market share of less than 1% of the active trader segment. We believe that
because of the slowing of online trading in the year 2001, the active-trading
segment is growing in significance. The casual investor may have dropped off in
his volume of trades, but we believe that the active trader still represents
5-7% of the online trading universe and is still transacting over 50% of trading
volume.

We fully intend to continue to target active retail traders and other active
investors. It is our contention that our direct-access product offering is well
positioned to satisfy this "premium" market segment. We have established a very
good reputation as a market leader for direct-access trading platforms and
believe we are well positioned to benefit from both increased market demand and
by owning a superior product and service offering.

Corporate Client Segment

In addition to highly focused retail marketing, we began marketing our products
to other brokerage firms in September of 2000. Through these efforts we procured
our first licensing client. Our technological structure and products instilled
confidence in that we could deliver this product to tens of thousands of
customers of our licensing clients simultaneously, thus meeting the client's
needs. Our advantages over other competitors in this lucrative B-2-B licensing
arena include:

o Scalable and cost-efficient UNIX based architecture
o Highly flexible and adaptable system, allowing ease of client integration
o Proven software development support team, allowing for customized and
differentiated products
o Cost-efficient product delivery

8

Consistent with these competitive advantages, we entered into a licensing
agreement with E*Trade. Under the terms of this agreement, we are providing a
portion of our technology to E*Trade who will in turn offer it to its customers
under the E*Trade brand name. To date E*Trade, starting in September 2001, has
migrated approximately 1,000 customers onto our software. In December 2001
E*Trade, in accordance with our licensing agreement, has officially accepted our
software.

In addition to large brokerage firms and banks, we are marketing our products
and services to the broader day-trading small order execution system (SOES)
industry.

Retail Product and Feature Set Matrix

We currently offer clients and business partners access to DAVE through two
primary access points: (i) software (UltimateTrader(R) II ("UT II")); and (ii)
web-based (WatleyTrader ("WT")). The following table illustrates the feature
sets of each access point:

Product Access Points: . . . . . . . . . . . . . . . . . . . . . . UT II WT
FREE Realtime Level II Data. . . . . . . . . . . . . . . . . . . . X X
Quick buy and sell buttons with auto routing. . . . . . . . . . . X X
Detailed status report on each order entered. . . . . . . . . . . X X
Compatibility with MAC OS.X . . . . . . . . . . . . . . . . . . . X
All activity and account information. . . . . . . . . . . . . . . X X
Links to historical P&L. . . . . . . . . . . . . . . . . . . . . . X X
Dynamic Updating Quotations. . . . . . . . . . . . . . . . . . . . X X
Unlimited Customized Pages. . . . . . . . . . . . . . . . . . . . X
Realtime Purchasing Power. . . . . . . . . . . . . . . . . . . . . X X
Minder View Portfolio Minder. . . . . . . . . . . . . . . . . . . X X
Position Minder. . . . . . . . . . . . . . . . . . . . . . . . . . X X
Scrolling Tickers. . . . . . . . . . . . . . . . . . . . . . . . . X X
Alarms. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . X X
Quick Quotes. . . . . . . . . . . . . . . . . . . . . . . . . . . X X
Hot Keys. . . . . . . . . . . . . . . . . . . . . . . . . . . . . X X
Charts with Technical Studies. . . . . . . . . . . . . . . . . . . X
Color Coded Market Maker Screens. . . . . . . . . . . . . . . . . X X
Time and Sales. . . . . . . . . . . . . . . . . . . . . . . . . . X X
Pre-Market Open and Post-Market Close Trading. . . . . . . . . . . X X

Flagship Direct-access Product: UltimateTrader II

UltimateTrader II is our flagship and premium-level direct-access product
accounting for approximately 65% of total commissions. It provides the user with
the following feature set:

o FREE Realtime Level II Data - continuously updated display of market maker
and electronic communication network current prices and changes.

o Color Coded NASDAQ Market Maker Screens - designed to visually display, by a
special color in the screen, upward and downward trends in recent trades in
a security.

o Charts with Technical Studies - allows clients to view live, dynamically
updating, realtime intraday chart data and historical information for
stocks, option or indices.

o Time and Sales - reflects last and cumulative trades, prices and aggregate
daily volume in a security.

o Pre-Market Open and Post-Market Close Trading - access to trading during
both pre-market open (8:00 AM EST to 9:30 AM EST), and post-market close
(4:00 PM EST to 5:00 PM EST) hours.

o Auto routing - Quick buy and sell buttons with the ability to execute/cancel
trades with a simple keystroke.

o Detailed status report on each order entered - extensive review and order
notification including date stamp, quantity, average price, market
participant and user ID.

o Compatibility with MAC OS X - proprietary data delivery and execution
platform deliverable through the Macintosh OS X operating system.

o All activity and account information - a detailed breakdown of order status,
historical trade information and real time positions, buying power and
realized P&L.

o Links to historical P&L - the ability to see all realized profit and losses.

o Dynamic Updating Quotations - displays real time changes in prices and
markets as they occur.

o Unlimited Customized Pages and screen real estate - allows clients to create
computer screen layouts to their preference with their data and to scroll
freely among these pages.

9

o Realtime Purchasing Power - allows clients to view current buying power, the
value of the account as of the trading day's business morning.

o Portfolio Minder - used to create computer windows with comprehensive price
and other data relating to a number of different securities.

o Position Screen - displays existing open positions.

o Scrolling Tickers - displays price and trading volume information for the
symbols that a client chooses on a live basis. The quotes will move through
the ticker window as the server receives them.

o Alarms - alerts clients by an audio or visual pop-up when target criteria
have been met for a specified security.

o Minder View - a fully configurable quote screen that can display virtually
any information about the security selected.

o Hot Keys - the ability to execute/cancel trades with a simple keystroke.

Additional Brokerage Services

In addition to the features listed above, we offer our clients a full range of
services through third-party relationships. These include: Managed Asset Plan,
Unlimited Checkwriting, Visa Gold Card Services, and Automatic MAP Deposit.
Customers also have access to over 5,000 mutual funds. We also offer a full
suite of research tools including access to Briefing.com and Zacks earnings
estimates.

Client Services

Client services for all levels of our online service, including trading,
administrative, and technical support, are among our highest priorities. Based
on our experience in the industry and based on client feedback, providing an
effective client service team to handle client needs is critical to our success.
Our Client Service department helps clients get online, handles product and
services inquiries and addresses all brokerage and technical questions. The
Client Service department also conducts various surveys to verify the
satisfaction of our clients and to learn more about client preferences and
requirements.

We provide live client support from Monday through Friday between the hours of
8:00 AM and 8:00 PM EST. Our client services department operates on a one-stop
shopping basis, meaning that clients do not typically have to be transferred
between departments to receive answers to their inquiries. We currently employ
25 Client Service personnel (inclusive of management), all of whom are
registered representatives and are available to accept and execute client
orders, research past trades, discuss account information, and provide detailed
technical support. A separate technical support team helps clients with
particularly serious or persistent technical issues.

In order to provide professional and efficient client support, we have purchased
and implemented client relationship management (CRM) and computer telephony
integration (CTI) software. CRM databases are updated with each client contact
to track client service calls. A separate internal database tracks trading
patterns, changes in customer balances and compliance issues. Both databases are
used to generate periodic reports for management. Client services associates
access the latest product and account information through CRM and customer
account databases.

We have created a VIP client services team to service our most active online
clients. By providing client support for all issues on an account manager basis,
we intend for the VIP team to offer much more individualized service on a
prioritized basis. By providing highly prioritized, personalized and
professional client support, especially for our niche market high volume
clients, we will further differentiate our products and services from those of
our competitors.

Account Security

We use a combination of proprietary and industry standard security measures to
protect our clients' assets. Clients are assigned unique account numbers, user
identifications and passwords that must be used each time they log on to the
system. In accordance with standard industry practices, telephone orders require
authentication via personal identification number/password and/or other personal
information. In addition, our trade processing system is designed to compare the
Watley accounts database with the clearing firm's account information on a daily
basis to detect any discrepancies.

We rely on encryption and authentication technology, including public key
cryptography technology licensed from other parties, to provide the security and
authentication necessary to effect the secure exchange of information.

10

Firewalls and other software limit not only system access to the authorized
users, but also limit the authorized users to specifically approved
applications. This filter-software prevents unauthorized access to critical
areas of the system such as account information. Furthermore, public access
servers, such as e-mail, chat services and the file transfer protocol, are in a
network entirely separate from the rest of our systems.

We have implemented special policies relating to the transfer or withdrawal of
funds by clients to prevent unauthorized withdrawals. All requests for fund
withdrawal or transfer require a signed letter from the account holder. Checks
will only be made out in the account holder's name and wire transfers will only
be sent to a bank account in the account holder's name.

Operations, Clearing and Order Processing

We do not hold client funds or securities, nor do we generally execute and
process directly either our own or our clients' securities transactions. Since
October 1996, we have cleared all transactions for clients, on a fully disclosed
basis, with Penson Financial Services, Inc. for retail accounts and Weiss, Peck
& Greer, L.L.C. for institutional accounts. As of the acquisition of certain of
On-Site's assets, we initiated a relationship with Spear Leeds. Although we have
stated our intention in the past to convert to self-clearing operations, the
reduced level of trading activity by our customers coupled with our recently
renegotiated clearing agreements with our vendors has made the conversion to
self-clearing uneconomical at the present time. We will continue to monitor our
clearing relationships and may reconsider the option to self-clear once we have
built our trading volumes to sustainable levels that make it economical to
commit the capital and manpower necessary to make self-clearing a viable
endeavor.

Our agreement with such clearing brokers provide that the clearing brokers
process all securities transactions for our account and the accounts of our
clients for a fee. Services of the clearing brokers include billing and credit
control and receipt, custody and delivery of securities, for which we pay a per
ticket charge. We have agreed to indemnify and hold the clearing brokers
harmless from certain liabilities or claims, including claims arising from the
transactions of our clients, which could be material in amount. Our clearing
agreements may be terminated by either party, upon 60 days' written notice for
Penson Financial Services, Inc., and 30 days prior written notice for Weiss,
Peck & Greer, L.L.C. and Spear Leeds. We depend on the operational capacity and
the ability of the clearing brokers for the orderly processing of transactions.
By engaging the processing services of clearing brokers, however, we are exempt
from certain reserve requirements imposed by federal laws.

Clients' securities transactions are effected on either a cash or margin basis.
In connection with margin transactions, credit is extended to a client,
collateralized by securities and cash in the client's account, for a portion of
the purchase price. The client is charged for margin financing at interest rates
based on the brokers call rate plus an additional amount of up to 1.75%. The
brokers call rate is the prevailing interest rate charged by banks on secured
loans to broker-dealers.

Margin lending is subject to the margin rules of the Board of Governors of the
Federal Reserve System. Margin lending subjects us to the risk of a market
decline that would reduce the value of our collateral below the client's
indebtedness before the collateral can be sold. Under applicable rules, in the
event of a decline in the market value of the securities in a margin account,
the client is required to deposit additional securities or cash in the account.

Third-Market Institutional Sales Desk

Our third-market institutional sales and trading desk specializes in
facilitating and/or executing large-block transactions in approximately 500
thinly traded equity securities, and services approximately 600 institutional
clients. These services are provided to clients who often require that their
purchases or sales of large positions remain anonymous, with average trades
ranging in the 25,000 to 50,000 share size. Approximately forty-percent of the
transactions handled represent a "cross" trade (where we match both buyer and
seller). We match these institutional buyers and sellers to execute off-exchange
transactions, to minimize the impact on the market and prevent our client's
positions from being disclosed to competing firms. Our third-market
institutional sales clients include mutual and pension funds, insurance
companies, banks, corporations and independent fund and money managers.
Approximately 33% of our commission revenues for our fiscal year ended
September 30, 2001 were derived from the institutional trading desk.

Investment Considerations and Risk Factors

Although we are optimistic that we will be able to continue our growth and
strengthen our position in the online and electronic trading of securities, we
also acknowledge that our business and this industry in general are subject to a
number of risks and uncertainties which could adversely affect future results.
Among these are:

11

1. Requirement of Additional Financing. We may need to obtain additional
financial resources as we have not yet begun to generate sufficient internal
cash flow to support our activities. To the extent that such additional sources
of financing are not available or feasible, such lack of financing could have a
material adverse effect on our business. Even if we are able to arrange
additional financing, the terms may not be favorable to our company and may
cause substantial dilution to the ownership percentages of existing
stockholders.

2. Continued Downturns in the Securities Industry Could Adversely Affect Our
Business. A significant portion of our revenues in recent years has been from
online brokerage commissions and related services. During the last fiscal year,
we experienced a decrease of 2,831 UltimateTrader accounts or 48.94% of such
accounts, as well as a significant decrease in overall trading activity by
on-line traders. If we continue to lose accounts or continue to see a
significant decrease in trading activity by our customers, it could severely
negatively impact our viability.

3. Competition In the Online and Electronic Brokerage Business Is Increasing.
Not only are we faced with competing with the traditional electronic trading
firms, such as E*Trade and E-Schwab, as well as smaller sized competitors, but
we are also faced with the entry of new firms, including traditional brokerage
firms such as Merrill Lynch, and the emergence of giants, such as Goldman Sachs
& Co., as a sponsor or joint venturer of e-commerce brokerage firms and
electronic communications networks. We will continue to compete based upon what
we perceive as the excellence of our trading systems, the skills of our customer
service personnel, the breadth of information and other services provided,
attractive pricing of our services and maintenance and upgrade of our
technology. Although added competition has also served to increase the overall
market for this type of brokerage service, the increased competition also places
more pressure on us in our competitive efforts, including a need to increase our
marketing efforts, which is already underway.

4. We Are Expanding Rapidly and Need to Properly Manage Our Increased
Infrastructure. The expansion of our business has led us to increase our systems
and personnel. These must be managed efficiently and places additional burdens
upon executive management.

5. We Must Maintain Our Access to The Most Improved Technology. Technological
changes continue in the electronic commerce field generally and in our segment
of online brokerage. We must keep pace with these technological developments by
a combination of licensing and developing software, to be able to continue to
provide what we regard as highly efficient and attractive services and systems
for our accounts.

6. Our Industry Faces Substantial Regulatory Supervision. We, as well as all
members of the U.S. securities brokerage industry, are regulated by the NASD and
SEC. These supervisory bodies have tended to increase the intensity of their
regulatory efforts, particularly with respect to the online trading industry.
Additional regulations have been proposed, from time to time, dealing with the
suitability of online trading and broker supervision of accounts. All these
place a greater burden on the conduct of our electronic and online brokerage
business.

Suppliers

We obtain financial information from a number of third-party suppliers of
software and information services, including Townsend Analytics, Ltd. and S&P
ComStock, Inc. We have a number of alternative sources of supply of these items
of software and information services available to us at comparable cost, on a
timely basis to provide adequate replacements, if arrangements with any of our
current suppliers are abrogated.

12

Marketing and Advertising

We have significantly reduced our marketing and advertising expenditures and, in
turn, are growing the business through acquisitions and further development of
our branch businesses.

Competition

The market for electronic brokerage services is highly competitive and rapidly
changing. We believe that we compete on the basis of speed of order execution,
processing and confirmation, quality of client service, ease of use, amount and
timeliness of information provided, price and reliability of our trading
systems. We expect that our ability to compete will also be affected by our
ability to introduce new services and enhancements to existing services into the
market on a timely basis.

We believe our competition consists of large and small brokerage firms utilizing
the Internet to transact retail brokerage business. Among these competitors are
E*TRADE Group, Inc.; Charles Schwab & Co., Inc.; Cybertrader, Inc.; Quick &
Reilly, Inc.; Waterhouse Securities, Inc.; Fidelity Brokerage Services, Inc.;
Datek Securities Corp.; Protrader Securities Corp. and Tradecast Securities Ltd.
We also face competition for clients from full commission brokerage firms,
including Merrill Lynch & Co., Inc.; Morgan Stanley Dean Witter & Co.;
PaineWebber Incorporated; and Salomon Smith Barney, as well as financial
institutions and mutual funds.

