-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, OEF2AZUAZ0Xu/Zt9Xj8im8KnB36BTwmvlC/Xuai0eOoMWP/Cnggl7430S7xMyb4O iqTsoXyxv386lKbARHqZQw== /in/edgar/work/0001012870-00-005405/0001012870-00-005405.txt : 20001026 0001012870-00-005405.hdr.sgml : 20001026 ACCESSION NUMBER: 0001012870-00-005405 CONFORMED SUBMISSION TYPE: 10-Q/A PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20000630 FILED AS OF DATE: 20001025 FILER: COMPANY DATA: COMPANY CONFORMED NAME: E TRADE GROUP INC CENTRAL INDEX KEY: 0001015780 STANDARD INDUSTRIAL CLASSIFICATION: [6211 ] IRS NUMBER: 942844166 STATE OF INCORPORATION: DE FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-Q/A SEC ACT: SEC FILE NUMBER: 001-11921 FILM NUMBER: 745734 BUSINESS ADDRESS: STREET 1: 4500 BOHANNON DRIVE CITY: MENLO PARK STATE: CA ZIP: 94025 BUSINESS PHONE: 6508422500 MAIL ADDRESS: STREET 1: 4500 BOHANNON DRIVE CITY: MENLO PARK STATE: CA ZIP: 94025 10-Q/A 1 0001.txt AMENDMENT 1 TO FORM 10-Q/A - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------------- FORM 10-Q/A QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2000 Commission file number 1-11921 ---------------- E*TRADE Group, Inc. (Exact name of registrant as specified in its charter)
Delaware 94-2844166 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification Number)
4500 Bohannon Drive, Menlo Park, CA 94025 (Address of principal executive offices and zip code) Registrant's telephone number, including area code: (650) 331-6000 ---------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [_] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: As of August 10, 2000, the number of shares outstanding of the registrant's common stock was 299,908,164. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- E*TRADE Group, Inc. Form 10-Q/A Quarterly Report For the Quarter Ended June 30, 2000 Table of Contents
Page ---- Part I--Financial Information Item 1. Financial Statements Consolidated Statements of Operations.......................... 3 Consolidated Balance Sheets.................................... 4 Condensed Consolidated Statements of Cash Flows................ 5 Notes to Condensed Consolidated Financial Statements........... 6 Management's Discussion and Analysis of Financial Condition and Item 2. Results of Operations.......................................... 18 Item 3. Quantitative and Qualitative Disclosures About Market Risk..... 42 Part II--Other Information Item 1. Legal and Administrative Proceedings........................... 44 Item 2. Changes in Securities and Use of Proceeds...................... 45 Item 3. Defaults Upon Senior Securities................................ 45 Item 4. Submission of Matters to a Vote of Security Holders............ 45 Item 5. Other Information.............................................. 45 Item 6. Exhibits and Reports on Form 8-K............................... 46 Signatures.............................................................. 48
UNLESS OTHERWISE INDICATED, REFERENCES TO "COMPANY" MEAN E*TRADE GROUP, INC. AND ITS SUBSIDIARIES. This Form 10-Q/A is being filed to amend Part II Item 6 to include the Company's Amended and Restated Strategic Alliance Agreement dated as of September 26, 2000, between the Company and Wit SoundView Group, Inc. Other than the inclusion of that additional exhibit and updates to the Exhibits list in Part II Item 6, this Form 10-Q/A has not been updated to give effect to any items addressed in documents filed with the SEC subsequent to June 30, 2000. E*TRADE(R) and the E*TRADE logo are registered trademarks of E*TRADE Securities, Inc. All other products, trademarks or service marks mentioned in this document or any document incorporated by reference herein are trademarks or service marks of E*TRADE Group, Inc., its subsidiaries, or other companies with which they are associated or with which they have a business relationship. FORWARD-LOOKING STATEMENTS Certain statements in this report, including statements regarding the Company's strategy, financial performance and revenue sources, are forward- looking statements based on current expectations and entail various risks and uncertainties. The Company's actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including, but not limited to, those set forth under "Risk Factors" and elsewhere in this report. Readers are urged to carefully review and consider the various disclosures made by the Company in this report and in the Company's other reports filed with the SEC, including the Company's Annual Report on Form 10-K/A as filed with the SEC on April 17, 2000, that attempt to advise interested parties of certain risks and factors that may affect the Company's business. Readers are cautioned not to place undue reliance on these forward-looking statements to reflect events or circumstances occurring after the date hereof. The following should be read in conjunction with the Company's consolidated financial statements and notes thereto contained in that filing. 2 PART I. FINANCIAL INFORMATION Item 1. Financial Statements E*TRADE GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share amounts) (Unaudited)
Three Months Ended Nine Months Ended June 30, June 30, ------------------- -------------------- 2000 1999 2000 1999 --------- -------- --------- --------- Revenue: Transaction revenues.............. $ 180,194 $106,067 $ 587,102 $ 256,911 Interest income................... 257,193 104,129 657,065 245,696 Global and institutional.......... 33,906 26,937 108,989 84,351 Other............................. 24,863 8,606 60,786 27,245 --------- -------- --------- --------- Gross revenues.................. 496,156 245,739 1,413,942 614,203 Interest expense.................. (164,841) (58,652) (405,762) (145,154) Provision for loan losses......... (974) (665) (2,767) (1,435) --------- -------- --------- --------- Net revenues.................... 330,341 186,422 1,005,413 467,614 --------- -------- --------- --------- Cost of services.................... 124,489 82,237 366,470 198,967 --------- -------- --------- --------- Operating expenses: Selling and marketing............. 115,081 99,784 422,245 235,667 Technology development............ 32,526 20,659 111,033 50,481 General and administrative........ 50,179 24,574 142,482 69,654 Amortization of goodwill and other intangibles...................... 6,716 565 13,900 1,934 Merger-related expenses........... 1,133 3,652 31,519 3,652 --------- -------- --------- --------- Total operating expenses........ 205,635 149,234 721,179 361,388 --------- -------- --------- --------- Total cost of services and operating expenses............. 330,124 231,471 1,087,649 560,355 --------- -------- --------- --------- Operating income (loss)............. 217 (45,049) (82,236) (92,741) --------- -------- --------- --------- Non-operating income (expense): Gain on sale of investments....... 24,416 8,439 66,647 41,806 Unrealized gain (loss) on venture fund............................. (3,462) -- 7,363 -- Corporate interest--net and other............................ (8,178) 3,158 (15,478) 13,291 --------- -------- --------- --------- Total non-operating income...... 12,776 11,597 58,532 55,097 --------- -------- --------- --------- Pre-tax income (loss)............... 12,993 (33,452) (23,704) (37,644) Income tax expense (benefit)........ 7,888 (12,230) (1,732) (15,659) Minority interest in subsidiary..... (585) 539 318 1,671 --------- -------- --------- --------- Income (loss) before cumulative effect of accounting change and extraordinary loss................. 5,690 (21,761) (22,290) (23,656) Cumulative effect of accounting change, net of tax................. -- -- -- (469) Extraordinary loss on early extinguishment of subordinated debt, net of tax................... -- (1,985) -- (1,985) --------- -------- --------- --------- Net income (loss)................... 5,690 (23,746) (22,290) (26,110) Preferred stock dividends........... -- 60 -- 180 --------- -------- --------- --------- Income (loss) applicable to common stock.............................. $ 5,690 $(23,806) $ (22,290) $ (26,290) ========= ======== ========= ========= Income (loss) per share before cumulative effect of accounting change and extraordinary loss: Basic............................. $ 0.02 $ (0.08) $ (0.08) $ (0.09) ========= ======== ========= ========= Diluted........................... $ 0.02 $ (0.08) $ (0.08) $ (0.09) ========= ======== ========= ========= Income (loss) per share: Basic............................. $ 0.02 $ (0.09) $ (0.08) $ (0.10) ========= ======== ========= ========= Diluted........................... $ 0.02 $ (0.09) $ (0.08) $ (0.10) ========= ======== ========= ========= Shares used in computation of income (loss) per share before cumulative effect of accounting change and extraordinary loss and income (loss) per share: Basic............................. 294,015 271,276 275,337 265,434 Diluted........................... 309,346 271,276 275,337 265,434
See notes to condensed consolidated financial statements. 3 E*TRADE GROUP, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in thousands, except share amounts)
June 30, September 30, 2000 1999 ----------- ------------- (Unaudited) ASSETS ------ Cash and equivalents................................ $ 178,894 $ 124,801 Cash and investments required to be segregated under Federal or other regulations....................... 86,414 104,500 Brokerage receivables--net.......................... 5,657,869 2,912,581 Mortgage-backed securities.......................... 3,345,760 1,426,053 Loans receivable--net............................... 3,535,825 2,154,509 Investments......................................... 966,646 830,329 Property and equipment--net......................... 263,692 178,854 Goodwill and other intangibles...................... 471,895 17,211 Other assets........................................ 385,602 159,386 ----------- ---------- Total assets.................................... $14,892,597 $7,908,224 =========== ========== LIABILITIES AND SHAREOWNERS' EQUITY ----------------------------------- Liabilities: Brokerage payables................................ $ 5,044,173 $2,824,212 Banking deposits.................................. 3,987,954 2,162,682 Borrowings by bank subsidiary..................... 2,858,000 1,267,474 Accounts payable, accrued and other liabilities... 462,253 203,971 Convertible subordinated notes.................... 650,000 -- ----------- ---------- Total liabilities............................... 13,002,380 6,458,339 ----------- ---------- Company-obligated mandatorily redeemable preferred capital securities of E*TRADE Financial Corporation subsidiary trusts holding solely junior subordinated debentures of and other mandatorily redeemable preferred securities.................... 30,631 30,584 ----------- ---------- Shareowners' equity: Common stock, $.01 par: shares authorized, 600,000,000; shares issued and outstanding: June 30, 2000, 298,283,829; September 30, 1999, 275,145,791...................................... 2,983 2,751 Additional paid-in capital........................ 1,746,753 1,269,167 Unearned ESOP shares.............................. (1,697) (2,122) Shareowners' notes receivable..................... (18,743) -- Accumulated deficit............................... (30,654) (8,364) Accumulated other comprehensive income............ 160,944 157,869 ----------- ---------- Total shareowners' equity....................... 1,859,586 1,419,301 ----------- ---------- Total liabilities and shareowners' equity....... $14,892,597 $7,908,224 =========== ==========
See notes to condensed consolidated financial statements. 4 E*TRADE GROUP, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) (Unaudited)
Nine Months Ended June 30, ------------------------ 2000 1999 ----------- ----------- Net cash used in operating activities, net of effects from acquisitions................................... $ (374,834) $ (34,677) ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of available-for-sale securities.......... (6,754,919) (4,749,045) Proceeds from sales, maturities of and principal payments on available-for-sale securities......... 4,704,934 4,419,793 Net increase in loans held for investment.......... (1,394,055) (733,742) Increase in restricted deposits.................... (71,445) -- Cash used in business acquisitions, net of cash acquired.......................................... (31,770) -- Purchases of property and equipment, net of capital lease and property and equipment acquired......... (134,342) (82,893) Other.............................................. 15,714 15,667 ----------- ----------- Net cash used in investing activities.......... (3,665,883) (1,130,220) ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in banking deposits................... 1,825,273 566,849 Advances from the Federal Home Loan Bank of Atlanta........................................... 2,168,000 1,989,510 Payments on advances from the Federal Home Loan Bank of Atlanta................................... (1,295,000) (1,777,510) Net increase in securities sold under agreements to repurchase........................................ 717,526 104,626 Net proceeds from convertible subordinated notes... 631,312 -- Proceeds from issuance of common stock............. 17,921 401,827 Proceeds from associate stock transactions......... 28,594 15,805 Proceeds from bank loans and lines of credit, net of transaction costs.............................. 177,455 -- Payments on bank loans and lines of credit......... (151,843) -- Issuance of shareowners' notes receivable.......... (18,607) -- Net decrease in other borrowed funds............... -- (29,792) Other.............................................. (5,821) (5,711) ----------- ----------- Net cash provided by financing activities...... 4,094,810 1,265,604 ----------- ----------- INCREASE IN CASH AND EQUIVALENTS..................... 54,093 100,707 CASH AND EQUIVALENTS--Beginning of period............ 124,801 71,317 ----------- ----------- CASH AND EQUIVALENTS--End of period.................. $ 178,894 $ 172,024 =========== =========== SUPPLEMENTAL DISCLOSURES: Non-cash investing and financing activities: Unrealized gain on available-for-sale securities... $ 8,029 $ 404,502 =========== =========== Tax benefit on exercise of stock options........... $ 27,498 $ 39,436 =========== =========== Assets acquired under capital lease obligations.... $ 32,752 $ -- =========== =========== Purchase acquisitions, net of cash acquired: Common stock issued and stock options assumed.... $ 411,411 $ -- Cash paid, less acquired (including acquisition costs).......................................... $ 31,770 $ -- Liabilities assumed.............................. $ 19,586 $ -- Carrying value of joint-venture investment....... $ 5,343 $ -- ----------- ----------- Fair value of assets recorded (including goodwill of $447,691).................................... $ 468,110 $ -- =========== ===========
See notes to condensed consolidated financial statements. 5 E*TRADE GROUP, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. BASIS OF PRESENTATION The accompanying unaudited interim condensed consolidated financial statements include E*TRADE Group, Inc., a financial services holding company, and its subsidiaries (collectively, the "Company"), including E*TRADE Securities, Inc. ("E*TRADE Securities"), a securities broker-dealer, E*TRADE Financial Corporation ("ETFC"), formerly Telebanc Financial Corporation, a provider of banking and related financial services, and TIR (Holdings) Limited ("TIR"), a provider of global securities brokerage and other related services to institutional clients. The primary business of ETFC consists of the activities conducted by E*TRADE Bank, Inc. (the "Bank" or "E*TRADE Bank"), formerly known as Telebank, and E*TRADE Capital Markets, Inc. ("ETCM"), formerly Telebanc Capital Markets. E*TRADE Bank is a federally chartered savings bank that provides deposit accounts insured by the Federal Deposit Insurance Corporation ("FDIC") to customers nationwide. ETCM is a funds manager and registered broker-dealer. These interim condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC") and, in the opinion of management, reflect all normal recurring adjustments necessary to present fairly the financial position, results of operations and cash flows for the periods presented in conformity with accounting principles generally accepted in the United States of America. All significant intercompany accounts and transactions have been eliminated. These interim condensed consolidated financial statements should be read in conjunction with the audited annual consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K/A for the fiscal year ended September 30, 1999. The condensed consolidated financial statements of the Company have been prepared to give retroactive effect to the acquisition of ETFC on January 12, 2000, which was accounted for as a pooling of interests (see Note 23 to the Company's Annual Report on Form 10-K/A for the fiscal year ended September 30, 1999). NOTE 2. BROKERAGE RECEIVABLES--NET AND PAYABLES Brokerage receivables--net and payables consist of the following (in thousands):
June 30, September 30, 2000 1999 ---------- ------------- Receivable from customers and non-customers (less allowance for doubtful accounts of $6,440 at June 30, 2000 and $975 at September 30, 1999).......... $4,791,836 $2,559,283 Receivable from brokers, dealers and clearing organizations: Net settlement and deposits with clearing organizations................................... 116,662 20,066 Deposits paid for securities borrowed............ 730,245 306,326 Securities failed to deliver..................... 4,950 7,508 Other............................................ 14,176 19,398 ---------- ---------- Total brokerage receivables--net............... $5,657,869 $2,912,581 ========== ========== Payable to customers and non-customers............. $1,483,961 $ 946,760 Payable to brokers, dealers and clearing organizations: Deposits received for securities loaned.......... 3,505,736 1,806,590 Securities failed to receive..................... 5,398 7,235 Other............................................ 49,078 63,627 ---------- ---------- Total brokerage payables....................... $5,044,173 $2,824,212 ========== ==========
6 Receivable from and payable to brokers, dealers and clearing organizations result from the Company's brokerage activities. Receivable from customers and non-customers represents credit extended to customers to finance their purchases of securities on margin. At June 30, 2000 and September 30, 1999, credit extended to customers and non-customers with respect to margin accounts was $4,752.5 million and $2,452.1 million, respectively. Securities owned by customers and non-customers are held as collateral for amounts due on margin balances, the value of which is not reflected in the accompanying consolidated balance sheets. Payable to customers and non-customers represents free credit balances and other customer and non-customer funds pending completion of securities transactions. The Company pays interest on certain customer and non-customer credit balances. NOTE 3. INVESTMENTS Investments are comprised of trading and available-for-sale debt and equity securities, as defined under the provisions of SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. Also included in investments are investments in entities in which the Company owns between 20% and 50%, which are accounted for under the equity method. The carrying amounts of investments are shown below (in thousands):
June 30, September 30, 2000 1999 -------- ------------- Trading securities.................................... $ 5,090 $ 38,269 Available-for-sale investment securities.............. 825,384 685,555 Equity method investments: Venture capital funds............................... 66,697 36,270 Other equity method investments..................... 54,370 57,402 Other investments..................................... 15,105 12,833 -------- -------- Total investments................................. $966,646 $830,329 ======== ========
E*OFFERING Included in other equity method investments is a 23.6% investment in E*OFFERING Corp. ("E*OFFERING"), a full service, Internet-based investment bank. On May 15, 2000, Wit Capital Group, Inc., renamed Wit SoundView Group, Inc. ("Wit"), entered into a definitive agreement to acquire E*OFFERING. Under the terms of the agreement, E*TRADE shareholders will receive approximately 10,532,000 shares of Wit. Concurrently with this agreement, E*TRADE and Wit entered into a strategic alliance pursuant to which Wit will be the exclusive source of IPOs, follow-on offerings, and other investment banking products to E*TRADE for a three year term, and E*TRADE will acquire Wit's retail brokerage business. As part of the consideration for the exclusivity rights, Wit has agreed to issue to E*TRADE approximately 4,026,000 shares of common stock which are subject to a three-year prohibition on transfer. In addition, Wit has agreed to issue to E*TRADE a warrant to purchase up to 2,000,000 shares of Wit common stock for $10.25 per share, contingent upon maintaining the exclusivity rights for years four and five of the strategic alliance. In connection with the strategic alliance, E*TRADE also agreed to purchase 2,000,000 shares of Wit common stock for $10.25 per share. The transactions contemplated by the strategic alliance are contingent upon each other and on the closing of the merger of E*OFFERING into Wit, which is subject to approval by Wit's shareholders. The agreement is expected to close at the end of the current calendar year. Publicly-Traded Equity Securities Included in available-for-sale securities are investments in several companies that are publicly-traded and carried at fair value. During the nine months ended June 30, 2000, the Company sold shares of its publicly-traded investments generating proceeds of $66.0 million, resulting in a pre-tax gain of $65.4 million. Unrealized gains 7 related to these investments were $314.1 million and $282.3 million at June 30, 2000 and September 30, 1999, respectively. There were no unrealized losses related to these investments at June 30, 2000 and September 30, 1999. Venture Capital Funds The Company made a $50.3 million capital commitment to the E*TRADE eCommerce Fund II, L.P. ("Fund II") as of June 16, 2000. It is anticipated that Fund II will have total committed capital of between $200-$250 million, with all capital in excess of the E*TRADE contributions being raised from third parties. Fund II invests in early to mid-stage companies offering e- commerce related services, products or infrastructure. Through Fund II, the Company is able to leverage its own investment capital, expand the scope of its strategic investments (beyond financial services) and keep it in a position to capitalize on leading-edge technologies. Fund II is managed by its General Partner, E*TRADE Ventures II, LLC ("General Partner II"). Christos M. Cotsakos, the Chairman of the Board of Directors and Chief Executive Officer of the Company, and Thomas Bevilacqua, the Company's Chief Strategic Investment Officer, are the managing members of General Partner II. The Company is a non-managing member of General Partner II. General Partner II receives an annual management fee of approximately 1.75% of the total committed capital. The management fee is used to offset the costs and expenses of the Company's corporate development/strategic group. In addition, to the extent that Fund II generates profits, 25% are allocated to General Partner II as a carried interest. As a member of General Partner II, the Company is entitled to receive 32% of such amount provided that up to one-fifth of the Company's interest can be allocated by the managing members to Company personnel. The Company made a $25 million contribution to the E*TRADE eCommerce Fund, L.P. (the "Fund") on October 1, 1999. The Fund has committed capital of approximately $100 million, $75 million of which was raised from third party investors. The Fund invests in early to mid-stage Internet companies focused on e-commerce, infrastructure tools, communication and services. The Company received a general and limited partnership interest of approximately 28% in the Fund. Through the Fund, the Company is able to leverage its own investment capital, expand the scope of its strategic investments (beyond financial services) and keep it in a position to capitalize on leading-edge technologies. The Fund is managed by its General Partner, E*TRADE Ventures I, LLC (the "General Partner"). Christos M. Cotsakos, the Chairman of the Board of Directors and Chief Executive