UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

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FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2004

Commission File Number
001-32274

ARCHIPELAGO HOLDINGS, INC.(Exact name of registrant as specified in its charter)

|Delaware(State of Incorporation) |  | 36-4298373(I.R.S. Employer Identification No.)
|-------------------------------- |  | ----------------------------------------------

100 South Wacker Drive, Suite 1800
Chicago, IL 60606
(312) 960-1696

(Address, including zip code, and telephone number,
including area code, of the registrant's principal executive offices)

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

|Title of each class |  | Exchanges on which registered
|------------------- |  | -----------------------------
|Common Stock        |  | Pacific Exchange             

Securities registered pursuant to Section 12(g) of the Act: None

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 such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past
90 days. Yes ý    No o

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

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

The aggregate market value of the shares of the registrant's common stock held by non-affiliates (based upon the closing price of these shares on
ArcaEx®, the trading facility of the Pacific Exchange) as of the last business day of the registrant's most recently completed second fiscal quarter, was: N/A (the Registrant was not a
public company on June 30, 2004).

As
of March 7, 2005, approximately 47,145,000 shares of common stock of the registrant were outstanding.

Select
materials from the Proxy Statement for the Annual Meeting of Shareholders, scheduled for May 10, 2005, have been incorporated by reference into Part III of this
Form 10-K.



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Archipelago Holdings, Inc.    Table of Contents

|           |  |                                                                                                |  | Page
|---------- |  | ---------------------------------------------------------------------------------------------- |  | ----
|           |  | Part I                                                                                         |  |     
|Item 1.    |  | Business                                                                                       |  | 4   
|Item 2.    |  | Properties                                                                                     |  | 43  
|Item 3.    |  | Legal Proceedings                                                                              |  | 44  
|Item 4.    |  | Submission of Matters to a Vote of Security Holders                                            |  | 47  
|           |  | Part II                                                                                        |  |     
|Item 5.    |  | Market for Registrant's Common Equity and Related Stockholder Matters                          |  | 48  
|Item 6.    |  | Selected Consolidated Financial Data                                                           |  | 48  
|Item 7.    |  | Management's Discussion and Analysis of Financial Condition and Results of Operations          |  | 52  
|Item 7A.   |  | Quantitative and Qualitative Disclosure about Market Risk                                      |  | 76  
|Item 8.    |  | Financial Statements and Supplementary Data                                                    |  | 78  
|Item 9.    |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure           |  | 104 
|Item 9A.   |  | Controls and Procedures                                                                        |  | 104 
|           |  | Part III                                                                                       |  |     
|Item 10.   |  | Directors and Executive Officers of the Registrant                                             |  | 104 
|Item 11.   |  | Executive Compensation                                                                         |  | 104 
|Item 12.   |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |  | 104 
|Item 13.   |  | Certain Relationships and Related Transactions                                                 |  | 105 
|Item 14.   |  | Independent Registered Public Accountant Fees and Services                                     |  | 105 
|           |  | Part IV                                                                                        |  |     
|Item 15.   |  | Exhibits, Financial Statements Schedules                                                       |  | 106 
|Signatures |  | 109                                                                                           

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Cautionary Statement Pursuant to The Private Securities Litigation Reform Act of 1995

We have included or incorporated by reference in this Annual Report on Form 10-K, and from time to time our management may make statements that
may constitute "forward-looking statements" within the meaning of the safe harbor provisions of The Private Securities Litigation Reform Act of 1995. Forward-looking statements are not historical
facts but instead represent only our belief regarding future events, many of which, by their nature, are inherently uncertain and outside of our control. These statements include statements other than
historical information or statements of current conditions and may relate to our future plans, operations and objectives and results, among other things, and may also include our belief regarding the
effect of proposed transactions or various legal proceedings, as well as statements about trends in our businesses. It is possible that our actual results may differ, possibly materially, from the
anticipated results indicated in these forward-looking statements. Important factors that could cause actual results to differ from those in the forward-looking statements include, among others, those
discussed below and under the heading "Part IItem 1BusinessCertain Factors That May Affect Our Business."
Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this document. Except for our ongoing obligation to disclose material
information under the Federal securities laws, we undertake no obligation to release publicly any revisions to any forward-looking statements to reflect events or circumstances after the date of this
document.

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Part I

ITEM 1.    BUSINESS

Overview

We operate the Archipelago Exchange, or ArcaEx®, the first open all-electronic stock market in the United States for trading equity
securities listed with the New York Stock Exchange (NYSE), Nasdaq, American Stock Exchange (AMEX) and Pacific Exchange, as well as exchange-traded funds (ETFs) and other exchange-listed securities.
Our trading platforms link traders to multiple U.S. market centers without market intermediaries and provide customers with fast electronic execution and open, direct and anonymous market access. The
technological capabilities of our trading systems combined with our trading rules have allowed us to create a large pool of liquidity that is available to our customers internally on ArcaEx and
externally through other market centers. Currently, we operate ArcaEx as the exclusive equities trading facility of PCX Equities, Inc. (PCX Equities), a wholly-owned subsidiary of the Pacific
Exchange, Inc. (PCX).

Archipelago
Holdings, Inc. is the successor to Archipelago Holdings L.L.C., a Delaware limited liability company organized on October 20, 1998. On August 11, 2004,
Archipelago Holdings L.L.C. converted from a Delaware limited liability company to a Delaware corporation, Archipelago Holdings, Inc. On August 19, 2004, we completed an initial public
offering (IPO) of our common stock. Our common stock is listed on the Pacific Exchange and is traded on ArcaEx under the symbol "AX."

All
references to 2002, 2003 and 2004 refer to our fiscal year ended, or the date, as the context requires, December 31, 2002, December 31, 2003 and December 31,
2004, respectively.

Financial
information concerning our business segments for each of 2002, 2003 and 2004 is set forth in
"Part IIItem 7Management's Discussion and Analysis of Financial Condition and Results of Operations," and the
consolidated financial statements and the notes thereto.

When
we use the terms "Archipelago," the "Company," "we," "us" and "our," we mean Archipelago Holdings, Inc., a Delaware corporation, and its consolidated subsidiaries. When we
use the term "Holdings LLC" we mean our predecessor, Archipelago Holdings L.L.C.

Our
Internet address is www.archipelago.com. We make available free of charge, on or through the investor relations section of our website, annual reports on
Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to
Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange
Commission (SEC). Also posted on our website, and available in print upon request to our Investor Relations Department, are the charters for our Audit Committee, Compensation Committee and Corporate
Governance and Nominating Committee, our Procedures for Communications with Non-Management Directors, our Policy on Reporting of Concerns Regarding Accounting and Auditing Matters,
Corporate Governance Guidelines and our Code of Business Conduct and Ethics, which governs our directors, officers and employees. Within the time period required by the SEC and the Pacific Exchange,
we will post on our website any amendment to our Code of Business Conduct and Ethics and any waiver applicable to our senior financial officers, and our executive officers or directors. In addition,
information concerning purchases and sales of our equity securities by our directors and Section 16 reporting officers is posted on our website.

Our
Investor Relations Officer can be contacted at Archipelago Holdings, Inc., 100 South Wacker Drive, Suite 1800, Chicago, Illinois 60606, Attn: Investor Relations, telephone:
(312) 960-1696, e-mail: pmurphy@archipelago.com.

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Business Developments

Acquisition Agreement.On January 3, 2005, we entered into an acquisition agreement with PCX Holdings, Inc.
(PCXH), the parent company of PCX, under which we agreed to acquire PCXH and all of its wholly-owned subsidiaries, including PCX and PCX Equities, subject to the receipt of approval of the PCXH
shareholders and applicable regulatory approvals. In addition to functioning as a self
regulatory organization (SRO) under SEC rules, PCX operates an options trading exchange using a trading system called PCX Plus which allows for floor-based and electronic trading access. The
completion of this proposed acquisition will allow us to expand our lines of business by entering into the options trading market as well as providing SRO services through a wholly-owned subsidiary.
With this acquisition we plan to bring the all-electronic trading of equity securities and options products to one platform. Holdings LLC entered into a facility services agreement with
PCX in July of 2000, which allowed us to establish and operate ArcaEx as the exclusive equities trading facility of its wholly-owned subsidiary, PCX Equities. Upon completion of the acquisition, PCXH,
PCX and PCX Equities will operate as wholly-owned subsidiaries of Archipelago.

Conversion.On August 11, 2004, Holdings LLC converted from a Delaware limited liability company to a Delaware
corporation named Archipelago Holdings, Inc. As a result of this conversion, the members of Holdings LLC received 0.222222 shares of common stock of the Company for each of the membership
interests that they held in Holdings LLC, which corresponds to a 4.5-for-1 reverse stock split. The weighted average number of shares used in the basic and diluted earnings per
share computations gives retroactive effect to the 4.5-for-1 reverse stock split. As approved by the board of managers of Holdings LLC, on July 16, 2004, we made a
$24.6 million cash distribution to the members of Holdings LLC immediately prior to the conversion transaction.

IPO.On August 19, 2004, we completed our IPO. We received net proceeds of $67.6 million and incurred
approximately $6.8 million in expenses in connection with the IPO.

Clearing.In July 2004, we began to self-clear trades effected by certain broker-dealer customers
accessing ArcaEx through our subsidiary, Archipelago Trading Services, Inc. (ATS). In addition, in January 2005, we began self-clearing all customer orders routed out to
other market centers and executed by our wholly-owned subsidiary, Archipelago Securities L.L.C. (Arca Securities) on behalf of ArcaEx.

History

In December 1996, Gerald D. Putnam, our Chairman and Chief Executive Officer co-founded The Archipelago® Electronic Communications
Network, or the Archipelago® ECN, the precursor to ArcaEx, to take advantage of a market opportunity resulting from the SEC's new order handling rules that govern trading in Nasdaq-listed
securities. These rules were designed to address growing concerns regarding unfair and discriminatory pricing of customer orders for securities, and to promote transparency and enhance execution
opportunities for customer orders in U.S. equity markets. We refer to the Archipelago ECN and ArcaEx, collectively, as the Archipelago system.

Electronic
Communications Networks (ECNs) are electronic trading systems that automatically match buy and sell orders at specified prices. ECNs register with the SEC as broker-dealers.
The Archipelago ECN was the first ECN to link traders to pools of liquidity throughout the U.S. securities markets without market intermediaries. The Archipelago ECN accomplished this by developing an
"outbound" routing capability to provide customers with the best price execution across multiple market centers by routing customer orders to other market centers displaying better prices than those
available if the orders were only matched internally.

In
July 2000, we partnered with PCX to develop ArcaEx, the first open all-electronic stock market in the United States for trading in NYSE, Nasdaq, AMEX and
PCX-listed equity securities, exchange-

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traded
funds and other exchange-listed securities. The SEC approved the establishment of ArcaEx and the related rules in October 2001. Under these rules, ArcaEx continues to operate as the
exclusive equities trading facility of PCX Equities under the regulatory authority of the Pacific Exchange. For a further discussion of our relationships with PCX please see the headings in this
"Part IItem 1Business Developments,Our Relationship with the Pacific Exchange" and "RegulationRegulation by the
Pacific Exchange and SEC Oversight."

In
March 2002, ArcaEx's listed platform became operational and we began trading PCX-listed securities on ArcaEx. By November 2002, we completed the rollout of
exchange-listed securities on ArcaEx, and in February 2003 we began migrating the trading of Nasdaq-listed securities from the Archipelago ECN to ArcaEx. We fully integrated our trading
platforms and completed the migration of Nasdaq-listed securities to ArcaEx in April 2003. During the transition period, we continued to operate the Archipelago ECN for Nasdaq-listed
securities.

Our Business

We were the first trading system to link traders to multiple U.S. market centers without market intermediaries. We accomplished this by developing an "outbound"
routing capability that directs customers' orders to other market centers that displayed a better price than our trading system. We refer to this process as our "best execution" model. By bringing
together buy orders and sell orders in this manner, we have been able to increase the liquidity of our trading platformi.e., the number and range of buy orders and sell orders available
to our customers.

We
have also introduced trading platforms and services designed to enhance the speed and quality of trade execution for our customers. Our trading platforms provide our customers with
fast electronic execution, transparency, and open, direct and anonymous market access. In addition to our core
execution services, we provide customers with market data on a real-time and summary basis and, as the equities trading facility of PCX, we offer companies and index providers that list on
PCX a trading venue for their equity securities, exchange-traded funds and other structured products. We are committed to expanding and enhancing our suite of products and service offerings for both
trading clientele and listed companies.

In
2004, we generated approximately $541.3 million in total revenues, approximately 99% of which consisted of transaction fees and market data fees generated by securities
transactions executed on or through our trading platforms.

Our Trading Platforms and Services.ArcaEx's electronic trading system enables buyers and sellers to meet directly in an
electronic environment. Unlike the NYSE, Nasdaq and other market centers that require market intermediaries to link buyers and sellers, ArcaEx is designed to search across multiple market centers,
including the NYSE and other exchanges, Nasdaq and ECNs, to achieve best execution for each order. The rules governing trading on ArcaEx require automatic execution of orders, without discretion, in
accordance with the principles of openness, fairness and equal access. These trading rules are predicated on "price-time priority" within ArcaEx, which requires execution of orders at the
best available price and, if orders are posted at the same price, based on the time the order is entered on our trading system. Our electronic matching and routing systems actively seek out the best
price for our customers' orders by matching orders internally or by routing orders out to the best bid or offer displayed in the market using our "outbound" trading capability. The technological
capabilities of our trading systems, together with our trading rules, have allowed us to create a large pool of liquidity available to our customers internally on ArcaEx or externally through other
market centers. Our "best execution" model is different from traditional floor-based exchanges like the NYSE, where investors must rely on, and may compete with, intermediaries such as specialists for
order execution, and where orders are not necessarily treated on a first come, first served basis. Broker-dealers that hold exchange trading permits may access ArcaEx directly, and broker-dealers that
do not hold exchange trading

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permits
may access ArcaEx through our subsidiary ATS. We also operate The ArcaEdge®, a trading platform designed to bring the benefits of ArcaExfast electronic execution,
transparency and open market accessto the trading of small-cap equity securities.

During
2004, we generated approximately $484.2 million in revenues from transaction fees with over 99% being attributable to trading on ArcaEx. For a discussion of selected
transaction statistics for 2004, see"Part IItem 1Our BusinessTrading Platforms and Services"; and
for the methods by which we calculate our market share, our trading volumes and other operating measures, see "Part IIItem 7Management's
Discussion and Analysis of Financial Condition and Results of OperationsKey Statistical Information."

Market Data Products.Through the Pacific Exchange, we participate in the consolidation, dissemination and sale of market
data in U.S. exchange-listed securities and Nasdaq-listed securities. We receive market data fees, based on the level of trading activity on ArcaEx, for providing data to centralized aggregators that
in turn sell the data to third-party consumers, such as Thomson Financial Inc. and Bloomberg, L.P. We also offer customers informational and decision-making tools, including market data on a
real-time and on a summary basis. In 2004, we launched ArcaVision, a new product that provides detailed and analytic market trading information. Through ArcaVision, we offer a range of
analytic tools designed to improve trade execution for our customers and provide them with critical market data on particular stocks. During 2004, we generated approximately $56.6 million in
revenues from market data fees.

Listing Fees.Under our contractual agreements with the Pacific Exchange, we are entitled to all listing fees from issuers
that list their equity securities on the Pacific Exchange for trading on ArcaEx. Through our current alliance with the Pacific Exchange, we offer companies and index providers that list on PCX a
trading venue for equity securities, exchange-traded funds and other structured products. An issuer may obtain a PCX listing to accompany a listing on another exchange, or Nasdaq, or as an exclusive
listing. Almost all PCX listings represent dual listed NYSE issuers that selected PCX as an additional listing venue prior to the launch of ArcaEx. As of December 31, 2004, five new issuers
have obtained a listing on PCX since the launch of ArcaEx in 2002. During 2004, we generated approximately $0.4 million in revenues from listing fees. On February 28, 2005, PCX filed
with the SEC for public comment and approval, proposed revisions to its listing fees.

Agency Brokerage Services.Through our wholly-owned subsidiary, Wave Securities, L.L.C. (Wave), we also offer agency
brokerage services to institutional customers seeking to access ArcaEx and other market centers electronically. These institutional customers are not registered as broker-dealers and therefore may not
access ArcaEx or other market centers as members.

Unlike
traditional broker-dealers, Wave does not solicit customer orders. Wave offers its customers access to ArcaEx through RealTick® and WebTick®, which are
software programs distributed pursuant to license agreements. During 2004, we generated $51.5 million in revenues from our agency brokerage business operations.

Industry Overview



Historically, stock markets operated primarily on a trading floor with all trades in a particular stock taking place in a specific place on the floor through or
under the supervision of a designated dealer known as a specialist. The specialist oversaw trading and was required to maintain a fair and orderly market, acting as both a market maker and auctioneer.
The NYSE continues to operate in this manner. In 1971, the National Association of Securities Dealers Automated Quotation system, or Nasdaq, an electronic network without a physical trading floor, was
introduced as an outgrowth of the

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traditional
telephone-based over-the-counter market. Nasdaq dealers, also known as market makers, are connected via a screen-based electronic linkage known as the Nasdaq quote
montage.

Limited Access.While these two market models have accommodated historical trading patterns and volumes, we believe that they
have substantial shortcomings, the most significant of which is limited access. Both systems require buyers and sellers to deal with each other indirectly through intermediariesthe
specialists, in the case of the NYSE, and the market makers, in the case of Nasdaq. Access to these intermediaries may also be restricted due to membership requirements. Until 1997, when the SEC order
handling rules became effective, only market makers had access to the Nasdaq quote montage. We believe limited market access impairs the speed and quality of trade execution, raises transaction costs
and results in limited pricing information and a lack of transparency.

Shortcomings of Floor-Based Model.The traditional floor-based model may also reduce the speed of execution and increase the
potential for errors and disputes, resulting in increased market and execution risk. Sophisticated trading strategies, such as those involving the execution of trades in more than one security or
using multiple types of financial instruments, are particularly difficult to accomplish without rapid, direct and anonymous electronic market access.

Market Data and Order Handling Rules.Regulatory and technological developments over the past few years have led to gradual
increases in competition among trading facilities for securities that are listed on an exchange or traded on Nasdaq. To fulfill its statutory mandate of fostering competition while integrating the
trading of securities on different venues into the National Market System (NMS), the SEC has required the national securities exchanges and associations, also known as SROs, trading those stocks to
jointly operate and participate in:



Market
data for exchange-listed securities is consolidated through the Consolidated Tape Association Plan and for Nasdaq-listed securities through the Nasdaq OTC/UTP Plan. Through the
Pacific Exchange, we have gained access to the Intermarket Trading System (ITS), enabling us to access publicly displayed orders in all ITS participant markets trading U.S. exchange-listed stocks and
make our own orders available for execution through ITS. Through the Pacific Exchange, we have also gained access to other national market system plans, enabling us to share in the revenues generated
by the sale of consolidated market data to vendors and market participants, and entitling us to direct connectivity to those systems.

Decimalization.The introduction in April 2001 of decimalization, or the quoting of stock prices in dollars and cents
rather than in dollars and fractions of a dollar (such as 1/8 or 1/16), has also had an impact on the U.S. securities markets and increased competition among trading
participants. The smaller price increments possible after decimalization have enabled investors to obtain price improvement more often than with the previous method of quoting stock prices in dollars
and fractions of a dollar. Because decimalization narrows average trading spreads (the difference between the price offered by a buyer and that asked by a seller), it has had a negative impact on the
profitability of traditional market makers. Due to the lower margins created by decimalization, the use by market makers of electronic trading systems, where there is no need for
higher-cost human brokers, has increased.

The
impact of decimalization, together with increasing competition, led many ATSs to lower their commissions dramatically. As a result, we were forced to lower our commissions to remain
competitive. Such pricing pressures have had a significant negative impact on our profitability.

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In
December of 2004 the SEC re-published for public comment in the Federal Register "Regulation NMS," a series of market-reform proposals designed to modernize the regulatory
structure of the U.S. equity markets. The comment period for the re-published Regulation NMS proposals expired on January 26, 2005 and the SEC may vote on the proposals during 2005.
Regulation NMS's current proposals include:

Trade Through Rule.Currently, the U.S. markets employ an order execution rule called the "trade-through rule" which applies
only to exchange-listed securities, not to Nasdaq-listed securities. Generally, the trade through rule prohibits markets from executing orders at inferior prices when there
is a better bid or offer available on another market. Regulation NMS proposes two alternative changes to the trade through rule. The first alternative would require broker-dealers to make available,
for protection under the trade through rule, the best bids and offers, also known as "top of the book", across all markets. The second alternative would require that broker-dealers take price
discovery further by exposing several levels of quotes, known as "depth of book", across all markets. In both alternatives, bids and offers displayed on an automated market would be protected from
being traded through by any market. Bids and offers displayed on a non-automated market, however, would not be protected from being traded through by any market under both alternatives. An
"automated market" is essentially one that executes an incoming order on an immediate basis without human intervention.

Intermarket Access Rule.The proposed Intermarket Access Rule would allow for the use of private linkages, rather than
mandating a collective linkage facility such as ITS to facilitate order interaction between markets. The proposed rule would also require: (i) setting a limit on the access fees charged by
trading centers when incoming orders execute against their quotes (the current proposed cap is $0.003 per share or 30 cents per 100 share order); (ii) lowering the volume threshold at which an
ATS would be required to display its prices (currently the threshold is 20% of the average daily volume in a security, but the threshold would be lowered to 5%); and (iii) SROs to establish and
enforce rules that prohibit members from displaying quotes that internally lock or cross the automated quotes of other trading centers. A locked market occurs when the price to buy a stock is the same
as the price to sell the stock. A crossed market occurs when the price to buy a stock is higher than the price to sell a stock.

Market Data.The Market Data proposal would change the current formula for allocating revenues generated by market data fees
to market centers that produce the data for investors. The new formula would allocate revenues to market centers based on the value of the quotes and trades for all securities rather than the current
system that is based simply on the number of trades (as it relates to exchange-listed securities) or a combination of trades and shares (as it relates to Nasdaq-listed securities). The new rule would
give market centers and their members the ability to distribute their own data independently with or without fees. However, market centers would still be required to provide their best bids and offers
and last sale information for consolidated dissemination through the joint-industry plans.

Sub-Penny Pricing.The Sub-Penny Pricing proposal would prohibit ECNs, exchanges, market makers and
alternative trading systems from displaying, ranking or accepting quotes in stocks and other symbols as determined by the SEC that are priced in increments of less than a penny, unless the stock price
is less than $1.00.

We
cannot predict whether or when one or more of these proposals will be adopted by the SEC; nor can we predict whether any proposal will be adopted in its current proposed form or in a
different form. For a discussion of proposed Regulation NMS and its potential adverse effects on our revenues, see
"Part IIItem 7Management's Discussion and Analysis of Financial Condition and Results of OperationsSources of
RevenuesTransaction Execution Services."

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In
December 2004, the SEC published a proposal (the "Fair Administration Release") and a related concept release concerning the system of self-regulation in the U.S.
securities markets. The proposal and the concept release address, among other things, SRO governance, disclosure, structure and funding. We cannot predict whether the proposal will be adopted by the
SEC in its proposed form, in a different form or at all, or the effect on PCX or our proposed acquisition of PCXH in the event any such proposal is adopted.

In
a separate effort designed to address the SEC's concern that some trading behavior by market participants may be motivated by maximizing market data fees that they receive from market
centers, the SEC recently asked the Pacific Exchange and other SROs to implement rule changes that would discourage the practice of "tape shredding." Tape shredding occurs when a trader divides an
order into smaller orders to increase the number of potential trades without actually changing the volume traded. In its request, the SEC also asked each market center to consider modifying the manner
in which it reports trades to the consolidated tape and to consider bundling trades resulting from incoming orders executed at the same price into a single trade. In its response to the SEC, PCX
stated that it believes addressing tape shredding through a rule-based approach is impractical and that the more appropriate approach would be a solution that focuses on modifying the market data
revenue formula, which has already been proposed by the SEC as part of Regulation NMS. We cannot predict whether or when the Pacific Exchange will adopt or implement any rules that would
discourage the practice of tape shredding, nor can we predict the form of any such proposed rulemaking. We also cannot predict whether the Pacific Exchange will modify the manner in which it reports
trades to the consolidated tape.



Innovations in technology and telecommunication have increased the speed of communications and the availability of information, facilitated the globalization of
commerce, and lowered transaction costs. New methods enable investors to access and participate in the equity securities markets more easily, quickly and less expensively. Electronic markets have
reduced the need for intermediaries, such as NYSE specialists or Nasdaq market makers, because they enable participants to effectively "meet" and determine the best price at which a trade can be
executed. These developments, combined with the
regulatory changes discussed above that allowed for the emergence of ATSs and the establishment of ArcaEx, have led to dramatic growth in electronic trading.



The U.S. equity markets have historically experienced growth in trading volumes of equity securities. From time to time, volumes have declined due to weak
economic performance and other related factors. From 1995-2000, the major U.S. equity market indices experienced substantial growth, followed by a severe decline and significant
volatility. The growth in equity volumes resulted from a number of factors, including strong economic conditions, technological innovations and greater market access. Technological innovations,
including the increasing importance of electronic trading platforms, have reduced transaction costs and further stimulated trading activity. New technology has also fostered the development of
high-volume electronic trading strategies.

During
2000 through early 2003, the major U.S. market indices experienced a severe decline and significant volatility. The weak and uncertain economic climate, together with corporate
governance and accounting concerns, contributed to lower equity prices, decreased corporate activity, increased market volatility, and a generally more difficult business environment. These trends
came after a period of tremendous growth throughout the late 1990s in the global equity markets. Beginning in the second half of 2001, through 2002, the growth rate of the volume of trading in the
U.S. markets began to slow, and in 2002, Nasdaq market volumes declined, although the volume of U.S. exchange-listed securities

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still
maintained moderate growth. In late 2003, however, the equities market experienced an unusually robust upward move following the challenging markets of 2000 through 2002.

During
2004, the U.S. equities market performance was decidedly mixed when compared to 2003, however, initial public offerings and merger and acquisition activity was strong, providing
for more trading activity in new issues and in the arbitrage arena. Overall, total U.S. market volumes in Nasdaq-, NYSE-, and AMEX-listed securities increased by 6.9% in 2004,
up from 926.5 billion shares in 2003 to 990.5 billion shares in 2004. For information concerning our market share, our trading volumes and other operating measures during 2004, see
"Part IIItem 7Management's Discussion and Analysis of Financial Condition and Results of OperationsKey Statistical
Information."

Our Competitive Strengths



As the operator of ArcaEx, the first open all-electronic stock market in the United States, we believe we have business flexibility and the
opportunity to increase our revenues. We believe these advantages, together with our efficient regulatory structure, will enable us to continue to improve our competitive position. For example:



Accordingly,
we believe our right to operate ArcaEx as the exclusive equities trading facility of PCX Equities allows us to compete more effectively with Nasdaq, the NYSE and ECNs.



Our technologically-advanced trading platform offers:



We
believe our technology has been and will continue to be a major factor in the development and growth of our business.

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Led by Gerald D. Putnam, our Chairman and Chief Executive Officer, we have a strong and dedicated management team with significant experience in the securities
trading industry and technology sector. These individuals have worked together closely since we partnered with PCX to create ArcaEx in 2000. We believe that through their leadership we have
successfully recognized and responded to market opportunities and adapted to numerous changes in our operating and regulatory environment, while
continuing to grow our business. We believe we have demonstrated our ability to innovate and execute successfully our business objectives:





We are committed to building strong relationships with our customers, and believe we have been successful in doing so through:



We
believe that the strong relationships we have forged with our customers, together with this embedded connectivity, make ArcaEx the preferred trading platform of many of our customers.

Strategy

We are committed to becoming the leading destination for equity securities trading in the United States. We seek to use our status as the operator of ArcaEx and
our technology platform to take advantage of growth opportunities in the securities trading industry resulting from evolving regulatory, market and technology conditions.



We seek to continue to sustain and grow our market share in our key markets: Nasdaq-listed securities, NYSE-listed securities and exchange-traded
funds. We believe that the advantages of ArcaExfast electronic execution, transparency and open market accesswill continue to attract more and more liquidity from the trading
community. Having achieved a leading market share in trading Nasdaq-listed securities, we believe we are well positioned to become the leading trading platform for

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Nasdaq-listed
securities. We will seek to use our established leadership in the over-the-counter and exchange-traded funds to take advantage of opportunities to increase our
market share in NYSE-listed securities.



We seek to grow and diversify our revenues by capitalizing on our status as the operator of a facility of PCX Equities and increasing our product offerings.

Increase our product offerings.We anticipate that the completion of our proposed acquisition of PCX will allow us to expand
our lines of business by entering into the options trading market as well as by functioning as a SRO. Additionally, we plan to continue to improve our technology and approach to delivering
high-quality trade execution services to our customers. We intend to enhance our market data products and develop new products based on our understanding of our customers' needs and our
ability to quickly bring new products to market. We will continue to seek to provide our customers with the most advanced and comprehensive products suited to their particular needs. We will also
continue to evaluate the attractiveness of new business development initiatives, and consider expanding our product offerings to provide products and services based on these new initiatives, such as
the creation of trading platforms for futures and other equity derivative instruments.

Promote Initial and Dual Listings.We intend to continue to promote, expand and enhance the benefits offered by our Corporate
Client Group to listed companies. Currently, these benefits include: (i) increased exposure to ArcaEx's broad client base; (ii) access to market data products such as ArcaVision, a
product that offers analytic tools that go beyond the traditional trading data that is available to customers; and (iii) competitive listing fees. We intend to continue to develop and market
our products and services to companies that are already listed on another market or exchange, such as
Nasdaq or NYSE, companies preparing for initial public offerings and companies currently traded on the OTC bulletin board.

Brand Awareness.To promote and build the ArcaEx brand, in September 2004, we launched our "Numbers This Big Are Hard
To Ignore" campaign which focused on generating initial awareness of Archipelago and ArcaEx among corporate issuers interested in both primary and dual listings as well as providing continued
awareness among the trading community. Specifically, "Numbers This Big Are Hard to Ignore" refers both to the masses that assemble in the campaign's commercials and to the trade volume and dollar
amounts that change hands on the ArcaEx every day. We intend to continue to build the ArcaEx brand and generate awareness of Archipelago and ArcaEx among corporate issuers and the trading community
through our marking and promotional efforts.



In recent years, the securities trading industry has experienced increased consolidation among market participants, and we believe this trend will continue. We
intend to take advantage of this trend by selectively pursuing acquisitions and entering into strategic alliances that will enable us to strengthen our current business, enter new markets and advance
our technology. We may also pursue partnerships and commercial agreements to take advantage of potential changes in our industry. We believe that the REDIBook merger and our acquisition of GlobeNet
have demonstrated our ability to successfully execute this strategy by rapidly integrating the facilities and technologies we acquired, with positive effects on our business. Except for our proposed
acquisition of PCXH and its wholly-owned subsidiaries, we have not entered into any other definitive agreements for any material acquisitions or alliances.

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Our Operations



We provide trading platforms and services that are designed to improve the speed and quality of trade execution for our customers. Our revenues are derived
primarily from transaction fees and market data fees. In an effort to diversify our business, we are in the early stages of introducing new products, such as our analytic market data tools designed to
enhance customers' understanding of market dynamics. To date, however, these activities have not contributed significantly to our revenues.



We operate two trading platforms, ArcaEx and the ArcaEdge, and offer a variety of execution-related services, including our outbound trading capability and
routing services through the NYSE's Designated Order Turnaround system (DOT). Until April 2003, we also operated the Archipelago ECN.

The Archipelago Exchange or ArcaEx®.Through ArcaEx, our customers can trade over 8,000 equity securities,
including securities listed on the NYSE, Nasdaq, AMEX and PCX, exchange-traded funds and other exchange-listed securities. ArcaEx operates on three simple but fundamental principles: fast electronic
execution, transparency and open market access. On ArcaEx, buyers and sellers meet directly in an open electronic environment governed by trading rules designed to reflect these three fundamental
principles.