Securities Regulation

Our Watley subsidiary is a broker-dealer registered with the SEC and NASD and is
licensed as a broker-dealer in 49 states.

The securities industry in the United States is subject to extensive regulation
under federal and state laws. In addition, the SEC, NASD, other self regulatory
organizations, such as the various stock exchanges, and other regulatory bodies,
such as state securities commissions, require strict compliance with their rules
and regulations. As a matter of public policy, regulatory bodies are charged
with safeguarding the integrity of the securities and other financial markets
and with protecting the interests of clients participating in those markets, and
not with protecting the interests of our stockholders.

Broker-dealers are subject to regulations covering all aspects of the securities
business, including sales methods, trade practices among broker-dealers, use and
safekeeping of clients funds and securities, capital structure, record keeping
and the conduct of directors, officers and employees. Because of the recent
increase in the number of complaints by online traders, the SEC, NASD and other
regulatory organizations may adopt more stringent regulations for online firms
and their practices. If we fail to comply with any laws, rules or regulations we
could be censured, fined, issued a cease-and-desist order or Watley or our
officers and employees could be suspended or expelled.

In addition, significant changes in Watley's current business or practices,
including converting to self-clearing operations, require NASD and other
regulatory approval.

To expand our services internationally, we would have to comply with regulatory
controls of each specific country in which we conduct business. The brokerage
industry in many foreign countries is heavily regulated. The varying compliance
requirements of these different regulatory jurisdictions and other factors may
limit our ability to expand internationally.

13

All marketing activities by Watley are regulated by the NASD. The NASD can
impose penalties, including censure, fine, suspension of all advertising, the
issuance of cease-and-desist orders or the suspension or expulsion of a
broker-dealer and its officers or employees for violations of the NASD's
advertising regulations.

Net Capital Requirements

The SEC, NASD and various other regulatory agencies have stringent rules
requiring the maintenance of specific levels of net capital by securities
brokers, including the SEC's uniform net capital rule which governs Watley. Net
capital is defined as assets minus liabilities, plus other allowable credits and
qualifying subordinated borrowings less mandatory deductions that result from
excluding assets that are not readily convertible into cash and from valuing
other assets, such as a firm's positions in securities, conservatively. Among
these deductions are adjustments in the market value of securities to reflect
the possibility of a market decline prior to disposition.

As of September 30, 2001, Watley was required to maintain minimum net capital,
in accordance with SEC rules, of approximately $176,021 and had total net
capital of $423,436 or approximately $247,415 in excess of minimum net capital
requirements.

If Watley fails to maintain the required net capital Watley may be subject to
suspension or revocation of registration by the SEC and suspension or expulsion
by the NASD and other regulatory bodies, which ultimately could require Watley's
liquidation. In addition, a change in the net capital rules, the imposition of
new rules, a specific operating loss, or any unusually large charge against net
capital could limit those operations of Watley that require the intensive use of
capital and could limit our ability to expand our business. The net capital
rules also could restrict our ability to withdraw capital from Watley, which
could limit our ability to pay dividends, repay debt and repurchase shares of
our outstanding stock.

Intellectual Property Rights

We rely on a combination of copyright, trademark and trade secrets laws and
non-disclosure agreements to protect our proprietary technologies, ideas,
know-how and other proprietary information. We hold a United States trademark
registration for the UltimateTrader name. We have no patents or registered
copyrights. Third parties may copy or otherwise obtain and use our proprietary
technologies, ideas, know-how and other proprietary information without
authorization or independently develop technologies similar or superior to our
technologies. In addition, the confidentiality and non-competition agreements
between us and our key employees, distributors and clients may not provide
meaningful protection of our proprietary technologies or other intellectual
property in the event of unauthorized use or disclosure. Policing unauthorized
use of our technologies and other intellectual property is difficult,
particularly because the global nature of the Internet makes it difficult to
control the ultimate destination or security of software or other data
transmitted.

There has been substantial litigation in the software industry involving
intellectual property rights. We believe that our technologies and trading
systems have been developed independent of others. Third parties may assert
infringement claims against us and our technologies and trading systems may be
determined to infringe on the intellectual property rights of others.

14

Acquisition of Assets of On-Site Trading, Inc.

On November 2, 2001 our company acquired substantially all the assets of
On-Site, a privately-held direct-access trading firm based in Great Neck, New
York. However, on October 1, 2001, prior to the signing of a definitive
agreement On-Site agreed to transfer the customer accounts to A.B. Watley. The
purchase included the acquisition of approximately 500 Internet-based accounts
and 1,200 accounts in 14 service locations that constitute approximately $84
million of customer assets. On-Site's active client base averages 88 trades per
account per month generating approximately $1.3 million in monthly gross
revenues for the month of October 2001. The cost of the acquisition was valued
at $7.4 million, consisting of 1,875,000 shares of our common stock and the
assumption over a three-year period of up to $1.8 million in liabilities.

Personnel

As of December 1, 2001, we employed a total of 124 persons, of whom 8 are
engaged in executive management, 24 in trading activities, 6 in information
technology, 2 in client service, 10 in sales and marketing, 9 clerical and back
office personnel, as well as 11 other employees. We believe our relations with
our employees are generally good and we have no collective bargaining agreements
with any labor unions.

Our registered representatives are required to take examinations administered by
the NASD and state authorities to be qualified to transact business, and are
required to enter into agreements with Watley obligating them to adhere to
Watley's supervisory procedures and not to solicit customers in the event of
termination of employment. Watley's agreements with registered representatives
do not obligate these representatives to be associated with Watley for any
length of time.

Item 2. Properties.

Our principal offices are located at 40 Wall Street, New York, New York, where
we occupy approximately 49,117 square feet at an annual cost of approximately
$1,400,000, or $116,000 per month, plus escalations. The initial term of the
lease for such office space expires in June 2009. We also occupy approximately
16,000 square feet at an annual cost of $204,000 in Allen, Texas. The initial
term of the lease for such space expires in June 2004.

Item 3. Legal Proceedings.

Our business involves substantial risks of liability, including exposure to
liability under federal and state securities laws in connection with the
underwriting or distribution of securities and claims by dissatisfied clients
for fraud, unauthorized trading, churning, mismanagement and breach of fiduciary
duty. In recent years, there has been an increasing incidence of litigation
involving the securities industry, including class actions which generally seek
rescission and substantial damages.

15

In the ordinary course of business, we and our principals are, and may become, a
party to legal or regulatory proceedings or arbitration. We are not currently
involved in any legal or regulatory proceedings or arbitration, the outcome of
which is expected to have a material adverse effect on our business.

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

a) Annual Meeting of Stockholders, July 17, 2001.

b) Directors elected at the meeting:

Steven Malin
Robert Malin
Anthony G. Huston
Leon Ferguson
Mark Chambre
Michael B. Kraines
Stanley Weinstein

c) Election of Directors:

For Against
--- -------
Steven Malin 7,432,302 20,520
Robert Malin 7,432,302 20,520
Anthony G. Huston 7,432,302 20,520
Leon Ferguson 7,432,302 20,520
Mark Chambre 7,432,302 20,520
Michael B. Kraines 7,432,302 20,520
Stanley Weinstein 7,432,302 20,520

Approval of 2000 Stock Option Plan:

For Against Abstained Unvoted
--- ------- --------- -------
3,878,974 56,520 9,048 3,508,280

Ratification of selection of Ernst & Young LLP as independent
accountants:

For Against Abstained Unvoted
--- ------- --------- -------
7,449,651 1,735 1,436 0

PART II

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

(a) Trading in our company's shares of common stock presently takes
place on the NASDAQ National Market under the symbol ABWG.

The following table sets forth the range of high and low sales prices
for our company's common stock for the last two completed fiscal years:

Fiscal 2000: High Low
------------ ---- ---

10/1/99 -12/31/99 $14.25 $9.4375
1/01/00 - 3/31/00 $28.25 $9.75
4/01/00 - 6/30/00 $27.50 $15.25
7/01/00 - 9/30/00 $26.9375 $9.00

16

Fiscal 2001: High Low
------------ ---- ---

10/1/00 -12/31/00 $15.13 $4.56
1/01/01 - 3/31/01 $10.25 $5.25
4/01/01 - 6/30/01 $14.30 $4.94
7/01/01 - 9/30/01 $7.93 $2.80

(b) The number of holders of our company's common stock was 76 on
December 31, 2001, computed by the number of record holders, inclusive
of holders for whom shares are being held in the name of brokerage
houses and clearing agencies.

(c) Our company has not paid a cash dividend since inception.

Item 6. Selected Financial Data.

Income Statement Data

Years ended
-----------
September 30, September 30, September 30,
2001 2000 1999
---- ---- ----

Revenues:
Commissions $18,887,752 $32,968,193 $16,198,858
Data service fees 1,297,117 2,015,396 1,640,123
Principal transactions 3,196,844 5,689,695 2,456,874
Interest and other income 2,084,009 2,073,190 685,578
Interest income - related party 6,180 6,180 6,180
------------ ----------- -----------
Total revenues 25,471,902 42,752,654 20,987,613

Interest expense 852,967 373,354 333,457
Interest expense to officer 398,117 71,417 15,000
------------ ----------- -----------
Net revenues 24,220,818 42,307,883 20,639,156
------------ ----------- ----------
Expenses:
Commissions, floor brokerage, and clearing charges 10,572,220 20,605,576 7,967,765
Employee compensation and related costs 12,686,615 11,802,131 5,306,590
Other expenses 21,253,846 19,436,768 7,956,784
------------ ----------- -----------
Total expenses 44,512,681 51,844,475 21,231,139
------------ ----------- -----------

Loss from operations (20,291,863) (9,536,592) (591,983)

Loss on investments 703,614 256,386 -
------------ ----------- -----------
Loss before income tax and extraordinary loss on early
extinguishment of debt (20,995,477) (9,792,978) (591,983)
Income tax provision 28,697 53,913 32,494
------------ ----------- -----------
Loss before extraordinary loss on early extinguishment
of debt (21,024,174) (9,846,891) (624,477)
Extraordinary loss on early extinguishment of debt - - (177,125)
------------ ----------- -----------
Net income (loss) $(21,024,174) ($9,846,891) ($801,602)
============ =========== ===========

17

Per Share Data
Basic and diluted earnings before extraordinary item per
common share ($2.12) ($1.21) ($0.09)
======= ======= =======

Basic and diluted earnings per common share ($2.12) ($1.21) ($0.11)
======= ======= =======

Weighted average shares outstanding - basic and diluted 9,888,597 8,122,393 7,136,434
========= ========= =========

Balance Sheet and Other Operating Data

Total assets $21,532,676 $29,032,644 $23,244,954
Property and Equipment, net of accumulated depreciation $14,806,945 $18,523,320 $10,852,956
Long term obligations
Stockholders' equity $ 2,945,432 $12,177,786 $15,842,987

Quarterly Data (Unaudited)

(In millions except per share data)
Year Ended September 30,
First Quarter Second Quarter Third Quarter Fourth Quarter Full Year
- ---------------------------------------------------------------------------------------------------------------------------------

2001
Revenues $ 3,180 $ 6,459 $ 4,797 $ 6,551 $ 20,988
Net revenues 3,073 6,193 4,701 6,495 20,462
Loss from operations (250) 143 94 (775) (788)
Net income (loss) (254) 137 90 (774) (802)
Basic and diluted earnings per share (0.26) (0.52) (0.61) N/A

First Quarter Second Quarter Third Quarter Fourth Quarter Full Year
- ---------------------------------------------------------------------------------------------------------------------------------
2000
Revenues $ 8,544 $ 12,698 $ 12,065 $ 9,446 $ 42,753
Net revenues 8,476 12,625 12,000 9,207 42,308
Loss from operations (1,045) (182) (2,810) (5,500) (9,537)
Net income (loss) (1,056) (190) (2,812) (5,789) (9,847)
Basic and diluted earnings per share (0.13) (0.02) (0.35) (0.71) (1.21)

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

The following discussion of the financial condition and results of operations of
our company should be read in conjunction with the consolidated financial
statements and notes thereto appearing elsewhere herein.

Results of Operations

Fiscal year ended September 30, 2001 compared to fiscal year ended September 30,
2000

Total revenues for fiscal 2001 were $25,471,902, a decrease of 40.42%, as
compared to revenues of $42,752,654 for fiscal 2000. Revenues from commissions
decreased by $14,080,441, or 42.71%, from $32,968,193 for fiscal 2000 to
$18,887,752 for fiscal 2001 due primarily to a decrease of 2,831 UltimateTrader
accounts or 48.94% of such accounts, as well as a significant decrease in
overall trading activity by on line traders due to adverse market conditions,
increased competition and pricing pressure. During fiscal 2001, our company's
online brokerage division had total billed transactions of 883,454 and average
billed transactions of 3,577 per day, a decrease of 40.00% compared to an
average daily billed transaction rate of 5,966 per day during fiscal 2000
totaling 1,509,448 billed transactions. Data service revenues decreased by
$718,279, or 35.64%, from $2,015,396 for fiscal 2000 to $1,297,117 for fiscal
2001 due to the increasing number of accounts migrated to UltimateTrader II from
other licensed software providers available through our services. We charge our
customers a data source fee for using other software providers and do not charge
for UltimateTrader II. Revenues from principal transactions decreased by
$2,492,851, or 41.81%, from $5,689,695 for fiscal 2000 to $3,196,844 for fiscal
2001, mainly as a function of lower volume of business conducted by both the
online brokerage division's trading desk and the third-market institutional
sales division due to adverse market conditions. Interest and other income
increased from $2,079,370 for fiscal 2000 to $2,090,189 due to the introduction
of a minimum charge for all customers, which was offset by lower interest
income.

Interest expense increased from $373,354 for fiscal 2000 to $852,967 for fiscal
2001 as a result of increased borrowings.

Interest expense - related party increased by $326,700 as a result of additional
borrowings from related parties during the year.

As a result of the foregoing, net revenues decreased by $18,087,065, or 42.75%,
from $42,307,883 for fiscal 2000 to $24,220,818 for fiscal 2001. Nearly all of
our revenues were generated by clients in the United States and no single group
of related clients accounted for 10% or more of our revenues.

Total expenses decreased by $7,331,794 or 14.14%, from $51,844,475 for fiscal
2000 to $44,512,681 for fiscal 2001. Commissions, floor brokerage and clearing
charges represent payments to our clearing and floor brokers who facilitate our
clients' transactions. As a result of

18

a significant decrease in the volume of business conducted by our online trading
accounts, such expenses decreased by $10,033,356, or 48.69%, from $20,605,576
for fiscal 2000 to $10,572,220 for fiscal 2001. Employment compensation and
related costs increased by $1,884,484 or 7.49%, from $11,802,131 for fiscal 2000
to $12,686,615 for fiscal 2001, due to expenses for software developers that
were no longer working on capitalized software development projects but instead
were working on the E*Trade integration of product enhancements and accordingly,
had their salaries expensed during fiscal 2001. Communications expense increased
by $332,347, or 17.70%, from $1,877,709 for fiscal 2000 to $2,210,056 for fiscal
2001 as a function of adding a back-up site. We expect that the foregoing
expenses will decrease as we continue to renegotiate contracts with our vendors.

Business development costs consist of television, radio, on-line and print
advertising to obtain new clients. These expenses decreased by $6,223,504, or
72.63%, from $8,569,200 for fiscal 2000 to $2,345,696 for fiscal 2001 as the
company decreased its planned advertising and promotional efforts.

