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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(Mark One)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1999
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 0-28191
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eSpeed, Inc.
(Exact name of Registrant as Specified in Its Charter)
Delaware 13-4063515
(State or Other Jurisdiction of (I.R.S. Employer Identification
Incorporation) No.)
One World Trade Center, 103rd Floor, New York, NY 10048
(Address of Principal Executive Offices) (Zip Code)
(212) 938-3773
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of Each Exchange on which Registered
None None
Securities registered pursuant to Section 12(g) of the Act:
Class A Common Stock, $. 01 par value
(Title of Class)
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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 aggregate market value of voting common equity held by non-affiliates
of the registrant, based upon the closing price of the Class A common stock on
March 15, 2000 as reported on the Nasdaq National Market, was approximately
$719,372,500.
Indicate the number of shares outstanding of each of the Registrant's
classes of common stock, as of the latest practicable date.
Class Outstanding at March 15, 2000
Class A Common Stock, par value $.01 per share 10,350,000 shares
Class B Common Stock, par value $.01 per share 40,650,000 shares
DOCUMENTS INCORPORATED BY REFERENCE.
None.
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eSPEED, INC.
1999 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
Page
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PART I
ITEM 1 BUSINESS.............................................................1
ITEM 2 PROPERTIES..........................................................38
ITEM 3 LEGAL PROCEEDINGS...................................................38
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.................41
PART II
ITEM 5 MARKET FOR THE REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS....................................42
ITEM 6 SELECTED FINANCIAL DATA.............................................45
ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.................................46
ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK................................................53
ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.........................54
ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE.................................71
PART III
ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.................72
ITEM 11 EXECUTIVE COMPENSATION.............................................76
ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT.......................................................82
ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.....................84
PART IV
ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES,
AND REPORTS ON FORM 8-K...........................................95
PART I
ITEM 1. BUSINESS
The information in this report contains forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. Such statements
are based upon current expectations that involve risks and uncertainties. Any
statements contained herein that are not statements of historical fact may be
deemed to be forward-looking statements. For example, words such as "may,"
"will," "should," "estimates," "predicts," "potential," "continue," "strategy,"
"believes," "anticipates," "plans," "expects," "intends" and similar expressions
are intended to identify forward-looking statements. Our actual results and the
timing of certain events may differ significantly from the results discussed in
the forward-looking statements. Factors that might cause or contribute to such a
discrepancy include, but are not limited to, those discussed elsewhere in this
report in the section entitled "Risk Factors."
Overview of Our Business
eSpeed, Inc. is a leading provider of business-to-business electronic
marketplace solutions for the trading of products via the Internet or over our
global privately managed private network. Our eSpeed(((Service Mark))) system is
an end-to-end marketplace and trading community solution, which includes
real-time and auction-based transaction processing, risk management tools and
back-end processing and billing systems available to our clients. Our system is
designed to enable market participants to transact business instantaneously,
more effectively and at lower cost than traditional trading methods. Our
revenues are driven by trading activity and volumes in the marketplaces we
operate.
Our eSpeed((((Service Mark)))) system employs our international high speed
private electronic network and proprietary transaction processing software,
enabling significant capacity for fully electronic trading by our clients. We
believe these components form one of the most robust large scale, instantaneous,
mission critical trading systems in the world. Our network is internationally
distributed and permits market participants to view information and execute
trades in a fraction of a second from locations around the globe. Our system
operates and accesses a fully regulated U.S. futures exchange currently known as
the Cantor Exchange((((Service Mark)))). This exchange is the first fully
electronic futures exchange in the U.S. and will serve as our platform for the
electronic trading of a broad range of futures contracts globally.
Our eSpeed((((Service Mark)))) system includes our proprietary trading
application engine, which currently processes 150 transactions per second per
tradable instrument, our proprietary credit and risk module, which provides
real-time credit analysis and oversight, and our back-office and clearance
modules, which provide straight-through processing. Our eSpeed((((Service
Mark)))) system is accessible to our clients in four ways: through our
proprietary application programming interface (or API), through a dedicated
software application, via the Internet through a browser interface or Java
applet, or through front-end trading systems developed by third-party software
companies.
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Our objective is to create the leading business-to-business marketplace
trading solution. Our strategy is to leverage the scale and extendibility of our
system, our leading marketplace development expertise and our proprietary
futures exchange across markets.
Recent Events
We commenced operations in March 1999 as a division of Cantor Fitzgerald
(Cantor). Cantor currently operates with us the largest wholesale marketplace
for U.S. Treasury securities and leading marketplaces for many other global
fixed-income securities and financial instruments. Cantor also operates in other
non-financial markets, such as energy, commodities and acid rain emissions. Over
the past 25 years, Cantor has been a leading intermediary for the fixed income
markets. In 1972, Cantor developed the world's first screen-based marketplace
for the trading of U.S. government securities. Since the early 1990s, Cantor has
developed systems to promote fully electronic marketplaces. Since 1996, Cantor
has invested more than $200 million in information technology, including the
development of proprietary electronic transaction processing software, network
distribution systems and related contractual rights that comprise our
eSpeed((((Service Mark)))) system. In connection with the initial public
offering of our Class A common stock in December 1999, Cantor contributed to us
this proprietary software, network distribution systems, technologies and
related contractual rights.
We began marketing our eSpeed((((Service Mark)))) system throughout 1999
and, through our relationship with Cantor, we focused primarily on the financial
services industry and, in particular, fixed income products (which we refer to
as the Interest Rate Vertical). We now operate the largest global electronic
marketplace for U.S. Treasury securities, transacting billions of dollars daily,
and we operate leading global electronic marketplaces for other fixed income
securities and financial instruments. Most of the largest financial institutions
currently use our marketplaces to trade a wide range of global fixed income
securities, futures, options and other financial instruments. These financial
instruments include government securities denominated in U.S. dollars, Euros,
Yen, British Pounds Sterling, Canadian dollars and currencies of emerging market
countries, as the well as securities of U.S. agencies, municipal securities,
Eurobonds, corporate bonds and other global fixed income securities and U.S.
Treasury futures.
Within the Interest Rate Vertical, we believe we operate the only
electronic marketplaces used for trading multiple securities in multiple
currencies, and on a global basis provide a fully registered futures exchange.
Over 500 institutions worldwide participate in the Interest Rate Vertical,
including the 25 largest bond trading firms in the world, as identified by
Euromoney Magazine. Most of these institutions use our proprietary eSpeed screen
displays and/or trading platforms, which allow us to deliver information and
execute transactions instantaneously through the computer security barriers that
permit or exclude entry into the internal networks of these institutions. We
have devoted significant resources to developing client arrangements, providing
point-to-point communication links and creating proprietary software to
establish connectivity through these security barriers in order to deliver data
and execute transactions for our clients on a secure basis.
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Industry Background
Growth of the Internet and Business-to-Business Electronic Commerce. The
Internet has emerged as the fastest growing communications medium in history.
With over 165 million users at the end of 1998, growing to 623 million users by
2002, as estimated by IDC, the Internet is dramatically changing how businesses
and individuals communicate and share information. The Internet has created new
opportunities for conducting commerce, such as business-to-consumer and
person-to-person electronic commerce. Recently, the widespread adoption of
intranets and the acceptance of the Internet as a business communications
platform has created a foundation for business-to-business electronic commerce
that will enable organizations to streamline complex processes, lower costs and
improve productivity. With this foundation, Internet-based business-to-business
electronic commerce is poised for rapid growth and is expected to represent a
significantly larger opportunity than business-to-consumer or person-to-person
electronic commerce. According to Forrester Research, business-to-business
electronic commerce is expected to grow from $43 billion in 1998 to $1.3
trillion in 2003, accounting for more than 90% of the dollar value of electronic
commerce in the United States. This market is expected to create a substantial
demand for Internet-based electronic commerce applications.
Electronic Marketplaces. Electronic marketplaces have emerged as major
interactive mediums for business-to-business transactions, including auctions
and exchange-like trading mechanisms. In an electronic marketplace,
substantially all of the participants' actions are facilitated through an
electronic medium, such as a private electronic network or the Internet, which
effectively eliminates the need for actual face-to-face or voice-to-voice
participant interaction and saves time and money thereby creating enormous
efficiencies.
Our Trading Services and Technology Platform
In our electronic marketplaces, participants may either electronically
execute trades themselves or call brokers/terminal operators who then input
trade orders into the eSpeed system for them. In a fully electronic trade, all
stages of the trade occur electronically. The participant inputs its buy or sell
order instructions directly into our electronic trading system, using a
web-browser, a keyboard, an application programming interface or other software.
The system provides to the participant, normally within 300 milliseconds, an
on-screen confirmation that the participant's order has been accepted.
Instantaneously, once a trade is executed, the participant receives an on-screen
trade confirmation. Simultaneously, an electronic confirmation can be sent to
the participant's back office and risk system, enabling risk management
capabilities and straight-through processing for the participant. A
broker/terminal operator assisted trade is executed in substantially the same
manner as an electronic trade, except that the participant telephones a
broker/terminal operator who then inputs the participant's order into our
electronic marketplace system.
Over time, we expect fully electronic trading to become the predominant
trading method in our marketplaces. However, through our affiliation with
Cantor, we have the ability to offer to our clients broker/terminal operator
trading capabilities, thereby providing instantaneous back-up and marketplace
access. Unlike most traditional exchanges that have created side-by-side
competitive markets for voice and electronic access and, as a result, have
created separate pools
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of liquidity, our markets permit access to fully electronic and broker/terminal
operator orders to be all transacted within our eSpeed system in one liquidity
pool, seamlessly.
Our electronic marketplaces operate on our proven technology platform that
emphasizes scalability, performance and reliability. Our technology platform
consists of:
o our proprietary, internally developed real-time global network
distribution system;
o our proprietary transaction processing software, which includes order
matching auction engines, fully integrated credit and risk management
systems, pricing engines and associated middle and back office operations
systems;
o client interfaces ranging from Windows, Java, UNIX, our proprietary static
library API and proprietary vendor access; and
o customized inventory distribution and auction protocols designed to be
used by our clients in their distribution and trading systems.
Together, these components enable participants in our marketplaces to
trade almost every commodity in real-time efficiently, with straight-through
processing capabilities and certainty of execution.