Officer of the Company, and Thomas Bevilacqua, the Company's Chief Strategic Investment Officer, are the managing members of the General Partner. The Company is a non-managing member of the General Partner. The General Partner receives an annual management fee of approximately 1.75% of the total committed capital. The management fee is paid in its entirety to the Company and is used to offset the costs and expenses of its corporate development/strategic group. In addition, to the extent that the Fund generates profits, 20% are allocated to the General Partner as a carried interest. As a member of the General Partner, the Company is entitled to receive 50% of such amount provided that up to one-fifth of the Company's interest can be allocated by the managing members to Company personnel. The Company also has limited partnership interests in two other unrelated venture capital funds. NOTE 4. RELATED PARTY TRANSACTIONS During the second and third quarters of fiscal year 2000, the Company made relocation loans to three executive officers in the aggregate principal amount of $9.8 million. The relocation loans accrue interest at the rates of between 6.2% and 6.8% per annum, and are collateralized by residential properties. The principal amounts of $1.6 million, $4.0 million, and $4.2 million are due in March 2002, March 2005, and May 2005, respectively. Interest on the $4.0 million and $4.2 million loans begins to accrue in March 2003 and May 2003, respectively, and interest on the $1.6 million loan begins to accrue immediately. Accrued interest on the loans is due upon loan maturity. Related party loans receivable are recorded in other assets. NOTE 5. SUBORDINATED NOTES AND OTHER BORROWINGS On February 7, 2000, the Company completed a Rule 144A offering of $500 million convertible subordinated notes due February 2007. On March 17, 2000, the initial purchasers exercised an option to purchase 8 an additional $150 million of notes. The notes are convertible, at the option of the holder, into a total of 27,542,373 shares of the Company's common stock at a conversion price of $23.60 per share. The notes bear interest at 6%, payable semiannually, and are non-callable for three years and may then be called by the Company at a premium, which declines over time. The holders have the right to require redemption at a premium in the event of a change in control or other defined redemption event. The Company used $145.0 million of the net proceeds to repay the outstanding balance on a line of credit in February 2000. Debt issuance costs of $19.1 million are included in other assets and are being amortized to corporate interest expense over the term of the notes. Had these securities been issued at the beginning of the fiscal year and the proceeds used to reduce the borrowings under the line of credit, income per share would have been reduced to loss per share of $0.01 for the three months ended June 30, 2000 and loss per share would have been increased to $0.17 per share for the nine months ended June 30, 2000, compared to income per share of $0.02 and loss per share of $0.08 recorded in the three and nine months ended June 30, 2000, respectively, due to the additional interest expense and amortization of issuance costs associated with the notes. In December 1999, the Company obtained a $150 million line of credit agreement with a syndicate of banks. The line of credit, which had an expiration date of March 31, 2000, was dissolved by the Company in February 2000 following the Company's issuance of convertible subordinated notes and repayment of the $145.0 million outstanding balance. In November 1999, the Company obtained a $50 million line of credit under an agreement with a bank that expires in November 2000. The line of credit is collateralized by investment securities that are owned by the Company. Borrowings under the line of credit bear interest at 0.35% above LIBOR. The agreement requires the Company to meet certain financial covenants. As of June 30, 2000, the Company was in compliance with all such covenants and had $30.8 million outstanding under this line of credit. NOTE 6. SHAREOWNERS' NOTES RECEIVABLE During the third quarter of fiscal year 2000, the Company made full recourse loans to several of its executive officers in the aggregate principal and interest amount of $18.7 million. The proceeds of these loans were used to fund the purchase of shares of E*TRADE common stock through the exercise and hold of stock options. The loans accrue interest at the rate of 7.75% per annum. The principal amount and accrued interest on the shareowners' notes receivable are due through July 2001. NOTE 7. COMPREHENSIVE INCOME On October 1, 1998, the Company adopted SFAS No. 130, Reporting Comprehensive Income, which requires that an enterprise report, by major components and as a single total, the change in net assets during the period from non-owner sources. The reconciliation of net income (loss) to comprehensive income (loss) is as follows (in thousands):
Three Months Ended Nine Months Ended June 30, June 30, ------------------- ------------------ 2000 1999 2000 1999 --------- -------- -------- -------- Net income (loss)................. $ 5,690 $(23,746) $(22,290) $(26,110) Changes in other comprehensive income (loss): Unrealized gain (loss) on available-for-sale securities, net of tax..................... (109,696) 25,234 1,616 239,246 Cumulative translation adjustments.................... 3,004 (880) 1,459 (265) --------- -------- -------- -------- Total comprehensive income (loss)....................... $(101,002) $ 608 $(19,215) $212,871 ========= ======== ======== ========
9 NOTE 8. INCOME (LOSS) PER SHARE The following table sets forth the computation of the numerator and denominator used in the computation of basic and diluted income (loss) per share (in thousands):
Nine Months Ended Three Months ended June 30, June 30, -------------------------------- ---------------------- 2000 1999 2000 1999 ------------------- ------------ ------------ --------- Basic and Basic Diluted Basic and Basic and diluted income income diluted loss diluted loss loss per per share per share per share per share share --------- --------- ------------ ------------ --------- Numerator: Income (loss) before cumulative effect of accounting change and extraordinary loss... $ 5,690 $ 5,690 $(21,761) $(22,290) $ (23,656) Premium on redemption of trust preferred securities (a)....... -- -- (381) -- -- -------- -------- -------- -------- --------- Adjusted income (loss) before cumulative effect of accounting change and extraordinary loss... 5,690 5,690 (22,142) (22,290) (23,656) Cumulative effect of accounting change, net of tax........... -- -- -- -- (469) Extraordinary loss on early extinguishment of subordinated debt, net of tax........... -- -- (1,985) -- (1,985) -------- -------- -------- -------- --------- Adjusted net income (loss)............... 5,690 5,690 (24,127) (22,290) (26, 110) Less: preferred stock dividends............ -- -- 60 -- 180 -------- -------- -------- -------- --------- Adjusted income (loss) applicable to common stock................ $ 5,690 $ 5,690 $(24,187) $(22,290) $(26, 290) ======== ======== ======== ======== ========= Denominator: Weighted average shares outstanding... 294,015 294,015 271,276 275,337 265,434 Dilutive effect of options issued to associates........... -- 14,502 -- -- -- Dilutive effect of warrants outstanding.......... -- 829 -- -- -- -------- -------- -------- -------- --------- 294,015 309,346 271,276 275,337 265,434 ======== ======== ======== ======== =========
- -------- (a) This charge represents costs incurred to purchase certain of the Company's trust preferred securities on the open market. The costs were charged against additional paid-in capital but increase the net loss for earnings per share purposes (see Note 15 to the Company's Annual Report on Form 10- K/A). Because the Company reported a net loss in the nine months ended June 30, 2000 and in the three and nine months ended June 30, 1999, the calculation of diluted loss per share for these periods does not include common stock equivalents as they are anti-dilutive and would result in a reduction of loss per share. If the Company had reported net income in the nine months ended June 30, 2000 and in the three and nine months ended June 30, 1999, there would have been approximately 17,263,000, 21,029,000 and 19,003,000 additional shares for options outstanding, respectively, and approximately 875,000, 1,129,000, and 1,278,000 additional shares for warrants outstanding, respectively, in the calculation of diluted loss per share. Excluded from the calculation of diluted income (loss) per share for all periods presented are approximately 27,542,000 shares of common stock issuable under convertible subordinated notes as the effect of applying the treasury stock method on an as-if-converted basis would be anti-dilutive in the calculation of diluted income (loss) per share. 10 The following options to purchase shares of common stock have not been included in the computation of diluted income (loss) per share because the options' exercise price was greater than the average market price of the Company's common stock for the periods stated; therefore, the effect would be anti-dilutive (in thousands, except exercise price data):
Three Months Nine Months Ended June Ended June 30, 30, ------------- ------------- 2000 1999 2000 1999 ------ ------ ------ ------ Options excluded from computation of diluted income (loss) per share...................... 13,303 145 8,451 182 Exercise price ranges: High......................................... $58.75 $58.75 $58.75 $58.75 Low.......................................... $19.72 $48.25 $24.63 $25.56
NOTE 9. REGULATORY REQUIREMENTS E*TRADE Securities is subject to the Uniform Net Capital Rule (the "Rule") under the Securities Exchange Act of 1934 administered by the Securities and Exchange Commission ("SEC") and the National Association of Securities Dealers Regulation, Inc. ("NASDR"), which requires the maintenance of minimum net capital. E*TRADE Securities has elected to use the alternative method permitted by the Rule, which requires that the Company maintain minimum net capital equal to the greater of $250,000 or two percent of aggregate debit balances arising from customer transactions, as defined. E*TRADE Securities had amounts in relation to the Rule as follows (in thousands, except percentage data):
June 30, September 30, 2000 1999 -------- ------------- Net capital.......................................... $451,153 $162,729 Percentage of aggregate debit balances............... 9.1% 6.2% Required net capital................................. $ 99,155 $ 52,206 Excess net capital................................... $351,998 $110,523
Under the alternative method, a broker-dealer may not repay subordinated borrowings, pay cash dividends or make any unsecured advances or loans to its parent or employees if such payment would result in net capital of less than 5% of aggregate debit balances or less than 120% of its minimum dollar amount requirement. TIR's brokerage subsidiary companies and the Company's international affiliates are also subject to net capital requirements. These companies are located in the United States, Australia, Hong Kong, the Philippines and Europe. The companies outside the United States have various and differing capital requirements, all of which were met at June 30, 2000 and September 30, 1999. ETFC's registered broker-dealer subsidiary, ETCM, is also subject to the Rule and is required to maintain net capital equal to the greater of $100,000 or 6.67% of aggregate indebtedness, as defined. The Rule also requires that the ratio of aggregate indebtedness to net capital shall not exceed 15 to 1. The table below summarizes the minimum and excess net capital requirements for the Company's United States based broker subsidiaries (in thousands):
June 30, 2000 September 30, 1999 ------------------------ ------------------------ Required Excess Required Excess Net Net Net Net Net Net Capital Capital Capital Capital Capital Capital -------- ------- ------- -------- ------- ------- TIR Securities, Inc......... $250 $ 1,714 $ 1,464 $ 82 $ 2,289 $ 2,207 TIR Investor Select, Inc.... $ 5 $ 423 $ 418 $ 5 $ 254 $ 249 Marquette Securities, Inc... $250 $ 502 $ 252 $250 $ 445 $ 195 E*TRADE Capital Markets, Inc........................ $252 $20,086 $19,834 $190 $17,310 $17,120
11 The Bank is also subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory--and possibly additional discretionary--actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, E*TRADE Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. E*TRADE Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about the strength of components of capital, risk weightings of assets and off-balance-sheet transactions, and other factors. Quantitative measures established by regulation to ensure capital adequacy require E*TRADE Bank to maintain minimum amounts and ratios of total and Tier I capital to risk-weighted assets and of Tier I capital to average assets. Management believes, as of June 30, 2000, that the Bank meets all capital adequacy requirements to which it is subject. As of June 30, 2000 and September 30, 1999, E*TRADE Bank qualified as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, E*TRADE Bank must maintain minimum total risk-based, Tier I risk- based, and Tier I leverage ratios as set forth in the following table. There are no conditions or events since June 30, 2000 that management believes have changed the institution's category. E*TRADE Bank's required and actual capital amounts and ratios are presented in the table below (dollars in thousands):
Required To Be Well Capitalized Required For Under Prompt Capital Corrective Adequacy Action Actual Purposes Provisions -------------- --------------- --------------- Amount Ratio Amount Ratio Amount Ratio -------- ----- --------- ----- --------- ----- As of June 30, 2000: Core capital (to adjusted tangible assets)........... $475,258 6.42% >$296,024 >4.0% >$370,030 > 5.0% Tangible capital (to tangible assets)........... $475,258 6.42% >$111,248 >1.5% N/A N/A Tier I capital (to risk weighted assets)........... $475,258 16.17% N/A N/A >$178,747 > 6.0% Total capital (to risk weighted assets)........... $484,598 16.48% >$238,329 >8.0% >$297,911 >10.0% As of September 30, 1999: Core capital (to adjusted tangible assets)........... $440,469 11.20% >$157,320 >4.0% >$196,651 > 5.0% Tangible capital (to tangible assets)........... $440,469 11.20% >$ 58,995 >1.5% N/A N/A Tier I capital (to risk weighted assets)........... $440,469 25.97% N/A N/A >$101,768 > 6.0% Total capital (to risk weighted assets)........... $447,170 26.36% >$135,691 >8.0% >$169,614 >10.0%
NOTE 10. COMMITMENTS, CONTINGENCIES AND OTHER REGULATORY MATTERS As of June 30, 2000, the Bank had commitments to purchase $26.9 million in fixed rate and $632.9 million in variable rate loans and certificates of deposit scheduled to mature in less than one year approximating $2,112.5 million. In the normal course of business, the Bank makes various commitments to extend credit and incur contingent liabilities that are not reflected in the balance sheets. The Company is a defendant in civil actions arising in the normal course of business, including several putative class action filings. The matters alleged by the plaintiffs include: . False and deceptive advertising and other communications regarding the Company's commission rates and ability to timely execute and confirm online transactions; . Damages arising from alleged problems in accessing brokerage accounts and placing orders; . Damages arising from system interruptions; and 12 . Unfair business practices regarding the extent to which initial public offering shares are made available to the Company's customers. These proceedings are at early stages, and the Company is unable to predict their ultimate outcome; however, the Company believes that all of these claims are without merit and intends to defend against them vigorously. An unfavorable outcome in any of these matters, if they are not covered by insurance, could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, even if the ultimate outcomes are resolved in favor of the Company, the defense of such litigation could entail considerable cost and the diversion of efforts of management, either of which could have a material adverse effect on the Company's results of operation. From time to time, the Company has been threatened with, or named as a defendant in, lawsuits, arbitrations and administrative claims. Compliance and trading problems that are reported to the NASDR or the SEC by dissatisfied customers are investigated by the NASDR or the SEC, and, if pursued by such customers, may rise to the level of arbitration or disciplinary action. One or more of such claims or disciplinary actions decided adversely against the Company could have a material adverse effect on the Company's business, financial condition and results of operations. The Company is also subject to periodic regulatory audits and inspections. The securities and banking industries are subject to extensive regulation under federal, state and applicable international laws. As a result, the Company is required to comply with many complex laws and rules and its ability to so comply is dependent in large part upon the establishment and maintenance of a qualified compliance system. The Company is aware of several instances of its noncompliance with applicable regulations. NOTE 11. ACQUISITIONS On June 14, 2000, the Company entered into a definitive agreement to acquire VERSUS Technologies, Inc. ("VERSUS"), a Canadian-based provider of electronic securities trading services for institutional and retail investors and owner of the E*TRADE Canada license, in which the Company has an existing $1.5 million investment at June 30, 2000. Through the acquisition of VERSUS, the Company will increase its retail and institutional client base and be able to incorporate the technology underlying the VERSUS Network, a scalable proprietary electronic trading platform, into its global cross border trading platform, enabling institutions and investment dealers worldwide to route orders globally through its trading networks. In connection with this transaction, the Company agreed to acquire all of the outstanding shares of VERSUS stock in exchange for E*TRADE common stock valued at approximately $174.0 million, with VERSUS to become a wholly-owned subsidiary of the Company. The acquisition of VERSUS is subject to the satisfaction of certain conditions and is expected to close by the end of fiscal year 2000. The acquisition is expected to be accounted for as a pooling of interests. 13 On January 12, 2000, the Company completed the acquisition of ETFC. ETFC is the holding company for E*TRADE Bank, an Internet-based bank. Under the terms of the agreement, ETFC shareowners received 1.05 shares of E*TRADE common stock for each share of ETFC common stock representing a total of approximately 35,600,000 shares of the Company's common stock. The Company also assumed all outstanding ETFC options, which were converted to options to purchase approximately 5,494,000 shares of the Company's common stock. The acquisition was accounted for as a pooling of interests and, accordingly, all prior financial data of the Company has been restated to include the historical operations of ETFC. There were no significant intercompany transactions requiring elimination for any prior periods presented. The Company has incurred $0.2 million and $27.1 million of merger-related expenses in the three and nine months ended June 30, 2000, respectively, related to the acquisition of ETFC. The information below reflects the operations of E*TRADE and ETFC through the date of acquisition (in thousands):
Income (Loss) Before Cumulative Effect of Accounting Change and Net Net Extraordinary Income Revenues Loss (Loss) ---------- ------------- -------- Nine months ended June 30, 2000 E*TRADE Group............................. $ 981,990 $(22,713) $(22,713) ETFC through December 31, 1999............ 23,423 423 423 ---------- -------- -------- Combined.................................. $1,005,413 $(22,290) (22,290) ========== ======== ======== Nine months ended June 30, 1999 E*TRADE Group............................. $ 432,365 $(27,719) $(27,719) ETFC...................................... 35,249 4,063 1,609 ---------- -------- -------- Combined.................................. $ 467,614 $(23,656) $(26,110) ========== ======== ========
On May 5, 2000, the Company completed the acquisition of Card Capture Services, Inc. ("CCS"), the largest independent network of centrally-managed automated teller machines in the United States, for an aggregate purchase price of $94.0 million. The aggregate purchase price is comprised of: approximately 4,247,000 shares of common stock valued at $87.4 million issued in exchange for 100% of the outstanding shares of CCS, the assumption of employee stock options, and incentive payments to management; cash paid of $5.1 million; and acquisition costs of $1.5 million. The acquisition was accounted for using the purchase method of accounting, and the results of CCS's operations have been combined with those of the Company since the date of acquisition. The purchase price allocation at June 30, 2000 is preliminary and has been allocated based on the estimated fair value of net tangible and intangible assets acquired. At June 30, 2000, the Company allocated $17.3 million to acquired assets and assumed liabilities of $13.6 million. The purchase price exceeded the fair value of the assets acquired by $90.3 million, which was primarily recorded as goodwill to be amortized over fifteen years, pending the completion of an independent valuation of CCS net assets. Merger-related expenses related to the acquisition of CCS were not significant through June 30, 2000. Additional costs associated with the CCS merger are expected to be incurred throughout fiscal 2000. During the quarter ended December 31, 1999, the Company acquired 100% ownership of three of its foreign affiliates, E*TRADE Nordic AB, a Swedish company, E*TRADE @ Net Bourse S.A., a French company, and the remaining portion of its E*TRADE UK joint venture, for an aggregate purchase price of $362.0 million. The purchase price was comprised of 11.7 million shares of the Company's common stock, cash of $26.7 million and the assumption of options of the affiliates. The purchase price exceeded the fair value of the assets acquired by $357.4 million, which was recorded as goodwill to be amortized over 20 years. Merger-related expenses related to foreign acquisitions were not significant. 14 The pro forma information below assumes that the acquisitions of the Company's foreign affiliates and CCS occurred at the beginning of fiscal 1999 and includes the effect of amortization of goodwill from that date (in thousands, except per share amounts):
Nine Months ended June 30, -------------------- 2000 1999 ---------- -------- Net revenues.......................................... $1,026,320 $512,205 Net loss.............................................. $ (29,960) $(46,710) Basic and diluted loss per share...................... $ (0.10) $ (0.17)
The pro forma information is for informational purposes only and is not necessarily indicative of the results of future operations nor results that would have been achieved had the acquisitions taken place at the beginning of fiscal 1999. 15 NOTE 12. SEGMENT INFORMATION The Company provides securities brokerage and related investment and financial services. Following the acquisitions of TIR in fiscal 1999 and ETFC in fiscal 2000 (see Note 11), the Company classified the operations of E*TRADE's historical business, TIR and ETFC as separate reportable segments due to the relatively short operating history of the combined operations of E*TRADE's historical business with TIR and ETFC and due to ETFC's online banking services which represent a new line of business. With the acquisition of three foreign affiliates in the quarter ended December 31, 1999, their results have been combined with TIR to constitute the International segment. With the acquisition of CCS in the quarter ended June 30, 2000, the operations of CCS have been combined with ETFC to comprise the Banking segment. This is the manner in which management currently evaluates the Company's operating performance. Financial information for the Company's reportable segments is presented in the table below and the totals are equal to the Company's consolidated amounts as reported in the condensed consolidated financial statements.