Professional fees increased from $1,726,598 for fiscal 2000 to $3,698,724 for
fiscal 2001 due to the use of software consultants totaling $2,040,996, an
investors relation firm totaling $230,000, and the use of consultants to raise
capital, totaling $369,083. Occupancy and equipment costs increased by
$1,638,132 or 35.06%, from $4,671,865 for fiscal 2000 to $6,309,997 for fiscal
2001, primarily due to the expansion of our offices by an additional 40,000
square feet in New York and Texas and the leasing of additional equipment to
increase our capacity. Depreciation and amortization increased by $3,915,968, or
247.23%, from $1,583,954 for fiscal 2000 to $5,499,922 for fiscal 2001 due to
the implementation of our direct access trading platform and the related
amortization of capitalized software, as well as the amortization of capitalized
lease obligations. Other expenses increased by $182,009, or 18.07%, from
$1,007,442 for fiscal 2000 to $1,189,451 for fiscal 2001, due to additional
administrative costs.

A loss of $703,614 was recorded in fiscal year 2001 as a result of the write off
of our investments in a technology company, Gale Technologies, Inc.

As a consequence of the foregoing, our operating loss increased from $9,536,592
for fiscal 2000, to a loss of $20,291,863 for fiscal 2001.

The income tax provision increased from $32,494 for fiscal 1999 to $53,913 for
fiscal 2000.

On September 11, 2001, the World Trade Center towers in New York City were
destroyed. This event did not materially impact our company's operational
capacity and our company has continued its operations. Our company's principal
executive offices in New York were not directly damaged by the collapse of the
World Trade Center buildings, but are located in an area that was evacuated and
closed during the recovery efforts. In addition, this tragic event resulted in
the closing of U.S. financial markets for an unprecedented four days. The events
of September 11, 2001, therefore, may result in continued volatile markets or
further decreased investor activity, which may impact our operating results.

Fiscal year ended September 30, 2000 compared to fiscal year ended September 30,
1999

Total revenues for fiscal 2000 were $42,752,654, an increase of 103.7%, as
compared to revenues of $20,987,613 for fiscal 1999. Revenues from commissions
increased by $16,769,335, or 103.5%, from $16,198,858 for fiscal 1999 to
$32,968,193 for fiscal 2000 due primarily to the significantly increased number
of online trades executed as well as due to the growth in our third-market
institutional sales division. During fiscal 2000, our company's online brokerage
division had total billed transactions of 1,509,448 and average billed
transactions of 5,966 per day, an increase of 129.1% compared to an average
daily billed transaction rate of 2,604 per day during fiscal 1999 totaling
656,217 billed transactions. Data service revenues increased by $375,273, or
22.9%, from $1,640,123 for fiscal 1999 to $2,015,396 for fiscal 2000 due to the
increase in the number of online accounts. We experienced an increase in the
number of online brokerage accounts from approximately 3,500 at September 30,
1999 to approximately 11,800 at September 30, 2000. We expect the number of
accounts and corresponding revenue to increase during fiscal 2001 but the extent
of these increases is dependent on market conditions and the relative success of
our sales and marketing efforts. Revenues from principal transactions increased
by $3,232,821, or 131.6%, from $2,456,874 for fiscal 1999 to $5,689,695 for
fiscal 2000, mainly as a function of the significantly higher volumes of
business conducted by both the online brokerage division's trading desk and the
third-market institutional sales division. Interest and other income increased
from $685,578 for fiscal 1999 to $2,073,190 for fiscal 2000 due to the overall
growth of our business.

As a result of the foregoing, net revenues increased by $21,668,727, or 105.0%,
from $20,639,156 for fiscal 1999 to $42,307,883 for fiscal 2000. Nearly all of
our revenues were generated by clients in the United States and no single group
of related clients accounted for 10% or more of our revenues.

Interest expense increased from $333,457 for fiscal 1999 to $373,354 for fiscal
2000 as a result of increased borrowings.

Interest expense - related party increased by $56,417 as a result of additional
borrowings of $3,500,000. These amounts were borrowed at various dates during
fiscal 2000.

19

Total expenses increased by $30,613,336, or 144.2%, from $21,231,139 for fiscal
1999 to $51,844,475 for fiscal 2000. Commissions, floor brokerage and clearing
charges represent payments to our clearing and floor brokers who facilitate our
clients' transactions. As a result of the large increase in the volume of
business conducted by our online trading accounts, such expenses increased by
$12,637,811, or 158.6%, from $7,967,765 for fiscal 1999 to $20,605,576 for
fiscal 2000. Employment compensation and related costs increased by $6,495,541,
or 122.4%, from $5,306,590 for fiscal 1999 to $11,802,131 for fiscal 2000,
largely due to the hiring of 95 new employees in the last quarter of fiscal year
1999, and an additional 50 employees throughout fiscal 2000. In addition, we
added four senior managers and provided current employees raises and bonuses to
stay competitive in the marketplace and retain key employees. Our company does
not expect to increase our head count other than in our technology group.
Communications expense increased by $641,260, or 51.9%, from $1,236,449 for
fiscal 1999 to $1,877,709 for fiscal 2000 as a function of the growth in our
online trading accounts. We expect that the foregoing expenses will continue to
increase as we expand our client base.

Business development costs consist primarily of advertising costs to obtain new
accounts, which have mostly been for online print and media advertising. These
expenses increased by $6,552,828, or 325.0%, from $2,016,372 for fiscal 1999 to
$8,569,200 for fiscal 2000 as we increased our planned advertising and
promotional efforts. We do not anticipate these costs increasing but instead
intend to reallocate our resources to those activities which have demonstrated
the best results.

Professional services increased from $1,532,994 for fiscal 1999 to $1,726,598
for fiscal 2000 due to the general growth in our business. Occupancy and
equipment costs increased by $2,764,785, or 145.0%, from $1,907,080 for fiscal
1999 to $4,671,865 for fiscal 2000, primarily due to the expansion of our
offices by an additional 40,000 square feet in New York and Texas and the
leasing of additional equipment to increase our capacity and to facilitate the
relocation efforts. Depreciation and amortization increased by $962,766, or
154.9%, from $621,188 for fiscal 1999 to $1,583,954 for fiscal 2000 due to our
overall growth. Other expenses increased by $364,741, or 56.8%, from $642,701
for fiscal 1999 to $1,007,442 for fiscal 2000 due to our overall growth.

The income tax provision increased from $32,494 for fiscal 1999 to $53,913 for
fiscal 2000.

A loss of $256,386 was recorded as a result of our investments in an Israeli
online broker/dealer, Insider Financial Services Online Ltd., and a technology
company, Gale Technologies, Inc.

As a consequence of the foregoing, our operating loss increased from $591,983
for fiscal 1999, to a loss of $9,536,592 for fiscal 2000.

20

Liquidity and Capital Resources

For the year ended September 30, 2001 ABWG incurred consolidated losses of
approximately $21 million and used cash in its operating activities of nearly
$16 million. These losses and use of cash are in addition to the approximately
$10.6 million of losses and $6.1 million of cash used in operating activities
during the two years ending September 30, 2000. The market conditions during our
fiscal 2001 have been very challenging for online brokerage firms such as ABWG
as well as for the brokerage industry in general. Trading volume has
significantly decreased, the Company has lost customers in its core direct
access business and increased competition has put pricing and margin pressures
on the Company.

ABWG has invested heavily in the last few years in building its proprietary
technology, its people and its technology and service infrastructure. Management
believes that these investments have positioned the Company as one of the
larger, independent, direct access brokerage providers and have enabled the
Company to sign a significant licensing agreement with E*Trade Group, Inc.
("E*Trade"). The Company's software licensing agreement with E*Trade moved out
of the testing stage and into the production environment in September 2001.
Licensing and post-production development fees approximated $350,000 through
December 2001. The Company expects such E*Trade fees to increase as additional
E*Trade customers are converted to the platform; the Company is also pursuing
licensing arrangements with other banks and brokerage firms. However, the
operating losses of ABWG will require the Company to obtain additional
financings (debt and/or equity), as the Company has not yet begun to generate
sufficient internal cash flow to support its activities.

To respond to its liquidity and capital resource needs, Management has initiated
various cost cutting initiatives, targeted acquisitions in complementary
brokerage businesses and raised additional capital. Its cost cutting initiatives
include reductions in workforce, reductions in capital expenditure outlays, and
renegotiating clearing corporation agreements at more favorable rates. Further,
the Company has continued to evaluate acquisitions that might increase cash flow
and enhance economies of scale to our existing infrastructure. The Company
consummated an acquisition on November 2, 2001 (see note 17).

Subsequent to September 30, 2001, Management has raised approximately $3.8
million in new, convertible preferred stock, exchanged an outstanding $2.5
million promissory note into convertible preferred stock and extended the
maturity date of approximately $3,800,000 million of outstanding notes payable.
(See note 17). Management anticipates that the Company will have sufficient cash
to execute its business plans during the fiscal year ending 2002. However, there
can be no assurances that actual costs will not exceed estimated costs, actual
revenues and fees will not be less than estimated amounts, or the Company will
be able to generate sufficient cash from operations to meet capital
requirements, debt service and other obligations when required.

On November 29, 2001 the Company issued 630 shares of its Series A convertible
preferred stock, at a price of $10,000 per share. Each share is convertible into
3,390 shares of common stock. Stock dividends are cumulative at a rate of 6% for
the first eighteen months and 15% thereafter. The aggregate purchase price of
the preferred stock and warrants is $6,300,000. The purchasers were issued
Series A warrants to purchase 1,601,460 shares of common stock at an exercise
price of $2.95 per share. A portion of the purchase price was paid with a senior
subordinated demand note issued by the Company in connection with the Note and
Warrant Purchase Agreement dated August 30, 2001 (see note 7). The Company
issued warrants to purchase 85,236 and 83,362 shares of common stock on October
31, 2001 and November 29, 2001, respectively, in connection with the terms of
the Note and Warrant Agreement.

On August 30, 2001, we obtained a $2,500,000 loan from SDS Merchant Fund, L.P.
bearing interest at an annual rate of 6% due on demand. In connection with the
loan we issued to the lender a $2,500,000 promissory note and warrants to
purchase 67,824 shares of common stock at an exercise price of $3.686 per share.
Each 30 days following the closing date, not to exceed six 30 day periods,
until the loan is repaid, additional warrants shall be issued for a number of
shares of common stock equal to 10% of the principal amount of the note
outstanding, divided by the market price. On September 30, 2001 we issued
warrants to purchase 75,075 shares of common stock at an exercise price of $3.33
per share.

On April 2, 2001 the Company sold 2,027,241 shares of common stock in a private
placement offering. The common stock was issued at $5.50 per share. The private
placement offering generated total net proceeds of $10,012,127. In addition, the
Company issued warrants expiring April 1, 2004 to acquire 608,174 shares of the
Company's common stock at an exercise price of $6.75 per share. The Company has
registered the shares for resale under the Securities Act of 1933, as amended.

Effective August 8, 2000, we entered into an agreement with an investment group
providing us with an eighteen-month equity line of up to $48,000,000. The
agreement allows us to draw down funds in exchange for equity. We are not
obligated to take down any of the funds and pricing is based upon ninety four
percent of the volume weighted average price of our common stock for the 22 days
prior to each takedown. We have registered the securities to be sold to the
investment group pursuant to the equity line facility for resale under the
Securities Act of 1933. On September 6, 2000, we drew down $3,000,000 of the
equity line, and issued 333,333 shares to the investment group and received net
proceeds of $2,850,000.

During fiscal 2000 and 2001 our company borrowed $4,350,000 from officers of our
company at rates ranging from 7% to 10%, which loans mature in the next two
years.

On April 23, 1999, we consummated our initial public offering of common stock.
Our company sold 2,300,000 shares of common stock at a gross offering price of
$7 per share, receiving net proceeds of approximately $13,250,000. We utilized
approximately $776,800 for the repayment of outstanding notes payable of
$500,000 to New York Small Business Venture Fund LLC and a $250,000 promissory
note, including any accrued interest on these same notes payable. We used
the proceeds of the IPO to expand our operations and finance our future working
capital requirements.

21

In January 1999, we obtained a $400,000 loan from New York Community Investment
Company L.L.C. ("NYCIC"), bearing interest at an annual rate of 12%, payable
monthly. In connection with this loan, we issued to the lender a $400,000
principal amount promissory note and warrants to purchase 140,000 shares of our
common stock at an exercise price equal to the initial public offering price of
our common stock. We granted the lender a security interest in substantially all
of our assets to secure our obligations under the loan. We used these funds
for marketing expenses and working capital.

In January 1999, we sold an aggregate of 221,500 shares of common stock to 12
investors in a private placement at a price of $4.80 per share for which we
received aggregate net proceeds of approximately $1,050,000.

Cash used by operating activities during fiscal 2001 was $15,998,533. We had a
net loss of $21,024,174 and an increase from other assets of $324,319,
receivables from clearing brokers of $1,174,624, loans receivable from related
party of $129,126 and a decrease in accountants payable and accrued liabilities
of $694,080 which was offset by an increase in other liabilities of $67,288, and
non-cash items such as depreciation and amortization of $5,499,922, loss on
investments of $703,614 and non-cash compensation/service costs of $779,162.

Cash used in investing activities was $1,579,553 during fiscal 2001. Uses of
cash in fiscal 2001 related to purchases of equipment, software and leasehold
improvements made in our new facility at 40 Wall Street of $1,759,660, offset by
deferred rent incentives of $180,107. In addition to the cash used in investing
activities during the year 2001, we accrued accounts payable relating to
purchases of property and equipment of $198,348 during this period.

Cash provided by financing activities was $12,996,056 during fiscal 2001. Cash
provided by financing activities during fiscal 2001 consisted primarily of
proceeds from the sale of common stock in a private equity offering of 2,027,241
shares at an offering price of $5.50, employee exercised stock options of
$987,290, loans from officers of approximately $850,000, and a loan of
$2,500,000. We used a portion of these proceeds to pay $790,935 in notes
payable, and $559,090 to pay obligations on capital leases.

Cash used by operating activities during fiscal 2000 was $6,107,588. We had a
net loss of $9,846,891 and an increase from other assets of $1,037,957,
restricted cash of $17,679, securities owned of $176,780 and receivables from
clearing brokers of $493,621, which was offset by an increase in accounts
payable and accrued liabilities of $2,876,407, and other liabilities of
$535,275, and non-cash items such as depreciation and amortization of
$1,583,954, loss on investments of $256,386, and non-cash compensation/service
costs of $94,697.

Cash used in investing activities was $8,960,548 during fiscal 2000. Uses of
cash in fiscal 2000 related to purchases of equipment, software and leasehold
improvements made in our new facility at 40 Wall Street as well as investments
in Insider Financial Services Online Ltd. and Gale Technologies, Inc., offset by
deferred rent incentives of $647,042. In addition to the cash used in investing
activities during the year 2000, we accrued accounts payable relating to
purchases of property and equipment of $625,870 during this period.

Cash provided by financing activities was $10,859,397 during fiscal 2000. Cash
provided by financing activities during fiscal 2000 consisted primarily of
proceeds from the sale of common stock in a private equity offering of 333,333
shares at an offering price of $9.00, employee exercised stock options of
approximately $1,282,000, exercised warrants of approximately $1,960,000 and
loans from officers of approximately $3,500,000 and proceeds from obligations
under capital leases of approximately $2,047,000. We used a portion of these
proceeds to pay $485,487 in notes payable, and $257,852 to pay obligations on
capital leases.

22

A.B. Watley, Inc. has outstanding an aggregate of $530,000 in the form of
subordinated loans, under agreements approved by the NASD. These loans are
included by Watley for purposes of computing its net capital under the SEC's net
capital rules. These borrowings by Watley consist of:

o a $55,000 principal amount non-interest bearing loan and a $125,000
principal amount loan bearing interest at 12% from a stockholder.

o a $200,000 principal amount loan, bearing interest at an annual rate
of 15% and a $150,000 principal amount loan bearing interest at an
annual rate of 13%, from Mel Steinberg, father of Eric Steinberg, our
Executive Vice President.

Watley is currently required to maintain minimum net capital such that the ratio
of aggregate indebtedness to net capital both as defined shall not exceed 15 to
1 under the SEC's net capital rule. Such rule also prohibits "equity capital",
including the subordinated loans, from being withdrawn or cash dividends from
being paid if Watley's net capital ratio would exceed 10 to 1 or if Watley would
have less than its minimum required net capital. Accordingly, Watley's ability
to repay the subordinated loans may be restricted under the net capital rule. At
September 30, 2001, Watley had net capital of $423,436, which was $247,415 in
excess of its minimum required net capital, and Watley's aggregate indebtedness
to net capital ratio was 6.2 to 1.