Network Distribution System. Our eSpeed((((Service Mark)))) system
contains a proprietary hub and spoke digital network. This network uses Cisco
Systems network architecture and is operated by certified Cisco engineers. Our
network's high speed points of presence comprise the major financial hubs of the
world, including New York, London, Tokyo, Frankfurt, Paris, Milan, Chicago, Los
Angeles and Toronto. Altogether, we manage 22 hubs linked by over 50,000 miles
of cable, over 800 Cisco routers and switches and over an aggregate of 550 high
capacity Sun servers, Compaq Alpha super servers and Windows NT servers. The
redundant structure of the system provides multiple backup paths and re-routing
of data transmission if one spoke of a hub fails. This instantaneous backup is
critical to maintaining our clients' connectivity. We believe we operate one of
the largest and most robust interactive trading network distribution systems
currently in operation.
Our distribution system accepts orders and postings instantaneously and
distributes responses, generally in 300 milliseconds. The network can transport
150 million bits of information per second around the world and is currently
running at approximately 12% of capacity.
In addition to our own network system, we also distribute encrypted data
and receive trading information from clients using the services of multiple,
major Internet service providers throughout the world. These connections enable
us to offer Internet-based trading to our global clients which is completely
integrated with our private network.
Transaction Processing Software. Most of our software applications have
been developed internally and are central to the success of our
eSpeed((((Service Mark)))) system. Our order-matching auction and trading
engines operate in real-time, facilitating efficient interaction between buyers
and sellers. Our credit and risk management systems monitor and regulate these
buyers and
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sellers, limiting market and credit risk. Our pricing engines provide prices for
illiquid financial products through multiple trades in other related financial
instruments. These critical applications work together seamlessly and are
supported by middle and back office software that verifies, confirms, reports,
stores, tracks and, if applicable, clears each trade.
o eSpeed Trading Engines. Our auction and trading engines use
Interactive Matching((Service Mark)), our proprietary rules-based
method, to process in excess of 150 transactions per second per
auction, instrument or product. These engines were developed to
support trading of the largest capital markets in the world, such as
government bonds and futures contracts, and the more diverse,
fragmented and database intensive markets, such as U.S. municipal
bonds (with over 1.7 million different issues), corporate bonds and
Eurobonds. These trading engines are designed to be modular and
flexible to allow modification in order to apply them to other
markets and auction types. In Europe, for example, we have added a
component that allows us to process trading and auctions in multiple
currencies simultaneously. Our trading engines have embedded
security features and an added messaging layer to provide security
from unauthorized use. In addition, we use encryption to protect our
clients that trade over the Internet. When used together, our
trading engines can trade a wide range of instruments and products
and facilitate trade in auctions and markets. Our systems have
handled trades ranging in size from $100 to billions of dollars.
We believe our marketplace expertise and rules based systems provide
incentives for clients to actively participate in our marketplaces.
For example, Interactive Matching provides incentives to participate
in our marketplaces by encouraging participants to expose their
orders to the market by providing them priority in an interactive
marketplace. In standard auctions, the incentive is for participants
to wait until the last moment to make a bid or offer. Our priority
rules encourage trading activity by giving the last successful
active participant a time-based right of first refusal on the next
sale/purchase. In addition, in many markets we have structured our
pricing policy to provide that the party that provides auction
products for the market or creates liquidity by inputting a price to
buy or sell pays less commission (or no commission) than the
participant that consummates the trade by acting on that price. With
our pricing policies and proprietary priority rules, our system is
designed to increase activity and to draw participants into the
market. This proprietary rules-based system is easily adaptable and,
as part of our business strategy, we intend to apply it across other
non-financial markets for a multiple of products and services.
o eSpeed Credit Master - Credit and Risk Management Systems. Our
credit and risk management systems are critical to the operation of
our electronic marketplaces. Our proprietary credit and risk
management systems (1) continuously monitor trades of our clients to
ensure that they have not exceeded their credit limits, (2)
automatically prevent further trading once a client has reached a
pre-determined credit limit, and (3) evaluate trade transactions and
calculate both individual positions and risk exposure across various
products and credit limits. These systems can also be made available
to our global clients to enable them to monitor the position of
their traders and integrated with our private label systems so they
can monitor the credit of their clients who participate in our
marketplaces. These systems store client data relevant to credit
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and risk management, such as financial statements, credit documents,
contacts and internal analyses. These systems also enable our
clients to make our electronic marketplaces available to their
clients while maintaining control of their trading activity and
risk.
o eSpeed Pricing Engines and Analytics. We have internally developed a
number of sophisticated, analytical software tools that permit us to
price products that trade in less liquid markets and for which
current pricing information is not readily available. For example,
our MOLE((Service Mark)) system (Multiple Order Link Engine) is a
computer application that enables us to link multiple markets, offer
prices and create and enhance marketplaces for products that have
limited liquidity. For example, in the Interest Rate Vertical, MOLE
currently uses data from existing cash and futures markets to
calculate pricing for transactions where no market prices currently
exist, thereby enabling liquidity.
o eSpeed Back-Office - Middle and Back-Office Applications. Our middle
and back office applications support clearance, settlement, tracking
and reporting of trades and provide links to outside clearing
entities. In the financial markets, we outsource our fulfillment
services to Cantor, where both parties to a trade send either cash
or a security to Cantor and Cantor settles the trade and sends each
party the cash or security due. Our reporting and accounting systems
are designed to ensure that all charges and commissions for a trade
are tracked and recorded. Our accounting systems are designed to
ensure that books and records are kept in accordance with regulatory
guidelines and accounting standards.
o Client Interfaces. Our systems can be accessed by our clients in
four ways:
o using our eSpeed((Service Mark)) proprietary front end trading
software;
o using our application programming interface to write their own
software linking their networks and software applications
directly to our systems;
o through the Web via a browser, or using a downloaded java
application or dedicated proprietary software application via
the Internet, both for wholesale clients and for retail
clients who participate in our marketplaces; and
o through software developed in alliances with third-party
vendors such as QV Trading and SunGard/ASC. Our application
programming interface enables clients to conduct computer
price updating, program trading and straight-through
processing.
o eSpeed Private Label Products. We enable our clients to serve their
customers more effectively be supplying them with a private label
version of our eSpeed((Service Mark)) system, which incorporates the
functionality of our eSpeed((Service Mark)) system but allows them
to place their branding on the system for distribution to their
customers, whether via the Web or via a private network. These
products encompass our strategy to enable our clients to better
serve their institutional clients, as well as allowing us to enable
online and
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traditional retail brokers to provide their clients with
instantaneous access to a broad range of financial instruments:
o our Private Label products for the institutional market will
enable our clients to create their own customized versions of
our eSpeed((Service Mark)) system to enable them to transact
with their customers in an efficient manner utilizing a
co-branded version of our eSpeed((Service Mark)) system. Our
customers will use the system to allow more efficient
distribution of a wide variety of instruments that these
dealers will support, enabling them to transact more cost
effectively with their clients, and ensuring that they have a
turnkey e-commerce solution for their own marketing efforts.
We will enable these clients to deliver a customized
e-commerce solution to their customers, quickly, efficiently
and cost effectively.
o our Private Label products for the retail marketplace will
enable online and traditional retail brokers to provide their
clients with instantaneous access to previously unavailable
wholesale marketplaces for the retail trading of fixed income
instruments, futures, options and other financial instruments.
While retail investors generally have been able to buy and
sell equity securities at the same prices and spreads as
wholesale market participants and institutional investors,
this has not been the case with fixed income securities,
futures, options and other financial instruments. We believe
our eSpeed((Service Mark)) system will expand marketplaces
and/or retail volume and enhance execution for individual
retail investors.
Benefits of Our eSpeed((Service Mark)) System
The benefits of our eSpeed((Service Mark)) system include the following:
Instantaneous Price Dissemination and Auction and Trade Execution. Our
eSpeed((Service Mark)) system provides our clients with the ability to access
pricing and other information, operate auctions and execute trades
instantaneously, as opposed to traditional trading methods which provide less
timely information, non-real-time auctions and less efficient trade execution.
Lower Transaction Costs. Our eSpeed((Service Mark)) system streamlines the
entire trading process by eliminating the significant layers of manual
intervention that currently exist at both the front-end of the process,
including order entry, matching and postings functions, as well as at the middle
and back-end of the process (clearance, settlement, tracking and reporting
functions), resulting in significantly lower transaction costs for our clients.
Multiple Product Program Trading. Our eSpeed((Service Mark)) system
provides our clients with the ability to execute sophisticated and complex
transactions and trading strategies, including the trading of multiple products
across multiple markets simultaneously.
Greater Accuracy and Decreased Probability of Erroneous Trades. Our
eSpeed((Service Mark)) system includes verification mechanisms at various stages
of the execution process, which result in significantly reduced manual
intervention, decreased probability of erroneous trades and more accurate
execution for clients.
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Integrated Compliance and Credit Risk Functions. Our eSpeed((Service
Mark)) system includes a comprehensive range of compliance and credit risk
management components that perform several critical functions, including: (1)
continuously monitoring trading activity to ensure that clients are staying
within credit limits; (2) automatically preventing further trades once credit
limits have been exceeded; and (3) evaluating and calculating positions and risk
exposure across various products and credit limits. These risk, credit and
compliance tools are highly sophisticated and can be customized for our clients
and integrated into their information technology platforms.
Highly Efficient Pricing on Illiquid Securities. Our MOLE((Service Mark))
system enables us to provide prices for illiquid products through multiple
trades in other related products. These multi-variable trades are extremely
difficult to execute in traditional markets due to their complexity and the slow
speed of manual execution.
Ability to Automate Back-Office Functions. Our eSpeed((Service Mark))
system automates previously paper and telephone-based transaction processing,
confirmation and other functions, substantially improving and reducing the cost
of client back-offices, and enabling straight-through processing.
Private Label Products. Our private label initiative will allow our
clients to better serve their customers by enabling them to deliver an
e-commerce solution quickly, efficiently and cost effectively. We believe we not
only enhance the overall liquidity and efficiency of the market but also
maintain a stronger client relationship.
Leveraging Our eSpeed((Service Mark)) System Horizontally to Expand to
Additional Non-Financial Marketplaces (Vertical Markets).