E*TRADE Group International Banking Total ---------- ------------- ---------- ----------- (in thousands) Three months ended June 30, 2000: Interest income--net of interest expense......... $ 59,192 $ 765 $ 32,395 $ 92,352 Non-interest revenue--net of provision for loan losses................... 195,753 36,043 6,193 237,989 ---------- -------- ---------- ----------- Net revenues.............. $ 254,945 $ 36,808 $ 38,588 $ 330,341 ========== ======== ========== =========== Operating income (loss)... $ 1,419 $ (4,567) $ 3,365 $ 217 Pre-tax income (loss)..... $ 14,699 $ (4,518) $ 2,812 $ 12,993 Three months ended June 30, 1999: Interest income--net of interest expense......... $ 30,001 $ 273 $ 15,203 $ 45,477 Non-interest revenue--net of provision for loan losses................... 117,181 24,997 (1,233) 140,945 ---------- -------- ---------- ----------- Net revenues.............. $ 147,182 $ 25,270 $ 13,970 $ 186,422 ========== ======== ========== =========== Operating income (loss)... $ (47,259) $ 1,563 $ 647 $ (45,049) Pre-tax income (loss)..... $ (39,247) $ 1,037 $ 4,758 $ (33,452) Nine months ended June 30, 2000: Interest income--net of interest expense......... $ 166,976 $ 1,296 $ 83,031 $ 251,303 Non-interest revenue--net of provision for loan losses................... 634,799 111,599 7,712 754,110 ---------- -------- ---------- ----------- Net revenues.............. $ 801,775 $112,895 $ 90,743 $ 1,005,413 ========== ======== ========== =========== Operating loss............ $ (78,945) $ (384) $ (2,907) $ (82,236) Pre-tax loss.............. $ (19,286) $ (970) $ (3,448) $ (23,704) Nine months ended June 30, 1999: Interest income--net of interest expense......... $ 68,718 $ 670 $ 31,154 $ 100,542 Non-interest revenue--net of provision for loan losses................... 282,254 80,723 4,095 367,072 ---------- -------- ---------- ----------- Net revenues.............. $ 350,972 $ 81,393 $ 35,249 $ 467,614 ========== ======== ========== =========== Operating income (loss)... $ (104,653) $ 5,939 $ 5,973 $ (92,741) Pre-tax income (loss)..... $ (53,309) $ 5,386 $ 10,279 $ (37,644) As of June 30, 2000: Segment assets............ $7,185,102 $274,902 $7,432,593 $14,892,597 As of September 30, 1999: Segment assets............ $3,771,370 $155,610 $3,981,244 $ 7,908,224
No one single customer accounted for greater than 10% of total revenues in the three or nine months ended June 30, 2000 or 1999. 16 NOTE 13. Recent Accounting Pronouncements In December 1999, the Securities and Exchange Commission ("SEC") staff issued Staff Accounting Bulletin No. 101 Revenue Recognition in Financial Statements ("SAB 101"). SAB 101 states that all registrants are expected to apply the accounting and disclosures described in it. The SEC staff, however, will not object if registrants that have not applied SAB 101 do not restate prior financial statements provided they report a change in accounting principle in accordance with Accounting Principles Board Opinion No. 20 Accounting Changes, by cumulative catch-up adjustment no later than the second quarter of the fiscal year beginning after December 15, 1999. The Company is currently evaluating the impact, if any, of SAB 101 on its revenue recognition policy and its consolidated financial statements. 17 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Statements The following discussion of the financial condition and results of operations of E*TRADE Group, Inc. should be read in conjunction with the condensed consolidated financial statements and notes thereto included elsewhere in this Form 10-Q. This discussion contains forward-looking statements, including statements regarding our Company's strategy, financial performance and revenue sources, which involve risks and uncertainties. Actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including, but not limited to, those set forth in the section entitled "Risk Factors" and elsewhere in this Form 10-Q. Results of Operations Revenue Detail (in millions, except percentage data) The following table sets forth the components of revenue and the percentage change for the three and nine months ended June 30, 2000 and 1999:
Three Months Nine Months Ended Ended June 30, June 30, --------------- ----------------- Percentage Percent 2000 1999 Change 2000 1999 Change ------- ------- ---------- --------- ------- ------- Transaction revenues: Commission.............. $ 161.5 $ 95.0 70% $ 524.0 $ 227.9 130% Order Flow.............. 18.7 11.1 68% 63.1 29.0 118% ------- ------- --------- ------- Total transaction revenues............. 180.2 106.1 70% 587.1 256.9 129% ======= ======= ========= ======= Interest income: Brokerage-related activities............. 121.6 54.1 125% 329.1 119.0 177% Banking-related activities............. 135.6 50.0 171% 328.0 126.7 159% ------- ------- --------- ------- Total interest income............... 257.2 104.1 147% 657.1 245.7 167% ------- ------- --------- ------- Global and institutional.. 33.9 26.9 26% 109.0 84.4 29% Other..................... 24.9 8.6 189% 60.8 27.2 123% ------- ------- --------- ------- Gross revenues........ 496.2 245.7 102% 1,414.0 614.2 130% ======= ======= ========= ======= Interest expense: Brokerage-related activities............. 61.6 24.1 156% 160.8 49.6 224% Banking-related activities............. 103.2 34.6 198% 245.0 95.6 156% ------- ------- --------- ------- Total interest expense.............. 164.8 58.7 181% 405.8 145.2 180% Provision for loan losses................... 1.0 0.7 46% 2.8 1.4 93% ------- ------- --------- ------- Net revenues.......... $ 330.3 $ 186.4 77% $ 1,005.4 $ 467.6 115% ======= ======= ========= =======
(Percentages may not recalculate and balances may not add due to rounding.) Net Revenues Net revenues increased to $330.3 million in the third quarter of fiscal 2000, up 77% from $186.4 million in the equivalent period of fiscal 1999. Net revenues increased to $1,005.4 million for the nine months ended June 30, 2000, up 115% from $467.6 million in the equivalent period of fiscal 1999. The increase in net revenue is mainly due to the growth in our diversified and global revenue streams, improvements in our cross-selling ability across business lines, and sustained growth in customer trading volumes, net new active bank and brokerage customer accounts and customer assets. 18 Transaction Revenues Transaction revenues increased to $180.2 million in the third quarter of fiscal 2000, up 70% from $106.1 million in the equivalent period in fiscal 1999. Transaction revenues increased to $587.1 million for the nine months ended June 30, 2000, up 129% from $256.9 million for the equivalent period in fiscal 1999. Transaction revenues consist of commission revenues and payments for order flow. Growth in transaction revenues reflects the overall high level of trading volume in U.S. financial markets for the nine months ended June 30, 2000. Further, sustained growth in new customer accounts coupled with our Power E*TRADE program, which extends special initiatives to participating, highly active customers who remained active this quarter, despite declining volumes in the market, and the implementation of our Customer Relationship Management ("CRM") technology, which has enabled us to identify and attract higher quality accounts, contributed to the growth in transaction revenues during the third quarter in fiscal 2000 despite a historic decline in overall market trading volumes during that quarter. Commission revenues for the third quarter of fiscal 2000 increased to $161.5 million, up 70% from $95.0 million in the same period a year ago. Commission revenues for the nine months ended June 30, 2000 increased to $524.0 million, up 130% from $227.9 million in the same period a year ago. Domestic brokerage transactions for the third quarter of fiscal 2000 totaled 10.5 million, or an average of 166,528 transactions per day. This is an increase of 107% over the average daily domestic brokerage transaction volume of 80,635 for the same period in the prior year. Domestic brokerage transactions for the nine months ended June 30, 2000 totaled 33.2 million, or an average of 174,757 transactions per day. This is an increase of 171% over the average daily domestic brokerage transaction volume of 64,444 for the same period in the prior year. Commissions per trade decreased from $18.51 and $18.59 in the three and nine months ended June 30, 1999, respectively, to $17.33 and $17.70 for the three and nine months ended June 30, 2000, respectively. The decline in commissions per trade was a result of promotional activities, changes in the mix of revenue generating transactions and the August 1999 implementation of the Power E*TRADE program, a component of which provides reduced commissions for active traders. Further, market conditions in the third quarter of fiscal 2000 coupled with our efforts to diversify revenue streams during this period have resulted in a reduction in transaction revenues as a percentage of gross revenues to 36% from 43% in the third quarter of fiscal 1999. Commission revenues as a percentage of gross revenues are expected to decrease as we continue to execute on cross-selling initiatives across business lines, leveraging our diversified business model. Payments for order flow increased to $18.7 million for the third quarter of fiscal 2000, up 68% from $11.1 million for the same period a year ago. Order flow revenue increased to $63.1 million for the nine months ended June 30, 2000, up 118% from $29.0 million for the same period in the prior year. As a percentage of transaction revenues, payments for order flow were 10% for the three months ended June 30, 2000 and 1999. As a percentage of transaction revenues, payments for order flow were 11% for the nine months ended June 30, 2000 and 1999. Payments for order flow did not increase at the same rate as transactions due to changes in the order flow mix, a decrease in the average shares per equity transaction and the continued impact of the SEC's order handling rules. Interest Income and Expense Interest income from brokerage-related activities is comprised of interest earned by our brokerage subsidiary on credit extended to customers to finance their purchases of securities on margin and fees on customer assets invested in money market accounts. Interest expense from brokerage-related activities is comprised of interest paid to customers on certain credit balances, interest paid to banks and interest paid to other broker-dealers through our brokerage subsidiary's stock loan program. Interest income from banking- related activities reflects interest earned on assets, consisting primarily of loans receivable and mortgage-backed securities. Interest expense from banking-related activities is comprised of interest-bearing liabilities which include customer deposits, advances from the Federal Home Loan Bank of Atlanta and other borrowings. Brokerage interest income increased to $121.6 million in the third quarter of fiscal 2000, up 125% from $54.1 million in the same period a year ago. Brokerage interest income increased to $329.1 million for the nine months ended June 30, 2000, up 177% from $119.0 million in the same period in fiscal 1999. These increases 19 primarily reflect the overall increase in average customer margin balances, which increased 119% to $5,048.4 million in the third quarter of fiscal 2000, from $2,306.9 million in the same period a year ago, and average customer money market fund balances, which increased 133% to $7,224.1 million in the third quarter of fiscal 2000, from $3,098.3 million in the same period a year ago. Brokerage interest expense increased to $61.6 million in the third quarter of fiscal 2000, up 156% from $24.1 million in the comparable prior year period. Brokerage interest expense increased to $160.8 million for the nine months ended June 30, 2000, up 224% from $49.6 million in the comparable prior year period. This increase is due to an overall increase in average customer credit balances, which increased 113% to $1,426.0 million in the third quarter of fiscal 2000, from $670.7 million in the same period a year ago, and average stock loan balances, which increased 95% to $3,715.1 million in the third quarter of fiscal 2000, from $1,910.0 million in the same period a year ago. Banking interest income increased to $135.6 million in the third quarter of fiscal 2000, up 171% from $50.0 million for the same period a year ago. Banking interest income increased to $328.0 million for the nine months ended June 30, 2000, up 159% from $126.7 million for the same period a year ago. These increases reflect an increase in the average interest-earning asset balances coupled with an increase in the average interest yield. Average interest-earning assets increased 140% to $6,907.2 million during the third quarter of fiscal 2000, from $2,875.0 million in the same period a year ago. The average yield increased to 7.86% in the third quarter of fiscal 2000 from 6.93% in the same period a year ago. Average interest-earning assets increased 135% to $5,702.9 million during the nine months ended June 30, 2000, from $2,429.3 million in the same period a year ago. The average yield increased to 7.67% in the nine months ended June 30, 2000 from 7.00% in the same period a year ago. Interest expense from banking activities increased to $103.2 million in the third quarter of fiscal 2000, up 198% from $34.6 million for the same period a year ago. Interest expense from banking activities increased to $245.0 million in the nine months ended June 30, 2000, up 156% from $95.6 million for the same period a year ago. These increases reflect an increase in the average interest-bearing liabilities coupled with an increase in the average cost of the borrowings. Average interest-bearing liabilities increased 165% to $6,552.8 million during the third quarter of fiscal 2000, from $2,470.6 million in the same period a year ago. The average cost increased to 6.33% in the third quarter of fiscal 2000 from 5.62% in the same period a year ago. Average interest-bearing liabilities increased 140% to $5,357.0 million during the nine months ended June 30, 2000, from $2,229.0 million in the same period a year ago. The average cost increased to 6.11% in the nine months ended June 30, 2000 from 5.73% in the same period a year ago. 20 The following tables present average balance data and income and expense data for our banking subsidiary's operations and the related interest yields and rates for the three and nine months ended June 30, 2000 and 1999. The tables also present information for the periods indicated with respect to net interest margin, an indicator of an institution's profitability, which is calculated by dividing net interest income by interest-earning banking assets. Another indicator of profitability is net interest spread, which is the difference between the weighted average yield earned on interest-earning assets and weighted average rate paid on interest-bearing liabilities. Interest includes the incremental tax benefit of tax exempt income.
Three Months Ended June 30, Three Months Ended June 30, 2000 1999 ------------------------------- ------------------------------- Interest Average Interest Average Average Income/ Annualized Average Income/ Annualized Balance Expense Yield/Cost Balance Expense Yield/Cost ----------- -------- ---------- ----------- -------- ---------- (Dollars in thousands) (unaudited) Interest-earning banking assets: Loans receivable, net.................. $ 3,374,777 $ 68,620 8.13% $ 1,306,819 $ 24,755 7.58% Interest-bearing deposits............. 45,721 737 6.48 31,339 370 4.73 Mortgage-backed and related available- for-sale securities.. 3,187,770 60,992 7.65 1,277,246 20,578 6.44 Available-for-sale investment securities........... 223,459 3,873 7.13 213,934 3,285 6.35 Investment in FHLB stock................ 69,414 1,341 7.77 24,403 456 7.50 Trading securities.... 6,077 78 5.11 21,257 388 7.31 ----------- -------- ------ ----------- -------- ------ Total interest- earning banking assets............. 6,907,218 $135,641 7.86% 2,874,998 $ 49,832 6.93% Non-interest-earning banking assets......... 288,330 109,208 ----------- ----------- Total banking assets............. $ 7,195,548 $ 2,984,206 =========== =========== Interest-bearing banking liabilities: Retail deposits....... $ 3,491,184 $ 53,547 6.12% $ 1,416,953 $ 19,909 5.64% Brokered callable certificates of deposit.............. 91,730 1,478 6.46 67,093 1,110 6.63 FHLB advances......... 1,354,077 21,694 6.34 467,434 6,351 5.38 Other borrowings...... 1,615,762 26,472 6.48 499,026 6,668 5.29 Subordinated debt, net.................. -- -- -- 20,062 591 11.77 ----------- -------- ----------- -------- Total interest- bearing banking liabilities........ 6,552,753 $103,191 6.33% 2,470,568 $ 34,629 5.62% Non-interest bearing banking liabilities.... 161,966 61,426 ----------- ----------- Total banking liabilities........ 6,714,719 2,531,994 Total banking shareowner's equity............. 480,829 452,212 ----------- ----------- Total banking liabilities and shareowner's equity.... $ 7,195,548 $ 2,984,206 =========== =========== Excess of interest- earning banking assets over interest-bearing banking liabilities/net interest income........ $ 354,465 $ 32,450 $ 404,430 $ 15,203 =========== ======== =========== ======== Net interest spread..... 1.53% 1.31% ====== ====== Net interest margin (net yield on interest- earning banking assets)................ 1.88% 2.12% ====== ====== Ratio of interest- earning banking assets to interest-bearing banking liabilities.... 105.41% 116.37% ====== ====== Return on average total banking assets......... 0.07%* 0.17% ====== ====== Return on average net banking assets......... 0.07%* 0.25% ====== ====== Equity to total banking assets................. 6.68%* 15.15% ====== ======
- -------- * Ratios calculated by excluding ESOP and merger related costs of $0.2 million and $0.5 million, respectively in the three months ended June 30, 2000 and 1999, respectively. 21
Nine Months Ended June 30, Nine Months Ended June 30, 2000 1999 ------------------------------- ------------------------------ Interest Average Interest Average Average Income/ Annualized Average Income/ Annualized Balance Expense Yield/Cost Balance Expense Yield/Cost ---------- --------- ---------- ---------- -------- ---------- (Dollars in thousands) (unaudited) Interest-earning banking assets: Loans receivable, net................... $2,828,210 $ 168,439 7.94% $1,054,103 $ 60,636 7.67% Interest-bearing deposits............... 65,540 2,768 5.64 26,673 891 4.46 Mortgage-backed and related available- for-sale securities......... 2,535,820 142,366 7.49 1,083,575 53,108 6.54 Available-for-sale investment securities............................. 201,858 10,391 6.94 219,044 10,163 6.31 Investment in FHLB stock................ 53,502 3,109 7.76 21,913 1,229 7.49 Trading securities...................... 17,956 926 6.88 23,945 1,299 7.24 ---------- --------- ------ ---------- -------- ------ Total interest-earning banking assets............................... 5,702,886 $ 327,999 7.67% 2,429,253 $127,326 7.00% Non-interest-earning banking assets....... 231,192 97,265 ---------- ---------- Total banking assets.................. $5,934,078 $2,526,518 ========== ========== Interest-bearing banking liabilities: Retail deposits......................... $2,900,118 $ 130,101 5.98 $1,234,211 $ 52,869 5.98% Brokered callable certificates of deposit................................ 87,551 4,266 6.49 67,070 3,330 6.61 FHLB advances........................... 1,048,832 48,913 6.13 406,848 16,542 5.34 Other borrowings........................ 1,286,937 61,633 6.29 498,098 20,448 5.39 Subordinated debt, net.................. 33,536 -- -- 22,732 2,358 13.83 ---------- --------- ---------- -------- Total interest-bearing banking liabilities.......................... 5,356,974 $ 244,913 6.11% 2,228,959 $ 95,547 5.73% Non-interest bearing banking liabilities:............................. 81,843 67,727 ---------- ---------- Total banking liabilities............... 5,438,817 2,296,686 Total banking shareowner's equity....... 495,261 229,832 ---------- ---------- Total banking liabilities and shareowner's equity................................... $5,934,078 $2,526,518 ========== ========== Excess of interest-earning banking assets over interest-bearing banking liabilities/net interest income.......... $ 345,912 $ 83,086 $ 200,294 $ 31,779 ========== ========= ========== ======== Net interest spread....................... 1.56% 1.27% ====== ====== Net interest margin (net yield on interest-earning banking assets)......... 1.94% 1.74% ====== ====== Ratio of interest-earning banking assets to interest-bearing banking liabilities.. 106.46% 108.99% ====== ====== Return on average total banking assets.... 0.16%* 0.14% ====== ====== Return on average net banking assets...... 0.17%* 0.15% ====== ====== Equity to total banking assets............ 8.35%* 9.10% ====== ======
- -------- * Ratios calculated by excluding ESOP and merger related costs of $17.1 million and $1.1 million, respectively, in the nine months ended June 30, 2000 and 1999, respectively. 22 Global and Institutional Global and institutional revenues increased to $33.9 million in the third quarter of fiscal 2000, up 26% from $26.9 million in the same period a year ago. For the nine months ended June 30, 2000, global and institutional revenues increased to $109.0 million from $84.4 million, up 29% from the same period in fiscal 1999. Global and institutional revenues are comprised of revenues from TIR's operations, as well as licensing fees, royalties and brokerage-related transaction revenue from our international affiliates. TIR's net revenues increased to $33.3 million in the third quarter of fiscal 2000, up 32% from $25.3 million for the same period a year ago. These increases are primarily attributable to strong market conditions in Asia and Europe during the nine months ended June 30, 2000, partially offset by historic market volatility during the three months ended June 30, 2000, which resulted in an 18% decline in global and institutional revenues from $41.4 million in the second quarter of fiscal 2000. TIR's revenues are largely comprised of commissions from institutional trade executions; for the third quarter of fiscal 2000, approximately 69.5% of TIR's transactions were from outside the U.S., and approximately 72.4% were from cross-border transactions. Other Revenues Other revenues increased to $24.9 million in the third quarter of fiscal 2000, up 189% from $8.6 million for the comparable period in fiscal 1999. Other revenues increased to $60.8 million for the nine months ended June 30, 2000, up 123% from $27.2 million for the comparable period in fiscal 1999. Other revenues increased primarily due to growth in E*TRADE Business Solutions revenue, mutual funds revenue, revenues from fees charged for advertising on our Web site, investment banking revenue, and brokerage and banking-related fees for services. Further, with the acquisition of CCS on May 5, 2000, accounted for under the purchase method, other revenues in the three and nine month periods ended June 30, 2000 include both net ATM transaction fees and the gross proceeds from the sale of ATM machines. Provision for Loan Losses The Company recorded a provision for loan losses of $1.0 million in the third quarter of fiscal 2000, up 46% from $0.7 million for the comparable period in fiscal 1999. For the nine months ended June 30, 2000, the provision for loan losses increased to $2.8 million from $1.4 million, up 93% from the same period in fiscal 1999. The provision for loan losses recorded reflects increases in our allowance for loan losses based upon management's review and assessment of the risk in our loan portfolio, as well as the level of charge- offs as a portion of our allowance for loan losses. The increase in the provision for loan losses in the third quarter of fiscal 2000 primarily reflects the growth in the Company's loan portfolio. As of June 30, 2000, the total loan loss allowance was $9.7 million, or 0.27% of total loans outstanding. The total loan loss allowance as of September 30, 1999 was $7.1 million, or 0.33% of total loans outstanding. As of June 30, 2000, the general loan loss allowance was $9.3 million, or 93% of total non-performing assets of $10.0 million. As of September 30, 1999, the general loan loss allowance was $6.7 million, or 79% of total non-performing assets of $8.5 million. Cost of Services Total cost of services increased to $124.5 million for the third quarter of fiscal 2000, up 51% from $82.2 million in the comparable period in fiscal 1999. Total cost of services increased to $366.5 million for the nine months ended June 30, 2000, up 84% from $199.0 million in the comparable period in fiscal 1999. Cost of services includes expenses related to our brokerage clearing operations, customer service activities, Web site content costs, system maintenance, communication expenses and depreciation. These increases reflect the overall increase in customer transactions processed by our brokerage and banking subsidiaries, a related increase in customer service inquiries, and operations and maintenance costs associated with our technology centers in Rancho Cordova, California and Alpharetta, Georgia. Cost of services as a percentage of net revenues was 38% in the third quarter of fiscal 2000 and 44% in the comparable period in fiscal 1999. Cost of services as a percentage of net revenues was 36% for the nine months ended June 30, 2000, compared to 43% in the comparable period in fiscal 1999. The improvement in cost of services as a percentage of net revenue is reflective of increased trading volumes and the diversification of revenue streams. 23 Operating Expenses Selling and marketing expenses increased to $115.1 million in the third quarter of fiscal 2000, up 15% from $99.8 million in the comparable period in fiscal 1999. Selling and marketing expenses increased to $422.2 million for the nine months ended June 30, 2000, up 79% from $235.7 million in the comparable period in fiscal 1999. The increases reflect expenditures for advertising placements, creative development and collateral materials resulting from a variety of advertising campaigns directed at building brand name recognition, growing the customer base and market share, and maintaining customer retention rates. Selling and marketing expenditures in the three and nine months ended June 30, 2000 reflect expenditures which resulted from our sponsorship of Super Bowl XXXIV. International marketing and banking expenditures are expected to increase as we expand our advertising efforts for these segments; however, overall marketing expenditure levels are not expected to continue to grow at the same rate in the fourth quarter of fiscal 2000 as in the first two quarters of the year. Technology development expenses increased to $32.5 million in the third quarter of fiscal 2000, up 57% from $20.7 million in the comparable period in fiscal 1999. Technology development expenses increased to $111.0 million for the nine months ended June 30, 2000, up 120% from $50.5 million in the comparable period in fiscal 1999. The increased level of expense was incurred to enhance our existing product offerings, including maintenance of our Web site and development of our CRM technology prior to achievement of technological feasibility, reflecting our continuing commitment to invest in new products and technologies. Technology development expenses in the third quarter of fiscal 2000 decreased by $9.6 million or 23% from the second quarter of fiscal 2000 primarily due to an increase in capitalizable development costs for certain internally developed software which reached technological feasibility at the end of the second quarter of fiscal 2000, as well as a reduction in the use of outside consultants as we refocused our efforts on fewer, but more beneficial projects. Capitalized costs will be amortized to technology development expense over the expected life of the developed applications. General and administrative expenses increased to $50.2 million in the third quarter of fiscal 2000, up 104% from $24.6 million in the comparable period in fiscal 1999. General and administrative expenses increased to $142.5 million for the nine months ended June 30, 2000, up 105% from $69.7 million in the comparable period in fiscal 1999. These increases were the result of personnel additions and the development of administrative functions resulting from our overall growth. Amortization of goodwill and other intangibles was $6.7 million in the third quarter of fiscal 2000, an increase of $6.2 million from $0.6 million in the comparable period in fiscal 1999. Amortization of goodwill and other intangibles increased to $13.9 million for the nine months ended June 30, 2000, an increase of $12.0 million from $1.9 million in the comparable period in fiscal 1999. These increases primarily consist of amortization of goodwill related to the acquisition of three of our foreign affiliates and CCS during fiscal 2000. Goodwill is amortized over 15 to 20 years. Merger-related expenses of $1.1 million were recognized in the third quarter of fiscal 2000, compared to $3.7 million of merger-related expenses recognized in the third quarter of fiscal 1999. Merger-related expenses of $31.5 million were recognized in the nine months ended June 30, 2000, compared to $3.7 million of merger-related expenses recognized in the comparable period of fiscal 1999. Merger-related expenses primarily relate to transaction costs associated with the E*TRADE Financial Corporation acquisition. Additional costs associated with mergers and acquisitions are expected to be incurred throughout fiscal 2000. Non-operating Income (Expense) Corporate interest expense-net was $6.0 million for the quarter ended June 30, 2000, compared with $4.2 million in corporate interest income-net in the comparable period in fiscal 1999. Corporate interest expense-net was $8.4 million for the nine month period ended June 30, 2000, compared with $14.8 million in corporate interest income-net in the comparable period in fiscal 1999. Corporate interest expense-net increased primarily as a result of a decrease in average corporate investment balances coupled with an increase in interest 24 expense resulting from the issuance of $650 million in convertible subordinated notes during the three months ended March 31, 2000. In the third quarter of fiscal 2000, we continued to liquidate portions of our investment portfolio and recognized realized gains of $24.4 million, compared with $8.4 million in recognized realized gains in the third quarter of fiscal 1999. The gain on sale of investments for the nine month period ended June 30, 2000 was $66.6 million, compared with $41.8 million in recognized realized gains for the equivalent period in fiscal 1999. We recorded an unrealized loss of $3.5 million during the third quarter of fiscal 2000 on our participation in the E*TRADE eCommerce Fund L.P., representing market declines on public investments held by the fund. We recorded