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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d)

OF THE SECURITIES EXCHANGE
ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004



001-14223

Commission File Number



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KNIGHT TRADING GROUP, INC.

(Exact name of registrant as specified in its charter)



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DELAWARE

(State or other jurisdiction of incorporation or organization)



22-3689303

(I.R.S. Employer
Identification Number)



525 Washington Boulevard, Jersey
City, NJ 07310

(Address of principal executive offices and zip code)



Registrants telephone number, including area code: (201) 222-9400



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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 whether the registrant is an accelerated filer (as defined in Exchange Act Rule
12b-2)    Yes  x    No ̈



Indicate the number of shares outstanding of each of the issuers
classes of common stock, as of the latest practicable date:



At
May 4, 2004 the number of shares outstanding of the Registrants Class A Common Stock was 116,018,142 and there were no shares outstanding of the Registrants Class B Common Stock as of such date.

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##### Table of Contents

KNIGHT TRADING GROUP, INC.



FORM 10-Q QUARTERLY REPORT



For the Quarter Ended March 31, 2004



TABLE OF CONTENTS



|           |  |                                                                                       |  |   
|---------- |  | ------------------------------------------------------------------------------------- |  | --
|PART I     |  | FINANCIAL INFORMATION:                                                                |  |   
|           |  |                                                                                      
|Item 1.    |  | Financial Statements                                                                  |  | 3 
|           |  | Consolidated Statements of Operations                                                 |  | 3 
|           |  | Consolidated Statements of Financial Condition                                        |  | 4 
|           |  | Consolidated Statements of Cash Flows                                                 |  | 5 
|           |  | Notes to Consolidated Financial Statements                                            |  | 6 
|           |  |                                                                                      
|Item 2.    |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 16
|           |  |                                                                                      
|Item 3.    |  | Quantitative and Qualitative Disclosures About Market Risk                            |  | 26
|           |  |                                                                                      
|Item 4.    |  | Controls and Procedures                                                               |  | 28
|           |  |                                                                                      
|PART II    |  | OTHER INFORMATION:                                                                    |  |   
|           |  |                                                                                      
|Item 1.    |  | Legal Proceedings                                                                     |  | 28
|           |  |                                                                                      
|Item 2.    |  | Changes in Securities and Use of Proceeds                                             |  | 29
|           |  |                                                                                      
|Item 3.    |  | Defaults Upon Senior Securities                                                       |  | 29
|           |  |                                                                                      
|Item 4.    |  | Submission of Matters to a Vote of Security Holders                                   |  | 29
|           |  |                                                                                      
|Item 5.    |  | Other Information                                                                     |  | 29
|           |  |                                                                                      
|Item 6.    |  | Exhibits and Reports on Form 8-K                                                      |  | 29
|           | 
|Signatures |  | 31                                                                                   



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##### Table of Contents

PART I. FINANCIAL INFORMATION



Item 1. Financial Statements



KNIGHT TRADING GROUP, INC.



CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)



|                                                                  |  |                                     |             |   |      |   |             |  
|----------------------------------------------------------------- |  | ----------------------------------- | ----------- | - | ---- | - | ----------- | -
|                                                                  |  | For the three monthsended March 31, |            
|                                                                  |  | 2004                                |             |   | 2003 |  
|REVENUES                                                          |  |                                     |             |   |      |   |             |  
|Net trading revenue                                               |  | $                                   | 137,070,189 |   |      | $ | 70,188,203  |  
|Commissions and fees                                              |  |                                     | 85,372,641  |   |      |   | 32,693,643  |  
|Asset management fees                                             |  |                                     | 13,932,132  |   |      |   | 14,225,722  |  
|Interest and dividends, net                                       |  |                                     | (2,858,133  | ) |      |   | 1,770,364   |  
|Investment income and other                                       |  |                                     | 6,326,767   |   |      |   | 7,457,900   |  
|                                                                  |  |                                     |             |   |      |   |             |  
|Total revenues                                                    |  |                                     | 239,843,596 |   |      |   | 126,335,832 |  
|                                                                  |  |                                     |             |   |      |   |             |  
|EXPENSES                                                          |  |                                     |             |   |      |   |             |  
|Employee compensation and benefits                                |  |                                     | 79,848,954  |   |      |   | 54,017,973  |  
|Execution and clearance fees                                      |  |                                     | 44,292,329  |   |      |   | 29,217,624  |  
|Payments for order flow                                           |  |                                     | 19,511,497  |   |      |   | 10,912,792  |  
|Soft dollar and commission recapture                              |  |                                     | 15,775,915  |   |      |   | 667,473     |  
|Communications and data processing                                |  |                                     | 7,777,425   |   |      |   | 8,734,307   |  
|Depreciation and amortization                                     |  |                                     | 5,791,378   |   |      |   | 8,115,637   |  
|Occupancy and equipment rentals                                   |  |                                     | 4,821,175   |   |      |   | 4,435,630   |  
|Professional fees                                                 |  |                                     | 3,590,875   |   |      |   | 3,792,164   |  
|Business development                                              |  |                                     | 2,142,799   |   |      |   | 1,949,906   |  
|Writedown of assets and lease loss accrual                        |  |                                     |            |   |      |   | 17,412,066  |  
|Other                                                             |  |                                     | 2,961,937   |   |      |   | 2,664,557   |  
|                                                                  |  |                                     |             |   |      |   |             |  
|Total expenses                                                    |  |                                     | 186,514,284 |   |      |   | 141,920,129 |  
|                                                                  |  |                                     |             |   |      |   |             |  
|Income (loss) before income taxes and discontinued operations     |  |                                     | 53,329,312  |   |      |   | (15,584,297 | )
|Income tax expense (benefit)                                      |  |                                     | 21,514,856  |   |      |   | (6,804,898  | )
|                                                                  |  |                                     |             |   |      |   |             |  
|Net income (loss) from continuing operations                      |  |                                     | 31,814,456  |   |      |   | (8,779,399  | )
|Loss from discontinued operations, net of tax                     |  |                                     |            |   |      |   | (1,055,934  | )
|                                                                  |  |                                     |             |   |      |   |             |  
|Net income (loss)                                                 |  | $                                   | 31,814,456  |   |      | $ | (9,835,333  | )
|                                                                  |  |                                     |             |   |      |   |             |  
|Basic earnings per share from continuing operations               |  | $                                   | 0.28        |   |      | $ | (0.08       | )
|                                                                  |  |                                     |             |   |      |   |             |  
|Diluted earnings per share from continuing operations             |  | $                                   | 0.26        |   |      | $ | (0.08       | )
|                                                                  |  |                                     |             |   |      |   |             |  
|Basic and diluted earnings per share from discontinued operations |  | $                                   |            |   |      | $ | (0.01       | )
|                                                                  |  |                                     |             |   |      |   |             |  
|Basic earnings per share                                          |  | $                                   | 0.28        |   |      | $ | (0.09       | )
|                                                                  |  |                                     |             |   |      |   |             |  
|Diluted earnings per share                                        |  | $                                   | 0.26        |   |      | $ | (0.09       | )
|                                                                  |  |                                     |             |   |      |   |             |  
|Shares used in computation of basic earnings per share            |  |                                     | 113,473,360 |   |      |   | 114,050,350 |  
|                                                                  |  |                                     |             |   |      |   |             |  
|Shares used in computation of diluted earnings per share          |  |                                     | 121,988,464 |   |      |   | 114,050,350 |  
|                                                                  |  |                                     |             |   |      |   |             |  



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



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##### Table of Contents

KNIGHT TRADING GROUP, INC.



CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(Unaudited)



|                                                                                                                                                                                                                                          |  |                |               |   |                   |   |               |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------- | ------------- | - | ----------------- | - | ------------- | -
|                                                                                                                                                                                                                                          |  | March 31, 2004 |               |   | December 31, 2003 |  
|ASSETS                                                                                                                                                                                                                                    |  |                |               |   |                   |   |               |  
|Cash and cash equivalents                                                                                                                                                                                                                 |  | $              | 228,735,532   |   |                   | $ | 262,200,309   |  
|Securities owned, held at clearing brokers, at market value                                                                                                                                                                               |  |                | 3,462,361,308 |   |                   |   | 3,025,120,511 |  
|Receivable from brokers and dealers                                                                                                                                                                                                       |  |                | 312,054,120   |   |                   |   | 269,815,897   |  
|Investment in Deephaven sponsored funds                                                                                                                                                                                                   |  |                | 227,435,643   |   |                   |   | 197,605,068   |  
|Fixed assets and leasehold improvements at cost, less accumulated depreciation and amortization                                                                                                                                           |  |                | 36,060,918    |   |                   |   | 37,557,829    |  
|Strategic investments                                                                                                                                                                                                                     |  |                | 25,098,984    |   |                   |   | 20,516,876    |  
|Goodwill                                                                                                                                                                                                                                  |  |                | 23,438,150    |   |                   |   | 21,109,518    |  
|Intangible assets, less accumulated amortization                                                                                                                                                                                          |  |                | 13,478,980    |   |                   |   | 14,696,175    |  
|Other assets                                                                                                                                                                                                                              |  |                | 112,351,947   |   |                   |   | 109,196,325   |  
|                                                                                                                                                                                                                                          |  |                |               |   |                   |   |               |  
|Total assets                                                                                                                                                                                                                              |  | $              | 4,441,015,582 |   |                   | $ | 3,957,818,508 |  
|                                                                                                                                                                                                                                          |  |                |               |   |                   |   |               |  
|LIABILITIES & STOCKHOLDERS EQUITY                                                                                                                                                                                                        |  |                |               |   |                   |   |               |  
|                                                                                                                                                                                                                                          |  |               
|Liabilities                                                                                                                                                                                                                               |  |                |               |   |                   |   |               |  
|Securities sold, not yet purchased, at market value                                                                                                                                                                                       |  | $              | 2,803,583,358 |   |                   | $ | 2,658,090,718 |  
|Payable to brokers and dealers                                                                                                                                                                                                            |  |                | 657,382,833   |   |                   |   | 313,744,175   |  
|Accrued compensation expense                                                                                                                                                                                                              |  |                | 68,149,185    |   |                   |   | 116,668,586   |  
|Accounts payable, accrued expenses and other liabilities                                                                                                                                                                                  |  |                | 86,968,555    |   |                   |   | 79,183,251    |  
|                                                                                                                                                                                                                                          |  |                |               |   |                   |   |               |  
|Total liabilities                                                                                                                                                                                                                         |  |                | 3,616,083,931 |   |                   |   | 3,167,686,730 |  
|                                                                                                                                                                                                                                          |  |                |               |   |                   |   |               |  
|Stockholders equity                                                                                                                                                                                                                      |  |                |               |   |                   |   |               |  
|Class A Common Stock, $.01 par value, 500,000,000 shares authorized; 129,832,882 shares issued and 116,243,965 shares outstanding at March 31,
2004 and 128,187,060 shares issued and 115,110,555 shares outstanding at December 31, 2003 |  |                | 1,298,329     |   |                   |   | 1,281,871     |  
|Additional paid-in-capital                                                                                                                                                                                                                |  |                | 391,274,385   |   |                   |   | 370,897,405   |  
|Retained earnings                                                                                                                                                                                                                         |  |                | 530,871,211   |   |                   |   | 499,056,756   |  
|Treasury stock, at cost; 13,588,917 shares at March 31, 2004 and 13,076,505 at December 31, 2003                                                                                                                                          |  |                | (75,027,891   | ) |                   |   | (68,795,258   | )
|Unamortized stock-based compensation                                                                                                                                                                                                      |  |                | (23,484,383   | ) |                   |   | (12,308,996   | )
|                                                                                                                                                                                                                                          |  |                |               |   |                   |   |               |  
|Total stockholders equity                                                                                                                                                                                                                |  |                | 824,931,651   |   |                   |   | 790,131,778   |  
|                                                                                                                                                                                                                                          |  |                |               |   |                   |   |               |  
|Total liabilities and stockholders equity                                                                                                                                                                                                |  | $              | 4,441,015,582 |   |                   | $ | 3,957,818,508 |  
|                                                                                                                                                                                                                                          |  |                |               |   |                   |   |               |  



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



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##### Table of Contents

KNIGHT TRADING GROUP, INC.



CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)



|                                                                                                  |  |                                     |              |   |      |   |              |  
|------------------------------------------------------------------------------------------------- |  | ----------------------------------- | ------------ | - | ---- | - | ------------ | -
|                                                                                                  |  | For the three monthsended March 31, |             
|                                                                                                  |  | 2004                                |              |   | 2003 |  
|Cash flows from operating activities                                                              |  |                                     |              |   |      |   |              |  
|Net income (loss)                                                                                 |  | $                                   | 31,814,456   |   |      | $ | (9,835,333   | )
|Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities |  |                                     |              |   |      |   |              |  
|Writedown of assets and lease loss accrual                                                        |  |                                     |             |   |      |   | 17,412,066   |  
|Depreciation and amortization                                                                     |  |                                     | 5,791,378    |   |      |   | 8,501,826    |  
|Stock-based compensation                                                                          |  |                                     | 2,227,785    |   |      |   | 668,255      |  
|Income tax benefit on stock awards exercised                                                      |  |                                     | 2,153,142    |   |      |   |             |  
|Minority interest in losses of discontinued operations                                            |  |                                     |             |   |      |   | (651,205     | )
|(Increase) decrease in operating assets                                                           |  |                                     |              |   |      |   |              |  
|Securities owned                                                                                  |  |                                     | (437,240,797 | ) |      |   | (326,746,325 | )
|Receivable from brokers and dealers                                                               |  |                                     | (42,238,223  | ) |      |   | (29,920,220  | )
|Other assets                                                                                      |  |                                     | (3,155,622   | ) |      |   | 6,240,457    |  
|Increase (decrease) in operating liabilities                                                      |  |                                     |              |   |      |   |              |  
|Securities sold, not yet purchased                                                                |  |                                     | 145,492,640  |   |      |   | 355,147,236  |  
|Payable to brokers and dealers                                                                    |  |                                     | 343,638,658  |   |      |   | (7,468,446   | )
|Accrued compensation expense                                                                      |  |                                     | (48,519,401  | ) |      |   | (33,521,346  | )
|Accounts payable, accrued expenses and other liabilities                                          |  |                                     | 7,962,091    |   |      |   | (223,547     | )
|                                                                                                  |  |                                     |              |   |      |   |              |  
|Net cash provided by (used in) operating activities                                               |  |                                     | 7,926,107    |   |      |   | (20,396,582  | )
|                                                                                                  |  |                                     |              |   |      |   |              |  
|Cash flows from investing activities                                                              |  |                                     |              |   |      |   |              |  
|Investment in Deephaven sponsored funds                                                           |  |                                     | (29,830,575  | ) |      |   | (31,055,158  | )
|Purchases of fixed assets and leasehold improvements                                              |  |                                     | (3,778,603   | ) |      |   | (2,178,933   | )
|Purchases, net of proceeds, from strategic investments                                            |  |                                     | (4,582,109   | ) |      |   | (1,289,551   | )
|Sale of options trading posts                                                                     |  |                                     | 501,000      |   |      |   |             |  
|                                                                                                  |  |                                     |              |   |      |   |              |  
|Net cash used in investing activities                                                             |  |                                     | (37,690,287  | ) |      |   | (34,523,642  | )
|                                                                                                  |  |                                     |              |   |      |   |              |  
|Cash flows from financing activities                                                              |  |                                     |              |   |      |   |              |  
|Stock options exercised                                                                           |  |                                     | 4,837,123    |   |      |   |             |  
|Cost of common stock repurchased                                                                  |  |                                     | (6,209,088   | ) |      |   | (28,057,119  | )
|Purchase of shares from minority investors in Knight Roundtable Europe Limited                    |  |                                     | (2,328,632   | ) |      |   |             |  
|                                                                                                  |  |                                     |              |   |      |   |              |  
|Net cash used in financing activities                                                             |  |                                     | (3,700,597   | ) |      |   | (28,057,119  | )
|                                                                                                  |  |                                     |              |   |      |   |              |  
|Decrease in cash and cash equivalents                                                             |  |                                     | (33,464,777  | ) |      |   | (82,977,343  | )
|Cash and cash equivalents at beginning of period                                                  |  |                                     | 262,200,309  |   |      |   | 313,515,646  |  
|                                                                                                  |  |                                     |              |   |      |   |              |  
|Cash and cash equivalents at end of period                                                        |  | $                                   | 228,735,532  |   |      | $ | 230,538,303  |  
|                                                                                                  |  |                                     |              |   |      |   |              |  
|Supplemental disclosure of cash flow information:                                                 |  |                                     |              |   |      |   |              |  
|Cash paid for interest                                                                            |  | $                                   | 83,845       |   |      | $ | 2,987        |  
|                                                                                                  |  |                                     |              |   |      |   |              |  
|Cash paid for income taxes                                                                        |  | $                                   | 12,023,081   |   |      | $ | 154,081      |  
|                                                                                                  |  |                                     |              |   |      |   |              |  



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



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##### Table of Contents

KNIGHT TRADING GROUP, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



MARCH 31, 2004

(Unaudited)



1. Organization and Description of the Business



Knight Trading Group, Inc. and its subsidiaries (the Company) operate in Equity Markets, Derivative Markets and Asset Management segments. The
Companys business segments are comprised of the following operating subsidiaries:



Equity Markets



| |  |  | Knight Equity Markets, L.P. (KEM) operates as a market maker in over-the-counter equity securities (OTC securities), primarily those traded in the Nasdaq
stock market and on the OTC Bulletin Board (OTCBB). Additionally, in December 2003, KEM acquired the business of Donaldson & Co., Incorporated (Donaldson), a firm that offers soft dollar and commission recapture services.
KEM is a broker-dealer registered with the Securities and Exchange Commission (SEC) and is a member of the National Association of Securities Dealers (NASD), the National Stock Exchange and the Pacific Stock Exchange.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Knight Capital Markets LLC (KCM) operates as a market maker in the Nasdaq Intermarket, the over-the-counter market for New York Stock Exchange (NYSE) and American Stock Exchange (AMEX) listed
securities. KCM is a broker-dealer registered with the SEC and is a member of the NASD.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Knight Roundtable Europe Limited (KREL) owns Knight Securities International, Ltd. (KSIL), a U.K. registered broker-dealer that provides execution services
for European clients in European and U.S. equities. At March 31, 2004, the Company owned an approximate 99% interest in KREL. In the first quarter of 2004, the Company acquired substantially all of the ownership interests of the minority owners of
KREL. The Company intends to acquire the remaining interests in 2004. KSIL is regulated by the Financial Services Authority in the U.K. and is a member of the London Stock Exchange.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Knight Securities Japan Ltd. (KSJ) operated as a market maker in Japanese equity securities until it ceased its trading operations and was subsequently liquidated in
2003. The Company owned 60% of KSJ through a joint venture with Nikko Cordial Group. See Footnote 9 Discontinued Operations for a further discussion of KSJ.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Derivative Markets



| |  |  | Knight Financial Products LLC (KFP) operates as a market maker and specialist in options on individual equities, equity indices and fixed income and commodity futures
instruments in the U.S. KFP, through its affiliate Knight Execution Partners LLC (KEP), also manages a professional option and equity execution services business. KFP and KEP are broker-dealers registered with the SEC and are members of
the Chicago Board Options Exchange, American Stock Exchange, Philadelphia Stock Exchange, Pacific Stock Exchange and the International Securities Exchange (ISE) and operate on the Boston Options Exchange. KFP is also a member of the
Chicago Board of Trade, the Chicago Mercantile Exchange, the New York Mercantile Exchange and the Philadelphia Board of Trade. KEP is also a member of the NASD.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Asset Management



| |  |  | Deephaven Capital Management LLC (Deephaven) is the investment manager and sponsor of the Deephaven investment funds (the Deephaven Funds). Also included in
this segment is the Companys corporate investment in the Deephaven Funds.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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2. Significant Accounting Policies



Basis of consolidation and form of presentation



The accompanying unaudited consolidated financial statements include the accounts of the Company and its majority and
wholly-owned subsidiaries and, in the opinion of management, reflect all adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of the results for the interim period. All significant intercompany transactions
and balances have been eliminated. Certain footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to SEC rules and regulations,
although the Company believes that the disclosures are adequate to make the information presented not misleading. The nature of the Companys business is such that the results of an interim period are not necessarily indicative of the results
for the full year. These unaudited consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Companys Annual Report on Form 10-K for the year ended December 31, 2003 as
filed with the SEC.



Certain prior period amounts have been
reclassified to conform to the current period presentation.



Cash and cash equivalents



Cash and cash
equivalents include money market accounts, which are payable on demand, or short-term investments with an original maturity of less than 30 days. The carrying amount of such cash equivalents approximates their fair value due to the short-term nature
of these instruments.



Market making and sales activities



Securities owned and securities sold, not yet purchased,
which primarily consist of listed and OTC equities and listed options contracts, are carried at market value and are recorded on a trade date basis. Net trading revenue (trading gains, net of trading losses) and commissions (which includes
commission equivalents earned on riskless principal transactions) and related expenses are also recorded on a trade date basis. In the first quarter of 2004, the Company changed the classification of commission equivalents on riskless principal
transactions from inclusion in Net trading revenues to inclusion in Commissions and fees as commission equivalents are similar in nature to commissions on agency transactions. Commission equivalents for the three months ended March 31, 2004 and 2003
were $39.4 million and $20.9 million, respectively.



Payments
for order flow represent payments to broker-dealer clients for directing their order executions to the Company. Soft dollar and commission recapture expense represents payments to institutions in connection with soft dollar and commission recapture
programs. The Companys clearing agreements call for payment or receipt of interest income, net of interest expense for facilitating the settlement and financing of securities transactions.



Asset management fees



The Company earns asset management fees for sponsoring and managing the
Deephaven Funds. Such fees are recorded monthly as earned and are calculated as a percentage of the Deephaven Funds monthly net assets, plus a percentage of a new high net asset value (the Incentive Allocation Fee), as defined, for
any six month period ended June 30th or December 31st. A new high net asset value is generally defined as the amount by which the net asset value of the Deephaven Funds exceeds the greater of either the highest previous net asset value in the
Deephaven Funds, or the net asset value at the time each investor made a purchase. If any of the Deephaven Funds recognize a loss in the second half of a calendar year, the Incentive Allocation Fee for such fund is recalculated on an annual rather
than a semi-annual basis.



Estimated fair value of financial
instruments



The Companys securities owned and
securities sold, not yet purchased are carried at market value, which is estimated using market quotations available from major securities exchanges, clearing brokers and dealers. Management estimates that the fair values of other financial
instruments recognized on the Consolidated Statements of Financial Condition (including receivables, payables and accrued expenses) approximate their carrying values, as such financial instruments are short-term in nature, bear interest at current
market rates or are subject to frequent repricing.



Accounting for derivatives



The Companys
derivative financial instruments, primarily comprised of listed options and futures, are all held for trading purposes and are carried at market value.



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##### Table of Contents

Goodwill and intangible assets



The Company applies the provisions of Statement of Financial Accounting Standards (SFAS) No. 142 Goodwill and
Other Intangible Assets,which requires that goodwill and intangible assets with an indefinite useful life no longer be amortized, but instead, be tested for impairment annually or when an event occurs or circumstances change that signify the
existence of impairment. Other intangible assets are amortized over their useful lives.



Strategic investments



Strategic investments include equity ownership interests of less than 20% in financial services-related businesses and are accounted for under the equity method or at fair value. The equity method of accounting is used for investments in
limited partnerships and limited liability corporations. The fair value of investments for which a quoted market or dealer price is not available for the size of our investment, is based on managements estimate. Among the factors considered by
management in determining the fair value of investments are the cost of the investment, terms and liquidity, developments since the acquisition of the investment, the sales price of recently issued securities, the financial condition and operating
results of the issuer, earnings trends and consistency of operating cash flows, the long-term business potential of the issuer, the quoted market price of securities with similar quality and yield that are publicly traded, and other factors
generally pertinent to the valuation of investments. The fair value of these investments is subject to a high degree of volatility and may be susceptible to significant fluctuations in the near term. The valuations of strategic investments are
reviewed by management on an ongoing basis.



Treasury stock



The Company records its purchases of treasury stock at
cost as a separate component of Stockholders equity. The Company obtains treasury stock through purchases in the open market or through privately negotiated transactions.



Foreign currencies



The functional currency of the Companys consolidated foreign subsidiaries is the U.S. dollar. Assets and liabilities in foreign currencies are
translated into U.S. dollars using current exchange rates at the date of the Consolidated Statements of Financial Condition. Revenues and expenses are translated at average rates during the periods. Prior to its liquidation, KSJs functional
currency was the Japanese yen. The foreign exchange gains and losses resulting from the translation of the financial statements of KSJ were included within a separate component of Stockholders equity until KSJs liquidation. As discussed
in Footnote 9 Discontinued Operations, in the second quarter of 2003, KSJ ceased its operations, and its results, including the effects of translation, are included in Loss from discontinued operations on the Consolidated Statements of
Operations.



Depreciation, amortization and occupancy



Fixed assets are being depreciated on a straight-line
basis over their estimated useful lives of three to seven years. Leasehold improvements are being amortized on a straight-line basis over the shorter of the life of the related office lease or the expected useful life of the assets. The Company
records rent expense on a straight-line basis over the lives of the leases. The Company capitalizes certain costs associated with the acquisition or development of internal-use software and amortizes the software over its estimated useful life of
three years, commencing at the time the software is placed in service.



Writedown of fixed assets



Writedowns of fixed
assets are recognized when it is determined that the fixed assets are no longer actively used and are determined to be impaired. The amount of the impairment writedown is determined by the difference between the carrying amount and the fair value of
the fixed asset. In determining the impairment, an estimated fair value is obtained through research and inquiry of the market. Fixed assets are reviewed for impairment on a quarterly basis.



Lease loss accrual



It is the Companys policy to identify excess real estate capacity and
where applicable, accrue for such future costs. In determining the accrual, a nominal cash flow analysis is performed for lease losses initiated prior to December 31, 2002, the effective date of SFAS No. 146 Accounting for Costs Associated with
Exit or Disposal Activities (which requires the accrual of future costs to be made using a discounted cash flow analysis for lease losses initiated after such date), and costs related to the excess capacity are accrued.



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##### Table of Contents

Income taxes



The Company records deferred tax assets and liabilities for the expected future tax consequences of temporary differences
between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when such differences are expected to reverse. Deferred tax assets and liabilities are included in
Other assets and Accounts payable, accrued expenses and other liabilities, respectively.



Stock-Based compensation



The Company applies Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) and related interpretations in accounting for its stock option plans. As options are granted at the then
market value, no compensation expense has been recognized for the fair values of the options granted to employees.