Net Operating Loss Carryforwards

Our net operating loss carryforwards expire beginning in the year 2013. The
issuance of additional equity securities, together with our recent financings
and the IPO, could result in an ownership change and, thus, could limit our use
of our prior net operating losses. If we achieve profitable operations, any
significant limitation on the utilization of our net operating losses would have
the effect of increasing our tax liability and reducing net income and available
cash reserves. We are unable to determine the availability of these net
operating losses since this availability is dependent upon profitable
operations, which we have not achieved in prior periods. Accordingly, all net
operating loss carry forwards have been fully reserved for on our consolidated
statements of financial condition.

Relevant Accounting Standards

We generally grant stock options to employees and consultants with an exercise
price not less than the fair market value at the date of grant. We account for
stock option grants to employees in accordance with Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees," and, accordingly,
recognize no compensation expense related to option grants issued at or above
the fair market value of the stock. In cases where we grant options below the
fair market value of the stock at the date of grant, the difference between the
strike price and the fair market value is treated as compensation expense and
amortized over the vesting period of the option, if any. Stock options granted
to consultants and others instead of cash compensation are recorded based upon
management's estimate of the fair value of the options or the related services
provided and expensed over the vesting period, if any.

Pro forma information regarding net income (loss) is required under Statement of
Financial Accounting Standards No.123, "Accounting for Stock-Based
Compensation," and has been determined as if we had accounted for all stock
option grants on the fair value method.

23

In September 2000, the FASB issued SFAS No. 140, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities." SFAS No. 140
replaces SFAS No. 125, "Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities." It revises the standards for
accounting for securitizations and other transfers of financial assets and
collateral and requires certain disclosures, but it carries over most of SFAS
No. 125's provisions without reconsideration. SFAS No. 140 is effective for
transactions after March 31, 2001. This standard is not expected to impact our
company's financial position or statement of operations.

After the development of our internal-use software Ultimate Trader II was
completed, the Company began to market the software to E*Trade. In accordance
with SOP 98-1, proceeds received from the license of the computer software, net
of direct incremental costs of marketing, such as commissions, software
reproduction costs, warranty and service obligations, and installation costs,
will be applied against the carrying amount of that software. No profit will be
recognized until aggregate net proceeds from licenses and amortization have
reduced the carrying amount of the software to zero. Subsequent proceeds will be
recognized in revenue as earned.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

Our primary financial instruments are cash in banks and money market
instruments. We do not believe that these instruments are subject to material
potential near-term losses in future earnings from reasonably possible near-term
changes in market rates or prices. We do not have derivative financial
instruments for speculative or trading purposes. In the normal course of
business, our customers enter into transactions where the risk of potential loss
due to market fluctuations or failure to perform exceeds the amount reported for
the transaction. We have established policies, procedures and internal processes
governing our management of market risk in the normal course of our business
operations. We, along with our clearing brokers, continuously monitor our
exposure to market and counter-party risk through the use of a variety of
financial, position and credit exposure reporting and control procedures. In
addition, we review the creditworthiness of each customer and/or other
counter-party with which we conduct business. We are not currently exposed to
any material currency exchange risk because the risk is borne by international
customers and our international licensees, and we do not hold any assets or
incur any liabilities denominated in foreign currency.

Item 8. Financial Statements and Supplementary Data.

The financial statements required by this Item are enumerated in Item 14 and are
found following page 33 of this Report.

Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.

None.

PART III

Item 10. Directors and Executive Officers of the Registrant.

Our executive officers and directors are as follows:

Name Age Position
- ---- --- --------

Steven Malin 44 Chairman of the Board, Chief Executive Officer and Director
Robert Malin 36 Vice Chairman, President of A.B. Watley, Inc. and Director
Anthony G. Huston 38 President and Director
Linda J. Malin 40 General Counsel and Secretary
Eric Steinberg 36 Executive Vice President -Administration
Leon Ferguson 39 Executive Vice President and Chief Information Officer
Peter A. Wigger 55 Executive Vice President and Director of Operations

24

Name Age Position
- ---- --- --------

Joseph M. Ramos, Jr. 43 Executive Vice President and Chief Financial Officer
Gary D. Mednick 46 Executive Vice President - Business Development
Mark Chambre 40 Director
Michael B. Kraines 38 Director
Stanley Weinstein 75 Director

Steven Malin. Steven Malin co-founded our company in May 1996 and has been our
Chairman of the Board and Chief Executive Officer since inception. From August
1993 to December 1996, Mr. Malin served as a consultant to Watley. From 1987 to
1993, he was a Senior Foreign Exchange Options Broker for Tullett and Tokyo
Forex, Inc., a global inter-bank money brokering firm with its primary offices
located in London, New York and Tokyo. Mr. Malin attended the Fletcher School of
Law and Diplomacy from 1982 to 1984. He received a bachelor of arts degree from
Vassar College in 1980.

Robert Malin. Robert Malin is a co-founder of our company and has served as a
director since inception. He has been associated with Watley since August 1993,
initially as General Securities Principal and director of day-to-day operations
and, most recently, serving as President. His earlier experience includes
managing equity trading, client services and brokerage operations. Mr. Malin and
Steven Malin are brothers.

Anthony G. Huston. Mr. Huston has been our President since September 2000 and a
director since August 2001. From May 1996 to September 2000, he was Executive
Vice President. From September 1995 to May 1996, Mr. Huston served as a
consultant to Watley. From August 1988 to May 1995, he served as Vice President
and Manager in the Foreign Exchange Options Department in the New York, Tokyo,
and London offices of Tullett and Tokyo Forex, Inc. Mr. Huston received a
bachelor of arts degree in asian studies and international relations from the
University of Michigan in 1985. He attended New York University as a post
graduate student in economics.

Linda Malin. Linda Malin has been our General Counsel and Secretary since June
2000. From May 1996 to June 2000 she was legal counsel. Ms. Malin has been
President of Centennial Ventures, Ltd., a broker-dealer, since February 2000 and
is the sole shareholder thereof. From May 1997 to February 2000, she was
Executive Vice President of Centennial. Ms. Malin received a bachelor of arts
degree from the State University of New York in 1983 and her Juris Doctor from
George Washington National Law Center in 1986. Linda Malin is the sister of
Steven and Robert Malin.

Eric Steinberg. Mr. Steinberg has been our Executive Vice President of
Administration since March 1998. His responsibilities include management of our
offices and negotiating our purchase and leasing arrangements. From May 1996 to
February 1998, Mr. Steinberg served as an administrative consultant to our
company. From August 1993 to May 1996 he served as a consultant to Watley. From
1991 to 1993, he was a manager at Primary Financial Services, Inc., a financial
consulting and leasing company. From September 1986 to May 1991, Mr. Steinberg
was employed as an account manager by Manhattan Leasing, Inc., a New York based
leasing company.

Leon Ferguson. Mr. Ferguson joined us in October 1998 as Senior Vice President
and Chief Information Officer in connection with our acquisition of Computer
Strategies, Inc., a software consulting firm he formed in 1996 and served as its
President and Chief Executive Officer since inception. From May 1994 to January
1996, Mr. Ferguson served as Director of Information Technology Strategies at
Williams Telecommunications Group, a long-distance telecommunications company
that was acquired by WorldCom, Inc. in 1995. From May 1990 to May 1994, Mr.
Ferguson served as Chairman of Digital Communications Associates, Inc., a
software development company he founded which specializes in high speed
transaction solutions for the long distance telecommunications industry. Mr.
Ferguson received a bachelor of computer science degree from the University of
Oklahoma in 1988.

Peter A. Wigger. Mr. Wigger has been our Executive Vice President and Director
of Operations since September 1999. From January 1997 to January 1999, he was
Chairman and Chief Executive Officer of National Investor Services Corp., the
clearing subsidiary of TD Waterhouse Securities Inc., an international
broker-dealer. From October 1987 to December 1997, he was Executive Vice
President and a member of the Waterhouse Securities Board of Directors. From
July 1986 to October 1987, he was Senior Vice President and Director of
Operations for Scotia Mcleod. From January 1970 to July 1986, Mr. Wigger was
Vice President and Director of Operations for Richardson Greenfields Securities
Inc.

Joseph M. Ramos, Jr. Mr. Ramos has been our Executive Vice President and Chief
Financial Officer since October 2000. From June 1999 to October 2000 he was
Senior Vice President and Chief Financial Officer. From March 1998 to June 1999,
he was Chief Financial Officer of Nikko Securities Co., International, an
international broker-dealer. He was also Controller with Nikko Securities Co.,
International from November 1997 to March 1998. From April 1997 to November
1997, he was Chief Financial Officer of Brunswick

25

Securities Inc., an international broker-dealer. From September 1987 to February
1996, he served in various management positions at Cantor Fitzgerald Securities,
a broker-dealer. His most recent position was Chief Financial Officer of their
broker-dealer operations based in Los Angeles, California. From October 1982 to
September 1987, he was on the audit staff of Deloitte & Touche, LLP, an
international accounting firm. Mr. Ramos is a Certified Public Accountant,
licensed in New York State. He received a bachelor of science degree in
accounting from St. John's University in 1982.

Gary D. Mednick. Mr. Mednick has been our Executive Vice President - Business
Development since October 2001. From July 1993 to October 2001 Mr. Mednick was
the Chief Executive Officer of On-Site, a company he founded in 1993. From 1991
to July 1993, he served as Executive Vice President of the Professional Trading
Division at Redstone Securities, a firm founded by Mr. Mednick. Mr. Mednick
received a bachelor of arts degree in psychology and business from Hofstra
University in 1978.

Mark Chambre. Mr. Chambre has served as a director of our company since April
1999. Since June 1993, he has served as Senior Broker in the Yen Swaps Division
of the Tokyo Forex Co., Inc. in Tokyo, Japan. From April 1988 to March 1993, Mr.
Chambre served as Manager of the Tokyo Forex Co.'s Financial Futures Division.
Mr. Chambre joined its parent company, Tullett and Tokyo, Inc., in New York in
1983. Mr. Chambre received a bachelor of arts degree from Drew University in
1982.

Stanley Weinstein. Mr. Weinstein has served as a director of our company since
April 1999. He has been an independent corporate financial consultant since
1991. From 1960 to 1991 he served as a partner with Deloitte & Touche, LLP, an
international accounting firm. Mr. Weinstein served for fifteen years as adjunct
Associate Professor of Accounting at Pace University and co-authored the widely
recognized SEC Compliance - Financial Reporting and Forms handbook. He received
a bachelor of business administration degree in accounting from City College of
New York in 1949. Since May 1995, he has served as a director of York Research
Corp., a company engaged in the production and marketing of energy related
products.

Directors are elected at each annual meeting of stockholders and hold office
until the next annual meeting of stockholders and the election and
qualifications of their successors. Executive officers are elected by and serve
at the discretion of the board of directors.

Compliance with Section 16(a) of the Exchange Act.

During the fiscal year ended September 30, 2001, based upon an examination of
the public filings, all of our company's officers and directors timely filed
reports on Forms 3 and 4, except for Steven Malin (3 late reports); Robert Malin
(2 late reports); Linda Malin (1 late report); Anthony Huston (1 late report);
and Eric Steinberg (1 late report).

Item 11. Executive Compensation.

The following table sets forth for the fiscal year indicated the compensation
paid by our company to our Chief Executive Officer and other executive officers
with annual compensation exceeding $100,000:

Summary Compensation Table

Long-Term
Compensation
---------------
Annual Compensation Awards
Name and --------------------- Underlying
Principal Position Fiscal Year Salary Bonus Options/SARs(#)
- ------------------ ----------- ------ ----- ---------------

Steven Malin, 2001 $110,000 $ 0 30,000
Chairman and Chief 2000 110,000 22,000 0
Executive Officer 1999 93,075 18,615 0

Anthony G. Huston 2001 175,000 25,000 0
President 2000 110,000 22,000 0
1999 72,887 14,577 0

Peter A. Wigger, 2001 175,000 50,000 0
Executive Vice President and 2000 175,000 50,000 0
Director of Operations 1999 6,731 0 150,000

Leon Ferguson, 2001 175,000 0 300,000
Executive Vice President 2000 100,000 20,000 0
and Chief Information 1999 86,769 17,353 150,000
Officer

Joseph M. Ramos, Jr. 2001 175,000 55,000 180,000
Executive Vice President and 2000 150,000 30,000 50,000
Chief Financial Officer 1999 37,500 0 10,000

26

Employment Agreements

We have entered into a four-year employment agreement with Steven Malin and
three-year employment agreements with Robert Malin, Anthony G. Huston, Eric
Steinberg, Leon Ferguson and Joseph M. Ramos all of which are automatically
renewable for additional one-year terms. We have also entered into a two-year
employment agreement with Gary D. Mednick which is renewable for a one-year term
if certain revenues are achieved. The employment agreements provide for annual
base compensation of $110,000, except for Mr. Ferguson ($100,000), Mr. Ramos
($150,000), Mr. Wigger ($175,000) and Mr. Mednick ($250,000). Except for Mr.
Mednick, each agreement provides for a bonus equal to 20% of their salaries,
payable semi-annually except for Mr. Wigger ($50,000 paid annually), based upon
certain revenue levels achieved by us, as may be approved by the board of
directors or a committee of the board. Mr. Mednick is entitled to a bonus of
$50,000 in the first year of his employment agreement. In addition, if certain
revenues are achieved during the second year of his employment agreement, Mr.
Mednick will be entitled to an additional bonus of $50,000.

Each of the employment agreements requires the officer to devote his full time
and efforts to our business and contains non-competition and non-disclosure
covenants of the officer for the term of his employment and for a period of two
years thereafter. Each employment agreement provides that we may terminate the
agreement for cause. In addition, each employment agreement provides for
termination by either party without cause upon at least 180 days written notice
prior to the end of the original term or any renewal term.

Directors' Compensation

All directors are reimbursed for their reasonable expenses incurred in attending
meetings of the board of directors and its committees. Directors who are
employees receive no additional compensation for service as members of the board
of directors or committees. All of our non-employee directors are compensated
annually for their services at $2,000 and granted non-qualified options to
acquire 1,500 shares of our common stock at the end of each year of service.

Option Grants in Last Fiscal Year

The following table contains information concerning options granted to executive
officers named in the Summary Compensation Table during the fiscal year ended
September 30, 2001:

Individual Grants

Number of Securities % of Total Options
Underlying Options Granted to Employees
Name Granted (#) in Fiscal Year Exercise Price ($/sh) Expiration Date
---- ----------- -------------- --------------------- ---------------

Steven Malin 30,000 4% 8.00 October 4, 2010
Joseph M. Ramos, Jr. 30,000 18% 8.00 October 4, 2010
150,000 3.50 August 22, 2011
Anthony G. Huston 0 n/a 0 n/a
Leon Ferguson 300,000 31% 6.00 April 1, 2011
Peter A. Wigger 0 n/a 0 n/a

27

Option Exercises in Last Fiscal Year and Fiscal Year-End Option Values

The following table contains information concerning the number and value, at
September 30, 2001, of unexercised options held by executive officers named in
the Summary Compensation Table:

Number of Securities Underlying Value of Unexercised In-the-Money
Unexercised Options at FY-End (#) Options at FY-End ($)
Name (Excisable/Unexercisable) (Exercisable/Unexercisable)(1)
- ---- ------------------------- ------------------------------

Steven Malin 0/30,000 0/0
Leon Ferguson 180,000/300,000 0/0
Anthony G. Huston 0/0 0/0
Joseph M. Ramos, Jr. 18,000/222,000 0/39,000
Peter A. Wigger 100,000/50,000 0/0

(1) Fair market value of underlying securities (the closing price of the
Company's common stock on the National Association of Securities Dealers
Quotation System) at fiscal year end (September 30, 2001) minus the exercise
price.

