INVESTMENT TECHNOLOGY GROUP INC - 10-K Annual Report

Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

INVESTMENT TECHNOLOGY GROUP, INC.
(Exact name of registrant as specified in its charter)

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 ý No o

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 ý

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

Proxy Statement relating to the 2003 Annual Meeting of Stockholders (incorporated, in part, in Form 10-K Part III).

		Page
PART I
Item 1.	Business	1
Item 2.	Properties	15
Item 3.	Legal Proceedings	16
Item 4.	Submission of Matters to a Vote of Security Holders	16
PART II
Item 5.	Market for Registrant's Common Stock and Related Stockholder Matters	17
Item 6.	Selected Financial Data	17
Item 7.	Management's Discussion and Analysis of Financial Condition and Results of Operations	20
Item 7A.	Quantitative and Qualitative Disclosure About Market Risk	38
Item 8.	Financial Statements and Supplementary Data	40
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	68
PART III
Item 10.	Directors and Executive Officers of the Registrant	68
Item 11.	Executive Compensation	68
Item 12.	Security Ownership of Certain Beneficial Owners and Management	68
Item 13.	Certain Relationships and Related Transactions	68
Item 14.	Controls and Procedures	68
PART IV
Item 15.	Exhibits, Financial Statements, Schedules and Reports on Form 8-K	69

QuantEX, Investment Technology Group and ITG are registered trademarks of the Investment Technology Group, Inc. companies. POSIT is a registered service mark of the POSIT Joint Venture. TriAct is a trademark of the POSIT Joint Venture. SmartServer, SPI, SPI SmartServer, VWAP SmartServer, ITG ACE, TCA, ITG WebAccess, ITG/Opt, ITG PRIME, ResRisk, Hoenig and AlterNet are trademarks of the Investment Technology Group, Inc. companies.

In addition to the historical information contained throughout this Annual Report on Form 10-K, there are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). All statements regarding our expected future financial position, results of operations, cash flows, dividends, financing plans, business strategies, competitive positions, plans and objectives of management for future operations, and concerning securities markets and economic trends are forward-looking statements. Although we believe our expectations reflected in such forward-looking statements are based on reasonable assumptions, there can be no assurance that such expectations will prove to have been correct. Important factors that could cause actual results to differ materially from the expectations reflected in the forward-looking statements herein include, among others, the actions of both current and potential new competitors, rapid changes in technology, fluctuations in market trading volumes, financial market volatility, evolving industry regulations, risk of errors or malfunctions in our systems or technology, cash flows into or redemptions from equity funds, effects of inflation, customer trading patterns, the success of our new products and services offerings as well as general economic and business conditions, internationally or nationally, securities, credit and financial market conditions, and adverse changes or volatility in interest rates. Certain of these factors, and other factors, are more fully discussed in Management's Discussion and Analysis of Financial Condition and Results of Operations—Issues and Uncertainties—in this Annual Report on Form 10-K, which you are encouraged to read.

Investment Technology Group, Inc. ("ITG" or the "Company") was formed as a Delaware corporation on July 22, 1983. Its principal subsidiaries include: (1) ITG Inc. and AlterNet Securities, Inc. ("AlterNet"), United States ("U.S.") broker-dealers in equity securities, (2) Hoenig Group Inc. (since the date of the acquisition on September 3, 2002) and its operating affiliates, Hoenig & Co., Inc. and Hoenig (Far East) Limited (collectively, "Hoenig"), primarily agency soft dollar broker-dealers in equity securities in the U.S. and Hong Kong, (3) Investment Technology Group Limited ("ITG Europe"), an institutional broker-dealer in Europe, (4) ITG Australia Limited ("ITG Australia"), an institutional broker-dealer in Australia, (5) ITG Canada Corp. ("ITG Canada"), an institutional broker-dealer in Canada, (6) KTG Technologies Corp. ("KTG"), a direct access provider in Canada, (7) ITG Hong Kong Ltd. ("ITG Hong Kong"), our start-up brokerage operation in Hong Kong, (8) ITG Software, Inc., our intangible property management subsidiary in the U.S., and (9) ITG Software Solutions, Inc., our software development and maintenance subsidiary in the U.S.

We have two reportable segments: U.S. Operations and International Operations. The U.S. Operations segment provides equity trading and research services to institutional investors, brokers and alternative investment funds and money managers in the United States of America. The International Operations segment includes our agency brokerage businesses in Europe, Australia, Canada and Hong Kong, as well as a research facility in Israel.

We are a full service trade execution firm that uses technology to increase the effectiveness and lower the cost of trading. With an emphasis on ongoing research, we offer the following products and services to our clients:

We generate revenues on a "per transaction" basis for all orders executed. Orders are delivered to us from our "front-end" software products, QuantEX, ITG Platform and ITG WebAccess, as well as other vendors' front-ends and direct computer-to-computer links to customers. In the U.S., orders may be executed on or through (1) POSIT, (2) TriAct, (3) our SmartServers, (4) the New York Stock Exchange ("NYSE"), (5) the American Stock Exchange, (6) certain regional exchanges, (7) the Nasdaq National Market, (8) market makers, (9) electronic communication networks ("ECNs"), systems which trade equity securities and (10) third party alternative trading systems ("ATSs"). We also earn commissions by providing independent research, proprietary research, and other services to alternative investment funds and money managers, and by paying expenses of, or commission refunds to, customers under directed brokerage or commission recapture arrangements. These services are typically referred to as soft dollar programs. In our International Operations, we generate revenues on a "per transaction" basis on the volume of securities executed or on the contract value of securities traded through POSIT or our Electronic Trading Desk. We also earn commissions through soft dollar programs and provide our international customers with certain other research products offered in the U.S. such as QuantEX and TCA.