On
ArcaEx, buyers and sellers can view our open limit order book, known as the ArcaBookSM, which displays orders simultaneously to both the buyer and the seller. Buyers and
sellers also can submit these orders on an anonymous basis if they so choose. Permitted users of ArcaEx, referred to as equity
trading permit holders, and other users of ArcaEx who are introduced to the system by equity trading permit holders, are able to submit orders to the ArcaBook. Any registered broker-dealer who wishes
to trade on ArcaEx must become a permit holder by obtaining an equity trading permit from PCX Equities. Broker-dealers that do not hold exchange trading permits may access ArcaEx through our
subsiduary ATS. Once orders are submitted, all trades are executed in the manner designated by the party entering the order, which is often at prices equal to or better than the national best bid or
offer. The national best bid or offer is the highest bid or lowest offer quote reported to the Consolidated Tape Association and Nasdaq pursuant to the quotation and transactions reporting plans
discussed below under"Part IItem 1BusinessMarket Data Products." As part of our best execution
model, our trading system is designed to search across different market centers, including the NYSE and other exchanges, ECNs and Nasdaq, for the best price for each order. Our trading rules are
predicated on the principle of "price-time priority" within ArcaEx, which requires execution of orders at the best available price and, if orders are posted at the same price, based on the
time the order is entered on ArcaEx. Buy orders and sell orders are posted on ArcaEx in price order (best to worst) and then if prices are the same, they are ordered based on the time the buy order or
sell order was posted (earliest to latest). ArcaEx users may choose to have their unexecuted orders left on the ArcaBook, returned to them, or routed to other markets using our outbound trading
capability. One of our broker-dealer subsidiaries provides us with a routing service on a non-exclusive basis and routes orders for our participating customers to external market centers.
The technological capabilities of our trading systems, together with our trading rules, have allowed us to create a large liquidity pool available to customers internally on ArcaEx and externally
through other market centers. For more detailed information, see"Part IItem 1BusinessTrading on
ArcaEx"below.

We
believe that ArcaEx provides customers with faster electronic execution, more transparency and open market access than traditional floor-based exchanges. First, ArcaEx's electronic
trading system enables buyers and sellers to meet directly in an electronic environment. Second, unlike traditional, floor-based exchanges, ArcaEx provides fully automated and totally transparent
opening and closing

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auctions
for all eligible securities traded on ArcaEx. All orders are on equal footing, providing all participants the opportunity to be competitive.

During
2004, our customers executed approximately 416.6 million transactions in U.S. equity securities through ArcaEx, with 86.6% of the volume represented by transactions
executed within our internal liquidity pooli.e., the matching buy and sell orders were posted on ArcaExwithout routing to other market centers. We refer to these customer
orders as "customer orders matched internally," and to customer orders that we route to other market centers as "customer orders routed out." Other trading statistics for 2004 include:



We
believe that as market participants recognize the benefits of ArcaEx as an alternative to floor-based trading systems, we can continue to grow our market share for
NYSE-listed securities over time. For a discussion of the methods by which we calculate our market share, our trading volumes and other operating measures, see
"Part IIItem 7Management's Discussion and Analysis of Financial Condition and Results of OperationsKey Statistical
Information."

The ArcaEdge.We also operate The ArcaEdge, a trading platform designed to bring the benefits of ArcaExfast
electronic execution, transparency and open market accessto the trading of small-cap equity securities that are quoted on the OTC Bulletin Board. During 2004 trading on
ArcaEdge accounted for less than 1% of our transaction fees.

Additional Transaction-Related Services.In addition to operating our trading platforms, we offer additional execution
services through our wholly-owned subsidiaries, including routing services through the NYSE's DOT.

Through
Archipelago Securities, our broker-dealer subsidiary, our customers can route orders to DOT, an electronic order delivery system operated by the NYSE. This DOT routing service
offers our customers anonymous electronic access to the NYSE, and is offered as a separate service from ArcaEx trading. Orders sent to ArcaEx may be sent to the NYSE for execution through our outbound
trading capability if the NYSE offers the best price in the market at the time the order is submitted. Through our DOT routing service, certain of our customers can choose to send their orders
directly to the NYSE without first submitting them to ArcaEx. We obtain access to the DOT system either indirectly through a third-party broker-dealer or directly through Archipelago Securities. As
described below under"Part IItem 1BusinessTrading on ArcaExClearing". Archipelago
Securities also provides execution services for customer orders that are routed to other market centers.

In
2001, we formed Archipelago Europe Limited, a broker-dealer registered with the Financial Services Authority in the United Kingdom. Archipelago® Europe maintains an office
in London and markets the products and services we offer to European institutional investors. We believe that our expanded presence in Europe will enable us to promote our
over-the-counter and exchange-listed

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trading
capabilities to potential European customers. We believe that Archipelago Europe will also provide our existing European customers with direct customer support.

In
2002, we formed Wave Securities Canada Inc., a broker-dealer formed under the laws of New Brunswick, Canada, and registered as an Investment Dealer with the British Columbia
Securities Commission, the Ontario Securities Commission and the Quebec Securities Commission. Wave Securities Canada Inc. maintains its offices in Toronto. We formed Wave Securities
Canada Inc. to comply with Canada's newly promulgated Regulation ATS. Currently, Wave Securities Canada Inc. acts as an introducing broker for Canadian institutions that wish to access
ArcaEx.



We offer customers market data products on a real-time and on a summary basis. Our market data products are designed to improve trade execution and
enhance understanding of market dynamics. Our customers can view in real time the bids and offers posted on ArcaEx and can access other extensive market and trading data through our website. In 2004,
we launched ArcaVision, a product that provides customers with critical market data on particular stocks.

Real-time Data Feeds and Market Data Fees.Through the Pacific Exchange, we participate in the national market
system for the consolidation, dissemination and sale of market data in U.S. exchange-listed securities and Nasdaq-listed securities. Market data for exchange-listed securities is consolidated through
the Consolidated Tape Association Plan, or CTA Plan, and for Nasdaq-listed securities through the Nasdaq OTC/UTP Plan. Through the Pacific Exchange, we earn market data fees, based on the level of
trading activity on ArcaEx, by providing our data to the centralized aggregators of this information that in turn sell the data to third-party consumers such as Thomson Financial Inc. and
Bloomberg, L.P.

The
Consolidated Tape Association is an association consisting of representatives from the Pacific Exchange (through which we participate), AMEX, the Chicago Stock Exchange, Inc.,
Nasdaq (through its delegated authority from NASD), NYSE, the Philadelphia Stock Exchange, the National Exchange, Inc. (formerly the Cincinnati Stock Exchange), the Boston Stock
Exchange, Inc., and the Chicago Board Options Exchange, Inc. CTA's function is to oversee the dissemination, on a current and
continuous basis, of last sale prices of transactions in securities listed on a national securities exchange. Under the CTA Plan, the nine market centers:



The
nine participants select an exclusive securities information processor, or SIP, currently the Securities Industry Automation Corporation, or SIAC, to operate their common data
facility. The SIP's functions are:



The
participants of the OTC/UTP Plan are Nasdaq, AMEX, the Chicago Stock Exchange, the Philadelphia Stock Exchange, the Boston Stock Exchange, the National Exchange, and the Pacific
Exchange (through which we participate). Under the OTC/UTP Plan, Nasdaq currently operates as the SIP for the collection and dissemination of best bid and offer and the last transaction information
from

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all
of the exchanges and markets that quote and trade in Nasdaq-listed securities. Each participant of the OTC/UTP Plan can quote and trade any security listed on Nasdaq.

Under
each of the CTA Plan and the OTC/UTP Plan, there is a revenue sharing arrangement. Under the revenue sharing agreement for the OTC/UTP Plan, the SIP and the Plan administrators are
permitted to deduct certain costs associated with their functions from the total amount of the market data fees collected. After these costs are deducted from the market data fees, the Plan
administrator distributes to the respective plan participants, including the Pacific Exchange, their share of market data fees based on their respective number of executed transactions, in the case of
the CTA Plan, and a combination of their respective trade volume and share volume, in the case of the OTC/UTP Plan. ArcaEx receives its share of these market data fees through the Pacific Exchange.
Under the CTA Plan, the SIP and the Plan administrators may bill each exchange independently for SIP services, and they may only deduct certain costs associated with its functions from the total
amount of the market data fees collected.

In
recent years, the SEC and some market participants have proposed changes to the CTA Plan and the OTC/UTP Plan, including a proposal to eliminate the exclusive role of the SIPs. As
discussed above in this "Part IItem 1BusinessIndustry OverviewU.S. Market Structure and Recent
Trends", in December 2004, the SEC re-published "Regulation NMS," which if adopted as proposed would change the formula by which market data fees are divided
among participants under the CTA Plan and OTC/UTP Plan. For a discussion of this proposal, including risks we may face if Regulation NMS is adopted as proposed, see
"Part IIItem 7Management's Discussion and Analysis of Financial Condition and Results of OperationsSources of
RevenuesTransaction Execution Services".

ArcaVision.In 2004, we launched ArcaVision, a product that offers analytic tools that go beyond the traditional trading data
that is available to customers. ArcaVision, developed in response to customer demand for increasingly detailed analyses of trading patterns, is designed to provide customers with critical market data
on particular stocks. The ArcaVision website is now available to issuers listed on the Pacific Exchange, customers executing trades on ArcaEx, and the general public. ArcaVision's sophisticated
permissioning system enables us to customize the views available to each user to meet their specific needs. Through ArcaVision, we offer the following types of analytic data products:



We
offer ArcaVision to our trading customers and listed companies.



Under our contractual agreements with the Pacific Exchange, we are entitled to all listing fees from issuers that list their equity securities on the Pacific
Exchange. Because we are not a national

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securities
exchange, an issuer seeking to obtain an "ArcaEx listing" must list on PCX for trading on ArcaEx. Through our current alliance with the Pacific Exchange, we offer companies and index
providers that list on PCX a trading venue for their equity securities, exchange-traded funds and other structured products. ArcaEx offers various benefits to PCX-listed issuers, including
competitive listing fees and access to real-time and summary market data. Summary data products include ArcaVision. Compliance with the listing standards is monitored and enforced by PCX
Equities. We believe that our introduction of value-added products, such as ArcaVision, for our existing clients will make the Pacific Exchange a more attractive listing venue for trading on ArcaEx.
On February 28, 2005, PCX filed with the SEC for public comment and its approval, proposed revisions to our listing fees.

As
of December 31, 2004, there were approximately 236 companies listed on the Pacific Exchange, spanning a broad range of industries, including many Fortune 500®
companies. Almost all of these companies have been listed prior to our partnership with the Pacific Exchange in 2000. Of these companies, six were exclusively listed on the Pacific Exchange for
trading on ArcaEx including our common stock.

Most
companies listed on the Pacific Exchange are also listed on the NYSE. Of the 236 companies listed on the Pacific Exchange for trading on ArcaEx in 2004, approximately 200 of these
companies were also listed on the NYSE, approximately 24 were also listed on the AMEX and 7 were also listed on Nasdaq.

In
order to list on the Pacific Exchange, a company must meet quantitative and qualitative listing criteria, including minimum market capitalization, net worth, number of shares
outstanding and number of beneficial owners. In addition, listed companies must comply with corporate governance rules of the Pacific Exchange, which implement the corporate governance provisions of
the Sarbanes-Oxley Act of 2002.



Through our wholly-owned subsidiary, Wave Securities, L.L.C. (Wave), we also offer customers brokerage execution services. Wave provides a broker-dealer platform
and software for institutional customers and other customers looking to trade on ArcaEx and to access other U.S. equity markets electronically.

Institutional
customers, such as mutual fund managers, other investment advisers and hedge funds, are generally not registered as broker-dealers and therefore are not eligible to obtain
an equity trading permit, which is required to execute trades on ArcaEx. Therefore, as an equity trading permit holder, Wave provides access to ArcaEx by delivering direct access technology and
connectivity to these non-equity trading permit holders, allowing them to enter orders to purchase and sell equity securities themselves rather than directing those orders to a traditional
broker.

In
addition to providing access, Wave provides trade support as well as clearing and trade allocation services to these institutional customers. Wave may provide access to ArcaEx for
broker-dealers that may be seeking to maintain anonymity of their trades and, to a lesser extent, reduce their clearing charges.

Wave
does not engage in proprietary trading or provide sales trading services to customers. Wave's most significant expenses include execution fees paid to market centers to which it
offers access, clearing fees, license fees for software provided to institutional customers, and connectivity fees paid to network providers.

For
regulatory reasons, Wave is required to be physically separate from ArcaEx. In accordance with an SEC order approving proposed rule changes by the Pacific Exchange in connection with
the establishment of ArcaEx as the equities trading facility of PCX Equities, the functions of Wave and its separation from ArcaEx were established. Wave is also a registered broker-dealer under the
Securities

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Exchange
Act of 1934 (Exchange Act), a member of the NASD and a member of the Securities Investor Protection Corporation.



As previously discussed above in this"Part IItem 1BusinessBusiness
Developments", we have entered into an agreement to acquire PCXH and all of its subsidiaries, including PCX. Our current relationship with our regulator PCX, which is a
wholly-owned subsidiary of PCXH, is described below. Currently, we cannot predict the effects of our proposed acquisition of PCXH on our current relationship with PCX.

In
July 2000, we entered into a facility services agreement with the Pacific Exchange governing our relationship with the Pacific Exchange and PCX Equities, a
for-profit corporate subsidiary of the Pacific Exchange to which the Pacific Exchange has delegated certain regulatory authority for ArcaEx. Under the terms of the agreement and a related
contribution agreement (collectively referred to as the "contractual agreements"), the Pacific Exchange granted us the exclusive right to establish and operate ArcaEx as a facility of PCX Equities
with respect to instruments traded on or eligible to be traded on the equities floor of the Pacific Exchange, as well as the right to receive all transaction fees, all market data fees and all listing
fees from the operation of ArcaEx.

Gerald
D. Putnam, our Chairman and Chief Executive Officer, is a member of the board of directors of the Pacific Exchange. Under a contribution agreement between the PCX and Archipelago,
the Company has the right to appoint an individual to be appointed or elected to the Board of Governors of the Pacific Exchange. Philip D. DeFeo, Chairman and Chief Executive Officer of the Pacific
Exchange, is a member of the board of directors of Archipelago. Under our certificate of incorporation, for so long as ArcaEx remains an equities trading facility of PCX Equities and our facility
services agreement with the Pacific Exchange and PCX Equities remains in effect, one of our directors must be a member of the board of directors of the Pacific Exchange or an officer or employee of
the Pacific Exchange nominated by the board of directors of the Pacific Exchange.

Under
the terms of the contractual agreements, we are required to negotiate the regulatory fee in good faith. In 2004, we paid the Pacific Exchange approximately $7.2 million for
regulatory services.

On
October 25, 2001, the SEC issued an order approving proposed rule changes by the Pacific Exchange in connection with the establishment of ArcaEx as the equities trading
facility of PCX Equities. Under these rules, PCX Equities, using its own regulatory staff and not the employees of Archipelago, is responsible for conducting surveillance, examinations and enforcement
to monitor compliance by ArcaEx and the broker-dealers who trade on ArcaEx, as well as their associated persons, with PCX Equities rules and procedures and federal securities laws and regulations. The
Pacific Exchange retains the ultimate responsibility, as our self-regulatory organization, for the administration, compliance, and oversight of ArcaEx's rules and regulations as well as
compliance by its members with the federal securities laws and regulations. The Pacific Exchange's board of directors must review and approve rule making and enforcement decisions of PCX Equities.
ArcaEx's rules and regulations are designed to ensure fairness, encourage competition and maintain an open and
transparent market. We operate ArcaEx and are responsible for ArcaEx's business activities to the extent that those activities are not inconsistent with the regulatory and oversight functions of the
Pacific Exchange and PCX Equities as set forth in the PCX rules and the SEC order.

In
addition, PCX Equities rules provide that the books, records, premises, officers, directors, agents and employees of Archipelago are deemed to be the books, records, premises,
officers, directors, agents and employees of the Pacific Exchange and PCX Equities for purposes of the federal securities laws. As a result of these rules, in addition to direct oversight by the
Pacific Exchange and PCX Equities, Archipelago and its directors and officers are also subject to the SEC's oversight to the same extent as the Pacific Exchange, PCX Equities and the Pacific
Exchange's directors and officers.

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Information Technology



Technology is fundamental to our overall business strategy. We are committed to the ongoing development, maintenance and use of technology and to providing our
customers with technological solutions. We spent approximately $30.0 million on our information technology in 2004.

Our
technological initiatives are focused on satisfying each of the objectives set forth below:



Our
electronic trading platform runs on mid-range Sun Microsystems servers. Our system is also designed to accept up to 10,000 orders per second and to provide up to 2,000
simultaneous customer connections. During 2004, our system handled an average of 19.2 million orders daily and 1.7 million trades daily, with a capacity to handle 6 million trades
daily. We believe that we can quickly increase this capacity to a maximum of 10 million trades daily.



Data Centers.To enhance the capacity and reliability of our systems, we have established data centers located in Chicago,
Illinois and Weehawken, New Jersey. Our primary data center is located in Chicago, Illinois and is approximately 14,000 square feet in size. This data center became operational in the second quarter
of 2002. We occupy approximately 8,200 square feet of space in Weehawken, New Jersey as our backup and recovery data center. This facility is redundant with the Chicago facility, permitting continued
operations if either facility should fail.

We
help ensure the integrity of our data network through a variety of methods, including access restrictions and firewalls. We monitor traffic and components of our data network, and we
use an application to detect network intrusions and monitor external traffic. Customer circuits and routers are monitored around the clock and anomalies in customer circuits are reported to our staff
and carrier support personnel for resolution.

Connection options.We provide customers with a variety of ways to connect to ArcaEx. Customers can connect to ArcaEx through
a wide variety of order management systems, third party private networks and service bureaus. ArcaEx can be accessed through the following networks: IXNet/Global Crossing, MacGregor, Radianz, TNS and
TradeRoute.

For
a dedicated private line, standard telecommunications equipment includes a network router and associated hardware. To ensure proper installation, customers must provide a contact for
communications, firewall, LAN and software issues in addition to the exact address and location for the line installation. Most customers interface to ArcaEx via one of two primary methods: frame
relay or point-to-point (leased lines). Typically the choice of method is based on two criteria: the bandwidth requirements of the customer and the most cost effective way to
satisfy those requirements. If a customer is in a major metropolitan area close to one of our data centers (Chicago or New York), a leased line affords the best price and performance. Alternatively,
customers more distant from our data

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centers
generally find that the less expensive frame relay connection meets their needs. Regardless of the method chosen, circuit redundancy and diversity can be provided.

A
virtual private network test connection provides customers with a secure encrypted private connection over the Internet between the customer's network and ArcaEx. Customers can use a
VPN to test their application.

Interface options.We offer our customers different ways of interfacing with ArcaEx. These include FIX Gateway Interface and
RealTick® Interface. Through the Archipelago® FIX Gateway, our customers can access ArcaEx using their existing trading system and third party vendors. The Financial
Information eXchange (FIX) protocol is a messaging standard developed specifically for real-time electronic exchange of securities trading information. Archipelago confirms a customer's
FIX connectivity through Arca Certification Testing.



The securities markets generally and our business in particular are intensely competitive, and we expect competition to intensify. We compete on the basis of
several factors, including the following:



Our
primary competitors for trade execution of Nasdaq-listed securities are Nasdaq and Instinet. We also compete to a lesser extent with other ECNs and ATSs. Our primary competitors for
trade execution of exchange-listed securities are the NYSE and the AMEX, the exchanges on which most exchange-listed equity securities in the United States have their primary listing. We primarily
compete with Instinet, Nasdaq and AMEX with respect to trade execution of exchange-traded funds.

We
intend to compete with the NYSE, AMEX and Nasdaq for listing fees. Although Nasdaq and the NYSE currently generate significantly more listing revenues than the Pacific Exchange, we
seek to grow our listing revenues and have launched a marketing campaign designed to increase brand awareness of ArcaEx in 2004. We also compete with these entities for market data fees based
generally on our share of total trading volume.

We
will face many challenges in competing with other market centers. We believe that the NYSE and Nasdaq have significantly more developed brands than we do, giving them a competitive
advantage in attracting listings to their trading markets. In addition, listing fees provide our principal competitors with more diversified revenues than we have, giving them a competitive advantage
in the event of a
market-wide reduction in trading volumes or a decrease in transaction fees or market data fees.

We
believe that one of our greatest competitive challenges lies in attracting trading volume in NYSE-listed securities away from the NYSE. The NYSE has significantly more
liquidity in trading securities listed on its exchange than we do. This means that market participants send many more orders for purchase or sale of NYSE-listed securities to the NYSE than
to ArcaEx. It is easier for sellers to find buyers, and for buyers to find sellers, in a large group of buyers and sellers than in a small group (i.e., a more liquid market). Market participants are
also more likely to get the best price

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for
their orders when their orders are exposed to the largest number of buyers and sellers. Because established liquidity pools attract buyers and sellers, it is difficult for developing market
centers to increase their market share. We also believe that the "trade-through" rule of the Intermarket Trading System may place the NYSE at a significant competitive advantage over electronic
marketplaces such as ArcaEx. For a discussion of the trade-through rule, see below"Part IItem 1BusinessCertain Factors
That May Affect our BusinessThe 'trade-through' rule of the Intermarket Trading System limits our ability to grow our market share in trading of NYSE-listed
securities".

We
also face substantial price competition. In recent years, the pricing model for trade execution for equity securities has changed in response to competitive market conditions. To
encourage investors to trade in their market centers, many of our competitors in the over-the-counter market reduced the fees they charge customers for trade execution. In
addition, some competitors offered to pay fees, referred to as "liquidity payments," to customers who added liquidity to their systems by posting buy orders or sell orders that were matched, or
executed against, on their system by participants purchasing or selling securities. For example, beginning in 2001, Instinet aggressively reduced prices by introducing a reduced fee schedule for
market participants "taking liquidity" from its system (by matching, or executing against, an order posted on its system). In addition, Instinet offered to make payments to market participants
providing liquidity to its system (by posting a buy or sell order on its system that is matched, or executed against, by a liquidity taker). As a result of increased price competition, beginning in
April 2002, we aggressively reduced our transaction fees to match our competitors and, as a result, our revenues per transaction executed on the Archipelago system declined. In addition, in
April 2002 we began making liquidity payments to customers adding liquidity to the Archipelago system in select securities. Since that time, we have continued to experience significant price
competition for trade execution.

Price
competition also extends to market data fees, a portion of which we rebate to our customers for trading in exchange-listed securities. Recently our competitors have started to
share the market data fees paid to them for trades executed on their system to encourage trading on their market centers. For example, Instinet recently revised its pricing structure to provide that
customers that add liquidity to the Instinet limit order book in Tape B securities (e.g., AMEX-listed securities) will receive a portion of the market data revenue paid by the Consolidated
Tape Association based on the number of reportable transactions executed by the customer. However, customers removing liquidity
will not receive market data revenue from Instinet. Nasdaq also implemented a pricing structure where it will share market data revenue with customers for Tape A and B securities.

It
is likely that we will continue to experience significant pricing pressures and that some of our competitors will seek to increase their market share by further reducing their
transaction fees, by offering higher liquidity payments or by offering another form of financial or other incentive. For example, on February 1, 2005, Nasdaq and its affiliate Brut implemented
new pricing for trading exchange-listed securities which: (i) reduced the fees for trade executions for AMEX-listed ETFs; and (ii) charged a fee of $0.004 per share executed for certain
routed orders. In addition, Nasdaq and its affiliate Brut have also eliminated access fees for trade executions in NYSE-listed securities.

Competition
has also intensified due to an increase in consolidations among participants in our industry. As a result of a consolidation, the surviving entity may have greater resources
than we do and may offer a larger internal liquidity pool than Archipelago. However, we believe that our outbound order routing system would allow us to compete effectively with such a combined
entity.



To promote and build the ArcaEx brand, in September 2004, we launched our print and electronic media "Numbers This Big Are Hard To Ignore" campaign which
focused on generating initial awareness of Archipelago and ArcaEx among corporate issuers interested in both primary and dual

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listings
as well as providing continued awareness among the trading community. Specifically, "Numbers This Big Are Hard to Ignore" refers both to the masses that assemble in the campaign's commercials
and to the trade volume and dollar amounts that change hands on ArcaEx every day.



As of December 31, 2004, we had 234 employees. None of our employees is subject to collective bargaining agreements or represented by a union. We consider
our relations with our employees to be good.

Certain Factors That May Affect Our Business



As
previously discussed above in this "Part IItem 1BusinessBusiness Developments", we
have entered into an agreement to acquire PCXH and all of its subsidiaries including PCX. Upon completion of the acquisition, PCXH, PCX and PCX Equities will operate as wholly-owned subsidiaries of
Archipelago.

There
are significant risks and uncertainties associated with our proposed acquisition of PCXH and its subsidiaries. For example, the acquisition may not be consummated, or may not be
consummated during 2005 as currently anticipated, as a result of several factors, including but not limited to: (i) the inability to obtain regulatory approvals of the acquisition, or to obtain
such approvals on the proposed terms; (ii) the submission of alternative proposals to acquire PCXH or its subsidiaries from competitors; or (iii) the failure of PCXH to receive
shareholder approval for the acquisition.

Furthermore,
we may fail to realize the growth opportunities and the anticipated benefits to be derived from the combined businesses. There can be no assurances that our systems,
policies or procedures will be implemented or integrated successfully into PCXH or its subsidiaries. There also can be no assurance that we will be able to successfully and timely integrate the
operations, products, services or technology of PCXH and its subsidiaries with our Company. There also may be delays, complications and expenses relating to such implementation and integration. If we
are not able to successfully combine our businesses, the anticipated benefits from the acquisition of PCXH and its subsidiaries may not be realized fully or at all or may take longer to realize than
expected. It is possible that the integration process could result in the loss of key employees, or that the disruption of our business or the ongoing business of PCXH and its subsidiaries due to the
acquisition could adversely affect our ability to maintain relationships with customers or compete effectively in the market. Finally, upon consummation of the acquisition, management's present
expectations of the future results of the acquisition may be modified or revised.

Failure
to manage our proposed acquisition of PCXH and its subsidiaries, or any other future acquisition we may undertake, could adversely affect our growth strategy and our future
profitability and subject us to the risks identified above. Additionally, PCX and PCX Equities serve as our regulator. In the event that our proposed acquisition of PCX is not consumated and material
conflicts of interest develop between our regulator and us, our operations could be adversely affected.



Currently, we operate in the equities securities market only and we do not trade non-equity securities, including options. We intend to expand our
services with the ability to trade additional products upon the completion of our acquisition of PXCH and its subsidiaries, including options.

The
options market is rapidly evolving, highly competitive and extensively regulated. Upon entering into the options market, we face competition from both established and emerging market
centers

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including
AMEX, the International Securities Exchange, the Philadelphia Stock Exchange, the Boston Options Exchange, LLC, and the Chicago Board Options Exchange, Inc. There can be no assurance
that a demand for our option trading services will develop or be sustained once generated. Furthermore, we cannot predict whether our option trading services will compete successfully with those of
existing competitors or new market entrants. Additionally, the steps that have been taken to protect PCXH intellectual property may be inadequate to prevent its unauthorized use by competitors. In
that event, defending our intellectual property rights could result in the expenditure of significant financial and managerial resources which could adversely affect the business, financial condition
and operating results. In the future we may be subject to intellectual property rights claims which may be costly to defend, could require us to pay damages and could limit our ability to use certain
technologies.

We
cannot predict whether we can successfully integrate the trading of option products or any other security into our current business. Accordingly, there can be no assurances that we
will be able to generate revenues from our future ability to trade options products or any other security.



We
derived over 99% of our total revenues from our transaction-based business for the year ended December 31, 2004. Currently, our transaction-based revenues consist of fees we
earn for trade execution primarily on ArcaEx (transaction fees), whether the trade is executed internally on ArcaEx or routed out to another market center, and fees we receive for market data we
provide to centralized aggregators based on trading activity on ArcaEx (market data fees). If we fail to diversify our product and service offerings, or fail to successfully integrate new products
into our business model, our operating results and future profitability will depend on our transaction-based business. The occurrence of any event that reduces the amount of transaction fees or market
data fees we receive, whether as a result of fee reductions, declines in trading volumes or regulatory changes, will have a direct and significant impact on our operating results and future
profitability.

In
addition, our dependence upon revenues derived solely from our transaction-based business may place us at a competitive disadvantage. Some of our competitors derive their revenues
from more than one source as a result of more diversified product and service offerings. For example, Nasdaq realizes substantial revenue from listing fees. As a result, lower transaction fees or
market data fees may impact our operating results and future profitability more significantly than our competitors', providing them with a competitive advantage in pricing their products and services
or withstanding a reduction in trading volume.

If
the amount of trading volume on ArcaEx decreases, we will experience a decline in both transaction fees and market data fees. If our share of total trading volumes decreases relative
to our competitors, we may be less attractive to market participants as a source of liquidity and we may lose trading volume and associated transaction fees and market data fees as a result. Other
securities exchanges, Nasdaq and ECNs compete vigorously with us for trading volume. For a discussion of the factors that may impact trading volumes, see below "Part IItem 1BusinessCertain Factors
That May Affect Our BusinessFactors beyond our control can cause trading
volumes to fluctuate, which could significantly reduce demand for our services and harm our business".



We
operate in a highly competitive business environment. We compete with a number of entities on several different bases, including the cost, quality and speed of our trade execution,
the functionality and ease of use of our trading platforms, the range of our products and services, our technological innovation and adaptation and our reputation. Our principal competitors include
the NYSE, Nasdaq and Instinet, which operates the INET ATS, the single electronic trading platform formed from the

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consolidation
of the Instinet ECN and the Island ECN. We also compete to a lesser extent with other ECNs and alternative trading systems. Some of our competitors are better capitalized and
substantially larger than we are and have substantially greater financial, technical, marketing and other resources. Some of our competitors, particularly with regard to public company listings, offer
a wider range of services, have broader name recognition and have a larger customer base than we do. Some of them may be able to respond more quickly to new or evolving opportunities, technologies and
customer requirements than we can, and may be able to undertake more extensive promotional activities. In addition, broker-dealers can internally match their customers' buy orders and sell orders
instead of sending them to market centers for execution, thus decreasing trading volume. If we are unable to compete successfully in the future, our business, financial condition and operating results
will be adversely affected. For a discussion of the competitive environment in which we operate, see above "Part IItem1BusinessOur BusinessCompetition".



The securities trading industry is characterized by intense price competition. In recent years, the pricing model for trade execution for equity securities has
changed in response to competitive market conditions. For example, beginning in late 2001 and early 2002, Nasdaq, Island and Instinet aggressively reduced prices by introducing a reduced fee schedule
for market participants "taking liquidity" from their systems (by matching, or executing against, buy orders or sell orders posted on their systems). In addition, Instinet offered to make payments to
market participants providing liquidity to its system (by posting buy orders or sell orders on its system that were matched, or executed against, by a liquidity taker). As a result of increased price
competition, beginning in April 2002, we aggressively reduced our transaction fees to match our competitors and began making liquidity payments to customers adding liquidity to the Archipelago
system in selected securities. As a result, our revenues per transaction executed on the Archipelago system declined and the growth of our transaction fees was significantly lower than the growth in
our trading volumes over this period. For example: (i) in 2002 our transaction fees increased by 106.4%, although our trading volumes increased by over 170% in the same period; (ii) in
2003 our transaction fees increased by 20.5%, although our trading volumes increased by over 40% in the same period; and (iii) in 2004 our transaction fees increased by 13.1%, although our
trading volumes increased by over 20% in the same period.

Our
revenues derived from market data fees are also subject to price competition. We currently rebate to our customers 50% of the market data fees we receive for trading in Tape B
securities (e.g., AMEX-listed securities), and many of our competitors offer their customers similar rebates. For example, Instinet recently revised its pricing structure to provide that
customers that add liquidity to the Instinet limit order book in Tape B securities will receive a portion of the market data revenue paid by the Consolidated Tape Association based on the number of
reportable transactions executed by the customer. Customers removing liquidity will not receive market data revenue from Instinet, however. Nasdaq recently also implemented a pricing structure where
it will share market data revenue with customers for Tape A and B securities. Price competition with respect to market data rebates could attract trading volume away from ArcaEx, leading to loss of
market share and decreased revenues.

Since
April 2002, we have continued to experience significant price competition for trade execution. It is likely that we will continue to experience significant pricing pressures
and that some of our competitors will seek to increase their market share by further reducing their transaction fees, by offering higher liquidity payments or by offering another form of financial or
other incentive. In the event that our competitors engage in any of these activities, our operating results and future profitability could be adversely affected. For example, we could lose a
substantial percentage of our market share if we are unable to price our transactions in a similar manner, or our margins could decline if we do reduce our pricing in response. In addition, one or
more competitors may engage in aggressive pricing strategies and significantly decrease or completely eliminate their profit margin for a

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period
of time to capture market share. This environment could lead to loss of market share and decreased revenues, and could adversely affect our operating results.