Stock Option Plans

On January 27, 1997, the board of directors and stockholders adopted our 1997
stock option plan, on March 16, 1998, our board of directors and stockholders
adopted our 1998 stock option plan and on November 1, 1999 and March 14, 2000,
the board of directors and stockholders, respectively, adopted our 1999 stock
option plan. We have reserved 400,000 shares of common stock for issuance upon
exercise of options granted from time to time under the 1997 stock option plan
and 800,000 shares of common stock for issuance upon exercise of options granted
from time to time under each of the 1998 and 1999 stock option plans. The 1997,
1998 and 1999 stock option plans are intended to assist us in securing and
retaining key employees, directors and consultants by allowing them to
participate in our ownership and growth through the grant of incentive and
non-qualified options.

Under each of the stock option plans we may grant incentive stock options only
to key employees and employee directors, or we may grant non-qualified options
to our employees, officers, directors and consultants. The 1997 stock option
plan is administered by a committee, appointed by our board of directors,
consisting of from one to three directors. The 1998 and 1999 stock option plans
are administered directly by our board of directors.

Subject to the provisions of each of the stock option plans, either the board or
the committee will determine who shall receive options, the number of shares of
common stock that may be purchased under the options, the time and manner of
exercise of options and exercise prices. The term of options granted under each
of the stock option plans may not exceed ten years or five years for an
incentive stock option granted to an optionee owning more than 10% of our voting
stock. The exercise price for incentive stock options shall be equal to or
greater than 100% of the fair market value of the shares of the common stock at
the time granted; provided that incentive stock options granted to a 10% holder
of our voting stock shall be exercisable at a price equal to or greater than
110% of the fair market value of the common stock on the date of the grant. The
exercise price for non-qualified options will be set by the board or the
committee, in its discretion, but in no event shall the exercise price of
options granted under the 1997 or 1998 stock option plans be less than the fair
market value of the shares of common stock on the date of grant. The exercise
price may be payable in cash or, with the approval of the board or the
committee, by delivery of shares or by a combination of cash and shares. Shares
of common stock received upon exercise of options granted under each of the
plans will be subject to restrictions on sale or transfer.

As of September 30, 2001, we have granted options to purchase 2,102,511 shares
of common stock under our stock options plans at an exercise price ranging from
$2.00 to $23.50 per share. Of these options, options to purchase 990,000 shares
have been granted to our officers and directors. All of the options granted to
such officers and directors terminate on the ten year anniversary of their grant
date.

On October 24, 2000 and July 17, 2001, the board of directors, and stockholders,
respectively, adopted our 2000 stock option plan. We have reserved 1,600,000
shares of common stock for issuance upon exercise of options granted from time
to time under the 2000 stock option plan. The 2000 stock option plan is intended
to assist us in securing and retaining key employees, directors and consultants
by allowing them to participate in our ownership and growth through the grant of
incentive and non-qualified options.

Under the 2000 stock option plan we may grant incentive stock options only to
key employees and employee directors, or we may grant non-qualified options to
our employees, officers, directors and consultants. The 2000 stock option plan
will be administered directly by our board of directors.

Subject to the provisions of the 2000 stock option plan, the board will
determine who shall receive options, the number of shares of common stock that
may be purchased under the options, the time and manner of exercise of options
and exercise prices. The term of options granted under the 2000 stock option
plan may not exceed ten years or five years for an incentive stock option
granted to an optionee owning more than 10% of our voting stock. The exercise
price for incentive stock options shall be equal to or greater than 100% of the
fair market value of the shares of the common stock at the time granted;
provided that incentive stock options granted to a 10%

28

holder of our voting stock shall be exercisable at a price equal to or greater
than 110% of the fair market value of the common stock on the date of the grant.
The exercise price for non-qualified options will be set by the board, in its
discretion. The exercise price may be payable in cash or, with the approval of
the board, by delivery of shares or by a combination of cash and shares. Shares
of common stock received upon exercise of options granted under the 2000 stock
option plan will be subject to restrictions on sale or transfer.

As of December 1, 2001, we have granted options to purchase 814,925 shares of
common stock under the 2000 stock option plan at exercise prices ranging from
$3.50 to $12.23 per share. All of the options granted terminate on the ten year
anniversary of their grant date.

Item 12. Security Ownership of Certain Beneficial Owners and Management.

The following table sets forth information known to us, as of December 1, 2001,
relating to the beneficial ownership of shares of common stock by: each person
who is known by us to be the beneficial owner of more than five percent of the
outstanding shares of common stock; each director; each of the executive
officers named in the summary compensation table; and all executive officers and
directors as a group.

Unless otherwise indicated, the address of each beneficial owner in the table
set forth below is care of A.B. Watley Group Inc., 40 Wall Street, New York, New
York 10005.

We believe that all persons named in the table have sole voting and investment
power with respect to all shares of common stock beneficially owned by them.

A person is deemed to be the beneficial owner of securities that can be acquired
by him within 60 days from December 1, 2001 upon the exercise of options,
warrants or convertible securities. Each beneficial owner's percentage ownership
is determined by assuming that options, warrants or convertible securities that
are held by him, but not those held by any other person, and which are
exercisable within 60 days of December 1, 2001 have been exercised and
converted.

Number of Shares Percentage of Shares
Name and Address of Beneficial Owner Beneficially Owned Beneficially Owned
- ------------------------------------ ------------------ ------------------

Steven Malin 2,257,570 17.5%
On-Site Trading, Inc. 1,875,000 14.6
Franklin Mutual Advisers, LLC 1,843,595 13.8
DMG Legacy International Ltd. 1,394,020 9.8
DMG Legacy Institutional Fund LLC 1,394,020 9.8
DMG Legacy Fund LLC 1,394,020 9.8
SDS Merchant Fund, L.P. 1,237,374 8.8
Linda Malin 1,016,530 7.9
Robert Malin 872,600 6.8
Anthony G. Huston 354,600 2.8
Leon Ferguson 273,685 2.1
Peter A. Wigger 100,000 *
Mark Chambre 46,500 *
Joseph M. Ramos, Jr. 18,000 *
Stanley Weinstein 2,000 *
All directors and executive officers as a
group (10 persons) 5,288,738 40.1%

* Less than 1%.

The number of shares beneficially owned by Steven, Linda and Robert Malin
include shares held in irrevocable family and charitable trusts for which they
are trustees. In addition, the number of shares held by Steven Malin includes
shares held by a family partnership for which Steven Malin is the general
partner.

The number of shares beneficially owned by Steven Malin does not include 30,000
shares of common stock issuable upon exercise of options which are not currently
exercisable.

The number of shares beneficially owned by On-Site Trading, Inc. includes (i)
468,750 shares of common stock held in escrow to secure indemnification
obligations, if any, owed by On-Site Trading, Inc. to our company pursuant to
the Agreement, dated November 1, 2001 between On-Site Trading, Inc. and our
company, and (ii) 468,750 shares of common stock held in escrow subject to the
achievement of certain revenue thresholds pursuant to the Agreement, dated
November 1, 2001 between On-Site Trading, Inc. and our company.

The number of shares beneficially owned by Franklin Mutual Advisers, LLC
includes 425,445 shares of common stock issuable upon exercise of currently
exercisable warrants.

29

The number of shares beneficially owned by DMG Legacy International Ltd., DMG
Legacy Institutional Fund LLC and DMG Legacy Fund LLC (collectively, the "DMG
Group") are aggregated since such entities are affiliates and includes (i)
796,650 shares of common stock issuable upon the conversion of shares of series
A convertible preferred stock owned by the DMG Group and (ii) 597,370 shares of
common stock issuable upon the exercise of currently exercisable warrants.

The number of shares beneficially owned by SDS Merchant Fund, L.P. ("SDS")
includes (i) 1,169,550 shares of common stock issuable upon the conversion of
shares of series A convertible preferred stock owned by SDS and (ii) 67,824
shares of common stock issuable upon the exercise of currently exercisable
warrants. Under the terms of the convertible preferred stock purchase agreement,
SDS is not entitled to convert any portion of the series A convertible preferred
stock or exercise any portion of the warrants or to dispose of any portion of
the series A convertible preferred stock or warrants to the extent that the
right to effect the conversion, exercise or disposition would result in SDS or
any of its affiliates owning more than 4.95% of the outstanding shares of common
stock of our company.

The number of shares beneficially owned by Linda Malin does not include 30,000
shares of common stock issuable upon exercise of options which are not currently
exercisable.

The number of shares beneficially owned by Robert Malin does not include 30,000
shares of common stock issuable upon exercise of options which are not currently
exercisable.

The number of shares beneficially owned by Anthony G. Huston does not include
175,000 shares of common stock held by an irrevocable family trust of which
Anthony G. Huston is a beneficiary.

The number of shares beneficially owned by Leon Ferguson includes 180,000 shares
of common stock issuable upon exercise of currently exercisable options, 52,000
shares of common stock held by a trust of which Leon Ferguson is a trustee and a
beneficiary and 175 shares of common stock held in an individual retirement
account but does not include 300,000 shares of common stock issuable upon
exercise of options which are not currently exercisable.

The number of shares beneficially owned by Peter A. Wigger includes 100,000
shares of common stock issuable upon exercise of currently exercisable options
but does not include 50,000 shares of common stock issuable upon exercise of
options which are not currently exercisable.

The number of shares beneficially owned by Mark Chambre does not include 2,000
shares of common stock owned by his wife, as to which he disclaims beneficial
ownership.

The number of shares beneficially owned by Joseph M. Ramos, Jr. includes 18,000
shares of common stock issuable upon exercise of currently exercisable options,
but does not include 222,000 shares of common stock issuable upon exercise of
options which are not currently exercisable.

The number of shares beneficially owned by all of our officers and directors as
a group includes 298,000 shares of common stock issuable upon exercise of
currently exercisable options, but does not include 662,000 shares of common
stock issuable upon exercise of options which are not currently exercisable.

The address of all of the foregoing parties is c/o our company at 40 Wall
Street, New York, NY 10005 except for On-Site Trading, Inc. whose address is 98
Cutter Mill Road, Great Neck, New York 11021, Franklin Mutual Advisers, LLC
whose address in 51 John F. Kennedy Parkway, Short Hills, New Jersey 07078, SDS
Merchant Fund, L.P. whose address is c/o SDS Capital Partners, One Sound Shore
Drive, Greenwich, Connecticut 06830, and each member of the DMG Group, whose
address is c/o DMG Advisors LLC, One Sound Shore Drive, Greenwich, Connecticut
06830.

Item 13. Certain Relationships and Related Transactions.

During fiscal year 2000, we borrowed $3,500,000 from officers and major
stockholders. Such loans were comprised of (i) a $3,200,000 loan from Steven
Malin; (ii) a $150,000 loan from a corporation controlled by Steven Malin; (iii)
a $75,000 loan from a corporation controlled by Linda Malin; and (iv) a $75,000
loan from a corporation controlled by Eric Steinberg. The notes bear interest
ranging from 7% to 10% maturing in two years from the effective date. On April
30, 2000, a subordinated borrowing of $125,000 from Steven Malin matured,
however Mr. Malin continued to loan our company $125,000 at an interest rate of
12% with no stated maturity date.

During fiscal year 2001, we borrowed an additional $850,000 from officers and
major stockholders. Total borrowings from others and stockholders were: (i)
aggregate loans of $1,375,000 from a corporation controlled by Steven Malin;
(ii) aggregate loans of $1,075,000 from a corporation controlled by Robert
Malin; (iii) a $950,000 loan from a corporation controlled by Linda Malin; and
(iv) a $950,000 loan from a corporation controlled by Eric Steinberg. The notes
bear interest ranging from 7% to 10% maturing in one or two years from the
effective date.

We believe that prior transactions with our officers, directors and principal
stockholders were on terms that were no less favorable than we could have
obtained from unaffiliated third parties. All future transactions, including
loans and advances, between us and our officers, directors and stockholders
beneficially owning 5% or more of our outstanding voting securities, or their
affiliates, will be for bona fide business purposes and on terms not less
favorable to us than we could have obtained in arm's length transactions from
unaffiliated third parties.

Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.

(a) Documents filed as part of this report:

1. Financial Statements:

Consolidated Financial Statements of A.B. Watley Group Inc. and
subsidiaries

Report of Independent Auditors

Consolidated Statements of Financial Condition--Years ended September
30, 2001 and 2000, Consolidated Statements of Operations--Years ended
September 30, 2001, 2000 and 1999, Consolidated Statements of Changes
in Stockholders'

30

Equity--Years ended September 30, 2001, 2000 and 1999, Consolidated
Statements of Cash Flows--Years ended September 30, 2001, 2000 and
1999, Notes to Consolidated Financial Statements

2. Financial Statement Schedules:

Financial Statement schedules have been omitted because the required
information is inapplicable or because the information is presented in
the financial statements or related notes.

(b) Reports on Form 8-K:
A report on Form 8-K was filed on July 31, 2001 under the caption "Item 5. Other
Events and Regulation FD Disclosure."

31

(c). Exhibits.
- --------------

Exhibit
No. Description
- --- -----------

3.1 Restated Certificate of Incorporation of the Company and form of amendment thereto.*
3.2 By-Laws of the Company, as amended.*
4.1 Specimen Common Stock Certificate.*
4.2 Form of Underwriter's Warrant Agreement, including Form of Warrant Certificate.*
10.1 1997 Stock Option Plan.*
10.2 Second Amended and Restated 1998 Stock Option Plan.*
10.3 Employment Agreement dated as of May 1, 1997 between the Company and Steven Malin and
Amendment to Employment Agreement dated as of October 1, 1998
between the Company and Steven Malin.*
10.4 Employment Agreement dated as of June 1, 1997 between the Company and Harry Simpson and
Amendment to Employment Agreement dated October 1, 1998 between the Company and Harry
Simpson.*
10.5 Employment Agreement dated as of January 1, 1999 between the Company and Robert Malin.*
10.6 Employment Agreement dated as of June 1, 1997 between the Company and Anthony G. Huston and
Amendment to Employment Agreement dated as of October 1, 1998 between the Company and
Anthony G. Huston.*
10.7 Employment Agreement dated as of March 1, 1998 between the Company and Eric Steinberg.*
10.8 Office lease dated as of June 20, 1997 between 40 Wall Development Associates, LLC, as Landlord
and the Company as Tenant for premises located at 40 Wall Street, New York, New York.*
10.9 [Intentionally omitted.]
10.10 [Intentionally omitted.]
10.11 Co-Branding Agreement dated October 11, 1996 between PC Quote,Inc. and A.B. Watley, Inc., as
amended.*
10.12 Computer Software License Agreement dated December 8, 1996 between Townsend Analytics, Ltd.
and A.B. Watley, Inc., as amended.*
10.13 Fully Disclosed Clearing Agreement dated October 3, 1996 and Amendment dated June 8, 1998
between Penson Financial Services,Inc. and A.B. Watley, Inc.*
10.14 Fully Disclosed Correspondent Agreement dated November 18, 1996 between Weiss, Peck & Greer,
L.L.C. and A.B. Watley, Inc.*
10.15 License Agreement dated as of October 1, 1998 between Ethos Corporation and A.B. Watley, Inc.*
10.16 Service Marketing Representative Agreement dated as of January 29, 1998 between S&P ComStock,
Inc. and A.B. Watley, Inc.*
10.17 Master Lease Agreement dated December 17, 1998 between General Electric Capital Corporation
and the Company.*
10.18 Security Agreement dated December 17, 1998 between General Electric Capital Corporation and the
Company.*
10.19 Letter of Credit Agreement dated December 17, 1998 between General Electric Capital Corporation
and the Company.*
10.20 Loan Agreement dated January 28, 1999 between New York CommunityInvestment Company L.L.C.,
the Company and A.B. Watley,Inc.*
10.21 Promissory Note of the Company and A.B. Watley, Inc. dated January 28, 1999 issued to the New
York Community Investment Company L.L.C.*
10.22 Security Agreement dated January 28, 1999 between New York Community Investment Company
L.L.C. and A.B. Watley, Inc.*
10.23 Security Agreement dated January 28, 1999 between New York Community Investment Company
L.L.C. and the Company.*
10.24 Objectivity Master License and Support Agreement dated September 30, 1999 between Objectivity,
Inc. and A.B. Watley Group Inc. **

32

Exhibit
No. Description
- --- -----------
10.25 Reseller Network License Order Form dated May 26, 1999 between Database Consultants Inc. and
A.B. Watley Group Inc. **
10.26 1999 Stock Option Plan.***
10.27 Employment Agreement dated as of June 18, 1999 between the Company and Joseph Ramos.
10.28 Employment Agreement dated as of September 1, 1999 between the Company and Peter Wigger.
10.29 2000 Stock Option Plan.****
10.30 Agreement, dated November 1, 2001, by and among A.B. Watley Group Inc. and On-Site Trading, Inc. *****
10.31 Employment Agreement, dated as of November 2, 2001, between the Company and Gary Mednick.
23.2 Consent of Ernst & Young LLP, independent auditors.
* Filed as an exhibit to the Company's Registration Statement on Form SB-2 (File No. 333-71783) and
hereby incorporated by reference herein.
** Filed as an exhibit to the Company's Annual Report on Form 10-KSB for the year ended
September 30, 1999 and hereby incorporated by reference herein.
*** Filed as an exhibit to the Company's Registration Statement on Form S-8 (File No. 333-35340) and
hereby incorporated by reference herein.
**** Filed as an exhibit to the Company's Registration Statement on Form S-8 (File No. 333- 67014) and
hereby incorporated by reference herein.
***** Filed as an exhibit to the Company's Current Report on Form 8-K filed on November 16, 2001.