an unrealized gain of $7.4 million in the nine months ended June 30, 2000. This fund was formed in the first quarter of fiscal 2000. Equity in losses of investments included in other non-operating income (expense) was $1.4 million in the third quarter of fiscal 2000, which resulted from our minority ownership in investments which are accounted for under the equity method, compared to $0.9 million in the comparable period in fiscal 1999. Equity in losses of investments was $6.0 million for the nine month period ended June 30, 2000, compared to $1.9 million in the equivalent period in fiscal 1999. These investments include E*TRADE Japan and Archipelago. We expect that these companies will continue to invest in the development of their products and services and will incur operating losses throughout fiscal 2000, which will result in future charges to reflect our proportionate share of those losses. Included in equity in losses of investments is our proportionate share of the operating losses in E*OFFERING. The pending acquisition of E*OFFERING by Wit Capital Group, Inc., renamed Wit Soundview Group, Inc., announced May 15, 2000, is not expected to have a material effect on equity in losses of investments. Income Tax Expense (Benefit) Income tax expense (benefit) represents the expense for federal and state income taxes at an effective tax rate of 61% for the third quarter of fiscal 2000 and the benefit for federal and state income taxes at an effective tax rate of 37% for the comparable period in fiscal 1999. Income tax benefit represents the benefit for federal and state income taxes at an effective tax rate of 7% for the nine months ended June 30, 2000 and 42% for the comparable period in fiscal 1999. The rate for the three and nine months ended June 30, 2000 reflects the impact of non-deductible merger-related expenses and amortization of goodwill arising from acquisitions. Minority Interest in Subsidiaries Minority interest in the net loss of subsidiaries was $0.6 million in the third quarter of fiscal 2000 compared to $0.5 million in minority interest in the net income of subsidiaries in the third quarter of fiscal 1999. Minority interest in the net income of subsidiaries was $0.3 million and $1.7 million in the nine months ended June 30, 2000 and 1999, respectively. Minority interest in the net loss of subsidiaries results primarily from ETFC's interest payments to subsidiary trusts which have issued Company-obligated mandatorily redeemable capital securities and which hold junior subordinated debentures of ETFC. Also included in minority interest in subsidiaries for the three months ended June 30, 2000 is the net income (loss) attributed to minority interests in E*TRADE Nordic and E*TRADE Germany. Cumulative Effect of Change in Accounting Principle The cumulative effect of change in accounting principle was $0.5 million in the nine months ended June 30, 1999, resulting from the implementation by ETFC of Statement of Position 98-5, Reporting on the Cost of Start-Up Activities, which requires that the cost of start-up activities be expensed as incurred rather than capitalized, with initial application reported as the cumulative effect of a change in accounting principle. Extraordinary Loss on Early Extinguishment of Debt In June 1999, ETFC redeemed all of its outstanding debt. ETFC wrote off both the related premium and the remaining discount as an extraordinary loss on the early extinguishment of debt, totaling approximately $2.0 million, net of tax. 25 Liquidity and Capital Resources We have financing facilities totaling $425.0 million to meet the needs of E*TRADE Securities. These facilities, if used, would be collateralized by customer securities. There were no borrowings outstanding under these lines on June 30, 2000. We also have a short term line of credit for up to $50 million, collateralized by marketable securities owned by us, of which $30.8 million was outstanding as of June 30, 2000. In addition, we have entered into numerous agreements with other broker-dealers to provide financing under our stock loan program. On February 7, 2000, we completed a Rule 144A offering of $500 million convertible subordinated notes due February 2007. The notes are convertible, at the option of the holder, into a total of 21,186,441 shares of our common stock at a conversion price of $23.60 per share. The notes bear interest at 6%, payable semiannually, and are non-callable for three years and may then be called by us at a premium, which declines over time. The holders have the right to require redemption at a premium in the event of a change in control or other defined redemption event. On March 17, 2000, the initial purchasers exercised an option to purchase an additional $150 million of notes, which are convertible into 6,355,932 shares of common stock. We used $145.0 million of the $631.3 million in net proceeds to pay the outstanding balance on a $150 million line of credit, which was subsequently dissolved, in February 2000. We expect to use the remaining net proceeds for general corporate purposes, including the future growth of the business. Debt issuance costs of $19.1 million are included in other assets and are being amortized to corporate interest expense over the term of the notes. Had these securities been issued at the beginning of the fiscal year, and the proceeds used to repay the outstanding balance on the $150 million line of credit agreement, income per share would have decreased to loss per share of $0.01 for the three months ended June 30, 2000 and loss per share would have increased to $0.17 for the nine months ended June 30, 2000, respectively, compared to income per share of $0.02 and loss per share of $0.08 recorded in the three and nine months ended June 30, 2000, respectively, due to the additional net interest expense and issuance costs associated with the securities. We currently anticipate that our available cash resources, credit facilities, and liquid portfolio of equity securities, along with the convertible subordinated debt offering described above, will be sufficient to meet our presently anticipated working capital and capital expenditure requirements for at least the next 12 months. However, we may need to raise additional funds in order to support more rapid expansion, develop new or enhanced services and products, respond to competitive pressures, acquire complementary businesses or technologies or take advantage of unanticipated opportunities. Our future liquidity and capital requirements will depend upon numerous factors, including costs and timing of expansion of technology development efforts and the success of such efforts, the success of our existing and new service offerings and competing technological and market developments. Our forecast of the period of time through which our financial resources will be adequate to support our operations is a forward-looking statement that involves risks and uncertainties, and actual results could vary. The factors described earlier in this paragraph will impact our future capital requirements and the adequacy of our available funds. If additional funds are raised through the issuance of equity securities, the percentage ownership of the shareowners in our company will be reduced, shareowners may experience additional dilution in net book value per share or such equity securities may have rights, preferences or privileges senior to those of the holders of our common stock. There can be no assurance that additional financing will be available when needed on terms favorable to our company, if at all. If adequate funds are not available on acceptable terms, we may be unable to develop or enhance our services and products, take advantage of future opportunities or respond to competitive pressures, any of which could have a material adverse effect on our business, financial condition and operating results. Cash used in operating activities, net of effects from acquisitions, was $374.8 million for the nine months ended June 30, 2000 compared to $34.7 million in the equivalent period in fiscal 1999. Cash used in operating activities, net of effects from acquisitions, primarily reflects the increase in brokerage-related assets in excess of liabilities of $570.2 million and an increase in other assets and intangibles of $170.8 million offset by a decrease in segregated cash balances of $67.3 million and an increase in accounts payable, accrued and other liabilities of 26 $255.0 million. Cash used in operating activities in the prior year period primarily reflects an increase in brokerage-related assets in excess of liabilities of $112.8 million offset by proceeds from the sales and maturities of loans, net of purchases, of $46.7 million, proceeds from the sales and maturities of trading assets, net of purchases, of $23.5 million, and an increase in interest credited to customer deposits of $45.0 million. Cash used in investing activities was $3,665.9 million for the nine months ended June 30, 2000 and $1,130.2 million in the equivalent period in fiscal 1999. For the nine months ended June 30, 2000, cash used in investing activities was the result of the excess of purchases of investments over the net sale/maturity of investments of $2,050.0 million, purchases of $134.3 million of property and equipment, a decrease in loans held for investment of $1,394.1 million, an increase in restricted deposits of $71.4 million, and $31.8 million paid for the acquisition of three foreign affiliates and CCS. This compares to cash used in investing activities in the equivalent period of fiscal 1999 where the Company had an excess of purchases of investments over the net sale/maturity of investments of $329.3 million, purchases of $82.9 million of property and equipment, and an increase in loans held for investment of $733.7 million. Cash provided by financing activities was $4,094.8 million for the nine months ended June 30, 2000, compared with $1,265.6 million in the equivalent period in fiscal 1999. Cash provided by financing activities for the nine months ended June 30, 2000 primarily resulted from $3,415.8 million in increased banking deposits, net advances from the Federal Home Loan Bank of Atlanta, and increases in securities sold under agreements to repurchase and the issuance of $631.3 million in convertible subordinated debt, net of issuance costs. Cash provided by financing activities in the comparable period of fiscal 1999 primarily resulted from $883.5 million in increased banking deposits, net advances from the Federal Home Loan Bank of Atlanta and increases in securities sold under agreements to repurchase and proceeds from issuance of common stock and associate stock transactions of $417.6 million. Recent Accounting Pronouncements In December 1999, the Securities and Exchange Commission ("SEC") staff issued Staff Accounting Bulletin No. 101 Revenue Recognition in Financial Statements ("SAB 101"). SAB 101 states that all registrants are expected to apply the accounting and disclosures described in it. The SEC staff, however, will not object if registrants that have not applied SAB 101 do not restate prior financial statements provided they report a change in accounting principle in accordance with Accounting Principles Board Opinion No. 20 Accounting Changes, by cumulative catch-up adjustment no later than the second quarter of the fiscal year beginning after December 15, 1999. We are currently evaluating the impact, if any, of SAB 101 on our revenue recognition policy and our consolidated financial statements. 27 RISK FACTORS You should carefully consider the risks described below before making an investment decision in our company. The risks and uncertainties described below are not the only ones facing us and there may be additional risks that we do not presently know of or that we currently deem immaterial. All of these risks may impair our business operations. This document also contains forward- looking statements that involve risks and uncertainties, and actual results may differ materially as a result of certain factors, including those set forth below and elsewhere in this filing. If any of the following risks actually occur, our business, financial condition or results of operations could be materially adversely affected. In such case, the trading price of our common stock could decline, and you may lose all or part of your investment. In accordance with "plain English" guidelines provided by the Securities and Exchange Commission, the risk factors have been written in the first person. We could suffer substantial losses and be subject to customer litigation if our systems fail or our transaction processing is slow We receive and process transactions mostly through the Internet, online service providers and touch-tone telephone. Thus, we depend heavily on the integrity of the electronic systems supporting these types of transactions, including our internal software programs and computer systems. Our systems or any other systems in the transaction process could slow down significantly or fail for a variety of reasons including: . undetected errors in our internal software programs or computer systems; . our inability to effectively resolve any errors in our internal software programs or computer systems once they are detected; or . heavy stress placed on our system during certain peak trading times. If our systems or any other systems in the transaction process slow down significantly or fail even for a short time, our customers could suffer delays in transaction processing, which could cause substantial losses and possibly subject us to claims for such losses or to litigation claiming fraud or negligence. We have experienced such systems failures and degradation in the past, including failures on February 3, 4, and 5, 1999, March 19, 1999, July 19, 1999, August 10, 1999, September 27, 1999, January 25, 2000, March 2, 2000 and May 3, 2000. We could experience future system failures and degradations, including instances in foreign markets where we must implement new transaction processing infrastructures. To promote customer satisfaction and protect our brand name, we have, on certain occasions, compensated customers for verifiable losses from such failures. To date, during our systems failures, we were able to take orders by telephone; however, with respect to our brokerage transactions, only associates with securities brokers' licenses can accept telephone orders. An adequate number of such associates may not be available to take customer calls in the event of a future systems failure. We may not be able to increase our customer service personnel and capabilities in a timely and cost-effective manner. We could experience a number of adverse consequences as a result of these systems failures, including the loss of existing customers and the inability to attract or retain new customers. There can be no assurance that our network structure will operate appropriately in any of the following events: . a subsystem, component or software failure; . a power or telecommunications failure; . human error; . an earthquake, fire or other natural disaster; or . an act of God or war. 28 There can be no assurance that, in any such event, we will be able to prevent an extended systems failure. Any such systems failure that interrupts our operations could have a material adverse effect on our business, financial condition and operating results and we have adverse publicity in the past in the financial press and elsewhere relating to systems failures. Our security could be breached, which could damage our reputation and deter customers from using our services We must protect our computer systems and network from physical break-ins, security breaches and other disruptions caused by unauthorized access. The open nature of the Internet makes protecting against these threats more difficult. Computer break-ins could jeopardize the security of information stored in and transmitted through our computer systems and network, which could adversely affect our ability to retain or attract customers, damage our reputation and subject us to litigation. We have in the past, and could in the future, be subject to denial of service, vandalism and other attacks on our systems by Internet hackers. In addition, we must guard against damage by insiders with access to the system. Although we intend to continue to implement security technology and establish operational procedures to prevent break-ins, damage and failures, these security measures may or may be unable to prevent future attacks from disrupting operations. Our insurance coverage in certain circumstances may be insufficient to cover losses that may result from such events. Our business could suffer if we cannot protect the confidentiality of customer information transmitted over public networks A significant barrier to online commerce is the need for secure transmission of confidential information over public networks. We rely on encryption and authentication technology, including cryptography technology licensed from RSA Data Security, Inc., to provide secure transmission of confidential information. There can be no assurance that advances in computer and cryptography capabilities or other developments will not result in a compromise of the RSA or other algorithms we use to protect customer transaction data. If any such compromise of our security were to occur, it could have a material adverse effect on our business, financial condition and operating results. Our quarterly results fluctuate and do not reliably indicate future operating results We do not believe that our historical operating results should be relied upon as an indication of our future operating results. We expect to experience large fluctuations in future quarterly operating results that may be caused by many factors, including the following: . fluctuations in the fair market value of our equity investments in other companies, including through existing or future private investment funds managed by us; . fluctuations in interest rates, which will impact our investment and loan portfolios; . increased levels of advertising, sales and marketing expenditures for customer acquisition, which may be affected by competitive conditions in the marketplace; . the timing of introductions or enhancements to online financial services and products by us or our competitors; . market acceptance of online financial services and products; . the pace of development of the market for online commerce; . changes in trading volume in securities markets; . trends in securities and banking markets; . domestic and international regulation of the brokerage, banking and internet industries; 29 . implementation of new accounting pronouncements, such as Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities; . changes in domestic or international tax rates; . changes in pricing policies by us or our competitors; . changes in strategy; . the success of, or costs associated with, acquisitions, joint ventures or other strategic relationships; . changes in key personnel; . seasonal trends; . the extent of international expansion; . the mix of international and domestic revenues; . fluctuation in foreign exchange rates; . changes in the level of operating expenses to support projected growth; and . general economic conditions. We have also experienced fluctuations in the average number of customer transactions per day. Thus, the rate of growth in customer transactions at any given time is not necessarily indicative of future transaction activity. Our business will suffer if we cannot effectively compete The market for financial services over the Internet is new, rapidly evolving and intensely competitive. We expect competition to continue and intensify in the future. We face direct competition from financial institutions, brokerage firms, banks, mutual fund companies, Internet portals and other organizations. These competitors include, among others: . American Express; . America Online, Inc.; . Ameritrade, Inc.; . Bank of America; . Charles Schwab & Co., Inc.; . Citigroup, Inc.; . Datek Online Holdings Corporation; . DLJdirect; . Fidelity Brokerage Services, Inc.; . Fleet Boston Financial; . Intuit Inc.; . Merrill Lynch, Pierce, Fenner & Smith Incorporated; . Microsoft Money; . National Discount Brokers; . Net.B@nk, Inc.; 30 . PaineWebber Incorporated; . Salomon Smith Barney, Inc.; . TD Waterhouse Securities, Inc.; . Wells Fargo & Company; . WingspanBank.com; and . X.com; and . Yahoo! Inc. Many of our competitors have longer operating histories and significantly greater financial, technical, marketing and other resources than we do. In addition, many of our competitors offer a wider range of services and financial products than we do, and thus may be able to respond more quickly to new or changing opportunities, technologies and customer requirements. Many of our competitors also have greater name recognition and larger customer bases that could be leveraged, thereby gaining market share from us. Such competitors may conduct more extensive promotional activities and offer better terms and lower prices to customers than we do, possibly even sparking a price war in the online financial services industry. Moreover, certain competitors have established cooperative relationships among themselves or with third parties to enhance their services and products. For example, Charles Schwab's One-Source mutual fund service and similar services may discourage potential customers from using our brokerage services. Accordingly, it is possible that new competitors or alliances among existing competitors may significantly reduce our market share. General financial success within the financial services industry over the past several years has strengthened existing competitors. We believe that such success will continue to attract new competitors, such as software development companies, insurance companies and others, as such companies expand their product lines. Commercial banks and other financial institutions have become more competitive with our brokerage operations by offering their customers certain corporate and individual financial services traditionally provided by securities firms. The current trend toward consolidation in the commercial banking industry could further increase competition in all aspects of our business. Commercial banks generally are expanding their securities and financial services activities. While we cannot predict the type and extent of competitive services that commercial banks and other financial institutions ultimately may offer, we may be adversely affected by such competition. To the extent our competitors are able to attract and retain customers, our business or ability to grow could be adversely affected. In many instances, we are competing with such organizations for the same customers. In addition, competition among financial services firms exists for experienced technical and other personnel. There can be no assurance that we will be able to compete effectively with current or future competitors or that such competition will not have a material adverse effect on our business, financial condition and operating results. Our success depends on our ability to effectively adapt to changing business conditions We have grown rapidly and our business and operations have changed substantially since we began offering electronic investing services in 1992, and Internet investing services in February 1996, and we expect this trend to continue. Such rapid change and expansion places significant demands on our administrative, operational, financial, and technical management and other resources. We expect operating expenses and staffing levels to increase substantially in the future. In particular, we have hired and intend to hire a significant number of additional skilled personnel, including persons with experience in the computer, brokerage and banking industries, and, specifically, persons with Series 7 or other broker-dealer licenses. Competition for such personnel is intense, and there can be no assurance that we will be 31 able to find or keep additional suitable senior managers or technical persons or licensed representatives in the future. In particular, we depend heavily on our chief executive officer and other members of senior management, the loss of any of whom could seriously harm our business. We also expect to expend resources for future expansion of our accounting and internal information management systems and for a number of other new systems and procedures. In addition, we expect that future expansion will continue to challenge our ability to successfully hire and retain associates. If our revenues do not keep up with expenses, our information management systems do not expand to meet increasing demands, we fail to attract, assimilate and retain qualified personnel, or we fail to manage our expansion effectively, there could be a material adverse effect on our business, financial condition and operating results. The rapid growth in the use of our services has strained our ability to adequately expand technologically. As we acquire new equipment and applications quickly, we have less time to test and validate hardware and software, which could lead to performance problems. We also rely on a number of third parties to process our transactions, including online and Internet service providers, back office processing organizations, service providers and market-makers, all of which will need to expand the scope of the operations they perform for us. Any backlog caused by a third party's inability to expand sufficiently to meet our needs could have a material adverse effect on our business, financial condition and operating results. As transaction volume increases, we may have difficulty hiring and training qualified personnel at the necessary pace, and the shortage of licensed personnel could cause a backlog in the processing of brokerage orders that need review, which could not only lead to unsatisfied customers, but also to liability for brokerage orders that were not executed on a timely basis. Through our Digital Financial Media initiative, we plan to deliver interactive multimedia content and commerce through a variety of broadband communications channels and electronic platforms. We believe that achieving success in this strategy is essential to our ability to compete in the rapidly evolving electronic marketplaces in which we operate. We have limited experience in these media and our failure to execute this strategy successfully may limit our future growth. Due to our status as a savings and loan holding company, our ability to engage in some media activities may be restricted. See "Risk Factors--Due to our recent merger with Telebanc (now E*TRADE Financial Corporation), we may be restricted in expanding our activities, and our inexperience with being regulated as a savings and loan holding company could negatively affect both us and E*TRADE Financial Corporation." If we lose the services of key members of our management, in particular, our Chief Executive Officer and our Chief Financial Officer and President, we may not be able to effectively execute our business plan and our trading price may suffer Our future success depends to a significant degree on the skills, experience and efforts of our Chief Executive Officer, Chief Financial Officer, President and other key personnel. The loss of the services of any of these individuals could compromise our ability to effectively operate our business. Our ability to attract customers and our profitability may suffer if changes in government regulation favor our competition or restrict our business practices The securities and banking industries in the United States are each subject to extensive regulation under both federal and state laws. Broker-dealers are subject to regulations covering all aspects of the securities business, including: . sales methods; . trade practices among broker-dealers; . execution of customers' orders; . use and safekeeping of customers' funds and securities; . capital structure; 32 . record keeping; . advertising; . conduct of directors, officers and employees; and . supervision. Because we are a self-clearing broker-dealer, we have to comply with many complex laws and rules. These include rules relating to possession and control of customer funds and securities, margin lending, and execution and settlement of transactions. Our ability to so comply with these rules depends largely on the establishment and maintenance of a qualified compliance system. Similarly, E*TRADE and ETFC, as savings and loan holding companies, and E*TRADE Bank, as a federally chartered savings bank and subsidiary of ETFC, are subject to extensive regulation, supervision and examination by the Office of Thrift Supervision ("OTS") and, in the case of E*TRADE Bank, the Federal Deposit Insurance Corporation. Such regulation covers all aspects of the banking business, including lending practices, safeguarding deposits, capital structure, record keeping, and conduct and qualifications of personnel. In November 1999, the Gramm-Leach-Bliley Act was enacted into law. This act reduces the legal barriers between banking, securities and insurance companies, and will make it easier for bank holding companies to compete directly with our securities business, as well as for our competitors in the securities business to diversify their revenues and attract additional customers through entry into the banking and insurance businesses. The Gramm- Leach-Bliley Act may have a material impact on the competitive landscape that we face. Additionally our mode of operation and profitability may be directly affected by: . additional legislation; . changes in rules promulgated by the SEC, the National Association of Securities Dealers Regulation, Inc., ("NASDR"), the Board of Governors of the Federal Reserve System, the OTS, the various stock exchanges and other self-regulatory organizations; or . changes in the interpretation or enforcement of existing laws and rules. The SEC, the NASDR or other self-regulatory organizations and state securities commissions can censure, fine, issue cease-and-desist orders or suspend or expel a broker-dealer or any of its officers or employees. The OTS may take similar action with respect to our banking activities. Our ability to comply with all applicable laws and rules is largely dependent on our establishment and maintenance of a system to ensure such compliance, as well as our ability to attract and retain qualified compliance personnel. Our growth has placed considerable strain on our ability to ensure such compliance. We could be subject to disciplinary or other actions due to claimed noncompliance in the future, which could have a material adverse effect on our business, financial condition and operating results. We have initiated an aggressive marketing campaign designed to bring brand name recognition to E*TRADE and E*TRADE Bank. All marketing activities by E*TRADE Securities are regulated by the NASDR, and all marketing materials must be