On
April 12, 2004, Nasdaq implemented a new pricing schedule for its SuperMontage trading platform that (i) increased the amount Nasdaq pays high-volume
customers (customers providing more than a daily average of 20 million shares) for "providing liquidity" to its platform and (ii) increased to a lesser extent the amount it charges all
customers for "taking liquidity" from its platform based on the average daily shares of liquidity provided by each customer. As a result of these changes, Nasdaq significantly reduced the spread
between the amount it charges high-volume customers and the amount it pays them, and reduced the amount per share it earns for these customers' trading activity. Because we rely on
high-volume market participants for a significant portion of our trading volumes and revenues, we believe this new pricing schedule may have partially contributed to the slight decrease in
our market share of Nasdaq-listed securities in the fourth quarter of 2004.

On
May 6, 2004, Nasdaq stopped charging market participants for "taking liquidity" in AMEX-listed securities (excluding ETFs) from its SuperMontage trading platform.
We currently charge our customers a $0.003 per share fee for taking liquidity from ArcaEx in AMEX-listed securities.

On
February 1, 2005, Nasdaq and its affiliate Brut implemented new pricing for trading exchange-listed securities which: (i) reduced the fees for trade executions in
AMEX-listed ETFs; (ii) charged a fee of $0.004 per share executed for certain routed orders. In addition, Nasdaq and its affiliate Brut have also eliminated access fees for trade
executions in NYSE-listed securities.

If
any or all of Nasdaq's pricing initiatives succeed in encouraging market participants to shift trading activity from ArcaEx to Nasdaq, our trading volumes and our revenues will be
materially and adversely affected.



As
a facility of the Pacific Exchange we are bound by the SEC rules that apply to exchanges. Under current rules, although exchanges are permitted to execute trades in
sub-penny increments, they may not display or rank quotes in increments that are less than a penny. All exchanges are required to round all quotes that are displayed on their proprietary
data feed to the nearest penny. ECNs, however, are able to both display quotes in increments that are less than a penny in their proprietary data feed, as well as execute trades in
sub-penny increments. As a result, ECNS could be a preferable trading venue for customers that desire to trade an equity security in sub-penny increments.



We
operate in a business environment that has undergone significant and rapid technological change. To remain competitive, we must be capable of identifying and responding to customers'
demands and evolving industry standards and regulations. For example, to achieve their trading objectives, our customers may demand new order types and enhanced order routing technology, which we may
not be able to develop successfully. If we are unable to anticipate and respond to the demand for new services, products and technologies on a timely and cost-effective basis, our
inability may have a material adverse effect on our business, financial condition and operating results. Moreover, even if we are able to develop and introduce new products and services on a timely
and cost-efficient basis, our products and services may not achieve market acceptance.

In
addition, we will face significant challenges as we seek to diversify our product and service offerings. We intend, for example, to diversify our business by competing with the NYSE,
other exchanges and Nasdaq for listing fees from new market entrants. We will face substantial competition from these market centers, which have greater brand recognition than we do and a substantial
number

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of
listings. Many of these competitors also offer a broader range of services to accompany their listings than we currently offer. We currently generate substantially less than 1% of our total
revenues from listing fees. Almost all of our listing fee revenue is derived from dual listed NYSE-issuers that selected the Pacific Exchange as an additional listing venue prior to our
launch of ArcaEx. As of December 31, 2004, only five issuers have listed their equity securities on the Pacific Exchange since the launch of ArcaEx. There can be no assurances that we will be
able to increase our revenues or to compete successfully by diversifying our product and service offerings in the future.

In
2004, the NYSE announced its intention to increase its focus on electronic trading with its "hybrid market" proposal that was filed with the SEC for approval on August 2, 2004.
The proposal would create a hybrid market that would still include the traditional system of floor traders who manually handle orders, but would increase the use of the NYSE's electronic trading
platform. Under its hybrid proposal, the NYSE would eliminate many of the limits on the size, timing and types of orders that could be placed through its electronic trading platform. We believe our
electronic trading model has significant advantages over the NYSE's current floor-based model and its proposed hybrid market. However, a move to enhance market participants' ability to engage in
automated electronic trading on the NYSE could undermine one of our competitive advantages and may negatively impact our business.



On
January 30, 2004, Nasdaq filed an amended registration statement with the Securities and Exchange Commission to modify the eligibility requirements for inclusion in the
Nasdaq-100 Index, traded as "QQQQ" (formerly "QQQ"), one of the most widely-traded exchange-traded funds. This amendment limits the eligibility for inclusion in the index to companies that
either are listed exclusively
on Nasdaq or were dually-listed on another U.S. market prior to January 1, 2004. Nasdaq-listed companies that obtain a dual listing on the Pacific Exchange after January 1, 2004 will be
ineligible to be included in the index. This amendment could create a significant disincentive to obtaining a dual listing on the Pacific Exchange for companies that desire to be included in the
Nasdaq-100 Index.



In
recent years, the securities trading industry has witnessed increased consolidation among market participants. Consolidations and alliances among our current competitors may create
larger internal liquidity pools than we offer. The resulting larger liquidity pools may attract orders away from us, leading to reductions in trading volume and liquidity on ArcaEx, and therefore to
decreased revenues. In addition, consolidations or alliances among our current competitors may achieve cost reductions or other increases in efficiency, which may allow them to offer better prices or
customer service than we do.

In
2004, Nasdaq acquired Brut, L.L.C., the owner and operator of a competing ECN. This transaction represents further consolidation among securities trading venues, which has increased
the competition among ArcaEx, Instinet and Nasdaq for increased market share of Nasdaq-listed securities. In addition, the increasing consolidation eliminates potential acquisition targets or
strategic partners.



We
are highly dependent upon our co-founder and Chief Executive Officer, Gerald D. Putnam. Mr. Putnam's talents and leadership have been, and continue to be, critical
to our success. The diminution or loss of the services of Mr. Putnam for any reason, and any negative market or industry perception arising from that diminution or loss, would have a material
adverse effect on our business. We have entered into an employment agreement with Mr. Putnam that is currently set to expire in December 2005, and will renew automatically for successive
one-year terms each December unless advance notice is provided by either party to the contrary. This agreement is important to the future of our business, and if we were to lose our rights
under this agreement for any reason, including as a

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result
of Mr. Putnam's voluntary resignation or retirement, our business would be materially adversely affected.

Our
success also depends largely on the efforts and abilities of the other key members of our senior management team. These individuals have worked together closely since we partnered
with the Pacific
Exchange to create ArcaEx in 2000. With the exception of Mr. Putnam, we do not have employment agreements with any member of our senior management team. Accordingly, it is possible that one or
more members of our senior management team will resign to work elsewhere. Because each member of our senior management team has a different area of specialization, the departure of any one of these
individuals could create a deficiency in one of the core aspects of our business. In addition, we may be unable to attract and retain qualified management and personnel in the future.

Our
success also depends on the efforts of our qualified and highly trained sales personnel and on our ability to recruit and retain highly skilled and often specialized personnel,
particularly in light of the rapid pace of technological advances. The level of competition in our industry for individuals with this level of experience or these skills is intense. Significant losses
of key personnel, particularly to competitors, could make it difficult for us to compete successfully in the securities trading industry.



The
regulations applicable to ArcaEx as a facility of PCX Equities are different from, and in some respects more restrictive than, those governing ECNs. As a result, the regulatory
structure applicable to ArcaEx may impact our operational flexibility in ways that could have a material adverse effect on our business. In addition, many of the regulations applicable to our business
may have the effect of limiting our future activities, including activities that may be profitable to us.

Rules
governing trading on ArcaEx, including any changes to those rules, must be approved by the SEC and the Pacific Exchange, our regulator and self-regulatory organization.
Some rules are submitted for public notice and comments are considered for an extended period of time by the SEC. As a result, developing new functionality for ArcaEx that requires rule changes may be
subject to significant regulatory delays, which could lead to loss of business opportunities. Some of our competitors may be able to develop new functionality with less regulatory difficulty or delay.
Our competitive position could be significantly weakened if our competitors are able to obtain SEC and any required self-regulatory organization approval for new functionality faster and
with less difficulty than we can.

PCX,
our regulator, is also highly regulated as a self-regulatory organization by the SEC, which will be subject to any final rule adopted by the SEC as a result of its
current proposal relating to the system of self-regulation in the U.S. securities markets. In addition to regulatory changes the SEC may propose in the future, regulatory actions against
the PCX could adversely affect our business. As previously discussed above under"Part IItem 1BusinessBusiness
Developments", we have entered into an agreement to acquire PCXH and all of its subsidiaries including PCX. Upon completion of the acquisition PCXH, PCX and PCX Equities will
operate as wholly-owned subsidiaries of Archipelago Holdings, Inc.



We
may face substantial difficulties in attempting to increase our market share in NYSE-listed securities trading. Our ability to increase our market share in
NYSE-listed securities trading may be limited by the "trade-through" rule of the Intermarket Trading System, or ITS, which we believe disadvantages electronic exchanges and trading
platforms. This rule generally prohibits "trading through" a better price, which occurs when a market center ignores a better buy or sell order disseminated on a competing market center.

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We
believe that the effect of this rule is often to delay the speed of execution and reduce execution quality. An order routed through ITS to another market center with a better price is
known as a "commitment to trade." Under current rules, a market center generally has at least 30 seconds (and, in some cases, up to two minutes) to decide whether to execute a commitment to trade.
However, during this time, the customer cannot cancel a buy or sell order once it has been placed. As a result of this time delay, there is a risk that the transaction will not be executed at all, or
will not be executed on terms as favorable to those available at the time the order was entered and routed through ITS. Despite the requirement that market centers route orders through ITS to another
market center, other market centers sometimes trade through better prices available on ArcaEx. We believe that the requirement to route commitments to trade through ITS has discouraged many of our
customers from increasing the volume of NYSE-listed securities they execute on ArcaEx.

Additionally,
Regulation NMS would establish a uniform trade-through rule for all market centers that would reaffirm price priority and, thus, require self-regulatory
organizations to establish procedures reasonably designed to prevent trade execution at a price inferior to the best bid or offer of each "order execution facility" that displays a quote in the
consolidated quotation system. As proposed, a "fast" or "automated" market would be able to ignore a superior price on a slow market if the price at which the order is executed is one cent to five
cents (depending upon the price of the stock) within the quoted national best bid or best offer. Investors deemed to be "informed" under the proposal could "opt-out" of application of the
trade-through rule and receive trade executions that trade through the quoted national best bid or best offer. We cannot predict whether these changes will be made to the trade-through rule in their
proposed form, a different form or at all.

In
September 2002, the SEC implemented a "de minimis" exemption to the trade-through rule for exchange-traded funds, or ETFs, tracking the Nasdaq-100 Index ("QQQs"),
the Dow Jones Industrial Average ("DIAMONDs") and the Standard & Poor's 500 Index ("SPDRs") for trade throughs up to 3 cents. These ETFs represented approximately 69.2% of our total trading
volume of ETFs on ArcaEx during 2004. In 2004, we handled 15.6 billion shares of ETFs on ArcaEx. This exemption has been extended from time to time and most recently has been extended through
September 4, 2005. We cannot predict whether the SEC will elect to extend the temporary de minimis exception beyond that date, propose a final rule or allow the exemption to lapse. If the de
minimis
exemption for ETFs is not extended, our trading volume of these ETFs could decrease, and our revenues could be adversely affected as a result.



In
December 2004, the SEC re-published in the Federal Register "Regulation NMS," a series of market-reform proposals designed to modernize the regulatory structure of
the U.S. equity markets. The comment period for the re-published Regulation NMS proposals expired on January 26, 2005 and the SEC may vote on the proposals during 2005. Although
there is significant uncertainty involving the interpretation of the proposed regulations, if adopted as proposed, we believe that they could have a material adverse effect on our revenues. For
example:



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We
cannot predict whether these proposed changes will be adopted by the SEC in their proposed form, a different form or at all. In addition, many interpretive questions have been raised
regarding the proposals as drafted and many variables must be considered in analyzing their impact. Accordingly, we cannot predict or quantify with any level of certainty the impact these proposed
rule changes will have on our business. However, we believe that if the SEC adopts a proposal that would reduce our revenues from trade execution or limit our operating margins by regulating pricing,
our results of operations and future profitability would be adversely affected. See"Part IIItem 7Management's Discussion and Analysis of
Financial Condition and Results of Operations".



We
operate in a highly regulated industry. In recent years, the securities trading industry and, in particular, the securities markets, have been subject to significant regulatory
changes. Regulatory changes are generally made in response to innovations in markets and technology or to address regulators' specific concerns, such as ensuring best execution for investors.
Moreover, the securities markets have been the subject of increasing political and public scrutiny in the past several years in response to a number of developments and inquiries. Any of these factors
or events may result in future regulatory or other changes, although we cannot predict the nature of these changes or their impact on our business at this time.

In
June 2004, the SEC adopted "Regulation SHO," which establishes procedures to allow the SEC to temporarily suspend the operation of the current "tick" test (under which a short
sale may be made generally when the price of the security is rising), and any short sale price test of any exchange or national securities association, for specified securities. In July 2004,
the SEC established a pilot program under Regulation SHO, which will commence on May 2, 2005. The Company is considering the impact of the pilot program to its business. The SEC deferred
consideration of the original proposal to replace the current "tick" test with a new uniform "bid test," which if adopted would allow short sales to be effected at a price one cent above the
consolidated best bid. This proposal would apply to all exchange-listed securities and Nasdaq-listed securities, wherever traded, with the exception of certain pilot stocks in which there will be no
short sale price test. The SEC could take further action on these proposals after the completion of the pilot program. We cannot predict whether the pilot program will be continued or modified in some
manner or whether the "bid test" proposal will be adopted by the SEC at a later date in its proposed form, in a different form or at all. Accordingly, we cannot predict the impact Regulation SHO would
have on our business.

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Our
customers also operate in a highly regulated industry. The SEC and other regulatory authorities could impose regulatory changes that could impact the ability of our customers to use
ArcaEx. The loss
of a significant number of customers or a reduction in trading activity on ArcaEx as a result of such changes could have a material adverse effect on our business.



During
2004, eight of our top ten customers by revenues were also our stockholders. Revenues generated from the investors represented 49.6%, 38.4% and 36.3% of our total revenues in
2002, 2003 and 2004, respectively. Transaction fees paid by The Goldman Sachs Group, Inc. and its subsidiaries, including Spear, Leeds & Kellogg L.P., accounted for 27.7%, 13.9% and 9.8%
of our total revenues in 2002, 2003 and 2004, respectively. The loss of one or more of these significant customers could have a material adverse effect on our business and results of operations.



The
volume of securities transactions and the demand for our products and services are directly affected by factors that are beyond our control, including:



The
economic climate in recent years has been characterized by challenging business and economic conditions. During 2000 through early 2003, the major U.S. market indices experienced a
severe decline and significant volatility. The weak and uncertain economic climate, together with corporate governance and accounting concerns, contributed to a reduction in corporate transactions,
increased market volatility, and a generally more difficult business environment.

During
2004, the U.S. equities market performance was decidedly mixed; however, initial public offerings and merger and acquisition activity was strong, providing for more trading
activity in new issues and in the arbitrage arena. Overall, total U.S. market volumes in Nasdaq-, NYSE-, and AMEX-listed securities increased by 6.9% in 2004, up from
926.5 billion shares in 2003 to 990.5 billion shares in 2004. Our total U.S. market volume increased 20.1% in 2004, up from 116.8 billion shares in 2003 to 140.3 billion
shares in 2004. In addition, we handled 25.3%, 1.8%, and 22.7% of the total trading volume in Nasdaq-, NYSE-, and AMEX-listed equities, respectively, in 2004. For more
information concerning our market share, our trading volumes and other operating measures during 2004, see"Part IIItem 7Management's
Discussion and Analysis of Financial Condition and Results of OperationsKey Statistical Information".

Because
a significant percentage of our revenues are tied directly to the volume of securities traded on ArcaEx, it is likely that a general decline in trading volumes would reduce our
revenues and have a significant impact on our future profitability. An extension or worsening of the weak economic conditions that prevailed beginning in 2000 could result in a further decline in
trading volumes and our revenues. Declining trading volumes and pricing pressures in the past have had, and in the future may again have, a significant adverse effect on our business, financial
condition and results of operations.

Our
business may be affected by declines in trading volumes in technology-related securities. Equity securities of companies in the technology sector have in recent years experienced
greater

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volatility,
including fluctuations in trading volumes, than those in other sectors. We believe that Nasdaq is generally regarded as having a significant number of issuers that would be commonly
considered as technology companies. Nasdaq-listed securities accounted for 91.7%, 89.3% and 81.2% of the trading activity handled on ArcaEx in 2002, 2003 and 2004, respectively. Accordingly, we
believe that a decline in the total trading volume in Nasdaq-listed equity securities could have an adverse impact on our business. Based on historic volatility, we believe that a
market-wide reduction in trading volumes could have a disproportionate impact on trading volumes in Nasdaq-listed securities, and on our operating results.



Our
business experiences seasonal fluctuations, reflecting reduced trading activity during summer months, particularly in August. As a result, our operating results for the third quarter
of any year may not be indicative of the results we expect for the full year. Our operating results may also fluctuate quarter to quarter due to a variety of factors beyond our control, including the
factors discussed above under"Part IItem 1BusinessCertain Factors That May Affect Our BusinessFactors beyond our
control can cause trading volumes to fluctuate, which could significantly reduce demand for our services and harm our business".



Our business depends on the performance and reliability of the computer and communications systems supporting it. Notwithstanding our current capacity to execute
up to six million trades per day, heavy use of our computer systems during peak trading times or at times of unusual market volatility could cause our systems to operate slowly or even to fail for
periods of time. If our systems cannot be expanded successfully to handle increased demand, or otherwise fail to perform, we could experience disruptions in service, slower response times, and delays
in introducing new products and services.

Our
trading activities may be impacted by system failures of other trading systems, as a result of which we may be required to suspend trading activity in particular stocks or cancel
previously executed trades under certain circumstances. These consequences could result in lower trading volumes, financial losses, decreased customer service and satisfaction, litigation, customer
claims or regulatory sanctions. We have experienced occasional systems failures and delays in the past and, although we cannot predict the likelihood of these events in the future, we could experience
future systems failures or delays.

Our
systems and operations also are vulnerable to damage or interruption from human error, natural disasters, power loss, sabotage or terrorism, computer viruses, intentional acts of
vandalism, and similar events. Any system failure that causes an interruption in service or decreases the responsiveness of our service could impair our reputation, damage our brand name and
negatively impact our revenues. We also rely on a number of third parties for systems support. Any interruption in these third-party services or deterioration in the performance of these services
could also be disruptive to our business and have a material adverse effect on our business, financial condition and operating results. We cannot predict the likelihood that services provided by third
parties may be interrupted.



We
have experienced significant growth in our business over the last three years through our merger with REDIBook ECN L.L.C., our acquisition of GlobeNet Securities, Inc. and our
transition from operating an ECN to operating ArcaEx as the exclusive equities trading facility of PCX Equities.

Continuing
to grow our business will require increased investment in our facilities, personnel, and financial and management systems and controls. Unless our growth results in an
increase in our revenues that is proportionate to the increase in our costs associated with this growth, our gross margin, and our future profitability, will be adversely affected.

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As
part of our growth strategy, we intend to continue to evaluate potential acquisition opportunities, such as our proposed acquisition of PCXH and its subsidiaries, and strategic
alliances in the future. Any such transaction may be effected quickly, may occur at any time and may be significant in size relative to our existing assets and operations. The market for acquisition
targets and strategic alliances is highly competitive, particularly in light of increasing consolidation in the securities trading industry, which may adversely affect our ability to find acquisition
candidates or strategic partners that fit our growth strategy and our investment parameters. These transactions, including our proposed acquisition of PCXH and its subsidiaries, involve numerous
risks, including, among others:



Failure
to manage successfully any acquisition we may make in the future, including our proposed acquisition of PCXH and its subsidiaries, could adversely affect our growth strategy and
our future profitability and subject us to the risks identified above. We may face similar risks in managing future strategic alliances.



We depend on the availability of adequate capital to maintain and develop our business. Historically, our capital requirements have been met from internally
generated funds and funds raised from private investors. However, based on a variety of factors, including increased price competition, the cost of technology improvements and increased regulation,
our ability to fund our capital requirements may vary from period to period. Additional capital may not be available to us on a timely basis, on favorable terms or at all.



We may seek to raise additional funds, finance acquisitions or develop strategic relationships by issuing equity or convertible debt securities, which would
reduce the percentage ownership of existing stockholders. Furthermore, any newly issued securities could have rights, preferences and privileges senior to those of our common stock.



To
protect our intellectual property rights, we rely on a combination of trademark laws, copyright laws, patent laws, trade secret protection, confidentiality agreements and other
contractual arrangements with our affiliates, customers, strategic investors and others. The protective steps we have taken may be inadequate to deter misappropriation of our proprietary information.
We may be unable to detect the unauthorized use of, or take appropriate steps to enforce, our intellectual property rights. Failure to protect our intellectual property adequately could harm our brand
and affect our ability to compete effectively. Further, defending our intellectual property rights could result in the expenditure of significant financial and managerial resources, which could
adversely affect our business, financial condition and operating results.

In
the future we may be subject to intellectual property rights claims, which may be costly to defend, could require us to pay damages and could limit our ability to use certain
technologies. We

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currently
do not own any patents. However, some of our competitors currently own patents and have actively been filing patent applications in recent years. For example, since 2002 we believe Nasdaq
has filed directly or indirectly a substantial number of patent applications that may be ripe for review by the patent office in the near future and that may relate to our trading platforms and
business processes. As a result, we could in the future face allegations that we have infringed or otherwise violated the intellectual property rights of third parties. Any intellectual property
claims, with or without merit, could be time-consuming, expensive to litigate or settle and could divert management resources and attention. Successful challenges against us could require
us to modify or change or discontinue use of the portions of our technology that are found to be infringing or violating the rights of others or to obtain licenses from third parties.



We
face legal risks in our businesses. These risks include potential liability under securities or other laws for unauthorized or erroneous trade execution, breach of contract,
unlicensed trading or materially false or misleading statements made in connection with securities and other transactions. Many of these risks may be difficult to assess or quantify and their
existence and magnitude often remain unknown for substantial periods of time. We incur significant legal expenses in defending against litigation, and we expect to continue to do so in the future.

In
addition, a former business partner of our co-founders (including Mr. Putnam, our Chairman and Chief Executive Officer) has alleged misappropriation of a corporate
opportunity, among other claims. Although it is not entirely clear what other relief the plaintiff may seek, the plaintiff may seek specific performance to transfer a portion of Mr. Putnam's
equity interest in Terra Nova Trading, L.L.C., which owns a 0.6% interest in our company. In addition, the plaintiff may seek revenues derived from Archipelago's use of certain software, including
future revenues. Accordingly, we cannot determine the impact this litigation could have on our business. If the litigation were to be determined adversely to Mr. Putnam, the plaintiff may be
entitled to monetary damages, including punitive damages, which Mr. Putnam may need to satisfy through the sale of a portion of his common stock.



Our
ability to comply with all applicable laws and rules is largely dependent on our establishment and maintenance of compliance, audit and reporting systems and procedures, as well as
our ability to attract and retain qualified compliance, audit and risk management personnel. These systems and procedures may not be fully effective. We face the risk of intervention by regulatory
authorities, including extensive examination and surveillance activity. In the case of actual or alleged non-compliance
with regulations, we could be subject to investigations and judicial or administrative proceedings that may result in substantial penalties or civil lawsuits, including by customers, for damages,
which can be substantial. We have been subject to NASD disciplinary actions. Any failure to comply with applicable laws and rules could adversely affect our business, reputation, financial condition
and operating results and, in extreme cases, our ability to conduct our business or portions thereof.



We
have adopted policies and procedures to identify, monitor and manage our risks. These policies and procedures, however, may not be fully effective. Some of our risk management methods
depend upon evaluation of information regarding markets, customers or other matters that are publicly available or otherwise accessible by us. That information may not in all cases be accurate,
complete, up-to-date or properly evaluated. If our policies and procedures are not fully effective or we are not always successful in monitoring or evaluating the risks to
which we are or may be exposed, our

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business,
reputation, financial condition and operating results could be materially adversely affected. We have recently adopted new employee trading policies, and have limited experience monitoring
and enforcing them. In addition, our insurance policies may not provide adequate coverage.



We
rely on services provided by several companies owned by or affiliated with our strategic investors. For example, Spear, Leeds & Kellogg L.P., a subsidiary of The Goldman Sachs
Group, Inc., or Goldman Sachs, provides us with certain clearing and settlement services. Townsend Analytics, indirectly owned in part by two of our co-founders, provides us with
technological and administrative services. Several other related companies provide similar services. If any of these suppliers were to breach their contractual obligations to us or in the event of any
other disruption, we may be unable to make alternative arrangements for the supply of these services on comparable terms and conditions. As a result, our business, financial condition and operating
results could be materially adversely affected.



We
are exposed to credit risk from third parties, including customers, counterparties and clearing agents. For example, we are exposed to credit risk for transaction fees we bill to
customers on a monthly basis in arrears. Our customers and other third parties may default on their obligations to us due to bankruptcy, lack of liquidity, operational failure or other reasons. Our
exposure to credit risk
may be further impacted by volatile securities markets that may affect the ability of our customers and other third parties to satisfy their contractual obligations to us. In addition, we may not be
successful in managing our credit risk through reporting and control procedures or by maintaining credit standards. Any losses arising from such defaults or other credit losses could adversely affect
our financial condition and operating results. See "Part IIItem 7Management's Discussion and Analysis of Financial Condition and Results of
OperationsQuantitative and Qualitative Disclosures about Market Risk."



We
experienced net losses in each of 2000, 2001 and 2002 of $(39.2) million, $(38.0) million and $(35.6) million, respectively. Although we earned net income of $1.8 million in
2003 and net income attributable to common stockholders of $59.3 million in 2004, we may operate at a loss in the future. Our operating results may fluctuate significantly in the future as a
result of a variety of factors, including:



As
a result of these factors and our limited operating history, it is difficult to predict our future earnings, if any, and we may experience significant losses in the future.

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TRADING ON ARCAEX

Overview

We believe that our combination of innovative market structure and leading-edge technology provides our subscribers with a trading venue that is
faster and more transparent and that offers more consistent trading than our competitors. Fully electronic order matching, in opening auctions and during regular and extended trading sessions,
replaces physical auctions on the trading floor of a traditional exchange. All orders are on equal footing, providing all participants the opportunity to compete electronically.

Permitted
users of ArcaEx, referred to as equity trading permit holders; and other users of ArcaEx discussed below are able to submit orders to an electronic file of orders, called the
"ArcaEx Book," where trades are executed at prices equal to or better than the national best bid or offer. As part of our "best execution" model, ArcaEx employs a proprietary algorithm to search for
the best execution for each order. Price-time priority means that bids are posted on ArcaEx in price order (best to worst) and then, if prices are the same, they are ordered based on the
time the bid was posted (earliest to latest). ArcaEx users may choose to have their unexecuted orders left on the ArcaEx Book, returned to them, or routed to other markets. One of our broker-dealer
subsidiaries offers facility routing services for orders that will be executed in other market centers. ArcaEx users may, however, establish routing arrangements with another provider of order-routing
services or may use their own proprietary routing mechanisms.

Trading Sessions/Hours of Operation

ArcaEx operates daily from 8:00 a.m. to 8:00 p.m. Eastern Time, excluding Saturday, Sunday and public holidays. In April 2005, we expect to
begin opening ArcaEx at 4:00 a.m. Eastern Time. Currently, ArcaEx maintains three trading sessions each trading day:



Supported Order Types

Archipelago has created new and innovative order types to meet customer needs for speed, immediacy and consistency. In addition to standard market orders and
limit orders, ArcaEx also handles reserve orders, discretionary orders, intermediate or cancel orders and post-no-preference orders. ArcaEx currently offers over 20 order types
to
meet the needs of traders using basic and sophisticated market strategies. Set forth below is a sampling of order types used by traders on ArcaEx:



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Order Display and Execution

ArcaEx maintains the ArcaEx Book, through which orders are displayed and matched. The ArcaEx Book features several components, called processes. Orders that
cannot be executed through each of the processes are routed to the next process in accordance with the rules of PCX Equities.



If
the best price is not available on ArcaEx, the order can be automatically routed to another market center using our smart-order routing algorithm, referred to as our "outbound"
trading capability. For trading in OTC securities and exchange-listed funds for which the SEC has granted a temporary "de minimis" exemption from the trade-through rule of the Intermarket Trading
System, our customers can choose not to have their orders sent to other market centers that display better prices. For NYSE-listed securities, however, the trade-through rule requires
outbound routing of customer ordersregardless of a customer's preference to have an order executed only through ArcaExwhenever a better price is being quoted at another
market center. For more information on the trade-through rule see"Part IItem 1BusinessCertain Factors That May Affect Our
BusinessThe 'trade-through' rule of the Intermarket Trading System limits our ability to grow our market share in NYSE-listed securities trading".

Our
customers are able to display their quotes anonymously, meaning that the counterparty to a trade would not know the identity of the other party until clearing of the trade. On
December 15, 2003, we rolled out our new "attributed quote" functionality, but each user must make internal changes to use this functionality. Using an attributed quote, participants can choose
to display orders, at their
discretion, using their own ArcaEx market participant identifier. The functionality is provided on an order-by-order basis that allows order senders to decide whether they
would prefer to advertise specific orders with their name or remain anonymous.

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The following diagram illustrates the ArcaEx Book and the trading processes:

GRAPHIC

The
best-ranked displayed order to buy and sell in the ArcaEx Book and the corresponding aggregate size of such orders associated with such prices are collected and made
available to quotation vendors. We derive our "tape" revenues by providing these data, as well as price and volume of executed transactions.

Auctions

As part of the price discovery process, in the opening trading session, ArcaEx conducts two single-price auctions: the opening auction at 8:00 a.m. Eastern
Time and the market order auction at 9:30 a.m. Eastern Time. Both auctions are single-price Dutch auctions that match buy and sell orders at the price that maximizes the amount of tradable
stock. The primary difference between the two auctions is that the market order auction will allow market orders, which require special accommodations because they are not priced, and the opening
auction will not. During each of these auctions, ArcaEx will calculate and continually disseminate the indicative match price, the indicative match volume and the imbalance during the opening session.

Opening Auction.At 8:00 a.m. Eastern Time, limit orders designated for the opening session are matched and executed
in the opening auction. ArcaEx accepts orders for the opening auction from 7:30 a.m. Eastern Time until the opening auction is concluded. Only limit orders are eligible to participate in the
opening auction.

The
opening auction occurs at the "indicative match price" for each security, which means, generally, the price at which the maximum volumes of shares are executable at the time of the
auction. If two or more prices can maximize executable volume, the opening auction occurs at the price closest to the closing price of the prior day's normal market hours. Unexecuted orders become
eligible for the opening session immediately upon conclusion of the opening auction.

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Market Order Auctions.The market order auction serves as a "bridge" between the opening auction and the core trading
session; the executions of the market order auction are the first trades of the core trading session. Beginning at 8:00 a.m. Eastern Time and at various times thereafter, the "indicative match
price" of the market order auction and the volume available to trade at such price is published electronically. Any market order imbalances associated with the auction are published electronically
from time to time. Limit orders, market orders, and auction-only orders participate in the auction.

As
with the opening auction, ArcaEx calculates and continually disseminates the indicative match price, the indicative match volume and any imbalances associated with the auction. At
9:30 a.m. Eastern Time, the market order auction executes at a single price and all unexecuted orders are released into the core trading session.

The
match price is the best price that maximizes the volume that can be executed. The market order auction uses the match price closest to the closing price of the previous trading day
(based on normal market hours) if more than one indicative match price is valid. Imbalances and indicative match prices in the market order auction are disseminated through the auction process.

Closing Auctions.In December 2003, the SEC approved the establishment of closing auctions in securities traded on
ArcaEx. Market participants are able, beginning at 7:30 a.m. Eastern Time, to enter "market on close" and "limit on close" orders for inclusion in the closing auction, which takes place at
4:00 p.m. Eastern Time, at the close of the core trading session.

Similar
to the market order auction, the closing auction generally prices the auction based upon the best price that maximizes the volume that can be executed.