Had compensation expense for the Companys options been determined based on the fair value at the grant dates in accordance with SFAS No. 123,
Accounting for Stock-Based Compensation, the Companys net income (loss) and earnings per share amounts for the three months ended March 31, 2004 and 2003 would have been as follows:



|                                                                                    |  |                                     |            |   |      |   |             |  
|----------------------------------------------------------------------------------- |  | ----------------------------------- | ---------- | - | ---- | - | ----------- | -
|                                                                                    |  | For the three months endedMarch 31, |           
|                                                                                    |  | 2004                                |            |   | 2003 |  
|Net income (loss), as reported                                                      |  | $                                   | 31,814,456 |   |      | $ | (9,835,333  | )
|                                                                                    |  |                                    
|Pro forma compensation expense determined under fair value based method, net of tax |  |                                     | (2,032,847 | ) |      |   | (1,980,068  | )
|                                                                                    |  |                                    
|Pro forma net income (loss)                                                         |  |                                     | 29,781,609 |   |      |   | (11,815,401 | )
|                                                                                    |  |                                    
|Basic earnings per share, as reported                                               |  |                                     | 0.28       |   |      |   | (0.09       | )
|                                                                                    |  |                                    
|Diluted earnings per share, as reported                                             |  |                                     | 0.26       |   |      |   | (0.09       | )
|                                                                                    |  |                                    
|Pro forma basic earnings per share                                                  |  |                                     | 0.26       |   |      |   | (0.10       | )
|                                                                                    |  |                                    
|Pro forma diluted earnings per share                                                |  |                                     | 0.24       |   |      |   | (0.10       | )



The Company records
the fair market value of restricted stock awards on the date of grant as unamortized stock-based compensation in Stockholders equity and amortizes the balance to compensation expense ratably over the vesting period.



Other



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



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3. Securities Owned and Securities Sold, Not Yet Purchased



Securities owned and securities sold, not yet purchased are carried at
market value and consist of the following:



|                                    |  |                |               |                  |   |              
|----------------------------------- |  | -------------- | ------------- | ---------------- | - | -------------
|                                    |  | March 31, 2004 |               | December 31,2003
|Securities owned:                   |  |                |               |                  |   |              
|Equities                            |  | $              | 2,264,969,472 |                  | $ | 1,934,637,018
|Options                             |  |                | 1,185,482,756 |                  |   | 1,078,600,859
|U.S. government obligations         |  |                | 11,909,080    |                  |   | 11,882,634   
|                                    |  |                |               |                  |   |              
|                                    |  | $              | 3,462,361,308 |                  | $ | 3,025,120,511
|                                    |  |                |               |                  |   |              
|Securities sold, not yet purchased: |  |                |               |                  |   |              
|Equities                            |  | $              | 1,206,208,983 |                  | $ | 1,144,381,039
|Options                             |  |                | 1,597,374,375 |                  |   | 1,513,709,679
|                                    |  |                |               |                  |   |              
|                                    |  | $              | 2,803,583,358 |                  | $ | 2,658,090,718
|                                    |  |                |               |                  |   |              



4. Receivable from and Payable to
Brokers and Dealers



Amounts receivable from and payable
to brokers and dealers consist of the following:



|                             |  |                |             |                  |   |            
|---------------------------- |  | -------------- | ----------- | ---------------- | - | -----------
|                             |  | March 31, 2004 |             | December 31,2003
|Receivable:                  |  |                |             |                  |   |            
|Clearing brokers             |  | $              | 275,076,303 |                  | $ | 241,752,880
|Securities failed to deliver |  |                | 25,218,178  |                  |   | 19,533,934 
|Other                        |  |                | 11,759,639  |                  |   | 8,529,083  
|                             |  |                |             |                  |   |            
|                             |  | $              | 312,054,120 |                  | $ | 269,815,897
|                             |  |                |             |                  |   |            
|Payable:                     |  |                |             |                  |   |            
|Clearing brokers             |  | $              | 641,811,790 |                  | $ | 301,962,160
|Securities failed to receive |  |                | 15,228,167  |                  |   | 11,641,366 
|Other                        |  |                | 342,876     |                  |   | 140,649    
|                             |  |                |             |                  |   |            
|                             |  | $              | 657,382,833 |                  | $ | 313,744,175
|                             |  |                |             |                  |   |            



5. Goodwill and Intangible Assets



The Company adopted the provisions of SFAS No. 142
Goodwill and Other Intangible Assetsas of January 1, 2002. This statement established new standards for accounting for goodwill and intangible assets acquired outside of, and subsequent to, a business combination. Under the new standards,
goodwill and intangible assets with indefinite useful lives are no longer being amortized, but are tested for impairment annually or when an event occurs or circumstances change that signify the existence of impairment. As part of our annual test
for impairment, we consider the profitability of the respective segment or reporting unit, an assessment of the fair value of the respective segment or reporting unit as well as the overall market value of the Company compared to its net book value.



In June 2003, the Company tested for the impairment of
goodwill and concluded that there was no impairment. The goodwill balance of $23.4 million at March 31, 2004, consists of $19.0 million related to the Equity Markets segment and $4.4 million related to the Derivative Markets segment. Goodwill is net
of accumulated amortization of $22.5 million recorded through December 31, 2001, the effective date the Company adopted SFAS No. 142. In the first quarter of 2004, the Company acquired substantially all of the ownership interests of the minority
owners of KREL for $2.3 million, which was recorded as goodwill and is attributable to the Equity Markets business segment.



At March 31, 2004, the Company had intangible assets, net of accumulated amortization, of $13.5 million. Intangible assets, net of accumulated
amortization, of $11.9 million resulted from the purchase of the business of Donaldson. These assets primarily represent client relationships and are included within the Equity Markets business segment. The carrying value of these intangible assets
is being amortized over the remaining useful lives, which have been determined to range from five to thirty years.



Intangible assets, net of accumulated amortization, of $1.6 million, which primarily resulted from the purchase of various options related specialists
posts, are included within the Derivative Markets business segment. These intangible assets are being amortized over the remaining useful lives, the majority of which are less than one year, with the remainder having lives of up to fourteen years.





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In the first quarter of 2004, the Company recorded amortization expense relating to all of its intangible
assets of $716,000. The estimated amortization expense relating to the intangible assets for each of the next five years approximates $1.2 million for the remainder of 2004 and $670,000 per year in the subsequent four years.



The chart below summarizes the activity of the Companys Goodwill and
Intangible assets, net of accumulated amortization for the three months ended March 31, 2003 and 2004 (in millions), respectively:



|                                                   |  |                |      |                   |   |       |  |               |      |  |                   |      |   |       |   |      |   |  |   |      |  
|-------------------------------------------------- |  | -------------- | ---- | ----------------- | - | ----- |  | ------------- | ---- |  | ----------------- | ---- | - | ----- | - | ---- | - |  | - | ---- | -
|                                                   |  | Goodwill       |      | Intangible Assets |  
|                                                   |  | Equity Markets |      | DerivativeMarkets |   | Total |  | EquityMarkets |      |  | DerivativeMarkets |      |   | Total |  
|Balance at January 1, 2003                         |  | $              | 13.1 |                   | $ | 4.4   |  | $             | 17.5 |  | $                 |     |   |       | $ | 34.9 |   |  | $ | 34.9 |  
|Amortization Expense                               |  |                |     |                   |   |      |  |               |     |  |                   |     |   |       |   | (0.7 | ) |  |   | (0.7 | )
|                                                   |  |                |      |                   |   |       |  |               |      |  |                   |      |   |       |   |      |   |  |   |      |  
|Balance at March 31, 2003                          |  | $              | 13.1 |                   | $ | 4.4   |  | $             | 17.5 |  | $                 |     |   |       | $ | 34.2 |   |  | $ | 34.2 |  
|                                                   |  |                |      |                   |   |       |  |               |      |  |                   |      |   |       |   |      |   |  |   |      |  
|Balance at January 1, 2004                         |  | $              | 16.7 |                   | $ | 4.4   |  | $             | 21.1 |  | $                 | 12.0 |   |       | $ | 2.7  |   |  | $ | 14.7 |  
|Purchase of shares from minority investors in KREL |  |                | 2.3  |                   |   |      |  |               | 2.3  |  |                   |     |   |       |   |     |   |  |   |     |  
|Sale of options trading posts                      |  |                |     |                   |   |      |  |               |     |  |                   |     |   |       |   | (0.5 | ) |  |   | (0.5 | )
|Amortization Expense                               |  |                |     |                   |   |      |  |               |     |  |                   | (0.1 | ) |       |   | (0.6 | ) |  |   | (0.7 | )
|                                                   |  |                |      |                   |   |       |  |               |      |  |                   |      |   |       |   |      |   |  |   |      |  
|Balance at March 31, 2004                          |  | $              | 19.0 |                   | $ | 4.4   |  | $             | 23.4 |  | $                 | 11.9 |   |       | $ | 1.6  |   |  | $ | 13.5 |  
|                                                   |  |                |      |                   |   |       |  |               |      |  |                   |      |   |       |   |      |   |  |   |      |  



6. Investment in Deephaven
Sponsored Funds and Strategic Investments



The
Companys wholly-owned subsidiary, Deephaven, is the investment manager and sponsor of the Deephaven Funds, which engage in various trading strategies involving equities, debt instruments and derivatives. The underlying investments in the
Deephaven Funds are carried at market value. Of the $2.2 billion of assets under management in the Deephaven Funds as of March 31, 2004, the Company had a corporate investment of $227.4 million. Additionally, Other assets on the Consolidated
Statements of Financial Condition at March 31, 2004 and December 31, 2003 included $19.9 million and $3.5 million, respectively, of investments in the Deephaven Funds related to employee deferred compensation plans. In addition to the $19.9 million
held by the Company related to employee deferred compensation plans, certain officers, directors and employees of the Company had direct investments of approximately $15.4 million in the Deephaven Funds, in the aggregate, as of March 31, 2004.



Strategic investments, which primarily include the
Companys investment in Nasdaq and the ISE, are reviewed on an ongoing basis to ensure that the fair value of the investment has not been impaired. In accordance with this policy, the Company wrote down its investment in Nasdaq, to fair value,
resulting in an impairment charge of $6.8 million in the first quarter of 2003.



7. Significant Clients



The Company considers
significant clients to be clients who account for 10% or more of the total U.S. equity dollar value traded or the total U.S. options contracts traded by the Company during the period. One customer accounted for approximately 12.3% of the
Companys U.S. equity dollar value traded during the three months ended March 31, 2004. Payments for order flow to this firm for U.S. equity and U.S. options contract order flow amounted to $7.4 million during the three months ended March 31,
2004.



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Additionally, the Companys corporate investment in the Deephaven Funds of $227.4 million accounted
for 10.3% of total assets under management as of March 31, 2004. In addition to the Company, one institutional investor accounted for more than 10% of the Deephaven Funds assets under management, with 15.4% as of March 31, 2004.



8. Writedown of Assets and Lease Loss Accrual



No additional Writedown of assets and lease loss accruals were recorded
during the three months ended March 31, 2004.



The Writedown of
assets and lease loss accrual for the three months ended March 31, 2003 was $17.4 million. The writedown primarily consists of $10.3 million related to costs associated with excess real estate capacity, primarily in Jersey City, NJ, $6.8 million
related to the writedown of our investment in Nasdaq to fair value and $260,000 related to the writedown of fixed assets that are no longer actively used.



9. Discontinued Operations



There were no charges from discontinued operations incurred during the first quarter of 2004. The loss from discontinued operations for the three months
ended March 31, 2003 represents the results of operations of KSJ. On March 31, 2003 the Company and its joint venture partner, Nikko Cordial Group, announced that KSJ would cease its operations. KSJs business plan was significantly impaired
due to changes in market structure, the withdrawal of Nasdaq Japan, poor market conditions and limited market-making opportunities in Japan. As a result, trading operations ceased at KSJ on May 2, 2003. After the cessation of trading, the parties
liquidated KSJ, and all charges related to this liquidation were incurred during the second quarter of 2003. The loss, included in Loss from discontinued operations, net of tax, on the Consolidated Statements of Operations was $1.1 million for the
three months ended March 31, 2003. Included in these results were revenues and pre-tax losses as follows:



|                                                                   |  |                                                        |        |  
|------------------------------------------------------------------ |  | ------------------------------------------------------ | ------ | -
|                                                                   |  | For the three monthsended March 31, 2003(in thousands) |       
|Revenues                                                           |  | $                                                      | 644    |  
|Pre-tax loss from discontinued operations before minority interest |  |                                                        | (1,760 | )
|Minority interest in losses of KSJ                                 |  |                                                        | 704    |  
|                                                                   |  |                                                        |        |  
|Loss from discontinued operations, net of tax                      |  | $                                                      | (1,056 | )
|                                                                   |  |                                                        |        |  



10. Commitments and Contingent
Liabilities



The Company leases office space under
noncancelable operating leases. The office leases contain certain escalation clauses whereby the rental commitments may be increased if certain conditions are satisfied and specify yearly adjustments to the lease amounts based on annual adjustments
to the Consumer Price Index. Rental expense under the office leases was $2.8 million for each of the three month periods ended March 31, 2004 and 2003, respectively.