Because of the scale of our system and its ease of adaptability, we
believe our eSpeed((Service Mark)) system and Interactive Matching((Service
Mark)) have applications across a broad range of products, including any
business-to-business marketplace involving multiple buyers and sellers. We are
well positioned to leverage the significant costs and efforts that have been
incurred developing our eSpeed((Service Mark)) system to quickly create
electronic markets in a wide range of products.
We expect to extend our marketplaces to include additional financial and
non-financial products, including energy, telecommunications products, including
bandwidth and telephone minutes, and bulk commodity chemicals, electronic
components and other decentralized or illiquid markets, through a variety of
approaches, together with Cantor as well as with other strategic partners.
Initially, we will focus our expansion efforts on the securities and
financial instruments traded by Cantor that have not yet been converted to
electronic trading. We plan to significantly expand the types of securities and
financial products traded in the Interest Rate Vertical marketplaces. Our goal
is to include in our electronic marketplaces the full range of fixed income
securities, futures, options and other securities and financial products that
are currently traded in today's markets worldwide.
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The Interest Rate Vertical
Wholesale Fixed Income Securities Trading. The global fixed income
securities market is the largest financial market in the world. In the United
States alone, there are over $13 trillion of fixed income securities
outstanding, and in the U.S. Government Securities market alone, there is
reported to be approximately $200 billion a day in trading just among the
primary dealers and their clients. Other fixed income instruments are traded
widely, and in Europe, Asia and the emerging markets, there is another
approximately $13 trillion of fixed income securities outstanding, with an
average daily trading volume of approximately $300 billion. In Europe, the
creation of the Euro has manifested a market second only to the United States in
breadth. We expect continued significant growth in these fixed income markets as
the issue of currency translation is removed as an obstacle to the development
of a large unified Pan-European market for securities.
Futures and Options Trading. Futures and options trading is a leading
financial activity throughout the world, with contracts traded on a wide variety
of financial instruments, commodities and indexes. In 1998, over 1.5 billion
futures contracts were traded in the world's futures markets, and over 750
million options contracts were traded on a variety of exchanges. Futures and
options provide several important economic benefits, including the ability to
shift or otherwise manage market risk. In part because these markets provide the
opportunity for leveraged investments, they attract large pools of risk capital.
Currently, most futures trading is still being done on open outcry exchanges,
but there has been a significant movement towards the conversion of these
markets to electronic trading. To date, we believe the most successful
initiatives have been made in Europe. We believe that there is significant
opportunity in the continued conversion of these markets to electronic networks,
such as our own.
Interest Rate Vertical. The Interest Rate Vertical includes many of the
largest Cantor marketplaces, including U.S. Treasury and European government
securities, global fixed income securities, futures, options and other financial
products. We intend to convert most of Cantor's remaining marketplaces to our
electronic trading platform by the end of 2000. Today, together with Cantor, our
systems execute in excess of $45 trillion in transaction volume annually and are
major facilitators and, in some cases, providers, of liquidity in numerous
financial products through our offices in the United States, Canada, Europe and
Asia. We share with Cantor a portion of the transaction-based revenues paid by
financial market participants for trades using our electronic marketplaces.
Cantor and most of the largest financial institutions in the world are currently
our primary clients. Our eSpeed((Service Mark)) system provides the only way to
electronically access Cantor's marketplaces. Consequently, we believe that
clients will be strongly motivated to use our interactive electronic
marketplaces.
Traditional Trading Methods for Financial Marketplaces. In both the fixed
income and futures markets, trading practices historically have centered on a
method of trading known as open outcry, where all trading activity is focused on
a central physical location, or pit. This method of trading can create
significant value for the market participants in the pit, who often have access
to better and more timely market information than other market participants. All
other market participants have to access the market through this central
location. Additionally, in order to access the pit, individuals and
institutional traders must send their orders through several layers of
middlemen, who assist in handling such orders. This process is inefficient. In
today's
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heavily regulated open outcry U.S. futures markets, for example, an
order can be routed through multiple people during its execution, adding
significant costs to the transaction. Virtually all U.S. futures exchanges are
controlled by their members and floor traders. Professional broker-dealers,
traders, institutional traders and individuals currently must trade with these
floor members, who are the market makers. These factors result in higher direct
and indirect costs of trade execution.
Traditional Order Execution
Limitation of Traditional Trading Methods. While traditional financial
markets facilitate large volume trading, they have significant shortcomings such
as the following:
o limited direct access and, therefore, many investors may not receive
efficient pricing;
o high transaction costs due to the number of people involved in an
open outcry system;
o slow execution;
o program trading, especially programs designed to automatically and
simultaneously execute multiple trades in different, but related,
financial products, is difficult to implement because of the current
manual nature of these markets;
o significant expense is also incurred in processing, confirming,
clearing and implementing compliance programs designed to monitor
and manage the exposure of individual professionals, as well as the
entire enterprise;
o paper and telephone-based trading produces delayed information and
results in compliance programs that are expensive to manage and can
be circumvented.
Therefore, institutions bear increased risk. These factors impede trading by
limiting volume and liquidity.
Emergence of Electronic Exchanges. Many financial exchanges worldwide,
including certain exchanges in France, Germany, Japan, Sweden, Switzerland and
the United Kingdom, are now partially or completely electronic. In the United
States, however, trading in many types of financial instruments continues to be
conducted primarily on open outcry exchanges. Recently, many exchanges have
introduced side-by-side markets for voice and electronic access and, as a
result, have created separate pools of liquidity. Moreover, substantially all of
the electronic trading systems introduced internationally and in the United
States have been implemented on a regional basis. Most of these systems provide
limited market liquidity and are designed to accommodate trading in one or a
limited number of securities and financial products, typically equity
securities. We believe that wholesale market participants and institutions will
ultimately look for a limited number of marketplaces to meet most of their
trading needs. This is because market participants will not want to work with
multiple trading platforms and connect their information technology platforms
and compliance programs to a large number of disparate systems. We believe the
trend toward electronic trading will continue and will ultimately result in a
majority of markets worldwide becoming fully electronic.
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In addition, recently there has been considerable discussion regarding the
move toward the demutualization of exchanges. Exchanges have historically been
operated on a not-for-profit basis for the benefit of their respective members,
and this governance structure has limited their ability to adopt new
technologies and respond quickly to market changes. In response to technological
advances in trading systems, many exchanges are contemplating the reorganization
of their ownership and management structures and are seeking to form alliances
with strategic partners. These developments have created, and are expected to
continue to create, opportunities for strategic acquisitions and alliances.
Online Trading. Favorable investing environments and advances in
technology have led to the rapid development of online and traditional retail
brokerage businesses. Technological advances have created new and inexpensive
means for individual investors to directly access markets online and participate
in the securities markets. According to International Data Corporation, the
number of online brokerage accounts grew from approximately 1.5 million at the
end of 1996 to over 6.4 million at the end of 1998, representing $324.0 billion
in assets and over 300,000 trades per day, primarily in equity securities.
International Data Corporation also estimates that, by 2002, 30% of investors
will trade online, and there will be over 24 million online accounts, a 275%
increase from 1998. Despite the growth in online accounts and access to public
equity markets, there has been very limited access for retail Internet trading
in fixed income securities, futures, options and other wholesale financial
instruments at cost-effective pricing and spreads. We believe that the emergence
of electronic marketplaces which promote greater liquidity, enhanced access and
more efficient pricing will increase trading among retail investors.
Our Interest Rate Vertical Marketplace Solution
Our private electronic network for wholesale financial markets is
connected to most of the largest financial institutions worldwide. We have
installed in the offices of our existing client base, comprising more than 500
leading dealers, banks and other financial institutions, the technology
infrastructure necessary to provide price information and trade execution on an
instantaneous basis in a broad range of securities and financial instruments. We
believe our eSpeed((Service Mark)) system enables us to introduce and distribute
a broad mix of financial products and services more quickly, cost effectively
and seamlessly than competitors.
Our eSpeed((Service Mark)) system:
o has a flexible design which allows us to quickly and easily add new
financial instruments in multiple currencies and trading models;
o uses a network distribution system, which we believe is one of the
most robust systems in operation, and which enables us to provide
access to a broad mix of accurate, instantaneous market data and
fast and highly reliable trade execution;
o is designed to minimize the need for human intermediaries in the
trading process by providing clients with multiple methods of
accessing our marketplaces and executing trades directly; and
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o uses Interactive Matching((Service Mark)), our proprietary,
rules-based trading method that interactively executes buy and sell
orders from multiple market participants.
These system features enable us to operate what we believe is the only
integrated trading network engaged in electronic trading in multiple products
and marketplaces on a global basis.
We believe our eSpeed((Service Mark)) system provides us with significant
competitive advantages over existing electronic trading systems and new entrants
seeking to develop and introduce limited electronic trading systems to the
global securities and financial instruments marketplaces. We also believe that
the time and expense required to develop and install electronic trading networks
will serve as a significant barrier to entry to many other potential
competitors.
Our Growth Strategy
Our objective is to be the leading provider of interactive electronic
marketplaces in the world. We believe we can extend our expertise in the
creation of instantaneous electronic marketplaces to a broad range of financial
and non-financial products and services. Our growth strategy to achieve this
objective includes the following key elements:
Focus Exclusively on Developing and Operating Interactive Electronic
Marketplaces. We intend to capitalize on the trend toward the increased use of
electronic trading platforms by focusing our business exclusively on the
development and operation of interactive electronic marketplaces worldwide. We
believe this operational focus provides us with a significant advantage over
competitors that have multiple and sometimes conflicting business objectives,
rigid business practices and cumbersome ownership structures that may impede
their ability to efficiently develop and implement electronic trading platforms
of their own.
Leverage Our eSpeed((Service Mark)) System for Use in Other
Business-to-Business and Consumer Markets. Because of the scale of our system
and its ease of adaptability, we believe our eSpeed((Service Mark)) system and
Interactive Matching((Service Mark)) have applications across a broad range of
products, including Internet-based marketplaces for a wide array of goods and
services, particularly those involving multiple buyers and sellers. We are well
positioned to leverage the significant costs and efforts that have been incurred
developing our eSpeed((Service Mark)) system to quickly create electronic
markets in a wide range of products.