ARCA Executions Website

ArcaEx subscribers can view nine days of historical data and the current day's execution data though a secured website. Detailed reports including reports
detailing all trades executed on ArcaEx can be accessed seven days a week, 24 hours a day. Information available on a single execution record includes trade date, order ID, symbol, buy/sell,
price, CUSIP, and execution ID as well as information relating to crosses and clearing. Execution information is updated to the execution website throughout the day. Under normal operations, execution
data should be available within 5 minutes of execution. The final file for the current day is generated at the end of our extended trading hours and is available at approximately 12:00 a.m.
Eastern Time.

Erroneous Execution Policy

Pursuant to a policy designed to maintain the integrity of ArcaEx, the Pacific Exchange and its subsidiary PCX Equities, Inc., PCX Equities reserves the
right to cancel or modify the terms of transactions executed through ArcaEx if PCX Equities determines that the transaction resulted from the placement of an order or a system malfunction that
resulted in a demonstrably erroneous execution, which is defined as an execution at a price, for a quantity of shares or with a symbol that is substantially inconsistent with the current trading
pattern of the security. Under this policy, the Pacific Exchange also reserves the right to delete from the consolidated tape any demonstrably erroneous execution even if the parties do not agree to
cancel or modify the terms of the transaction. Under this policy, the Pacific Exchange also reserves the right to delete from the consolidated tape any execution that PCX Equities deems erroneous,
even if PCX Equities does not cancel or modify the terms of the transaction as being demonstrably erroneous.

If
a user believes that a demonstrably erroneous execution has occurred, the user is required to contact the trading operations desk of ArcaEx generally within 30 minutes of the trade to
request a ruling by PCX Equities. In certain circumstances, PCX Equities may consider requests made more than

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30
minutes after the trade. If an order is routed away from ArcaEx, the execution is subject to the rules and policies of the market center to which the trade is routed.

Clearing

Once a trade has been executed, records are sent to the Securities Industry Automation Corporation, or SIAC, the facility manager of the National Securities
Clearing Corporation for clearance and settlement. All trading activity is transmitted to SIAC via computer as "locked in" transactions. A locked in transaction is one in which a computer has already
matched the details of the trade from the buyer and seller.

It
is necessary for firms to become clearing equity trading permit holders to clear trades on behalf of introduced participants. Any equity trading permit holder that does not
self-clear must provide the name of the entity providing clearing services (i.e., "clearing" broker) to the Pacific Exchange. The clearing broker must also be an equity trading permit
holder. Additional agreements are required if the clearing firm would also like to be able to direct orders to ArcaEx.

Clearing by our Broker-Dealer subsidiaries.Archipelago Securities, L.L.C., one of our SEC-registered
broker-dealer subsidiaries, provides optional outbound order routing services for our customers when the best price for a trade is displayed at another market center. When an outbound order is
executed, Archipelago Securities, L.L.C. "steps in" the middle of the tradethat is, it buys or sells the security at the market center with the best price and enters into an offsetting
transaction with our customer. For example, if the best price is available at Instinet's INET ATS for a customer's purchase of 100 shares of Microsoft stock, Archipelago Securities, L.L.C. will
purchase 100 shares of Microsoft at INET and, through the facilities of ArcaEx, sell 100 shares of Microsoft to our customer. Archipelago Securities, L.L.C. is currently an "introducing broker" and a
"routing broker" that clears these trades through DTCC directly.

Wave
Securities, L.L.C., as an equity trading permit holder, provides access to ArcaEx to non-equity trading permit holders. Unlike Archipelago Securities, L.L.C., Wave
carries securities for the accounts of some of its customers (i.e., trades are not all "netted out" each day). Wave is also an "introducing broker" that does not provide its own clearing and custody
of customer securities, and currently has clearing and custody arrangements with both Spear, Leeds & Kellogg and a subsidiary of Merrill Lynch.

Self-Clearing.In July 2004, we began to self-clear trades effected by certain broker-dealer
customers accessing ArcaEx through our subsidiary, ATS. In addition, in January 2005, we began self-clearing all customer orders routed out to other market centers and executed by
our wholly-owned subsidiary, Archipelago Securities, L.L.C., on behalf of ArcaEx.

ArcaEx Participants

With the introduction of ArcaEx, PCX Equities simplified its membership rules to more accurately reflect the change in market structure from a traditional trading
floor environment to an electronic one. Accordingly, PCX Equities provides for only one category of permit holders on ArcaEx, referred to as equity trading permit holders.

Broker-dealers.Any registered broker-dealer who wishes to trade on ArcaEx must obtain an equity trading permit from PCX
Equities. An institutional investor can gain direct access to ArcaEx by becoming a "sponsored participant" of an equity trading permit holder. To become a sponsored participant, the institution must
enter into a sponsorship arrangement with a sponsoring equity trading permit holder, which is an equity trading permit holder who has been designated by the institution to execute transactions on
ArcaEx and clear and settle the transactions for the institution. PCX Equities will authorize any equity trading permit holder or sponsored participant who meets certain

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requirements
to obtain access to ArcaEx. All users, both equity trading permit holders and sponsored participants, must enter into a User Agreement with Archipelago Exchange, L.L.C., the operator of
ArcaEx.

Retail participants.Retail participants are not permitted to become direct participants of ArcaEx. Retail investors may
access ArcaEx only through a registered broker-dealer.

Market makers.Almost all trades currently executed on ArcaEx are executed without the participation of a market maker. A
security does not need to have a designated market maker to be traded on ArcaEx. As of December 31, 2004, there were five market makers registered to make markets on ArcaEx. However, Pacific
Exchange and PCX Equities rules and our trading systems permit participants to register as market makers for securities traded on ArcaEx. All ArcaEx market makers must be equity trading permit
holders, and must comply with the rules of the Pacific Exchange regarding order execution, clearing and settlement and minimum net capital requirements. As of December 31, 2004, approximately
365 securities traded on ArcaEx had registered market makers.

All
market makers trading on ArcaEx will be subject to the following responsibilities and duties:



REGULATION

Overview

As a participant in the securities industry, we are subject to extensive regulations in the United States and in certain other jurisdictions in which we
operate. The regulatory framework that applies to our business activities and operations includes:



These
activities are subject to U.S. federal and state laws, as well as certain foreign regulations as described below. The rules and regulations applicable to our business are
generally intended to safeguard the integrity of the securities markets and to protect the interests of public market participants. They are not, however, designed to protect the interests of
Archipelago's stockholders. Our regulatory environment is subject to change. Any future legislation or regulation, or changes in the interpretation or enforcement of existing laws and rules, may
adversely affect our business, financial condition and operating results.

Federal
securities laws have established a two-tiered system for the regulation of securities markets and market participants. The first tier consists of the SEC, which has
primary responsibility for enforcing federal securities laws. The second tier consists of "self-regulatory organizations," or SROs, which are non-governmental entities that
must register with, and are regulated by, the SEC. SROs include national securities exchanges, such as the Pacific Exchange and the NYSE, and national

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securities
associations, such as the NASD. Among other roles, SROs periodically inspect their member firms and enforce federal securities laws and SEC regulations. SROs also establish and enforce
their own rules.

Regulation by the Pacific Exchange and SEC Oversight

The Archipelago Exchange was created in connection with our alliance in 2000 with the Pacific Exchange and the SEC's approval of related Pacific Exchange rule
changes in October 2001. Founded in 1862, the Pacific Exchange is a national securities exchange registered with the SEC under Section 6 of the Exchange Act. The Pacific Exchange was the
first U.S. stock exchange to demutualize, establishing PCX Equities, Inc. as a for-profit, corporate subsidiary of the Pacific Exchange in 2000. The Pacific Exchange is the SRO
responsible for regulating activity that takes place on ArcaEx. As an SRO, the Pacific Exchange is responsible for regulating its members through the adoption and enforcement of rules and regulations
governing their business conduct. The Pacific Exchange has delegated certain regulatory authority for ArcaEx to PCX Equities. PCX Equities is responsible for strict compliance by ArcaEx and the
persons using ArcaEx with its rules to promote public confidence and to assure a fair and orderly market.

All
regulatory functions of the Pacific Exchange, including establishing rules for the operation of ArcaEx, inspecting member firms and regulating market activity, are carried out
exclusively by Pacific Exchange or PCX Equities personnel. Archipelago employees do not participate in the regulatory function of the Pacific Exchange or PCX Equities. The Pacific Exchange and PCX
Equities, and not Archipelago, retain the ultimate regulatory authority over ArcaEx, including:



Archipelago
Exchange, L.L.C., the operator of the equities trading facility of PCX Equities, is subject to SEC rules and regulations governing national securities exchanges, although it
is not registered or required to register as an exchange under the Exchange Act. Through the rules of the Pacific Exchange and PCX Equities, the SEC has the authority to oversee the premises,
personnel and

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records
of ArcaEx in the same manner that the SEC has over the Pacific Exchange and other national securities exchanges. Under Pacific Exchange rules:



Accordingly,
the SEC may exercise direct supervisory and disciplinary authority over certain Archipelago activities, including ArcaEx. Rules established by the Pacific Exchange and PCX
Equities are also subject to SEC approval and, in some cases, public notice and comment.

U.S. Broker-Dealer Regulation

In addition to the regulations discussed above, Wave Securities, L.L.C., Archipelago Securities, L.L.C. and Archipelago Trading Services, Inc. are
"broker-dealers" regulated by both the SEC and the NASD. Registered broker-dealers are subject to a complex combination of federal law and SEC and SRO rules that cover all aspects of their business,
including sales methods, trade practices, use and safekeeping of customer funds and securities, capital structure, record-keeping, the financing of customers' purchases and the conduct of directors,
officers and employees. Broker-dealers are also required to notify regulators when net capital falls below certain predefined criteria, and are limited in their ability to distribute or withdraw
capital.

Foreign Subsidiaries

Our subsidiary in the United Kingdom, Archipelago Europe Limited, is registered with, and regulated by, the Financial Services Authority of the
United Kingdom. Our Canadian subsidiary, Wave Securities Canada Inc., is registered with, and regulated by the Ontario Securities Commission and the Quebec Securities Commission, and is
a member of the Investment Dealers Association of Canada, a SRO.

ITEM 2.    PROPERTIES

The Company does not own any real property. Currently our facilities include the following:



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In
addition to the above facilities, we sublease approximately 44,000 square feet of space in New York, New York and Altamont Springs, Florida.

Currently,
we lease over 143,000 square feet of office space. Our space requirements have increased significantly over the last several years as our business has grown. However, we have
been able to lease additional space promptly and we believe that the space we lease is sufficient to meet our current and anticipated needs.

ITEM 3.    LEGAL PROCEEDINGS

Matters Relating to Our Company

The following is a description of developments with regard to litigation matters relating to Archipelago and our Chief Executive Officer, each of which were
previously reported in our final Prospectus dated August 12, 2004 and Form 10-Q dated November 9, 2004.

Nasdaq Litigation.In October 2003, Nasdaq filed a complaint against our Company and the Pacific Exchange in the
United States District Court Southern District of New York alleging that we have improperly used the "Nasdaq" and "QQQ" trademarks in our advertising activities without entering into a license
agreement to do so. Nasdaq has alleged that, among other things, we have violated federal and common law and unfair competition laws, and have misappropriated intellectual property. Nasdaq seeks to
recover damages and profits relating to the use of the symbol "QQQ," including our use of "QQQ" in advertising, and to preliminarily and permanently enjoin us from trading the QQQ product and any
other proprietary financial product of Nasdaq without a license from Nasdaq.

On
September 15, 2004, Judge Denise Cote of the Southern District Court issued an order granting our motion to dismiss Nasdaq's common law claims and ruled that ArcaEx has the
right to facilitate trading of the Nasdaq-100 tracking stock, known as QQQ; and, that Nasdaq had no rights in the QQQ that would permit Nasdaq to restrict trading by ArcaEx through the
imposition of a licensing regime. In her order, Judge Cote also denied Archipelago's motion to dismiss Nasdaq's Lanham Act claim against Archipelago's advertisements, although she stated that the
claim "appear[s] weak." We filed an answer in response to Nasdaq's remaining Lanham Act claim on October 6, 2004 and Nasdaq filed a leave to file an amended complaint on
November 12, 2004. On January 20, 2005, Archipelago filed a motion for Rule 11 sanctions against
Nasdaq with regard to Nasdaq's amended complaint. Currently, the parties are engaged in discovery with regard to the remaining claim.

Island Arbitration.In September 2002, an arbitration claim was filed by The Island ECN, Inc. (which is now
owned by Instinet) with the NASD against REDIBook ECN L.L.C. (now known as Archipelago Securities, L.L.C.), alleging that we had failed to make full payments pursuant to certain modified fee schedules
under a subscription agreement with Island. The claimant alleged, among other things, breach of contract and unjust enrichment, and sought to recover unpaid fees in excess of $9 million. In
December 2002, we filed counterclaims against the claimant for the payments we made from January 2001 to May 2002 under the claimant's allegedly discriminatory fee schedules,
alleging breach of contract, breach of the obligation of good faith, and violations of the federal antitrust statutes. Our countersuit requested dismissal of Island's demands for relief and sought
$90 million in treble damages under the federal antitrust statutes. In addition, in January 2003, we brought similar claims against Instinet in a separate action before the NASD seeking
no less than $123 million in treble damages. These three actionsthe action brought by Island, our countersuit against Island, and our suit against Instinethave been
consolidated into one case before the NASD. The responses from

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Island
and Instinet to our answers to their claims were made on January 9, 2004. The NASD re-served Island's statement of claim on Archipelago Securities on March 12, 2004.
In response, Archipelago Securities re-filed its statement of answer and counterclaims against Island on April 26, 2004. On June 2, 2004, Archipelago Securities filed an
amended answer and statement of claim against Island and an amended statement of claim against Instinet. On June 29, 2004, both Island and Instinet filed amended responses to our submitted
pleadings. The parties have also served document demands and information requests ("discovery requests") upon each other. Island and Instinet served their discovery requests on Archipelago on
April 16, 2004. Archipelago served discovery requests on Island and Instinet on May 5, 2004.

The
arbitrators have been selected by the NASD for this matter and a discovery plan has been adopted. The parties have agreed to an arbitration schedule under which the panel will hear
the arbitration in the fall of 2005. Currently the parties are engaging in discovery.

IIG Capital Litigation.In December 2003, IIG Capital L.L.C., a factoring company, filed a claim against us in a
New York state court as successor in interest to REDIBook ECN L.L.C., alleging that it purchased various claims from Market XT ECN, including claims against Archipelago and REDIBook for fees
owed for access and trading on the Market XT ECN during 2002. The plaintiff is claiming damages of approximately $7,000,000. On January 15, 2004, the plaintiff served us with a complaint. On
March 2, 2004, we filed a motion to dismiss the complaint based upon a failure to state a claim. The plaintiff responded on April 11, 2004, and we filed a reply brief on May 3,
2004. Oral argument on our motion to dismiss took place on June 23, 2004. On January 3, 2005 the court issued a decision denying our motion to dismiss the claim. The parties engaged in a
status hearing on March 14, 2005 where the parties set a discovery schedule.

In
addition to the matters described above, from time to time we are involved in various legal proceedings arising in the ordinary course of our business. We do not believe, based on
currently available information, that the results of any of these proceedings will have a material adverse effect on our operating results or financial condition.

Matters Relating to Mr. Putnam

In addition to the matters described above under"Matters Relating to Our Company", Mr. Putnam
is currently, or was involved in the following legal proceedings. The Company had also been a party to each of the matters described below, however, as reported in our Quarterly Report on
Form 10-Q dated November 9, 2004, the Company has been dismissed from each matter.

Borsellino Litigation.In September 2000, plaintiffs Lewis Borsellino, a former business partner of Mr. Putnam
and equity holder in CTA, and I.M. Acquisitions, L.L.C, an entity owned by Mr. Borsellino, filed a complaint in Illinois State Circuit Court naming Mr. Putnam and other former members of
CTA as defendants. The complaint alleged that Mr. Putnam and the other defendants secretly diverted assets of CTA to their other business ventures. The complaint also alleges that a 1998
Settlement Agreement between the parties addressing these allegations was based on fraud, and that the defendants violated their fiduciary duties with respect to plaintiffs by allegedly failing to
disclose material information during the 1998 settlement negotiations. Archipelago, L.L.C. (the predecessor company to the Company's wholly-owned subsidiary Wave Securities, L.L.C.) was also named as
a defendant in this action although it was never a member of CTA.

On
April 11, 2001, the court dismissed Archipelago L.L.C. and the other defendants with prejudice from the September 2000 complaint. On May 2, 2001, the plaintiffs
filed a motion to vacate the court's April 2001 dismissal order and for leave to file an amended complaint against the original defendants. On May 7, 2001, the court denied the
plaintiffs' motion to vacate the April 2001 dismissal order, but granted to the plaintiffs the right to file another amended complaint against all of the defendants except Archipelago L.L.C.,
stating that "there is no just reason to delay the enforcement or appeal of

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this
Court's Order of April 11, 2001, dismissing defendant Archipelago L.L.C. with prejudice." The plaintiffs did not appeal the court's decision with respect to Archipelago, L.L.C.

On
May 21, 2001, the plaintiffs filed a second motion to vacate the court's April 2001 dismissal order, and for leave to file an amended complaint against all of the
defendants, except Archipelago L.L.C. In November 2001, the court granted the plaintiffs' motion and allowed the plaintiffs to file their amended complaint against Mr. Putnam and
the other defendants, except Archipelago L.L.C.

On
January 16, 2002, the plaintiffs filed a second amended complaint that seeks compensatory and punitive damages in excess of $80.0 million, as well as reimbursement of
attorneys' fees and the cost of litigation. On November 12, 2002, Mr. Putnam and the other defendants filed a motion to dismiss the second amended complaint; however on
October 27, 2004, the court denied the defendants' motion.

On
March 24, 2004, the plaintiffs filed a motion for leave to file a third amended complaint, which, if granted, would replace the second amended complaint. On
April 28, 2004, the defendants filed a motion in opposition to the plaintiffs' motion for leave to file a third amended complaint. No hearing date has been set for argument on this
motion.

In
addition to the litigation described above, on March 23, 2004, the plaintiffs filed a separate complaint against Holdings, L.L.C. and "ArcaEx" alleging, among other things,
unjust enrichment in connection with the alleged activities of the CTA member defendants, including Mr. Putnam. The complaint sought a constructive trust on all property received as a result of
the alleged activities. On May 21, 2004, the Company filed a motion to dismiss plaintiffs' claims against Archipelago Holdings, L.L.C. and "ArcaEx". On September 14, 2004, the Illinois
Circuit Court entered an order dismissing both Archipelago Holdings and "ArcaEx" from this litigation with prejudice.

Lozman Litigation.Archipelago, L.L.C., Archipelago Holdings, L.L.C., Terra Nova Trading, L.L.C., an investor that owns 0.6%
of our company, and Mr. Putnam, our Chairman and Chief Executive Officer, were named as defendants in a civil action filed in the Circuit Court of Cook County, Illinois, on August 9,
1999. One plaintiff, Fane Lozman, is a former business associate of Mr. Putnam, and another plaintiff, Blue Water Partners, Inc., is a corporation owned by Mr. Lozman.
Mr. Putnam was at one time its president. The wrongful conduct alleged in plaintiffs' complaint predates Archipelago's formation in December 1996. Plaintiffs alleged that Archipelago
(i) breached a joint venture agreement with the plaintiffs, (ii) engaged in corporate oppression in violation of Illinois law, (iii) usurped corporate opportunities belonging to
the plaintiffs in the form of the plaintiffs' "ideas" concerning electronic communication networks, electronic trading and electronic stock exchanges, (iv) breached duties of good faith and
fair dealing, and (v) conspired with the other defendants to injure the plaintiffs. The lawsuit seeks, among other relief, money damages, an accounting and the imposition of a constructive
trust on all property, benefits, profits and unjust enrichment the defendants have received and will receive by virtue of the alleged wrongful acts. We believe these claims relate only to Terra Nova
Trading's ownership in Archipelago and any direct or indirect interest of Mr. Putnam, Stuart Townsend and MarrGwen Townsend in Archipelago.

The
Circuit Court dismissed all of the plaintiffs' claims against Archipelago on March 20, 2000. In April 2002, the Appellate Court of Illinois affirmed the Circuit Court's
order of dismissal, except that it determined that it did not have appellate jurisdiction to review the dismissal of the plaintiffs' claims against Archipelago for usurpation of corporate
opportunities, which contend that Archipelago is derivatively liable for the conduct of the remaining defendants. The Appellate Court determined that it did not have appellate jurisdiction to review
the claims against Archipelago for usurpation of corporate opportunities because as to these claims, the Circuit Court's order of dismissal was not final and appealable under the applicable rules
governing appellate jurisdiction. In March 2003, the plaintiffs moved the Circuit Court to vacate its March 20, 2000 order of dismissal as it concerns the plaintiffs' claims against
Archipelago for usurpation of corporate opportunities. On April 7, 2004, the Circuit

46

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Court
denied the plaintiffs' motion to vacate and to reinstate Archipelago as a defendant. Plaintiffs have not yet taken an appeal from this decision.

With
regard to the remaining claims against the Mr. Putnam and Terra Nova Trading, LLC, a trial by jury commenced in November 2004. On December 16, 2004, the jury
rendered binding verdicts on the oral and written contract claims and found that Mr. Putnam and Terra Nova Trading, L.L.C. were not liable. The jury also found that the releases executed in
1995 by and between the plaintiffs and Mr. Putnam and Terra Nova Trading, LLC, were valid and enforceable. The judge has not yet entered judgment on these verdicts. As for the claim that
Mr. Putnam breached his fiduciary duty to the plaintiffs, the jury issued an advisory verdict to the judge in which it determined that Mr. Putnam and Terra Nova Trading, LLC, had usurped
a corporate opportunity in violation of his fiduciary duties. The jury also answered a non-binding special interrogatory in which it valued the usurped opportunity at $2.5 million.
However, the judge has determined that because Plaintiff's fiduciary duty claim is equitable in nature, the judge, rather than the jury, will make the final, binding determination as to
Mr. Putnam's liability under this claim and the amount of damages. Accordingly, the parties are currently awaiting the court's final ruling on the fiduciary duty claim, as well as the entry of
judgment in favor of Mr. Putnam and Terra Nova Trading, LLC, on the oral and written contract claims.

ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

There were no matters submitted to a vote of security holders for the fiscal year ended December 31, 2004 following our initial public offering on
August 12, 2004.

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Part II

ITEM 5.    MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Market Information

Our common stock has been trading on ArcaEx, the equities trading facility of the Pacific Exchange ("PCX"), under the symbol "AX" since our initial public
offering on August 12, 2004. The following table sets forth, for the periods indicated, the high and low sales prices for our common stock as reported by PCX:

High

Low2004Third Quarter (from August 12, 2004)

$
15.45

$
12.30Fourth Quarter


22.25


14.01


On
March 7, 2005, the closing sales price per share for our common stock as reported on ArcaEx was $19.00.

Holders

As of March 7, 2005, there were approximately 2,800 registered holders of record of our common stock.

Dividends

We have not paid dividends on our common stock since our conversion to a Delaware corporation in August 2004 and do not intend to pay any cash dividends
for the foreseeable future. Any determination to pay dividends in the future will be at the discretion of our Board of Directors and will be dependent upon our results of operations, our financial
condition, restrictions imposed by applicable law and other factors deemed relevant by the Board of Directors.

Use of Proceeds from Initial Public Offering

All of the net initial public offering proceeds remain invested in short-term marketable securities pending application of the funds to general
corporate purposes. There has been no material change in the planned use of the initial public offering proceeds as described in our final Prospectus dated August 12, 2004 filed with the SEC
pursuant to Rule 424(b).

Repurchases of Equity Securities

We did not repurchase any of our securities during the fourth quarter of 2004.

ITEM 6.    SELECTED CONSOLIDATED FINANCIAL DATA

The selected financial data presented below is derived from our consolidated financial statements, which have been audited by Ernst and Young LLP, independent
registered public accountants. Such selected financial data should be read in connection with our consolidated financial statements and related notes and
"Part IIItem 7Management's Discussion and Analysis of Financial Condition and

48

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Results of Operations" included elsewhere in this report. Historical financial statement information may not be indicative of our future performance.

|                                                      |                                                     | Year ended December 31, |        
|----------------------------------------------------- | --------------------------------------------------- | ----------------------- | -------
|
|
|Results of Operations:                                |                                                     |                         |        
|Revenues(3)                                           |                                                     |                         |        
|                                                      | Transaction fees                                    |                         | $      
|                                                      | Market data fees(4)                                 |                         |        
|                                                      | Listing fees                                        |                         |        
|                                                      |                                                     |                         |        
|                                                      |                                                     |                         | 80,598 
|                                                      | Equity entitlements(5)                              |                         |        
|                                                      |                                                     |                         |        
|Total revenues                                        |                                                     |                         | 60,084 
|                                                      |                                                     |                         |        
|Cost of revenues(3)                                   |                                                     |                         |        
|                                                      | Liquidity payments(6)                               |                         |        
|                                                      | Routing charges                                     |                         |        
|                                                      | Clearance, brokerage and other transaction expenses |                         |        
|                                                      |                                                     |                         |        
|Total cost of revenues                                |                                                     |                         | 42,404 
|                                                      |                                                     |                         |        
|Gross margin                                          |                                                     |                         | 17,680 
|                                                      |                                                     |                         |        
|Indirect expenses(3)                                  |                                                     |                         |        
|                                                      | Employee compensation and benefits                  |                         |        
|                                                      | Depreciation and amortization                       |                         |        
|                                                      | Communications                                      |                         |        
|                                                      | Marketing and promotion                             |                         |        
|                                                      | Legal and professional                              |                         |        
|                                                      | Occupancy                                           |                         |        
|                                                      | General and administrative                          |                         |        
|                                                      |                                                     |                         |        
|Total indirect expenses                               |                                                     |                         | 57,942 
|                                                      |                                                     |                         |        
|Operating income (loss)                               |                                                     |                         | (40,262
|Interest and other, net                               |                                                     |                         | 8,466  
|Unrealized loss on investment owned                   |                                                     |                         | (7,397 
|                                                      |                                                     |                         |        
|Income (loss) before income tax provision             |                                                     |                         | (39,193
|Income tax provision(7)                               |                                                     |                         |       
|                                                      |                                                     |                         |        
|Net income (loss)                                     |                                                     |                         | (39,193
|Deemed dividend on convertible preferred shares(8)    |                                                     |                         |       
|                                                      |                                                     |                         |        
|Net income (loss) attributable to common stockholders |                                                     | $                       | (39,193
|                                                      |                                                     |                         |        
|Basic earnings (loss) per share(9)                    |                                                     | $                       | (2.57  
|                                                      |                                                     |                         |        
|Diluted earnings (loss) per share(9)                  |                                                     | $                       | (2.57  
|                                                      |                                                     |                         |        
|Basic weighted average shares outstanding(9)          |                                                     |                         | 15,271 
|Diluted weighted average shares outstanding(9)        |                                                     |                         | 15,271 
|                                                      |                                                     |                         |        

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|Balance Sheet (As of the end of the year) |                                                     |  |   |         |  |   |         |  |   |         |  |   |         |  |   |        
|----------------------------------------- | --------------------------------------------------- |  | - | ------- |  | - | ------- |  | - | ------- |  | - | ------- |  | - | -------
|                                          | Cash and cash equivalents(8)(10)(11)                |  | $ | 99,102  |  | $ | 54,752  |  | $ | 48,964  |  | $ | 111,815 |  | $ | 177,878
|                                          | Receivables from brokers, dealers and customers(12) |  |   | 10,081  |  |   | 20,842  |  |   | 25,662  |  |   | 38,666  |  |   | 31,400 
|                                          | Receivables from related parties                    |  |   | 4,358   |  |   | 10,092  |  |   | 18,595  |  |   | 38,548  |  |   | 41,726 
|                                          | Total assets(10)                                    |  |   | 238,597 |  |   | 234,355 |  |   | 376,419 |  |   | 465,892 |  |   | 534,448
|                                          | Total stockholders' equity(11)                      |  |   | 216,754 |  |   | 195,758 |  |   | 302,822 |  |   | 303,293 |  |   | 460,873

|                                                                  |  | Year ended December 31, |  
|----------------------------------------------------------------- |  | ----------------------- | -
|
|Statistical Data (unaudited)(13)                                  |  |                         |  
|Our total U.S. market volume (millions of shares)                 |  | 29,966                  |  
|Our share of total U.S. market volume(14)                         |  | 3.48                    | %
|Our total volume of Nasdaq-listed securities (millions of shares) |  | 27,356                  |  
|Our share of total volume of Nasdaq-listed securities(14)         |  | 5.89                    | %
|% of handled shares matched internally                            |  | 2.42                    | %
|% of handled shares routed out                                    |  | 3.47                    | %
|Our volume in NYSE-listed securities (millions of shares)         |  | 2,040                   |  
|Our share of total volume of NYSE-listed securities(14)           |  | 0.56                    | %
|Our volume in AMEX-listed securities (millions of shares)         |  | 570                     |  
|Our share of total volume of AMEX-listed securities(14)           |  | 1.80                    | %
|Our ETF volume (millions of shares)                               |  | 535                     |  
|% of customer order volume matched internally                     |  | 48.7                    | %
|% of customer order volume routed out                             |  | 51.3                    | %

---

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ITEM 7.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The statements in this discussion regarding the industry outlook, our expectations regarding the future performance of our business, and the other
non-historical statements in this discussion are forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties, including, but not limited
to, the risks and uncertainties described in "Part IItem 1BusinessCertain Factors That May Affect Our
Business." You should read the following discussion together with "Part IItem 1BusinessCertain
Factors That May Affect Our Business." and our consolidated financial statements and notes thereto included elsewhere in this report.

Introduction

We operate ArcaEx, the first open all-electronic stock market in the United States for trading in NYSE-, Nasdaq-, AMEX- and
PCX-listed equity securities, exchange-traded funds and other exchange-listed securities. During 2003 and 2004, our customers executed 295.1 million and 416.6 million
transactions in U.S. equity securities through ArcaEx, respectively. Our trading platforms and services have been designed to enhance the speed and quality of trade execution for our customers. Our
trading platforms provide our customers with fast electronic execution and open, direct and anonymous market access. The technological capabilities of our trading systems, together with our trading
rules, have allowed us to create a large pool of liquidity that is available to our customers internally on ArcaEx and externally through other market centers. In addition to operating ArcaEx and
providing our core execution services, we provide customers with market data on a real-time and on a summary basis and, through our alliance with PCX, we offer companies and index
providers that list on PCX a trading venue for their equity securities, exchange-traded funds and other structured products. Through our wholly-owned subsidiary, Wave Securities, L.L.C., we also offer
agency brokerage services for institutional customers seeking to access ArcaEx and other U.S. market centers electronically. Our total revenues grew from $357.4 million in 2002 to
$541.3 million in 2004.

Executive Summary

In 2004, our results of operations improved as a result of the increased volume of securities traded on ArcaEx and our expanded market share of the total U.S.
equities trading market. Our results of operations also benefited from our ability to attract additional liquidity to ArcaEx and collect increased market data fees.

Although
the performance of U.S. equities market was mixed in 2004, initial public offerings and merger and acquisition activity was strong, providing for more trading activity in new
issues and in the arbitrage arena. Industry pricing and consolidation intensified competitive pressures in 2004; however, Archipelago was able to grow its market share and revenues and decrease its
expenses through increased efficiencies from improved operations, such as reductions in clearing expenses.

We
expect to experience continued challenges from competitive pricing, industry consolidation and potential regulatory changes. We intend to continue to distinguish Archipelago by
consistently providing fast, reliable and high-quality electronic trade execution and increased functionality. We also intend to enhance our market data products and develop new products
based on our understanding of our customers' needs and our ability to quickly bring new products to market.

Business Development

On January 3, 2005, we entered into a definitive agreement to acquire PCX Holdings, Inc. and its subsidiaries for $50.7 million, consisting
of $40.6 million in cash and $10.1 million in stock, subject to working capital and certain other possible adjustments. This acquisition is subject to approvals from PCXH shareholders as
well as the SEC and other regulatory entities.