reviewed by an E*TRADE Securities Series 24 licensed principal prior to release. The NASDR has in the past asked us to revise certain marketing materials. We are currently the subject of formal NASDR and SEC investigations into our advertising practices. At the same time, we have voluntarily agreed to prefile all advertising ten (10) days prior to first use for the NASDR's review and comment. This prefiling requirement began June 12, 2000 and will expire on September 12, 2000. The NASDR can impose certain penalties for violations of its advertising regulations, including: . censures or fines; 33 . suspension of all advertising; . the issuance of cease-and-desist orders; or . the suspension or expulsion of a broker-dealer or any of its officers or employees. We do not currently solicit orders from our customers or make investment recommendations. However, if we were to engage in such activities, we would become subject to additional rules and regulations governing, among other things, sales practices and the suitability of recommendations to customers. We have entered into a letter of intent with Ernst & Young LLP to jointly establish a new company that will provide financial advice for on-line investors. We intend to continue expanding our business to other countries and to broaden our customers' abilities to trade securities of non-U.S. companies and execute other transactions through the Internet and other gateways. In order to expand our services globally, we must comply with the regulatory controls of each specific country in which we conduct business. Our international expansion could be limited by the compliance requirements of other national regulatory jurisdictions. We intend to rely primarily on local third parties and our subsidiaries for regulatory compliance in international jurisdictions. See "Risk Factors--We face numerous risks associated with doing business in international markets." There can be no assurance that other federal, state or foreign agencies will not attempt to regulate our online and other activities. We anticipate that we may be required to comply with record keeping, data processing and other regulatory requirements as a result of proposed federal legislation or otherwise. We may also be subject to additional regulation as the market for online commerce evolves. Because of the growth in the electronic commerce market, Congress has held hearings on whether to regulate providers of services and transactions in the electronic commerce market. As a result, federal or state authorities could enact laws, rules or regulations affecting our business or operations. We may also be subject to federal, state or foreign money transmitter laws and state and foreign sales or use tax laws. If such laws are enacted or deemed applicable to us, our business or operations would be rendered more costly or burdensome, less efficient or even impossible. Any of the foregoing could have a material adverse effect on our business, financial condition and operating results. Due to the increasing popularity of the Internet, laws and regulations may be passed dealing with issues such as user privacy, pricing, content and quality of products and services. As required by the Gramm-Leach-Bliley Act, the SEC and OTS have recently adopted regulations on financial privacy, to take effect in July 2000, that will require E*TRADE Securities and E*TRADE Bank to notify consumers about the circumstances in which they may share consumers' personal information with unaffiliated third parties and to give consumers the right to prohibit such information sharing in specified circumstances. Although E*TRADE Securities and E*TRADE Bank already provide such opt-out rights in our privacy policies, the regulations will require us to modify the text and the form of presentation of our privacy policies and to incur additional expense to ensure ongoing compliance with the regulations. In addition, several recent reports have focused attention on the online brokerage industry. For example, the New York Attorney General carried out an investigation of the online brokerage industry and issued a report in November 1999, citing consumer complaints about delays and technical difficulties conducting online stock trading. SEC Commissioner Laura Unger also issued a report in November 1999 on issues raised by online brokerage, including suitability and marketing issues. Most recently, the United States General Accounting Office issued a report to certain Congressional Requestors citing a need for better investor protection information on brokers' Web sites. Increased attention focused upon these issues could adversely affect the growth of the online financial services industry, which could, in turn, decrease the demand for our services or could otherwise have a material adverse effect on our business, financial condition and operating results. 34 We may be fined or forced out of business if we do not maintain the net capital levels required by regulators The SEC, NASDR, OTS and various other regulatory agencies have stringent rules with respect to the maintenance of specific levels of net capital by securities broker-dealers and regulatory capital by banks. Net capital is the net worth of a broker or dealer (assets minus liabilities), less deductions for certain types of assets. If a firm fails to maintain the required net capital it may be subject to suspension or revocation of registration by the SEC and suspension or expulsion by the NASDR, and could ultimately lead to the firm's liquidation. In the past, our broker-dealer subsidiaries have depended largely on capital contributions by us in order to comply with net capital requirements. If such net capital rules are changed or expanded, or if there is an unusually large charge against net capital, operations that require the intensive use of capital would be limited. Such operations may include investing activities, marketing and the financing of customer account balances. Also, our ability to withdraw capital from brokerage subsidiaries could be restricted, which in turn could limit our ability to pay dividends, repay debt and redeem or purchase shares of our outstanding stock. A large operating loss or charge against net capital could adversely affect our ability to expand or even maintain our present levels of business, which could have a material adverse effect on our business, financial condition and operating results. The table below summarizes the minimum net capital requirements for our domestic broker-dealer subsidiaries as of June 30, 2000 (in thousands):
Required Excess Net Net Net Capital Capital Capital -------- -------- -------- E*TRADE Securities, Inc.......................... $99,155 $451,153 $351,998 TIR Securities, Inc.............................. $ 250 $ 1,714 $ 1,464 TIR Investor Select, Inc......................... $ 5 $ 423 $ 418 Marquette Securities, Inc........................ $ 250 $ 502 $ 252 E*TRADE Capital Markets, Inc..................... $ 252 $ 20,086 $ 19,834
Similarly, banks, such as E*TRADE Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on a bank's operations and financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, a bank must meet specific capital guidelines that involve quantitative measures of a bank's assets, liabilities, and certain off- balance-sheet items as calculated under regulatory accounting practices. A bank's capital amounts and classification are also subject to qualitative judgments by the regulators about the strength of components of the bank's capital, risk weightings of assets and off balance sheet transactions, and other factors. Quantitative measures established by regulation to ensure capital adequacy require a bank to maintain minimum amounts and ratios of total and Tier 1 capital to risk-weighted assets and of Tier 1 capital to average assets. To be categorized as well capitalized, a bank must maintain minimum total risk- based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the following table. The table below summarizes the capital adequacy requirements for E*TRADE Bank as of June 30, 2000 (dollars in thousands):
Required To Be Well Capitalized Under Prompt Corrective Action Actual Provisions -------------- -------------- Amount Ratio Amount Ratio -------- ----- -------- ----- Core Capital (to adjusted tangible assets................................... $475,258 6.42% $370,030 > 5.0% Tier 1 Capital (to risk weighted assets).. $475,258 16.17% $178,747 > 6.0% Total Capital (to risk weighted assets)... $484,598 16.48% $297,911 >10.0%
35 As a significant portion of our revenues come from online investing services, any downturn in the securities industry could significantly harm our business A significant portion of our revenues in recent years has been from online investing services, and we expect this business to continue to account for a significant portion of our revenues in the foreseeable future. We, like other financial services firms, are directly affected by economic and political conditions, broad trends in business and finance and changes in volume and price levels of securities and futures transactions. The U.S. securities markets are characterized by considerable fluctuation and a downturn in these markets could adversely affect our operating results. Significant downturns in the U.S. Securities markets occurred in October 1987 and October 1989. A significant downturn in the U.S. securities markets most recently began in March of 2000, as a result of which the volume of trading has decreased industry-wide and many broker-dealers, including E*TRADE, have suffered financial losses. When trading volume is low, our operating results may be adversely affected because overhead remains relatively fixed. Severe market fluctuations in the future could have a material adverse effect on our business, financial condition and operating results. Some of our competitors with more diverse product and service offerings might withstand such a downturn in the securities industry better than we would. See "Risk Factors-- Our business will suffer if we cannot effectively compete." Our brokerage business, by its nature, is subject to various other risks, including customer default and employee misconduct and errors. We sometimes allow customers to purchase securities on margin, therefore we are affected because we are subject to risks inherent in extending credit. This risk is especially great when the market is rapidly declining and the value of the collateral we hold could fall below the amount of a customer's indebtedness. Under specific regulatory guidelines, any time we borrow or lend securities, we must correspondingly disburse or receive cash deposits. If we fail to maintain adequate cash deposit levels at all times, we run the risk of loss if there are sharp changes in market values of many securities and parties to the borrowing and lending transactions fail to honor their commitments. Any such losses could have a material adverse effect on our business, financial condition and operating results. Changes in interest rates may reduce E*TRADE Financial Corporation's profitability The results of operations for ETFC depend in large part upon the level of its net interest income, that is, the difference between interest income from interest-earning assets, such as loans and mortgage-backed securities, and interest expense on interest-bearing liabilities, such as deposits and borrowings. Many factors cause changes in interest rates, including governmental monetary policies and domestic and international economic and political conditions. If ETFC is unsuccessful in managing the effects of changes in interest rates, its financial condition and results of operations could suffer. Changes in market interest rates could reduce the value of ETFC's financial assets. Fixed-rate investments, mortgage-backed and related securities and mortgage loans generally decline in value as interest rates rise. We could lose customers and have difficulty attracting new customers if we are unable to quickly introduce new products and services that satisfy changing customer needs Our future success depends, in part, on our ability to develop and enhance our services and products. There are significant technical risks in the development of new services and products or enhanced versions of existing services and products. There can be no assurance that we will be successful in achieving any of the following: . effectively using new technologies; . adapting our services and products to meet emerging industry standards; . developing, introducing and marketing service and product enhancements; or . developing, introducing and marketing new services and products. We may also experience difficulties that could delay or prevent the development, introduction or marketing of these services and products. Our status as a regulated savings and loan holding company resulting from the 36 acquisition of Telebanc Financial Corporation (now ETFC) could also lead to delays in or prevent the development, introduction and marketing of new services and products. Additionally, these new services and products may not adequately meet the requirements of the marketplace or achieve market acceptance. If we are unable to develop and introduce enhanced or new services and products quickly enough to respond to market or customer requirements, or if they do not achieve market acceptance, our business, financial condition and operating results will be materially adversely affected. Our success depends upon the growth of the Internet as a commercial marketplace The market for financial services, particularly over the Internet, is rapidly evolving. Consequently, demand and market acceptance for newly introduced services and products are subject to a high level of uncertainty. For us, this uncertainty is compounded by the risks that consumers will not continue to adopt online commerce and that commerce on the Internet will not adequately develop or flourish to permit us to continue to grow. Sales of many of our services and products will depend on consumers continuing to adopt the Internet as a method of doing business. There can be no assurance that the Internet infrastructure will continue to be able to support the demands placed on it by this continued growth. In addition, the Internet could be adversely affected by slow development or adoption of standards and protocols to handle increased Internet activity, or due to increased governmental regulation. Moreover, critical issues including security, reliability, cost, ease of use, accessibility and quality of service remain unresolved and may negatively affect the growth of Internet use or commerce on the Internet. Adoption of online commerce by individuals who have relied upon traditional means of commerce in the past will require such individuals to accept new and very different methods of conducting business. Moreover, our brokerage and banking services over the Internet involve a new approach to securities trading and banking which require extensive marketing and sales efforts to educate prospective customers regarding their uses and benefits. For example, consumers who trade with traditional brokerage firms, or even discount brokers, may be reluctant or slow to change to obtaining brokerage services over the Internet. Also, concerns about security and privacy on the Internet may hinder the growth of online investing and banking, which could have a material adverse effect on our business, financial condition and operating results. The market price of our common stock, like other technology stocks, may be highly volatile and any significant decrease in our stock price may make it difficult for our shareowners to sell their stock The market price of our common stock has been, and is likely to continue to be, highly volatile and subject to wide fluctuations due to various factors, many of which may be beyond our control, including: . quarterly variations in operating results; . volatility in the stock market; . volatility in the general economy; . changes in interest rates; . announcements of acquisitions, technological innovations or new software, services or products by us or our competitors; and . changes in financial estimates and recommendations by securities analysts. In addition, there have been large price and volume fluctuations in the stock market which have affected the market prices of securities of many technology, Internet and financial services companies, often unrelated to the operating performance of such companies. These broad market fluctuations may adversely affect the market price of our common stock. In the past, volatility in the market price of a company's securities has often led to securities class action litigation. Such litigation could result in substantial costs and a diversion of our attention and resources, which could have a material adverse effect on our business, financial condition and operating results. 37 Our success depends on our ability to protect our intellectual property and any failure to do so could substantially harm our business Our success and ability to compete are dependent to a significant degree on our proprietary technology. We rely primarily on copyright, trade secret and trademark law to protect our technology and our brand. Effective trademark protection may not be available for our trademarks. Although we have registered the trademark "E*TRADE" in the United States and certain other countries, and have certain other registered trademarks, there can be no assurance that we will be able to secure significant protection for these trademarks. Our competitors or others may adopt product or service names similar to "E*TRADE," thereby impeding our ability to build brand identity and possibly leading to customer confusion. Our inability to adequately protect the name "E*TRADE" could have a material adverse effect on our business, financial condition and operating results. Despite any precautions we take, a third party may be able to copy or otherwise obtain and use our software or other proprietary information without authorization or to develop similar software independently. Policing unauthorized use of our technology is made especially difficult by the global nature of the Internet and difficulty in controlling the ultimate destination or security of software or other data transmitted on it. The laws of other countries may afford us little or no effective protection for our intellectual property. There can be no assurance that the steps we take will prevent misappropriation of our technology or that agreements entered into for that purpose will be enforceable. In addition, litigation may be necessary in the future to: . enforce our intellectual property rights; . protect our trade secrets; . determine the validity and scope of the proprietary rights of others; or . defend against claims of infringement or invalidity. Such litigation, whether successful or unsuccessful, could result in substantial costs and diversion of resources, either of which could have a material adverse effect on our business, financial condition and operating results. We may face claims for infringement of third parties' proprietary rights and it could be costly and time-consuming to defend against such claims, even those without merit We have received in the past, and may receive in the future, notices of claims of infringement of other parties' proprietary rights. There can be no assurance that claims for infringement or invalidity--or any indemnification claims based on such claims--will not be asserted or prosecuted against us. Any such claims, with or without merit, could be time consuming and costly to defend or litigate, divert our attention and resources or require us to enter into royalty or licensing agreements. There can be no assurance that such licenses would be available on reasonable terms, if at all, and the assertion or prosecution of any such claims could have a material adverse effect on our business, financial condition and operating results. Our attempts to enter new markets may be unsuccessful, which could decrease our earnings and consequently decrease the market value of our common stock One element of our strategy is to leverage the E*TRADE brand and technology to enter new markets. No assurance can be given that we will be able to successfully adapt our proprietary processing technology for use in other markets. Even if we do adapt our technology, no assurance can be given that we will be able to compete successfully in any such new markets. There can be no assurance that our pursuit of any of these opportunities will be successful. If these efforts are not successful, we could realize less than expected earnings, which in turn could result in a decrease in the market value of our common stock. Furthermore, such efforts may divert management attention or inefficiently utilize our resources. 38 As a result of our recent merger with Telebanc (now E*TRADE Financial Corporation), we face numerous new risks, including possible failure to successfully integrate and assimilate E*TRADE Financial Corporation's operations with our own On January 12, 2000, we acquired Telebanc Financial Corporation (now ETFC). ETFC is an online provider of Internet banking services. This represents a new line of business for us. No assurance can be given that we will be successful in this market. We may experience difficulty in assimilating ETFC products and services with our own and we may not be able to integrate successfully the employees of ETFC into our organization. These difficulties may be exacerbated by the geographical distance between our various locations and ETFC's Virginia location. If we fail to successfully integrate ETFC's operations with our own, our operating results and business could be adversely affected. E*TRADE Bank holds a loan portfolio consisting primarily of one- to four- family residential loans. A critical component of the banking industry is the ability to accurately assess credit risk and establish corresponding loan loss reserves. This is a new industry for us and accordingly, we are dependent upon ETFC's management and employees to advise us in this area. Our status as a regulated savings and loan holding company resulting from the acquisition of ETFC could also lead to delays or prevent the development, introduction and marketing of new services and products. Due to our recent merger with Telebanc (now E*TRADE Financial Corporation), we may be restricted in expanding our activities, and our inexperience with being regulated as a savings and loan holding company could negatively affect both us and E*TRADE Financial Corporation. Upon the completion of our acquisition of Telebanc (now ETFC) and its subsidiary, Telebank (subsequently renamed E*TRADE Bank), on January 12, 2000, we became subject to regulation as a savings and loan holding company. As a result, we are required to register with the OTS and file periodic reports, and are subject to examination by the OTS. Under financial modernization legislation recently enacted into law, our activities are restricted to activities that are financial in nature and certain real estate-related activities. We may also make merchant banking investments in companies whose activities are not financial in nature, if those investments are engaged in for the purpose of appreciation and ultimate resale of the investment, and we do not manage or operate the company. Such merchant banking investments may be subject to maximum holding periods and special capital requirements. We believe that all of our existing activities and investments are permissible under the new legislation, but the OTS has not yet issued regulations or otherwise interpreted the new statute. Even if all of our existing activities and investments are permissible, under the new legislation we will be constrained in pursuing future new activities that are not financial in nature. We are also limited in our ability to invest in other savings and loan holding companies, and all transactions between us and E*TRADE Bank must be conducted on an arms' length basis. In addition to regulation of us and ETFC as savings and loan holding companies, federal savings banks such as E*TRADE Bank are subject to extensive regulation of their activities and investments, their capitalization, their risk management policies and procedures, and their relationship with affiliated companies. In addition, as a condition to approving our acquisition of ETFC, the OTS imposed various notice and other requirements, primarily a requirement that E*TRADE Bank obtain prior approval from the OTS of any future material changes to E*TRADE Bank's business plan. These regulations and conditions, and our inexperience with them, could affect our ability to realize synergies from the merger, and could negatively affect both us and E*TRADE Bank following the merger. We face numerous risks associated with doing business in international markets One component of our strategy is a planned increase in efforts to attract more international customers. To date, we have limited experience in providing brokerage services internationally, and ETFC has had only limited 39 experience providing banking services to customers outside the United States. There can be no assurance that our international licensees or subsidiaries will be able to market our branded services and products successfully in international markets. In addition, there are certain risks inherent in doing business in international markets, particularly in the heavily regulated brokerage and banking industries, such as: . unexpected changes in regulatory requirements, tariffs and other trade barriers; . difficulties in staffing and managing foreign operations; . the level of investor interest in cross-border trading; . authentication of on-line customers; . increased regulation of the use of customer data; . political instability; . fluctuations in currency exchange rates; . reduced protection for intellectual property rights in some countries; . seasonal reductions in business activity during the summer months in Europe and certain other parts of the world; . the level of adoption of the Internet in international markets; and . potentially adverse tax consequences. Any of the foregoing could adversely impact the success of our international operations. In addition, because some of these international markets are served through license arrangements with others, we rely upon these third parties for a variety of business and regulatory compliance matters. We have limited control over the management and direction of these third parties. We run the risk that their action or inaction could harm our operations and/or the goodwill associated with our brand name. Additionally, certain of our international licensees have the right to sell sub-licenses. Generally, we have less control over sub-licensees than we do over licensees. As a result, the risk to our operations and goodwill is higher. There can be no assurance that one or more of the factors described above will not have a material adverse effect on our future international operations, if any, and, consequently, on our business, financial condition and operating results. Any failure to successfully integrate the companies that we acquire into our existing operations or failure to maintain our relationships with strategic partners could harm our business We recently acquired Telebanc (now ETFC), TIR, Card Capture Services, Electronic Investing Corporation, and several of our European licensees. Additionally, we signed a definitive agreement to acquire our Canadian licensee. We may also acquire other companies or technologies in the future, and we regularly evaluate such opportunities. Acquisitions and mergers entail numerous risks, including: . difficulties in the assimilation of acquired operations and products; . diversion of management's attention from other business concerns; . amortization of acquired intangible assets; and . potential loss of key employees of acquired companies. We have limited experience in assimilating acquired organizations into our operations. No assurance can be given as to our ability to integrate successfully any operations, technology, personnel, services or new businesses or products that might be acquired in the future. Failure to successfully assimilate acquired organizations could have a material adverse effect on our business, financial condition and operating results. We have established a number of strategic relationships with online and Internet service providers, as well as software and information service providers. There can be no assurance that any such relationships will be 40 maintained, or that if they are maintained, they will be successful or profitable. Additionally, we may not be able to develop any new relationships of this type in the future. We also make investments, either directly or through affiliated private investment funds, in equity securities of other companies without acquiring control of those companies. There may be no public market for the securities of the companies we invest in. In order for us to realize a return on our investment, such companies must be sold or successfully complete a public offering of their securities. There can be no assurance that such companies will be acquired or complete a public offering or that such an acquisition or public offering will allow us to sell our securities at a profit, or at all. Due to the foregoing factors, quarterly revenues and operating results are difficult to forecast. We believe that period-to-period comparisons of our operating results will not necessarily be meaningful and you should not rely on them as any indication of future performance. Our future quarterly operating results may not consistently meet the expectations of securities analysts or investors, which in turn may have an adverse effect on the market price of our common stock. We have substantially increased our indebtedness, which may make it more difficult to make payments on our debts or to obtain financing As a result of our sale of 6% convertible subordinated notes in February 2000, we have incurred $650 million of additional indebtedness, increasing our ratio of debt to equity (expressed as a percentage) to approximately 38% as of June 30, 2000. We may incur substantial additional indebtedness in the future. The level of our indebtedness, among other things, could: . make it difficult for us to make payments on our debt; . make it difficult for us to obtain any necessary financing in the future for working capital, capital expenditures, debt service requirements or other purposes; . limit our flexibility in planning for, or reacting to, changes in our business; and . make us more vulnerable in the event of a downturn in our business. There can be no assurance that we will be able to meet our debt service obligations, including obligations under the notes. Loss or reductions in revenue from order flow rebates could harm our business Order flow revenue as a percentage of revenue has