Expand the Number of Financial and Non-Financial Products in Our
Electronic Marketplaces. Our electronic marketplaces currently handle the
trading of financial products which have among the highest average annual
trading volumes of all financial products, including U.S. government securities,
U.S. Treasury futures, non-U.S. G-7 government bonds, Eurobonds, corporate
bonds, agency securities, U.K. gilts, emerging markets securities, U.S.,
European and other repurchase agreements and municipal bonds. We plan to
significantly expand the types of securities and financial products traded in
our marketplaces. Our goal is to include in our electronic marketplaces the full
range of fixed income securities, futures, options and other securities and
financial products that are currently traded in today's markets worldwide.
Initially, we will focus our expansion efforts on the securities and financial
instruments traded by Cantor that have not yet been converted to electronic
trading. We expect to further extend our marketplaces to include additional
financial and non-financial products, including energy,
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communications, including bandwidth and telephone minutes and other
decentralized or illiquid markets, through a variety of approaches together with
Cantor or other strategic partners.
Convert Existing Clients to Fully Electronic Trading. Currently, less than
4% of the trades executed daily in our marketplaces, representing more than $6
billion in volume, are executed on a fully electronic basis without the
assistance of a broker. We intend to continue to convert substantially all of
Cantor's clients to a fully electronic trading environment. We believe the ease
of use, low price and efficient execution that our electronic marketplaces
afford will encourage clients to convert their trading to fully electronic
trading. We have a team of over 30 persons dedicated to enhancing client
awareness of the advantages of electronic trading and providing client support
in converting trading activity to a fully electronic trading format, and we
intend to increase that number. We also expect to leverage Cantor's historical
client relationships in connection with these efforts.
Leverage Existing eSpeed((Service Mark)) System Connectivity to Deploy New
Products and Services. Our eSpeed((Service Mark)) system provides connectivity
to, and the opportunity to electronically interact with, a global client base
that includes dealers, banks and financial institutions at hundreds of sites
around the globe. As a result, a significant number of our major clients
currently have installed the hardware necessary to trade on a fully electronic
basis. Utilizing the existing infrastructure and flexible architecture of this
system, we will be able to install with relative ease and at marginal
incremental cost, the components that will enable a client to electronically
trade in additional types of securities and financial products. We expect access
to this existing global private trading network to enable us to introduce and
distribute a broad mix of electronic trading products and services, more
quickly, cost effectively and seamlessly than competitors without access to such
a network.
Creating Online Retail Broker Access to Wholesale Markets for Fixed Income
Securities and Other Financial Products. We intend to create retail
marketplaces, where appropriate, to enable online and traditional retail brokers
to provide their clients with instantaneous access to previously unavailable
wholesale marketplaces for retail trading of fixed income securities, futures,
options and other financial instruments. While retail investors generally have
been able to buy and sell equity securities at the same prices and spreads as
wholesale market participants and institutional investors, this has not been the
case with fixed income securities, futures, options and other financial
instruments. We believe our eSpeed((Service Mark)) system will expand
marketplaces and/or retail volume and enhance execution for individual retail
investors.
Pursue Acquisitions and Strategic Alliances. We intend to capitalize on
the highly fragmented nature of the financial marketplaces and the trends toward
exchange demutualization and consolidation among regional and global market
participants. We expect to pursue an acquisition-based growth program that will
enable us (1) to acquire complementary technologies and service capabilities in
a cost-effective manner and (2) to broaden our product base and the securities
markets in which we provide our electronic trading services. We will seek to
enter into joint ventures and other strategic alliances to create additional
liquidity in the global financial products markets and to attract new trading
participants to those markets. We believe the flexibility afforded by our
corporate governance structure will enable us to implement these strategies, as
well as to anticipate and respond to developments and trends in the global
financial markets, more efficiently than competitors, such as exchanges, which
have broadly dispersed
13
memberships and cumbersome management structures. Additionally, in connection
with our strategy for non-financial marketplaces, we may pursue acquisitions and
strategic alliances to allow us to enter these markets quickly. We also may
pursue acquisitions which may add functionality to our technology offerings.
Sales and Marketing
We expect to promote our electronic marketplaces and brokerage-related
services to Cantor's existing clients and new clients through a combination of
sales, advertising, marketing and co-marketing campaigns. We also expect to
leverage the historical client relationships of Cantor's employees under our
Joint Services Agreement with Cantor. We intend to build and enhance the eSpeed
brand name recognition through a sales, advertising and marketing campaign. We
expect to market to retail clients through a variety of campaigns, including
co-marketing campaigns with our online and traditional retail brokers. We intend
to design our sales, marketing and advertising campaigns to promote brand
awareness and educate the marketplace regarding the nature of our electronic
marketplaces, products and services and the advantages associated with the
automation of trading activities, such as enhanced instantaneous information
flow, price transparency and more direct and cost-effective market access, tight
spreads and instantaneous trade execution.
Our Clients
Clients in our marketplaces include banks, dealers, brokers and other
wholesale market participants, over 500 of which currently participate in our
electronic marketplaces, including the 25 largest bond trading firms in the
world, as identified by Euromoney Magazine. Through our eSpeed((Service Mark))
system, we expect to enable retail brokerage firms to expand their businesses by
providing them with the ability to offer their individual clients the option of
trading bonds and futures electronically in the same way they trade equity
securities, and we expect to include other marketplaces previously unavailable
to retail investors, or not available to them at reasonable spreads or
commissions. We intend to provide to wholesale and retail investors and to
Cantor access to our electronic marketplaces and brokerage-related services
supported by our eSpeed((Service Mark)) system. We expect that a significant
portion of our clients who use brokers will migrate to fully electronic access
over the coming years. We also intend to provide to third parties and to Cantor
the infrastructure, including systems administration, internal network support
and operations and disaster recovery services, that is critical to providing
fully electronic marketplaces for trading in a wide range of financial products.
Other than Cantor, no client of ours accounts for more than 10% of our revenues.
Strategic Alliances
In 1997, Cantor entered into an agreement with the New York Cotton
Exchange, which, upon merging with the Coffee, Sugar & Cocoa Exchange, became
known as the New York Board of Trade. The agreement sets forth the terms and
conditions pursuant to which Cantor operates an electronic marketplace, called
the Cantor Exchange, for futures contracts cleared by and under the regulatory
supervision of the New York Board of Trade. Cantor has assigned to us all of its
rights and obligations under its agreement with a subsidiary of the New York
Board of Trade to jointly operate the Cantor Exchange. Under the agreement, the
New York Board of
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Trade, through its subsidiaries, provides clearing and regulatory services and
we provide electronic execution and related services for the Cantor Exchange.
Pursuant to the agreement, neither we nor our affiliates will during the
term of the agreement establish in the United States an electronic market for
trading futures contracts or options on futures contracts on cotton, cheese,
coffee, sugar, cocoa, milk or frozen orange juice. We have agreed that within
the United States we will exclusively operate for the Cantor Exchange markets
for U.S. Treasury futures and other products so designated by the Cantor
Exchange. We and our affiliates may establish any electronic market that is
located physically outside the United States for such products if the New York
Board of Trade is not capable of providing regulatory or clearing services with
respect to such products.
Software Development
We devote substantial efforts to the development and improvement of our
electronic marketplaces. We will work with our clients to identify their
specific needs and make modifications to our software, network distribution
systems and technologies which are responsive to those needs. We are pursuing a
four-pronged approach to our research and development efforts: (1) internal
development; (2) strategic partnering; (3) acquisitions; and (4) licensing. We
have approximately 200 persons involved in our internal software development
efforts. Our technology team's objective will be to develop new products and
services that employ proven technology designed to provide superior electronic
trade execution and marketplace services to our clients. We will also focus our
efforts on enhancing our Web site and Internet screen interface to facilitate
real-time markets, comply with the standard Internet security protocol and
future security protocols and migrate transactions to the public networks in
order to capitalize on the development of new commercial marketplaces. We are
continuing to develop new marketplaces and products using our internally
developed application software having open architecture and standards. In
addition, we have forged strategic alliances with organizations such as
Sungard/ASC and QV Trading through which we will work to develop sophisticated,
front-end trading applications and products. We expect to license products from
and to companies when it is cost effective or profitable to do so.
Competition
The development and operation of electronic trading marketplaces are
evolving. As a result, competition in these marketplaces is currently very
fragmented. We expect to face competition from a number of different sources
varying in size, business objectives and strategy.
In the Interest Rate Vertical, our eSpeed((Service Mark)) system currently
competes, and we expect it to compete, directly and indirectly, with:
o traditional trading methods, including manual buy/sell order input
by registered brokers in response to telephone originated requests
and execution of trades in open outcry trading pits on exchange
floors, such as the Chicago Board of Trade, the Chicago Mercantile
Exchange and other exchanges and over-the-counter markets;
15
o products developed and used by exchanges and financial services
firms, such as Liberty Brokerage Investment Corporation and
Garban-Intercapital plc, seeking to act as market intermediaries;
o automated trade execution services developed by third party vendors
for commercialization in a wide range of financial products markets;
o products and services of market data, information and communication
vendors, such as Reuters Group plc, Bloomberg L.P. and Bridge
Information Systems Inc., that have created electronic networks
which link them to most major financial institutions and that have
attempted, in some cases, to expand their networks to include
trading platforms; and
o consortia comprised of leading financial institutions and service
providers, such as BrokerTec Global LLC, which has announced its
intention to explore the development of electronic trading networks,
and EuroMTS.
In the business-to-business sector in general, we compete, directly and
indirectly, with:
o business-to-business marketplace infrastructure companies like Ariba
and CommerceOne, as well as with other Internet-based marketplace
trading and infrastructure platforms; and
o Niche market Internet-based trading systems, including AltraEnergy
Trading and HoustonStreet.
The electronic trading services we provide our wholesale clients enable
them to expand the range of services they provide to their ultimate customers,
which are also potential participants in our electronic marketplaces. We intend
to structure our relationships with our clients and conduct our operations to
mitigate the potential for this competition. We do not intend to use the access
to the customer base of our wholesale clients that we obtain in providing our
electronic trading services to compete with these wholesale clients in other
securities and financial instrument transactions.
We believe our electronic marketplaces will compete primarily on the basis
of speed, efficiency, price and ability to provide access to liquidity to market
participants.