33

A.B. Watley Group Inc.

Consolidated Financial Statements

Years Ended September 30, 2001, 2000 and 1999

Contents

Report of Independent Auditors F-2
Consolidated Statements of Financial Condition as of September 30, 2001 and 2000 F-3
Consolidated Statements of Operations for the Years Ended September 30, 2001, 2000 and 1999 F-4
Consolidated Statements of Changes in Stockholders' Equity for the Years Ended F-5
September 30, 2001, 2000 and 1999
Consolidated Statements of Cash Flows for the Years Ended September 30, 2001, 2000 and 1999 F-6
Notes to Consolidated Financial Statements F-7

F-1

Report of Independent Auditors

To the Board of Directors and Stockholders of A.B. Watley Group Inc.

We have audited the accompanying consolidated statements of financial condition
of A.B. Watley Group Inc. (the "Company") as of September 30, 2001 and 2000, and
the related consolidated statements of operations, changes in stockholders'
equity and cash flows for the years ended September 30, 2001, 2000, and 1999.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of A.B.
Watley Group Inc. as of September 30, 2001 and 2000, and the consolidated
results of its operations and its cash flows for the years ended September 30,
2001, 2000 and 1999 in conformity with accounting principles generally accepted
in the United States.

/s/ Ernst & Young LLP

New York, New York
January 11, 2002

F-2

A.B. Watley Group Inc.

Consolidated Statements of Financial Condition

September 30, 2001 September 30, 2000
------------------ ------------------

ASSETS

Cash and cash equivalents $508,053 $5,090,083
Restricted cash 500,334 531,432
Securities owned at market value 343,434 391,161
Receivables from clearing brokers 2,294,533 1,119,909
Property and equipment at cost, net of accumulated
depreciation of $8,659,868 and $2,929,737 at September 30, 2001
and September 30, 2000, respectively 14,806,945 18,523,320
Investments - 728,614
Loans receivable from related party 257,197 128,071
Security deposits 1,444,480 1,471,907
Other assets 1,377,700 1,048,147
----------- -----------
Total assets $21,532,676 $29,032,644
=========== ===========

LIABILITIES AND STOCKHOLDERS' EQUITY

Liabilities:
Subordinated borrowings $350,000 $350,000
Subordinated borrowings from officer 180,000 55,000
Securities sold, not yet purchased 372,545 180,993
Notes payable to related parties 4,350,000 3,625,000
Notes payable, net of unamortized discount of $47,198 and $127,533,
at September 30, 2001 and September 30, 2000, respectively 3,437,323 1,728,261
Bank loan - 3,333
Deferred rent incentives 1,385,434 1,399,554
Accounts payable and accrued liabilities 6,568,108 7,063,840
Other liabilities 1,957,075 2,448,877
----------- -----------
Total liabilities 18,600,485 16,854,858
----------- -----------

Stockholders' equity:
Common stock, $.001 par value, 20,000,000 shares
authorized at September 30, 2001 and
September 30, 2000; 10,995,796 and
8,798,090 issued and outstanding at September 30, 2001
and September 30, 2000, respectively 10,996 8,798
Additional paid-in capital 37,224,984 24,814,573
Option costs, net (295,798) (93,331)
Deferred compensation (431,563) -
Accumulated deficit (33,576,428) (12,552,254)
----------- -----------
Total stockholders' equity 2,932,191 12,177,786
----------- -----------
Total liabilities and stockholders' equity $21,532,676 $29,032,644
=========== ===========

See notes to consolidated financial statements.

F-3

A.B. Watley Group Inc.

Consolidated Statements of Operations

Years ended
-----------
September 30, September 30, September 30,
2001 2000 1999
---- ---- ----

Revenues:
Commissions $18,887,752 $32,968,193 $16,198,858
Data service fees 1,297,117 2,015,396 1,640,123
Principal transactions 3,196,844 5,689,695 2,456,874
Interest and other income 2,084,009 2,073,190 685,578
Interest income - related parties 6,180 6,180 6,180
----------- ----------- -----------
Total revenues 25,471,902 42,752,654 20,987,613

Interest expense 852,967 373,354 333,457
Interest expense to related parties 398,117 71,417 15,000
----------- ----------- -----------
Net revenues 24,220,818 42,307,883 20,639,156
----------- ----------- -----------

Expenses:
Commissions, floor brokerage, and clearing charges 10,572,220 20,605,576 7,967,765
Employee compensation and related costs 12,686,615 11,802,131 5,306,590
Business development 2,345,696 8,569,200 2,016,372
Occupancy and equipment 6,309,997 4,671,865 1,907,080
Communications 2,210,056 1,877,709 1,236,449
Professional fees 3,698,724 1,726,598 1,532,994
Depreciation and amortization 5,499,922 1,583,954 621,188
Other expenses 1,189,451 1,007,442 642,701
----------- ----------- -----------
Total expenses 44,512,681 51,844,475 21,231,139
----------- ----------- -----------

Loss from operations (20,291,863) (9,536,592) (591,983)

Loss on investments 703,614 256,386 -
----------- ----------- -----------
Loss before income tax and extraordinary loss on early
extinguishment of debt (20,995,477) (9,792,978) (591,983)
Income tax provision 28,697 53,913 32,494
----------- ----------- -----------
Loss before extraordinary loss on early extinguishment
of debt (21,024,174) (9,846,891) (624,477)
Extraordinary loss on early extinguishment of debt - - 177,125
----------- ----------- -----------
Net income (loss) ($21,024,174) ($9,846,891) ($801,602)
=========== ========== ========

Basic and diluted earnings before extraordinary item per
common share ($2.13) ($1.21) ($0.09)
=========== ========== ========
Basic and diluted earnings per common share ($2.13) ($1.21) ($0.11)
=========== ========== ========

Weighted average shares outstanding - basic and diluted 9,888,597 8,122,393 7,136,434
=========== ========== ========

See notes to consolidated financial statements.

F-4

A.B. Watley Group Inc.
Statement of Changes in Stockholders' Equity

Common Stock Issued
-------------------------
Additional Unamortized
Paid-in Option
Shares Par Value Capital Costs
----------- ----------- ------------ --------------

Balance at October 1, 1998 5,137,500 $ 5,138 $ 3,758,333 $(100,292)

Issuance of common stock 2,794,245 2,794 14,548,137

Issuance of non-employee stock options 24,029

Option cost - net 331,250 (21,039)

Net Loss

Balance at September 30, 1999 7,931,745 $ 7,932 $18,661,749 $(121,331)

Issuance of common stock 866,345 866 6,091,127

Option cost - net 28,000

Net loss

Other 61,697
------------------------------------------------------------

Balance at September 30, 2000 8,798,090 $ 8,798 $24,814,573 $ (93,331)
========== ======== =========== =========

Issuance of common stock 2,197,706 2,198 10,997,219

Deferred stock based compensation 555,182

Warrants issued to non-employees 369,083

Option cost - net 488,927 $(174,467)

Net loss

Balance at September 30, 2001 10,995,796 $10,996 $37,224,984 $(295,795)
========== ======== =========== =========

Deferred Accumulated
Compensation Deficit Total
-------------- -------------- -----------

Balance at October 1, 1998 $ (1,903,761) $ 1,759,418

Issuance of common stock 14,550,931

Issuance of non-employee stock options 24,029

Option cost - net 310,211

Net loss (801,602) (801,602)

Balance at September 30, 1999 $(2,705,363) $15,842,987

Issuance of common stock 6,091,993

Option cost - net 28,000

Net loss (9,846,891) (9,846,891)

Other 61,697
----------------------------------------------

Balance at September 30, 2000 $(12,552,254) $12,177,786
============ ===========

Issuance of common stock 10,999,417

Deferred stock based compensation (555,182)

Warrants issued to non-employees

Amortization of warrants issued to non-employees 369,083

Amortization of deferred compensation 95,619 95,619

Options issued to non-employees 369,083 369,083.00

Option cost - net 314,460

Net loss (21,024,174) (21,024,174)

Balance at September 30, 2001 (459,563) $(33,576,428) $ 2,932,191
======== ============ ============

See notes to consolidated financial statements.

F-5

A.B. Watley Group Inc.

Consolidated Statements of Cash Flows

Years ended
-----------
September 30, September 30, September 30,
2001 2000 1999
----- ----- -----

CASH FLOWS USED IN OPERATING ACTIVITIES
Net loss $(21,024,174) $(9,846,891) $(801,602)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization, net 5,499,922 1,583,954 626,187
Non-cash compensation/service costs 779,162 94,697 210,683
Loss on early extinguishment of debt - - 177,125
Loss on investments 703,614 256,386 -
Changes in assets and liabilities
(Increase) decrease in operating assets:
Restricted cash 31,098 (17,679) (513,753)
Securities owned 47,727 (176,780) (109,863)
Receivables from clearing brokers (1,174,624) (493,621) (94,453)
Loans receivable from related party (129,126) (6,180) (6,180)
Security deposits 27,427 - -
Other assets (324,319) (1,037,957) (1,350,857)
Increase (decrease) in operating liabilities:
Securities sold, not yet purchased 191,552 124,801 37,055
Accounts payable and accrued liabilities (694,080) 2,876,407 1,552,517
Other liabilities 67,288 535,275 247,952
----------- ---------- -----------
Net cash used in operating activities (15,998,533) (6,107,588) (25,189)
----------- ---------- -----------

CASH FLOWS USED IN INVESTING ACTIVITIES
Purchases of property and equipment, net (1,759,660) (8,732,590) (6,013,595)
Investments - ( 875,000) (110,000)
Deferred rent incentives 180,107 647,042 -
----------- ---------- -----------
Net cash used in investing activities (1,579,553) (8,960,548) (6,123,595)
----------- ---------- -----------

CASH FLOWS PROVIDED BY FINANCING ACTIVITIES
Proceeds from sale of common stock, net 10,012,127 2,850,000 14,364,798
Proceeds from exercised stock options 987,290 1,281,993 2,500
Proceeds from exercised stock warrants - 1,960,000 -
Proceeds from notes payable 2,500,000 - -
Proceeds from notes payable to related parties 850,000 3,500,000 -
Proceeds from (repayment of) notes payable, net (790,938) (485,487) 150,000
Payment of lease obligations under capital leases (559,090) (257,852) -
Proceeds from obligations under capital leases - 2,047,410 -
Repayment of bank loan (3,333) (36,667) (40,000)
----------- ---------- -----------

Net cash provided by financing activities 12,996,056 10,859,397 14,477,298
----------- ---------- -----------

Net (decrease) increase in cash and cash equivalents (4,582,030) (4,208,739) 8,328,514
Cash and cash equivalents at beginning of year 5,090,083 9,298,822 970,308
----------- ---------- -----------

Cash and cash equivalents at end of year $508,053 $5,090,083 $9,298,822
=========== ========== ===========

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Accounts payable for purchases of property and equipment $198,348 $625,870 $715,242
Notes payable for purchases of property and equipment - - $1,813,748
Cash paid for:
Interest $539,627 $316,800 $184,371
Taxes $15,456 $40,425 $5,858

See notes to consolidated financial statements.

F-6

A.B. Watley Group Inc.

Notes to Consolidated Financial Statements

Years ended September 30, 2001, 2000, and 1999

1. Organization, Liquidity and Capital Resources

A.B. Watley Group Inc. ("ABWG" or the "Company"), which was formerly known as
Internet Financial Services Inc., conducts business primarily through its
principal subsidiary, A.B. Watley, Inc. ("A.B. Watley"). A.B. Watley is a
registered broker-dealer under the Securities Exchange Act of 1934, as amended
(the "1934 Act") and is a member of the National Association of Securities
Dealers, Inc.

A.B. Watley is an introducing broker-dealer which conducts business in
electronic trading, information and brokerage services, as well as institutional
block trading. A.B. Watley clears all transactions through three clearing
brokers on a fully disclosed basis. Accordingly, A.B. Watley is exempt from Rule
15c3-3 of the 1934 Act.

For the year ended September 30, 2001 ABWG incurred consolidated losses of
approximately $21 million and used cash in its operating activities of nearly
$16 million. These losses and use of cash are in addition to the approximately
$10.6 million of losses and $6.1 million of cash used in operating activities
during the two years ending September 30, 2000. The market conditions during our
fiscal 2001 have been very challenging for online brokerage firms such as ABWG
as well as for the brokerage industry in general. Trading volume has
significantly decreased, the Company has lost customers in its core direct
access business and increased competition has put pricing and margin pressures
on the Company.

ABWG has invested heavily in the last few years in building its proprietary
technology, its people and its technology and service infrastructure. Management
believes that these investments have positioned the Company as one of the
larger, independent, direct access brokerage providers and have enabled the
Company to sign a significant licensing agreement with E*Trade Group, Inc.
("E*Trade"). The Company's software licensing agreement with E*Trade moved out
of the testing stage and into the production environment in September 2001.
Licensing and post-production development fees approximated $350,000 through
December 2001. The Company expects such E*Trade fees to increase as additional
E*Trade customers are converted to the platform; the Company is also pursuing
licensing arrangements with other banks and brokerage firms. However, the
operating losses of ABWG will require the Company to obtain additional
financings (debt and/or equity), as the Company has not yet begun to generate
sufficient internal cash flow to support its activities.

To respond to its liquidity and capital resource needs, Management has initiated
various cost cutting initiatives, targeted acquisitions in complementary
brokerage businesses and raised additional capital. Its cost cutting initiatives
include reductions in workforce, reductions in capital expenditure outlays, and
renegotiating clearing corporation agreements at more favorable rates. Further,
the Company has continued to evaluate acquisitions that might increase cash flow
and enhance economies of scale to our existing infrastructure. The Company
consummated an acquisition on November 2, 2001 (see note 17).

Subsequent to September 30, 2001, Management has raised approximately $3.8
million in new, convertible preferred stock, exchanged an outstanding $2.5
million promissory note into convertible preferred stock and extended the
maturity date of approximately $3,800,000 million of outstanding notes payable.
(See note 17). Management anticipates that the Company will have sufficient cash
to execute its business plans during the fiscal year ending 2002. However, there
can be no assurances that actual costs will not exceed estimated costs, actual
revenues and fees will not be less than estimated amounts, or the Company will
be able to generate sufficient cash from operations to meet capital
requirements, debt service and other obligations when required.