POSIT was introduced in 1987 in the U.S. as a technology-based solution to the trade execution needs of quantitative and passive investment managers. It has since grown to also serve the active trading and broker-dealer communities. There are 559 clients currently using POSIT in the U.S., including corporate and government pension plans, insurance companies, bank trust departments, investment advisors, broker-dealers and mutual funds. There are 218, 70 and 17 clients using versions of POSIT in Europe, Australia and Hong Kong, respectively. In Canada, the POSIT joint venture licenses a Canadian version of the POSIT system to the Toronto Stock Exchange ("TSX"). POSIT operates as a facility of the TSX for TSX listed securities.

POSIT is an electronic stock crossing system through which clients enter buy and sell orders to trade single stocks and portfolios of equity securities among themselves in a confidential environment. Orders may be submitted to the system directly via QuantEX, ITG Platform, ITG WebAccess or other computer-to-computer links, or indirectly via ITG Electronic Trading Desk personnel. We also work in partnership with vendors of other popular trading systems, allowing users the flexibility to route orders directly to POSIT from trading products distributed by Bridge Information Systems, BRASS, Bloomberg and others.

U.S. POSIT currently accepts orders for a universe of approximately 23,880 different equity securities, but may be modified, as the need arises, to include additional equity securities. At the end of the submission window the POSIT algorithm is run. It optimizes the maximum possible number of buy and sell orders that match or "cross". Clients may specify conditions on their orders that must be satisfied, such as the requirement that the net cash resulting from buys and sells remain within specified constraints. A client may also specify a minimum number of shares to be executed for a given order. POSIT prices trades at the midpoint of the best bid and offer for each security at the time of the cross, based on information provided directly to the system by a third-party data vendor. There are currently eight scheduled crosses every business day, at 9:40 a.m., 10:00 a.m., 10:30 a.m. and then hourly, on the hour, from 11:00 a.m. to 3:00 p.m. (Eastern Standard Time, "EST"). We also recently introduced POSIT after hours, which runs once nightly after 6:30 pm (EST). In the POSIT after hours cross, all trades are priced at the day's closing price. These trades are executed the following day at 12:01 am (EST) and are reported to Nasdaq shortly after 8:00 am (EST).

POSIT gives users the option of customizing their trading objectives and specifying additional constraints, while preserving the functionality of the existing POSIT system. This capability is referred to collectively as a "POSIT strategy." This capability allows orders that might otherwise be ineligible for POSIT to participate in the match. POSIT strategies include ResRisk, which allows users to control the risk of the unexecuted "residual" portfolio, and Pairs, which makes execution of one trade contingent on the execution of another, at or better than a given relative valuation. Clients engaging in portfolio funding, liquidation, restructuring and rebalancing transactions often utilize ResRisk. Risk arbitrage, statistical arbitrage and portfolio substitution trades are examples of transactions that can be implemented using the Pairs strategy. We also implement custom applications upon request.

Clients can also access POSIT through our brokerage subsidiary, AlterNet. AlterNet enables clients to execute trades in POSIT on a net basis, i.e.with the commission payable to us for the POSIT trade included in the price at which the client executes their POSIT trade. This feature is particularly attractive to our broker-dealer customers and AlterNet was created in response to broker-dealers' desires to have net pricing in POSIT.

The following graph illustrates the average daily volume of shares crossed on U.S. POSIT since 1994:

TriAct is a continuous, intra-day trading vehicle available to our customers. TriAct offers full anonymity, continuous execution opportunities, no market impact in respect of executions, and provides access to our POSIT system. TriAct provides price improvement on every transaction and opportunities

for size improvement. Participants in TriAct submit orders that may be executed in one of three ways: (a) against the ongoing flow of market bound orders submitted by other ITG clients and our Electronic Trading Desk, (b) against orders from other TriAct participants (liquidity suppliers) and (c) against orders sent to TriAct to participate in all of POSIT's eight intra-day crosses. Both listed and OTC securities can be traded in TriAct.

An execution in TriAct is priced between the bid/offer spread, at the midpoint if the counterparty is a TriAct liquidity supplier, or at 75% of the spread if trading with market flow participants. TriAct allows traders to control how their orders are traded by offering order expiration time, control of the rate at which orders are traded (1, 5, or 15 minute intervals), price protection, and portfolio buy/sell and minimum share constraints. In addition, TriAct enforces the tick/bid test rules for short sales of securities. TriAct is available from ITG Platform and QuantEX as well as third party trade order management systems.

SmartServers are automated trading destinations that accept orders from client workstations and execute them using a computerized trading strategy. All SmartServers are physically located at ITG, and are accessed electronically by clients via the ITG Platform or QuantEX, via direct connections or via our Electronic Trading Desk. Each SmartServer is an automated trading agent pre-programmed with a particular trading style. By using these agents, traders can focus their attention on a subset of their orders, letting the SmartServer trade the rest of the orders on the list.

Currently, we provide three strategy-based servers: VWAP SmartServer, SPI SmartServer and OTC Router. The VWAP SmartServer is designed to allow clients to direct their orders to us to be executed in a manner designed to closely track a security's volume-weighted average price, or VWAP, throughout the trading day. The VWAP SmartServer analyzes liquidity and market conditions continuously throughout the day and determines the appropriate order size and order price to approximate the VWAP. Clients may choose to execute relative to the VWAP price for the entire trading day, or for some subset of that trading day.

The SPI SmartServer is designed to improve trading performance of small- and medium-size orders that are traditionally executed as market orders. The SPI SmartServer analyzes momentum, volatility, and indicators to decide how and when to trade an order to improve upon the results expected from a market order. Clients may choose a time horizon for each order, anywhere from 5 to 30 minutes, whereby the SPI SmartServer monitors the market and determines the timing, pricing, and size of outgoing orders using real-time market data.