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Our
business has grown substantially since we began trading operations in January 1997 on the Archipelago ECN, the precursor to ArcaEx. We attribute the growth of our business to
the change in our business model and our organic and external growth. These developments included:



As
discussed above, in recent years, we have experienced significant growth in our trading volumes, which has exceeded our growth in revenues. This trend has resulted from declining
revenue per transaction, which we believe has been driven by increased price competition and the resulting shift in the market fee structure. In addition to our growth in trading volumes, we have
witnessed an increasing percentage of share volume (as well as of shares handled on ArcaEx) executed within our internal liquidity pool or "matched internally." We believe that this trend has been
driven by: (i) industry consolidation, our acquisitions and a more competitive market environment; (ii) the migration of our trading operations to a more reliable trading platform in
connection with the launch of ArcaEx, which we believe has attracted more customers to our system; and (iii) our sales and marketing efforts and our customers' pursuit of greater cost
efficiencies, which has led them to rely on our technology and embed it in their infrastructure, enabling them to do business with us more easily. The trend of increased internally matched trades has
contributed to our improved gross margin in absolute terms and as a percentage of our total revenues (due primarily to lower clearing costs for trades matched internally and increased revenues from
market data fees generated by these types of trades), despite the decline in our average transaction-related gross margin per share until the first quarter of 2004. Management currently expects that
these trends will continue in the short term (without giving effect to Regulation NMS).

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In
the future, we will continue to seek to increase our market share and trading volumes, particularly in NYSE-listed securities, although we may not be successful in doing
so due to many factors, including the business environment in which we operate.

Business Environment

The business environment in which we operate has been characterized in recent years by challenging business and economic conditions, intense competition among
market participants and an increased focus on electronic trading due to technological advancements and regulatory changes, including the decimalization of security prices. Our business has been and
will continue to be impacted by these key factors:



The
interplay of these factors will affect our future revenues, gross margin and profitability. Each factor is presented below and discussed elsewhere in this report. See
"Part IIItem 7Management's Discussion and Analysis of Financial Condition and Results of OperationSources of
Revenues,Components of Expenses andResults of Operations".

Economic ConditionsTrading Volumes

During 2000 through early 2003, the major U.S. market indices experienced a severe decline and significant volatility. The weak and uncertain economic climate,
together with corporate governance and accounting concerns, contributed to lower equity prices, a reduction in corporate transactions, increased market volatility, and a generally more difficult
business environment. These trends came after a period of tremendous growth throughout the late 1990s in the global equity markets. Beginning in the second half of 2001, through 2002, the growth rate
in the volume of trading in U.S. equity markets began to slow, and in 2002, Nasdaq market volumes declined, although the U.S. exchange-listed securities still maintained moderate growth. In 2003,
overall volume in U.S. equity markets increased slightly, although the total volume of Nasdaq-listed securities, which represents a significant portion of the trading volume on ArcaEx, continued to
decline. Trading volume in U.S. equity markets increased in 2004 versus 2003. Average daily share volume traded in Nasdaq-listed equities increased by 7.3% in 2004 compared to 2003. In addition,
merger and acquisition activity and new stock issuances have increased with the upturn in economic activity.

Competition

We operate in a highly competitive business environment and have experienced intense price competition from other trading venues seeking to attract liquidity to
their systems. To encourage investors to trade in their market centers, many of our competitors in the over-the-counter market reduced the transaction fees they charged
customers for trade execution. They also offered to pay fees, referred to as "liquidity payments," to customers who added liquidity to their systems by posting buy orders or sell orders that were
matched, or executed against, on their system by market participants purchasing or selling securities. We introduced liquidity payments in April 2002 as the competitive environment to attract
liquidity intensified (as discussed below under "Part IIItem 7Management's Discussion and Analysis of Financial Condition and Results of
OperationComponents of Expenses"). As a result of this competition, we also significantly reduced the transaction fees we charged our customers for trade execution
(as described below under "Part IIItem 7Management's Discussion and Analysis of Financial Condition and Results of
OperationSources of Revenues"). As a result of this pricing

54

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pressure,
our revenues per transaction executed on the Archipelago system declined, offsetting increased revenues generated by increased trading volumes on the Archipelago system. In addition,
increased competition has led to a number of consolidations among market participants, including our merger with REDIBook ECN L.L.C., Instinet's acquisition of the Island ECN and Nasdaq's acquisition
of Brut, LLC.

Technological Advancements and Regulatory Developments

The securities trading industry has also experienced technological advancements and regulatory changes that have impacted our business environment. In particular,
in 2000, the SEC mandated the quotation of stock prices in dollars and cents rather than in dollars and fractions of a dollar (such as 1/8 or 1/16) and required
implementation for all securities by April 9, 2001. Because decimalization narrows average trading spreads (the difference between the price offered by a buyer and the price asked by a seller),
it has had a negative impact on the profitability of traditional market makers. One consequence of decimalization has been a move by market makers towards an electronic trading model, and away from
higher-cost human brokers, resulting in an increase in trading on electronic venues like the Archipelago system. In 2004, a series of market reform proposals known as Regulation NMS was
proposed by the SEC. These proposals were designed to modernize the regulatory structure of the securities trading industry. For a further discussion of regulatory, technological and other changes
relevant to our business, see "Part 1Item 1BusinessIndustry Overview".

Our Reorganization

On August 11, 2004, we converted from a Delaware limited liability company (Archipelago Holdings, L.L.C.) to a Delaware corporation (Archipelago
Holdings, Inc.). Our conversion to the corporate form of organization did not have any material effect on our consolidated financial statements. When we use the terms "Archipelago," "we" and
"our" in the following discussion, we mean, prior to the conversion, Archipelago Holdings, L.L.C., a Delaware limited liability company, and its consolidated subsidiaries and, after the conversion,
Archipelago Holdings, Inc., a Delaware corporation, and its consolidated subsidiaries.

Income Taxes

As a limited liability company, we were treated as a partnership for federal, state and local income tax purposes. As a result, all items of income, expense, gain
and loss of Archipelago were generally reportable on the tax returns of members of Archipelago Holdings, L.L.C. Accordingly, we made no provisions for income taxes at the company level.

Following
the conversion of our company to a corporation, our earnings have been subject to federal, state and local income taxes at a combined rate of approximately 41.5%. For the year
ended December 31, 2004, our effective tax rate was 9.2% primarily because the taxable income we generated from January 1, 2004 through August 11, 2004the date we
converted to the corporate form of organizationwas the responsibility of Archipelago Holdings, L.L.C.'s members. We do not have any deferred tax assets related to Archipelago Holdings,
L.L.C.'s net operating loss
carry forwards, as those losses were incurred when we were treated as a partnership for federal income tax purposes.

Segment Reporting

For financial reporting purposes, our business is divided into two reportable segments: transaction execution services and agency brokerage services. Our
transaction execution business includes trade execution on the Archipelago system (including transaction fees paid by customers accessing ArcaEx through our subsidiary ATS) as well as fees we receive
for market data and from issuers listed on the Pacific Exchange for trading on ArcaEx. Our agency brokerage services are provided through Wave

55

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Securities,
L.L.C., our broker-dealer subsidiary. For a discussion of our segments and related financial disclosure, see ourConsolidated Financial Statements and
Note 10thereto.

Sources of Revenues



In our transaction execution business, we derive revenues from three sources: transaction fees, market data fees and listing fees. Whether a trade is matched
internally or routed out will not impact our revenues from transaction fees (net of the applicable liquidity payments or routing charges) because our operating margin is the same for either trade.
However, whether a trade is matched internally or routed out will impact our market data fees and our clearing costs as discussed below under
"Part IIItem 7Sources of RevenuesMarket Data Fees andComponents of ExpensesCost of
Revenues".

Transaction Fees.Our revenues in our transaction execution services segment are derived primarily from transaction fees,
which we charge customers for trade execution on the Archipelago system. We earn transaction fees for customer orders matched internally, as well as for customer orders routed out.

We
charge a per share fee (denominated in tenths of a cent per share) to each customer that executes against a buy order or sell order posted internally on the Archipelago system. We
refer to these customers when they purchase or sell securities as "liquidity takers," as they remove liquidity from the Archipelago system. A liquidity taker may be either a purchaser or a seller, and
is distinguished from a "liquidity provider" generally by the type of buy order or sell order it posts on our system. A liquidity provider will likely enter a non-marketable limit order on
the Archipelago system (i.e., either a limit order to buy a security with a limit price below the best offer or a limit order to sell a security with a limit price above the best bid).
Non-marketable limit orders are placed on the Archipelago limit order book and await execution. A liquidity taker, on the other hand, is likely to enter a marketable limit order (i.e., a
limit order to buy a security with a limit price at or above the best offer or a limit order to sell a security with a limit price at or below the best bid for that security). Accordingly, liquidity
providers generally "post" buy orders or sell orders that are subsequently executed against by the sell order or buy order, as the case may be, of a customer that is the liquidity taker. As discussed
below, we pay liquidity providers a per share fee for posting buy orders and sell orders on our system.

We
also charge a per share fee (denominated in tenths of a cent per share) to customers whose orders are routed out to an external market center displaying the best buy order or sell
order in the market for a particular security.

The
amount of transaction fees we earn in any period fluctuates based upon (i) trading volumes of shares handled and (ii) the prices we charge for trade execution. As a
result of increased price competition, in the past we have reduced the amount per share we charge customers for taking liquidity from the Archipelago system, as well as for routing orders to an
external market center. In 2004, Instinet, one of our principal competitors, announced a price reduction for its outbound order routing services. In 2004, Nasdaq has also announced a reduced fee
schedule for market participants taking liquidity from its system. Given the competitive nature of our business, we expect to continue to experience pricing pressure from our principal competitors in
establishing the rates at which we charge our customers for our execution services. Accordingly, in the future, we may change the amounts we charge our customers for trade execution.

We
expect that the amount of transaction fees we earn in the future could also depend on the outcome of certain regulatory proposals. In December of 2004, the SEC
re-published its proposals for "Regulation NMS," which, among other things, would cap access fees, or transaction fees, charged by

56

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market
centers and broker-dealers for access against displayed quotes. The comment period for the NMS proposals expired on January 26, 2005 and the SEC could vote on the proposals in 2005. We
cannot predict the outcome of deliberations and discussions on the proposal or the final form that the proposed rule may take or whether any proposed rule will ultimately be approved. As drafted, the
proposed rule imposes a cap of $0.003 per share on the transaction fees charged by market centers to members, or customers, and non-members who execute trades on these market centers. As a
result, the transaction fees we charge our customers for "taking liquidity" from ArcaEx (discussed above) would be capped at $0.003 per share under the proposed rule when accessing the best bid or
best offer displayed through ArcaEx. We are in the process of analyzing the potential impact of the proposed regulation to our business and results of operations. If the proposal is ultimately adopted
in this form, we believe that the amount of transaction fees we earn, which represented over 89.5% of our total revenues for the year ended December 31, 2004, would potentially decrease. Our
preliminary analysis assumes, however, that trading volumes and our market share remain constant and does not give effect to changes investors may make in their trading patterns as a result of, or in
response to, the proposed regulation. Under the proposed rule, we would be potentially unable to increase our revenues through higher pricing of transaction fees in the future, which could have a
material adverse effect on our revenues and operating results. See also "Part IIItem 7Components of ExpensesCost of
Revenues".

A
related provision of the proposal would permit broker-dealer customers to charge their own fee to other market participants that execute against their displayed quotes. Because the
$0.003 per share cap described above is a limitation imposed on overall transaction fees, we believe the fee that ArcaEx could charge would be limited by the difference between $0.003 per share and
the fee charged by the broker-dealer. Accordingly, this could result in further reductions of ArcaEx's transaction fee revenues.

As
discussed under "Part 1Item 1BusinessCertain Factors that May Affect Our BusinessThe SEC's
proposed 'Regulation NMS' could significantly and adversely affect our revenues and our operating results", we believe that there is a significant amount of uncertainty
regarding the interpretation of, and issues raised by, the proposed rules. We cannot predict whether the proposed changes will be adopted by the SEC in their proposed form, a different form or at all.
In addition, many interpretive questions have been raised regarding the proposals and many variables must be considered in analyzing their impact. Accordingly, we cannot predict or quantify with any
level of certainty the impact these proposed rule changes will have on our business including the impact of market data fees described below.

Market Data Fees.Following the launch of ArcaEx in March 2002, we began earning revenues from market data fees in
connection with the sale of our market data, through the Pacific Exchange, pursuant to the Consolidated Tape Association Plan, or CTA Plan, in the case of exchange-listed securities, and the Nasdaq
OTC/UTP Plan, in the case of Nasdaq-listed securities. As an ECN, we were
ineligible to participate in these Plans directly. Under the Plans, the information collected from all participants is sold to data vendors that in turn sell the data to third-party consumers such as
Thomson Financial Inc. and Bloomberg, L.P. Under the CTA Plan, our market data fees are directly related to both the percentage of our trades in exchange-listed securities executed on ArcaEx
that are reported through the CTA Plan and the size of the revenue sharing pool. Under the Nasdaq OTC/UTP Plan, through PCX we share revenues with Nasdaq and exchanges that are members of the Nasdaq
OTC/UTP Plan and that trade Nasdaq-listed securities. The market data fees we receive through PCX under this plan are directly related to the total shares and trades that are executed on ArcaEx as a
percentage of all shares and trades executed in Nasdaq-listed securities. For a description of the revenue sharing arrangements under these Plans, see
"Part 1Item 1BusinessOur BusinessMarket Data Products." We do not earn market data
fees in connection with customer orders or shares handled that are routed out to an external market center for execution.

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Under proposed Regulation NMS, the existing formulas for allocating revenues derived from market data fees would be changed. The SEC proposed a new formula that would divide market data
fees between trades, shares and quoting activity, rather than based solely on the number of trades executed at each market center for exchange-listed securities, or based solely on trading and volume
activity, which is the current formula for Nasdaq-listed securities. Because this proposal would change the formula for allocating market data fees, it would also change the incentives created under
existing market data plans. Regulation NMS, as proposed, introduces a new method of allocating revenue to particular securities which we believe will inappropriately discount actively traded stocks
and favor less actively traded stocks. We cannot predict how other market centers would respond to these new incentives and, accordingly, whether trading and quoting activitythe elements
that determine allocation of market data feeswould remain constant. In this dynamic environment, we cannot predict with certainty the effect the rules would have on our market data fees.
However, our preliminary analysis of this proposal indicates that, if trading and quoting activity remained constant, our market data fees could potentially decline by a material amount if the
proposal were adopted in its current form. We analyze the potential impact of proposed Regulation NMS to our business on an ongoing basis.

We
also currently rebate 50% of the market data fees we receive under the CTA Plan to customers that trade exchange-listed securities (except with respect to NYSE-listed securities),
including exchange-traded funds, on ArcaEx based on their aggregate exchange-listed trading activity. We introduced this revenue rebate plan in the fourth quarter of 2002, and set the rate at 50% in
response to competitive market conditions. In the future we may, at our discretion, change the percentage of fees we rebate or eliminate the plan. For financial reporting purposes, we record our
market data fees net of amounts rebated to customers under this revenue rebate arrangement. We rebated approximately 32.1% and 23.8% of the total market data fees we received in 2003 and 2004,
respectively. We initiated our revenue rebate plan to encourage customers to execute trades of exchange-listed securities on ArcaEx and to remain competitive with other market centers. The SEC does
not permit market data fees generated under the Nasdaq OTC/UTP Plan to be rebated to participants in this manner.

Listing Fees.Under our facility services agreement with the Pacific Exchange, we are entitled as the operator of ArcaEx to
all listing fees from issuers that list their equity securities on the Pacific Exchange. After launching ArcaEx in March 2002, we began receiving listing fees from legacy issuers that had
selected the Pacific Exchange as a listing venue and maintained their listing following the creation of ArcaEx, as well as from new listings on PCX. Since the launch of ArcaEx in March 2002,
there have been only 6 new listings of equity securities on the Pacific Exchange. Listing fees represented less than 0.1% of our total revenues in 2004.



Our revenues in our agency brokerage services segment are derived primarily from transaction fees. Institutional clients pay us for use of Wave's agency brokerage
services. These transaction fees fluctuate based on share volumes and the prices Wave charges customers for access to ArcaEx, and are subject to greater variability than the fees we charge for our
transaction execution services. Similar to fees charged by broker-dealers in the electronic direct access sector, the transaction fees charged per share are negotiated between Wave and the individual
customers, and are subject to soft dollar arrangements discussed below.



In the securities trading industry, quarterly revenue fluctuations are common and are due primarily to variations in trading volumes, competition and
technological and regulatory changes. Typically, revenues are lowest in the third quarter, primarily in August, due to reduced trading activity during the summer months.

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We generate revenues from a large number of customers. During 2003 and 2004, we generated revenues from over 700 customers.



Some of our customers are also our investors. Revenues generated from our investors represented 49.6%, 38.4% and 36.3% of our total revenues, respectively, in
2002, 2003 and 2004. We generated 27.7%, 13.9% and 9.8% of our total revenues, respectively, in 2002, 2003 and 2004 from Goldman
Sachs and its subsidiaries. For more information regarding our transactions with our investors as our customers, see ourConsolidated Financial Statement and
Note 7thereto.

Components of Expenses



Our business is dependent on the liquidity of the Archipelago system (i.e., the number and range of buy orders and sell orders posted on our system and available
to our customers). As a result, our most significant cost of generating revenues is the cost of liquidity, which we pay for in one of two ways. First, to enhance the liquidity of our system, we pay a
small fee per share (denominated in tenths of a cent per share) to participants, referred to as "liquidity providers," that post buy orders and sell orders on the Archipelago system, when the quote is
executed against, or "hit," by liquidity takers purchasing or selling securities internally on our system. We began incurring the cost of liquidity payments in April 2002. We do not pay these
fees for orders posted in NYSE-listed securities. Second, as part of our best execution business model, we incur routing charges when the Archipelago system does not have the best buy or
sell order in the market for a security that a customer is trying to buy or sell on our system. In that case, we will route the customer's order to the external market center that displays the best
buy order or sell order. The external market center will charge us a fee per share (denominated in tenths of a cent per share) for routing to its system.

As
a general matter, the pricing model for transaction execution services has changed over time in response to increasing competition. As the amount of liquidity is determined by the
number and ranges of buy or sell orders posted to a particular trading platform, the concept of paying liquidity providers developed to encourage these customers to place their orders on the trading
system that paid them a per share fee to post their order. As discussed above, we began paying fees to liquidity providers in April 2002. Making liquidity payments and incurring routing charges
are part of the costs we incur to generate revenues through increased liquidity on the Archipelago system. We seek to reduce these costs by increased trade execution on the Archipelago system. Our
cost of liquidity generally fluctuates based on (i) trading volumes and (ii) the per share fee we pay liquidity providers for trades executed internally on ArcaEx or the per share
routing charge we pay to external market centers for outbound trades. Under proposed Regulation NMS, liquidity payments and routing charges could be functionally eliminated due to the cap that would
be imposed on access fees, which could impact the liquidity of our platform.

In
addition to liquidity payments and routing charges, we also incur clearance, brokerage and related transaction expenses, which include transaction expenses paid to clearing entities
for clearing and settlement, service fees paid per trade to exchanges for trade execution, costs incurred due to erroneous trade execution and charges we record from time to time for doubtful
accounts, or bad debt, once we determine a receivable is not likely to be collected. As the operator of a facility of PCX Equities, we do not incur clearing charges for trades executed on ArcaEx by
two independent market participants. As a result, our cost per trade is lower for trades executed internally on ArcaEx. If we route a trade to an external market center, we bear clearing and
settlement costs.

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This
category of expenses also includes soft dollar expenses incurred by Wave in providing agency brokerage services through its purchase of research products and other services from
third parties for customers as part of the overall trade execution fees negotiated with them.

Indirect Expenses

In addition to our direct cost of revenues, we incur the following indirect expenses:



As
a public company, we are subject to the provisions of the Sarbanes-Oxley Act of 2002, which requires us to incur significant expenditures to establish systems, and to hire and train
personnel to comply with these requirements.

In
addition, starting in the third quarter of 2005, we will be required to recognize in our financial statements the compensation costs associated with share-based payment transactions,
including stock options. We are currently evaluating the option pricing model to be utilized and the overall impact of the adoption of this fair value method. The adoption of the fair value method
will impact our results of operations, although it will have no impact on our overall financial condition.

SegmentsCorporate Allocations

Prior to January 2003, direct costs and certain indirect costs incurred by us but not directly paid by either segment were allocated based on each
segment's trading volume. In addition, certain other indirect costs (including a portion of our management time, legal, accounting and other corporate functions as well as a portion of
technology-related services) were allocated between the agency brokerage services segment and the transaction execution services segment based on management's estimate of the resources used during the
period.

During
the year ended December 31, 2003, we allocated certain indirect costs incurred by us but not paid directly by either segment (i) based on our estimate of the expense
attributable to each segment based on the amount of services provided to each; and (ii) to the extent we could not estimate the expenses attributable to one segment over the other, based on the
volume attributable to each segment. In 2004, we improved the method by which we allocate indirect expenses to each segment and reduced the amount of expenses required to be allocated based on our
estimates. This resulted primarily from the development of the infrastructure of our agency brokerage services segment as separate from our transaction execution services segment. As the level of
shared services between segments was reduced, we were able to more easily identify the expenses attributable to each segment.

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Key Statistical Information

Our revenues and gross margin have been directly impacted by trading volumes of U.S. equity securities on the Archipelago system. Our profitability depends to a
significant extent on our ability to attract and retain trading volumes, both in absolute terms and relative to other market centers. We derive revenues on both a per-share basis and a
per-transaction basis, depending upon the source of revenue. The transaction fees we receive for trade execution and the payments we make to liquidity providers are determined on a per
share basis. Market data fees for exchange-listed securities are determined on a per transaction basis, and market data fees for Nasdaq-listed securities are determined based on a combination of share
volume and transaction volume.

The
following table presents unaudited key transaction volume information, as well as selected operating information, for the periods presented. A description of how we calculate our
market share, our trading volumes and other operating measures is set forth below.

|                                                                         |                                                  | Year ended December 31, |        
|------------------------------------------------------------------------ | ------------------------------------------------ | ----------------------- | -------
|
|Trading Days                                                             |                                                  |                         | 252    
|Total U.S. market volume (millions of shares)(1)                         |                                                  |                         | 920,863
|Our total U.S. market volume (millions of shares)(1)                     |                                                  |                         | 81,587 
|Our share of total U.S. market volume(1)(2)                              |                                                  |                         | 8.86   
|                                                                         | % of handled shares matched internally(3)        |                         |        
|                                                                         | % of handled shares routed out(3)                |                         |        
|Total volume of Nasdaq-listed securities (millions of shares)            |                                                  |                         | 433,791
|Our total volume of Nasdaq-listed securities (millions of shares)        |                                                  |                         | 74,781 
|Our share of total volume of Nasdaq-listed securities(2)                 |                                                  |                         | 17.24  
|                                                                         | % of handled shares matched internally(3)        |                         |        
|                                                                         | % of handled shares routed out(3)                |                         |        
|Total volume of NYSE-listed securities (millions of shares)              |                                                  |                         | 438,989
|Our volume in NYSE-listed securities (millions of shares)                |                                                  |                         | 4,146  
|Our share of total volume of NYSE-listed securities(2)                   |                                                  |                         | 0.94   
|                                                                         | % of handled shares matched internally(3)        |                         |        
|                                                                         | % of handled shares routed out(3)                |                         |        
|Total volume of AMEX-listed securities (millions of shares)              |                                                  |                         | 48,083 
|Our volume in AMEX-listed securities (millions of shares)                |                                                  |                         | 2,659  
|Our share of total volume of AMEX-listed securities(2)                   |                                                  |                         | 5.53   
|                                                                         | % of handled shares matched internally(3)        |                         |        
|                                                                         | % of handled shares routed out(3)                |                         |        
|Our ETF volume (millions of shares)                                      |                                                  |                         | 2,543  
|Our U.S. equity transaction volume (thousands of transactions)           |                                                  |                         | 183,471
|Our average U.S. equity transaction size (shares per transaction)        |                                                  |                         | 445    
|Our average U.S. equity transactions per day (thousands of transactions) |                                                  |                         | 728    
|Our average transaction-related revenue (per share)(4)                   |                                                  | $                       | 0.0044 
|Our average transaction-related cost of revenue (per share)(5)           |                                                  | $                       | 0.0024 
|Our average transaction-related gross margin (per share)(6)              |                                                  | $                       | 0.0020 
|                                                                         | % of customer order volume matched internally(7) |                         |        
|                                                                         | % of customer order volume routed out(7)         |                         |        

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For
purposes of calculating our volume, we include all shares that are "handled" on the Archipelago system. Handled shares include both shares that are bought or sold within our internal
liquidity pool and shares that are routed to external markets for execution. We count every transaction handled by the Archipelago system once; we do not count both sides of any transaction. For
example, if a customer's 10,000 share buy order is matched with another customer's 10,000 share sell order in our internal liquidity pool, our handled volume will be 10,000 shares. As another example,
if one of our customers sends us an order to buy 10,000 shares and the best price for that order is displayed at another market center, we will route that order to the other market center for
execution. The other market center will report a 10,000 share transaction in the consolidated tape, and our handled volume will be 10,000 shares. As a result, the 10,000 shares we report as handled by
us in this example are also handled by the external market center.

In
computing the percentage of customer order volume matched internally and the percentage of customer order volume routed out, we calculate the percentage based on the volume of
individual customer orders, not the volume of matched trades (i.e., only counting one side of a matched transaction). For example, we calculate two customer orders matched internally on our system as
two customer orders matched internally, and we include the volume of both the buy order and the sell order in computing our percentages of customer order volume matched internally and routed out. We
calculate one customer order routed to an external market center (which will be matched with an order at that other market center) as one outbound trade or one customer order. We calculate one
customer order routed to us from an external market center and matched with an order on our system as one inbound trade or one customer order.

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Transactions
in Nasdaq and exchange-listed securities are reported in the consolidated tape, a high-speed system that continuously provides last sale price and volume in
listed securities. Our handled volume is higher than our volume reported to the centralized aggregators for inclusion in the consolidated tape for two reasons. First, we do not report trades routed to
another market center to the centralized aggregators of this data. Instead, the destination market center reports
these trades. For example, if a customer's 10,000 share buy order is routed to another market center for execution, our handled volume will be 10,000 shares, but we will not report the trade. Second,
our handled volume includes odd lot transactions, generally defined as trades of fewer than 100 shares, which, by rule, we do not report to the centralized aggregators for inclusion in the
consolidated tape. For example, if one of our customers buys 50 shares, our handled volume will be 50 shares but we will not report this trade.

For
purposes of calculating our market share, we use the volume of shares that are handled on the Archipelago system (as described above) as the numerator, and the aggregate volume of
shares reported by all securities exchanges and associations in the consolidated tape as the denominator. Our market share may be expressed as:

Number of shares handled on the Archipelago system  Overall market volume as reported in the consolidated tape

As
an alternative method of calculating market share, we could include in the numerator of the above formula only transactions that we report in the consolidated tape. This would exclude
shares routed to other market centers and odd-lot transactions from our market share calculation.

For
purposes of calculating the percentage of handled shares matched internally or routed out, we count all shares that are "handled" on the Archipelago system as described above. We
count every transaction handled by the Archipelago system once; we do not count both sides of any transaction. Therefore, if five trades are executed on ArcaEx for 10,000 shares each, three of which
are routed out, we will have handled 50,000 shares and our percentage of that share volume matched internally would be 40% and routed out would be 60%.

Alternatively,
for the purpose of calculating the percentage of customer order volume matched internally or routed out, we count each customer order exactly once. If two customers'
orders are matched within our internal liquidity pool, we count the volume of both the buy order and the matched sell order. On the other hand, if a customer's order is routed to another market center
and matched with an order posted at that other market center, we count only the volume of the order routed out.

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Results of Operations

The following table sets forth our consolidated statements of operations data for the periods presented as a percentage of total revenues:

|                                                      |                                                     | Year ended December 31, |     
|----------------------------------------------------- | --------------------------------------------------- | ----------------------- | ----
|
|Revenues:                                             |                                                     |                         |     
|                                                      | Transaction fees                                    |                         | 99.5
|                                                      | Market data fees                                    |                         | 0.4 
|                                                      | Listing fees                                        |                         | 0.1 
|                                                      |                                                     |                         |     
|Total revenues                                        |                                                     | 100.0                   | %   
|                                                      |                                                     |                         |     
|Cost of revenues:                                     |                                                     |                         |     
|                                                      | Liquidity payments                                  |                         | 12.8
|                                                      | Routing charges                                     |                         | 42.4
|                                                      | Clearance, brokerage and other transaction expenses |                         | 25.2
|                                                      |                                                     |                         |     
|Total cost of revenues                                |                                                     | 80.4                    |     
|                                                      |                                                     |                         |     
|Gross margin                                          |                                                     | 19.6                    | %   
|                                                      |                                                     |                         |     
|Indirect expenses:                                    |                                                     |                         |     
|                                                      | Employee compensation and benefits                  |                         | 6.8 
|                                                      | Depreciation and amortization                       |                         | 5.0 
|                                                      | Communications                                      |                         | 6.6 
|                                                      | Marketing and promotion                             |                         | 5.3 
|                                                      | Legal and professional                              |                         | 2.1 
|                                                      | Occupancy                                           |                         | 0.8 
|                                                      | General and administrative                          |                         | 2.6 
|                                                      |                                                     |                         |     
|Total indirect expenses                               |                                                     | 29.2                    | %   
|                                                      |                                                     |                         |     
|Operating income (loss)                               |                                                     | (9.6                    | )%  
|Interest and other, net                               |                                                     | 0.4                     |     
|Unrealized loss on investment owned                   |                                                     | (0.8                    | )   
|                                                      |                                                     |                         |     
|Income (loss) before income tax provision             |                                                     | (10.0                   | )%  
|Income tax provision                                  |                                                     |                        |     
|                                                      |                                                     |                         |     
|Net income (loss)                                     |                                                     | (10.0                   | )%  
|Deemed dividend on convertible preferred shares       |                                                     |                        |     
|                                                      |                                                     |                         |     
|Net income (loss) attributable to common stockholders |                                                     | (10.0                   | )%  
|                                                      |                                                     |                         |     
|Revenues by segment:                                  |                                                     |                         |     
|                                                      | Transaction execution services                      |                         | 88.8
|                                                      | Agency brokerage services                           |                         | 11.2
|                                                      |                                                     |                         |     
|                                                      |                                                     | 100.0                   | %   
|                                                      |                                                     |                         |     

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Year Ended December 31, 2004 versus Year Ended December 31, 2003



For
the year ended December 31, 2004, our income before income tax provision increased to $75.9 million, a $74.1 million improvement compared to the year ended
December 31, 2003. Our improved results of operations for the period primarily reflect the following principal factors:



Total
U.S. market volumes in Nasdaq-, NYSE-, and AMEX-listed securities increased by 6.9% from 926.5 billion shares for the year ended December 31,
2003 to 990.5 billion shares for the year ended December 31, 2004. Over the same period our total U.S. market volume increased 20.1% from 116.8 billion shares to
140.3 billion shares. For the year ended December 31, 2004, we handled 25.3%, 1.8%, and 22.7% of the total trading volume in Nasdaq-, NYSE-, and AMEX-listed
equities, respectively. This compares to 24.6%, 1.1%, and 12.2% for the year ended December 31, 2003.

Revenues

Our total revenues increased by $83.0 million, or 18.1%, from $458.3 million for the year ended December 31, 2003 to $541.3 million
for the year ended December 31, 2004.

This
growth in our total revenues was primarily driven by:



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Transaction
fee revenue increased from $428.4 million for the year ended December 31, 2003 to $484.2 million for the year ended December 31, 2004. The
increase was driven by the 20.1% increase we experienced in transaction volumes and was partially offset by the increase in the percentage of customer shares matched internally.

Market
data fees increased from $29.5 million for the year ended December 31, 2003 to $56.6 million for the year ended December 31, 2004, an increase of
$27.1 million, or 91.9%. Market data fees derived from trading Nasdaq-listed securities increased from $19.1 million to $32.4 million. Market data fees derived from trading
Amex-listed securities increased from $9.7 million in 2003 to $22.0 million in 2004. Market data fees derived from trading NYSE-listed securities increased from
$0.7 million in 2003 to $2.2 million in 2004. For the year ended December 31 2004, we benefited fully from the improved economics of operating ArcaEx as a facility of PCX
Equities.

Revenues
from listing fees decreased from $0.5 million for the year ended December 31, 2003 to $0.4 million for the year ended December 31, 2004.

Revenues
derived from our agency brokerage services segment increased from $49.2 million for the year ended December 31, 2003 to $51.5 million for the year ended
December 31, 2004. Despite the absolute increase in revenues derived from our agency brokerage services segment, its contribution to total revenues declined from 10.7% for the year ended
December 31, 2003 to 9.5% for the year ended December 31, 2004. Total share volume in this segment declined from 3.6 billion shares traded in 2003 to 3.5 billion shares
traded in 2004. The average rate per share, inclusive of soft dollar arrangements, increased from $0.014 per share in 2003 to $0.015 per share in 2004.