Our Intellectual Property
We have adopted a comprehensive intellectual property protection program
to protect our proprietary technology. We currently have licenses covering four
of Cantor's patents in the United States. One patent relates to a data
processing system and method for electronically trading select items such as
fixed income instruments. Two patents relate to a fixed income portfolio index
processor. One patent relates to a system for shared remote access of multiple
application programs by one or more computers. Foreign counterpart applications
for some of these U.S. patents have been filed. The licenses are exclusive,
except in the event that we do not
16
seek to or are unable to provide to Cantor any requested services covered by the
patents and Cantor elects not to require us to do so.
We also have an agreement to license several pending U.S. patent
applications relating to various other aspects of our electronic trading
systems, including both functional and design aspects. Additional patent
applications likely will be filed in the near future to further protect our
proprietary technology.
We cannot at this time determine the significance of any of the foregoing
patents, or future patents, if issued, to our business. We can give no assurance
that any of the foregoing patents is valid and enforceable, or that any of these
patents would not be infringed by a third party competing or seeking to compete
with our business.
Regulation
The securities industry and financial markets in the United States and
elsewhere are subject to extensive regulation. As a service provider to the
securities industry and financial markets, and as a registered broker-dealer,
our business activities fall within the scope of these regulations.
Regulation of the U.S. Securities Industry and Broker-Dealers.
As a matter of public policy, regulatory bodies in the United States and
the rest of the world are charged with safeguarding the integrity of the
securities and other financial markets and with protecting the interests of
investors participating in those markets. In the United States, the Securities
and Exchange Commission is the federal agency responsible for the administration
of the federal securities laws. Our regulated U.S. subsidiaries, eSpeed
Securities, Inc. and eSpeed Government Securities, Inc., are registered with the
Securities and Exchange Commission as broker-dealers. They are also members of
the National Association of Securities Dealers, Inc., a self regulatory body to
which most broker-dealers belong. Certain self-regulatory organizations, such as
the National Association of Securities Dealers, Inc., adopt rules and examine
broker-dealers and require strict compliance with their rules and regulations.
The Securities and Exchange Commission and self-regulatory organization rules
cover many aspects of a broker-dealer's business, including capital structure
and withdrawals, sales methods, trade practices among broker-dealers, use and
safekeeping of customer's funds and securities, record-keeping, the financing of
clients' purchases, broker-dealer and employee registration and the conduct of
directors, officers and employees. In connection with a violation of these
rules, the Securities and Exchange Commission, self-regulatory organizations and
state securities commissions may conduct administrative proceedings which can
result in censure, fine, the issuance of cease-and-desist orders or the
suspension or expulsion of a broker-dealer, its officers or employees.
Effect of Net Capital Requirements. The Securities and Exchange Commission
and the National Association of Securities Dealers, Inc. impose rules that
require notification when net capital falls below certain predefined criteria,
dictate the ratio of debt to equity in the regulatory capital composition of a
broker-dealer and constrain the ability of a broker-dealer to expand its
business under certain circumstances. Additionally, the Uniform Net Capital Rule
and the National Association of Securities Dealers, Inc. rules impose certain
requirements that may have
17
the effect of prohibiting a broker-dealer from distributing or withdrawing
capital and requiring prior notice to the Securities and Exchange Commission and
the National Association of Securities Dealers, Inc. for certain withdrawals of
capital.
Through our broker-dealer subsidiary, eSpeed Government Securities, Inc.,
we are subject to SEC broker-dealer regulation under Section 15C of the
Securities Exchange Act of 1934, which requires the maintenance of minimum
liquid capital, as defined. At December 31, 1999, eSpeed Government Securities,
Inc.'s liquid capital of $1,536,699 was in excess of minimum requirements by
$1,511,699. Additionally, our other broker-dealer subsidiary, eSpeed Securities,
Inc., is subject to SEC broker-dealer regulation under Rule 17a-5 of the
Securities Exchange Act of 1934, which requires the maintenance of minimum net
capital and requires that the ratio of aggregate indebtedness to net capital,
both as defined, shall not exceed 8 to 1. At December 31, 1999, eSpeed
Securities, Inc. had net capital of $1,048,849, which was $572,325 in excess of
its required capital of $476,524. eSpeed Securities, Inc.'s net capital ratio
was 3.63 to 1.
Application of Exchange Act to Internet Business. The Securities Exchange
Act of 1934 governs, among other things, the operation of the financial products
markets and broker-dealers. When enacted, the Securities Exchange Act of 1934
did not contemplate the conduct of a securities business throughout the
Internet. Although the Securities and Exchange Commission, in releases and
no-actions letters, has provided guidance on various issues related to the
conduct of a securities business through the Internet, the application of the
laws to the conduct of a securities business through the Internet continues to
evolve. Uncertainty regarding these issues may adversely affect the viability
and profitability of our business.
Financial Futures and Options. Financial futures and options in financial
futures are subject to regulation by the Commodity Futures Trading Commission
under the Commodity Exchange Act, and exchanges that provide facilities for the
trading of those products are also subject to Commodity Futures Trading
Commission regulation. As a service provider to the Cantor Exchange((Service
Mark)), a futures exchange that is a designated contract market under the
Commodity Exchange Act, we could be adversely affected by changes in laws or
regulations governing the products or clients of the Cantor Exchange((Service
Mark)).
Exchange Regulation. Securities exchanges must register with the
Securities and Exchange Commission and comply with various requirements of the
Securities Exchange Act of 1934. Effective April 1999, new rules expanded the
scope of exchange regulation to include many brokerage matching and execution
systems, such as the matching systems that we support. The new rules impose
various requirements relating to fair access, capacity, security, record-keeping
and reporting. Our subsidiaries expect to comply with these requirements.
Although we do not expect the compliance costs to be significant, our
subsidiaries could encounter unforeseen expenses associated with operation of
these rules.
Regulation of the Non-U.S. Securities Industries and Investment Service
Providers.
The securities industry and financial markets in the European Union and
elsewhere are subject to extensive regulation. As the owner and operator of
electronic marketplaces for the securities industry and financial markets, our
business activities may fall within the scope of
18
those regulations depending upon the extent to which we are characterized as
providing a regulated investment service.
The securities industry in the member states of the European Union is
extensively regulated by agencies in each member state. European Union measures
provide for the mutual recognition of regulatory agencies and of prudential
supervision making possible the grant of a single authorization for the provider
of investment services which, broadly, is valid throughout the European Union.
As an investment service provider in the United Kingdom, our principal regulator
would be the Securities and Futures Authority. The conduct of an investment
business is also regulated by agencies in each of the other member states in
which we may provide investment services. The provision of investment services
is also regulated by other agencies in other jurisdictions in which we operate
such as the Securities and Futures Commission in Hong Kong and the local
government agency delegated by the Japanese Financial Supervisory Agency in
Japan.
As a matter of public policy, regulatory bodies in the European Union and
the rest of the world are charged with safeguarding the integrity of the
securities and other financial markets and with protecting the interests of
investors participating in those markets. We are seeking authorization from the
Securities and Futures Authority to provide investment services in the United
Kingdom and we intend to exercise our rights under the European Union Investment
Services Directive to provide such investment services throughout the European
Union. Similar authorization applications will be made in other jurisdictions,
such as Hong Kong and Japan, where such authorization is necessary to operate an
electronic marketplace.
The Securities and Futures Authority and other regulatory agencies in the
European Union may conduct administrative proceedings which can result in
censure, fine, the prevention of activities or the suspension or expulsion of an
investment services provider. The applicable investment service regulations
cover minimum financial resource requirements and conduct of business rules for
all authorized investment businesses.
Investment exchanges may be operated and authorized as investment
businesses in the European Union, subject to the provision of the Investment
Services Directive. Alternatively, investment exchanges can obtain authorization
as an investment exchange from each member state in the European Union in
accordance with the applicable regulations of that member state.
Changes in Existing Laws and Rules. Additional legislation or regulation,
changes in existing laws and rules or changes in the interpretation or
enforcement of existing laws and rules, either in the United States or
elsewhere, may directly affect our mode of operation and our profitability.
Employees
As of December 31, 1999, we had 370 employees, five of whom are our
executive officers. None of these employees is represented by a union. We
believe that we have good relations with our employees.
19
RISK FACTORS
An investment in our company involves a high degree of risk. You should
carefully consider the risks below, together with the other information
contained in this report, before you decide to invest in our company. If any of
the following risks occur, our business, results of operations and financial
condition could be harmed, the trading price of our Class A common stock could
decline, and you could lose all or part of your investment.
RISKS RELATED TO OUR COMPANY AND OUR BUSINESS
Because we have a limited operating history, you may not be able to accurately
evaluate eSpeed.
We are a recently formed company. We have had limited operations to date
and, as a result, we have a limited operating history upon which to evaluate the
merits of investing in our Class A common stock. As an early stage company, we
are subject to risks, expenses and difficulties associated with implementing our
business plan that are not typically encountered by more mature companies. In
particular, our prospects are subject to risks, expenses and uncertainties
encountered by companies in the new and rapidly evolving market for electronic
commerce products and services. These risks include our failure or inability to:
o provide services to our clients that are reliable and cost-effective;
o expand our sales structure and marketing programs;
o increase awareness of our brand or market positioning; and
o respond to technological developments or service offerings by competitors.
We may not be able to implement our business plan successfully, or at all.
Because we have a history of losses, we expect to continue to incur losses and
generate negative cash flow from operations for the foreseeable future.
Since our inception, we have incurred substantial costs to develop our
technology and infrastructure. As a result, from our inception through December
31, 1999, we have sustained cumulative net losses of approximately $12.6
million. We expect that we will continue to incur losses and generate negative
cash flow from operations for the foreseeable future as we continue to develop
our systems and infrastructure and expand our brand recognition and client base
through increased marketing efforts.
If we do not expand the use of our electronic systems, or if our and Cantor's
clients do not use our marketplaces or services, our revenues and profitability
will be adversely affected.
The use of electronic marketplaces is relatively new. The success of our
business plan depends, in part, on our ability to maintain and expand the
network of brokers, dealers, banks and other financial institutions that will
use our interactive electronic marketplaces. We cannot assure you that we will
be able to continue to expand our marketplaces, or that we will be able to
20
retain the current participants in our marketplaces. None of our agreements with
market participants require them to use our electronic marketplaces.
If we are unable to enter into marketing and strategic alliances, we may not
generate increased trading in our electronic marketplaces.
