Expenses
Our operating expenses largely consist of employee compensation and benefits, payments for order flow and execution and clearance fees. A substantial portion of these expenses is variable in nature. Employee compensation and benefits expense, which is largely profitability-based, fluctuates, for the most part, based on changes in net trading revenue and our profitability. Payments for order flow fluctuate based on share volume, the mix of market orders and limit orders and the mix of orders received from broker-dealers who accept payments for order flow. Execution and clearance fees fluctuate primarily based on changes in trade and share volume, the mix of trades of OTC securities compared to listed securities and the clearance fees charged by clearing brokers.

Employee compensation and benefits expense primarily consists of salaries and wages paid to administrative and customer service personnel and profitability-based compensation, which includes compensation and benefits paid to market-making and sales personnel based on their individual performance, and incentive compensation paid to all other employees based on our overall profitability. Profitability-based compensation represented 78%, 80% and 85% of total employee compensation and benefits expense for the years ended December 31, 1997, 1998 and 1999 respectively. We have grown from 317 employees at December 31, 1997 to 446 and 615 employees as of December 31, 1998 and 1999, respectively. Approximately 80% of our employees are directly involved in market-making, sales or customer service activities. Compensation for employees engaged in market-making and sales activities, the largest component of employee compensation and benefits, is determined primarily based on a percentage of gross trading profits net of expenses including payments for order flow, execution and clearance costs and overhead allocations. Employee compensation and benefits will, therefore, be affected by changes in payments for order flow, execution and clearance costs and the costs we allocate to employees engaged in market-making and sales activities.

Payments for order flow represent customary payments to broker-dealers, in the normal course of business, for directing their order flow to us. As a result of the new Order Handling Rules implemented by the SEC in 1997, we changed our order flow payment policy from paying broker-dealers for substantially all order executions, to paying broker-dealers only for orders which provide us with a profit opportunity. For example, we make payments on market orders, but do not pay on limit orders. Payments for order flow change as we modify our payment formulas and as our percentage of customers whose policy is not to accept payments for order flow varies.

Execution and clearance fees primarily represent clearance fees paid to clearing brokers for OTC and listed securities, transaction fees paid to Nasdaq, and execution fees paid to third parties, primarily for executing trades in listed securities on the NYSE and AMEX and for executing orders through electronic communications networks, commonly referred to as ECNs. Execution and clearance fees are higher for listed securities than for OTC securities. Due to our significant growth in share and trade volume, we have been able to negotiate favorable rates and volume discounts from clearing brokers and providers of execution services. As a result of these lower rates and discounts and the increase in trade volume of OTC securities as a percentage of total trade volume, execution and clearance fees per trade have decreased.

Communications and data processing expense primarily consists of costs for obtaining stock market data and telecommunications services.

Depreciation and amortization expense results from the depreciation of fixed assets purchased by us or financed under a capital lease, and the amortization of goodwill, which includes contingent consideration, primarily resulting from the acquisition of the listed securities market-making businesses of Trimark and Tradetech Securities, L.P. which we acquired in November 1997.

Occupancy and equipment rentals expense primarily consists of rental payments on office and equipment leases.

Professional fees primarily consist of fees paid to computer programming and systems consultants, as well as legal fees and other professional fees.

Business development expense primarily consists of advertising costs and marketing expenses, including travel and entertainment expenses and promotion costs.

Interest on Preferred Units represents required interest payments on our Mandatorily Redeemable Preferred A and B Units at a rate approximating the Federal Funds rate. On April 15, 1998, we redeemed all of the remaining outstanding Preferred A Units for $12.5 million in cash. On April 15, 1998, we redeemed $1.2 million of Preferred B Units and, on July 17, 1998, we used $13.8 million of the proceeds from our initial public offering to redeem all of the remaining outstanding Preferred B Units.

Merger-related expenses primarily consist of investment banking, legal and accounting costs incurred in connection with our merger with Arbitrade Holdings LLC. This transaction closed in January 2000.

Other expenses primarily consist of administrative expenses and other operating costs incurred in connection with our business growth, as well as directors' fees and restricted stock granted to directors in connection with the initial public offering.