Cost of Revenues

Our total cost of revenues declined from $333.6 million for the year ended December 31, 2003 to $330.2 million for the year ended
December 31, 2004. As a percentage of total revenues, our cost of revenues declined from 72.8% to 61.0%. As our internal match rate increases, our liquidity payments increase and routing
charges and clearance, brokerage and other transaction expenses decline. The percentage of customer order volume matched internally on ArcaEx increased from 80.6% (with 19.4% routed to other market
centers for execution) for the year ended December 31, 2003 to 86.6% (with 13.4% routed to other market centers for execution) for the year ended December 31, 2004.

Liquidity
payments increased by $47.9 million, or 31.3%, from $152.8 million for the year ended December 31, 2003 to $200.7 million for the year ended
December 31, 2004. Our increased liquidity payments primarily reflect an increase in the percentage of customer order volume matched internally on ArcaEx and the larger transaction volumes we
achieved in 2004 compared to 2003.

Routing
charges declined by $24.6 million, or 21.4%, from $115.0 million for the year ended December 31, 2003 to $90.4 million for the year ended
December 31, 2004. This decline primarily reflects an increase in the percentage of customer order volume matched internally, partially offset by increased volume year over year.

Clearing,
brokerage and other transaction expenses declined by $26.6 million, or 40.5%, from $65.7 million for the year ended December 31, 2003 to
$39.1 million for the year ended December 31, 2004. This decline was the result of reduced clearing costs per trade that became effective in November 2003, the migration of
trading from the Archipelago ECN to ArcaEx as a facility of PCX Equities in April 2003 (as a result of which we did not incur clearing charges for trades executed internally), and a decrease in
the relative number of trades subject to clearing costs due to the lower percentage of orders routed out. In addition, effective in July 2004, we began to self-clear trades

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effected
by non-ETP broker-dealer customers accessing ArcaEx through our subsidiary, ATS, which contributed to the reduction of our clearing cost.

Clearance,
brokerage and other transaction expenses for the year ended December 31, 2003 included $4.5 million in costs related to fees charged by Spear, Leeds &
Kellogg L.P., a subsidiary of The Goldman Sachs Group, Inc., under our service bureau agreement with them for the development, operation, management and support services provided to the
REDIBook ECN in connection with the integration of the REDIBook ECN into the Archipelago system. We did not incur these charges in 2004 due to the migration of trading of Nasdaq-listed securities from
the Archipelago ECN to ArcaEx in April 2003.

Clearance,
brokerage and other transaction expenses for the year ended December 31, 2003 included $8.0 million of bad debt expense for accounts receivable balances that we
deemed uncollectible. For the year ended December 31, 2004, we took back into income approximately $0.9 million as a result of improved collections, which provided for a
$8.9 million decrease of clearing, brokerage and other transaction expenses year over year.

Our
agency brokerage services segment accounted for $30.3 million, or 9.2%, of our total cost of revenues for the year ended December 31, 2004, compared to
$23.4 million, or 7.0%, for the same period a year ago. The increased contribution of this segment to our consolidated cost of revenues was
driven by a lower cost of revenues as a percentage of total revenues in our core transaction services segment and increased soft dollar expenditures by our agency brokerage services segment.

Gross Margin

Gross margin increased by $86.4 million, or 69.3%, from $124.7 million for the year ended December 31, 2003 to $211.1 million for the
year ended December 31, 2004. Our gross margin percentage increased from 27.2% in 2003 to 39.0% in 2004. The improved gross margin was primarily the result of reduced clearance, brokerage and
other expenses. These costs declined by $26.6 million, not withstanding the fact that transaction volumes increased by 20.1%. Additionally, market data revenues increased from 6.4% of total
revenues for the year ended December 31, 2003 to 10.5% for the year ended December 31, 2004, which also contributed to our gross margin improvement. Our combined liquidity and routing
expenses declined as a percentage of our total revenues to 53.8% from 58.4%.

Indirect Expenses

Total indirect expenses increased by $14.2 million, or 11.5%, from $123.9 million for the year ended December 31, 2003 to
$138.1 million for the year ended December 31, 2004. Although total indirect expenses increased, they declined as a percentage of total revenues from 27.0% to 25.5%. The absolute
increase was primarily due to the following:



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Interest and Other

Interest and other income and expenses increased by $2.0 million to $2.9 million in fiscal 2004. This was due to increased average cash and cash
equivalent balances and to a lesser extent higher interest rates.

Income Tax Provision

For the income earned from the date of our conversion to a Delaware corporation through December 31, 2004, we provided for income taxes at a 41.5% blended
tax rate. In 2003, we were treated as a partnership for federal, state and local income tax purposes. As a result, all items of income, expense, gain and loss were generally reportable on the tax
returns of our members.

Deemed Dividend on Convertible Preferred Shares

Upon the conversion of redeemable preferred shares into shares of common stock in connection with of our IPO, we issued approximately 717,000 additional shares of
common stock attributable to a beneficial conversion feature included in the previously issued redeemable preferred interest. The $9.6 million intrinsic value of such shares is a deemed
dividend on convertible preferred shares, which is reported after net income to reach net income attributable to common stockholders.

Net Income Attributable to Common Stockholders

As a result of the foregoing, we reported net income attributable to common stockholders of $59.3 million for the year ended December 31, 2004; an
increase of $57.5 million compared to net income of $1.8 million for the year ended December 31, 2003.

Year Ended December 31, 2003 versus Year Ended December 31, 2002

Highlights

Our net income improved from a $(35.6) million net loss for the year ended December 31, 2002 to $1.8 million in net income for the year ended
December 31, 2003.

Our
improved results of operations for the period reflect the following principal trends:



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Revenues

Total Revenues.Our total revenues increased $100.9 million, or 28.1%, to $458.3 million for the year ended
December 31, 2003 from $357.4 million for the year ended December 31, 2002. Revenue growth was driven by a significant increase in transaction fees, reflecting transaction volume
growth, and a significant increase in market data fees, reflecting the benefit of completing the transition of Nasdaq-listed trading from the Archipelago ECN to ArcaEx in April 2003. Our
revenue growth for the year ended December 31, 2003 reflects our acquisition of REDIBook in March 2002, which resulted in higher transaction volumes. Our total revenues for the year
ended December 31, 2003 reflect 12 months of increased volumes due to this acquisition, compared to nine months for the year ended December 31, 2002. Increased revenues in each
period were offset by reduced fees per transaction due to increased price competition.

Transaction
fees increased $72.8 million, or 20.5%, to $428.4 million for the year ended December 31, 2003 from $355.6 million for the year ended
December 31, 2002. The increase in transaction fees was driven by strong volume growth. Our total U.S. market volume in Nasdaq-listed, NYSE-listed and AMEX-listed
securities increased by 43.1% to 116.8 billion shares in 2003 from 81.6 billion shares in 2002. We handled 24.6% of the total trading volume in Nasdaq-listed securities for the year
ended December 31, 2003 (of which 16.8% was matched internally and 7.8% was routed out), compared to 17.2% for the prior year (of which 10.4% was matched internally and 6.8% was routed out).
The number of shares handled on the Archipelago system as a percentage of the total trading volume in NYSE-listed securities remained relatively constant in both periods, representing
4.9 billion shares, or 1.1%, for the year ended December 31, 2003 (of which 0.5% was matched internally and 0.6% was routed out) and 4.1 billion shares, or 0.9%, for the prior
year (of which 0.3% was matched internally and 0.7% was routed out). We handled 12.2% of the total trading volume of AMEX-listed securities for the year ended December 31, 2003, (of
which 9.4% was matched internally and 2.8% was routed out) compared to 5.5% for the prior year (of which 2.9% was matched internally and 2.6% was routed out).

Market
data fees increased significantly to $29.5 million for the year ended December 31, 2003 from $1.5 million for the year ended December 31, 2002. We were
ineligible to earn market data fees as an ECN, which we were still operating in 2002 and on which we executed approximately 95% of our total trading volume during that period. Although we launched
ArcaEx in March 2002, the migration of exchange-listed securities from the Archipelago ECN to ArcaEx was not completed until August 2002, and the migration of Nasdaq-listed securities
was not completed until April 2003.

Revenues
from listing fees increased $0.2 million to $0.5 million for the year ended December 31, 2003 from $0.3 million for the year ended
December 31, 2002.

Our
agency brokerage services segment contributed $49.2 million, or 10.7%, to our total revenues for the year ended December 31, 2003, compared to $40.0 million, or
11.2%, for the year ended December 31, 2002. The absolute increase in agency brokerage revenues was due primarily to an increase in transaction volume and average rate charged to institutional
clients. Total volume and average rate charged for this segment for the year ended December 31, 2003 was approximately 3.6 billion shares and $0.014 per share (inclusive of soft dollar
arrangements). Total volume and average rate charged for the year ended December 31, 2002 was approximately 3.4 billion shares and $0.012 per share (inclusive of soft dollar
arrangements). The decline in agency brokerage revenues as a percentage of our total revenues is due to relatively stronger growth within our core execution service segment.

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Cost of Revenues

Our total cost of revenues increased $46.1 million, or 16.0%, to $333.6 million for the year ended December 31, 2003 from
$287.5 million for the year ended December 31, 2002. This increase was due to a significant increase in liquidity payments, offset in part by decreased clearing, brokerage and other
transaction expenses as well as decreased routing charges. Our increased liquidity payments reflected higher transaction volumes from the REDIBook acquisition. Our cost of revenues was generally
impacted by an increase in the percentage of our customer orders matched internally and a corresponding decrease in the percentage of customer orders routed out. This change in trade behavior resulted
in an increase in liquidity payments offset by a decrease in routing charges, and a decrease in clearing charges.

Liquidity Payments.Our liquidity payments increased significantly to $152.8 million for the year ended
December 31, 2003 from $45.8 million for the year ended December 31, 2002. As a percentage of revenues, liquidity payments increased by 20.6% from 12.8% for the year ended
December 31, 2002 to 33.4% for the year ended December 2003. The increase in liquidity payments was due primarily to an increase per share in the amount paid to liquidity providers
(representing approximately $32.0 million of the increase) and an increase in the volume of buy orders and sell orders posted on the Archipelago system by liquidity providers that were executed
against, or "hit," internally on the Archipelago system by liquidity takers buying or selling those securities (representing approximately $75.0 million of the increase). We began making
liquidity payments in April 2002 (for non-NYSE-listed securities) and only made payments during part of the period. Our Nasdaq-listed share volume and our
AMEX-listed share volume for the year ended December 31, 2003 increased by 44.4% to an aggregate of 111.9 billion shares (of which 81.4% was matched internally and 18.6% was
routed out) from 77.5 billion shares for the prior period (of which 66.9% was matched internally and 33.1% was routed out).

Routing Charges.Routing charges decreased $36.4 million, or 24.0%, to $115.0 million for the year ended
December 31, 2003 from $151.5 million for the year ended December 31, 2002. As a percentage of total revenues, routing charges decreased by 17.3% to 25.1% for the year ended
December 31, 2003 from 42.4% for the year ended December 31, 2002. The decrease in routing charges was due primarily to an average per share decline of approximately $0.001 in fees
charged by external market centers to execute orders originating from the Archipelago system, and to a decrease in the number of customer orders routed out during this period. The percentage of
customer order volume routed out decreased to 19.4% of our total customer order volume for the year ended December 31, 2003 from 34.1% of our total customer order volume routed out for the
prior year, resulting from increased internal liquidity on our system.

Clearance, Brokerage and Other Transaction Expenses.Clearance, brokerage and other transaction expenses decreased
$24.6 million, or 27.2%, to $65.7 million for the year ended December 31, 2003 from $90.3 million for the year ended December 31, 2002. The decrease was due
primarily to (i) the migration of trading from the Archipelago ECN to ArcaEx, as a result of which we did not incur clearing charges for trades executed on ArcaEx by two independent market
participants; (ii) an increase in the percentage of customer order volume matched internally; and (iii) lower clearing charges per transaction. In addition, the decrease in these
expenses was partially due to a smaller bad debt expense recorded for the year ended December 31, 2003, compared to the year ended December 31, 2002. We recorded a bad debt expense of
$8.0 million for the year ended December 31, 2003 due to receivables acquired in connection with the REDIBook acquisition, continuing business and, to a lesser extent, receivables from
non-subscribers who accessed our ECN via SelectNet, a Nasdaq order routing system. As the operator of a trading facility of PCX Equities, we no longer execute orders from
non-subscribers via SelectNet.

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Our
agency brokerage services segment accounted for $23.4 million, or 7.0%, of our total cost of revenues for the year ended December 31, 2003, compared to
$13.4 million, or 4.7%, for the year ended December 31, 2002. The absolute increase in agency brokerage expenses was due to higher soft dollar expenses in 2003. For the year ended
December 31, 2003 we incurred approximately $16.2 million in soft dollar expenses, compared to $6.9 million in 2002. The increase in agency brokerage expenses as a percentage of
our total cost of revenues is primarily due to these increased soft dollar expenses.

Gross Margin

Gross margin increased $54.8 million, or 78.4%, to $124.7 million for the year ended December 31, 2003 from $69.9 million for the year
ended December 31, 2002. As a percentage of revenues, gross margin increased to 27.2% for the year ended December 31, 2003 from 19.6% for the year ended December 31, 2002, driven
substantially by improvements in our transaction execution services business segment. The improvement in gross margin reflects our shift in business from operating the Archipelago ECN to operating
ArcaEx as the exclusive equities trading facility of PCX Equities. As the operator of an exchange facility, our per trade transaction costs declined by 28.0% due to reduced clearing costs, and we
earned increased market data fees with the launch of our Nasdaq-listed platform in February 2003. The migration of Nasdaq-listed securities to ArcaEx was completed by April 2003. These
improvements in gross margin were offset by a reduction in our per share transaction fees in April 2002, which reduced our revenues per trade for the year ended December 31, 2003.

Indirect Expenses

Total indirect expenses increased $19.7 million, or 18.9%, to $123.9 million for the year ended December 31, 2003 from $104.2 million
for the year ended December 31, 2002. This increase was due primarily to increased employee compensation and benefits expenses, increased depreciation and amortization expenses and increased
general administrative expenses, offset in part by decreased communications and marketing expenses for the period. However, as a percentage of total revenues, total indirect expenses decreased
slightly to 27.0% for the year ended December 31, 2003 from 29.2% for the year ended December 31, 2002.

Employee Compensation and Benefits.Employee compensation and benefits expenses increased $15.7 million, or 64.4%, to
$40.0 million for the year ended December 31, 2003 from $24.3 million for the year ended December 31, 2002. Increased compensation expenses were primarily due to increased
staffing and related expenses.

Depreciation and Amortization.Depreciation and amortization expenses increased by $12.8 million, or 72.7%, to
$30.5 million for the year ended December 31, 2003 from $17.7 million for the year ended December 31, 2002. The increase was due primarily to an accelerated depreciation
charge we recorded beginning in the third quarter of 2003 after determining on June 30, 2003 that software and computer equipment relating to our original trading platform would be retired in
March 2004. We decided to phase out the original platform after developing a new platform with technology acquired in the GlobeNet transaction. We discontinued using our original trading
platform after successfully migrating our listed trading operations in the first quarter of 2004. As a result, we shortened the expected life of the old platform to reflect the expected completion of
the migration in March 2004, resulting in the accelerated depreciation expense. We recorded $13.3 million in depreciation on these assets, compared to $7.6 million we would have
recorded had the depreciation not been accelerated. The increase was also due to a lesser extent to the amortization of software developed for internal use and the depreciation of fixed assets
purchased to develop our trading system.

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Communications.Communications expenses decreased $3.0 million, or 12.7%, to $20.7 million for the year ended
December 31, 2003 from $23.7 million for the year ended December 31, 2002. The decrease was primarily due to our cost containment efforts and a change in our customer connectivity
policy. Effective April 2002, in connection with our reduction of transaction fees, we began passing through to our broker-dealer customers the charges for network connectivity to the
Archipelago system, rather than incurring the line charges directly.

Marketing and Promotion.Marketing and promotion expenses decreased $10.8 million, or 56.7%, to $8.3 million
for the year ended December 31, 2003 from $19.1 million for the year ended December 31,
2002. As a percentage of total revenues, marketing and promotion expenses decreased to 1.8% for the year ended December 31, 2003 from 5.3% for the year ended December 31, 2002. This
substantial reduction was due to the suspension of our broad-based media advertising campaign in 2003 as we focused our resources on launching the ArcaEx trading platform.

Legal and Professional.Legal and professional expenses increased $1.1 million, or 14.6%, to $8.6 million for
the year ended December 31, 2003 from $7.5 million for the year ended December 31, 2002. The increase was due to increased legal and consulting fees.

Occupancy.Occupancy expenses increased $1.5 million, or 55.6%, to $4.2 million for the year ended
December 31, 2003 from $2.7 million for the year ended December 31, 2002. The increase was due primarily to an increase in the amount of office space leased during this period.

General and Administrative.General and administrative expenses increased $2.5 million, or 27.2%, to
$11.7 million for the year ended December 31, 2003 from $9.2 million for the year ended December 31, 2002. The increase was due primarily to an increase in operating lease
commitments during the period.

Interest and Other

Interest and other income and expenses decreased by $0.4 million, or 32.1%, to 0.9 million, due to reduced average cash balances and interest
earning assets. The unrealized loss on investments in 2002 was due to the mark-to-market valuation of our investment in TradePoint Group LDC, or TradePoint, which represented
our indirect investment in Virt-x Plc, a new pan-European blue chip market in which TradePoint was a minority owner. In 2003, we disposed of our entire investment in
Virt-x Plc.

Net Income

As a result of the foregoing, we recorded $1.8 million in net income for the year ended December 31, 2003, as compared to a $(35.6) million net loss
for the year ended December 31, 2002.

Liquidity and Capital Resources

Historically, our primary sources of liquidity have been cash provided by operations and proceeds generated from the sale of our common equity and preferred
shares. On August 19, 2004, we completed the sale of 6,325,000 shares of common stock at $11.50 per share in our IPO, for which we received net proceeds of $67.6 million. We incurred
approximately $6.8 million in expenses related to our IPO. Certain former members of Holdings LLC sold another 6,325,000 million shares to the public, for which we received no proceeds.
We intend to use the net proceeds from our IPO for general corporate purposes, including providing additional funds for our operations and to expand and diversify our products and service offerings.

On
January 3, 2005, we entered into a definitive agreement to acquire PCX Holdings, Inc. and all of its wholly-owned subsidiaries for $50.7 million
($40.6 million in cash and $10.1 million in stock).

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Our
principal liquidity requirements are for working capital, capital expenditures and general corporate purposes. Our capital expenditures have historically related primarily to
developing our trading platforms, which included investments in software development and hardware, as well as building our data centers. In addition to the anticipated acquisition of PCX
Holdings, Inc., we estimate that our capital expenditures for 2005 will be approximately $23.0 million for continued development of our trading platforms, and the development of new
products and services, including market data products.

At
December 31, 2004, we had cash and cash equivalents of $177.9 million, an increase of $66.1 million as compared to December 31, 2003. As of
December 31, 2003 and 2004, cash and cash equivalents included $34.6 million and $7.7 million, respectively, of fees collected from customers on sales of certain securities
transacted on our trading platform and subsequently remitted to PCX which, in turn, remits such fees to the SEC. In November 2004, these fees began to be paid directly to PCX through withdrawal
by the National Securities Clearing Corporation. As such, we are still responsible for billing these fees to our customers but are no longer directly involved in the collection and subsequent
remittance to PCX.

For
the year ended December 31, 2004, we provided cash of $61.3 million from our operating activities, consisting of net income of $68.9 million, partially offset by
the $7.6 million net effect of non-cash items and changes in working capital. We used $24.8 million in investing activities to purchase fixed assets and develop software.
Also, we provided cash of $29.6 million from financing activities consisting of the $67.6 million net proceeds from our IPO, partially offset by (i) $6.8 million of direct
costs related to the IPO, (ii) a $24.6 million cash distribution to our former members of Holdings LLC, and (iii) repayment of a note and principal payments under capital lease
obligations of $6.7 million in the aggregate.

We
believe that cash flows from operating activities, together with net proceeds from our IPO, should be sufficient for us to fund our current operations for at least the next twelve
months. We believe that the net proceeds from our IPO strengthened our balance sheet and provide us with available cash to pursue our business strategy of expanding our business by increasing our
market share, developing new products and services and pursuing acquisitions and strategic alliances. If this proves insufficient, we intend to seek additional financing in the credit or capital
markets, although we may be unsuccessful in obtaining additional financing on acceptable terms or at all.

Our
broker-dealer subsidiaries are subject to regulatory requirements intended to ensure their respective general financial soundness and liquidity, which require that they comply with
certain minimum capital requirements. These regulations, which differ in the United States, the United Kingdom and Canadathe three countries in which our broker-dealer subsidiaries do
businessgenerally prohibit a broker-dealer subsidiary from repaying borrowings from us or our affiliates, paying cash dividends, making loans to us or our affiliates or otherwise entering
into transactions that would result in a significant reduction in its regulatory net capital position without prior notification or approval of its principal regulator. Our capital structure is
designed to provide each of our subsidiaries with capital and liquidity consistent with its business and regulatory requirements.

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Summary Disclosures About Contractual Obligations and Off-Balance Sheet Arrangements

Contractual Obligations

As of December 31, 2004, our contractual cash obligations and other commercial commitments consisted of the following (in thousands):

|                            |  | Payments due by year
|--------------------------- |  | --------------------
|
|Operating lease obligations |  | $                   
|Capital lease obligations   |  |                     
|Purchase obligations        |  |                     
|                            |  |                     
|Total                       |  | $                   
|                            |  |                     

We
sublease certain office space, which will result in income totaling approximately $0.9 million in 2005.

On
January 3, 2005, we entered into a definitive agreement to acquire PCX Holdings, Inc. and its subsidiaries for $50.7 million, consisting of $40.6 million
in cash and $10.1 million in stock, subject to working capital and certain other possible adjustments. This acquisition is subject to approvals from PCXH shareholders as well as the SEC and
other regulatory entities. This obligation is not included in the above table.

Off-Balance Sheet Arrangements

In November 2004, pursuant to a lease agreement, we applied for a $1.2 million irrevocable standby letter of credit, which has periodic reductions
to the amount required to be maintained until expiration in July 2015. In connection with this letter of credit, we entered into a compensating balance agreement with our bank for one and
one-half times the amount of the letter of credit.

In
June 2004, pursuant to a lease agreement, we applied for a $350,000 irrevocable standby letter of credit, which expires on March 31, 2005.

The
respective beneficiaries of these letters of credit are the landlords of certain office space leased by us in New York and Chicago.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based on our financial statements, which have been prepared in accordance
with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported
amounts of assets, liabilities and expenses. We review our estimates on an on-going basis. We base our estimates on historical experience and on various other assumptions that we believe
to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. While our significant accounting policies are described in more
detail in the notes to our financial statements, we believe the following accounting policies to be critical to the judgments and estimates used in the preparation of our financial statements.

Revenue Recognition

We recognize revenue in the form of transaction fees paid by customers for trade execution on the Archipelago system, whether the trade is executed internally or
routed out to an external market center. We also simultaneously recognize an expense, in the form of either a liquidity payment or a

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routing
charge, paid to the liquidity provider or the external market center, as the case may be. We recognize these fees and expenses on a gross basis in our consolidated financial statements in
accordance with Emerging Issues Task Force ("EITF") Issue No. 99-19, "Reporting Revenue Gross as a Principal versus Net as an Agent". Our application of EITF Issue
No. 99-19 includes an evaluation of a number of factors deemed relevant by management in making its determination with respect to gross versus net reporting of revenue.

We
also earn market data fees from the sale of market data, and in turn rebate a portion of those fees to our customers. In accordance with EITF Issue No. 99-19, we
recognize these fees as revenue net of the rebates provided to our customers in our consolidated financial statements. We estimate the market data fees we earn each quarter based on the number of
transactions executed on the Archipelago system in that quarter that qualify for payment under the various market data plans.

Our
listing fees consist of original listing fees, fees payable in connection with the listing of additional shares of equity securities and annual listing fees. We recognize annual
listing fees ratably over the following twelve-month period. We recognize initial listing fees and additional share listing fees over five-year estimated service periods.

Goodwill and Indefinite-Lived Intangible Assets

As of December 31, 2004, we had approximately $131.9 million in goodwill and a $90.0 million indefinite-lived intangible asset. Under SFAS
No. 142, "Goodwill and Other Intangible Assets", management is required to perform a detailed review at least annually of the carrying value of our intangible assets, which includes goodwill
and our right to operate as the exclusive equities trading facility of PCX Equities. In this process, management is required to make estimates and assumptions in order to determine the fair value of
our assets and liabilities and projected future earnings using various valuation techniques, including a discounted cash flow model. Management uses its best judgment and information available to it
at the time to perform this review, as well as the services of an expert valuation specialist. Because management's assumptions and estimates are used in the valuation, actual results may differ. If
management determines that the fair value of the intangible assets is less than their carrying value, an impairment loss would be recognized in an amount equal to the difference between the fair value
and the carrying value.

Provision for Doubtful Accounts

We evaluate the collectibility of accounts receivable based on the financial condition of our customers, the length of time a receivable is past due, our
historical experience with the particular customer and the likelihood of projected payments. If we know of a customer's inability to meet its financial obligations, we record a specific provision for
doubtful accounts for estimated losses resulting from the inability of that customer to make payments. The amount of the provision will be charged against the amounts due to reduce the receivable to
the amount we reasonably believe will be collected. Due to changing economic, business and market conditions, we review the provision monthly and make changes to the provision as appropriate.

Stock-Based Compensation

We have elected to follow APB No. 25, "Accounting for Stock Issued to Employees", and related interpretations in accounting for our employee stock options.
Under APB No. 25, we record compensation expense equal to the difference between the exercise price of the stock option and the fair market value of the underlying stock as of the measurement
date. For disclosure purposes only, we also estimate the impact on our net income of applying the fair value method of measuring compensation cost on stock options with the fair value determined under
the minimum value method

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as
provided by SFAS No. 123, "Accounting for Stock-Based Compensation" as amended by SFAS No. 148, "Accounting for Stock-Based CompensationTransition and Disclosure".

In
December 2004, the Financial Accounting Standards Board ("FASB") issued SFAS No. 123(R) (revised 2004), "Share-Based Payment", requiring that compensation cost
associated with share-based payment transactions be recognized in financial statements. Statement No. 123(R) replaces the former SFAS No. 123 and supersedes APB No. 25. We plan to
adopt SFAS No. 123(R) on July 1, 2005 using the modified-prospective method. We are currently evaluating the option pricing model to be utilized and the overall impact of the adoption of
SFAS No. 123(R). The adoption of the fair value method will have an impact on our results of operations, although it will have no impact on our overall financial condition.

Related Party Transactions

We have entered into significant transactions with our affiliates in the normal course of business. In the opinion of management, transactions and agreements with
affiliates are made at prevailing market rates, terms and conditions, and do not involve more than the normal risk of collectibility or present other unfavorable features. For a discussion of
transactions with our affiliates, see ourConsolidated Financial Statements and Note 7thereto.

Software Development

We account for software development costs under SOP 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use", and
other related guidance. We expense software development costs incurred during the preliminary project stage, while we capitalize costs incurred during the application development stage, which includes
design, coding, installation and testing activities. Amortization of capitalized software development costs is computed on a straight-line basis over the software's estimated useful life,
generally three years.

Income Taxes

The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and deferred tax liabilities and
assets for the future tax consequences of events that have been recognized in an entity's financial statements or tax returns. Significant judgment is required in assessing the future tax consequences
of events that have been recognized in our financial statements or tax returns. Fluctuations in the actual outcome of these future tax consequences could have a material impact on our financial
position or results of operations.

Other Significant Accounting Policies

Other significant accounting policies not involving the same level of measurement uncertainties as those described above are nevertheless important to an
understanding of our consolidated financial statements. Policies related to certain accounting policies require difficult judgments on complex matters that are often subject to multiple sources of
authoritative guidance. For a discussion of our other significant accounting policies, see ourConsolidated Financial Statement and Note 2thereto.

ITEM 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

We do not have material exposure to interest rate changes, commodity price changes, foreign currency fluctuations, or similar market risks. Furthermore, we have
not entered into any derivative contracts to mitigate such risks. In addition, as the operator of an exchange facility and as an agency broker, we do not trade securities for our own account or
maintain inventories of securities for sale, and therefore are not subject to equity price risk.

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We
are exposed to credit risk from third parties, including customers, counterparties and clearing agents. These parties may default on their obligations to us due to bankruptcy, lack of
liquidity, operational failure or other reasons. In particular, our subsidiaries, Archipelago Securities, L.L.C. (outbound routing broker-dealer) and Wave Securities, L.L.C. (agency brokerage
broker-dealer), may be exposed to credit risk, due to the default of trading counterparties, in connection with the external routing and agency brokerage services we provide our customers. While we
are not exposed to counterparty risk for trades executed on ArcaEx (which we are not a party to and are cleared through the National Securities Clearing Corporation ("NSCC"), we are exposed to
counterparty risk in connection with trades executed by our outbound routing broker-dealer and our agency brokerage broker-dealer. In July 2004, we began to self clear certain of our trades
while continuing to use to a lesser extent the clearing broker-dealer affiliates of Goldman, Sachs & Co. and Merrill Lynch, Pierce, Fenner & Smith Incorporated. Pursuant to our clearing
agreements, we are required to reimburse these broker-dealer affiliates for any losses incurred due to a counterparty's failure to satisfy its contractual obligations, either by making payment or
delivering securities, for trades executed by our broker-dealer subsidiaries. Adverse movements in the prices of securities that are the subject of these transactions can increase our credit risk.
However, we believe that our risk of loss is remote, as we do not allow our broker-dealer customers to trade on margin. In our history, we have never had to reimburse our clearing brokers due to our
customers' failure to satisfy their contractual obligations. Credit difficulties or insolvency or the perceived possibility of credit difficulties or insolvency of one or more large or visible market
participants could also result in market-wide credit difficulties or other market disruptions. We also have credit risk related to transaction fees that we bill to customers on a monthly
basis, in arrears. Our potential exposure to credit losses on these transactions is represented by the receivable balances on our statement of financial condition. Our customers are financial
institutions whose ability to satisfy their contractual obligations may be impacted by volatile securities markets. Credit losses such as those described above could adversely affect our financial
condition and operating results.

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ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

|                                                        |                                                            | Page
|------------------------------------------------------- | ---------------------------------------------------------- | ----
|Report of Independent Registered Public Accounting Firm |                                                            | 79  
|Consolidated Financial Statements                       |                                                            |     
|                                                        | Consolidated Statements of Financial Condition             |     
|                                                        | Consolidated Statements of Operations                      |     
|                                                        | Consolidated Statements of Changes in Stockholders' Equity |     
|                                                        | Consolidated Statements of Cash Flows                      |     
|                                                        | Notes to Consolidated Financial Statements                 |     

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The
Board of Directors
Archipelago Holdings, Inc.

We
have audited the accompanying consolidated statements of financial condition of Archipelago Holdings, Inc. (the "Company") as of December 31, 2003 and 2004, and the
related consolidated statements of operations, changes in stockholders' equity, and cash flows for the years ended December 31, 2002, 2003 and 2004. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

We
conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to peform an audit of the Company's internal control over financial reporting.
Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing
an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In
our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Archipelago Holdings, Inc. at
December 31, 2003 and 2004, and the consolidated results of their operations and their cash flows for the years ended December 31, 2002, 2003 and 2004 in conformity with U.S. generally
accepted accounting principles.