We expect to enter into strategic alliances with other market
participants, such as retail brokers, exchanges, market makers, clearinghouses
and technology companies, in order to increase client access to and use of our
electronic marketplaces. We cannot assure you that we will be able to enter into
these strategic alliances on terms that are favorable to us, or at all. The
success of these relationships will depend on the amount of increased trading in
our electronic marketplaces by the clients of these strategic alliance partners.
These arrangements may not generate the expected number of new clients or
increased trading volume we are seeking.
To increase awareness of our electronic marketplaces, we may need to incur
significant marketing expenses.
To successfully execute our business plan, we must build awareness and
understanding of our electronic marketplace services, brand and the adaptability
of our electronic marketplaces for non-financial products. In order to build
this awareness, our marketing efforts must succeed and we must provide
high-quality services. These efforts will require us to incur significant
expenses. We cannot assure you that our marketing efforts will be successful or
that the allocation of funds to these marketing efforts will be the most
effective use of those funds.
If we experience computer systems failures or capacity constraints, our ability
to conduct our operations could be harmed.
We internally support and maintain many of our computer systems and
networks. Our failure to monitor or maintain these systems and networks or, if
necessary, to find a replacement for this technology in a timely and
cost-effective manner, would have a material adverse effect on our ability to
conduct our operations.
We also rely and expect to rely on third parties for various computer and
communications systems, such as telephone companies, online service providers,
data processors, clearance organizations and software and hardware vendors. Our
systems, or those of our third party providers, may fail or operate slowly,
causing one or more of the following:
o unanticipated disruptions in service to our clients;
o slower response times;
o delays in our clients' trade execution;
o failed settlement by clients to whom we provide services to
facilitate settlement operations;
o decreased client service satisfaction;
21
o incomplete or inaccurate accounting, recording or processing of
trades;
o financial losses;
o litigation or other client claims; and
o regulatory sanctions.
We cannot assure you that we will not experience systems failures from
power or telecommunications failure, acts of God or war, human error, natural
disasters, fire, power loss, sabotage, hardware or software malfunctions or
defects, computer viruses, intentional acts of vandalism and similar events. The
assets acquired by us from Cantor in the formation transactions have been
acquired by us "as is." Although Cantor used in its business the systems and
technology it transferred to us in connection with the formation transactions,
there can be no assurance that such systems and technology were or are entirely
free from defects. To the extent any defects are discovered, we will not have
any recourse against Cantor. Any system failure that causes an interruption in
service or decreases the responsiveness of our service, including failures
caused by client error or misuse of our systems, could damage our reputation,
business and brand name.
If we do not effectively manage our growth, our existing personnel and systems
may be strained and our business may not operate efficiently.
In order to execute our business plan, we must grow significantly. This
growth will place significant strain on our personnel, management systems and
resources. We expect that the number of our employees, including technical and
management-level employees, will continue to increase for the foreseeable
future. We must continue to improve our operational and financial systems and
managerial controls and procedures, and we will need to continue to expand,
train and manage our technical workforce. We must also maintain close
coordination among our technical, compliance, accounting, finance and marketing
and sales organizations. We cannot assure you that we will manage our growth
effectively, and failure to do so could result in our business operating
inefficiently.
If we are unable to keep up with rapid technological changes, we may not be able
to compete effectively.
To remain competitive, we must continue to enhance and improve the
responsiveness, functionality, accessibility and features of our proprietary
software, network distribution systems and technologies. The financial services
and e-commerce industries are characterized by rapid technological change,
changes in use and client requirements and preferences, frequent product and
service introductions embodying new technologies and the emergence of new
industry standards and practices that could render our existing proprietary
technology and systems obsolete. Our success will depend, in part, on our
ability to:
o develop and license leading technologies useful in our business;
o enhance our existing services;
22
o develop new services and technologies that address the increasingly
sophisticated and varied needs of our existing and prospective
clients; and
o respond to technological advances and emerging industry standards
and practices on a cost-effective and timely basis.
The development of proprietary electronic trading technology entails
significant technical, financial and business risks. Further, the adoption of
new Internet, networking or telecommunications technologies may require us to
devote substantial resources to modify and adapt our services. We cannot assure
you that we will successfully implement new technologies or adapt our
proprietary technology and transaction-processing systems to client requirements
or emerging industry standards. We cannot assure you that we will be able to
respond in a timely manner to changing market conditions or client requirements.
If we were to lose the services of members of management and employees who
possess specialized market knowledge and technology skills, we may not be able
to manage our operations effectively or develop new electronic marketplaces.
Our future success depends, in significant part, on the continued service
of Howard Lutnick, our Chairman and Chief Executive Officer, Frederick Varacchi,
our President and Chief Operating Officer, and our other executive officers and
managers and sales and technical personnel who possess extensive financial
markets knowledge and technology skills. We cannot assure you that we would be
able to find an appropriate replacement for Mr. Lutnick or Mr. Varacchi if the
need should arise. Any loss or interruption of Mr. Lutnick's or Mr. Varacchi's
services could result in our inability to manage our operations effectively
and/or develop new electronic marketplaces. We have not entered into employment
agreements with and we do not have "key person" life insurance policies on any
of our officers or other personnel. All of the members of our senior management
team are also officers, partners or key employees of Cantor. As a result, they
dedicate only a portion of their professional efforts to our business and
operations. We cannot assure you that the time these persons devote to our
business and operations in the future will be adequate and that we will not
experience an adverse effect on our operations due to the demands placed on our
management team by their other professional obligations. We intend to strive to
provide high quality services that will allow us to establish and maintain
long-term relationships with our clients. Our ability to do so will depend, in
large part, upon the individual employees who represent us in our dealings with
clients. The market for qualified programmers, technicians and sales persons is
extremely competitive and has grown more so in recent periods as electronic
commerce has experienced growth. We cannot assure you that we will be successful
in our efforts to recruit and retain the required personnel.
If Cantor or we are unable to protect the intellectual property rights we
license from Cantor or own, our ability to operate electronic trading
marketplaces may be materially adversely affected.
Our business is dependent on proprietary technology and other intellectual
property rights. We license our patented technology from Cantor. The license
arrangement is exclusive, except in the event that (1) we are unwilling to
provide to Cantor any requested services covered by the patents with respect to
a marketplace and Cantor elects not to require us to do so, or we
23
are unable to provide such services or (2) we do not exercise our right of first
refusal to provide to Cantor electronic brokerage services with respect to a
marketplace, in which case Cantor retains a limited right to use the patents and
patent applications solely in connection with the operation of that marketplace.
We cannot guarantee that the concepts which are the subject of the patents and
patent applications covered by the license from Cantor are patentable or that
issued patents are or will be valid and enforceable. Where patents are granted
in the U.S., we can give no assurance that equivalent patents will be granted in
Europe or elsewhere, as a result of differences in local laws affecting
patentability and validity. Moreover, we cannot guarantee that Cantor's issued
patents are valid and enforceable, or that third parties competing or intending
to compete with us will not infringe any of these patents. Despite precautions
we or Cantor has taken or may take to protect our intellectual property rights,
it is possible that third parties may copy or otherwise obtain and use our
proprietary technology without authorization. It is also possible that third
parties may independently develop technologies similar to ours. It may be
difficult for us to monitor unauthorized use of our proprietary technology and
intellectual property rights. We cannot assure you that the steps we have taken
will prevent misappropriation of our technology or intellectual property rights.
We intend to use our eSpeed service mark for the services described herein
and have applied to register that service mark in a number of jurisdictions
around the world. Although several existing third party registrations and
applications for trademarks consisting of designations similar to ours in
certain European countries have recently come to light, they are for goods and
services that are different from those being offered under our eSpeed service
mark. Although we are not presently aware of any third party objections to our
use or registration of our eSpeed service mark in these countries, and believe
we could defend against any third party claims asserted in these countries, such
registrations and applications could potentially affect the registration, and/or
limit our use, of our eSpeed service mark in these European countries, thereby
requiring us to adopt and use another service mark for our services in such
countries.
If it becomes necessary to protect or defend our intellectual property rights,
we may have to resort to costly litigation.
We may have to resort to litigation to enforce our intellectual property
rights, protect our trade secrets, determine the validity and scope of the
proprietary rights of others or defend ourselves from claims of infringement,
invalidity or unenforceability. We may incur substantial costs and diversion of
resources as a result of litigation, even if we win. In the event we do not win,
we may have to enter into royalty or licensing agreements. We cannot assure you
that an agreement would be available to us on reasonable terms, if at all.
One of the patents we license from Cantor and which relates to Interactive
Matching((Service Mark)) is currently the subject of litigation involving
Liberty Brokerage Investment Corporation and Liberty Brokerage Inc. This patent
is exclusively licensed to us subject to certain conditions. We have assumed
responsibility for defending this suit on behalf of Cantor and its affiliates.
We have also agreed to indemnify Cantor with respect to all costs arising in
connection with or relating to this lawsuit, including any damages or judgments.
We cannot assure you that any of the patents owned or licensed by us will be
upheld by a court as valid and/or enforceable.
24
If our software licenses from third parties are terminated, our ability to
operate our business may be materially adversely affected.
We license software from third parties, much of which is integral to our
systems and our business. The licenses are terminable if we breach our
obligations under the license agreements. If any of these relationships were
terminated or if any of these third parties were to cease doing business, we may
be forced to spend significant time and money to replace the licensed software.
However, we cannot assure you that the necessary replacements will be available
on reasonable terms, if at all.
If the strength of our domain names is diluted, the value of our proprietary
rights may decrease.
We own many Internet domain names including "www.espeed.com." The
regulation of domain names in the United States and in foreign countries may
change and the strength of our names could be diluted. We may not be able to
prevent third parties from acquiring domain names that infringe or otherwise
decrease the value of our trademarks and other proprietary rights.
If we infringe on patent rights or copyrights of others, we could become
involved in costly litigation.
Patents or copyrights of third parties may have an important bearing on
our ability to offer certain of our products and services. We cannot assure you
that we are or will be aware of all patents or copyrights containing claims that
may pose a risk of infringement by our products and services. In addition,
patent applications in the United States are generally confidential until a
patent is issued. As a result, we cannot evaluate the extent to which our
products and services may be covered or asserted to be covered by claims
contained in pending patent applications. In general, if one or more of our
products or services were to infringe patents held by others, we may be required
to stop developing or marketing the products or services, to obtain licenses to
develop and market the services from the holders of the patents or to redesign
the products or services in such a way as to avoid infringing on the patent
claims, which could limit the manner in which we conduct our operations.