decreased over the past three years. There can be no assurance that payments for order flow will continue to be permitted by the SEC, the NASDR or other regulatory agencies, courts or governmental units. Loss of any or all of these revenues could have a material adverse effect on our business, financial condition and operating results. We may incur costs to avoid investment company status and may suffer adverse consequences if we are deemed to be an investment company We may incur significant costs to avoid investment company status and may suffer other adverse consequences if we are deemed to be an investment company under the Investment Company Act of 1940, which is commonly referred to as the "1940 Act". A company may be deemed to be an investment company if it owns investment securities with a value exceeding 40% of its total assets, subject to certain exclusions. After giving effect to the sale of 6% convertible subordinated notes, we will have substantial short-term investments until the net proceeds from the sale can be deployed. In addition, we and our subsidiaries have made minority equity investments in other companies that may constitute investment securities under the 1940 Act. In particular, many of our publicly-traded equity investments, which are owned directly by us or through related venture funds, are deemed to be investment securities. Although our investment securities currently comprise less than 40% of our total assets, the value of 41 these minority investments has fluctuated in the past, and substantial appreciation in some of these investments may, from time to time, cause the value of our investment securities to exceed 40% of our total assets. These factors may result in us being treated as an "investment company" under the 1940 Act. We believe we are primarily engaged in a business other than investing, reinvesting, owning, holding, or trading securities for our account and, therefore, are not an investment company within the meaning of the 1940 Act. However, in the event that such exemption is not available and the 40% limit were to be exceeded (including through fluctuations in the value of our investment securities), we may need to reduce our investment securities as a percentage of our total assets. This reduction can be attempted in a number of ways, including the sale of investment securities and the acquisition of non- investment security assets, such as cash, cash equivalents and government securities. If we sell investment securities, we may sell them sooner than we intended. These sales may be at depressed prices and we may never realize anticipated benefits from, or may incur losses on, these investments. Some investments may not be sold due to normal contractual or legal restrictions or the inability to locate a suitable buyer. Moreover, we may incur tax liabilities if we sell these assets. We may also be unable to purchase additional investment securities that may be important to our operating strategy. If we decide to acquire non-investment security assets, we may not be able to identify and acquire suitable assets, and will likely realize a lower return on any such investments. If we were deemed to be an investment company, we could become subject to substantial regulation under the 1940 Act with respect to our capital structure, management, operations, affiliate transactions and other matters. As a consequence, we could be barred from engaging in business or issuing our securities as we have in the past and might be subject to civil and criminal penalties for noncompliance. In addition, some of our contracts might be voidable, and a court-appointed receiver could take control of us and liquidate our business in certain circumstances. Item 3. Quantitative and Qualitative Disclosures About Market Risk For quantitative and qualitative disclosures about market risk, we have evaluated such risk for our brokerage, international, corporate and banking related operations separately. The following discussion about our market risk disclosures includes forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements as a result of certain factors, including those set forth in the section entitled "Risk Factors" and elsewhere in this filing. Reference is made to Part II, Item 7A, Quantitative and Qualitative Disclosures About Market Risk, in our Annual Report on Form 10-K/A for the year ended September 30, 1999. Brokerage, International, and Corporate Operations Our brokerage, international and corporate operations are exposed to market risk related to changes in interest rates, foreign currency exchange rates and equity security price risk. However, we do not believe any such exposures are material. To reduce certain risks, we utilize derivative financial instruments; however, we do not hold derivative financial instruments for speculative or trading purposes Interest Rate Sensitivity During the quarter ended June 30, 2000, we had a variable rate bank line of credit. As of June 30, 2000, we had $30.8 million outstanding under this line. The line of credit and the monthly interest payment are subject to interest rate risk. If market interest rates were to increase immediately and uniformly by one percent at June 30, 2000, the interest payments would increase by an immaterial amount. Foreign Currency Exchange Risk A portion of our operations consist of brokerage and investment services outside of the United States. As a result, our results of operations could be adversely affected by factors such as changes in foreign currency 42 exchange rates or economic conditions in the foreign markets in which we provide our services. We are primarily exposed to changes in exchange rates on the Japanese yen, the British pound and the Euro. When the U.S. dollar strengthens against these currencies, the U.S. dollar value of non-U.S. dollar-based revenues decreases. When the U.S. dollar weakens against these currencies, the U.S. dollar value of non-U.S. dollar-based revenues increases. Correspondingly, the U.S. dollar value of non-U.S. dollar-based costs increases when the U.S. dollar weakens and decreases when the U.S. dollar strengthens. We are a net payer of British pounds and, as such, benefit from a stronger dollar, and are adversely affected by a weaker dollar relative to the British pound. However, we are a net receiver of currencies other than British pounds, and as such, benefit from a weaker dollar, and are adversely affected by a stronger dollar relative to these currencies. Accordingly, changes in exchange rates may adversely affect our consolidated sales and operating margins as expressed in U.S. dollars. To mitigate the short-term effect of changes in currency exchange rates on our non-U.S. dollar-based revenues and operating expenses, we routinely hedge our material net non-U.S. dollar-based exposures by entering into foreign exchange forward and option contracts. Currently, hedges of transactions do not extend beyond twelve months. Given the short term nature of our foreign exchange forward and option contracts, our exposure to risk associated with currency market movement on the instruments is not material. Equity Price Risk We have investments in publicly-traded equity securities which, in conjunction with cash provided from operations and financing arrangements, are utilized to meet forecasted liquidity needs. The fair value of these securities at June 30, 2000 was $350.7 million. As a result of significant market volatility during the three months ended June 30, 2000, the fair value of our equity portfolio was subjected to significant fluctuations. As the Company accounts for these securities as available-for-sale, unrealized gains and losses resulting from changes in the fair value of these securities are reflected as a change in shareowners' equity, and not reflected in the determination of operating results until the securities are sold. Depreciation in the market value of our portfolio impacts our financing strategies which could result in higher interest expense if alternative financing strategies are used. At June 30, 2000, unrealized gains on these securities were $314.1 million. Financial Instruments For our working capital and reserves, which are required to be segregated under Federal or other regulations, we invest in money market funds, resale agreements, certificates of deposit, and commercial paper. Money market funds do not have maturity dates and do not present a material market risk. The other financial instruments are fixed rate investments with short maturities and do not present a material interest rate risk. Banking Operations We manage our banking related interest rate risk through the use of financial derivatives such as interest rate cap, swap and floor agreements. We use these instruments to ensure that the market value of equity and net interest income are protected from the impact of changes in interest rates. We have experienced no material changes in market risk pertaining to our banking operations during the quarter ended June 30, 2000. 43 PART II. OTHER INFORMATION Item 1. Legal and Administrative Proceedings On November 21, 1997, a putative class action was filed in the Superior Court of California, County of Santa Clara, by Larry R. Cooper on behalf of himself and other similarly situated individuals. The action alleges, among other things, that our advertising, other communications and business practices regarding our commission rates and our ability to timely execute and confirm transactions through our online brokerage services were false and deceptive. The action seeks injunctive relief enjoining the purported deceptive and unfair practices alleged in the action and also seeks unspecified compensatory and punitive damages, as well as attorney fees. On June 1, 1999, the Court entered an order denying plaintiffs' motion for class certification. On January 25, 2000, the court ordered plaintiffs to submit all claims seeking monetary relief to arbitration and stayed all other claims pending the outcome of arbitration. A motion to modify that order was denied on July 13, 2000. We are unable to predict the ultimate outcome of this proceeding. On February 11, 1999, a putative class action was filed in the Supreme Court of New York, County of New York, by Evan Berger, on behalf of himself and other similarly situated individuals. The action alleges, among other things, that our advertising, other communications and business practices regarding our ability to timely execute and confirm transactions through our online brokerage services were false and deceptive. Plaintiff seeks damages based on causes of action for breach of contract and violation of New York consumer protection statutes. By a Decision and Order, entered March 28, 2000, the Court ordered plaintiff to proceed to arbitration on her breach of contract claim and granted our motion to dismiss plaintiff's consumer protection claims. Although plaintiff has not filed for arbitration to date, we are unable to predict the ultimate outcome of this proceeding. On March 1, 1999, a putative class action was filed in the Court of Common Pleas, Cuyahoga County, Ohio, by Truc Q. Hoang. The Hoang complaint seeks damages and injunctive relief arising out of, among other things, plaintiff's alleged problems accessing her account and placing orders. Plaintiff alleges causes of action for breach of contract, breach of fiduciary duty, unjust enrichment, fraud, unfair and deceptive trade practices, negligence/intentional tort and injunctive relief. On September 1, 1999, the Court of Common Pleas denied our motion to compel arbitration and we appealed. By a Journal Entry and Opinion, dated March 16, 2000, the Court of Appeals reversed the Court of Common Pleas' decision and remanded this case to the Court of Common Pleas on the grounds that the Court of Common Pleas' resolution of our motion to compel arbitration could not be determined until it first determined whether this case should be certified as a class action. On June 16, 2000, we filed a "Motion to Dismiss for Lack of Subject Matter Jurisdiction" to which we anticipate plaintiff will be responding in the near future. We are unable to predict, however, the ultimate outcome of this proceeding. On March 10, 1999, a putative class action was filed in the Superior Court of California, County of Santa Clara, by Raj Chadha. The Chadha complaint seeks damages and injunctive relief arising out of, among other things, February 3, 4, and 5, 1999, system interruptions. Plaintiff brings causes of action for breach of fiduciary duty, violations of the Consumer Legal Remedies Act, and violations of the California Unfair Business Practices Act. On July 29, 1999, the Court granted our petition to compel arbitration and stayed all further proceedings. At this time, we are unable to predict the ultimate outcome of this proceeding. On March 11, 1999, a putative class action was filed in the Superior Court of California, County of Santa Clara, by Elie Wurtman. The Wurtman complaint seeks damages and injunctive relief arising out of, among other things, plaintiff's alleged problems accessing her account and placing orders. The complaint also makes allegations regarding access problems relating to our customers residing or traveling outside of the United States. Plaintiff brings causes of action for negligence and violations of the Consumer Legal Remedies Act and California Unfair Business Practices Act. On September 23, 1999 the Superior Court denied our motion to compel arbitration. We filed an appeal in October 1999, and all briefing on that appeal has now been completed. At this time, we are unable to predict the ultimate outcome of this proceeding. 44 On April 14, 1999, a putative class action was filed in the Superior Court of California, County of Los Angeles, by Matthew J. Rosenberg. Plaintiff seeks injunctive relief based on alleged violations of the California Unfair Business Practices Act regarding the extent to which shares in IPOs were made available to our customers. On October 6, 1999, the Superior Court dismissed plaintiff's class action claims with prejudice but granted plaintiff leave to amend his claim for injunctive relief. Plaintiff filed an amended complaint on October 26, 1999, and we subsequently filed a petition to compel arbitration that was granted on December 29, 1999. On February 29, 2000, plaintiff filed a notice of appeal, and the Court of Appeal for the State of California, Second Appellate District, dismissed plaintiff's appeal on July 20, 2000. At this time, we are unable to predict the ultimate outcome of this proceeding. We believe the foregoing claims are without merit and intend to defend against them vigorously. An unfavorable outcome in any matters which are not covered by insurance could have a material adverse effect on our business, financial condition and results of operations. In addition, even if the ultimate outcomes are resolved in our favor, the defense of such litigation could entail considerable cost and the diversion of efforts of management, either of which could have a material adverse effect on our results of operation. From time to time, we have been threatened with, or named as a defendant in, lawsuits, securities arbitrations before the NASDR, and administrative claims. Compliance and trading problems that are reported to the NASDR or the SEC by dissatisfied customers are investigated by the NASDR or the SEC and, if pursued by such customers, may rise to the level of arbitration or disciplinary action. One or more of such claims or disciplinary actions decided against us could have a material adverse effect on our business, financial condition and results of operations. We are also subject to periodic regulatory audits and inspections. The securities industry is subject to extensive regulation under federal, state and applicable international laws. As a result, we are required to comply with many complex laws and rules and our ability to so comply is dependent in large part upon the establishment and maintenance of a qualified compliance system. We are aware of several instances of our noncompliance with applicable regulations. In particular, in fiscal 1997, our failure to timely renew our broker dealer registration in Ohio resulted in a $4.3 million pre- tax charge against earnings. In March 2000, we paid a fine of $20,000 to the NASDR for failing to promptly respond to NASDR requests for information related to customer complaints on twelve instances between April 1999 and June 1999. In April 2000, we paid a fine of $20,000 to the NASDR for failure to report our short interest positions to the NASDR for the months of June 1996 through September 1998. We maintain insurance in such amounts and with such coverages, deductibles and policy limits as management believes are reasonable and prudent. The principal risks that we insure against are comprehensive general liability, commercial property, residential property, hardware/software damage, directors and officers, and errors and omissions liability. We believe that such insurance coverages are adequate for the purpose of our business but cannot guarantee that we will be able to, or elect to, purchase or maintain such coverages in the future. Item 2. Changes in Securities and Use of Proceeds--Not applicable. Item 3. Defaults Upon Senior Securities--Not applicable. Item 4. Submission of Matters to a Vote of Security Holders--None. Item 5. Other Information--None. 45 Item 6. Exhibits and Reports on Form 8-K (a) Exhibits *4.1 Indenture, dated February 1, 2000, by and between the Company and The Bank of New York. *10.1 Employment agreement, dated June 1, 1999, by and between the Company and Christos M. Cotsakos. *10.2 Employment agreement, dated June 1, 1999, by and between the Company and Kathy Levinson. *10.3 Purchase Agreement, dated February 1, 2000, by and among the Company, FleetBoston Robertson Stephens Inc., Hambrecht & Quist LLC and Goldman, Sachs & Co. *10.4 Registration Rights Agreement, dated February 1, 2000, by and among the Company, FleetBoston Robertson Stephens Inc., Hambrecht & Quist LLC and Goldman, Sachs & Co. *10.5 E*TRADE Ventures I, LLC, Limited Liability Company Operating Agreement. *10.6 E*TRADE eCommerce Fund, L.P., Amended and Restated Limited Partnership Agreement. *10.7 E*TRADE eCommerce Fund II, L.P., Limited Partnership Agreement. *10.8 E*TRADE Group, Inc. Note Secured by Deed of Trust dated March 17, 2000, by and between the Company and Theodore J. Theophilos. *10.9 E*TRADE Group, Inc. Amendment to Note Secured by Deed of Trust, dated May 5, 1999, by and between the Company and Theodore J. Theophilos. *10.10 Employment agreement, dated May 24, 2000, by and between the Company and Jerry Gramaglia. *10.11 Form of Note Secured by Stock Pledge Agreement by and between the Company and Christos M. Cotsakos, Jerry Gramaglia, Connie M. Dotson, Pamela Kramer, Michael Sievert and Leonard C. Purkis. *10.12 Form of Stock Pledge Agreement by and between the Company and Christos M. Cotsakos, Jerry Gramaglia, Connie M. Dotson, Pamela Kramer, Michael Sievert and Leonard C. Purkis. *10.13 E*TRADE Group, Inc. Note Secured by Deed of Trust dated May, 2000, by and between the Company and Chuck W. Thomson. **10.14 Amended and Restated Strategic Alliance Agreement dated September 26, 2000, by and between E*Trade Group, Inc. and Wit SoundView Group, Inc. *27.1 Financial Data Schedule. *99.1 Press release, dated January 25, 2000, relating to the 6% convertible subordinated notes due 2007. *99.2 Press release, dated February 2, 2000, relating to the 6% convertible subordinated notes due 2007.
-------- * Previously filed. ** Confidential treatment has been requested as to certain portions of this agreement. Such omitted confidential information has been designated by an asterisk and has been filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended, pursuant to an application for confidential treatment. (b) Reports on Form 8-K On July 18, 2000, the Company filed a Current Report on Form 8-K to report the announcement of an agreement to acquire VERSUS Technologies, Inc., a Canadian based provider of electronic securities. In connection with this transaction, the Company agreed to acquire all of the outstanding ordinary shares of 46 VERSUS in exchange for an aggregate of $174 million worth of the Company's common stock, with VERSUS to become a wholly-owned subsidiary of the Company. The acquisition is subject to the satisfaction of certain conditions and is intended to be accounted for as a pooling of interests. On June 20, 2000, the company filed a Current Report on Form 8-K to report the strategic alliance between E*TRADE Group, Inc. and Wit Capital Group, Inc., now known as Wit Soundview Group, Inc., ("Wit"). In connection with the strategic alliance, E*TRADE Securities, Inc. agreed to acquire from Wit substantially all of the retail brokerage accounts maintained by Wit's subsidiary, Wit Capital Corporation. The transactions contemplated by the strategic alliance are contingent on the closing of the merger of E*OFFERING Corp. into Wit's subsidiary, Wit Soundview Corporation. On April 17, 2000, the Company filed a Current Report on Form 8-K to report the first period of consolidated results of E*TRADE and E*TRADE Financial Corporation ("ETFC"). The acquisition of ETFC was completed on January 12, 2000 and was accounted for as a pooling of interests. On January 27, 2000, the Company filed a Current Report on Form 8-K to report the final closing of its merger with E*TRADE Financial Corporation. 47 SIGNATURES Pursuant to the requirements 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. E*TRADE Group, Inc. (Registrant) Dated: October 25, 2000 /s/ Christos M. Cotsakos ----------------------------- Christos M. Cotsakos Chairman of the Board and Chief Executive Officer (Principal Executive Officer) /s/ Leonard C. Purkis ----------------------------- Leonard C. Purkis Chief Financial Officer (Principal Financial and Accounting Officer) 48 EX-10.14 2 0002.txt AMENDED AND RESTATED STRATEGIC ALLIANCE AGRMT DATE 9/26/2000 EXHIBIT 10.14 CONFIDENTIAL TREATMENT AMENDED AND RESTATED STRATEGIC ALLIANCE AGREEMENT This Amended and Restated Strategic Alliance Agreement (this "Agreement") is entered into as of September 26, 2000 by and between E*TRADE Group Inc., a Delaware corporation ("E*TRADE"), and Wit SoundView Group, Inc. a Delaware corporation ("Wit"); provided, however, that the terms and conditions of this Agreement shall not become binding or effective until the effective time of the Merger. WHEREAS, the parties hereto are entering into an Account Transfer Agreement (the "Account Transfer Agreement"), pursuant to which Wit will cause Wit Capital Corporation to transfer to E*TRADE Securities, Inc. all right, title and interest in and to the online retail brokerage accounts maintained by Wit Group, in connection with Wit Group's agreement to no longer engage in the online retail brokerage business; and WHEREAS, Wit Group (as defined herein) wishes to offer, and E Group (as defined herein) wishes for Wit Group to offer, existing and future investment banking products and services to customers of E Group, upon the terms and conditions hereof; NOW, THEREFORE, in consideration of the covenants and agreements contained herein, and for other good and valuable consideration the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree as follows: 1. CERTAIN DEFINITIONS. (a) "Accounts" means those non-online brokerage accounts maintained by Wit Group for natural persons whose individual net worth, or joint net worth with that person's spouse, exceeds $5,000,000. As of the date of this Agreement, Wit Group maintains approximately 300 of such accounts and hereby covenants and agrees that it will not seek to expand this segment of its business at any time during the term of this Agreement, and in any event shall not at any time during the term of this Agreement maintain more than 500 of such accounts. Wit Group shall use its reasonable efforts to cause any potential new Accounts for natural persons to open online accounts at E Group and maintain retail brokerage accounts with E Group. (b) "Affiliate" of any Person means any other Person that directly or indirectly, through one or more intermediaries, controls, is controlled by or is under common control with such Person. For purposes of this definition, "control" (or "controlled," as the context may require) shall have the meanings set forth in Rule 12b-2 promulgated under the Securities Exchange Act of 1934, as amended. (c) "Change in Control" means, with respect to any Person, (i) the acquisition of such Person by another Person of a majority of the voting interests in such first Person; (ii) the sale of all or substantially all of the assets of such first Person; (iii) a merger, consolidation, or other business combination pursuant to which the stockholders of such Person prior to the effective date of such transaction have beneficial ownership of less than fifty percent (50%) of the total combined voting power or economic interests of the surviving or continuing entity immediately following such transaction; or (iv) any other acquisition by another Person of Confidential treatment has been requested for portions of this exhibit. The copy filed herewith omits the information subject to the confidentiality request. Omissions are designated as *****. A complete version of this exhibit has been filed separately with the Securities and Exchange Commission. CONFIDENTIAL TREATMENT primary control (as defined for purposes of the above definition of Affiliate) of the first Person, including through a proxy contest, proxy solicitation or the election or appointment of directors nominated or designated by such other Person. For purposes of the foregoing definition, a Person shall also include and refer separately to any subsidiaries of such Person that taken together account for more that 50% of such Person's broker-dealer or investment banking (including research) assets or revenues on a consolidated basis. (d) "Covered Issuer" means any issuer that (i) is organized in the U.S., (ii) is not a registered or an unregistered investment company (other than any particular registered closed-end investment company with respect to which Wit Group is acting as an Underwriter or dealer *****, it being understood that the foregoing exception is designed to provide exclusivity for registered closed-end funds only on a case-by case-basis) or an investment fund, pooled investment vehicle or trust; and (iii) is not a registered investment company or is not an investment fund or a pooled investment vehicle managed by E Group or Wit Group as a proprietary securities product. (e) "Covered Offering" means the U.S. tranche of any private placement of equity or equity derivative securities (including common stock, preferred stock, convertible debt securities and warrants or other securities convertible into or exchangeable for the same or other equity or equity derivative securities) of a Covered Issuer. (f) "Covered Securities" means all securities offered in Covered Offerings that are allocated through Wit Group for qualified retail investors. (g) "E Group" means E*TRADE and/or its controlled Affiliates, as the context may require. (h) "Excluded Securities" means (i) securities that are allocated by Wit Group for offering or sale to the Accounts and (ii) securities that are allocated by Wit Group for offering or sale to employees, directors and Affiliates of Wit Group. (i) "Initial Public Offering" means an underwritten initial public offering in the United States of common stock, ordinary shares, American Depository Shares or the equivalent by whatever name, of a Covered Issuer that is not a registered investment company or real estate investment trust, that is offered and sold in an initial public offering in which the aggregate offering price of the shares in the U.S. tranche without exercise of any overallotment option exceeds $***** and is less than $*****. (j) "IPO Retail Shares" means Retail Securities consisting of common stock, ordinary shares, American Depository Shares or the equivalent by whatever name offered and sold in an Initial Public Offering. ***** Confidential treatment has been requested for the redacted portions. The confidential redacted portions have been filed separately with the Securities and Exchange Commission. 2. CONFIDENTIAL TREATMENT (k) "Merger" means the merger of E*OFFERING Corp. into Wit SoundView Corp. pursuant to the Merger Agreement. (l) "Merger Agreement" means the Agreement and Plan of Merger dated as of May 15, 2000, by and among Wit, Wit SoundView Corporation and E*OFFERING Corp. (m) "NASD" means the National Association of Securities Dealers, Inc. (n) "Person" means any individual, corporation, partnership, limited liability company, firm, joint venture, association, joint stock company, trust, unincorporated organization or other entity or organization. (o) "Qualified Co-manager" means, with respect to any calendar year, one of the ten highest ranked investment banks in the United States from the previous calendar year, based on the total number of completed initial public offerings in the United States (as published by Commscan or, if Commscan ceases to publish such transaction statistics, Bloomberg, L.P. or another nationally recognized financial research organization). (p) "Registered Offering" means the U.S. tranche of any initial public offering, follow-on or secondary offering or other offering of equity or equity derivative securities (including common stock, preferred stock, convertible debt securities and warrants or other securities convertible into or exchangeable for the same or other equity or equity derivative securities) of a Covered Issuer that is registered with the U.S. Securities and Exchange Commission pursuant to the Securities Act of 1933, as amended. (q) "Retail Securities" means all securities offered in a Registered Offering that are allocated by Wit Group for retail distribution, which shall not in any event be less than *****% of the amount of "non-designated" shares available to Wit Group in such Registered Offering; provided, however, that any "non-designated" shares allocated by Wit Group that are Excluded Securities shall not be deemed available to Wit Group for purposes of determining compliance with Section 4(a) of this Agreement. (r) "Start Date" means July 1, 2000. (s) "Wit Group" means Wit and/or its controlled Affiliates, as the context may require. ***** Confidential treatment has been requested for the redacted portions. The confidential redacted portions have been filed separately with the Securities and Exchange Commission. 