/s/
Ernst & Young LLP
New York, NY
February 10, 2005

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Archipelago Holdings, Inc.        Consolidated Statements of Financial Condition        (In thousands, except per share data)

|                                           |                                                                                                        | December 31,                                                                                                  |                           
|------------------------------------------ | ------------------------------------------------------------------------------------------------------ | ------------------------------------------------------------------------------------------------------------- | --------------------------
|
|Assets                                     |                                                                                                        |                                                                                                               |                           
|                                           | Current assets:                                                                                        |                                                                                                               |                           
|                                           |                                                                                                        | Cash and cash equivalents                                                                                     |                           
|                                           |                                                                                                        | Receivables from brokers, dealers and customers (net of allowance for doubtful accounts of $5,500 and $4,173) |                           
|                                           |                                                                                                        | Receivables from related parties                                                                              |                           
|                                           |                                                                                                        |                                                                                                               |                           
|                                           |                                                                                                        |                                                                                                               | Total current assets      
|                                           | Fixed assets, net                                                                                      |                                                                                                               |                           
|                                           | Goodwill                                                                                               |                                                                                                               |                           
|                                           | Intangible assetPacific Exchange facility agreement                                                   |                                                                                                               |                           
|                                           | Other intangible assets, net                                                                           |                                                                                                               |                           
|                                           | Deferred tax asset, net                                                                                |                                                                                                               |                           
|                                           | Other assets                                                                                           |                                                                                                               |                           
|                                           |                                                                                                        |                                                                                                               |                           
|                                           |                                                                                                        |                                                                                                               | Total assets              
|                                           |                                                                                                        |                                                                                                               |                           
|Liabilities and Stockholders' Equity       |                                                                                                        |                                                                                                               |                           
|                                           | Current liabilities:                                                                                   |                                                                                                               |                           
|                                           |                                                                                                        | Accounts payable and accrued expenses                                                                         |                           
|                                           |                                                                                                        | Payables to brokers, dealers and exchanges                                                                    |                           
|                                           |                                                                                                        | Payables to related parties                                                                                   |                           
|                                           |                                                                                                        | Current portion of note payable and capital lease obligations                                                 |                           
|                                           |                                                                                                        |                                                                                                               |                           
|                                           |                                                                                                        |                                                                                                               | Total current liabilities 
|                                           |                                                                                                        | Note payable                                                                                                  |                           
|                                           |                                                                                                        | Capital lease obligations                                                                                     |                           
|                                           |                                                                                                        |                                                                                                               |                           
|                                           |                                                                                                        |                                                                                                               | Total liabilities         
|                                           |                                                                                                        | Commitments and contingencies (Note 11)                                                                       |                           
|                                           |                                                                                                        | Redeemable convertible preferred shares                                                                       |                           
|Stockholders' equity                       |                                                                                                        |                                                                                                               |                           
|                                           | Members' equity                                                                                        |                                                                                                               |                           
|                                           | Common stock, $.01 par value, 165,000 shares authorized; zero and 47,138 shares issued and outstanding |                                                                                                               |                           
|                                           | Additional paid-in capital                                                                             |                                                                                                               |                           
|                                           | Unearned stock-based compensation                                                                      |                                                                                                               |                           
|                                           | Retained earnings                                                                                      |                                                                                                               |                           
|                                           |                                                                                                        |                                                                                                               |                           
|                                           |                                                                                                        |                                                                                                               | Total stockholders' equity
|                                           |                                                                                                        |                                                                                                               |                           
|Total liabilities and stockholders' equity |                                                                                                        | $                                                                                                             | 465,892                   
|                                           |                                                                                                        |                                                                                                               |                           

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

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Archipelago Holdings, Inc.        Consolidated Statements of Operations        (In thousands, except per share data)

|                                                      |                                                                                                          | Year ended December 31, |        
|----------------------------------------------------- | -------------------------------------------------------------------------------------------------------- | ----------------------- | -------
|
|Revenues                                              |                                                                                                          |                         |        
|                                                      | Transaction fees ($177,304, $175,880 and $196,618 with related parties)                                  |                         | $      
|                                                      | Market data fees ($1,279, $10,463 and $24,218 with related parties)                                      |                         |        
|                                                      | Listing fees                                                                                             |                         |        
|                                                      |                                                                                                          |                         |        
|Total revenues                                        |                                                                                                          |                         | 357,412
|                                                      |                                                                                                          |                         |        
|Cost of revenues                                      |                                                                                                          |                         |        
|                                                      | Liquidity payments ($28,121, $48,136 and $56,436 with related parties)                                   |                         |        
|                                                      | Routing charges ($43,998, $56,468 and $48,140 with related parties)                                      |                         |        
|                                                      | Clearance, brokerage and other transaction expenses ($62,840, $40,228, and $16,867 with related parties) |                         |        
|                                                      |                                                                                                          |                         |        
|Total cost of revenues                                |                                                                                                          |                         | 287,530
|                                                      |                                                                                                          |                         |        
|Gross margin                                          |                                                                                                          |                         | 69,882 
|                                                      |                                                                                                          |                         |        
|Indirect expenses                                     |                                                                                                          |                         |        
|                                                      | Employee compensation and benefits                                                                       |                         |        
|                                                      | Depreciation and amortization                                                                            |                         |        
|                                                      | Communications ($3,856, $3,132 and $4,712 with related parties)                                          |                         |        
|                                                      | Marketing and promotion ($548, $528 and $357 with related parties)                                       |                         |        
|                                                      | Legal and professional ($1,000, $1,000 and $1,988 with related parties)                                  |                         |        
|                                                      | Occupancy                                                                                                |                         |        
|                                                      | General and administrative ($1,500, $0 and $0 with related parties)                                      |                         |        
|                                                      |                                                                                                          |                         |        
|Total indirect expenses                               |                                                                                                          |                         | 104,205
|                                                      |                                                                                                          |                         |        
|Operating income (loss)                               |                                                                                                          |                         | (34,323
|Interest and other, net                               |                                                                                                          |                         | 1,386  
|Unrealized loss on investment owned                   |                                                                                                          |                         | (2,702 
|                                                      |                                                                                                          |                         |        
|Income (loss) before income tax provision             |                                                                                                          |                         | (35,639
|Income tax provision                                  |                                                                                                          |                         |       
|                                                      |                                                                                                          |                         |        
|Net income (loss)                                     |                                                                                                          |                         | (35,639
|Deemed dividend on convertible preferred shares       |                                                                                                          |                         |       
|                                                      |                                                                                                          |                         |        
|Net income (loss) attributable to common stockholders |                                                                                                          | $                       | (35,639
|                                                      |                                                                                                          |                         |        
|Basic earnings (loss) per share(a)                    |                                                                                                          | $                       | (1.14  
|                                                      |                                                                                                          |                         |        
|Diluted earnings (loss) per share(a)                  |                                                                                                          | $                       | (1.14  
|                                                      |                                                                                                          |                         |        
|Basic weighted average shares outstanding(a)          |                                                                                                          |                         | 31,222 
|Diluted weighted average shares outstanding(a)        |                                                                                                          |                         | 31,222 

---

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

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Archipelago Holdings, Inc.        Consolidated Statements of Changes in Stockholders' Equity        For the years ended December 31, 2002, 2003 and 2004    (In thousands)

|                                                                                                                      |  |   |          | Common Stock |        |  |   |     |  |   |         |   |  
|--------------------------------------------------------------------------------------------------------------------- |  | - | -------- | ------------ | ------ |  | - | --- |  | - | ------- | - | -
|
|
|Balance, January 1, 2002                                                                                              |  | $ | 195,758  |              |       |  | $ |    |  | $ |        |   | $
|Issuance of shares for acquisition                                                                                    |  |   | 142,704  |              |        |  |   |     |  |   |         |   |  
|Net loss                                                                                                              |  |   | (35,639  | )            |        |  |   |     |  |   |         |   |  
|                                                                                                                      |  |   |          |              |        |  |   |     |  |   |         |   |  
|Balance, January 1, 2003                                                                                              |  |   | 302,823  |              |       |  |   |    |  |   |        |   |  
|Issuance costs of redeemable convertible preferred shares                                                             |  |   | (1,636   | )            |        |  |   |     |  |   |         |   |  
|Deferred compensation, net                                                                                            |  |   | (170     | )            |        |  |   |     |  |   |         |   |  
|Addition to Members' equity due to deferred compensation                                                              |  |   | 503      |              |        |  |   |     |  |   |         |   |  
|Net income                                                                                                            |  |   | 1,773    |              |        |  |   |     |  |   |         |   |  
|                                                                                                                      |  |   |          |              |        |  |   |     |  |   |         |   |  
|Balance, January 1, 2004                                                                                              |  |   | 303,293  |              |       |  |   |    |  |   |        |   |  
|Amortization of stock-based compensation for the period from January 1 to August 11, 2004                             |  |   |          |              |        |  |   |     |  |   |         |   |  
|Members' distribution                                                                                                 |  |   | (24,613  | )            |        |  |   |     |  |   |         |   |  
|Net income for the period from January 1 to August 11, 2004                                                           |  |   | 50,525   |              |        |  |   |     |  |   |         |   |  
|Reorganization from LLC to "C" Corporation                                                                            |  |   | (329,205 | )            | 36,169 |  |   | 362 |  |   | 329,013 |   |  
|Conversion of redeemable convertible preferred shares to common                                                       |  |   |          |              | 3,732  |  |   | 37  |  |   | 49,963  |   |  
|Issuance of common stock in initial public offering, net of underwriting discounts                                    |  |   |          |              | 6,325  |  |   | 63  |  |   | 67,583  |   |  
|Direct costs of initial public offering                                                                               |  |   |          |              |        |  |   |     |  |   | (6,777  | ) |  
|Issuance of additional common stock to former REDIBook members                                                        |  |   |          |              | 192    |  |   | 2   |  |   | 2,197   |   |  
|Issuance of additional common stock to GAP Archa Holdings and related deemed dividend on convertible preferred shares |  |   |          |              | 717    |  |   | 7   |  |   | 9,612   |   |  
|Amortization of stock-based compensation from the period from August 12 to December 31, 2004                          |  |   |          |              |        |  |   |     |  |   |         |   |  
|Exercise of stock options                                                                                             |  |   |          |              | 3      |  |   |    |  |   | 34      |   |  
|Net income for the period from August 12 to December 31, 2004                                                         |  |   |          |              |        |  |   |     |  |   |         |   |  
|                                                                                                                      |  |   |          |              |        |  |   |     |  |   |         |   |  
|Balance, December 31, 2004                                                                                            |  | $ |         |              | 47,138 |  | $ | 471 |  | $ | 451,625 |   | $
|                                                                                                                      |  |   |          |              |        |  |   |     |  |   |         |   |  

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

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Archipelago Holdings, Inc.        Consolidated Statements of Cash Flows        (In thousands)

|                                                                                         |                                              | Year ended December 31,                         |        
|---------------------------------------------------------------------------------------- | -------------------------------------------- | ----------------------------------------------- | -------
|
|Cash flows from operating activities                                                     |                                              |                                                 |        
|Net income (loss)                                                                        |                                              | $                                               | (35,639
|Adjustments to reconcile net income (loss) to net cash provided by operating activities: |                                              |                                                 |        
|                                                                                         |                                              | Depreciation and amortization                   |        
|                                                                                         |                                              | Amortization of other intangible assets         |        
|                                                                                         |                                              | Provision for doubtful accounts                 |        
|                                                                                         |                                              | Deferred taxes                                  |        
|                                                                                         |                                              | Stock-based compensation                        |        
|                                                                                         |                                              | Tax benefit from stock option exercises         |        
|                                                                                         |                                              | Gain on sale of investment                      |        
|                                                                                         |                                              | Change in unrealized loss on investment owned   |        
|                                                                                         | Changes in operating assets and liabilities: |                                                 |        
|                                                                                         |                                              | Receivables from brokers, dealers and customers |        
|                                                                                         |                                              | Receivables from related parties                |        
|                                                                                         |                                              | Other assets                                    |        
|                                                                                         |                                              | Accounts payable and accrued expenses           |        
|                                                                                         |                                              | Payables to brokers, dealers and exchanges      |        
|                                                                                         |                                              | Payables to related parties                     |        
|                                                                                         |                                              |                                                 |        
|Net cash provided by operating activities                                                |                                              |                                                 | 23,421 
|                                                                                         |                                              |                                                 |        
|Cash flows from investing activities                                                     |                                              |                                                 |        
|Additions to fixed assets                                                                |                                              |                                                 | (21,126
|Acquisition of business and intangible assets                                            |                                              |                                                 | (8,083 
|Proceeds from sale of investment                                                         |                                              |                                                 |       
|                                                                                         |                                              |                                                 |        
|Net cash used in investing activities                                                    |                                              |                                                 | (29,209
|                                                                                         |                                              |                                                 |        
|Cash flows from financing activities                                                     |                                              |                                                 |        
|Proceeds from initial public offering, net of underwriting discounts                     |                                              |                                                 |       
|Direct costs of initial public offering                                                  |                                              |                                                 |       
|Cash distribution to former Members                                                      |                                              |                                                 |       
|Proceeds from exercise of stock options                                                  |                                              |                                                 |       
|Proceeds from issuance of note payable                                                   |                                              |                                                 |       
|Repayments of note payable                                                               |                                              |                                                 |       
|Proceeds from issuance of redeemable convertible preferred shares                        |                                              |                                                 |       
|Costs related to issuance of redeemable convertible preferred shares                     |                                              |                                                 |       
|Principal payments under capital lease obligations                                       |                                              |                                                 |       
|                                                                                         |                                              |                                                 |        
|Net cash provided by financing activities                                                |                                              |                                                 |       
|                                                                                         |                                              |                                                 |        
|Net increase (decrease) in cash and cash equivalents                                     |                                              |                                                 | (5,788 
|Cash and cash equivalents at beginning of year                                           |                                              |                                                 | 54,752 
|                                                                                         |                                              |                                                 |        
|Cash and cash equivalents at end of year                                                 |                                              | $                                               | 48,964 
|                                                                                         |                                              |                                                 |        
|Supplemental disclosures of cash flow information                                        |                                              |                                                 |        
|Cash paid for:                                                                           |                                              |                                                 |        
|                                                                                         | Interest                                     |                                                 |        
|                                                                                         | Income taxes                                 |                                                 |        
|Non-cash investing and financing activities                                              |                                              |                                                 |        
|Conversion of convertible preferred shares to common                                     |                                              |                                                 |       
|Issuance of common stock to former REDIBook Members                                      |                                              |                                                 |       
|Issuance of common stock to GAP Archa Holdings                                           |                                              |                                                 |       

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

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Archipelago Holdings, Inc.        Notes to Consolidated Financial Statements        December 31, 2004

1.     ORGANIZATION AND BASIS OF PRESENTATION

Organization

Archipelago Holdings, Inc. operates the Archipelago Exchange, or ArcaEx® ("ArcaEx"), the first open all-electronic stock market in
the United States for trading in all NYSE, Nasdaq, AMEX and Pacific Exchange-listed stocks. Archipelago Holdings, L.L.C. ("Holdings LLC"), a Delaware limited liability company and the
predecessor to the Company, was organized in January 1999. In July 2000, Holdings LLC entered into a facility services agreement with the Pacific Exchange, Inc. ("PCX")
which allowed it to establish and operate ArcaEx. The Securities and Exchange Commission's ("SEC") approval of ArcaEx was announced in October 2001 and ArcaEx began trading operations for
listed securities in March 2002 and for over-the-counter securities ("OTC") in April 2003.

On
August 11, 2004, Holdings LLC converted to a Delaware corporation, Archipelago Holdings, Inc. We refer to Archipelago Holdings, Inc. and, prior to its
conversion to a Delaware corporation, Holdings LLC, as the "Company". On August 19, 2004, the Company completed an initial public offering ("IPO") of its common stock. See below
discussion of the"Conversion Transaction"and the"Initial Public Offering."

Through
certain subsidiaries, the Company also provides broker execution services to institutions for orders involving Nasdaq and listed securities, as well as introducing broker
services for ArcaEx to broker-dealers that do not hold an exchange trading permit ("ETP").

Conversion Transaction

On August 11, 2004, prior to the consummation of the IPO, Holdings LLC converted from a Delaware limited liability company to a Delaware
corporation, Archipelago Holdings, Inc. As a limited liability company, all income taxes were paid by the members of Holdings LLC. As a corporation, the Company is responsible for the
payment of all federal, state and local corporate income taxes. SeeNote 9, Income Taxes.

As
a result of the reorganization of Holdings LLC from a Delaware limited liability company into a Delaware corporation, the members of Holdings LLC received
0.222222 shares of common stock of the Company for each of their membership interests held by such member in Holdings LLC, which corresponds to a 4.5-for-1
reverse stock split. The weighted average number of shares used in the basic and diluted earnings per share computations gives retroactive effect to the 4.5-for-1 reverse stock
split.

As
approved by the Company's board of managers on July 16, 2004, the Company made a $24.6 million cash distribution to the members of Holdings LLC immediately prior
to the conversion transaction. The cash distribution permits the members to pay the taxes that the members owe for their share of the Company's profits in 2004 as a limited liability company through
the date of the conversion transaction, calculated primarily based on the highest federal and state income tax rate applicable for the tax withholding purposes to an individual.

Initial Public Offering

On August 19, 2004, the Company completed the IPO of its common stock as a result of which the Company sold 6,325,000 shares of common stock at
$11.50 per share. The Company received net proceeds of $67.6 million and incurred approximately $6.8 million in expenses in connection with the

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IPO.
In addition, 6,325,000 shares of common stock were sold in the IPO by certain selling stockholders of the Company, for which the Company received no proceeds. The Company's stock is listed
on the Pacific Exchange and is traded on ArcaEx under the symbol "AX". A summary of the terms of the IPO can be found in the Company's Registration Statement on Form S-1 (File
No. 333-113226) (the "Registration Statement"), which was declared effective by the SEC on August 12, 2004.

Basis of Presentation

The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, which principally include: Wave
Securities, L.L.C. (formerly, Archipelago, L.L.C.), Archipelago Exchange, L.L.C. ("ArcaExchange"), Archipelago Securities, L.L.C. ("ARCAS"), ARCA-GNC
Acquisition, L.L.C. ("GNC"), Archipelago Trading Services, Inc. ("ATSI"), Archipelago Europe Limited ("AEL"), Wave Securities Canada Inc., Archipelago
Direct, L.L.C. (formerly, Archipelago TP Investment, L.L.C.), Archipelago Brokerage Services, L.L.C. (formerly, Archipelago Services, L.L.C.), Archipelago Market Data
Services, L.L.C., and Archipelago Overseas, L.L.C. Intercompany accounts and transactions have been eliminated in consolidation. Certain reclassifications have been made to prior years
in order to conform to the current year's presentation.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Management believes that the estimates utilized in preparing its consolidated financial statements are reasonable and prudent. Actual
results could differ from these estimates.

2.     SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Revenue Recognition

Transaction fees are earned on a per trade basis, based on shares transacted, and are recognized as transactions occur. For each transaction executed, there is an
associated liquidity payment or routing charge paid. Pursuant to Emerging Issues Task Force ("EITF") Issue No. 99-19, "Reporting Revenue Gross as a Principal versus Net as an Agent"
("EITF 99-19"), the Company records such expenses as liquidity payments or routing charges in the consolidated statements of operations.

Market
data fees are earned on the sale of transaction market data. This revenue is recorded net of amounts due under revenue sharing arrangements with market participants, based on the
criteria provided by EITF 99-19. Market data fees are recognized as transactions occur.

Listing
fees are earned from companies and index providers that list on PCX as a trading venue for their equity securities, exchange-traded funds and other structured products. The
Company recognizes initial listing fees and additional share listing fees ratably over a five-year estimated service period. Annual listing fees are recognized ratably over the related
twelve-month period.

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Cash and Cash Equivalents

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

Provision for Doubtful Accounts

The Company maintains an allowance for doubtful accounts based upon the estimated collectibility of accounts receivable. The Company recorded provisions to the
allowance of approximately $8.0 million and $0.0 million, and write-offs against the allowance of approximately $11.9 million and $1.3 million during the years
ended December 31, 2003 and 2004, respectively. Additions to (reductions of) the allowance are charged to (reversed against) bad debt expense, which is included in clearance, brokerage and
other transaction expenses in the consolidated statements of operations.

Fixed Assets

Fixed assets consist of computer hardware and software, furniture, equipment (including assets under capital leases) and leasehold improvements. All fixed assets
are carried at cost and are depreciated on a straight-line basis over their estimated useful lives of three to seven years. The assets under capital leases are recorded at the lower of the
present value of the minimum lease payments or the fair value of the asset. The assets are amortized (or depreciated) over the lower of their related lease terms or their estimated useful lives. Gains
or losses related to retirements or disposition of fixed assets are recognized in the period incurred.

Leasehold
improvements are amortized over the shorter of the life of the lease or their estimated useful life.

In
accordance with the provisions of Statement of Position ("SOP") 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use", the Company
capitalizes qualifying software costs incurred during the application development stage, which includes design, coding, installation and testing activities. Amortization of capitalized software
development costs is computed on a straight-line basis over the software's estimated useful life, generally three years.

The
Company performs reviews for the impairment of fixed assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.

Goodwill and Other Intangible Assets

The Company reviews the carrying value of goodwill for impairment on a periodic basis based upon estimated fair value of the Company's reporting units. Using an
independent valuation specialist, the Company, on an annual basis, estimates fair value by using a discounted cash flow model. Should the review indicate that goodwill is impaired, the Company's
goodwill would be reduced by the difference between the carrying value of goodwill and its fair value.

The
Company reviews the useful life of its indefinite-lived intangible asset to determine whether events or circumstances continue to support the indefinite useful life. In addition, the
carrying value of the Company's indefinite-lived intangible asset is reviewed by the Company on at least an annual basis for impairment based upon the estimated fair value of the asset calculated by
an independent valuation specialist.

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The
Company performed its annual impairment tests as of December 31, 2003 and 2004, which indicated that no impairment charge was required for goodwill or its indefinite-lived
intangible asset.

Estimated Fair Value of Financial Instruments

Statement of Financial Accounting Standard ("SFAS") No. 107, Disclosure about Fair Value of Financial Instruments, requires the disclosure of the fair
value of financial instruments, including assets and liabilities recognized in the consolidated statements of financial condition. Management estimates that the fair value of financial instruments
recognized in the consolidated statements of financial condition (including cash and cash equivalents, receivables, payables and accrued expenses) approximates their carrying value, as such financial
instruments are short-term in nature, bear interest at current market rates or are subject to repricing monthly.

Income Taxes

The Company had elected to be treated as a partnership for federal, state and local income tax purposes prior to its reorganization on August 11, 2004.
Accordingly, all items of income, expense, gain and loss of the Company prior to August 12, 2004 were generally reportable on the tax returns of the
members of Holdings LLC. Therefore, the Company has no net loss carryforwards. On August 11, 2004, the Company converted to a Delaware corporation and has since then been subject to
income taxes.

The
Company records income taxes using the asset and liability method. Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. A valuation allowance is recorded against deferred tax assets if it is "more likely than
not" that such assets will not be realized.

Marketing and Promotion

Marketing and promotion costs consist of advertising costs, promotional items, trade shows, and selling expenses. Advertising costs include certain costs of
production, which are expensed at the time of first showing. The costs of communicating advertising are expensed over the period of the communication. The Company recorded $12.5 million,
$4.2 million and $15.1 million of advertising costs for the years ending December 31, 2002, 2003 and 2004, respectively.

Stock-Based Compensation

The Company accounts for stock option grants to employees in accordance with Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock
Issued to Employees", and, accordingly, recognizes compensation expense using the intrinsic value method. Under the intrinsic value method, stock-based compensation, if any, is measured as the excess
of the estimated fair value of the Company's stock over the option exercise price.

The
Company adopted the disclosure provisions of SFAS No. 123, "Accounting for Stock-Based Compensation" and SFAS No. 148, "Accounting for Stock-Based
CompensationTransition and Disclosure". Had compensation expense for the Company's stock option plans been determined based

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upon
fair value consistent with SFAS No. 123, the Company's net income and earnings per share would have been changed to the following pro forma amounts:

|                                                                                                                                                               |                      | Year ended December 31,
|-------------------------------------------------------------------------------------------------------------------------------------------------------------- | -------------------- | -----------------------
|
|
|Net income (loss) attributable to common stockholders, as reported                                                                                             |                      | $                      
|Add: Stock-based employee compensation cost included in net income                                                                                             |                      |                        
|Deduct: Stock-based employee compensation cost determined under the fair value based method for all awards, net of related tax effects of $495, $919, and $739 |                      |                        
|                                                                                                                                                               |                      |                        
|Net income (loss) attributable to common stockholders, pro forma                                                                                               |                      | $                      
|                                                                                                                                                               |                      |                        
|Earnings per share:                                                                                                                                            |                      |                        
|                                                                                                                                                               | Basic, as reported   |                        
|                                                                                                                                                               | Basic, pro forma     |                        
|                                                                                                                                                               | Diluted, as reported |                        
|                                                                                                                                                               | Diluted, pro forma   |                        

The fair value of each option grant was estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions:

|                         |  | Year ended December 31, |  
|------------------------ |  | ----------------------- | -
|
|Dividend yield           |  |                        |  
|Expected volatility      |  | 30.0                    | %
|Risk-free interest rate  |  | 5.0                     | %
|Expected life (in years) |  | 7                       |  

The Black-Scholes option pricing model was developed for use in estimating the value of traded options that have no vesting restrictions and are fully
transferable. In addition, option pricing models require the input of highly subjective assumptions. Because the Company's employee stock options have characteristics significantly different from
those of traded options, and because changes in the subjective input assumptions can materially affect the estimate, in management's opinion, the existing valuation models may not provide a reliable
measure of the fair value of the Company's employee stock options.

The
above pro forma information gives effect to the Company's conversion into a Delaware corporation as if it occurred at the beginning of the periods presented. In addition, the pro
forma information was tax effected at combined federal, state and local rates of 40.0%, 40.0% and 41.5% for the years ended December 31, 2002, 2003 and 2004, respectively.

In
December 2004, the Financial Accounting Standards Board ("FASB") issued SFAS No. 123(R) (revised 2004), "Share-Based Payment", requiring that compensation cost
associated with share-based payment transactions be recognized in financial statements. This cost is to be measured at the fair value of the instrument issued. SFAS No. 123(R) covers a wide
range of share-based compensation arrangements including stock options, restricted stock plans, performance based awards, share

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appreciation
rights and employee stock purchase plans. Statement No. 123(R) replaces the former SFAS No. 123 and supersedes APB No. 25. The Company plans to adopt SFAS
No. 123(R) on July 1, 2005 using the modified-prospective method. The Company is currently evaluating the option pricing model to be utilized and the overall impact of the adoption of
SFAS No. 123(R). The adoption of the fair value method will have an impact on the Company's results of operations, although it will have no impact on the Company's overall financial condition.

3.     FIXED ASSETS

Fixed consisted of the following:

December 31,2003

2004(In thousands)Software, including software development costs

$
35,047

$
44,511Computers and equipment


32,791


43,131Leasehold improvements


17,409


18,770Equipment under capital leases


18,070


18,070Routers


4,920


5,524Furniture and fixtures


1,895


3,074110,132


133,080Accumulated depreciation and amortization


(60,379
)

(83,585
)$
49,753

$
49,495


The Company is the lessee of computer equipment under capital leases expiring in 2005. Amortization of computer equipment under capital leases is included in
depreciation and amortization in the consolidated statements of operations. As of December 31, 2003 and 2004, the accumulated depreciation for computer equipment under capital leases was
approximately $14.5 million and $16.6 million, respectively.

The
Company capitalized software development costs of approximately $8.5 million and $2.5 million in 2003 and 2004, respectively. For the years ended December 31,
2002, 2003 and 2004, the Company directly expensed software development costs of approximately $3.9 million, $6.9 million and $3.6 million, respectively, as these costs were
incurred outside of the application development stage.

In
June 2003, the Company determined that certain software and computer equipment would be retired by March 2004 and, therefore, the Company accelerated depreciation on
these assets. For the years ended December 31, 2003 and 2004, the Company recorded approximately $13.8 million and $6.2 million in depreciation on these assets as opposed to
approximately $7.6 million and $8.0 million, respectively, had the depreciation period not been accelerated. As of March 31, 2004, the net book value of these assets was reduced
to zero.

In
May 2004, the Company vacated one of the floors in its headquarters. As a result, the Company wrote off fixed assets with a net book value of approximately $0.6 million
in the aggregate, which consisted primarily of leasehold improvements.

89

---



4.     GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill

In March 2002, the Company acquired REDIBook in a transaction accounted for as a purchase business combination. Approximately $20.8 million of the
$150.5 million purchase price was assigned to the net tangible and intangible assets acquired, with the remaining value of $129.7 million ascribed to goodwill. In August 2004, the
Company issued contingent consideration to former REDIBook members in the form of 192,194 shares of the Company's common stock valued at $11.50 per share and recorded $2.2 million of
additional goodwill.

PCX Exchange Facility Agreement

In May 2001, the Company acquired the right to operate as the exclusive equity trading facility of PCX Equities, Inc., ("PCX Equities") including
the rights to certain revenue streams comprised primarily of transaction fees, market data fees, and listing fees, for an aggregate consideration of $90.0 million consisting of a
$40.0 million cash payment and 10.8% equity interest in the Company. The Company determined that this intangible asset had an indefinite life and, as such, it is not subject to amortization.

In
addition, pursuant to this agreement, an affiliate of PCX provides certain regulatory services to the Company in return for regular payments as negotiated between the parties. Also,
the Company agreed to reimburse PCX for certain necessary costs incurred prior to the commencement of the operations of ArcaEx. SeeNote 7, Related Party
Transactions.

PCX
and PCX Equities have the right to terminate these arrangements in certain limited circumstances. PCX or PCX Equities may provide notice of termination to the Company (i) at
any time after a breach by the Company of the agreements or a violation by the Company of applicable law that has resulted in, or is reasonably likely to result in, PCX losing its status as a U.S.
national securities exchange or self-regulatory organization or the Archipelago Exchange having to terminate conducting all business for an indefinite period of time, and after PCX has
provided written notice to the Company of such breach or violation, the Company or such subsidiary of the Company has willfully failed to take any action to cure such breach or violation within
60 days of receiving such notice, or (ii) at any time after the Company becomes insolvent or bankrupt or is liquidated or winding-up or makes an assignment for the benefit of
its creditors or voluntarily files for, or is placed in, voluntary bankruptcy or takes any other action which would indicate insolvency, bankruptcy, liquidation or winding-up on its part.

Other Intangible Assets

In October 2002, the Company acquired Globenet Securities, Inc. and the net assets of its parent, Globenet Capital Corporation in a transaction
accounted for as an asset acquisition. The Company assigned $4.9 million to an intangible asset related to the technology acquired. This intangible asset is amortized over three years from the
implementation of the technology in May 2003. The Company recorded approximately $1.1 million and $1.6 million in amortization on this intangible asset for the years ended
December 31, 2003 and 2004, respectively. As of December 31, 2003 and 2004, the net book value of this intangible asset was approximately $3.8 million and $2.2 million,
respectively.

90

---





5.     ACCOUNTS PAYABLE AND ACCRUED EXPENSES

Accounts payable and accrued expenses consisted of the following:

December 31,2003

2004(In thousands)Trade payables

$
7,589

$
9,053Accrued compensation


13,305


16,268Other


2,023


3,253Total

$
22,917

$
28,574


6.     STOCKHOLDERS' EQUITY

Prior to its reorganization from a Delaware limited liability company to a Delaware corporation on August 11, 2004 (see Note 1, Organization and Basis
of PresentationConversion Transaction), the Company had three classes of common shares outstanding:
Class A, Class B and Class C. The common shares rankedpari passuwith regards to liquidation and distribution. Class A
shares had voting rights, while Class B and C shares had no voting rights. As part of the conversion transaction, all of the Class A, Class B and Class C shares were
converted to common stock.

Redeemable Convertible Preferred Shares

On November 12, 2003, the Company issued 16,793,637 Class A Preferred Shares, which were a newly-created class of voting shares, at $2.98 per share,
for total consideration of $50,000,000. The Company incurred approximately $1.6 million in transaction costs in conjunction with this issuance. The Class A Preferred Shares converted
automatically into 4,449,268 shares of common stock upon consummation of the Company's IPO in August 2004. Included in this conversion was the issuance of 717,349 shares of common
stock attributable to a beneficial conversion feature included in the previously issued redeemable preferred interest. The $9.6 million intrinsic value of such shares was treated as a deemed
dividend on convertible preferred shares, which was reported after net income to reach net income attributable to common stockholders in the consolidated statement of operations for the year ended
December 31, 2004.

Employee and Non Employee Director Stock and Benefit Plans

The Company has three long-term incentive plans (the "Plans") that provide for the granting of stock options and restricted stock units to officers,
key employees and non-employee directors. The objectives of the Plans include attracting and retaining the best personnel, providing for additional performance incentives, and promoting
the success of the Company by providing employees the opportunity to acquire common stock.

The
2000 Long-Term Incentive Plan (the "2000 Plan") was adopted in July 2000, and awards under this plan were first granted to employees in August 2000. The
awards issued under the plan vest in four equal installments over a four-year period beginning on the later of January 1, 2000 or the participant's first day of employment with the
Company, and have a term of ten years. The number of shares

91

---



delivered
in the aggregate under the 2000 Plan cannot exceed 577,778. All awards granted under the 2000 Plan have a $20.25 exercise price.