2. Summary of Significant Accounting Policies

Basis of Presentation:

The consolidated financial statements include the accounts of ABWG and its
wholly-owned subsidiary, A.B. Watley. All significant intercompany balances and
transactions have been eliminated. Certain prior year amounts reflect
reclassifications to conform to current year's presentations.

Cash and Cash Equivalents:

Cash and cash equivalents include highly liquid instruments with original
maturities of less than three months held by one global financial institution.

Restricted Cash:

Restricted cash consists of cash on deposit at a financial institution securing
letters of credit and lines of credit.

Securities Transactions, Revenues, and Related Expenses:

Securities transactions and related revenues and expenses, including commissions
revenues and expenses, are recorded on a trade date basis. Data service revenues
represent fees charged to customers for rea1-time access to various financial
data. These fees are recorded as earned.

Securities Owned and Sold, Not Yet Purchased:

Securities owned and securities sold, not yet purchased are stated at market or
fair values, with resulting unrealized gains and losses reflected in the
consolidated statements of operations. Market value is generally based on listed
market prices. If listed market prices are unattainable, fair value is
determined based on other relevant factors including broker or dealer price
quotes.

Property and Equipment:

Computer equipment and furniture and fixtures are carried at cost and
depreciated/amortized on the straight-line basis over their estimated useful
lives, generally three to five years.

Construction-in-progress, is amortized on a straight-line basis over the term of
the lease, generally ten years upon occupancy. Deferred rent incentives, which
represent construction costs reimbursed by the lessor of the Company's office
space, will be amortized on a straight-line basis over the term of the lease,
which is ten years.

Computer software is amortized on the straight-line basis over a period of three
years. The cost of internally developed computer software is capitalized when
management commits to funding a project it believes will be completed and used
to perform the functions intended. The capitalized software is not amortized
until the projects are complete. Pilot projects and projects where expected
future economic benefits are less than probable are not eligible for
capitalization. In accordance with accounting principles, proceeds from
licensing software developed for internal use to third parties is recorded as
a reduction of capitalized software, until the capitalized balance is fully
written off.

F-7

A.B. Watley Group Inc.

Notes to Consolidated Financial Statements - (Continued)

Years ended September 30, 2001, 2000, and 1999

Investments:

The Company accounts for its investments using the equity method.

The Company evaluates its investments periodically for any permanent impairment
which may have occurred. As a result, the Company has recorded a permanent
impairment writedown on its investments of $703,614 and $256,386 as of September
30, 2001 and 2000, respectively. Accordingly, at September 30, 2001, the
Company's investments were fully reserved.

Use of Estimates:

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

Stock Options:

The Company accounts for stock option grants to employees in accordance with
Accounting Principles Board Opinion ("APB") No.25, "Accounting for Stock Issued
to Employees". In cases where the Company grants options below the fair market
value of the stock at the date of grant, the difference between the strike price
and the fair market value is treated as compensation expense and amortized over
the vesting period of the option. Stock options granted to consultants and
others in lieu of cash compensation are recorded based upon management's
estimate of fair value of the options or the related services provided and
expensed in the same period(s) and in the same manner as if the Company had paid
cash for the services instead of paying with or using the stock options.

Fair Value of Financial Instruments:

Substantially all of the Company's financial instruments are carried at fair
value or amounts approximating fair value.

Business Development:

The Company expenses all promotional costs as incurred. Advertising production
costs are expensed when the initial advertisement is run. Costs of communicating
advertising are expensed as the services are received. Substantially all
business development costs relate to advertising.

Income Taxes:

Income taxes have been provided for using the liability method under Statement
of Financial Accounting Standards ("SFAS") No.109, "Accounting for Income
Taxes."

Segment Reporting:

In fiscal 1999, the Company adopted SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information". SFAS No. 131 supersedes SFAS No. 14,
"Financial Reporting for Segments of a Business Enterprise". Under the new
standard, the Company is required to use the management approach to reporting
its segments. The management approach designates the internal organization that
is used by management for making operating decisions and assessing performance
as the source of the Company's segments. Based on this approach, the Company has
determined that it operates in one reporting segment.

3. Net Capital Requirement

A.B. Watley is subject to the SEC's Uniform Net Capital Rule 15c3-1 (the "Net
Capital Rule") which requires A.B. Watley to maintain minimum net capital such
that the ratio of aggregate indebtedness to net capital, both as defined, shall
not exceed 15 to 1. The Net Capital Rule also requires that equity capital may
not be withdrawn or cash dividends paid if A.B. Watley's resulting net capital
ratio would exceed 10 to 1. At September 30, 2001, A.B. Watley had net capital,
as defined, of $423,436 which was $247,415 in excess of its required net capital
of $176,021. The aggregate indebtedness to net capital ratio was 6.2 to 1.

F-8

A.B. Watley Group Inc.

Notes to Consolidated Financial Statements - (Continued)

Years ended September 30, 2001, 2000, and 1999

4. Financial Instruments with Off-Balance Sheet Risk or Concentration of Credit
Risk

Pursuant to clearing agreements, the clearing and depository operations for A.B.
Watley's and customers' securities transactions are provided by two clearing
broker-dealers. A.B. Watley has agreed to indemnify its clearing brokers for
losses that the clearing brokers may sustain from the customer accounts
introduced by A.B. Watley. A.B. Watley, through its clearing brokers, seeks to
control the risks associated with these activities by requiring customers to
maintain margin collateral in compliance with various regulatory and internal
guidelines. The clearing brokers monitor required margin levels daily and,
pursuant to such guidelines, request customers to deposit additional collateral
or reduce securities positions when necessary. All customer transactions pending
as of September 30, 2001 settled without material adverse effect to the Company.

Also, in the normal course of business, customers may sell securities short.
Subsequent market fluctuations may require the clearing firms to obtain
additional collateral from A.B. Watley's customers. It is the policy of the
clearing firms to value the short positions and to obtain additional deposits
where deemed appropriate.

The Company may at times maintain inventories in equity securities on both a
long and short basis. While long positions represent the Company's ownership of
securities, short positions represent obligations of the Company. Accordingly,
both long and short positions may result in gains or losses to the Company as
market values of securities fluctuate. To manage the risk of losses, the Company
marks long and short positions to market daily and continuously monitors the
market fluctuations.

5. Property and Equipment

September 30, September 30,
2001 2000
---- ----
Computer equipment $5,654,754 $5,167,001
Software 11,615,793 10,867,859
Construction-in-progress - 273,770
Furniture, fixtures and leasehold improvements 6,196,266 5,144,427
--------- ---------

23,466,813 21,453,057
Less accumulated depreciation and amortization 8,659,868 2,929,737
----------- ---------
$14,806,945 $18,523,320
=========== ===========

At September 30, 2001, and 2000 substantially all software represents software
developed for internal use. For the years ended September 2001 and 2000, the
Company amortized $4,050,961 and $372,148 of capitalized software developed for
internal use. As of September 30, 2001 the Company is no longer capitalizing
software developed. During the year ended September 30, 2001, the Company began
marketing its internally developed software to third parties. As of September
30, 2001 we earned approximately $7,000 in licensing fees. The proceeds from
licensing to third parties is recorded as a reduction of capitalized software.
(See Note 2). No proceeds have been received as of September 30, 2001.
Construction-in-progress represents amounts related to leasehold improvements
being made on the Company's office space.

Included in computer equipment as of September 30, 2001 and 2000 is equipment
purchased under capital leases of $2,047,410. These assets secure the related
obligations under capital leases of $1,230,468 and $1,789,558 as of September
30, 2001 and 2000, respectively, which are included in other liabilities in the
consolidated statement of financial condition.

6. Subordinated Borrowings

The subordinated borrowings are covered by agreements approved by the National
Association of Securities Dealers, Inc. and are included by A.B. Watley for
purposes of computing net capital under the Net Capital Rule. To the extent that
such subordinated borrowings are required for A.B. Watley's continued compliance
with minimum net capital requirements, they may not be repaid. Of the total
subordinated borrowings, $180,000 and $55,000 for the year ended September 30,
2001 and September 30, 2000, respectively, is from an officer and stockholder of
the Company. For the year ended September 30, 2001, 2000 and 1999, interest
expense on the subordinated loans amounted to $62,825, $58,250 and $64,500,
respectively. Subordinated borrowings as of September 30, 2001 and 2000 are as
follows:

September 30, 2001 September 30, 2000 Interest Rate Maturity
- ------------------ ------------------ ------------- --------
$125,000 $ - 12% October 31, 2003*
55,000 55,000 0% October 31, 2002*
200,000 200,000 15% October 31, 2002
150,000 150,000 13% October 31, 2002
--------- --------
$530,000 $405,000
======== ========

* Subordinated borrowings from an officer and stockholder.

F-9

A.B. Watley Group Inc.

Notes to Consolidated Financial Statements - (Continued)

Years ended September 30, 2001, 2000, and 1999

7. Notes Payable

Effective January 28, 1999, the Company borrowed $400,000 from New York
Community Investment Company, L.L.C. ("NYCIC") under the conditions that the
proceeds of the loan be used as working capital to further the corporate
purposes of the Company and not to repay any debt or redeem any equity
interests. The loan accrues interest at 12% per annum which became payable first
in 24 monthly installments of $4,000 beginning March 1, 1999. Commencing March
1, 2001, the principal amount of the loan became payable in 35 monthly
installments of $6,667 plus interest on the unpaid balance, except for the last
installment which shall be in the amount of $166,665 plus interest on the unpaid
balance. At September 30, 2001 and 2000, the principal balance on this loan is
$360,000 and $400,000, respectively.

As collateral for the loan, NYCIC received a security interest in the Company's
assets. Under the terms and conditions of the loan agreement, NYCIC received
warrants expiring January 28, 2004 to acquire 140,000 shares of the Company's
common stock at an exercise price equal to the Company's initial public offering
("IPO") price. The fair value of the warrants on January 28, 1999 (approximately
$140,000) is being accounted for as a debt issuance cost and amortized over the
life of the loan. The unamortized amount of the debt issuance cost is included
as "Option costs, net" in Stockholders' Equity. Amortization expense relating to
the debt issuance cost for the years ended September 30, 2001, 2000 and 1999
amounted to $28,000, $28,000, and $18,669, respectively.

As of September 30, 2001 and 2000, the Company has notes payable of $624,522 and
$1,455,794, respectively, to two vendors for the purchase of software licenses.
The current value of the notes includes imputed interest totaling $47,199 and
$127,533, respectively. The average effective interest rate on the notes
approximates 8%. The notes are payable during the year ended September 30, 2002.

On August 30, 2001, we obtained a $2,500,000 loan bearing interest at an annual
rate of 6% due on demand (the "Senior Subordinated Demand Note"). In connection
with the loan, we issued to the lender a $2,500,000 promissory note and warrants
to purchase 67,824 shares of common stock at an exercise price of $3.686. On
each 30th day following the closing date, not to exceed six 30 day periods,
until the Senior Subordinated Demand Note is repaid, additional warrants shall
be issued for a number of shares of common stock equal to 10% of the principal
amount of the note outstanding, divided by the market price. Warrants to
purchase 45,000 shares at an exercise price of $3.686 per share of the Company's
common stock were issued to a consultant in connection with his efforts in
arranging this loan. All warrants issued under the terms of this loan have a
term of 5 years. On September 30, 2001 we issued warrants to purchase an
additional 75,075 shares of common stock at an exercise price of $3.33 per
share. The fair market value of the warrants, approximately $488,927, is being
accounted for as a debt issuance cost over the life of the loan. The unamortized
amount of the debt issuance cost is included as "option costs, net" in
stockholders' equity. Interest expense relating to the debt issuance cost for
the year ended September 30, 2001 amounted to $286,460.

8. Bank Loan

The bank loan, an unsecured term loan carrying an interest rate of 8.5%, was
fully paid on October 1, 2000.

9. Loans Receivable from Related Party

Notes receivable from related parties is as follows:

2001 2000
---- ----

103,000 103,000
131,059 --
------- -------
$234,059 $103,000
======= =======

The notes bear interest at 6%, accrued interest is $23,138 and $25,071 as of
September 30, 2001 and 2000, respectively.

F-10

A.B. Watley Group Inc.

Notes to Consolidated Financial Statements - (Continued)

Years ended September 30, 2001, 2000, and 1999

10. Notes Payable to Related Parties

As of September 30, 2000, the Company issued the following promissory notes to
officers and stockholders of the Company:

Effective Maturity Principal Interest
Date Date Amount Rate
---- ---- ------ ----
April 30, 2000 -- $125,000 12%
March 23, 2000 March 22, 2002 75,000 10%
March 23, 2000 March 22, 2002 150,000 10%
March 23, 2000 March 22, 2002 75,000 10%
May 31, 2000 May 30, 2002 500,000 7%
June 30, 2000 May 31, 2002 1,200,000 7%
August 20, 2000 July 31, 2002 1,000,000 7%
September 24, 2000 September 23, 2002 500,000 7%
----------
$3,625,000
==========

As of September 30, 2000, accrued interest on notes payable to related parties
was $71,417.

During the year ended September 30, 2001, the Company borrowed additional funds
from certain officers and major stockholders of the Company and restructured the
above notes payable. As of September 30, 2001, the following promissory notes to
officers and stockholders of the Company are outstanding:

Effective Principal Interest
Date Maturity Date Amount Rate
---- ------------- ------ ----
November 30, 2000 November 29, 2002 $300,000 7%
February 25, 2001 February 25, 2002 950,000 10%
February 25, 2001 February 25, 2002 950,000 10%
February 25, 2001 February 25, 2002 950,000 10%
February 25, 2001 February 25, 2002 950,000 10%
March 16, 2001 March 16, 2003 125,000 10%
March 16, 2001 March 16, 2003 125,000 10%
----------
$4,350,000
==========

As of September 30, 2001, accrued interest on these notes payable to related
parties was $283,679.

11. Commitments and Contingencies

The Company has entered into certain leases for office space under
noncancellable operating lease agreements that expire on June 23, 2009 and
contain escalation provisions. The Company has also entered into various
operating leases which are used to obtain computer equipment. As of September
30, 2001, the aggregate minimum future rental payments required under operating
leases were as follows:

Year ended September 30,
- ------------------------
2002 $
2003 2,785,851
2004 1,786,078
2005 1,710,556
2006 1,531,504
Thereafter 4,478,640
-----------
$16,195,993
===========

During the year ended September 30, 2000, the Company purchased $2,047,410 of
computer equipment under various capital leases and incurred capital lease
obligations of the same amount. The required future minimum payments under the
capital leases are $882,160 in 2002, and $513,900 in 2003. The Company did not
enter into any capital leases during the year ended September 30, 2001.

F-11

A.B. Watley Group Inc.

Notes to Consolidated Financial Statements - (Continued)

Years ended September 30, 2001, 2000, and 1999

Rent expense for the years ended September 30, 2001, 2000 and 1999 was
$1,858,639, $1,368,802 and $1,476,623, respectively.

In the ordinary course of business, the Company is party to several legal
proceedings, the outcome of which, either singularly or in the aggregate, is not
expected to have a material impact on the Company's financial position.

12. Stock Options

Under the Company's Stock Option Plans (collectively, the "Plans"), employees,
non-employee directors, officers, and consultants are generally granted options
(both incentive stock options and nonqualified stock options) to purchase shares
of common stock at prices not less than the estimated fair market value of the
common stock on the date the option is granted. The options are exercisable at
either the date of grant, in ratable installments or otherwise, generally over a
period of one to three years from the date of grant. The options generally
expire within ten years after the date of grant. The number of shares delivered
in the aggregate under the 2000, 1999, 1998 and 1997 Plans cannot exceed
1,600,000, 800,000, 800,000 and 400,000 shares, respectively, (3,600,000 shares
in total). No option shall be granted under the 2000 Plan after July 18, 2011;
under the 1999 Plan after November 1, 2009; under the 1998 Plan after March 16,
2008; or under the 1997 Plan after January 26, 2007.