3. CONFIDENTIAL TREATMENT 2. RELATIONSHIP. During the term of this Agreement, Wit Group, on a non-exclusive basis (except as specifically provided in Section 3(a)(ii) below), shall be entitled to offer securities of all kinds through E Group to customers of E Group. E Group shall be entitled to reject any such securities at its sole discretion; provided, however, that E Group may not offer for sale or sell any securities being offered by Wit in an E Group rejected offering that are subject to Wit Group's Exclusivity Right that are offered to it by another Person who is participating in such rejected offering (an "Alternative Allocation"), provided, further that E Group may accept an Alternative Allocation in an offering rejected by E Group that is not subject to Wit Group's Exclusivity Right if the relevant per unit selling concession or similar economic consideration payable to E Group in such Alternative Allocation is greater than that which Wit Group is prepared to pay after having been given an opportunity to match such selling concession or other economic consideration. Beginning as early as practicable in the course of each securities offering and placement, Wit Group shall consult with E Group regarding E Group's interest in offering the securities to customers of E Group. E Group shall endeavor to advise Wit Group within a commercially reasonable time of its intention to accept or not accept any offering. In any offering that E Group accepts that is not subject to Wit Group's Exclusivity Right, E Group shall take from or through Wit Group a mutually agreed upon proportion of the securities made available for distribution by E Group hereunder for offering and sale to its customers. 3. EXCLUSIVITY. (a) Exclusivity. ----------- (i) Wit Group's Obligations. Subject to Section 15(a) and the ----------------------- provisions of this Section 3, Wit Group shall make available for sale solely and exclusively through E Group to customers of E Group all Retail Securities and all Covered Securities (other than Excluded Securities). Retail Securities offered through the auction facility of Vostock shall be deemed to be offered solely and exclusively through E Group to customers of E Group for purposes of the preceding sentence and Section 4(a). Wit Group will coordinate and cooperate with E Group such that an efficient and cost effective process is established whereby all such Retail Securities and all Covered Securities are made available to E Group for offer, sale and delivery through E Group to customers of E Group. Wit Group and E Group will evaluate the Vostock process to determine how best to provide access to auctions conducted by Wit Group through Vostock with the objective of providing a seamless interface to Vostock auctions to help maximize the number of shares that can be distributed to E Group customers. In addition, Wit Group and E Group will evaluate whether the Vostock process is appropriate for initial public offerings and Wit Group agrees that it will not use Vostock for initial public offerings without E Group's consent. (ii) E Group's Obligations. Subject to Section 15(b) and the --------------------- provisions of this Section 3, so long as Wit Group is in compliance with Section 3(a)(i) and is not then in default of any of its material obligations under this Agreement, in each 4. CONFIDENTIAL TREATMENT Registered Offering and in each Covered Offering E Group shall only offer to its United States retail customers Retail Securities and Covered Securities, respectively, and shall not offer to its United States customers any Retail Securities in a Registered Offering, or Covered Securities in a Covered Offering, made available by any Person other than Wit Group in any Registered Offering or Covered Offering (the "Exclusivity Right"); it being understood that, notwithstanding anything herein to the contrary, E Group shall be permitted to offer to its United States customers any and all non-equity or non-equity-linked securities (such as debt securities) and equity or equity-linked securities of companies located outside the United States to those of its customers located either within or outside of the United States. (iii) Duration of Exclusivity Right. As a result of the ----------------------------- foregoing and subject to the other express provisions of this Agreement, for the five years following the Start Date, the Exclusivity Right shall be in existence. (b) Non-Competition. --------------- (i) At all times that the Exclusivity Right is in effect and E Group is not then in default of any of its material obligations under this Agreement in any manner that would permit termination of this Agreement by Wit pursuant to Section 18(c), Wit shall not, and shall not permit any of its subsidiaries to: (A) enter into or engage, directly or indirectly, in the business of operating a retail securities brokerage business in the United States, other than with respect to the Accounts; or (B) solicit retail customers, other than the Accounts, in competition with E Group or any of its Affiliates in the business of operating a retail securities brokerage business in the United States. (ii) At all times that the Exclusivity Right is in effect and Wit Group is not then in default of any of its material obligations under this Agreement in any manner that would permit termination of this Agreement by E*TRADE pursuant to Section 18(c), E*TRADE shall not, and shall not permit any of its subsidiaries to, enter into or engage, directly or indirectly, in the investment banking business in the United States with respect to those investment banking activities of E Group that are restricted by the Exclusivity Right. (iii) During the terms of this Agreement and for a period of twelve months thereafter, Wit Group will not solicit any employee of E Group for the purpose of offering employment to such Person and E Group will not solicit any employee of Wit Group for the purposes of offering employment to such person. The foregoing shall not prohibit Wit Group or E Group from offering employment to or hiring any employee responding to a newspaper or other general solicitation. (iv) Without limitation, the parties agree and intend that the covenants contained in this Section 3(b) shall be deemed to be a series of separate covenants and 5. CONFIDENTIAL TREATMENT agreements, one for each and every political subdivision of each jurisdiction. If, in any judicial proceeding, a court shall refuse to enforce in such action any of the separate covenants deemed included herein, then at the option of the party hereto entitled to the benefit of such covenants, wholly-unenforceable covenants or components thereof shall be deemed eliminated from the provisions hereof for the purpose of such proceeding to the extent necessary to permit the remaining separate covenants to be enforced in such a proceeding. The parties intend to have covenants enforceable to the fullest extent of the law as to scope, time and geography. (v) The parties agree that due to the nature of the services and capabilities of the parties, there can be no adequate remedy at law for any breach of the obligations of the other party under this Section 3(b) hereunder, that any such breach by one party may allow the other party hereto and/or third parties to unfairly compete with the breaching party and its affiliates resulting in irreparable harm to the other party and therefore, that upon any such breach or any threat thereof, the other party and its affiliates shall be entitled to appropriate equitable relief in addition to whatever remedies it might have at law and attorneys' fees and costs of suit, in connection with any breach, or any enforcement, of the breaching parties obligations pursuant to this Section 3(b). (vi) Each party acknowledges, and represents and warrants to the other, that its covenants in this Section 3(b) are reasonably necessary for the protection of the other party's interests under this Agreement and are not unduly restrictive upon it or any of its Affiliates. (vii) Each Party shall notify the other of any breach or alleged breach by the other of any provision of this Section 3(b). (c) Additional Consideration. At or prior to the Closing under the Account Transfer Agreement, Wit Group shall issue to E*TRADE, (i) four million twenty-five thousand nine hundred and forty-eight (4,025,948) shares (the "Alliance Shares") of Wit common stock, par value $0.01 per share ("Common Stock") and (ii) a warrant issued to E Group in the form attached hereto as Annex A (the "Warrant") to purchase up to an aggregate of two million (2,000,000) shares of Common Stock, as further consideration, together with the transactions contemplated by the Account Transfer Agreement, for E Group entering into the strategic alliance contemplated hereby and terminating the existing Letter of Intent referred to below. Certificates, in form reasonably satisfactory to E*TRADE, representing the Alliance Shares shall be delivered to E*TRADE at or prior to the Closing under the Account Transfer Agreement. The Alliance Shares and the shares issuable upon exercise of the Warrant, in each case upon issuance as provided herein, shall be (i) validly issued, fully paid, non-assessable and free and clear of any liens, charges, preemptive rights or other encumbrances or restrictions and (ii) issued in compliance with all applicable laws. The Alliance Shares shall be subject to prohibitions on transfer for a three-year period from the date of the Closing under the Merger Agreement, and each certificate for such Alliance Shares shall be subject to a restrictive legend substantially in the form set forth in Exhibit A to the Merger Agreement providing for a thirty-six month prohibition on transfer. 6. CONFIDENTIAL TREATMENT 4. SHARE ALLOCATION. (a) Wit Group Share Allocation. Wit Group agrees that (i) in each and -------------------------- every Registered Offering that Wit Group participates in as an underwriter, placement agent, broker-dealer, selling group member, distributor or otherwise, the amount of Retail Securities in such offering that shall be made available to E Group shall be ***** percent (*****%) of the total Retail Securities (other than Excluded Securities) in such offering and (ii) in each and every Registered Offering that Wit Group participates in as an underwriter, placement agent, broker-dealer, selling group member, distributor or otherwise, the amount of "non-designated" shares in such offering that shall be made available to E Group shall be at least ***** percent (*****%) of the total of such "non-designated" shares available to Wit Group in such offering; provided, however, that any "non-designated" shares allocated by Wit Group that are Excluded Securities shall not be deemed available to Wit Group for purposes of determining compliance with the preceding percentage threshold. For purposes of this Agreement, "non-designated" shares shall mean those shares that are not specifically designated for allocation to institutional accounts or other accounts by the lead managing underwriter or placement agent. Each of the allocation requirements set forth above may only be waived by the written approval of E Group or the member of the commitment committee of Wit Group designated by E Group. E*TRADE shall be entitled to reject or not accept participation in any equity offering at its sole discretion. (b) E Group's Allocations in Lead Managed Public Offerings. Solely ------------------------------------------------------ with respect to Registered Offerings in which Wit Group is the lead managing underwriter and in which shares are not rejected by E Group for distribution to customers of E Group, the amount of equity securities allocated or made available to E Group in each such offering must be at least *****% of the total amount of securities offered in each such offering. (c) E Group Customer Allocation. E Group shall establish --------------------------- commercially reasonable criteria for the allocation to retail brokerage accounts of securities made available by Wit Group to E Group in any offerings under this Agreement. E Group shall undertake commercially reasonable steps to maximize share retention of Registered Securities by its retail customers for at least thirty (30) days, subject to applicable regulatory requirements. Private Placements. The parties hereto shall negotiate in good faith ------------------ the terms and conditions under which Wit Group shall make available Covered Securities for offering by E Group in private placements, and such terms and conditions shall be evidenced in an addendum to this Agreement. Such addendum shall include matters such as identifying which types of Covered Offerings are appropriate or eligible for offering to qualified retail investor customers of E Group, the methods of qualifying customers for particular Covered Offerings, the methods for determining the amount of Covered Securities in such offerings that should be made available to qualified retail investors, the proportion thereof that should be made available for customers of E ***** Confidential treatment has been requested for the redacted portions. The confidential redacted portions have been filed separately with the Securities and Exchange Commission. 7. CONFIDENTIAL TREATMENT Group and the compensatory arrangements for E Group's participation in Covered Offerings, and other matters relating to such offerings. To the extent that the parties are unable to agree upon the terms and conditions of such addendum, any such disagreements shall be resolved by the Committee (as defined in Section 16(c)). 5. RETAIL ACCOUNT INQUIRIES; SHARE PROGRAMS. (a) Account Inquiries. Wit Group shall promptly direct to E Group ----------------- all inquiries with respect to Retail Securities or retail accounts (other than Accounts) that Wit Group receives, either directly or indirectly. (b) Share Programs. E Group shall pay to Wit Group, within 30 days -------------- following the end of each calendar quarter during the term of this Agreement, the Program Fee described below for each new retail brokerage account opened at E Group by a retail customer for the purpose of participating in an "affinity" or "directed" share program, or similar such program, administered by Wit Group, including without limitation, (i) Wit Group's electronic Affinity Share Program ("eASP") and (ii) Wit Group's electronic Directed Share Program ("eDSP"). The "Program Fee" shall be $***** for each such new account opened at any time prior to the first anniversary of the Merger, and shall be a mutually agreed upon comparable amounts paid by E Group to other Persons for similar customer account acquisitions executed by E Group over the then preceding 12-month period. E Group and Wit Group shall negotiate in good faith on an annual basis to determine the amount of the Program Fee prior to each yearly anniversary of the Merger, and the amount so determined shall be in effect thereafter until the next succeeding anniversary of the Merger. E Group shall be entitled to reject or not accept any such new account at its sole discretion. Notwithstanding Section 6 hereof, Wit Group shall pay to E Group ***** percent (*****%) of the selling concession in connection with the Retail Securities allocated to any eASP account or eDSP account. 6. SELLING CONCESSIONS. Lead/Co-Managed Deals. Subject to the requirements of NASD Rule 2710 --------------------- (Corporate Finance Rule), in connection with all public offerings in which Wit Group participates as a lead managing underwriter or co-managing underwriter, E Group, on the one hand, and Wit Group, on the other hand, will share the dealer selling concession otherwise allocable in respect of such offerings as follows: (i) E Group will receive ***** percent (*****%) of such concession on offerings in which the number of shares allocated or made available for sale through E Group to its customers in connection with the offering is ***** percent (*****%) or less of the total number of shares (before giving effect to any over- allotment option) offered to the public in such offering; (ii) E Group will receive ***** percent (*****%) of such concession on offerings in which the number of shares allocated or made ***** Confidential treatment has been requested for the redacted portions. The confidential redacted portions have been filed separately with the Securities and Exchange Commission. 8. CONFIDENTIAL TREATMENT available for sale through E Group to its customers in connection with the offering is greater than ***** percent (*****%), but less than ***** percent (*****%), of the total number of shares (before giving effect to any over- allotment option) offered to the public in such offering and (iii) E Group will receive ***** percent (*****%) of such concession on offerings in which the number of shares allocated or made available for sale through E Group pursuant to the offering is equal to or greater than ***** percent (*****%) of the total number of shares (before giving effect to any over-allotment option) offered to the public in such offering. (a) Minimum Payments on Co-Managed Deals. With respect to each and ------------------------------------ every Registered Offering in which Wit Group is a co-managing underwriter, to the extent the amount of Retail Securities allocated or made available for sale by E Group to its customers does not in the aggregate equal at least *****% *****%, and *****% of the total amount of all securities offered in each such public offering during any of the first, second or third *****-month periods following the Start Date (the amount of securities representing such shortfall, the "Allocation Deficiency"), Wit Group shall pay to E Group an amount equal to the portion of the dealer selling concession which would have been otherwise allocable under Section 6(a) above with respect to the Allocation Deficiency. All such payments shall be made on a quarterly basis, by wire transfer of immediately available funds to an account or accounts designated by E Group to Wit Group, within 15 days after the end of the calendar quarter in which the obligation to make such payments arise (or in the case of the last quarter or portion thereof during the term of this Agreement, within 15 days after the expiration or termination of this Agreement). (b) Other Equity Public Offerings. Subject to the requirements of ----------------------------- NASD Rule 2710 (Corporate Finance Rule), in connection with all Registered Offerings in which Wit Group participates as an underwriter, dealer or a member of the selling group, but is not a lead managing underwriter or co-managing underwriter, E Group, on the one hand, and Wit Group, on the other hand, will share the dealer selling concession otherwise allocable to Wit Group in respect of such public offerings as follows: (i) E Group will receive ***** percent (*****%) of such concession on offerings in which the number of shares allocated or made available for sale through E Group to its customers in connection with the offering is less than ***** shares and (ii) E Group will receive ***** percent (*****%) of such concession on offerings in which the number of shares allocated or made available for sale through E Group to its customers in connection with the offering is greater than ***** shares. (c) Other Public Offerings. Subject, where applicable, to the ---------------------- requirements of NASD Rule 2710 (Corporate Finance Rule), in connection with all other public offerings in which Wit Group participates as an underwriter, dealer or other member of the selling group, but is not the lead managing or co- managing underwriter, E Group and Wit Group shall negotiate the selling concession or similar payment in connection with any such offering on a class- by-class or case-by-case basis. ***** Confidential treatment has been requested for the redacted portions. The confidential redacted portions have been filed separately with the Securities and Exchange Commission. 9. CONFIDENTIAL TREATMENT (d) Time of Payment. The foregoing selling concession and comparable --------------- payments shall be paid to E Group at the same time as paid to other selling group participants, and as consistent with industry practice, except as provided in Section 6(b) of this Agreement. 7. TRADING FLOW. (a) Lead Managed Offerings. For any Registered Offering in which Wit ---------------------- Group is a lead managing underwriter, E Group shall use commercially reasonable efforts to direct all secondary market orders with respect to the particular security offered in such offering to Wit Group, or to a broker-dealer specified by Wit Group, for a period of ***** from the date on which such public offering commences trading. Wit Group shall pay to E Group a market rate trading flow rebate (currently $***** per share, to be adjusted at least annually to reflect adjustment to the prevailing market rate) for each share so directed. Notwithstanding anything herein to the contrary, E Group and Wit Group understand and agree that no provision of this Agreement shall restrict the other, in its reasonable good faith judgment, from taking, without liability to the other, any action required by any rule or regulation of the SEC, any self- regulatory organization or any governmental entity to which it is subject, or from complying with any fiduciary duties to its customers; provided that it shall, prior to taking such action, to the extent reasonably feasible in light of the then circumstances, notify the other in writing thereof and consult with the other regarding the steps to be taken to ensure compliance with such rule or regulation. (b) Co-Managed Offerings. For any Registered Offering in which Wit -------------------- Group is a co-managing underwriter but not a lead managing underwriter, E Group shall use commercially reasonable efforts to direct all secondary market orders with respect to the particular security offered in such public offering to Wit Group, or to a broker-dealer specified by Wit Group, for a period of 6 months from the date on which such public offering commences trading. Notwithstanding anything herein to the contrary, E Group and Wit Group understand and agree that no provision of this Agreement shall restrict the other, in its reasonable good faith judgment, from taking, without liability to the other, any action required by any rule or regulation of the SEC, any self-regulatory organization or any governmental entity to which it is subject, or from complying with any fiduciary duties to its customers; provided that it shall, prior to taking such action, to the extent reasonably feasible in light of the then circumstances, notify the other in writing thereof and consult with the other regarding the steps to be taken to ensure compliance with such rule or regulation. Wit Group shall pay to E Group, in addition to the selling concession paid pursuant to Section 6 hereof, an incremental ***** percent (*****%) of the selling concession that would otherwise be attributable to such allocated securities. (c) Market Making. Except for shares already covered by Section 7(a) ------------- and (b) above, E Group shall use commercially reasonable efforts to direct all secondary market orders ***** Confidential treatment has been requested for the redacted portions. The confidential redacted portions have been filed separately with the Securities and Exchange Commission. 10. CONFIDENTIAL TREATMENT with respect to each security for which Wit acts as market maker, to Wit Group from the time that Wit notifies E Group that it is properly registered and prepared to commence making a market in such security until Wit Group ceases making a market in such security. Except for shares already covered by Section 7(a) and (b) above, Wit Group shall pay to E Group a trading flow rebate (currently $***** per share for all shares directed to Wit Group (the "Blended Rate)). The parties agree to review the Blended Rate at least quarterly and to negotiate in good faith adjustments to the Blended Rate to ensure that the Blended Rate remains competitive with the highest trading flow rebate or other consideration received by E Group for similar types and sizes of orders from the two market makers, electronic communication networks, securities exchanges or other securities trading markets other than Wit Group ("Market Centers") to which E Group routes the largest and second largest number of secondary market orders for execution during the immediately preceding quarter. Notwithstanding anything herein to the contrary, E Group and Wit Group understand and agree that (i) no provision of this Agreement shall restrict the other, in its reasonable good faith judgment, from taking, without liability to the other, any action required by any rule or regulation of the SEC, any self-regulatory organization or any governmental entity to which it is subject, or from complying with any fiduciary duties to its customers, provided that it shall, prior to taking such action, to the extent reasonably feasible in light of the then circumstances, notify the other of such action prior to, or within a reasonable time after taking such action, and (ii) following the thirty (30) month anniversary of the effective time of the Merger, E Group or Wit Group may each release itself thereafter from the obligations under this Section 7(c) upon 180 days' written notice to the other. (d) Correspondent Orders. The phrase secondary market orders as used -------------------- in this Section 7, shall not include orders placed by customers of third parties unaffiliated with E Group who introduce orders to E Group pursuant to a correspondent clearing arrangement between such third parties and E Group if E Group receives direction by the correspondent to place such order through another Market Center. (e) Trade Information. Subject to Section 9(a), Wit Group shall ----------------- forward to E Group no less than monthly, information, in a mutually agreed upon format, requested by E Group that will assist E Group in analyzing the execution quality of secondary market orders directed to Wit Group in accordance with this Section 7. Such information shall include transaction order files that provide an audit trail for each secondary market order, including the time the order was received by Wit Group, the time of execution, relevant quotation information and other information that E Group reasonably requests. Wit Group agrees to provide reports to E Group that permit E Group to analyze the elements of secondary market order execution quality, including but not limited to, price improvement/disimprovement, execution speed, liquidity enhancement and auto- execution. 8. SALES AND MARKETING; priority status. (a) General. Wit Group and E Group shall each create and develop ------- advertising and marketing products and materials, and shall engage in mutually agreed upon co- ***** Confidential treatment has been requested for the redacted portions. The confidential redacted portions have been filed separately with the Securities and Exchange Commission. 11. CONFIDENTIAL TREATMENT branding activities, to promote the strategic alliance between the parties, which shall include the display of Wit's logos and brand names, including Vostock, on the E*TRADE web site, and E*TRADE's name and logos on the Wit Group web site, in each case as appropriate (in the reasonable discretion of E*TRADE or Wit, as applicable) for the location on the website, at no charge to the other party. The parties hereto shall negotiate in good faith the terms and conditions of an agreement covering other advertising and marketing, web site presentation, potential new product development and customer presentation, all as related to the ongoing business activities between the parties contemplated by this Agreement. Following execution of this Agreement, the parties shall designate appropriate representatives of their organizations to engage in such negotiations and to establish a timetable therefor; it being the intent of the parties to enter into such agreement as soon as reasonably practicable. Wit Group and E Group shall conduct their joint advertising and marketing activities in coordination with and subject to the approval of the other party and in a manner consistent with applicable NASD rules, securities regulations and other applicable laws. (b) Approvals. Any use by Wit Group of any E Group trademark, --------- license or tradename in any sales, marketing or advertising-related materials, including without limitation, press releases, marketing literature, print advertisements and commercials, must be approved by the Chief Marketing Officer of E*TRADE or such other person as E*TRADE duly authorizes and designates to Wit Group in writing (which approval shall not be unreasonably withheld). Any use by E Group of any Wit Group trademark, license or tradename in any sales, marketing or advertising-related materials, including without limitation, press releases, marketing literature, print advertisements and commercials, must be approved by the Senior Vice President of Marketing of Wit or such other person as Wit duly authorizes and designates to E Group in writing (which approval shall not be unreasonably withheld). Wit Group and E Group shall use commercially reasonable efforts to implement and maintain sales support capability for the purpose of offering and selling Wit Group's products and services to E Group's customers. (c) Priority Status. E Group agrees that with respect to investment --------------- funds managed by Wit Group or one of its Affiliates, it shall provide a priority status for such products compared to other competitor's products that E Group is distributing at the same time. 9. ACCOUNT DATA (a) Access to Data. Prior to the occurrence of a Performance -------------- Failure or any other default by Wit Group of its obligations under this Agreement and subject to applicable law, regulatory requirements and E*TRADE's customer privacy policies, E Group shall share demand data, trading data and other customer account data as shall be determined by the parities for all retail customer accounts to which shares are allocated form Wit Group. Wit Group shall share such share demand data, trading data and other customer account data as shall be determined by the parties. Any such data shall be made available in an aggregated format such that individual account information is not made available to the other party. (b) Privacy of Consumer Financial Information. Wit Group and E ----------------------------------------- Group are mindful of the interests of customers and consumers in privacy of their financial information. Accordingly, performance of the parties obligations under this Agreement shall be made in conformity with Regulation S-P of the SEC and other applicable privacy regulations. The parties 12. CONFIDENTIAL TREATMENT agree that it is their intent in the performance of their obligations under this Agreement and in the sharing of customer and consumer financial information to utilize the exceptions for sharing of information afforded by sections 9, 10 and 11 of Regulation S-P. 10. RESEARCH PRODUCTS Wit Group shall provide any and all research products in connection with the operation of the underwriting, investment banking and financial services business of Wit Group (to a comparable extent as the written research products provided to Wit Group's institutional clients, subject to the last sentence of this paragraph) to E Group for the benefit and use by the retail customers of E Group, subject to E Group's reasonable discretion and at no cost or expense to E Group or its Affiliates or such retail customers. E Group and Wit Group will cooperate with each other to develop promptly after the closing of the Merger the regulatory and technological processes and mechanisms for providing such research to retail customers of E Group at the same time as it is provided to institutional clients of Wit Group, reflecting the parties' intent to place retail and institutional recipients of such research products in the same position from a time perspective. Wit Group shall cooperate with E Group to develop such research products for the tailored use by retail customers, making such adjustments and modifications as are reasonably necessary. Wit Group shall not distribute any such research products to Competitors of E Group without E*TRADE's prior written consent. "Competitors" shall mean direct competitors in the online brokerage industry including, but not limited to, Charles Schwab, Merrill Lynch, Ameritrade and TD Waterhouse. Wit Group shall be able to distribute its research products through all other distribution channels and independent sources of research content; provided, however, that in providing any such research products, Wit Group shall work with E Group to develop differences in the delivery of content thereof in order to provide the customers of E Group with a meaningful advantage. 