The OTC Router provides convenient electronic access to the OTC market, a single portal through which traders can access all OTC destinations. For marketable orders, the OTC Router sweeps available liquidity from all destinations using SuperMontage and direct connections to all major ECNs. The OTC Router features liquidity-hunting algorithms that rapidly locate all hidden liquidity at each price level without leaking any information to the market. For non-marketable limit orders, the OTC Router supports all major ECN features to eliminate the guesswork from posting liquidity. Instead of keeping track of which ECNs support each of the various order types, traders specify the features they want and let the OTC Router determine the appropriate venue. Whenever the Router has a choice between several destinations, it uses historical execution quality to determine the best routing.

The Electronic Trading Desk is a full-service agency execution group that specializes in the use of our proprietary products, including extensive use of POSIT, TriAct and our SmartServers for trade execution. For clients that do not send orders electronically to POSIT, TriAct or our SmartServers, our account executives receive orders by telephone, fax or e-mail.

QuantEX, ITG Platform and ITG WebAccess clients deliver lists of orders electronically to our desk and, as orders are executed by the desk, reports are automatically delivered electronically to the client's terminal. The Electronic Trading Desk personnel are thereby able to assist customers with decision support analyses generated by ITG Platform, QuantEX or ITG WebAccess and with the execution of trades. Clients give our traders single stock orders or lists of orders to work throughout the day as well as unfilled orders that remain due to order imbalances in POSIT matches.

For order completion outside of POSIT match windows, the Electronic Trading Desk utilizes numerous sources of liquidity to complete trades. The Electronic Trading Desk will actively seek the contra side of client orders by soliciting interest among other clients, use QuantEX to route the orders to multiple markets, including primary exchanges, regional exchanges, over-the-counter market makers, ECNs and ATSs, or use our active order traders to execute the trade with floor brokers or over-the-counter brokers.

The Portfolio Trading Group focuses on agency-only list and program trading. By employing a step-by-step process that leverages technology and access to multiple sources of liquidity, the Portfolio Trading Group seeks to systematically achieve high quality executions for the client by controlling transaction costs. A client program is evaluated with a pre-trade analysis to determine aggregate portfolio characteristics, estimate market impact, and to quantify risk. The group implements a number of sophisticated trading strategies using QuantEX to meet execution objectives. After the execution is completed, we provide the client with comprehensive reports analyzing execution results utilizing ITG Research products.

We actively market and distribute independent third-party research products and services to professional investment managers with the expectation that these managers will use our products and services to execute securities trades, which generate specified amounts of commission revenues. These types of arrangements are referred to as soft dollar arrangements and are primarily pursued by our Hoenig subsidiaries.

An important aspect of our soft dollar programs involves identifying independent sources of investment research and information, that adds value to our customers' investment decision-making process. We seek research services from private research groups, independent analysts, information services organizations and other entities in the U.S. and overseas and collaborate with these providers to obtain products and services that assist our investment management customers in carrying out their investment management responsibilities.

We obtain research products and services from over 400 independent sources and regularly communicate the availability and suitability of these products and services to our customers. Through our relationships with independent research analysts and other service providers, we offer a wide variety of specialized and sophisticated research products and services, including fundamental research, economic research and forecasting, quantitative analysis, global research, quotation, news and database systems, fixed income research, software for securities analysis, portfolio management and performance measurement services. Many of these products and services are available directly from the research analyst or service provider, as well as from other brokerage firms, including specialty firms offering only independent research and firms that also provide proprietary research.

Our relationship with an independent research provider typically is one in which the research organization agrees to supply research products or services to our customers for a specified period of time (generally one year or less), and we agree to pay for such research. All of our research relationships are non-exclusive arrangements.

In addition, we engage in directed brokerage arrangements with certain institutional investors, particularly hedge funds, private investment funds and investment partnerships, corporations and pension plans. A directed brokerage arrangement is a contractual arrangement between a brokerage firm and its customer whereby the broker pays certain expenses of the customer, such as custodian fees, or refunds to the customer a portion of commissions paid in consideration of the customer directing commission business to the broker. These types of arrangements are commonly known as directed brokerage because the customer instructs its money managers to direct trades for the customer's account to the broker with whom the customer has a directed brokerage arrangement. In the case of pension plans, directed brokerage arrangements often involve the payment of commission refunds to the pension plan and are often referred to as "commission recapture" programs.

QuantEX is our Unix-based trade management system, an advanced tool for technologically sophisticated clients transacting large volumes of orders. QuantEX helps clients efficiently manage every step of the trading process: from decision-making to execution to tracking of trade list status. From a dedicated workstation at their desks, users can access fully-integrated real-time and historical data and analytics, route and execute orders electronically, and perform trade management functions. QuantEX is an integrated system that supports multiple trade-related activities that have traditionally required the use of several unrelated systems.

QuantEX is a rule-based decision support system that allows traders to quantify their trading processes to create automated strategies. It is designed to implement each client's trading styles and strategies and to apply them to hundreds of stocks, portfolios or industry groups at once. With QuantEX, clients can flag moment-to-moment opportunities they would ordinarily want to pursue, but do so much more efficiently and scientifically.

Rule-based strategies can be based on a wide range of quantitative models. Passive traders can use QuantEX strategies to help minimize slippage from various benchmarks, reduce tracking errors and achieve desired sector balances. Active traders can build models to match a wide variety of trading approaches, such as pairs trading, market-neutral algorithms and index or risk arbitrage. QuantEX strategies can involve the human trader in each order decision, or can fully automate the trading process, depending on the client's preference.

QuantEX analyzes lists of securities based on the individual user's trading strategy. QuantEX provides clients access to our proprietary research, including pre-trade, post-trade and intra-day analytical tools. QuantEX has access to the ITG Data Center, which is a comprehensive historical database that provides a variety of derived analytics based upon raw historical data. Our support specialists translate the trading criteria developed by the client into a set of rules for trading securities, which are then loaded into QuantEX. QuantEX applies the client's proprietary trading rules to a continuous flow of current market information on the list of securities selected by the user to generate real-time decision support. A user's rules can be based on a wide range of quantitative models or strategies, such as liquidity measures, technical indicators, price benchmarks, tracking to specific industries and sectors, pairs or other long or short strategies, index arbitrage, risk measurements and liquidity parameters for trade urgency, size or timing. These rules typically serve as a guide in support of a client's trading decisions. In addition, QuantEX supports the ability to implement these trading decisions automatically via an auto-trading strategy.