The Company leases certain computer and other equipment under noncancelable operating leases. In addition, the Company has
entered into guaranteed employment contracts with certain of its employees. As of March 31, 2004, future minimum rental commitments under all noncancelable office, computer and equipment leases (Operating Leases), and obligations on
clearing contracts and guaranteed employment contracts longer than one year (Other Obligations) were as follows:



|                                     |  |                  |       |                   |   |       |  |   |      
|------------------------------------ |  | ---------------- | ----- | ----------------- | - | ----- |  | - | -----
|                                     |  | Operating Leases |       | Other Obligations |   | Total
|Nine months ending December 31, 2004 |  | $                | 12.7  |                   | $ | 24.1  |  | $ | 36.8 
|Year ending December 31, 2005        |  |                  | 14.3  |                   |   | 20.4  |  |   | 34.7 
|Year ending December 31, 2006        |  |                  | 10.2  |                   |   | 14.0  |  |   | 24.2 
|Year ending December 31, 2007        |  |                  | 9.3   |                   |   | 0.8   |  |   | 10.1 
|Year ending December 31, 2008        |  |                  | 8.8   |                   |   |      |  |   | 8.8  
|Thereafter through October 31, 2021  |  |                  | 114.5 |                   |   |      |  |   | 114.5
|                                     |  |                  |       |                   |   |       |  |   |      
|                                     |  | $                | 169.8 |                   | $ | 59.3  |  | $ | 229.1
|                                     |  |                  |       |                   |   |       |  |   |      



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During the normal course of business, the Company collateralizes certain leases, employment agreements or
other contractual obligations through letters of credit or segregated funds held in escrow accounts. As of March 31, 2004, the Company has provided a $9.0 million letter of credit, collateralized by U.S. Treasury Bills, as a guarantee for one of the
Companys lease obligations.



The Company has agreements
with the ISE to purchase Class A and Class B membership interests of ISE with a total purchase price of approximately $28.5 million. The ISE demutualized on May 31, 2002 and as a result, the Company received shares of the ISE representing both
equity interest and trading rights. In accordance with the purchase agreement, the Company made an initial payment at the time of the closing with further periodic payments to be made in the future based on a fixed dollar amount per contract traded.
The Company capitalizes the membership interests at a fixed dollar amount per contract traded. As of March 31, 2004, the Company had capitalized $7.7 million of Equity Interest (Class A) and $16.3 million of Trading Rights (Class B). These amounts
are included in Strategic investments and Other assets, respectively, on the Consolidated Statements of Financial Condition. The Company is not obligated to make future payments; however, the Company would forfeit its equity interest and its trading
rights if it failed to meet its minimum payment obligations under the contract.



On October 22, 2003, the Company announced that it had entered into new long-term employment contracts with the senior management team of Deephaven (the Deephaven managers). These employment agreements,
which became effective on January 1, 2004, are for three-year terms and include an option for renewal by the Deephaven managers through 2009 under certain circumstances. In addition, the agreements provide that, in the event of a change of control
of the Company during the initial three- year term, the Deephaven managers would have the option to obtain a 51% interest in Deephaven in exchange for the termination of their employment contracts and associated profit-sharing bonuses. If a change
of control were to occur, and if the Deephaven managers exercised this option, the Company would retain a 49% interest in Deephaven.



In the ordinary course of business, the nature of the Companys business subjects it to claims, lawsuits, regulatory examinations and other
proceedings. The results of these matters cannot be predicted with certainty.



In March 2004, Knight Securities L.P. (KSLP, now known as KEM) and its former CEO, Kenneth D. Pasternak, received Wells Notices from the staff of the SECs Division of Enforcement and from NASDs
Department of Market Regulation. The Wells Notices from the SECs Division of Enforcement indicate that the Division is considering recommending that the SEC bring civil and administrative enforcement actions against KSLP and Mr. Pasternak for
possible violations of securities laws. These Wells Notices pertain to investigations into specific trade activity, conduct, supervision and record-keeping that occurred in 1999 through 2001. The Wells Notices from NASDs Department of Market
Regulation indicate that NASD intends to bring formal disciplinary proceedings against both parties relating to similar trade activity and conduct that occurred in 1999 and 2000. Three former KSLP employees have also received Wells Notices.



Although the Company filed its response to the Wells Notices
with the SEC and NASD in April 2004, it is premature to fully assess the potential impact of these Wells Notices to the Company, the outcome of the investigations or the timing of their resolution. There can be no assurance that these matters will
not have a material adverse effect on the Companys results of operations in any future period and a substantial judgment or other resolution could have a material adverse impact on the Companys financial condition and results of
operations. However, it is the opinion of management, based on information currently available, that it is not probable that the ultimate outcome of these matters will have a material adverse effect on the consolidated financial condition of the
Company, although they might be material to the operating results for any particular period, depending, in part, upon the operating results for that period.





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11. Comprehensive Income



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



|                                                    |  |                              |            |      |   |            |  
|--------------------------------------------------- |  | ---------------------------- | ---------- | ---- | - | ---------- | -
|                                                    |  | Three months ended March 31, |           
|                                                    |  | 2004                         |            | 2003 |  
|Net income (loss)                                   |  | $                            | 31,814,456 |      | $ | (9,835,333 | )
|Foreign currency translation adjustment, net of tax |  |                              |           |      |   | 79,124     |  
|                                                    |  |                              |            |      |   |            |  
|Total comprehensive income (loss), net of tax       |  | $                            | 31,814,456 |      | $ | (9,756,209 | )
|                                                    |  |                              |            |      |   |            |  



12. Earnings per Share



Basic earnings per common share (EPS) has
been calculated by dividing net income (loss) by the weighted average shares of Class A Common Stock outstanding during each respective period. Diluted EPS reflects the potential reduction in EPS using the treasury stock method to reflect the impact
of common stock equivalents if stock awards such as stock options and restricted stock were exercised or converted into Class A Common Stock.



The following is a reconciliation of the numerators and denominators of the basic and diluted earnings per share computations for the three month periods
ended March 31, 2004 and 2003:



|                                                          |  |                                      |            |                     |   |                     |  |   |                     |   |  |   |             |  
|--------------------------------------------------------- |  | ------------------------------------ | ---------- | ------------------- | - | ------------------- |  | - | ------------------- | - |  | - | ----------- | -
|                                                          |  | For the three months ended March 31, |           
|                                                          |  | 2004                                 |            | 2003                |  
|                                                          |  | Numerator /net income                |            | Denominator /shares |   | Numerator /net loss |  |   | Denominator /shares |  
|Net income (loss) and shares used in basic calculations   |  | $                                    | 31,814,456 |                     |   | 113,473,360         |  | $ | (9,835,333          | ) |  |   | 114,050,350 |  
|Effect of dilutive stock based awards                     |  |                                      |           |                     |   | 8,515,104           |  |   |                    |   |  |   |            |  
|                                                          |  |                                      |            |                     |   |                     |  |   |                     |   |  |   |             |  
|Net income (loss) and shares used in diluted calculations |  | $                                    | 31,814,456 |                     |   | 121,988,464         |  | $ | (9,835,333          | ) |  |   | 114,050,350 |  
|                                                          |  |                                      |            |                     |   |                     |  |   |                     |   |  |   |             |  
|Basic earnings per share                                  |  |                                      |            |                     | $ | 0.28                |  |   |                     |   |  | $ | (0.09       | )
|                                                          |  |                                      |            |                     |   |                     |  |   |                     |   |  |   |             |  
|Diluted earnings per share                                |  |                                      |            |                     | $ | 0.26                |  |   |                     |   |  | $ | (0.09       | )
|                                                          |  |                                      |            |                     |   |                     |  |   |                     |   |  |   |             |  



For the three months
ended March 31, 2003, 2,362,507 shares of common stock equivalents were not included in the calculation of weighted average shares for diluted EPS because the Company incurred losses during that period, and the effect of their inclusion would be
anti-dilutive.



13. Stock-Based Compensation



The Company established the Knight Trading Group, Inc. 1998 Long Term
Incentive Plan, the Knight Trading Group, Inc. 1998 Nonemployee Director Stock Option Plan and the Knight Trading Group, Inc. 2003 Equity Incentive Plan (collectively, the Plans). The purpose of the Plans is to provide long-term
incentive compensation to employees and directors of the Company. The Plans are administered by the Compensation Committee of the Companys Board of Directors, and allow for the grant of options, restricted stock and restricted stock units
(collectively, the awards), as defined by the Plans. In addition, the Plans limit the number of awards that may be granted overall and to an individual.



The Companys policy is to grant options for the purchase of shares of Class A Common Stock at not less than market
value, which the Plans define as the average of the high and low sales prices on the date prior to the grant date. Options and awards generally vest over a three or four-year period and expire on the fifth or tenth anniversary of the grant date,
pursuant to the terms of the agreements. Restricted stock awards generally vest over three years. The Company has the right to fully vest employees in their option grants and restricted stock awards upon retirement and in certain other
circumstances.



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##### Table of Contents

The Company granted 984,656 restricted shares under the Plans during the first quarter of 2004 as
stock-based compensation. At March 31, 2004 the Company had 2,989,198 restricted shares outstanding, in aggregate, both under and outside of the Plans.



The Company recognizes compensation expense for the fair values of the restricted shares of Class A Common Stock granted to employees over the vesting
period. For the three months ended March 31, 2004 and 2003, the Company recorded compensation expense of $2.2 million and $668,000, respectively, all of which has been included in Employee compensation and benefits in the Consolidated Statements of
Operations.



14. Business Segments



The Company has three reportable business segments: Equity Markets,
Derivative Markets, and Asset Management. Equity Markets primarily represents market-making in U.S. equities. Derivative Markets primarily represents market-making and specialist operations in U.S. options. The Asset Management segment consists of
investment management and sponsorship of the Deephaven Funds and the Companys corporate investment in the Deephaven Funds.



The Companys revenues, income (loss) before income taxes and discontinued operations and total assets by segment are summarized below (amounts in
millions). Other revenues and expenses that are not directly attributable to a particular segment are allocated to the segments based upon the Companys allocation methodologies, generally based on each segments respective resource usage
or other appropriate measures.



|                                                              |  |                 |       |   |                    |   |         |                  |  |               |       |  |                   |      |   |  |   |         |  
|------------------------------------------------------------- |  | --------------- | ----- | - | ------------------ | - | ------- | ---------------- |  | ------------- | ----- |  | ----------------- | ---- | - |  | - | ------- | -
|                                                              |  | Equity Markets1 |       |   | DerivativeMarkets2 |   |         | AssetManagement3 |  | Eliminations4 |       |  | ConsolidatedTotal |     
|For the three months ended March 31, 2004:                    |  |                 |       |   |                    |   |         |                  |  |               |       |  |                   |      |   |  |   |         |  
|Revenues                                                      |  | $               | 170.8 |   |                    | $ | 50.2    |                  |  | $             | 19.0  |  | $                 | (0.2 | ) |  | $ | 239.8   |  
|Income before income taxes and discontinued operations        |  |                 | 35.0  |   |                    |   | 8.3     |                  |  |               | 10.0  |  |                   |     |   |  |   | 53.3    |  
|Total assets                                                  |  |                 | 950.2 |   |                    |   | 3,219.4 |                  |  |               | 271.4 |  |                   |     |   |  |   | 4,441.0 |  
|                                                              |  |                 |       |   |                   
|For the three months ended March 31, 2003:                    |  |                 |       |   |                    |   |         |                  |  |               |       |  |                   |      |   |  |   |         |  
|Revenues                                                      |  | $               | 73.6  |   |                    | $ | 32.2    |                  |  | $             | 20.6  |  | $                 | (0.1 | ) |  | $ | 126.3   |  
|(Loss) income before income taxes and discontinued operations |  |                 | (27.6 | ) |                    |   | (1.8    | )                |  |               | 13.8  |  |                   |     |   |  |   | (15.6   | )
|Total assets                                                  |  |                 | 605.0 |   |                    |   | 2,646.3 |                  |  |               | 207.1 |  |                   |     |   |  |   | 3,458.4 |  

---

|1 |  | (Loss) income before income taxes and discontinued operations (Pre-tax income) for the three months ended March 31, 2003 includes $16.7 million in writedowns of assets
and lease loss accruals described in Footnote 8.
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|2 |  | Pre-tax income for the three months ended March 31, 2003 includes $700,000 in writedowns of assets and lease loss accruals described in Footnote 8.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------

|3 |  | The Company had corporate investments of $227.4 million and $179.7 million invested in the Deephaven Funds at March 31, 2004 and 2003, respectively. These investments are included
in the Asset Management segment. Revenues generated by these corporate investments for the three months ended March 31, 2004 and 2003 were $4.8 million and $6.1 million, respectively.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4 |  | Eliminations primarily represent management fees earned by certain of the Companys subsidiaries for management services provided to other subsidiaries.
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------



15



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##### Table of Contents

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



The following discussion of our results of operations should be read in conjunction with our consolidated financial statements and notes thereto included
in our Annual Report on Form 10-K for the year ended December 31, 2003 as filed with the Securities and Exchange Commission (SEC). This discussion contains forward-looking statements that involve risks and uncertainties, including those
discussed in our Form 10-K. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including, but not limited to, those set forth elsewhere in this document and in our Form
10-K.