11. COMMITMENT COMMITTEES. Prior to the expiration of the Exclusivity Right and provided that E Group is not then in default of any of its material obligations under this Agreement, subject to appropriate confidentiality provisions, E Group shall be entitled to participate in all meetings of Wit Group's commitment committees and shall receive all notices and materials provided to members of such committees at the same time as they are provided to other members of such committees. 12. BOARD REPRESENTATION. Prior to the occurrence of a Change of Control of E*TRADE and provided that E Group is not then in default of any its material obligations under this Agreement, and that either (a) E*TRADE continues to own at least 50% of the sum of (i) the number of shares of Common Stock of Wit (adjusted for stock splits and similar events) that it receives pursuant to the Merger and (ii) the Alliance Shares it receives pursuant to the terms of this Agreement or (b) the Exclusivity Right is then in effect; (i) E Group shall be entitled to designate for nomination one representative of E Group reasonably acceptable to Wit Group as a director of Wit Group (and Wit Group and its Board of Directors shall recommend and nominate for election of, and solicit votes in favor of election of, such nominee to the Board) and (ii) General Atlantic Partners, LLC shall be entitled to designate for nomination one representative of 13. CONFIDENTIAL TREATMENT General Atlantic Partners, LLC reasonably acceptable to Wit Group as a director of Wit Group (and Wit Group and its Board of Directors shall recommend and nominate for election of, and solicit votes in favor of election of, such nominee to the Board). It shall be deemed reasonably acceptable to Wit Group for E Group and General Atlantic Partners, LLC to designate for nomination the chief executive officer of E Group and a managing member of General Atlantic Partners, LLC, respectively. Wit Group shall use its reasonable best efforts to cause such designees to be elected to its Board of Directors. 13. INTERNATIONAL ALLIANCE. Wit Group and E Group agree that Wit Group, whether directly or through its affiliates, shall have a non-exclusive right to distribute its equity security offerings originating in foreign countries through E Group, its subsidiaries and affiliates, on economic terms that are customary for similar arrangements in such countries or if no such custom exists, substantially similar to those applicable to comparable transactions in the United States, except to the extent that E Group or such subsidiary or affiliate is subject, as of the date of this Agreement, to a contractual obligation that prevents it from entering into such an arrangement and such obligation has not been terminated. Wit Group and E Group shall use commercially reasonable efforts to negotiate an extension of the exclusivity provisions of the strategic alliance contemplated by this Agreement to the comparable activities of Wit Group and E Group in countries other than the United States in which they now or in the future might operate. In addition, E Group shall make a good faith effort to include Wit Group in offerings of issuers organized outside the United States with respect to securities offered and sold within the United States if the relevant per unit selling concession or similar economic consideration payable to E Group (after the potential inclusion of Wit Group in a particular offering) with respect to its United States sales is no less than that otherwise available to E Group. Notwithstanding the foregoing, this Agreement shall not prohibit E Group from either directly or indirectly engaging in such transactions. 14. BUSINESS NAME. Simultaneously with, or immediately following, the closing of the Merger, Wit shall, and shall cause Wit SoundView Corp., as the successor to E*OFFERING Corp. to unconditionally and irrevocably (i) forever set aside, and permanently discontinue any and all use in and to (and shall not assign, transfer or deliver to any third party, other than E*TRADE) the "E*OFFERING" corporate and trade name, and the E*OFFERING logo, or any part or combination of the "E*OFFERING" corporate and trade name, and the E*OFFERING logo, (ii) forever set aside, and permanently discontinue any and all use in and to, (and shall not assign, transfer or deliver to any third party, other than E*TRADE) the E*OFFERING website address, and (iii) destroy all documents, business stationery and cards, marketing literature, print advertisements, recordings and other physical indicia or embodiments of the "E*OFFERING" name or logo (provided that Wit Group shall be entitled to retain a copy of all books and records necessary for tax, accounting and corporate record keeping for non-commercial purposes). 14. CONFIDENTIAL TREATMENT 15. CHANGE IN CONTROL. (a) Change in Control of E*TRADE. In the event of any Change in ---------------------------- Control of E*TRADE during any period in which the Exclusivity Right is in effect and the Person who acquires control of E*TRADE or is its successor either breaches its obligations as the successor to E Group or does not honor the Exclusivity Right (or, in the case of a Person who acquires control of E*TRADE, fails to provide contractual assurances that it will cause E Group to honor the Exclusivity Right or satisfy such obligations) (all such Persons and successors collectively being referred to as the "E Group Successor") or materially breaches its obligations under Section 3 of this Agreement, (i) Wit Group shall continue to have the right (on a non-exclusive basis) to provide to E Group securities of all types for offering by E Group to its retail customers under the terms of this Agreement for a period of two years following such Change in Control as if the E Group Successor were E Group, but shall no longer be obligated to offer all of its Retail Securities (other than Excluded Securities) exclusively to customers of E Group and will no longer be the exclusive provider of Retail Securities to customers of the Successor; (ii) E Group or the E Group Successor shall pay to Wit the E Group Liquidated Damages Amount as liquidated damages and not as a penalty, in either (A) United States dollars or (B), subject to the following sentence, at its option, in the same nature, form and value as the consideration received by E*TRADE in the Change in Control transaction, if any, and (iii) Wit shall be entitled to transfer to it, free and clear of all liens, encumbrances and claims, title to all shares of common stock of Wit remaining at such time in the escrow established pursuant to Section 4.2 of the Merger Agreement. In lieu of accepting the same consideration that E- TRADE received in such Change in Control transaction, Wit Group may elect to receive up to that number of Wit Shares then held by E Group equal in value to the E Group Liquidated Damages Amount. Any consideration other than cash must be freely transferable, free and clear of all liens, encumbrances, restrictions and claims, so that Wit Group may immediately convert such consideration (other than Wit Shares) into cash. Value for such consideration shall be the Closing price for the primary trading session on the primary market for such security on the last business day immediately preceding payment to Wit Group; provided, however, that the value per share of Wit Common Stock shall not be less than $10.25 (as adjusted for stock splits and similar changes in capitalization). The option of paying the E Group Liquidated Damages Amount in other than cash applies only when such consideration involves fully registered and freely marketable common or preferred stock. The "E Group Liquidated Damages Amount" means the sum of $120,000,000, reduced by $3,333,333 at the end of each calendar month, commencing the month in which the Merger Closing occurs and continuing until the E Group Liquidated Damages Amount equals $80,000,000. (b) Change in Control of Wit. In the event of a Change in Control ------------------------ of Wit during any period in which the exclusivity rights of E Group are in effect and the Person who acquires control of Wit or is its successor either breaches its obligations as the successor to Wit Group or does not assume the obligations of Wit Group under this Agreement (or, in the case of a Person who acquires control of Wit Group, fails to provide contractual assurances that it will cause Wit to satisfy such obligations) (all such Persons and successors collectively being referred to as the "Wit Group Successor") or materially breaches its obligations under Section 3 of this Agreement (i) Wit or the Wit Group Successor shall continue to offer (on a non-exclusive basis) securities to customers of E Group through E Group, and E Group shall no longer be obligated to utilize the 15. CONFIDENTIAL TREATMENT Wit Group Successor as its exclusive provider of Retail Securities for offering and sale to customers; and (ii) the Wit Group Successor shall pay to E*TRADE the Wit Group Liquidated Damages Amount as liquidated damages and not as a penalty, in either (A) United States dollars or (B), subject to the following sentence, at its option, in the same nature, form and value as the consideration received by Wit in the Change in Control transaction, if any, and (iii) E*TRADE shall be entitled to transfer to it, free and clear of all liens, encumbrances and claims, of title to it to all shares of Common Stock of Wit that it beneficially owns remaining at such time in the escrow established pursuant to Section 4.2 of the Merger Agreement. Any consideration other than cash must be freely transferable, free and clear of all liens, encumbrances, restrictions and claims, so that E Group may immediately convert such consideration into cash. Value for such consideration shall be the closing price for the primary trading session on the primary market for such security on the last business day immediately preceding payment to E Group. The option of paying the Wit Group Liquidated Damages Amount in other than cash applies only when such consideration involves fully registered and freely marketable common or preferred stock. The "Wit Group Liquidated Damages Amount" means the sum of $75,000,000, reduced by $2,083,333 at the end of each calendar month, commencing the month in which the Merger Closing occurs and continuing until the Wit Group Liquidated Damages Amount equals $50,000,000. (c) Payment of the E Group Liquidated Damages Amount and the transfer of the shares of Wit common stock referred to in Section 15(a)(iii) shall constitute the sole and exclusive remedy of Wit with respect to any Change in Control of E*TRADE or its subsidiaries. Payment of the Wit Group Liquidated Damages Amount shall constitute the sole and exclusive remedy of E*TRADE with respect to any Change in control of Wit Group or its subsidiaries. The parties hereto expressly agree that they have arrived at the foregoing amounts as reasonable estimates of their total damages in light of their inability to agree on the amount of actual damages each would incur in the event of a breach or non-assumption by the other party following a Change in Control of such other party and their agreement that it would be extremely difficult to determine such damages at the time in light of the consideration being paid in connection with this Agreement, the scope of their business relationship, the exclusive nature of a portion of their business relationship, the creation of goodwill and the dynamic nature of the businesses they are in. 16. DISPUTE RESOLUTION. (a) Disputes. If despite the use of all reasonable efforts by Wit -------- Group and E Group, they are unable to resolve any disagreement, dispute, controversy or claim arising under or related to this Agreement (a "Dispute") under or regarding this Agreement relating to the Strategic Alliance, either Wit Group or E Group may, at any time and from time to time, provide written notice to that effect to the other with a reasonably complete description of the nature of the Dispute, whereupon the Chief Executive Officers of each of Wit and E*TRADE shall themselves use all commercially reasonable efforts to reach agreement or resolve such Dispute. If such Dispute remains unresolved after the 30th day after receipt by Wit or E*TRADE of such notice, either party may refer such Dispute to binding arbitration pursuant to Section 16(b). In the case of a Dispute consisting of failure to reach agreement on a Dispute, the arbitrator(s) shall select from among the courses of action or inaction proposed by each party that 16. CONFIDENTIAL TREATMENT course of action which the arbitrator(s) believe would best further the objective of this Agreement. In the case of a Dispute over the interpretation of this Agreement, the arbitrator(s) shall rule in accordance with his interpretation thereof under applicable law. (b) Arbitration. All Disputes and all other disputes and controversies ----------- of every kind and nature between the parties hereto arising out of or in connection with this Agreement as to the construction, validity, interpretation or meaning, performance, non-performance, enforcement, operation, or breach, shall, after the procedures required by Section 16(a) above, be submitted to arbitration pursuant to the following procedures in accordance with the provisions of the NASD Code of Arbitration Procedures. (c) Disputes Over the Details of Implementation. The Parties ------------------------------------------- recognize that the precise terms of the contemplated marketing agreement referred to in Section 8(a) and the basis of exclusivity for private placements referred to in Section 4(e) have not been determined, and that in negotiating such terms disagreements will inevitably occur. To assure that these disagreements do not delay or hinder the strategic alliance, the parties agree that any disagreement over the details of negotiations of such matters shall be decided by a committee initially consisting of Christos M. Cotsakos, the designee of E*TRADE, Steven M. Gluckstern, the designee of Wit Group and William Ford, the designee of General Atlantic Partners, LLC (the "Committee"). All decisions of this Committee shall be by majority vote and shall be binding on each party; provided, however, that if there is a change in the identity of the Wit Group representative that is not consented to by the E Group representative, then all decisions of the Committee must be unanimous. Either party may bring a disagreement to the Committee and the Committee shall meet in person or by telephone to resolve the disagreement within ten business days of written notification to the members of the Committee that a dispute exists. All decisions must be made within ten business days of such meeting. Each party recognizes that the members of the Committee are subject to multiple conflicts of interest, and each hereby waives such conflicts and agrees to indemnify each member to the fullest extent permitted by Delaware law as if such member were acting as a director of such party at all times. If any of the designated parties resigns from or is otherwise unable to serve on the Committee, the remaining members of the Committee shall choose a successor from a list of three names submitted by the employer of the member that is no longer serving, at least one of whom must be the CEO or comparable executive for that entity. 17. SUBLEASE. E Group and Wit shall enter into non-binding negotiations for the possible sublease of a mutually agreed portion of the property located at 123 Townsend, San Francisco, CA 94107. 18. TERM; TERMINATION. (a) Term. The term of this Agreement shall remain in effect until ---- the fifth anniversary of the Start Date, unless terminated earlier in accordance with the terms of this Agreement. On or after the fourth anniversary of the closing of the Merger, the Agreement shall be automatically renewed on a daily basis unless and until nine (9) months notice of cancellation 17. CONFIDENTIAL TREATMENT is provided by either party to the other party. Notice of cancellation pursuant to the preceding sentence may be given at any time during the term of this Agreement. (b) Automatic Termination. This Agreement shall be automatically --------------------- terminated if either the Merger Agreement or the Account Transfer Agreement is terminated in accordance with their respective terms. In the event of such early termination of this Agreement, the rights and obligations of the respective parties under this Agreement shall terminate and be of no further force or effect. (c) Termination for Breach. This Agreement may be terminated at ---------------------- any time by (i) Wit Group, on the one hand, or by E*TRADE on the other hand, if there shall have been a material breach of any of the covenants or agreements set forth in this Agreement on the part of E Group (in the case of termination by Wit Group) or on the part of Wit Group (in the case of termination by E Group), which breach shall not have been cured within thirty (30) business days following receipt by the breaching party of written notice of such breach from the other and a determination through the last step of the dispute resolution process taken that such party has materially breached the Agreement and has not cured such breach or (ii) by Wit, on the one hand, or by E*TRADE on the other hand in the event that the NASD, the Securities Exchange Commission or any other regulatory body, places a material restriction on the business of the other that materially limits the other's ability to perform its obligations hereunder. 19. LETTER OF INTENT. The binding letter of intent dated January 12, 2000 between E*OFFERING Corp. and E*TRADE (the "Letter of Intent") shall be deemed terminated and superceded in its entirety by this Agreement upon the closing of the Merger. Notwithstanding anything to the contrary in this Agreement, the Letter of Intent shall remain in full force and effect until the closing of the Merger and the performance by E Group of its obligations pursuant to the Letter of Intent shall not be deemed to be a breach by E Group of its obligations set forth in this Agreement, including without limitation, the exclusivity provision set forth in Section 3 hereof. 20. RIGHT OF INSPECTION; REPORTS. (a) Right of Inspection. At all reasonable times during the term ------------------- of this Agreement, E Group and Wit shall each have the right to inspect and copy, through its duly authorized representatives, books, records and accounts of the other in order to determine compliance by the other with the terms and conditions of this Agreement. (b) Yearly Reports. During the terms of this Agreement, each -------------- party shall deliver to the other, within thirty (30) calendar days after the end of each calendar year, a report (a "Yearly Report") certified by its chief financial officer of setting forth the following information: (i) statistical data relating to the performance by it of its agreements hereunder; (ii) statistical data relating to the compliance by it with its exclusivity requirements set forth in Section 3; and 18. CONFIDENTIAL TREATMENT (iii) a schedule of every public offering, private placement or other securities offering in which it or any of its Affiliates participated in as an underwriter, placement agent, broker-dealer, selling group member, distributor or otherwise, including whether it acted in the capacity of lead managing or co-managing underwriter (collectively, the "Compliance Statistics"). (c) Quarterly Reports. During the term of this Agreement, each party ----------------- shall deliver to the other within twenty (20) calendar days after the end of each of the first three calendar quarter of each calendar year, a report (a "Quarterly Report") certified by its chief financial officer setting forth the Compliance Statistics. (d) Confidentiality of Reports. Except as otherwise required by law, -------------------------- by governmental or regulatory authorities, or in response to court order, or upon the prior written consent of a party, all non-public information included in all Yearly Reports and Quarterly Reports shall be kept confidential by the other and its directors, officers, employees, agents and representatives, shall not be disclosed to any other person or entity, and shall only be used for the purposes provided herein. 21. MISCELLANEOUS. (a) Notices. All notices, demands or other communications to be given ------- or delivered under or by reason of the provisions of this Agreement shall be in writing and shall be deemed to have been given when delivered personally to the recipient, one (1) day after delivery to a reputable overnight courier service (charge prepaid) for overnight delivery to the recipient, three (3) days after deposit with the U.S. Postal Service for mailing to the recipient by certified or registered mail, return receipt requested and postage prepaid, or when transmitted by facsimile (with request for immediate confirmation or receipt in a manner customary for communications of such type and with physical delivery of the communication being made by one of the other means specified in this Section as promptly as practicable thereafter to the following addresses, respectively, or to such alternative address as either party may furnish in writing to the other from time to time: If to E*TRADE or E Group: If to Wit or Wit Group: E*TRADE Group, Inc. Wit SoundView Group, Inc. 4500 Bohannon Drive 826 Broadway Menlo Park, California 94025 New York, New York 10003 Fax: (650) 331-6803 Fax: (212) 253-5289 Attn: Thomas A. Bevilacqua Attn: Mark F. Loehr 19. CONFIDENTIAL TREATMENT with a copy (for legal notices) to: with a copy (for legal notices) to: Brobeck, Phleger & Harrison LLP Wit SoundView Group, Inc. Two Embarcadero Place 826 Broadway 2200 Geng Road New York, New York 10003 Palo Alto, CA 94303-0913 Attn: Lloyd H. Feller, Esq. Attn: Curtis L. Mo, Esq. Fax: (212) 253-5289 Fax: (650) 496-2736 (b) Successors and Assigns. This Agreement may not be assigned or ---------------------- delegated, in whole or in part, by any party hereto without the prior written consent of the other party hereto; provided, however, that this Agreement may be assigned to a successor or acquiring entity without such consent in the event of a Change in Control of the assigning party. Subject to the foregoing, this Agreement shall be binding upon the inure to the benefit of the parties hereto and their respective successors and permitted assigns. (c) Severability. In the event that any provision of this Agreement ------------ shall be declared invalid or unenforceable by a court of competent jurisdiction in any jurisdiction, such provision shall, as to such jurisdiction, be ineffective to the extent declared invalid or unenforceable without affecting the validity or enforceability of the other provisions of this Agreement, and the remainder of this Agreement shall remain binding on the parties hereto. (d) Section Headings. Section heading in this Agreement are inserted ---------------- for convenience of reference only, and shall not affect the interpretation of this Agreement. (e) Governing Laws. This Agreement shall in all respects be construed -------------- in accordance with and governed by the laws of the State of New York without regard to the conflicts or choice of law provisions thereof. Each of the parties hereto irrevocably consents to the exclusive jurisdiction of any court located within the State of California or the State of New York, in connection with any matter based upon or arising out of this Agreement or the matters contemplated herein, agrees that process may be served upon them in any manner authorized by the laws of the State of California or the State of New York for such persons and waives and covenants not to assert or plead any objection that they might otherwise have to such jurisdiction and such process. (f) Entire Agreement. This Agreement (including the exhibits hereto ---------------- and the documents and instruments referred to herein) contains the entire agreement and understanding of the parties with respect to the subject matter hereof and supersedes all prior written or oral agreements and understandings with respect thereto. (g) Amendments; Waivers. This Agreement may not be changed, amended, ------------------- terminated, augmented, rescinded, or discharged (other than by performance), in whole or in part, except by a writing executed by the parties hereto, and no waiver of any of the provisions or conditions of this Agreement or any of the rights of a party hereto shall be effective or binding unless such waiver shall be in writing and signed by the party claimed to have given or consented thereto. Except to the extent that a party hereto may have otherwise agreed in writing, no waiver by that party of any condition of this Agreement or breach by the other party of any of 20. CONFIDENTIAL TREATMENT its obligations or representations hereunder or thereunder shall be deemed to be a waiver of any other condition or subsequent or prior breach of the same or any other obligation or representation by the other party, nor shall any forbearance by the first party to seek a remedy for any noncompliance or breach by the other party be deemed to be a waiver by the first party of its rights and remedies with respect to such noncompliance or breach. (h) Representations and Warranties. E*TRADE hereby represents to Wit ------------------------------ that that all of the statements contained in Annex B to this Agreement are true and correct as of the date of this Agreement (or, if made as of a specified date, as of such date). (i) Counterparts. This Agreement may be executed in one or more ------------ counterparts, each of which shall be deemed an original and both of which together shall be considered one and the same Agreement. (j) Mutual Cooperation. The parties shall cooperate in good faith and ------------------ take such other commercially reasonable actions as are reasonably necessary to effect the intents and purposes of this Agreement and the strategic alliance contemplated hereby. 21. CONFIDENTIAL TREATMENT IN WITNESS WHEREOF, the parties hereto have caused this Strategic Alliance Agreement to be duly executed and delivered on its behalf as of the date first written above. E*TRADE GROUP INC. WIT SOUNDVIEW GROUP, INC. By: __________________________________ By: __________________________________ Name: Name: Title: Title: 22. CONFIDENTIAL TREATMENT ANNEX A FORM OF WARRANT 23. CONFIDENTIAL TREATMENT ANNEX B REPRESENTATIONS AND WARRANTIES OF E*TRADE Capitalized terms used in this Annex B but not otherwise defined in the Agreement shall have the meanings set forth in the Merger Agreement. 1. Authorization; Validity of Agreement. E*TRADE has full corporate power and authority to execute and deliver this Agreement , and to consummate the transactions contemplated hereunder. The execution, delivery and performance by E*TRADE of this Agreement , and the consummation by it of the transactions contemplated hereby have been duly authorized by the Board of Directors of E*TRADE and no other corporate action on the part of E*TRADE is necessary to authorize the execution and delivery by E*TRADE of this Agreement or the consummation by E*TRADE of such transactions. This Agreement has been duly executed and delivered by E*TRADE and, assuming due and valid authorization, execution and delivery thereof by Wit, this Agreement is the valid and binding obligations of E*TRADE enforceable against E*TRADE in accordance with its terms. 2. Consents and Approvals; No Violations. Except for the filings, permits, authorizations, consents and approvals as may be required under, and other applicable requirements of, the Advisers Act, the Exchange Act, the Securities Act, the rules and regulations of the NASD, the HSR Act, state securities or Blue Sky laws, Delaware Law and California Law, none of the execution, delivery or performance of this Agreement by E*TRADE, the consummation by E*TRADE of the transactions contemplated hereby or compliance by E*TRADE with any of the provisions hereof shall (i) conflict with or result ing any breach of any provision of the Certificate of Incorporation, the Bylaws or similar organizational documents of E*TRADE, (ii) require any filing with, or permit, authorization, consent or approval of, any Governmental Entity, (iii) result in a violation or breach of, or constitute (with or without due notice or the passage of time or both) a default (or give rise to any right of termination, amendment, cancellation or acceleration) under any of the terms, conditions or provisions of any material agreement or contract to which E*TRADE is a party (the "E*TRADE Agreements"), or (iv) violate any order, writ, injunction, decree, statute, rule or regulation applicable to E*TRADE, any to which E*TRADE is a party or by which any of the assets of it is bound, excluding from the foregoing clauses (ii), (iii) and (iv) such violations, breaches or defaults which would not, individually or in the aggregate, have a material adverse effect on E*TRADE and its Subsidiaries, taken as a whole. There are no third party consents or approvals required to be obtained under any of E*TRADE Agreements prior to the consummation of the transactions hereunder, except for such consents and approvals the failure of which to be obtained would not, individually or in the aggregate, have a material adverse effect on E*TRADE and its Subsidiaries, taken as a whole. 24. -----END PRIVACY-ENHANCED MESSAGE-----