As such, QuantEX can automate the complex trade management requirements typical of investment strategies that trade large volumes of securities through multiple sources of liquidity. Orders can be electronically routed to multiple markets, including the NYSE, the American Stock Exchange and certain regional stock exchanges, the Nasdaq National Market, POSIT, TriAct, our SmartServers, the Electronic Trading Desk, over-the-counter market-makers, and selected broker-dealers, ECNs and

third party ATSs. We continue to create links to additional ATSs and other liquidity sources where appropriate. Trades routed through QuantEX are automatically tracked and summarized. Each order can be monitored by source of execution, by trade list, by portfolio or globally with all other orders placed. QuantEX's built-in trade allocation features provide a facility for automated back-office clearance and settlement. QuantEX supports the Financial Information eXchange ("FIX") messaging protocol and can link to other FIX compliant systems.

QuantEX also allows our clients to access our ISIS facility, an equity pre- and post-trade analysis system. Via the ISIS facility, QuantEX users can request both aggregate and stock-by-stock liquidity reports for a portfolio trade prior to and during execution. Clients can generate standard reports or use a report writer to design custom reports. Certain elements of these reports can also be displayed directly on the QuantEX execution page and referenced in QuantEX strategies. These pre-trade analyses help QuantEX users make decisions about how best to trade a portfolio, for example by helping identify the most difficult trades for special handling. The ISIS post-trade reporting facility allows QuantEX users to compare actual executed prices to user-selected benchmark prices in order to help assess trade execution quality. Available benchmarks include the volume-weighted average price, closing price and opening price.

Our support specialists install the system, train users and provide ongoing support for the use of QuantEX's order routing and analysis capabilities. Our specialists are knowledgeable about portfolio management and trading as well as the system's hardware and software. Our support team works closely with each client to develop trading strategies and rules, explore new trading approaches, provide system integration services and implement system upgrades and enhancements.

Revenues are generated through commissions and transaction fees charged for each trade electronically routed through QuantEX to the many destinations available from the application. We do not derive royalties from the sale or licensing of the QuantEX software. As of December 31, 2002, there were 139 installations of QuantEX at 60 client sites in the U.S.

ITG Platform provides clients with seamless connectivity from their desktop to a variety of execution destinations, such as POSIT, TriAct, our SmartServers, the Electronic Trading Desk, the NYSE, the American Stock Exchange and certain regional stock exchanges, the Nasdaq National Market, over-the-counter market makers, selected ECNs and third party ATSs. We continue to create links to additional liquidity sources where appropriate. Orders may be corrected or cancelled electronically, and all reports are delivered electronically back to the ITG Platform. ITG Platform also supports special trading interfaces as needed by POSIT strategies and SmartServers. Allocation information can be associated with executions in the ITG Platform and delivered to us electronically. ITG Platform has access to historical data through the ITG Data Center, including a wide array of analytics, such as average historical share volumes, dollar volumes, volatility and historical spread statistics. ITG Platform also provides clients enhanced list trading capabilities, access to ECN order types and, in some cases, access to real time Nasdaq Level II data as well as the ability to communicate with us via the Internet or through private networks.

ITG Platform was intended for broad distribution to institutional clients, so it was designed to run in conventional PC environments alongside other applications, and be inexpensive to install, maintain and support.

As of December 31, 2002, there were 519 installations of ITG Platform at 230 client sites in the U.S.

ITG WebAccess allows users to take advantage of our advanced trading services from anywhere through the Internet. ITG WebAccess is a browser-based order routing tool for sending orders to POSIT and the Electronic Trading Desk.

Pre-trade Agency Cost Analysis ("ITG ACE") and Post-trade Transaction Cost Analysis ("TCA")

Accessed through the Internet, ITG ACE and TCA are equity pre- and post-trade analysis systems. ITG ACE and TCA users can request both aggregate and stock-by-stock liquidity reports for a trade portfolio prior to, during and following execution. Clients can generate standard reports built into the browser-based applications. Reports can be viewed, printed or saved to a file.

ITG ACE helps users make decisions about the expected cost of trading. It also helps determine how best to trade a portfolio, for example by identifying the most difficult trades for special handling and by providing a reference point for evaluating principal trade pricing. The TCA post-trade reporting facility allows users to compare actual executed prices to user-selected benchmark prices in order to help assess trade execution quality. Available benchmarks include the volume-weighted average price, closing price, pre-trade midquote and last trade, among others.

ITG/Opt is a computer-based equity portfolio selection system that employs advanced optimization techniques to help investors construct portfolios that meet their investment objectives. Special features of the system make it particularly useful to "long/short" and taxable investors, as well as any investor seeking to control transaction costs. ITG/Opt is usually delivered as a "turnkey" system that includes software and, in some cases, hardware and data. Included in the service is telephone and on-site support to assist in training and integrate the system with the user's other investment systems and databases, with the goal of tightly coupling ITG/Opt to the client's workflow. In addition to its core portfolio construction capabilities, ITG/Opt has powerful backtesting and batch scheduling features that permit efficient researching of new or refined investment strategies. The system, which is targeted at highly sophisticated investment applications, is offered primarily to our largest clients. Typically, portfolios that are constructed using ITG/Opt are executed via ITG, using one or more execution services, such as QuantEX, the Electronic Trading Desk and POSIT.

ITG PRIME is a web-based portfolio risk analysis and management platform that allows users to monitor and identify sources of risk in a portfolio or trade list, measure risk relative to a benchmark and forecast the future volatility of a portfolio. ITG PRIME provides risk information at the portfolio, sector and individual stock levels. The risk metrics are based on ITG's proprietary suite of equity risk models.