Certain statements contained in this Quarterly Report on
Form 10-Q, including without limitation, those under Managements Discussion and Analysis of Financial Condition and Results of Operations herein (MD&A), Quantitative and Qualitative Disclosures About Market
Risk in Part I, Item 3, and Legal Proceedings in Part II, Item 1, and the documents incorporated by reference, may constitute forward-looking statements. These forward-looking statements are not historical facts, and are based on
current expectations, estimates and projections about the Companys industry, managements beliefs and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond our control. Accordingly,
readers are cautioned that any such forward-looking statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict. Since such statements involve risks and
uncertainties, the actual results and performance of the Company may turn out to be materially different from the results expressed or implied by such forward-looking statements. Given these uncertainties, readers are cautioned not to place undue
reliance on such forward-looking statements. Unless otherwise required by law, the Company also disclaims any obligation to update its view of any such risks or uncertainties or to announce publicly the result of any revisions to the forward looking
statements made in this report. Readers should carefully review the risks and uncertainties under Certain Factors Affecting Results of Operations within MD&A herein, and in other reports or documents the Company files from time to
time with the SEC. This discussion should be read in conjunction with the Companys consolidated financial statements and the notes thereto contained in this report.



Executive Overview



The Company has three reportable business segments: Equity Markets, Derivative Markets, and Asset Management.



| |  |  | Equity MarketsWe are a leading execution specialist providing comprehensive trade execution services to institutional and broker-dealer clients, offering capital
commitment and access to a deep pool of liquidity across the depth and breadth of the U.S. equity markets.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Derivative MarketsWe are a leading U.S. listed options market maker and specialist, providing comprehensive trade execution services to institutions and broker-dealers
across a significant number of U.S. option products.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Asset ManagementWe operate an asset management business for institutions and high-net-worth individuals, managing $2.2 billion of assets as of March 31, 2004. The
Deephaven Funds received additional net contributions on April 1, 2004, bringing total assets under management to $2.5 billion. The Companys investment in the Deephaven Funds, which was $227.4 million at March 31, 2004, and related investment
returns, are included within this segment.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

The following table sets forth the revenues, expenses excluding writedown of assets and lease loss
accrual (Operating Expenses) and income (loss) before writedown of assets and lease loss accrual, income taxes and discontinued operations (Pre-Tax Operating Earnings) of our segments and on a consolidated basis (in
millions):



|                           |  |                                    |       |      |   |       |  
|-------------------------- |  | ---------------------------------- | ----- | ---- | - | ----- | -
|                           |  | For thethree months endedMarch 31, |      
|                           |  | 2004                               |       | 2003 |  
|Equity Markets             |  |                                    |       |      |   |       |  
|Revenues                   |  | $                                  | 170.8 |      | $ | 73.6  |  
|Operating Expenses         |  |                                    | 135.8 |      |   | 84.5  |  
|                           |  |                                    |       |      |   |       |  
|Pre-Tax Operating Earnings |  |                                    | 35.0  |      |   | (10.9 | )
|                           |  |                                    |       |      |   |       |  
|Derivative Markets         |  |                                    |       |      |   |       |  
|Revenues                   |  |                                    | 50.2  |      |   | 32.2  |  
|Operating Expenses         |  |                                    | 41.9  |      |   | 33.3  |  
|                           |  |                                    |       |      |   |       |  
|Pre-Tax Operating Earnings |  |                                    | 8.3   |      |   | (1.1  | )
|                           |  |                                    |       |      |   |       |  
|Asset Management           |  |                                    |       |      |   |       |  
|Revenues                   |  |                                    | 19.0  |      |   | 20.6  |  
|Operating Expenses         |  |                                    | 9.0   |      |   | 6.8   |  
|                           |  |                                    |       |      |   |       |  
|Pre-Tax Operating Earnings |  |                                    | 10.0  |      |   | 13.8  |  
|                           |  |                                    |       |      |   |       |  
|Consolidated               |  |                                    |       |      |   |       |  
|Revenues*                  |  |                                    | 239.8 |      |   | 126.3 |  
|Operating Expenses*        |  |                                    | 186.5 |      |   | 124.5 |  
|                           |  |                                    |       |      |   |       |  
|Pre-Tax Operating Earnings |  | $                                  | 53.3  |      | $ | 1.8   |  
|                           |  |                                    |       |      |   |       |  

---

|* |  |  Consolidated Revenues and Operating Expenses for the three months ended March 31, 2004 and 2003 include the elimination of intercompany management fees of $222,000 and
$75,000, respectively.
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Diluted earnings per
share was $0.26 for the three months ended March 31, 2004, compared to a loss of $0.09 per share for the same period in 2003. Total revenues for the three months ended March 31, 2004 increased 90% from the comparable period in 2003, while Operating
Expenses increased 50%. Pre-Tax Operating Earnings increased to $53.3 million for the three months ended March 31, 2004, up from $1.8 million for the same period in 2003.



The improvement in our first quarter of 2004 financial results was primarily a result of the strong turnaround in our Equity
Markets business, driven by the improvement in market conditions, the growth of our institutional business and reductions in our cost base in the U.S. Derivative Markets results also improved due to higher contract volumes and reductions in our
cost base. Pre-tax Operating Earnings from our Asset Management business decreased slightly due to lower fund returns offset, in part, by the growth in our assets under management and the increase in our investment in the Deephaven Funds.



A reconciliation of GAAP income (loss) before income taxes and
discontinued operations (Pre-Tax GAAP Income) to Pre-Tax Operating Earnings is included elsewhere in this section.



Market and Economic Conditions in the First Quarter of 2004



In the U.S., equity indices were virtually unchanged during the first quarter of 2004. The Dow Jones Industrial Average and the Nasdaq Composite declined
0.9% and 0.5%, respectively, from December 31, 2003. The S&P 500, however, rose 1.3% during the first quarter of 2004.



Certain Factors Affecting Results of Operations



We have experienced, and expect to continue to experience, significant fluctuations in operating results due to a variety of factors, including, but not
limited to, introductions or enhancements to market-making services by us or our competitors; the value of our securities positions and our ability to manage the risks attendant thereto; the volume of our market-making activities; the dollar value
of securities traded; volatility in the securities markets; our market share with institutional clients; the performance of our international operations; our ability to manage personnel, overhead and other expenses, including our occupancy expenses
under our office leases and legal fees related to our legal proceedings; the strength of our client relationships; the amount of, and volatility



17



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##### Table of Contents

in, the results of our quantitative market-making and program trading portfolios; changes in payments for order flow and
clearing costs; the addition or loss of executive management and sales, trading and technology professionals; legislative, legal and regulatory changes; legal and regulatory matters, including ongoing regulatory investigations; geopolitical risk;
the amount and timing of capital expenditures and divestitures; the incurrence of costs associated with acquisitions and dispositions; investor sentiment; the level of assets under management; technological changes and events; seasonality;
competition and market and economic conditions. Such factors may also have an impact on our ability to achieve our strategic objectives, including, without limitation, increases in our market share and revenue capture in our Equity Markets and
Derivative Markets segments and increases in our fund returns and assets under management in our Asset Management segment. If demand for our services declines in any of our business segments due to any of the above factors, and we are unable to
adjust our cost structure on a timely basis, our operating results and strategic objectives could be materially and adversely affected.



As a result of the foregoing factors, period-to-period comparisons of our revenues and operating results are not necessarily meaningful and such
comparisons cannot be relied upon as indicators of future performance. There also can be no assurance that we will be able to maintain the current rate of revenue growth or return to the rates of revenue growth that we have experienced in the past
or that we will be able to improve our operating results.



Trends



We believe that our business is currently impacted by
the following trends that may affect our financial condition and results of operations.



| |  |  | Over the past three years, the effects of decimalization and other market structure changes, competition and market conditions have resulted in a decline in revenue capture per U.S.
equity dollar value traded in our Equity Markets operations and revenue capture per option contract in our Derivative Markets operations.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Retail broker-dealer participation in the equity and options markets increased in 2003 and in the first quarter of 2004 from the prior two years, particularly in low-priced OTC
Bulletin Board issues. This growth in retail transaction volumes may not be sustainable.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Decimalization, market structure changes, competition and market conditions have triggered an industry shift from market makers trading OTC securities solely as principal to
executing trades on a riskless principal or agency basis with institutions paying commission-equivalents or commissions, respectively. Currently, we execute the majority of our institutional client orders on a riskless principal or agency basis,
charging commission-equivalents or commissions, respectively, and we execute the majority of our broker-dealer client orders as principal. In addition, institutional commission rates have fallen in the past few years, and this may continue
throughout 2004.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Market makers have reduced their payment for order flow rates as average revenue capture per U.S. equity dollar value traded and average revenue capture per option contract have
fallen. As a result, we have changed our payment for order flow rates several times over the past three years. In addition, we also have expanded our program of charging execution fees to certain of our broker-dealer clients for certain order flow.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The introduction of SuperMontage by Nasdaq and the increase in trading of Nasdaq-listed securities on other exchanges has increased market fragmentation in the Equity Markets segment, resulting in increased execution
expenses, fragmented liquidity pools and different market centers using different sets of regulatory rules and regulations. The Derivative Markets segment is also experiencing changes in market structure.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Due to regulatory scrutiny over the past two years relating to equity sell-side research and the continued focus by investors on execution quality and overall transaction costs,
more institutional commissions are being allocated to broker-dealers based on the quality of executions. In the past, institutional equity commissions were primarily allocated to broker-dealers in exchange for either research or soft dollar and
commission recapture programs.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Executions in the Equity Markets and Derivatives Markets segments are becoming increasingly automated. Increased automation results in improved efficiency and lower transaction
costs.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | There has been increased scrutiny of hedge funds and soft dollar practices by the regulatory and legislative authorities. New legislation or modifications to existing regulations
and rules could occur in the future.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



18



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##### Table of Contents

| |  |  | There has been a growing trend among fund management companies and institutions to allocate more of their assets to hedge fund investments. This has influenced the growth in the
hedge fund industry and may result in greater competition in the future.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Income Statement Items



The following
section briefly describes the key components of, and drivers to, our significant revenues and expenses.



Revenues



Our revenues consist principally of Net trading revenue and Commissions and fees from U.S. securities trading and market-making activities from both
Equity and Derivative Markets. Net trading revenue, which consists of trading gains net of trading losses, is primarily affected by changes in the amount and mix of U.S. equity trade and share volumes and U.S. option contract volumes, our revenue
capture, dollar value of equities traded, our ability to derive trading gains by taking proprietary positions, changes in our execution standards, volatility in the marketplace, our mix of broker-dealer and institutional clients, and regulatory
changes and evolving industry customs and practices.



Securities transactions with clients are executed as principal, riskless principal or agent. Profits and losses on principal transactions are included within Net trading revenue, and commissions and commission equivalents earned on agency
transactions and riskless principal transactions, respectively, are included within Commissions and fees. We execute the majority of our institutional client orders on a riskless principal or agency basis, generating commission equivalents or
commissions, respectively. In the first quarter of 2004, we changed the classification of commission equivalents on riskless principal transactions from inclusion in Net trading revenues to inclusion in Commissions and fees as commission equivalents
are similar in nature to commissions on agency transactions. Commission equivalents for the three months ended March 31, 2004 and 2003 were $39.4 million and $20.9 million, respectively. This classification is also in line with industry trends. As a
result, prior period amounts have been reclassified to conform to current period presentation. We also receive fees for providing certain information to market data providers and for directing trades to certain destinations for execution.
Commissions and fees are primarily affected by changes in our equity transaction volumes with institutional clients, changes in commission rates, the growth of our soft dollar and commission recapture activity as well as by changes in fees earned
for directing trades to certain destinations for execution.



Asset management fees represent fees earned by Deephaven Capital Management LLC (Deephaven) for sponsoring and managing the Deephaven investment funds (the Deephaven Funds). Asset management fees are primarily
affected by the rates of return earned on the Deephaven Funds and changes in the amount of assets under management.



We earn interest income from our cash held at banks and cash held in trading accounts at clearing brokers. The Companys clearing agreements call for
payment or receipt of interest income, net of transaction-related interest charged by clearing brokers for facilitating the settlement and financing of securities transactions. Net interest is primarily affected by interest rates, the changes in
cash balances held at banks and clearing brokers and our level of securities positions in which we are long compared to our securities positions in which we are short.



Investment income and other income primarily represents income earned, net of losses, related to our investment in the
Deephaven Funds and, to a lesser extent, our strategic investments. Investment income and other income are primarily affected by the rates of return earned by the Deephaven Funds as well as the performance and activity of our strategic investments.



Expenses



Our operating expenses largely consist of Employee compensation and
benefits, Payments for order flow and Execution and clearance fees. Employee compensation and benefits expense fluctuates, for the most part, based on changes in our revenues, our profitability and our number of employees. Payments for order flow
fluctuate based on U.S. equity share and option volume, our profitability, the mix of market orders and limit orders, the mix of orders received from broker-dealers and institutions who accept payments for order flow and changes in our payment for
order flow policy. Execution and clearance fees primarily fluctuate based on changes in equity trade and share volume, option contract volume, clearance fees charged by clearing brokers and fees paid to access ECNs, exchanges and certain regulatory
bodies.



Employee compensation and benefits expense primarily
consists of salaries and wages paid to all employees and profitability -based compensation, which includes compensation paid to market-making and sales personnel primarily based on their individual and overall performance and incentive compensation
paid to other employees based on our overall profitability. Compensation for



19



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##### Table of Contents

employees engaged in sales activities is determined primarily based on a percentage of their gross revenues net of
certain expenses including soft dollar and commission recapture expenses, execution and clearance costs and overhead allocations. The majority of compensation in Asset Management is determined based on a profitability-based formula.



Execution and clearance fees primarily represent clearance fees paid to
clearing brokers for equities and options transactions, transaction fees paid to Nasdaq and other regional exchanges and regulatory bodies, option exchange fees, payments made to third parties for exchange seat leases and execution fees paid to
third parties, primarily for executing trades in listed securities on the NYSE and AMEX, and for executing orders through ECNs.