Due to intense competition in our industry, our market share and financial
performance could suffer.
The electronic trading and Internet-based financial services markets are
highly competitive and many of our competitors are more established and have
greater financial resources than us. We expect that competition will intensify
in the future. Many of our competitors also have greater market presence,
engineering and marketing capabilities and technological and personnel resources
than we do. As a result, as compared to us, our competitors may:
o develop and expand their network infrastructures and service
offerings more efficiently or more quickly;
25
o adapt more swiftly to new or emerging technologies and changes in
client requirements;
o take advantage of acquisitions and other opportunities more
effectively;
o devote greater resources to the marketing and sale of their products
and services; and
o more effectively leverage existing relationships with clients and
strategic partners or exploit more recognized brand names to market
and sell their services.
Our current and prospective competitors are numerous and include:
o Interdealer brokerage firms, including Liberty Brokerage Investment
Corporation and Garban-Intercapital plc.
o Technology companies and market data and information vendors,
including Reuters Group plc, Bloomberg L.P. and Bridge Information
Systems, Inc.;
o Securities or futures exchanges or similar entities, including the
Chicago Board of Trade, the Chicago Mercantile Exchange, the Chicago
Board of Options Exchange, Eurex, the New York Stock Exchange and
the Nasdaq National Market;
o Electronic communications networks, crossing systems and similar
entities such as Investment Technology Group and Optimark
Technologies Inc.; and
o Consortia such as BrokerTec Global LLC and EuroMTS.
We believe that we may also face competition from large computer software
companies, media and technology companies and some securities brokerage firms
that are currently our clients. In addition, Market Data Corporation, which is
controlled by Iris Cantor and Rodney Fisher, has technology for electronic
trading systems that, if provided to our competitors in the wholesale market,
will be of substantial assistance to them in competing with us. Iris Cantor and
Rod Fisher are limited partners of Cantor.
The number of businesses providing Internet-based financial services is
rapidly growing, and other companies, in addition to those named above, have
entered into or are forming joint ventures or consortia to provide services
similar to those provided by us. Others may acquire the capabilities necessary
to compete with us through acquisitions.
In the event we extend the application of our Interactive
Matching((Service Mark)) technology to conducting or facilitating auctions of
consumer goods and services over the Internet, we expect to compete with both
online and traditional sellers of these products and services. The market for
selling products and services over the Internet is new, rapidly evolving and
intensely competitive. Current and new competitors can launch new sites at a
relatively low cost. We expect we will potentially compete with a variety of
companies with respect to each product or service we offer. We may face
competition from e-Bay, priceline.com, Amazon.com and a number of other large
Internet companies that have expertise in developing online commerce and in
facilitating Internet
26
traffic, including America Online, Microsoft and Yahoo!, which could choose to
compete with us either directly or indirectly through affiliations with other
e-commerce companies. We cannot assure you that we will be able to compete
effectively with such companies.
Because some of our clients may develop electronic trading networks, we could
compete with them in aspects of our business.
Consortia owned by some of our clients have announced their intention to
explore the development of electronic trading networks. BrokerTec Global LLC, a
proposed electronic inter-dealer fixed income broker whose members include
Citigroup, Credit Suisse First Boston, Deutsche Bank AG, Goldman Sachs Group,
Lehman Brothers, Merrill Lynch & Co., Dresdner Kleinwort Benson, ABN-AMRO and
Morgan Stanley Dean Witter, has announced its intention to develop or acquire a
facility for electronic trading of U.S. Treasury securities, Euro-denominated
sovereign debt and other fixed income securities and futures-related products.
All of the members of BrokerTec Global LLC are currently clients of Cantor and
ours. Consortia such as BrokerTec Global LLC may compete with us and our
electronic marketplaces in the future. We currently compete with a similar
consortium called EuroMTS in Europe. The members of EuroMTS include the leading
fixed income dealers in European government securities, as well as clients of
Cantor and ours. Additionally, in the non-financial business-to-business
marketplaces, we compete with Ariba, CommerceOne, AltraEnergy Trading and
HoustonStreet, as well as with other Internet-based trading and infrastructure
platforms.
If we experience low trading volume in securities and financial products, our
profitability could suffer.
We have experienced significant fluctuations in the aggregate trading
volume of securities and financial products being traded in our marketplaces. We
expect that fluctuations in the trading volume of securities and financial
products traded in our marketplaces will occur in the future from time to time
and have a direct impact on our future operating results. This may cause
significant fluctuations in our profitability when the trading volumes are low.
If adverse economic and political conditions occur, substantial declines in the
U.S. and global financial services markets may result and our profitability
could suffer.
The global financial services business is, by its nature, risky and
volatile and is directly affected by many national and international factors
that are beyond our control. Any one of these factors may cause a substantial
decline in the U.S. and global financial services markets, resulting in reduced
trading volume and turnover. These events could materially adversely affect our
profitability. These factors include:
o economic and political conditions in the United States and elsewhere
in the world;
o concerns over inflation and wavering institutional/consumer
confidence levels;
o the availability of cash for investment by mutual funds and other
wholesale and retail investors;
o rising interest rates;
27
o fluctuating exchange rates;
o legislative and regulatory changes; and
o currency values.
In the past several years, the U.S. financial markets have achieved
historic highs. We do not believe these strong markets can continue
indefinitely. Our revenues and profitability are likely to decline significantly
during periods of stagnant economic conditions or low trading volume in the U.S.
and global financial markets.
Because we expect to continue to expand our operations outside North America, we
may face special economic and regulatory challenges that we may not be able to
meet.
We operate electronic marketplaces throughout Europe and Asia and we plan
to further expand our operations throughout these regions in the future. There
are certain risks inherent in doing business in international markets,
particularly in the regulated brokerage industry. These risks include:
o less developed automation in exchanges, depositories and national
clearing systems;
o unexpected changes in regulatory requirements, tariffs and other
trade barriers;
o difficulties in staffing and managing foreign operations;
o fluctuations in currency exchange rates;
o reduced protection for intellectual property rights;
o seasonal reductions in business activity during the summer months;
and
o potentially adverse tax consequences.
We are required to comply with the laws and regulations of foreign
governmental and regulatory authorities of each country in which we conduct
business. These may include laws, rules and regulations relating to any aspect
of the securities business, including sales methods, trade practices among
broker-dealers, use and safekeeping of clients' funds and securities, capital
structure, record-keeping, the financing of clients' purchases, broker-dealer
and employee registration requirements and the conduct of directors, officers
and employees. Any failure to develop effective compliance and reporting systems
could result in regulatory penalties in the applicable jurisdiction.
The growth of the Internet as a means of conducting international business
has also raised many legal issues regarding, among other things, the
circumstances in which countries or other jurisdictions have the right to
regulate Internet services that may be available to their citizens from service
providers located elsewhere. In many cases, there are no laws, regulations,
judicial decisions or governmental interpretations that clearly resolve these
issues. This uncertainty may adversely affect our ability to use the Internet to
expand our international operations, and creates
28
the risk that we could be subject to disciplinary sanctions or other penalties
for failure to comply with applicable laws or regulations.
If we enter new markets, we may not be able to successfully adapt our technology
and marketing strategy for use in those markets.
We intend to leverage our eSpeed((Service Mark)) system and Cantor's
relationships to enter new markets. We cannot assure you that we will be able to
successfully adapt our proprietary software, electronic distribution networks
and technology for use in other markets. Even if we do adapt our software,
networks and technology, we cannot assure you that we will be able to attract
clients and compete successfully in any such new markets. We cannot assure you
that our marketing efforts or our pursuit of any of these opportunities will be
successful. If these efforts are not successful, we could suffer losses while
developing new marketplaces or realize less than expected earnings, which in
turn could result in a decrease in the market value of our Class A common stock.
Furthermore, these efforts may divert management attention or inefficiently
utilize our resources. We intend to create electronic marketplaces for many
financial products by the end of 2000, but there is no guarantee that we will be
able to do so.
If we acquire other companies, we may not be able to integrate their operations
effectively.
Our business strategy contemplates expansion through the acquisition of
exchanges and other companies providing services or having technologies and
operations that are complementary to ours. Acquisitions entail numerous risks,
including:
o difficulties in the assimilation of acquired operations and
products;
o diversion of management's attention from other business concerns;
o assumption of unknown material liabilities of acquired companies;
o amortization of acquired intangible assets, which would reduce
future reported earnings; and
o potential loss of clients or key employees of acquired companies.
We cannot assure you that we will be able to integrate successfully any
operations, personnel, services or products that might be acquired in the
future, and our failure to do so could adversely affect our profitability and
the value of our Class A common stock.
Because our business is subject to extensive government and other regulation, we
may face restrictions with respect to the way we conduct our operations.
The Securities and Exchange Commission, National Association of Securities
Dealers, Inc., Commodity Futures Trading Commission and other agencies
extensively regulate the U.S. securities industry. Our international operations
may be subject to similar regulations in specific jurisdictions. Our U.S.
subsidiaries are required to comply strictly with the rules and regulations of
these agencies. As a matter of public policy, these regulatory bodies are
responsible for safeguarding the integrity of the securities and other financial
markets and protecting the
29
interests of investors in those markets. Most aspects of our U.S. broker-dealer
subsidiaries are highly regulated, including:
o the way we deal with our clients;
o our capital requirements;
o our financial and Securities and Exchange Commission reporting
practices;
o required record keeping and record retention procedures;
o the licensing of our employees; and
o the conduct of our directors, officers, employees and affiliates.
If we fail to comply with any of these laws, rules or regulations, we may
be subject to censure, fines, cease-and-desist orders, suspension of our
business, suspensions of personnel or other sanctions, including revocation of
registration as a broker-dealer. Changes in laws or regulations or in
governmental policies could have a material adverse effect on the conduct of our
business. These agencies have broad powers to investigate and enforce compliance
and punish non-compliance with their rules and regulations. We cannot assure you
that we and/or our directors, officers and employees will be able to fully
comply with, and will not be subject to, claims or actions by these agencies.