Under the Investment Company Act of 1940, mutual funds and their directors/trustees are required to make a good faith determination of the fair value of a fund's portfolio securities when market quotations are not readily available. The ITG Fair Value Model facilitates such fair value computations.

In most instances, an open-end mutual fund's NAV is calculated based on the closing price for each security underlying the fund's portfolio. For mutual funds with foreign or thinly traded assets, however, this practice may raise concerns regarding the "fair value" of a fund's securities where the underlying securities' local markets close prior to the close of the U.S. markets and therefore do not account for market events in the U.S. or other subsequent events.

The ITG Fair Value Model is a research tool, which provides fair value adjustment factors to assist in determining whether to adjust securities' closing prices for liquidity, time zone, and other factors.

ITG Risk Models are equity risk models that assist portfolio managers, researchers and traders in measuring, analyzing and managing risk in a variety of market environments and applications. ITG Risk Models can be used to estimate tracking error relative to benchmark portfolios, forecast total volatility of long/short portfolios, construct market/sector/industry-neutral trade lists, measure exposure and decompose risk, as well as create optimal portfolios in conjunction with an equity portfolio selection system such as ITG/Opt.

In addition to its role in our overall research and development effort, Research provides both sales and consulting services to our clients and prospective clients. Taken together, these activities are a key component of our overall relationship development and maintenance activities.

In its sales capacity, Research introduces our clients and prospective clients to the full range of products and services offered by our company and provides information about features, pricing and technical/functional specifications. The sales process includes development of an in-depth understanding of client practices and requirements and the design and presentation of integrated solutions based on our products.

Consulting encompasses a set of value-added services for the benefit of our clients. These services break down into three main categories: product support, development of customized trading strategies and provision of quantitative analysis. Our research products include ITG ACE, TCA, ITG/Opt, ITG PRIME, Fair Value Model and ITG Risk Models. Support activities include trading strategy design and implementation, system integration, training and coordination of technical support. Strategy development involves building customized QuantEX strategies that automate the trading styles of specific clients. Quantitative analysis covers a broad range of activities such as transaction cost analysis, investment strategy simulations and provision of historical time series of proprietary analytics. As part of its analysis activities, Research publishes and distributes studies on topics of interest to our clients. In the same way users of fundamental research compensate the brokerage houses that provide such

research (i.e., directing commissions to such brokerage houses), our clients reward us for these value-added research services.

In the fourth quarter of 1998, we entered into a ⁵⁰/50 joint venture with Société Générale, and founded ITG Europe. On November 18, 1998, ITG Europe launched an agency brokerage operation that included the operation of a European version of the POSIT system. On May 2, 2001, we purchased Société Générale's entire interest in ITG Europe for $18.5 million. ITG Europe provides institutional investors throughout Europe many of the products and services provided to our U.S. customer base, including POSIT and certain other research products such as TCA.

In 1997, we entered into a ⁵⁰/50 joint venture with Burdett, Buckeridge & Young ("BBY") and founded ITG Australia Limited, an international brokerage firm that applies our cost-saving execution and transaction research technologies to Australian equity trading. In November of 2000, we acquired the remaining interest in ITG Australia (from BBY and certain employees of ITG Australia) that we did not already own, bringing our ownership interest up to 100%. ITG Australia provides institutional investors in Australia many of the products and services provided to our U.S. customer base, including POSIT and certain other research products such as TCA.

In April 2000, we announced the formation of our Canadian subsidiary, ITG Canada Corp., which functions as an institutional broker-dealer in Canada. ITG Canada provides Canadian institutions access to many of the ITG products provided to our U.S. customer base including a version of QuantEX developed for the Canadian markets. On June 29, 2001, the POSIT joint venture entered into an agreement to license a Canadian version of the POSIT system to the TSX. This Canadian version of POSIT was launched in 2002. It operates as a facility of the TSX for TSX listed securities.

On September 28, 2001, we acquired the KastenNet business of Kasten Chase Applied Research Limited for $4.7 million. KastenNet is a direct access provider that employs proprietary technology to connect its clients, Canadian broker-dealers, to the Toronto Stock Exchange. We acquired the assets of KastenNet via KTG, a new wholly-owned subsidiary of ITG.

In June 2001, we announced the formation of ITG Hong Kong Ltd. ITG Hong Kong is an institutional brokerage firm focusing on applying ITG's cost saving trading technologies in the Asian markets. POSIT was launched in Hong Kong in June 2002 for the matching of Hong Kong equities.

On September 3, 2002, we completed the acquisition of Hoenig Group Inc., which, through its operating affiliates, provides trade execution, independent research and other services to alternative investment funds and money managers globally.

Under the terms of the transaction, Hoenig stockholders received approximately $105.0 million, or $11.58 per share, of which approximately $2.4 million, or $0.23 per share, have been placed into an escrow account.

Such escrow requirement relates to the pursuit, on behalf of Hoenig Group Inc. shareholders, of certain insurance and other claims in connection with the $7.2 million pre-tax loss announced by

Hoenig Group Inc. on May 9, 2002 as a result of unauthorized trading in foreign securities, by a former employee of Hoenig & Company Limited, in violation of Hoenig's policies and procedures.

In connection with this acquisition, we incurred transaction costs consisting primarily of professional fees of approximately $2.8 million, which have been included in the purchase price. The purchase price was allocated to those assets acquired and liabilities assumed based on the estimated fair value of Hoenig's net assets as of September 3, 2002. Approximately $0.5 million was allocated to the "Hoenig" trade name, which is being amortized over three years. The excess of the purchase price over the estimated fair value of the net assets acquired was $57.3 million and has been allocated to goodwill. The results of operations of Hoenig have been included in our results of operations since September 3, 2002.