Payments for order flow represent payments to broker-dealer clients, in the normal course of business, for directing their order flow in U.S. equities and
U.S. option contracts to us. Payments for order flow fluctuate as we modify our payment rates and as our percentage of clients whose policy is not to accept payments for order flow varies.



Soft dollar and commission recapture expense represent payments to
institutions in connection with our soft dollar and commission recapture programs. As this is the first full quarter following our December 2003 purchase of the business of Donaldson, this is the first period in which these expenses are being
presented separately. Previously, these expenses were primarily included within Payments for order flow and Execution and clearance fees. Prior period amounts have been reclassified to reflect the current period presentation.



The Writedown of assets and lease loss accrual related to our domestic
businesses consists of costs associated with impairment charges on intangible assets, excess real estate, fixed assets that are no longer actively used and the writedown of certain domestic strategic investments and exchange seats to fair value.



Three Months Ended March 31, 2004 and 2003



Revenues



Equity Markets



|                                                                      |  |                                      |       |      |   |        |  |   |             |   |  |       |  
|--------------------------------------------------------------------- |  | ------------------------------------ | ----- | ---- | - | ------ |  | - | ----------- | - |  | ----- | -
|                                                                      |  | For the three months ended March 31, |      
|                                                                      |  | 2004                                 |       | 2003 |   | Change |  |   | % of Change |  
|Net trading revenue (millions)                                        |  | $                                    | 92.4  |      | $ | 43.8   |  | $ | 48.6        |   |  | 110.8 | %
|Commissions and fees (millions)                                       |  |                                      | 76.9  |      |   | 28.3   |  |   | 48.5        |   |  | 171.4 | %
|Interest and dividends, net (millions)                                |  |                                      | 0.6   |      |   | 0.6    |  |   | (0.0        | ) |  | 0.0   | %
|Investment income and other (millions)                                |  |                                      | 0.9   |      |   | 0.9    |  |   | 0.1         |   |  | 8.9   | %
|                                                                      |  |                                      |       |      |   |        |  |   |             |   |  |       |  
|Total Revenues                                                        |  | $                                    | 170.8 |      | $ | 73.6   |  | $ | 97.2        |   |  | 132.1 | %
|                                                                      |  |                                      |       |      |   |        |  |   |             |   |  |       |  
|U.S equity dollar value traded ($billions)                            |  |                                      | 503.8 |      |   | 274.7  |  |   | 229.1       |   |  | 83.4  | %
|U.S. equity trades executed (millions)                                |  |                                      | 59.6  |      |   | 34.3   |  |   | 25.3        |   |  | 73.9  | %
|Nasdaq and Listed equity shares traded (in billions)                  |  |                                      | 40.9  |      |   | 26.6   |  |   | 14.3        |   |  | 53.9  | %
|OTC Bulletin Board and Pink Sheet shares traded (in billions)         |  |                                      | 320.6 |      |   | 40.0   |  |   | 280.6       |   |  | 701.4 | %
|Average revenue capture per U.S. equity dollar value traded ($) (bps) |  |                                      | 2.84  |      |   | 2.54   |  |   | 0.30        |   |  | 11.8  | %



Total revenues from
our Equity Markets business segment, which is primarily comprised of Net trading revenue and Commissions and fees from our domestic businesses, increased 132.1% to $170.8 million for the three months ended March 31, 2004, from $73.6 million for the
comparable period in 2003. The first quarter of 2004 was positively impacted by an improvement in general market conditions, an increase in our institutional business and higher volumes from broker-dealer clients, particularly in low priced OTC
Bulletin Board and Pink Sheet shares. Net trading revenue increased 110.8% to $92.4 million for the three months ended March 31, 2004, from $43.8 million for the comparable period in 2003, as adjusted. Net trading revenues increased primarily due to
the increase in dollar value traded as well as the increase in average revenue capture per dollar value traded. Commissions and fees increased to $76.9 million for the three months ended March 31, 2004, from $28.3 million for the comparable period
in 2003, as adjusted. The increase in commissions and fees is primarily attributable to the overall growth of our institutional business and a full quarter of soft dollar related commissions from our Donaldson division, which was acquired on
December 1, 2003. Excluding the impact of Donaldson, Commissions and fees would have increased 102.4% to $57.3 million for the three months ended March 31, 2004, from $28.3 million for the comparable period in 2003, as adjusted.



20



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##### Table of Contents

Transaction volumes within our Equity Markets business segment were significantly higher for the first
quarter of 2004, compared to the first quarter of 2003. U.S. equity dollar value traded increased 83.4% for the first quarter of 2004 compared to the first quarter of 2003. Overall, U.S. equity share volume increased over 400%, primarily due to the
increase in volumes in low priced OTC Bulletin Board and Pink Sheet shares, and there was a 73.9% increase in the number of U.S. equity trades executed.



Average revenue capture per U.S. equity dollar value traded was 2.84 basis points (bps) for the three months ended March 31, 2004, an increase
of 11.8% from 2.54 bps in the comparable period in 2003. In the first quarter of 2004, we changed the formula for calculating the average revenue capture per dollar value traded metric. Average revenue capture per U.S. equity dollar value traded is
now calculated as the total of net trading revenues and institutional commissions and commission equivalents (included in Commissions and fees), (collectively, Core Equity Revenues) divided by the total dollar value of the related equity
transactions. In prior quarters, average revenue capture per dollar value traded was calculated solely using net trading revenues (which included commission equivalents), but excluded institutional commissions. All prior year metrics have been
adjusted to conform to the current period presentation. Core Equity Revenues were $143.2 million and $69.9 million for the three months ended March 31, 2004 and 2003, respectively.



Derivative Markets



|                                                     |  |                                      |      |   |      |   |        |  |   |             |   |  |        |  
|---------------------------------------------------- |  | ------------------------------------ | ---- | - | ---- | - | ------ |  | - | ----------- | - |  | ------ | -
|                                                     |  | For the three months ended March 31, |     
|                                                     |  | 2004                                 |      |   | 2003 |   | Change |  |   | % of Change |  
|Net trading revenue (millions)                       |  | $                                    | 44.7 |   |      | $ | 26.4   |  | $ | 18.3        |   |  | 69.5   | %
|Commissions and fees (millions)                      |  |                                      | 8.7  |   |      |   | 4.4    |  |   | 4.3         |   |  | 96.3   | %
|Interest and dividends, net (millions)               |  |                                      | (3.7 | ) |      |   | 0.9    |  |   | (4.6        | ) |  | -498.0 | %
|Investment income and other (millions)               |  |                                      | 0.5  |   |      |   | 0.5    |  |   | 0.0         |   |  | 0.0    | %
|                                                     |  |                                      |      |   |      |   |        |  |   |             |   |  |        |  
|Total Revenues                                       |  | $                                    | 50.2 |   |      | $ | 32.2   |  | $ | 18.0        |   |  | 55.8   | %
|                                                     |  |                                      |      |   |      |   |        |  |   |             |   |  |        |  
|U.S. option contracts (millions)                     |  |                                      | 21.5 |   |      |   | 12.9   |  |   | 8.6         |   |  | 66.9   | %
|Average revenue capture per U.S. option contract ($) |  |                                      | 1.91 |   |      |   | 2.13   |  |   | (0.22       | ) |  | -10.3  | %



Total revenues from
our Derivative Markets segment increased 55.8% to $50.2 million for the three months ended March 31, 2004, from $32.2 million for the comparable period in 2003. The increase was primarily due to a 66.9% increase in the number of U.S. option
contracts traded in the first quarter of 2004, compared to the first quarter of 2003 offset, in part, by a 10.3% decrease in average revenue capture per U.S. option contract traded. Additionally, the Derivative Markets segment earned higher
commissions related to its options order routing business primarily due to higher volumes.



Asset Management



|                                                                 |  |                                      |         |   |      |   |         |        |  |   |             |   |  |       |  
|---------------------------------------------------------------- |  | ------------------------------------ | ------- | - | ---- | - | ------- | ------ |  | - | ----------- | - |  | ----- | -
|                                                                 |  | For the three months ended March 31, |        
|                                                                 |  | 2004                                 |         |   | 2003 |   |         | Change |  |   | % of Change |  
|Asset management fees (millions)                                 |  | $                                    | 13.9    |   |      | $ | 14.2    |        |  | $ | (0.3        | ) |  | -2.1  | %
|Investment income and other (millions)                           |  |                                      | 5.0     |   |      |   | 6.3     |        |  |   | (1.3        | ) |  | -20.4 | %
|                                                                 |  |                                      |         |   |      |   |         |        |  |   |             |   |  |       |  
|Total Revenues                                                   |  | $                                    | 19.0    |   |      | $ | 20.6    |        |  | $ | (1.6        | ) |  | -7.6  | %
|                                                                 |  |                                      |         |   |      |   |         |        |  |   |             |   |  |       |  
|                                                                 |  |                                      |         |  
|Average month-end balance of assets under management ($millions) |  |                                      | 1,965.1 |   |      |   | 1,230.9 |        |  |   | 734.2       |   |  | 59.6  | %
|Quarter to date Fund return to investors*                        |  |                                      | 2.0     | % |      |   | 3.7     | %      |  |   | -1.7        | % |  | -45.9 | %

---

|* |  | Return represents average return across all assets under management in the Deephaven Funds
|- |  | ------------------------------------------------------------------------------------------



Total revenues from our Asset Management segment decreased 7.6% to $19.0 million for the three months ended March 31, 2004,
from $20.6 million for the comparable period in 2003. Asset management fees decreased to $13.9 million for the three months ended March 31, 2004, from $14.2 million for the comparable period in 2003. The decrease is due to the reduction in the
average fund returns to the investors. The average fund return for the three months ended March 31, 2004 was 2.0%, down from 3.7% in the comparable period in 2003. The decrease was offset, in part, by the increase in assets under management. The
average month-end balance of assets under management increased to $1.97 billion during the first quarter of 2004, from an average of $1.23 billion during the comparable period in 2003.



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Investment income and other, which primarily represents income from our corporate investments in the
Deephaven Funds, decreased 20.4%. The decrease is due to lower average returns on our corporate investment offset, in part, by a higher average investment balance. The Companys average corporate month-end balance invested in the Deephaven
Funds increased to $227.4 million during the first quarter of 2004, up from an average of $169.7 million during the comparable period in 2003.



Expenses



Employee compensation and benefits expense increased 47.8% to $79.8 million for the three months ended March 31, 2004, from $54.0 million for the
comparable period in 2003. As a percentage of total revenue, Employee compensation and benefits decreased to 33.3% for the three months ended March 31, 2004, from 42.8% in the comparable period in 2003. These changes were primarily due to higher
profitability-based compensation as a result of an increase in revenues and margins offset, in part, by reduced headcount. Our number of full time employees decreased to 933 at March 31, 2004, from 965 full time employees at March 31, 2003. In
connection with these headcount reductions, we incurred severance costs of $682,000 for the three months ended March 31, 2004, down from $2.9 million in the comparable period in 2003.



Execution and clearance fees increased 51.6% to $44.3 million for the three months ended March 31, 2004, from $29.2 million
for the comparable period in 2003. As a percentage of total revenue, Execution and clearance fees decreased to 18.5% for the three months ended March 31, 2004, from 23.1% for the comparable period in 2003. The increase on a dollar basis was due to
the increase in equity trades and options contracts executed as well as increased costs related to executing orders through ECNs offset, in part, by a reduction in clearance and execution rates. The decrease as a percentage of total revenue was
primarily due to lower clearance rates, higher revenue capture and the overall increase in commissions and fees from Donaldson, which have lower associated execution and clearance fees.



Payments for order flow increased 78.8% to $19.5 million for the three months ended March 31, 2004, from $10.9 million from
the comparable period in 2003. As a percentage of total revenue, Payments for order flow decreased to 8.1% for the three months ended March 31, 2004, from 8.6% for the comparable period in 2003. The increase on a dollar basis was due to the increase
in volumes offset, in part, by changes in our payment for order flow policy. The decrease on a percentage basis was primarily due to higher revenue capture, changes in our payment for order flow policy and higher commissions from Donaldson, which
have no associated payments for order flow.



Soft dollar and
commission recapture expense increased to $15.8 million for the three months ended March 31, 2004, from $667,000 for the comparable period in 2003. The increase is primarily due to the purchase of the business of Donaldson on December 1, 2003.



Communications and data processing expense decreased 11.0% to
$7.8 million for the three months ended March 31, 2004, from $8.7 million for the comparable period in 2003. This decrease was generally attributable to a decrease in headcount and related technology costs.



Depreciation and amortization expense decreased 28.6% to $5.8 million for the
three months ended March 31, 2004, from $8.1 million for the comparable period in 2003. This decrease was primarily due to assets fully depreciating in the normal course of business offset, in part, by the purchases of additional fixed assets during
2003 and the first quarter of 2004.



Occupancy and equipment
rentals expense increased 8.7% to $4.8 million for the three months ended March 31, 2004, from $4.4 million for the comparable period in 2003. This increase was primarily attributable to the leasing of additional office space offset, in part, by the
lease loss accruals recorded in the first quarter of 2003 related to our excess real estate capacity, primarily in Jersey City, NJ. We currently have 266,000 square feet of unoccupied office space in Jersey City.