A summary of the Company's stock option activity (exclusive of the warrants
discussed in Notes 7 and 14) and related information for the years ended
September 30, 2001, 2000, and 1999 is as follows:

NUMBER OF WEIGHTED AVG
SHARES EXERCISE PRICE
--------- --------------

Outstanding at October 1, 1998 420,100 2.34
Granted, September 30, 1999 1,068,850 7.89
Exercised, September 30, 1999 (125,000) 0.02
Forfeited, September 30, 1999 (1,500) 9.40
Outstanding at September 30, 1999 1,362,450 5.94
Granted, September 30, 2000 356,775 13.11
Exercised, September 30, 2000 (193,183) 6.68
Forfeited, September 30, 2000 (140,692) 8.45
Outstanding at September 30, 2000 1,385,350 9.90
Granted, September 30, 2001 1,072,100 6.54
Exercised, September 30, 2001 (170,590) 5.79
Forfeited, September 30, 2001 (183,923) 10.21
--------- -----
Outstanding at September 30, 2001 2,102,511 9.68
========= =====
Exerciseable at September 30, 1999 342,955 4.49
========= =====
Exerciseable at September 30, 2000 533,829 6.24
========= =====
Exerciseable at September 30, 2001 759,058 8.10
========= =====

Included in the table above are non-employee option grants of 9,500 shares for
the year ended September 30, 2000 and 44,750 shares for the year ended
September 30, 1999. These were zero non-employee option grants for the year
ended September 30, 2001.

During the year ended September 30, 2001 certain employees were granted stock
options below fair market value. Compensation expense related to these options
amounted to $95,619 for the year ended September 30, 2000.

The weighted average fair value of options granted during the years ended
September 30, 2001, 2000, and 1999 was $4.82, $8.88, and $3.05, respectively.
The fair value of each option grant was estimated at the date of grant using the
Black-Scholes option valuation model. The Black-Scholes option valuation model
was developed for use in estimating the fair value of traded options which have
no vesting restrictions and are fully transferable. Because the Company's stock
options have characteristics significantly different from those of traded
options, and because changes in the subjective input assumptions can materially
affect the fair value estimate, in management's opinion, the existing models do
not necessarily provide a reliable single measure of the fair value estimate of
its stock options. In calculating the fair values of the stock options, the
following weighted average assumptions were used:

F-12

A.B. Watley Group Inc.

Notes to Consolidated Financial Statements - (Continued)

Years ended September 30, 2001, 2000, and 1999

2001 Grants 2000 Grants 1999 Grants 1999 Grants
----------- ----------- ----------- -----------
Subsequent Prior
to IPO To IPO
------ ------

Dividend yield 0% 0% 0% 0%
Weighted average expected life:
Employees 4.0 years 4.5 years 4.8 years 4.8 years
Non-employees - 0.1 years 0.2 years 0.2 years
Weighted average risk-free interest rate 5.17 6.1% 5.1% 5.1%
Expected volatility 92% 79% 77% 0%

Pro forma information regarding net income or loss is required under Statement
of Financial Accounting Standards ("SFAS") No.123, "Accounting for Stock-Based
Compensation," and has been determined as if the Company had accounted for all
the 2000 and 1999 stock option grants on the fair value method. For purposes of
the pro forma information, the fair values of the 2000 and 1999 option grants to
employees are amortized over the vesting period. The effects of applying SFAS
No. 123 for providing pro-forma disclosures are not likely to be representative
of the effects on reported pro-forma net income for future years. The pro forma
information for the Years ended September 30, 2001, and 2000 is as follows:

Years ended September 30,
-------------------------
2001 2000 1999
---- ---- ----

Net loss as reported. . . . . . . . . . . $21,024,174 $(9,846,891) $(801,602)
Net loss pro forma. . . . . . . . . . . . $23,791,767 $(11,704,931) $(1,228,531)
Net loss per share as reported. . . . . . $(2.13) $(1.21) $(.11)
Net loss per share pro forma. . . . . . . $(2.41) $(1.44) $(.17)

Additional information regarding options outstanding as of September 30, 2001
(exclusive of the warrants discussed in Notes 7 and 14) is as follows:

Options Outstanding Options Exercisable
------------------- -------------------
Weighted Average
Number Remaining Number
Range of Exercisable Outstanding as Contractual Life Weighted Average Exercisable as Weighted Average
Prices of 9/30/01 (years) Exercise Price of 9/30/01 Exercise Price
------ ---------- ------- -------------- ---------- --------------

$2.00 99,000 6.52 $ 2.00 99,000 $ 2.00
$3.00 - $6.4375 817,700 9.39 $ 5.51 81,200 $ 5.00
$7.00 421,200 7.46 $ 7.00 256,298 $ 7.00
$8.00-$13.25 664,575 8.53 $ 9.76 263,266 $10.24
$15.25-$23.50 100,036 8.62 $17.43 59,295 $17.75
------- ------
2,102,511 759,058
========= =======

13. Income Taxes

The Company files consolidated federal, state and local income tax returns with
A.B. Watley. For all periods presented, the Company provides for income taxes as
required under SFAS No. 109. The Company records income taxes using a liability
approach for financial

F-13

A.B. Watley Group Inc.

Notes to Consolidated Financial Statements - (Continued)

Years ended September 30, 2001, 2000, and 1999

accounting and reporting which results in the recognition and measurement of
deferred tax assets and liabilities based upon the likelihood of realization of
tax benefits in future years.

The provision for income taxes for the years ending September 30, 2001, 2000 and
1999 is comprised of New York State and New York City taxes in the amount of
$28,697, $53,913 and $32,494, respectively. No benefit has been provided for the
Company's net operating losses.

Years Ended September 30,
2001 2000 1999
---- ---- ----
Tax benefit at federal statutory rate (34.0%) (34.0%) (34.0%)
State taxes, net of federal tax effect 0.1 0.4 2.7
Valuation allowance on deferred tax assets 33.9 34.1 32.0
Other 0.1 0 3.4
------ ------ ----
Effective tax rate 0.1% 0.5% 4.1%
====== ====== ====

Deferred income taxes reflect the tax effects of temporary differences between
the carrying amounts of assets and liabilities for financial reporting purposes
and the amounts used for income tax purposes. Components of the Company's
deferred tax assets and liabilities as of September 30, 2000 and 1999 are as
follows:

Years ended September 30,
-------------------------
2001 2000 1999
---- ---- ----
Net operating loss $14,444,884 $6,042,800 $1,276,868
Depreciation 174,207 (657,860) (291,171)
Other 455,588 12,261 1,201
---------- ---------- -----------
Total deferred tax assets 15,074,679 5,397,201 986,898
Valuation reserve (15,074,679) (5,397,201) (986,898)
---------- ---------- -----------

Net deferred tax asset $ 0 $ 0 $ 0
========== ========== ===========

At September 30, 2000, the Company had a net operating loss carryforward for
federal tax purposes of approximately $12,823,000 that will expire no sooner
than September 30, 2013.

The issuance of additional equity securities, together with our recent
financings and the IPO, could result in an ownership change and, thus, could
limit our use of our prior net operating losses.

14. Capital Stock

On January 14, 1999, the Board of Directors agreed to amend the Company's
certificate of incorporation to increase the authorized number of shares of
common stock to 20,000,000, and to authorize and delineate the terms under
which preferred stock may be issued. In addition, the Board agreed to issue,
subject to the effectiveness of the IPO, 70,771 additional shares of common
stock for nominal additional consideration to certain stockholders who
purchased private placement shares during the year ended September 30, 1998.

During January 1999, the Board of Directors approved the issuance of 221,500
shares of the Company's common stock in a private placement offering. The
common stock was issued at a price of $4.80 per share and was restricted with
regard to sale or disposition for a period of one year. This private placement
offering generated total gross proceeds of $1,063,200 and after related legal
and filing expenses of $13,200, the net proceeds were $1,050,000. Two employees
of the Company purchased an aggregate of 102,000 shares as part of this
offering.

On April 23, 1999, 2,300,000 shares of the Company's common stock (including
300,000 shares to cover over-allotments) were sold in the IPO. The net proceeds
from the offering of approximately $13,250,000 have been used primarily to
reduce outstanding indebtedness, expand sales and marketing, expand and upgrade
the Company's computing, physical, and personnel infrastructure and for working
capital and general corporate matters.

Upon effectiveness of the IPO, the Company issued 3,000 shares of common stock
with a three year restriction provision for nominal consideration to certain
employees of the Company. In addition, the Company issued 70,771 shares of
common stock for nominal additional consideration to certain stockholders who
purchased private placement shares during the year ended September 30, 1998.

During the quarter ending June 30, 2000, Whale Securities Co., L.P. ("Whale")
exercised 124,784 underwriter's warrants, on a cashless basis, and received
59,829 shares. The warrants were issued as a result of underwriting the
Company's IPO. The warrants were exercised at the price of $11.55 per share.
Whale continues to hold warrants to purchase an additional 75,216 shares with
an exercise price of $11.55, which expire April 23, 2004.

Effective October 2, 1998, the Company borrowed $500,000 from New York Small
Business Venture Fund, LLC ("NYSB"). Under the terms and conditions of the loan
agreement, NYSB received warrants expiring October 2, 2003 to acquire 191,250
shares of the Company's common stock at an exercise price equal to the IPO
price. The loan was subsequently repaid with the proceeds of the IPO. On
January 3, 2000, July 6, 2000 and July 17, 2000, NYSB exercised 50,000, 85,000
and 56,250 warrants, respectively, equal to an aggregate of 191,250 shares. The
warrants were exercised at the IPO price of $7.00 per share.

On July 17, 2000 and August 18, 2000, NYCIC exercised 28,750 and 60,000
warrants, respectively, equal to 88,750 shares. The warrants were exercised at
the IPO price of $7.00 per share. NYCIC continues to hold warrants to purchase
an additional 51,250 shares, which expire January 28, 2004.

Effective August 8, 2000, the Company entered into an agreement with an
investment group providing the Company with an eighteen-month equity line of up
to $48 million. The agreement allows the Company to draw down funds in exchange
for equity. The Company is not obligated to take down any of the funds and
pricing is based upon ninety four percent of the volume weighted average price
(VWAP) of the Company's stock for the 22 days prior to each takedown. The
Company will pay the placement agent a fee of 5% of any amount drawn down. In
addition, the Company provided 70,893 warrants each to the investment group and
placement agent at an exercise price of $19.47, expiring August 9, 2003. The
Company has registered the stock for resale under the Securities Act of 1933.
On September 6, 2000, the Company drew down $3,000,000 of the equity line,
issued 333,333 shares to the investment group, and received net proceeds of
$2,850,000.

For the fiscal year ended September 30, 2001, 2000 and 1999, stock options
aggregating 170,590, 193,183 and 125,000 shares were exercised resulting in
proceeds of $987,290, $1,281,993 and $2,500, respectively.

On October 2, 2000 the Company entered into a consulting agreement with KJS
Investment Corp. ("KJS") pursuant to which KJS would provide consulting on
numerous corporate matters, including public relations, mergers and
acquisitions, and obtaining corporate financing. As compensation KJS received
$40,000 and warrants to purchase 90,000 shares of common stock at an exercise
price of $8.00 per share. The warrants vest immediately upon receipt. The fair
market value of the warrants, $369,083, is included in professional fees.

On April 2, 2001 the Company sold 2,027,241 shares of common stock in a private
placement offering. The common stock

F-14

A.B. Watley Group Inc.

Notes to Consolidated Financial Statements - (Continued)

Years ended September 30, 2001, 2000, and 1999

was issued at $5.50 per share. The private placement offering generated total
net proceeds of $10,012,127. In addition, the Company issued warrants expiring
April 1, 2004 to acquire 608,174 shares of the Company's common stock at an
exercise price of $6.75 per share. The Company has registered the shares for
resale under the Securities Act of 1933, as amended.

15. Earnings Per Share

Per share data is determined based on the weighted average number of common
shares outstanding each year.

The weighted average number of shares outstanding for the year ended September
30, 1999 reflects the 70,771 shares (discussed in Note 14) as though the shares
were outstanding as of the beginning of the fiscal year. Since the Company
recognized a net loss in each of the years ended September 30, 2001, 2000, and
1999 diluted earnings per common share is the same as basic earnings per common
share.

16. Extraordinary Item

On April 29, 1999, the Company prepaid a $500,000 loan from NYSB bearing an
interest rate of 12% from the proceeds of the IPO. Accordingly, the Company
recorded an extraordinary loss of $177,125 ($0.02 per share) related to the
early retirement of debt. The extraordinary loss was comprised of a $5,000
prepayment penalty and unamortized option costs of $172,125. There was no tax
benefit recognized for the extraordinary item because of the Company's net
operating losses.

17. Subsequent Events

On November 2, 2001, the Company concluded the purchase of certain assets of
On-Site Trading, Inc., (the "Seller") in accordance with the Asset Purchase
Agreement. Purchased assets included customer accounts, Seller's interest in
branch management agreements, and Seller's class A interest in Onsite Trading
LLC, for 1,875,000 shares of common stock, and the assumption of approximately
$1.8 million of liabilities. The common stock is represented by three separate
certificates registered in the name of Seller, in respective amounts of 937,500
shares delivered to the Seller on the purchase date, 468,750 shares ("Escrowed
Shares"), and 468,750 shares ("Deferred Shares"). The Escrowed Shares will be
released to Seller on November 2, 2002, unless there are outstanding claims by
the Company for damages due to breach of the Asset Purchase Agreement. The
Deferred Shares will be released to the Seller monthly in accordance with the
following formula: Revenues generated by purchased assets divided by $1,000,000
times 39,062.5.

On November 29, 2001 the Company issued 630 shares of its Series A convertible
preferred stock, at a price of $10,000 per share. Each share is convertible into
3,390 shares of common stock. Stock dividends are cumulative at a rate of 6% for
the first eighteen months and 15% thereafter. The aggregate purchase price of
the preferred stock and warrants is $6,300,000. The purchasers were issued
Series A warrants to purchase 1,601,460 shares of common stock at an exercise
price of $2.95 per share. A portion of the purchase price was paid with a senior
subordinated demand note issued by the Company in connection with the Note and
Warrant Purchase Agreement dated August 30, 2001 (see note 7). The Company
issued warrants to purchase 85,236 and 83,362 shares of common stock on October
31, 2001 and November 29, 2001, respectively, in connection with the terms of
the Note and Warrant Agreement. The Company is currently assessing the impact of
EITF 00-27 with regard to the convertible preferred stock and warrants issued,
which may result in a significant preferred dividend deemed paid to the
investors and with regard to the Senior Subordinated Demand Note exchanged,
which may result in a significant income statement charge on the early
extinguishment of debt.

On January 10, 2001 all notes payable to related parties maturing February 2002
were extended through October 31, 2002 (see note 10).

On January 15, 2002 the Company has received a commitment from an officer and
stockholder for up to $2,000,000 in the form of equity or debt with a maturity
no sooner than January 15, 2003.

F-15

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.

A.B. WATLEY GROUP INC.

By: /s/ Steven Malin
--------------------------
Steven Malin
Chairman of the Board

Date: January 15, 2002

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated:

SIGNATURES TITLE DATE
- ---------- ----- ----

/s/ Steven Malin Chairman of the Board, Chief Executive Officer January 15, 2002
- ---------------- and Director (Principal Executive Officer and
Steven Malin Principal Financial Officer)

/s/ Anthony G. Huston President and Director January 15, 2002
- ---------------------
Anthony G. Huston

/s/ Joseph M. Ramos, Jr. Executive Vice President and Chief Financial January 15, 2002
- ------------------------ Officer (Principal Accounting Officer)
Joseph M. Ramos, Jr.

/s/ Robert Malin Director January 15, 2002
- ----------------
Robert Malin

/s/ Leon Ferguson Executive Vice President and Director January 15, 2002
- -----------------
Leon Ferguson

/s/ Mark Chambre Director January 15, 2002
- ----------------
Mark Chambre

/s/ Stanley Weinstein Director January 15, 2002
- ---------------------
Stanley Weinstein