Certain of our U.S. and non-U.S. subsidiaries are subject to various securities regulations and capital adequacy requirements promulgated by the regulatory and exchange authorities of the countries in which they operate. In the U.S., the Securities and Exchange Commission ("SEC") is the federal agency responsible for the administration of the federal securities laws, with the regulation of broker-dealers primarily delegated to self-regulatory organizations ("SROs"), principally the National Association of Securities Dealers, Inc. ("NASD") and national securities exchanges. In addition to federal oversight, securities firms are also subject to regulation by state securities administrators in those states in which they conduct business. Furthermore, our non-US subsidiaries are subject to regulation by central banks and regulatory bodies in those jurisdictions where each subsidiary is authorized to do business. The SROs, central banks and regulatory bodies conduct periodic examinations of our broker-dealers subsidiaries in accordance with the rules they have adopted and amended from time to time.

Broker-dealers are subject to regulations covering all aspects of the securities business, including sales methods, trade practices among broker-dealers, use and safekeeping of clients' funds and securities, capital structure of securities firms, record-keeping and conduct of directors, officers and employees. Additional legislation, changes in the interpretation or enforcement of existing laws and rules may directly affect the mode of operation and profitability of broker-dealers. The SEC, SROs, state securities commissions and foreign regulatory authorities 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. The principal purpose of regulation and discipline of broker-dealers is the protection of clients and the securities markets, rather than the protection of creditors and stockholders of broker-dealers.

ITG Inc., AlterNet and Hoenig & Co., Inc. are required by law to belong to the Securities Investor Protection Corporation. In the event of a U.S. broker-dealer's insolvency, the Securities Investor Protection Corporation fund provides protection for client accounts up to $500,000 per customer, with a limitation of $100,000 on claims for cash balances. ITG Canada is required by Canadian law to belong to the Canadian Investors Protection Fund ("CIPF"). In the event of a Canadian broker-dealer's insolvency, CIPF provides protection for client accounts up to 1,000,000 Canadian dollars per customer. ITG Hong Kong is required by law to belong to the Unified Exchange Compensation Fund, which is operated by the Hong Kong Stock Exchange and supervised by the SFC. The Unified Exchange Compensation Fund provides protection for ITG Hong Kong's clients accounts up to 8.0 million Hong Kong dollars per customer.

From the formation of the POSIT joint venture until the adoption of Regulation ATS, POSIT operated under a "no-action" letter from the SEC staff that it would not recommend that the SEC commence an enforcement action if POSIT were operated without registering as an exchange. We are currently operating POSIT, TriAct and SmartServers as part of our broker-dealer operations in accordance with Regulation ATS. Accordingly, none of POSIT, TriAct and SmartServers are registered with the SEC as an exchange. There can be no assurance that the SEC will not in the future seek to impose more stringent regulatory requirements on the operation of alternative trading systems such as POSIT, TriAct and SmartServers. In addition, certain of the securities exchanges have actively sought to have more stringent regulatory requirements imposed upon automated trade execution systems. There can be no assurance that Congress will not enact additional legislation applicable to alternative trading systems.

ITG Inc., AlterNet and Hoenig & Co., Inc. are subject to the Uniform Net Capital Rule (Rule 15c3-1) under the Exchange Act, which requires the maintenance of minimum net capital. ITG Inc. has elected to use the alternative method permitted by Rule 15c3-1, which requires that ITG Inc. maintain minimum net capital equal to the greater of $250,000 or 2% of aggregate debit balances arising from customer transactions. AlterNet and Hoenig & Co., Inc. have elected to use the basic method permitted by Rule 15c3-1, which requires that they maintain minimum net capital equal to the greater of $100,000 for AlterNet and $250,000 for Hoenig & Co., Inc., or 6²/3% of aggregate indebtedness.

At December 31, 2002, ITG Inc., AlterNet and Hoenig & Co., Inc. had net capital of $86.3 million, $3.4 million and $7.3 million, respectively, of which $86.0 million, $3.3 million and $6.7 million, respectively, was in excess of required net capital.

In addition, our Canadian, Australian, European and Asian operations had regulatory capital in excess of the minimum requirements applicable to each business as of December 31, 2002 of approximately $6.8 million, $2.7 million, $12.1 million and $4.3 million, respectively.

As of December 31, 2002, Hoenig & Co., Inc. held a $3.8 million cash balance in a segregated bank account for the benefit of customers under certain directed brokerage arrangements. In addition, Hoenig & Co., Inc. computes a deposit due on any fail to receive/deliver for foreign securities of their customers transacted through its foreign affiliates.

Although we believe that the combination of our existing net regulatory capital and operating cash flows will be sufficient to meet regulatory capital requirements for our subsidiaries, a shortfall in net regulatory capital would have a material adverse effect on our business and our results of operations.

In 1987, Jefferies & Company, Inc. and BARRA Inc. ("Barra") formed a joint venture for the purpose of developing and marketing POSIT. In 1993, Jefferies & Company, Inc. assigned all of its rights relating to the joint venture and the license agreement, discussed below, to us.

The technology used to operate POSIT in the U.S. is licensed to us pursuant to a perpetual license agreement between ITG Inc. and the POSIT joint venture. The license agreement grants ITG Inc. the exclusive right to use certain proprietary software necessary to the continued operation of POSIT and a non-exclusive license to use proprietary software that operates in conjunction with POSIT. Under the license agreement, ITG Inc. pays quarterly royalties to the POSIT joint venture equal to specified percentages of the transaction fees we charge on each share crossed through POSIT.

The license agreement permits Barra on behalf of the joint venture to terminate the agreement upon certain events of bankruptcy or insolvency or upon an uncured breach by ITG Inc. of certain covenants, the performance of which are all within our control. Although we do not believe that we will experience difficulty in complying with our obligations under the license agreement, any termination of the license agreement resulting from an uncured default would have a material adverse effect on us.

Under the license agreement and the terms of the joint venture, Barra continues to provide certain support services to ITG Inc. in connection with the operation of POSIT, including software updates and the availability of experienced personnel. Barra also provides support for the development and maintenance of POSIT.