Professional fees decreased 5.3% to $3.6 million for the three months ended
March 31, 2004, from $3.8 million for the comparable period in 2003. The decrease in 2004 was primarily due to a decrease in legal expenses, which will fluctuate based on the activity surrounding our various legal and regulatory proceedings.



Business development expense increased 9.9%, while Other
expenses increased 11.2%. The primary reasons for the changes were higher advertising, travel and entertainment costs and other administrative costs, consistent with our business growth in the past year.



There were no charges incurred related to our domestic businesses for the
three months ended March 31, 2004. During the three months ended March 31, 2003, charges of $17.4 million were incurred related to our domestic businesses. These charges



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consisted of $10.3 million of lease loss accruals related to the costs associated with our excess real estate capacity,
primarily in Jersey City, NJ, $6.8 million related to the writedown of our strategic investment in Nasdaq to fair value and $260,000 related to the writedown of fixed assets that are no longer actively used.



Our effective income tax rates, from continuing operations, of 40.3% and
43.7% for the three months ended March 31, 2004 and 2003, respectively, differ from the federal statutory income tax rate of 35% due primarily to state income taxes and, for the three months ended March 31, 2003, non-deductible foreign losses.



Reconciliation of Total GAAP Expenses and Pre-Tax GAAP Income to
Operating Expenses and Pre-Tax Operating Earnings, Respectively



In an effort to provide additional information regarding the Companys results as determined by generally accepted accounting principles (GAAP), the Company also discloses certain non-GAAP information
which management believes provides useful information to investors. Within this Form 10-Q, the Company has disclosed its Operating Expenses and Pre-Tax Operating Earnings to assist the reader in understanding the impact of the writedown of assets
and lease loss accrual on the Companys first quarter of 2003 results by segment, thereby facilitating more useful period-to-period comparisons of the Companys businesses. For additional information related to segments, please see
Footnote 14 to the Consolidated Financial Statements included elsewhere in this document.



As there was no Writedown of assets and lease loss accrual or other charges for the three months ended March 31, 2004, there is no difference between GAAP Expenses and Operating Expenses or Pre-Tax GAAP Income and
Pre-Tax Operating Earnings for this period. Charts are presented in millions.



Total GAAP Expenses to Operating Expenses



|                                                                                                     |  |                                           |       |   |                   |   |      |            |  |        |      |  |   |       |  
|---------------------------------------------------------------------------------------------------- |  | ----------------------------------------- | ----- | - | ----------------- | - | ---- | ---------- |  | ------ | ---- |  | - | ----- | -
|                                                                                                     |  | For the three months ended March 31, 2003 |      
|                                                                                                     |  | EquityMarkets                             |       |   | DerivativeMarkets |   |      | Asset Mgmt |  | Total* |     
|Total GAAP Expenses                                                                                  |  | $                                         | 101.2 |   |                   | $ | 34.0 |            |  | $      | 6.8  |  | $ | 141.9 |  
|                                                                                                     |  |                                           |       |  
|Writedown of assets and lease loss accrual                                                           |  |                                           | 16.7  |   |                   |   | 0.7  |            |  |        |     |  |   | 17.4  |  
|                                                                                                     |  |                                           |       |   |                   |   |      |            |  |        |      |  |   |       |  
|Operating Expenses                                                                                   |  | $                                         | 84.5  |   |                   | $ | 33.3 |            |  | $      | 6.8  |  | $ | 124.5 |  
|                                                                                                     |  |                                           |       |   |                   |   |      |            |  |        |      |  |   |       |  
|*   The
Total amounts presented include the elimination of intercompany management fees of $75,000. |  |                                           |       |  
|                                                                                                     |  |                                           |       |  
|Pre-Tax GAAP Income to Pre-Tax Operating Earnings                                                    |  |                                           |       |   |                   |   |      |            |  |        |      |  |   |       |  
|                                                                                                     | 
|                                                                                                     |  | For the three months ended March 31, 2003 |      
|                                                                                                     |  | EquityMarkets                             |       |   | DerivativeMarkets |   |      | Asset Mgmt |  | Total  |     
|                                                                                                     |  |                                           |       |  
|Pre-Tax GAAP Income                                                                                  |  | $                                         | (27.6 | ) |                   | $ | (1.8 | )          |  | $      | 13.8 |  | $ | (15.6 | )
|                                                                                                     |  |                                           |       |  
|Writedown of assets and lease loss accrual                                                           |  |                                           | 16.7  |   |                   |   | 0.7  |            |  |        |     |  |   | 17.4  |  
|                                                                                                     |  |                                           |       |   |                   |   |      |            |  |        |      |  |   |       |  
|                                                                                                     |  |                                           |       |  
|Pre-Tax Operating Earnings                                                                           |  | $                                         | (10.9 | ) |                   | $ | (1.1 | )          |  | $      | 13.8 |  | $ | 1.8   |  
|                                                                                                     |  |                                           |       |   |                   |   |      |            |  |        |      |  |   |       |  



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Liquidity



Historically, we have financed our business primarily through cash generated by operations, as well as the proceeds from our stock issuances. As of March
31, 2004, we had $4.4 billion in assets, 90% of which consisted of cash or assets readily convertible into cash, principally receivables from brokers and dealers and securities owned. Receivables from brokers and dealers include interest bearing
cash balances held with clearing brokers, including, or net of, amounts related to securities transactions that have not yet reached their contracted settlement date, which is generally within three business days of the trade date. Securities owned
principally consist of equity securities that trade in Nasdaq, on the OTC Bulletin Board and on the NYSE and AMEX markets and listed options contracts that trade on national exchanges. At March 31, 2004, the Company had net current assets, which
consists of net assets readily convertible into cash, of approximately $387.1 million. Additionally, our corporate investment in the Deephaven Funds was $227.4 million at March 31, 2004. The majority of this investment can be liquidated upon request
subject to a ninety-day written notification period and monthly redemption limits, or immediately by invoking our rights as the general partner of the Deephaven Funds.



Income (loss) before income taxes and discontinued operations was $53.3 million and ($15.6 million) for the three months
ended March 31, 2004 and 2003, respectively. Included in these balances were certain non-cash expenses such as depreciation and amortization and certain non-cash writedowns. Depreciation expense was $5.1 million and $7.8 million for the three months
ended March 31, 2004 and 2003, respectively. Amortization expense, which related to intangible assets was $716,000 and $671,000 for the three months ended March 31, 2004 and 2003, respectively. There were no non-cash writedowns for the three months
ended March 31, 2004. Non-cash writedowns consisted of $7.0 million during the three months ended March 31, 2003, primarily related to impaired strategic investments and fixed assets no longer actively being used.



Purchases, net of proceeds, from strategic investments and acquisitions were
$6.4 million and $1.3 million for the three months ended March 31, 2004 and 2003, respectively. Strategic investments and acquisition expenditures primarily relate to outside investments and acquisitions of the ownership interests of substantially
all of the minority owners of KREL. We increased our corporate investment in the Deephaven Funds by $29.8 million and $31.1 million during the three months ended March 31, 2004 and 2003, respectively.



Capital expenditures were $3.8 million and $2.2 million during the three
months ended March 31, 2004 and 2003, respectively. Capital expenditures primarily relate to the purchase of data processing and communications equipment, capitalized software and leasehold improvements. In acquiring fixed assets, particularly
technology equipment, we make a decision about whether to lease such equipment or purchase it outright based on a number of factors including its estimated useful life, obsolescence and cost. We anticipate moving our Jersey City, NJ offices into our
leased office space at 545 Washington Boulevard in the next 18 months. Currently, we estimate that we will spend approximately $45 million to $50 million related to this move, the majority of which will be for leasehold improvements that will be
amortized over the remaining life of the lease, which ends in October 2021.



At its April 20, 2004 meeting, the Board of Directors authorized an additional increase in the size of the Companys stock repurchase program from $95 million, to $110 million. The Company repurchased 501,700
shares during the first quarter of 2004 for a total cost of $6.1 million. Through March 31, 2004, the Company had repurchased 14,816,900 shares for $80.7 million under its stock repurchase program. The Company may repurchase shares in the open
market or through privately negotiated transactions, depending on prevailing market conditions, alternative uses of capital and other factors. The Company cautions that there are no assurances that any further repurchases may actually occur. The
Company had approximately 116.2 million shares of Class A Common Stock outstanding as of March 31, 2004.



As registered broker-dealers, Knight Equity Markets, L.P. (KEM), Knight Capital Markets LLC (KCM), Knight Financial Products LLC
(KFP) and Knight Execution Partners LLC (KEP) are subject to regulatory requirements intended to ensure the general financial soundness and liquidity of broker-dealers and requiring the maintenance of minimum levels of net
capital, as defined in SEC Rule 15c3-1. These regulations also prohibit a broker-dealer from repaying subordinated borrowings, paying cash dividends, making loans to its parent, affiliates or employees, or otherwise entering into transactions which
would result in a reduction of its total net capital to less than 120.0% of its required minimum capital. Moreover, broker-dealers, including KEM, KCM, KFP and KEP, are required to notify the SEC prior to repaying subordinated borrowings, paying
dividends and making loans to its parent, affiliates or employees, or otherwise entering into transactions, which, if executed, would result in a reduction of 30.0% or more of its excess net capital (net capital less minimum requirement). The SEC
has the ability to prohibit or restrict such transactions if the result is detrimental to the financial integrity of the broker-dealer. At March 31, 2004, KEM had net capital of $78.9 million, which was $73.8 million in excess of its minimum net
capital requirement of $5.1 million, KCM had net capital of $26.0 million which was $22.9 million in excess of its minimum net capital requirement of $3.1 million, KFP had net



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capital of $19.5 million which was $19.2 million in excess of its minimum net capital requirement of $250,000 and KEP had
net capital of $6.0 million which was $5.7 million in excess of its minimum net capital requirement of $272,000. Additionally, Knight Securities International Ltd. (KSIL) is subject to capital adequacy requirements of the Financial
Services Authority in the United Kingdom. KSIL had net capital of $9.6 million, which was $3.3 million in excess of its minimum net capital requirement of $6.3 million.



We have no long-term debt at March 31, 2004 nor do we currently have any material long-term debt commitments for the rest of
2004. We currently anticipate that available cash resources and credit facilities will be sufficient to meet our anticipated working capital and capital expenditure requirements for at least the next 12 months.



Critical Accounting Policies



The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions. We believe that, of our significant accounting policies, the following policies involve a higher degree of judgment.



Lease Loss AccrualIt is the Companys policy to identify excess real estate capacity and where
applicable, accrue against such future costs. In determining the accrual, a nominal cash flow analysis is performed for lease losses initiated prior to December 31, 2002, the effective date of SFAS No. 146 Accounting for Costs Associated with
Exit or Disposal Activities(which requires the accrual of future costs to be made using a discounted cash flow analysis for lease losses initiated after such date), and costs related to the excess capacity are accrued. The majority of this
amount is related to our lease at 545 Washington Boulevard in Jersey City, New Jersey, of approximately 266,000 square feet, all of which is currently unoccupied. The Company engaged a real estate broker in order to sub-lease approximately 78,000
square feet based on an assessment of our real estate needs. This accrual was derived from assumptions and estimates based on lease terms of the anticipated sub-lease agreement, which assumed a sub-lease would have commenced in the middle of 2005,
anticipated market prices along the Jersey City waterfront and estimated up-front costs, including broker fees and build out allowances. We continually monitor the market and space to assess the reasonableness of our applicable assumptions.



Impairment of Goodwill and Intangible AssetsThe
useful lives of goodwill and intangible assets are determined upon acquisition. Intangible assets are amortized over their respective lives. Goodwill and the useful lives of intangible assets are tested for impairment, at a minimum, on an annual
basis, or when an event occurs or circumstances change that signify the existence of impairment.



| |  |  | Our Goodwill of $23.4 million as of March 31, 2004 is related to the purchase of our listed equities market maker, KCM, our order routing business of KEP, the business of Donaldson
and the purchase of the shares of substantially all of the investors in KREL. During our annual tests for impairment done in 2003, it was determined that these assets were not impaired. As part of our test for impairment, we considered the
profitability of the applicable reporting unit, an assessment of fair value of the reporting unit based on various valuation methodologies, as well as the overall market value of the Company, compared to the Companys book value.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Our Intangible assets balance of $13.5 million as of March 31, 2004 is attributable to both our Equity Markets and our Derivative Markets business segments. Included in our Equity
Markets business segment is $11.9 million related to our acquisition of the business of Donaldson. These assets are being amortized over their useful lives, which have been determined to range from five to thirty years. Included in our Derivative
Markets business segment is $1.6 million related to our trading rights and trading posts on various options exchanges. During our annual tests for impairment done in 2003, it was determined that these intangible assets were permanently impaired.
Consequently, the intangible assets relating to our trading rights and trading posts on various options exchanges were written down to fair value, resulting in a $29.5 million impairment charge. The carrying value of the residual intangible assets
continues to be amortized over their remaining useful lives, the majority of which are less than one year, with the remainder up to fourteen years.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Strategic InvestmentsInvestments include ownership interests of less than 20% in financial services-related
businesses, which are accounted for under the equity method or at fair value. The equity method of accounting is used for investments in limited partnerships and limited liability corporations. The fair value of investments for which a quoted market
or dealer price is not available for the size of our investment is based on managements estimate. Among the factors considered by management in determining the fair value of investments are the cost of the investment, terms and liquidity,
developments since the acquisition of the investment, the sales price of recently issued securities, the financial condition and operating results of the issuer, earnings



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trends and consistency of operating cash flows, the long-term business potential of the issuer, the quoted market price
of securities with similar quality and yield that are publicly traded, and other factors generally pertinent to the valuation of investments. The fair value of these investments is subject to a high degree of volatility and may be susceptible to
significant fluctuations in the near term. The valuations of strategic investments, which include our investment in Nasdaq and the ISE, are reviewed on an ongoing basis.