The consumer products and services we anticipate offering through our
electronic marketplaces are likely to be regulated by federal and state
governments. Our ability to provide such services will be affected by these
regulations. The implementation of unfavorable regulations or unfavorable
interpretations of existing regulations by courts or regulatory bodies could
require us to incur significant compliance costs or cause the development of
affected markets to become impractical.
Because we are subject to risks associated with net capital requirements, we may
not be able to engage in operations that require significant capital.
The Securities and Exchange Commission, Commodity Futures Trading
Commission and various other regulatory agencies have stringent rules and
regulations with respect to the maintenance of specific levels of net capital by
broker-dealers. Net capital, which is assets minus liabilities, is the net worth
of a broker or dealer, less deductions for certain types of assets. If a firm
fails to maintain the required net capital, it may be subject to suspension or
revocation of registration by the Securities and Exchange Commission or
Commodity Futures Trading Commission, and suspension or expulsion by these
regulators could ultimately lead to the firm's liquidation. If these net capital
rules are changed or expanded, or if there is an unusually large charge against
net capital, operations that require the intensive use of capital would be
limited. Also, our ability to withdraw capital from broker-dealer subsidiaries
could be restricted, which in turn could limit our ability to pay dividends,
repay debt and redeem or purchase shares of our outstanding stock. A large
operating loss or charge against net capital could adversely affect our
30
ability to expand or even maintain our present levels of business, which could
have a material adverse effect on our business.
Because we intend to offer access to some of our marketplaces to online retail
brokers, we are subject to risks relating to uncertainty in the regulation of
the Internet.
There are currently few laws or regulations that specifically regulate
communications or commerce on the Internet. However, laws and regulations may be
adopted in the future that address issues such as user privacy, pricing,
taxation and the characteristics and quality of products and services. For
example, the Telecommunications Act sought to prohibit transmitting various
types of information and content over the Internet. Several telecommunications
companies have petitioned the Federal Communications Commission to regulate
Internet service providers and online service providers in a manner similar to
long distance telephone carriers and to impose access fees on those companies.
This could increase the cost of transmitting data over the Internet. Moreover,
it may take years to determine the extent to which existing laws relating to
issues such as property ownership, libel and personal privacy are applicable to
the Internet. Any new laws or regulations relating to the Internet could
adversely affect our business.
Because brokerage services involve substantial risks of liability, we may become
subject to risks of litigation.
Many aspects of our business, and the businesses of our clients, involve
substantial risks of liability. Dissatisfied clients frequently make claims
regarding quality of trade execution, improperly settled trades, mismanagement
or even fraud against their service providers. We and our clients may become
subject to these claims as the result of failures or malfunctions of systems and
services provided by us and may seek recourse against us. We could incur
significant legal expenses defending claims, even those without merit. An
adverse resolution of any lawsuits or claims against us could result in our
obligation to pay substantial damages.
In addition, we may also become subject to legal proceedings and claims
against Cantor and its affiliates as a result of the formation transactions.
Although Cantor has agreed to indemnify us against claims or liabilities arising
from our assets or operations prior to the formation transactions, we cannot
assure you that such claims or litigation will not harm our business.
If we cannot deter employee misconduct, we may be harmed.
There have been a number of highly publicized cases involving fraud or
other misconduct by employees in the financial services industry in recent
years, and we run the risk that employee misconduct could occur. Misconduct by
employees could include hiding unauthorized or unsuccessful activities from us.
In either case, this type of conduct could result in unknown and unmanaged risks
or losses. Employee misconduct could also involve the improper use of
confidential information, which could result in regulatory sanctions and serious
reputational harm. It is not always possible to deter employee misconduct, and
the precautions we take to prevent and detect this activity may not be effective
in all cases.
31
Because our business is developing, we cannot predict our future capital needs
or our ability to secure additional financing.
We anticipate, based on management's experience and current industry
trends, that our existing cash resources, combined with the net proceeds we
received from our initial public offering, will be sufficient to meet our
anticipated working capital and capital expenditure requirements for at least
the next 12 months. However, we believe that there are a significant number of
capital intensive opportunities for us to maximize our growth and strategic
position, including, among other things, acquisitions, joint ventures, strategic
alliances or other investments. We are currently considering such options and
their effect on our capital requirements. We may need to raise additional funds
to:
o increase the regulatory net capital necessary to support our
operations;
o support more rapid growth in our business;
o develop new or enhanced services and products;
o respond to competitive pressures;
o acquire complementary technologies;
o enter into strategic alliances;
o acquire companies with marketplace or other specific domain
expertise; and
o respond to unanticipated requirements.
We cannot assure you that we will be able to obtain additional financing
when needed on terms that are acceptable, if at all.
The market price of our Class A common stock may fluctuate.
The price of our Class A common stock may fluctuate widely, depending upon
many factors, including our perceived prospects, and the prospects of the
financial industries in general, differences between our actual financial and
operating results and those expected by investors and analysts, changes in
analysts' recommendations or projections, changes in general valuations for
Internet and e-commerce-related companies, changes in general economic or market
conditions and broad market fluctuations.
Future sales of our shares could adversely affect the market price of our
Class A common stock.
If our existing stockholders sell a large number of shares, or if we issue
a large number of shares of our common stock in connection with future
acquisitions, strategic alliances or otherwise, the market price of our Class A
common stock could decline significantly. Moreover, the perception in the public
market that these stockholders might sell shares of Class A common stock could
depress the market price of our Class A common stock.
32
Although we and our directors, executive officers and holders of common
stock and securities convertible into or exercisable or exchangeable for common
stock issued prior to our initial public offering in December 1999 have agreed
pursuant to certain "lock-up" agreements with the underwriters that we and they
will not offer, sell, contract to sell, pledge, grant any option to sell, or
otherwise dispose of, directly or indirectly, any shares of common stock or
securities convertible into or exercisable or exchangeable for common stock,
subject to certain exceptions, before June 7, 2000 without the prior written
consent of Warburg Dillon Read LLC, we and these persons may be released of this
obligation by Warburg Dillon Read LLC in its sole discretion in whole or in part
at any time with or without notice.
We may decide to register an additional 5,000,000 shares of our Class A
common stock under the Securities Act of 1933 for use by us as consideration for
future acquisitions. Upon such registration, these shares generally will be
freely tradable after issuance, unless the resale thereof is contractually
restricted or unless the holders thereof are subject to the restrictions on
resale provided in Rule 145 under the Securities Act. In any event, any
registered shares so issued will be subject to contractual restrictions and,
thus, will not be freely tradable before June 7, 2000.
We intend to initially register 20%, or approximately 10,000,000 shares of
Class A common stock, of the total outstanding shares of our common stock, which
are reserved for issuance upon exercise of options granted under our stock
option plan. If we increase our total outstanding shares of common stock, we
will register additional shares of Class A common stock so that the stock
available for issuance under our stock option plan will be registered. Once we
register these shares, they can be sold in the public market upon issuance,
subject to restrictions under the securities laws applicable to resales by
affiliates. We also plan to register the shares of Class A common stock issuable
under our stock purchase plan.
RISKS RELATED TO OUR RELATIONSHIP WITH CANTOR
Because we depend on Cantor's business, events which impact Cantor's operating
results may have a material adverse effect on our revenues.
We recognized over 66% of our revenues for the period from March 10, 1999
to December 31, 1999 from transactions in which we received amounts based on
fixed percentages of commissions paid to Cantor. Consequently, any reductions in
the amount of commissions paid to Cantor, including events which impact Cantor's
business or operating results, could have a material adverse effect on our most
significant source of revenues.
In addition, fees paid to us by Cantor for system services represented
32.6% of our revenues for the period from March 10, 1999 to December 31, 1999.
These fee revenues are remitted to us on a monthly basis.
We are a general creditor of Cantor to the extent that there are
transaction revenues and system service fees owing to us from Cantor. Events
that negatively impact Cantor's financial position and ability to remit our
share of transaction revenues and system service fees could have a material
adverse effect on our revenues.
33
Conflicts of interest and competition with Cantor may arise.
Various conflicts of interest between us and Cantor may arise in the
future in a number of areas relating to our past and ongoing relationships,
including competitive business activities, potential acquisitions of businesses
or properties, the election of new directors, payment of dividends, incurrence
of indebtedness, tax matters, financial commitments, marketing functions,
indemnity arrangements, service arrangements, issuances of our capital stock,
sales or distributions by Cantor of its shares of our common stock and the
exercise by Cantor of control over our management and affairs. Our Joint
Services Agreement with Cantor provides that in some circumstances Cantor can
unilaterally determine the commissions that will be charged to clients for
effecting trades in marketplaces in which we collaborate with Cantor. The
determination of the nature of commissions charged to clients does not affect
the allocation of revenues that Cantor and we share with respect to those
transactions. However, in circumstances in which Cantor determines to charge
clients lower commissions, the amount that we receive in respect of our share of
the commissions will correspondingly be decreased. A majority of our directors
and officers also serve as directors and/or officers of Cantor. Simultaneous
service as an eSpeed director or officer and service as a director or officer,
or status as a partner, of Cantor could create, or appear to create, potential
conflicts of interest when such directors, officers and/or partners are faced
with decisions that could have different implications for us and for Cantor. Mr.
Lutnick, our Chairman and Chief Executive Officer, is the sole stockholder of
the managing general partner of Cantor. As a result, Mr. Lutnick controls
Cantor. Cantor owns all of the outstanding shares of our Class B common stock,
representing approximately 98% of the combined voting power of all classes of
our voting stock. Mr. Lutnick's simultaneous service as our Chairman and Chief
Executive Officer and his control of Cantor could create or appear to create
potential conflicts of interest when Mr. Lutnick is faced with decisions that
could have different implications for us and for Cantor.
Because our Joint Services Agreement with Cantor has a perpetual term and
contains non-competition provisions and restrictions on our ability to pursue
strategic transactions, this agreement may become burdensome to our business.
As part of the formation transactions, Cantor contributed substantially
all of our assets to us. Although Cantor has agreed, subject to certain
conditions, not to compete with us in providing electronic brokerage services,
Cantor is currently engaged in securities transaction and other financial
instruments execution and processing operations and other activities that are
related to the electronic trading services we provide. Our Joint Services
Agreement obligates us to perform technology support and other services for
Cantor at cost, whether or not related to our electronic brokerage services,
sets forth the ongoing revenue sharing arrangeme