Under the terms of the joint venture, Barra generally has the right to approve any sale, transfer, assignment or encumbrance of our interest in the joint venture. The POSIT joint venture may earn a royalty from licensing the POSIT technology to other businesses. The joint venture licensed to ITG Australia, ITG Europe and ITG Hong Kong the right to use the POSIT technology for crossing Australian, European and Asian equity securities. The POSIT joint venture has also licensed the TriAct technology to ITG Inc. on an exclusive basis.

For the years ended December 31, 2002, 2001, and 2000, Barra earned aggregate royalty income in respect of POSIT of $19.6 million, $23.7 million, and $20.2 million, respectively, under the license agreement.

The automated trade execution and analysis services that we offer compete with services offered by leading brokerage firms and transaction processing firms, and with providers of electronic trading and

trade order management systems and financial information services. POSIT also competes with various national and regional securities exchanges and execution facilities, the Nasdaq National Market, ATSs and ECNs, as well as other share matching systems for trade execution services. In addition, the number of trading products that compete with our Client Site Trading Products has been increasing. Many of our competitors have substantially greater financial, research and development and other resources. We believe that our services compete on the basis of access to liquidity, transaction cost and market impact cost reduction, timeliness of execution and probability of trade completion. Although we believe that POSIT, TriAct, QuantEX, ITG Platform, SmartServers, the Electronic Trading Desk and our Research services have established certain competitive advantages, our ability to maintain these advantages will require continued identification of enhancements to our products, investment in the development of our services, additional marketing activities and customer support services. There can be no assurance that we will have sufficient resources to continue to make this investment, that our competitors will not devote significantly more resources to competing services or that we will otherwise be successful in maintaining our current competitive advantages. In addition, we cannot predict the effect that changes in regulations applicable to our business may have on the competitive environment.

We devote a significant portion of our resources to the development and improvement of technology-based services. Important aspects of our research and development effort include enhancements of existing software, the ongoing development of new software and services and investment in technology to enhance our efficiency. In our consolidated statements of income, we expensed research and development costs amounting to $23.0 million, $19.7 million, and $16.5 million for the years ended December 31, 2002, 2001, and 2000, respectively.

The development of technology-based services is a complex and time-consuming process. New products and enhancements to existing products can require long development and testing periods. Significant delays in new product releases or significant problems in creating new products could negatively impact our revenues.

Our success is dependent, in part, upon our proprietary intellectual property. We generally rely upon patents, copyrights, trademarks and trade secrets to establish and protect our rights in our proprietary technology, methods and products. A third party may still try to challenge, invalidate or circumvent the protective mechanisms that we select. We cannot assure that any of the rights granted under any patent, copyright or trademark that we may obtain will protect our competitive advantages. In addition, the laws of some foreign countries may not protect our proprietary rights to the same extent as the laws of the U.S.

In the past several years, there has been a proliferation of so-called "business method patents" applicable to the computer and financial services industries. There has also been a substantial increase in the number of such patent applications filed. Under current law, U.S. patent applications remain secret for 18 months and may, depending upon where else such applications are filed, remain secret until issuance of a patent. In light of these factors, it is not economically practicable to determine in advance whether our products or services may infringe the present or future patent rights of others. We believe that factors such as technological and creative skills of our personnel, new product developments, frequent product enhancements, name recognition and reliable product maintenance are essential to establishing and maintaining a state-of-the-art technological system. There can be no assurance that we will be able to protect our technology from disclosure or that others will not develop technologies that are similar or superior to our technology. It is likely that from time to time, we will receive notices from others of claims or potential claims of intellectual property infringement or we may be called upon to defend a joint venture partner, customer, vendee or licensee against such third

party claims. Responding to these kinds of claims, regardless of merit, could consume valuable time, result in costly litigation or cause delays, all of which could have a material adverse effect on us. Responding to these claims could also require us to enter into royalty or licensing agreements with the third parties claiming infringement. Such royalty or licensing agreements, if available, may not be available on terms acceptable to us.

As of December 31, 2002, we employed 635 personnel globally. Our U.S. Operations employed 451 personnel and our International Operations employed 184 personnel at that date.

Our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K are available without charge on our web site at http://www.itginc.com/investor. You may also obtain copies of our reports without charge by writing to: Investment Technology Group, Inc., 380 Madison Avenue, New York, NY, 10017, attn: Investor Relations.

Our principal offices are located at 380 Madison Avenue in New York, New York. We currently lease the entire 4^th floor and a portion of the 5^thand 7^th floors or approximately 83,400 square feet of office space. The fifteen-year lease terms for the 4^th and 5^th floors and the thirteen-year lease term for the 7^th floor expire in January 2013.

We maintain a research, development and technical support services facility in Culver City, California where we occupy approximately 78,000 square feet of office space. We lease the California facility pursuant to lease agreements that expire in December 2005.

Additionally, we have a backup and regional office in Boston, Massachusetts where we occupy approximately 21,300 square feet of office space. The ten-year lease term for this space expires in April 2005.

Hoenig & Co., Inc. maintains an office in Rye Brook, New York where we occupy approximately 28,000 square feet of office space. The lease agreement expires in December 2010.

We have a research facility in Herzliya, Israel where we occupy approximately 8,000 square feet of office space. We lease the Israel space pursuant to a seven-year lease agreement that expires in December 2008.

ITG Canada has offices in Toronto, Canada where we occupy approximately 7,800 square feet of office space pursuant to two leases expiring in December 2007 and August 2008, respectively. In addition, KTG has approximately 5,900 square feet of office space under a lease expiring in May 2013.

ITG Europe has offices in Dublin, Ireland and London, England where we occupy approximately 4,000 and 5,000 square feet of office space, respectively. We lease the Dublin space pursuant to a seventeen-year lease agreement that expires in July 2018 and we lease the London space pursuant to a five-year lease agreement that expires in July 2005.