Market-Making ActivitiesSecurities owned and securities sold, not yet purchased, which primarily consist of
listed and OTC stocks and listed options contracts, are carried at market value and are recorded on a trade date basis. Market value is estimated daily using market quotations available from major securities exchanges and dealers.



Asset Management FeesThe Company earns asset management fees for
sponsoring and managing the Deephaven Funds. Such fees are recorded monthly as earned and are calculated as a percentage of the Deephaven Funds monthly net assets, plus a percentage of a new high net asset value (the Incentive Allocation
Fee), as defined, for any six month period ended June 30th or December 31st. A new high net asset value is defined as the amount by which the net asset value of the Deephaven Funds exceeds the greater of either the highest previous net asset
value in the Deephaven Funds, or the net asset value at the time each investor made his purchase. If any of the Deephaven Funds recognize a loss in the second half of a calendar year, the Incentive Allocation Fee for such fund is recalculated on an
annual rather than a semi-annual basis.



Writedown of Fixed
AssetsWritedowns of fixed assets are recognized when it is determined that the fixed assets are no longer actively used and are determined to be impaired. The amount of the impairment is determined by the difference between the carrying
amount and the fair value of the fixed asset. In determining the impairment, an estimated fair value is obtained through research and inquiry of the market. Fixed assets are reviewed for impairment on a quarterly basis.



Recently Issued Accounting Standards



In January 2003, the FASB issued FIN No. 46, Consolidation of Variable
Interest Entities. FIN No. 46 requires a company to consolidate a variable interest entity (VIE) if the company has variable interests that give it a majority of the expected losses or a majority of the expected residual returns of
the entity. As the Company does not have any VIEs, the adoption of this statement is not expected to have an effect on our financial statements.



In April 2003, the FASB issued SFAS No. 149 Amendment of Statement 133 on Derivative Instruments and Hedging Activities. SFAS No. 149 amends
and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under FASB No. 133 Accounting
for Derivative Instruments and Hedging Activities. This statement is effective for derivative contracts and hedging instruments entered into after June 30, 2003. The adoption of this statement did not have a material impact on our financial
statements.



In May 2003, the FASB issued SFAS No. 150
Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both
liabilities and equity, and imposes certain additional disclosure requirements. The provisions of SFAS No. 150 were immediately effective for financial instruments entered into or modified after May 31, 2003 and applied to all financial instruments
at the beginning of the third quarter of 2003. The adoption of this statement did not have an effect on our financial statements.



Item 3. Quantitative and Qualitative Disclosures About Market Risk



Our market-making and trading activities expose our capital to significant risks. These risks include, but are not limited to, absolute and relative price
movements, price volatility and changes in liquidity, over which we have virtually no control.



For working capital purposes, we invest in money market funds, commercial paper, government securities or maintain interest-bearing balances in our trading accounts with clearing brokers, which are classified as Cash
and cash equivalents and Receivable from brokers and dealers, respectively, in the Consolidated Statements of Financial Condition. These other amounts do not have maturity dates or present a material market risk, as the balances are short-term in
nature and subject to daily repricing. Our cash and cash equivalents held in foreign currencies are subject to the exposure of foreign currency fluctuations. These balances are monitored daily, and are not material to the Companys overall cash
position.



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Equity Markets



We employ automated proprietary trading and position management systems that provide real-time, on-line position management
and inventory control. We monitor our risks by reviewing trading positions and their appropriate risk measures. We have established a system whereby transactions are monitored by senior management on a real-time basis as are individual and aggregate
dollar and inventory position totals and real-time profits and losses. The management of trading positions is enhanced by a review of mark-to-market valuations and position summaries on a daily basis.



In the normal course of our equities market-making business, we maintain
inventories which primarily consist of exchange-listed and OTC equity securities. The fair value of these securities at March 31, 2004 and 2003 was $314.8 million and $122.0 million, respectively, in long positions and $270.5 million and $89.4
million, respectively, in short positions. The potential change in fair value, using a hypothetical 10.0% decline in prices, is estimated to be a $4.4 million loss and a $3.3 million loss as of March 31, 2004 and 2003, respectively, due to the
offset of losses in long positions with gains in short positions.



Derivative Markets



We maintain
inventories of options, futures and equities. Our main exposure is from equity price and volatility risk. We manage these exposures by constantly monitoring and diversifying our exposures and position sizes and establishing offsetting hedges. Our
market-making staff and trading room managers continuously manage our positions and our risk exposures. Our systems incorporate trades and update our risk profile using options pricing models on a real-time basis.



Our proprietary options risk management system allows us to stress test our
portfolio on a real-time basis. On a daily basis, risk reports are distributed to senior management and the firms risk managers who incorporate this information in our market-making decisions. These reports identify potential exposures with
respect to options and futures on individual securities and index contracts under extreme price and volatility movements.



As of March 31, 2004, using a hypothetical 10% decrease in the underlying stock prices, the potential change in fair value of our entire equity options,
equity index options and commodity options portfolios, which contain the majority of the market risk for the Derivatives Market segment, is estimated to be a loss of $0.8 million. Using a hypothetical 10% increase in the underlying stock prices, the
potential change in fair value is estimated to be a gain of $22.7 million. This stress analysis covers positions in options and futures, underlying securities and related hedges. The estimated change in fair value due to hypothetical changes in
stock prices include our estimated impact of correlated moves in volatility, and make the assumption of a universal 10% price movement in all of our underlying positions. The analysis also includes a number of estimates that we believe to be
reasonable.



Asset Management



As of March 31, 2004, the Company had a $227.4 million corporate investment
in the Deephaven Funds. In addition, the Company held $19.9 million in investments in the Deephaven Funds related to employee deferred compensation plans. The general objective of market neutral strategies is to capture mispricings or
spreads between related capital instruments. Within the Market Neutral Fund, Deephaven employs a variety of market neutral investment strategies, including convertible arbitrage, event/risk arbitrage, relative value equity, distressed debt and
private placements in public companies. Because the basis of the Deephaven Funds strategy is capturing mispricings or spreads between related instruments, rather than attempting to predict or follow absolute price movements, the performance of
the Deephaven Funds is expected to be substantially non-correlated with the general debt and equity markets, as well as with a number of other non-traditional investment strategies. However, there will be unhedged credit risk in the convertible
arbitrage portfolio and that part of the portfolio will have some correlation to credit spreads. Market neutral trading involves substantial risks. Disruptions in historical pricing relationships can result in significant losses. The
Deephaven Funds also utilize leverage, to the extent available and deemed by Deephaven to be consistent with the Funds risk/reward objectives, in an attempt to increase returns while maintaining strict risk controls.



Similar to our Equity and Derivative Markets segments, the Deephaven Funds
employ automated proprietary trading and position management systems that provide position management and inventory control. We monitor our risks by reviewing trading positions and their appropriate risk measures. We have established a system
whereby transactions are monitored by senior management and a risk control function, as are individual and aggregate dollar and inventory position totals and profits and losses by strategy. There can be no assurances that the Deephaven Funds
strategy will be successful in achieving either its risk control or its profit objectives.



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Item 4. Controls and Procedures



As of the end of the period covered by this report, an evaluation was carried out under the supervision and with the participation of the Companys management, including our Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-14(c) under the Securities Exchange Act of 1934). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that the design and operation of these disclosure controls and procedures were effective. There have not been any changes in the Companys internal control over financial reporting (as such term is defined in Rule 13a-15(f) and
15d-15(f) under the Securities Exchange Act) during the last fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting.



PART II    OTHER INFORMATION



Item 1. Legal Proceedings



From
time to time, we and certain of our past and present officers, directors and employees are named as parties to legal actions, securities arbitrations and regulatory proceedings arising in connection with the conduct of our businesses. We are subject
to several of these actions. Although there can be no assurances, at this time the Company believes, based on information currently available, that it is not probable that the ultimate outcome of each of the actions will have a material adverse
effect on the consolidated financial condition of the Company, although they might be material to operating results for any particular period, depending, in part, upon operating results for that period.



Regulatory



The Company owns subsidiaries which are regulated broker-dealers and which are subject to extensive oversight under federal,
state and applicable international laws. Changes in market structure and the need to remain competitive require constant changes to our systems and order handling procedures. The Company makes these changes while continuously endeavoring to comply
with many complex laws and rules. Compliance, surveillance or trading issues, common in the securities industry, and which are monitored or reported to the SEC or self-regulatory organizations (SRO), are reviewed in the ordinary course
of business by our primary regulators: the SEC, the NASD and the CBOE. The Company, as a major order flow execution destination, is named from time to time, or is asked to respond to a number of regulatory matters brought by the SEC or SROs that
arise from its trading activity. In some instances, these matters may rise to an SEC or SRO disciplinary action and/or civil or administrative action.



As disclosed in our Annual Report on Form 10-K for the year ended December 31, 2003, KSLP received Wells Notices from the staff of the SECs Division
of Enforcement and NASDs Department of Market Regulation. In April 2004, KSLP provided its responses to both the SEC and NASD regarding the proposed charges.



For further information on Legal Proceedings, see the section entitled Legal Proceedings, in Part I, Item 3 of
our Annual Report on Form 10-K for the year ended December 31, 2003.



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Item 2. Changes in Securities and Use of Proceeds



The following table contains information about our purchases of our Class A Common Stock during the first quarter of 2004:



|                                       |  |                                     |  |                             |       |                                                                                   |         |                                                                                       |   |           
|-------------------------------------- |  | ----------------------------------- |  | --------------------------- | ----- | --------------------------------------------------------------------------------- | ------- | ------------------------------------------------------------------------------------- | - | ----------
|Period                                 |  | Total Number ofShares Purchased (2) |  | Average PricePaid per Share |       | Total Number of SharesPurchased as Part ofPublicly AnnouncedPlans or Programs (3) |         | Approximate DollarValue of Shares That MayYet Be Purchased Underthe Plans or Programs
|January 1, 2004 - January 31, 2004 (1) |  |                                    |  | $                           |      |                                                                                   |        |                                                                                       | $ | 20,370,410
|February 1, 2004 - February 29, 2004   |  | 26,700                              |  |                             | 13.28 |                                                                                   | 26,700  |                                                                                       |   | 20,015,821
|March 1, 2004 - March 31, 2004 (1)     |  | 475,000                             |  |                             | 12.05 |                                                                                   | 475,000 |                                                                                       |   | 14,293,008
|                                       |  |                                     |  |                             |       |                                                                                   |         |                                                                                       |   |           
|Total                                  |  | 501,700                             |  |                             | 12.11 |                                                                                   | 501,700 |                                                                                       |   |           
|                                       |  |                                     |  |                             |       |                                                                                   |         |                                                                                       |   |           

---

|(1) |  | As a matter of policy, the Company does not repurchase its Class A Common Stock during self-imposed closed window periods. These periods generally occur
during the last few weeks of a quarter and the first few weeks of a quarter prior to the release of the Companys quarterly earnings.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | All shares were repurchased through our publicly announced stock repurchase program. Table
excludes shares repurchased related to tax withholdings resulting from the vesting of employee restricted stock.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) |  | On April 4, 2002, the Companys Board of Directors announced the authorization of a stock repurchase program, which allowed for the purchase of Class A Common
Stock up to a total amount of $35 million. This repurchase program was increased by an aggregate of $75 million to a total of $110 million by resolutions of the Companys Board of Directors adopted on July 16, 2002, May 12, 2003 and April 20,
2004. The Company may repurchase shares in the open market or through privately negotiated transactions, depending on prevailing market conditions, alternative use of capital and other factors. The total remaining authorization under the program was
$24.7 million as of May 4, 2004. The repurchase program has no set expiration or termination date.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Item 3. Defaults Upon Senior Securities



None.



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



None.



Item 5. Other Information



None.



Item 6. Exhibits and Reports on Form 8-K



(a)
Reports on Form 8-K:



On January 22, 2004 the Company furnished a Current
Report on Form 8-K announcing its results for the quarter ending December 31, 2004.



On February 10, 2004 the Company filed a Current Report on Form 8-K announcing the resignation from the Board of Directors of Anthony M. Sanfilippo.



On February 26, 2004 the Company filed a Current Report on Form 8-K announcing the election of Thomas C. Lockburner to the Companys Board of Directors.



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On March 4, 2004 the Company filed a Current Report on Form 8-K announcing that its wholly-owned subsidiary, Knight
Securities, L.P. and its former CEO, Kenneth D. Pasternak, had received Wells Notices from the staff of the Division of Enforcement of the U.S. Securities and Exchange Commission and the NASDs Department of Regulation.



(b) Exhibits



|            |  |                                                                                                                                                  
|----------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Exhibit                                                                                                                                          
|            | 
|31.1        |  | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                               
|            | 
|31.2        |  | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                               
|            | 
|32.1        |  | Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
|            | 
|32.2        |  | Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002



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##### Table of Contents

SIGNATURES



Pursuant to the
requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Jersey City, State of New Jersey, on this
6th day of May, 2004.



KNIGHT TRADING GROUP,
INC.



|    |  |                                      
|--- |  | -------------------------------------
|By: |  | /s/ THOMAS M. JOYCE                  
|    |  | Chief Executive Officer and President



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