The
2003 Long-Term Incentive Plan (the "2003 Plan") was adopted in August 2003 and amended in November 2003. The awards granted under the 2003 Plan have a term
of ten years. The number of shares delivered in the aggregate under the 2003 Plan cannot exceed 2,423,805. Grants were made in three tranches: Supplemental Performance, New Hire Makeup and
Performance, as follows:



The
Company adopted the 2004 Stock Incentive Plan (the "2004 Plan"). The total number of shares of our common stock which may be delivered pursuant to awards granted under the 2004 Plan
will not exceed the sum of (i) 1,222,221 shares plus (ii) any shares of our common stock that are subject to grant under the 2000 Plan or the 2003 Plan and remain available for
grant under these plans. No new awards will be granted under the 2000 and 2003 Plans. For the year ended December 31, 2004, all awards granted under the 2004 Plan had an exercise price of
$11.50, vest over four years and have a ten-year term.

A
summary of the status of the Plans as of December 31, 2002, 2003 and 2004 and changes during the years ended on those dates is as follows:

Number of Options

Weighted Average Exercise PriceOutstanding at January 1, 2002

562,000

$
20.25Granted

4,444


20.25Forfeited

(7,333
)

20.25Outstanding at January 1, 2003

559,111


20.25Granted

1,261,694


10.92Forfeited

(40,111
)

20.25Outstanding at January 1, 2004

1,780,694


13.64Granted

811,479


11.50Exercised

(3,166
)

4.91Forfeited

(25,920
)

15.38Outstanding at December 31, 2004

2,563,087


12.96


In August 2003, the Company issued stock options with an exercise price of $4.91, a price lower than the fair value of the Company's stock, which was
estimated to be $6.26. The Company recognized compensation expense related to the issuance of these options in the consolidated statement of

92

---



operations
for the years ended December 31, 2003 and 2004 of $0.3 million and $0.2 million, respectively.

Additional
information regarding stock options outstanding as of December 31, 2004 is as follows:

|Options Outstanding |       | Options Exercisable
|------------------- | ----- | -------------------
|
|$                   | 4.91  |                    
|                    | 11.50 |                    
|                    | 13.41 |                    
|                    | 20.25 |                    
|                    |       |                    
|                    |       |                    

As part of their compensation for 2004, the Company's non-employee directors received an annual grant of restricted stock units ("RSUs") valued at
$75,000 based upon the fair market of the Company's shares of common stock on the date of grant. These RSUs vest in four equal installments on the first, second, third and fourth anniversaries of the
date of grant. In addition, non-employee directors were permitted to elect to take all or a portion of their $75,000 cash retainer in RSUs, which vest on the second anniversary of the date
of grant. For the year ended December 31, 2004, the Company issued 20,396 RSUs to its non-employee directors.

93

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7.     RELATED PARTY TRANSACTIONS

The following is a summary of the related party transactions involving the Company and certain former members (i.e., owners of Holdings LLC prior to the
IPO) and current stockholders (i.e., stockholders of the Company after the IPO), PCX and other affiliates as part of its operations:

|                                                                                                         |                                                                                                                            | Year ended December 31, |        
|-------------------------------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------- | ----------------------- | -------
|
|
|Revenues                                                                                                 |                                                                                                                            |                         |        
|Transaction fees earned from stockholders/former members and affiliates(1)                               |                                                                                                                            | $                       | 177,304
|Market data fees received from PCX (net of amounts shared with customers of $768, $9,773 and $21,285)(2) |                                                                                                                            |                         | 1,279  
|Cost of revenues                                                                                         |                                                                                                                            |                         |        
|Liquidity payments to stockholders/former members and affiliates(1)                                      |                                                                                                                            |                         | 28,121 
|Routing charges:                                                                                         |                                                                                                                            |                         |        
|                                                                                                         | Routing fees paid to stockholder/former member(3)                                                                          |                         |        
|                                                                                                         | Routing fees for listed securities paid to stockholders/former members(4)                                                  |                         |        
|Clearance, brokerage and other transaction expenses:                                                     |                                                                                                                            |                         |        
|                                                                                                         | PCX's cost of obtaining market data(5)                                                                                     |                         |        
|                                                                                                         | Clearing services provided by a stockholder/former member(6)                                                               |                         |        
|                                                                                                         | Clearing services provided by an affiliated clearing broker(6)                                                             |                         |        
|                                                                                                         | Management fees paid to a stockholder/former member for support of REDIBook ECN(7)                                         |                         |        
|                                                                                                         | Regulatory services fees paid to PCX(8)                                                                                    |                         |        
|                                                                                                         | Registered representative fees received from PCX(8)                                                                        |                         |        
|Indirect expenses                                                                                        |                                                                                                                            |                         |        
|Communications:                                                                                          |                                                                                                                            |                         |        
|                                                                                                         | Back office services provided by an affiliate(9)                                                                           |                         |        
|                                                                                                         | Software related services provided by an affiliate (net of amounts charged to customers of $3,196, $3,454, and $2,348)(10) |                         |        
|Marketing and promotion:                                                                                 |                                                                                                                            |                         |        
|                                                                                                         | Business development costs(11)                                                                                             |                         |        
|Legal and professional:                                                                                  |                                                                                                                            |                         |        
|                                                                                                         | Professional fees for services provided by an affiliate(12)                                                                |                         |        
|                                                                                                         | Consulting fees for services from a firm whose principle serves as a director of the Company(13)                           |                         |        
|General and administrative:                                                                              |                                                                                                                            |                         |        
|                                                                                                         | Costs reimbursed to PCX(14)                                                                                                |                         |        

---

94

---



95

---



An
affiliate provided software development services to the Company in the amount of $4.0 million and $1.5 million for the years ended December 31, 2003 and 2004,
respectively.

On
October 5, 2004, the Company entered into a financial advisory services engagement with a stockholder affiliate, under which the affiliate agreed to perform financial advisory
services to the Company. The Company has not made any payments under this agreement as of December 31, 2004.

In
October 2003, ArcaExchange entered into a $20.0 million credit facility with a stockholder/former member of Holdings LLC, pursuant to which trade receivables were
pledged as collateral. The facility terminated on October 21, 2004 and no amounts were ever drawn under the credit facility.

Receivables
from related parties consisted of the following:

December 31,2003

2004(in thousands)Transaction fees due from related parties

$
22,601

$
22,035Other fees due from related parties


8,668


2,820Transaction fees due from affiliate clearing broker


1,026


Market data fees due from PCX


6,153


16,401Other


100


470$
38,548

$
41,726


Payables to related parties consisted of the following:

December 31,2003

2004(in thousands)Fees due to PCX

$
34,627

$
6,356Other fees due to related party





1,339Clearing charges and other feed due to affiliate broker


2,850


684Routing charges due to related party


22,382


11,832Consulting, software and connectivity fees due to affiliate


1,413


603Advisory fees due to related party


1,000


Exchange fees due to related party


441


333Other


1,200


2,901$
63,913

$
24,048


As of December 31, 2003 and 2004, cash and cash equivalents held at affiliated financial institutions amounted to $4.3 million and
$0.1 million, respectively.

In
connection with the IPO, the Company paid commission, consisting primarily of underwriting discounts, to certain stockholders/former members of Holdings LLC totaling
approximately $4.4 million.

In
the opinion of management, transactions were made at prevailing rates, terms and conditions and do not involve more than the normal risk of collectibility or present other unfavorable
features.

96

---



8.     COMPUTATION OF EARNINGS PER SHARE

The following is a reconciliation of the basic and diluted earnings per share computations:

|                                                                                               |                                                     | Year ended December 31,                            
|---------------------------------------------------------------------------------------------- | --------------------------------------------------- | ---------------------------------------------------
|
|
|Net income (loss) attributable to common stockholders for basic and diluted earnings per share |                                                     | $                                                  
|                                                                                               |                                                     |                                                    
|Shares of common stock and common stock equivalents:                                           |                                                     |                                                    
|                                                                                               | Weighted average shares used in basic computation   |                                                    
|                                                                                               | Dilutive effect of:                                 |                                                    
|                                                                                               |                                                     | Preferred shares converted to common in August 2004
|                                                                                               |                                                     | Other                                              
|                                                                                               |                                                     |                                                    
|                                                                                               | Weighted average shares used in diluted computation |                                                    
|                                                                                               |                                                     |                                                    
|Basic earnings (loss) per share                                                                |                                                     | $                                                  
|                                                                                               |                                                     |                                                    
|Diluted earnings (loss) per share                                                              |                                                     | $                                                  
|                                                                                               |                                                     |                                                    

At December 31, 2002, 2003 and 2004, approximately 0.5 million, 1.4 million and 0.5 million securities, respectively, were excluded
from the computation of diluted earnings per share because their effect would have been antidilutive.

9.     INCOME TAXES

The income tax provision consisted of the following (in thousands):

Year ended December 31,2002

2003

2004Current:Federal

$


$


$
6,677State and Local








2,118Deferred:Federal








(1,430
)State and Local








(409
)Income tax provision

$


$


$
6,956


97

---



Significant components of the Company's deferred tax assets and liabilities were as follows (in thousands):

December 31,2003

2004Deferred tax assets:Bonuses

$


$
3,826Allowance for doubtful accounts





1,269Net operating loss carryforwards ("NOL") of ATSI subsidiary


1,487


1,444Valuation allowance


(1,487
)

(1,444
)Other





339Total deferred tax assets





5,434Deferred tax liabilities:Depreciation & amortization





3,328Capitalized salaries





267Total deferred tax liabilities





3,595Deferred tax asset, net

$


$
1,839


As of December 31, 2004, ATSI had approximately $3.5 million of net operating losses for Federal and State tax purposes, which will begin to expire
in 2012. A full valuation allowance was recorded against the approximately $1.4 million tax effect of these losses as it appears more likely than not that the corresponding asset will not be
realized due to certain tax limitations. There is no valuation allowance recorded against any of the remaining $5.4 million deferred tax assets based on management's belief that it is more
likely than not that such assets will be realized. The Company does not have any deferred tax assets related to Holdings L.L.C.'s net operating losses, as those losses were incurred when the
Company was treated as a partnership for federal income tax purposes.

The
effective tax rate varied from the U.S. Federal statutory income tax rate due to the following:

Year ended December 31,2002

2003

2004Federal statutory rate

(35.0
)%
35.0
%
35.0
%State, net of federal tax benefit


%

%
1.5
%Benefit from deferred taxes(1)


%

%
(4.4
)%Former Members' losses (income)(2)

35.0
%
(35.0
)%
(23.3
)%Other


%

%
0.4
%Effective tax rate


%

%
9.2
%


---

98

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10.   SEGMENT REPORTING

The Company operates in two reportable segments: Transaction Execution Services and Agency Brokerage Services.

Transaction
Execution Services consist primarily of transaction execution services, market data services on a real-time or summary basis and, through the Company's alliance
with PCX, a trading venue for issuers of equity securities, exchange traded funds and structured products. Under PCX rules, issuers are listed on PCX for trading on ArcaEx. The customers in this
segment are required to hold an ETP or be a broker-dealer introduced to ArcaEx by an ETP. An ETP holder must be a broker-dealer.

Agency
Brokerage Services are provided through Wave and consist of order execution services, on an agency basis, for orders received exclusively from institutions involving primarily
Nasdaq and listed securities. This segment provides institutions that are not ETP holders or are not sponsored by ETP holders access to all U.S. Nasdaq and exchange-listed securities markets through
ArcaEx.

Revenues
are generated primarily in the United States of America. Revenues derived from one stockholder/former member of Holdings LLC and its affiliates represented approximately
27.7%, 13.9% and 9.8%, of the consolidated revenues for the years ended December 31, 2002, 2003 and 2004, respectively. All of our long lived assets are located in the United States.

99

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Summarized
financial information concerning the Company's reportable segments is as follows (in thousands):

|                                        |  | Transaction Execution Services |         | Agency Brokerage Services |   | Eliminations |  | Consolidated |       
|--------------------------------------- |  | ------------------------------ | ------- | ------------------------- | - | ------------ |  | ------------ | ------
|2002                                    |  |                                |         |                           |   |              |  |              |       
|Revenues                                |  | $                              | 317,389 |                           | $ | 40,023       |  | $            |      
|Cost of revenues                        |  |                                | 274,177 |                           |   | 13,353       |  |              |      
|Gross margin                            |  |                                | 43,212  |                           |   | 26,670       |  |              |      
|Depreciation and amortization           |  |                                | 17,224  |                           |   | 457          |  |              |      
|Indirect expenses                       |  |                                | 92,511  |                           |   | 11,694       |  |              |      
|Operating income (loss)                 |  |                                | (49,300 | )                         |   | 14,977       |  |              |      
|2003                                    |  |                                |         |                           |   |              |  |              |       
|Revenues                                |  | $                              | 414,344 |                           | $ | 49,167       |  | $            | (5,173
|Cost of revenues                        |  |                                | 315,370 |                           |   | 23,404       |  |              | (5,173
|Gross margin                            |  |                                | 98,974  |                           |   | 25,763       |  |              |      
|Depreciation and amortization           |  |                                | 29,965  |                           |   | 564          |  |              |      
|Indirect expenses                       |  |                                | 100,875 |                           |   | 23,029       |  |              |      
|Operating income (loss)                 |  |                                | (1,901  | )                         |   | 2,734        |  |              |      
|Identifiable assets (as of December 31) |  |                                | 429,125 |                           |   | 41,666       |  |              | (4,899
|2004                                    |  |                                |         |                           |   |              |  |              |       
|Revenues                                |  | $                              | 495,834 |                           | $ | 51,453       |  | $            | (6,036
|Cost of revenues                        |  |                                | 305,932 |                           |   | 30,264       |  |              | (6,036
|Gross margin                            |  |                                | 189,902 |                           |   | 21,189       |  |              |      
|Depreciation and amortization           |  |                                | 26,295  |                           |   | 385          |  |              |      
|Indirect expenses                       |  |                                | 121,851 |                           |   | 16,241       |  |              |      
|Operating income                        |  |                                | 68,051  |                           |   | 4,948        |  |              |      
|Identifiable assets (as of December 31) |  |                                | 495,676 |                           |   | 40,172       |  |              | (1,400

In 2004, the Company revised its methodology for allocating certain expenses between the segments to reflect the fact that Agency Brokerage Services had built out
its own infrastructure and therefore relies less on Company shared services. Indirect costs allocated to Agency Brokerage Services were $9.0 million, $12.0 million and
$6.0 million for the years ended December 31, 2002, 2003 and 2004, respectively.

11.   COMMITMENTS AND CONTINGENCIES

In the normal course of conducting its business, the Company has been involved in various legal proceedings. In the opinion of management, after consultation with
legal counsel, the ultimate outcome of pending litigation matters will not have a material adverse effect on the financial condition or results of operations of the Company.

In
connection with a lawsuit filed in November 2003 in a state court in the State of New York regarding certain telecommunication services, in November 2004, the Company
entered into a definitive settlement agreement in principle under which the Company paid to AboveNet approximately $1.7 million in exchange for AboveNet's release of all claims against the
Company.

100

---



In
connection with the continued promotion of the Archipelago and ArcaEx brand names, the Company's future commitments under marketing and promotion agreements amounted to
$4.9 million as of December 31, 2004.

The
Company leases office space under non-cancelable operating leases. The Company leases certain computer equipment under capital leases. The future minimum commitments
under these non-cancelable leases at December 31, 2004 were as follows (in thousands):

Year ending December 31,2005

$
5,7612006


4,2192007


3,8682008


3,3182009


3,339Thereafter


12,086Net minimum lease payments

$
32,591


Total rent expense, including real estate taxes and common area maintenance, was approximately $2.7 million, $4.2 million and $4.6 million
for the years ended December 31, 2002, 2003 and 2004, respectively. The rent expense is recorded net of sublease payments received of approximately $0.5 million for the year ended
December 31, 2004.

The
Company applies the provisions of the Financial Accounting Standards Board's Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees of
Indebtedness of Others," which provides accounting and disclosure requirements for certain guarantees. The Company has agreed to indemnify its clearing brokers for losses that they may sustain from
customer accounts introduced by the Company. However, the Company has not had prior claims or losses pursuant to these contracts and expects the risk of loss to be remote. As such, the Company has not
recorded any liability related to this indemnification. The Company is unable to quantify the potential exposure related to the indemnification as it constantly fluctuates based on the number and size
of the unsettled transactions outstanding and the difference between the contractual trade price and the current fair value of the stock underlying the unsettled transactions.

12.   NET CAPITAL REQUIREMENTS

Wave, ARCAS and ATSI are registered broker-dealers and are subject to net capital requirements under SEC Rule 15c3-1. Wave and ATSI compute
their net capital using the basic method. Under this method, these subsidiaries must maintain minimum net capital (as defined) and the ratio of aggregate indebtedness (as defined) to net capital may
not exceed 15 to 1. ARCAS computes its net capital under the alternative method. This method requires that minimum net capital not be less than the greater of $250,000 or 2% of aggregate debit items
arising from customer transactions.

101

---



As
of December 31, 2003 and 2004, these subsidiaries were in compliance with their respective net capital requirements and their net capital, net capital in excess of required net
capital, and ratio of aggregate indebtedness to net capital were as follows (in thousands, except ratios):

December 31,2003

2004Net capitalWave

$
9,041

$
19,427ARCAS


5,268


7,043ATSI


441


2,652Net capital in excess of required net capitalWave

$
8,264

$
18,519ARCAS


5,018


6,793ATSI


436


2,485Ratio of aggregate indebtedness to net capitalWave


1.29 to 1


0.70 to 1ARCAS


N/A


N/AATSI


0.12 to 1


0.94 to 1


Advances to affiliates, dividend payments and other equity withdrawals are subject to certain notification and other provisions of the net capital rule of the SEC
and other regulatory bodies.

The
Company's international broker-dealer subsidiaries are subject to capital adequacy requirements promulgated by authorities of the countries in which they operate. As of
December 31, 2003 and 2004, these subsidiaries had met their local capital adequacy requirements.

13.   SUBSEQUENT EVENT

On January 3, 2005, the Company entered into a definitive agreement with PCX Holdings, Inc. ("PCXH") under which the Company has agreed to
acquire PCXH and all of its wholly-owned subsidiaries including the PCX and PCX Equities, by way of a merger of PCXH. The purchase price is approximately $50.7 million, consisting of
approximately $40.6 million in cash, or 80% of the purchase price, and approximately $10.1 million in stock, subject to working capital and certain other possible adjustments. This
acquisition is subject to approvals from PCXH shareholders as well as the SEC and other regulatory entities.

102

---



SUPPLEMENTAL QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

|                        |         | Three months ended
|----------------------- | ------- | ------------------
|
|
|Total revenues          |         | $                 
|Operating income (loss) |         |                   
|Net income (loss)       |         |                   
|Earnings per share:     |         |                   
|                        | Basic   |                   
|                        | Diluted |                   
|
|
|
|Total revenues          |         | $                 
|Operating income        |         |                   
|Net income              |         |                   
|Earnings per share:     |         |                   
|                        | Basic   |                   
|                        | Diluted |                   

103

---





ITEM 9.    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING                AND FINANCIAL DISCLOSURE

None.

ITEM 9A.    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 our management, including
our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company's disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange
Act). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of December 31, 2004, these disclosure controls and procedures were effective.
No material changes occurred in our internal controls over financial reporting (as defined in Rule 13a under the Exchange Act) or in other factors that could significantly affect these controls
subsequent to the date of their evaluation.

Part III

ITEM 10.    DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Information relating to our executive officers and directors, including our audit committee and audit committee financial experts, is contained in the Proxy
Statement for our 2005 Annual Meeting of Shareholders to be held on May 10, 2005 (the "2005 Proxy Statement") and such information is hereby incorporated herein by reference. Also incorporated
herein by reference is the information under the
caption "Other MattersSection 16(a) Beneficial Ownership Reporting Compliance" in the 2005 Proxy Statement. Information relating to our Code of Business Conduct and Ethics that
applies to senior financial officers is included in this Form 10-K under the section heading Part IItem 1BusinessOverview.

ITEM 11.    EXECUTIVE COMPENSATION

Information relating to our executive officer and director compensation is contained in the 2005 Proxy Statement and all such information is incorporated herein
by reference.

ITEM 12.    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND                  MANAGEMENT AND RELATED
STOCKHOLDER MATTERS

Securities authorized for issuance under our equity compensation plans as of December 31, 2004 are summarized below:

|Plan category                                              |  | Number of securities
to be issued upon
exercise of
outstanding options,
warrants and rights
(a) |  | Weighted-average
exercise price of
outstanding options,
warrants and rights
(b) |       | Number of securities
remaining available
for future issuance
under equity
compensation plans
(excluding securities
reflected in column(a))
(c)
|---------------------------------------------------------- |  | ----------------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------------- | ----- | ----------------------------------------------------------------------------------------------------------------------------------------------
|Equity compensation plans approved by security holders     |  | 2,563,087                                                                                       |  | $                                                                               | 12.96 |                                                                                                                                               
|Equity compensation plans not approved by security holders |  | N/A                                                                                             |  |                                                                                 | N/A   |                                                                                                                                               
|                                                           |  |                                                                                                 |  |                                                                                 |       |                                                                                                                                               
|Total                                                      |  | 2,563,087                                                                                       |  | $                                                                               | 12.96 |                                                                                                                                               
|                                                           |  |                                                                                                 |  |                                                                                 |       |                                                                                                                                               

Information
relating to security ownership of certain beneficial owners of our common stock is contained in the 2005 Proxy Statement and all such information is incorporated herein by
reference.

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ITEM 13.    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Information regarding certain relationships and related transactions is contained in the 2005 Proxy Statement and all such information is incorporated herein by
reference.

ITEM 14.    INDEPENDENT REGISTERED PUBLIC ACCOUNTANT FEES AND SERVICES

Information regarding independent registered public accountant fees and services is contained in the 2005 Proxy Statement and all such information is incorporated
herein by reference.

105

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Part IV

ITEM 15.    EXHIBITS, FINANCIAL STATEMENTS SCHEDULES

Documents filed as part of this Report:

2.1

Exchange Agreement, dated as of January 17, 2002, among Archipelago Holdings, L.L.C., REDIBook ECN L.L.C. and the parties named therein.*2.2

Contribution Agreement, dated as of November 12, 2003, between Archipelago Holdings, L.L.C. and GAP Archa Holdings, Inc.*2.3

Agreement and Plan of Merger, dated as of February 27, 2004, between Archipelago Holdings, L.L.C. and GAP Archa Holdings, Inc.*2.4

Letter Agreement, dated February 27, 2004, among GAP-W, L.L.C., Archipelago Holdings, L.L.C. and GAP Archa Holdings, Inc.*2.5

Contribution Agreement, dated July 12, 2000, among Archipelago Holdings, L.L.C., Pacific Exchange, Inc. and PCX Equities, Inc.*2.6

Agreement and Plan of Merger, dated January 3, 2005, among Archipelago Holdings, Inc., New Apple Acquisitions Corporation and PCX Holdings, Inc.***3.1

Form of Certificate of Incorporation of Archipelago Holdings, Inc.*3.2

Form of Bylaws of Archipelago Holdings, Inc.*3.3

Ninth Amended and Restated Limited Liability Company Agreement of Archipelago Holdings, L.L.C.*3.4

Amendment No.1 to Ninth Amended and Restated Limited Liability Company Agreement of Archipelago Holdings, L.L.C.*4.1

Specimen Certificate of Common Stock.*4.2

Registration Rights Agreement, dated November 12, 2003, among Archipelago Holdings, L.L.C., General Atlantic Partners 77, L.P., GAP Coinvestment Partners II, L.P., GapStar, L.L.C., GAPCO GmbH & Co. KG, GAP-W, L.L.C., GAP Archa Holdings,
 Inc., and the Class A Members of the Archipelago Holdings, L.L.C. and the affiliates of certain of such Class A Members.*10.1

ECN-to-ECN Direct Linkage Agreement, dated April 7, 2000, between Archipelago ECN and The Island ECN, Inc., assigned to Archipelago Holdings, L.L.C. as of December 1, 2002.*10.2

Mutual Services Agreement, dated as of March 27, 2001, amended April 15, 2002 and May 31, 2002, between Instinet Corporation and Archipelago, L.L.C.*10.3

License Agreement, dated as of January 7, 1999, between Archipelago Holdings, L.L.C. and Townsend Analytics, Ltd.*10.4

Support, Development and Enhancement Agreement, dated as of January 7, 1999, between Archipelago Holdings, L.L.C. and Townsend Analytics, Ltd.*10.5

License and Distribution Agreement, dated as of January 7, 1999, between Archipelago Holdings, L.L.C. and Townsend Analytics, Ltd.*10.6

Amendment of License and Distribution Agreement, dated as of May 11, 2004, between Archipelago Holdings, L.L.C. and Townsend Analytics, Ltd.*


106

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10.7

Application Service Provider Agreement, dated as of February 1, 2001, between TransactTools, Inc. and Archipelago, L.L.C.*10.8

Agreement for Professional Services, dated August 14, 2000, between TransactTools, Inc. and Archipelago, L.L.C.*10.9

Fully Disclosed Clearing Agreement, dated as of May 7, 2004, between Spear, Leeds & Kellogg, L.P. and Wave Securities, L.L.C.*10.10

Fully Disclosed Clearing Agreement, dated as of January 7, 2002, between Spear, Leeds & Kellogg, L.P. and REDIBook ECN, L.L.C.*10.11

Letter Agreement, dated January 17, 2002, between Spear, Leeds & Kellogg, L.P. and Archipelago Holdings, L.L.C.*10.12

Fully Disclosed Clearing Agreement, dated December 2002, between Spear, Leeds & Kellogg, L.P. and GlobeNet Securities, Inc.*10.13

Clearing Letter Agreement, dated November 15, 2003, between Spear, Leeds & Kellogg, L.P. and Archipelago Holdings, L.L.C.*10.14

Clearing Agreement, dated as of February 9, 2000 and effective as of February 25, 2000, between Broadcort Capital Corp. and Archipelago, L.L.C.*10.15

Client Access Agreement, dated June 25, 2002 and effective July 1, 2002, between Spear, Leeds & Kellogg, L.P. and Wave Securities, L.L.C.*10.16

Archipelago Holdings, L.L.C. 2000 Long-Term Incentive Plan.*10.17

Archipelago Holdings, L.L.C. 2003 Long-Term Incentive Plan.*10.18

Archipelago Holdings 2004 Stock Incentive Plan.*10.19

Archipelago Holdings Employee Stock Purchase Plan.*10.20

Archipelago Holdings Management Annual Bonus Plan.*10.21

Townsend Analytics Assistance Agreement, dated January 7, 1999, between Townsend Analytics, Ltd, and Archipelago Holdings, L.L.C.*10.22

Amended Schedule 2.1 to the Townsend Analytics Assistance Agreement, dated July 27, 2004.*10.23

Credit and Security Agreement, dated as of October 23, 2003, between Archipelago Exchange, L.L.C. and JPMorgan Chase Bank.*10.24

Electronic Trade Execution Agreement, dated November 12, 1999, between J.P. Morgan Securities Inc. and Archipelago, L.L.C.*10.25

Sun Terms and Conditions, dated February 1, 2003, between Sun Microsystems, Inc. and Archipelago Holdings, L.L.C.*10.26

Employment Agreement, dated December 19, 2001, between Archipelago Holdings, L.L.C. and Gerald D. Putnam.*10.27

Amendment, dated May 4, 2004, to the Employment Agreement between Archipelago Holdings, L.L.C. and Gerald D. Putnam.*10.28

License and Distribution Agreement dated as of August 2, 2004, between Wave Securities, L.L.C. and Townsend Analytics, Ltd.*


107

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10.29

Form of Indemnification Agreement, between Archipelago Holdings, L.L.C. and certain indemnitees specified therein.*10.30

Third Amendment to Sublease, dated as of May 15, 2004, between Townsend Analytics, Ltd. and Archipelago Holdings, L.L.C.*10.31

Office Lease, dated October 31, 2003, between MJH Wacker L.L.C. and Archipelago Holdings, L.L.C.*10.32

Form of stock option award agreement for use under the 2000 LTIP and 2003 LTIP.*10.33

Amended and Restated Facility Services Agreement, dated as of March 22, 2002, among Archipelago Holdings, L.L.C., Pacific Exchange, Inc. and PCX Equities, Inc.*10.34

Amended and Restated Change In Control Severance Agreement, dated as of June 15, 2004, between Archipelago Holdings, L.L.C. and Nelson J. Chai.*10.35

Amended and Restated Change In Control Severance Agreement, dated as of June 15, 2004, between Archipelago Holdings, L.L.C. and Michael A. Cormack.*10.36

Amended and Restated Change In Control Severance Agreement, dated as of June 15, 2004, between Archipelago Holdings, L.L.C. and Kevin J.P. O'Hara.*10.37

Amended and Restated Change In Control Severance Agreement, dated as of June 15, 2004, between Archipelago Holdings, L.L.C. and Steven C. Rubinow.*10.38

Change in Control Severance Agreement, dated as of June 15, 2004, between Archipelago Holdings, L.L.C. and Joseph Lombard.*10.39

Order Routing Services Agreement, dated February 8, 2001, between Archipelago, L.L.C. and BNP Paribas Brokerage Services, Inc.*10.40

Lease by and between Paramount Group, Inc., as Agent for 1177 Avenue of the Americas, L.P. and Archipelago Holdings, Inc. dated November 4, 2004.**10.41

Engagement Letter between Archipelago Holdings, Inc. and Goldman, Sachs & Co.10.42

Form employee compensation grant agreement for restricted stock units.14

Code of ethics21.1

Subsidiaries of Archipelago Holdings, Inc.23.1

Consent of Ernst & Young LLP.24.1

Power of Attorney.31.1

Rule 13a-14(a) Certification (CEO).31.2

Rule 13a-14(a) Certification (CFO).32.1

Section 1350 Certifications.


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108

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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.

| |  | ARCHIPELAGO HOLDINGS, INC.
| |  | --------------------------
| |  | By:                       
| |  | Date:                     

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

ARCHIPELAGO
HOLDINGS, INC.
Board of Directors

|By:                                                        | /s/GERALD D. PUTNAM      |  |  |                              | By:   | /s/RICHARD C. BREEDEN
|---------------------------------------------------------- | ------------------------ |  |  | ---------------------------- | ----- | ---------------------
|Gerald D. Putnam, Chairman and
    Chief Executive Officer |                          |  |  | Richard C. Breeden, Director
|Date:                                                      | March 22, 2005           |  |  |                              | Date: | March 22, 2005       
|By:                                                        | /s/PHILIP D. DEFEO       |  |  |                              | By:   | /s/WILLIAM E. FORD   
|Philip D. DeFeo, Director                                  |                          |  |  | William E. Ford, Director   
|Date:                                                      | March 22, 2005           |  |  |                              | Date: | March 22, 2005       
|By:                                                        | /s/JAMES J. MCNULTY      |  |  |                              | By:   | /s/GEORGE MUÑOZ      
|James J. McNulty, Director                                 |                          |  |  | George Muñoz, Director      
|Date:                                                      | March 22, 2005           |  |  |                              | Date: | March 22, 2005       
|By:                                                        | /s/MICHAEL J. PASSARELLA |  |  |                              | By:   | /s/STUART M. ROBBINS 
|Michael J. Passarella, Director                            |                          |  |  | Stuart M. Robbins, Director 
|Date:                                                      | March 22, 2005           |  |  |                              | Date: | March 22, 2005       
|By:                                                        | /s/ROBERT G. SCOTT       |  |  |                              |       |                      
|Robert G. Scott, Director                                  |                          |  |  |                             
|Date:                                                      | March 22, 2005           |  |  |                              |       |                      

109

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POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Gerald D. Putnam, Nelson J. Chai, and Kevin J.P.
O'Hara, and each of them severally, his or her true and lawful attorney-in-fact with power of substitution and resubstitution to sign in his or her name, place and stead, in
any and all capacities, to do any and all things and execute any and all instruments that such attorney may deem necessary or advisable under the Securities Exchange Act of 1934 and any rules,
regulations and requirements of the U.S. Securities and Exchange Commission in connection with this Annual Report on Form 10-K and any and all amendments hereto, as fully for all
intents and purposes as he or she might or could do in person, and hereby ratifies and confirms all said attorneys-in-fact and agents, each acting alone, and his or her
substitute or substitutes, may lawfully do or cause to be done by virtue hereof.

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

110

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