ITG Australia has trading facilities in Melbourne and Sydney, Australia where we occupy approximately 4,600 and 2,700 square feet of office space, respectively. We lease the Melbourne space

pursuant to a three-year lease agreement that expires in June 2003 and we lease the Sydney space pursuant to a five-year lease agreement that expires in February 2006.

Our Hong Kong operations occupy approximately 6,800 square feet of office space. The lease agreement expires in June 2004.

In 1998, we received a "30-day letter" proposing certain adjustments which, if sustained, would result in a tax deficiency of approximately $9.6 million plus interest. The adjustments proposed relate to (i) the disallowance of deductions taken in connection with the termination of certain compensation plans at the time of our initial public offering in 1994 and (ii) the disallowance of tax credits taken in connection with certain research and development expenditures. On September 18, 2000, we entered into a closing agreement with the Internal Revenue Service ("IRS") with respect to the compensation plan deductions, whereby the IRS agreed that the deductions taken were allowable deductions. This agreement eliminates approximately $7.6 million of the $9.6 million potential tax deficiency raised by the IRS in 1998. We are continuing to pursue the resolution of the research and development tax credit issue and we believe that the ultimate resolution will not be material to the financial position or results of operations of our company.

There were no matters submitted to a vote of security holders during the fourth quarter ended December 31, 2002.

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

Our common stock trades on the New York Stock Exchange under the symbol "ITG". Effective December 7, 2001, our outstanding shares of common stock split three-for-two. High and low closing sales prices have been retroactively restated to reflect such split.

The following table sets forth, for the periods indicated, the range of the high and low closing sales prices per share of our common stock as reported on the New York Stock Exchange.

	High	Low
2001
First Quarter	37.57	24.63
Second Quarter	36.53	30.70
Third Quarter	38.66	31.28
Fourth Quarter	43.56	36.87
2002
First Quarter	54.15	37.51
Second Quarter	51.23	30.31
Third Quarter	37.40	27.87
Fourth Quarter	33.36	21.31

On March 20, 2003, the closing sales price per share for our common stock as reported on the New York Stock Exchange was $15.10. On March 20, 2003, we believe that our common stock was held by approximately 8,400 stockholders of record or through nominees in street name accounts with brokers.

In 2002, our Board of Directors authorized the repurchase of an aggregate of 4.0 million additional shares of our common stock pursuant to our share repurchase program. The share repurchase program is being effected from time to time, depending on market conditions and other factors, through open market purchases and privately negotiated transactions. As of December 31, 2002, we were authorized to repurchase up to approximately 3.0 million shares of common stock. The share repurchase program may be suspended at any time.

Our dividend policy is to retain earnings to finance the operations and expansion of our businesses. We do not anticipate paying any cash dividends on our common stock at this time.

The selected Consolidated Statement of Income data and the Consolidated Statement of Financial Condition data presented below as of and for each of the years in the five-year period ended December 31, 2002, are derived from our consolidated financial statements, which financial statements have been audited by KPMG LLP, our independent auditors. Earnings per share information prior to 1999 has been retroactively restated to reflect our spin-off from Jefferies Group, Inc. In addition, earnings per share information for all periods has been retroactively restated to reflect our three-for-two stock split in December 2001. Such selected financial data should be read in connection with the consolidated financial statements contained in this report.

DELAWARE		95-2848406
(State of incorporation)		(IRS Employer Identification No.)
380 Madison Avenue, New York, New York		(212) 588-4000
(Address of principal executive offices)		(Registrant's telephone number, including area code)
10017
(Zip Code)

Common Stock, $0.01 par value		New York Stock Exchange
(Title of class)		(Name of exchange on which registered)
Aggregate market value of the voting stock held by		Number of shares outstanding of the Registrant's
non-affiliates of the Registrant at March 20, 2003:		Class of common stock at March 20, 2003:
$712,577,260		47,190,542

	Year Ended December 31,
	2002		2001		2000		1999		1998
	(In thousands, except per share amounts)
Consolidated Statement of Income Data:
Total revenues	$	387,581	$	377,407	$	310,405	$	232,044	$	212,205
Total expenses		260,328		241,295		197,409		149,183		131,270

Income before income taxes		127,253		136,112		112,996		82,861		80,935
Income tax expense		53,443		57,217		49,403		37,435		37,541

Net income	$	73,810	$	78,895	$	63,593	$	45,426	$	43,394

Basic earnings per share	$	1.52	$	1.65	$	1.37	$	0.99	$	0.99

Diluted earnings per share	$	1.51	$	1.62	$	1.34	$	0.95	$	0.94

Basic weighted average number of common shares outstanding (in millions)		48.5		47.9		46.5		46.0		44.0
Diluted weighted average number of common shares outstanding (in millions)		49.0		48.7		47.3		47.9		46.2
Consolidated Statement of Financial Condition Data:(1)
Total assets	$	594,254	$	418,478	$	281,712	$	179,488	$	180,706
Total stockholders' equity	$	356,509	$	317,944	$	210,416	$	115,652	$	143,709
Other Selected Financial Data:
Revenues per trading day (in thousands)	$	1,538	$	1,522	$	1,232	$	921	$	842
Shares executed per trading day by U.S. Operations (in millions)		98		91		65		46		43
Shares executed per trading day by Non U.S. Operations (in millions)		41		23		1		—		—
Revenues per average number of employees (in thousands)	$	603	$	720	$	843	$	793	$	899
Average number of employees		643		524		368		293		236
Total number of U.S. customers(2)		1,085		636		613		572		535
POSIT(2)		559		551		521		492		490
Electronic Trading Desk(2)		449		444		418		411		373
QuantEX(3)		60		52		55		52		52
ITG Platform(3)		230		206		199		188		140
Soft Dollar(2)		423		—		—		—		—
Total number of Non U.S. customers(2)		457		292		34		—