UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

Form 10-K

Commission file number: 001-32419

optionsXpress Holdings, Inc.

(Exact name of registrant as specified in its charter)

Securities Registered Pursuant to Section 12(b) of the Act:

Common Stock, Par Value $.0001 Per Share

Securities Registered Pursuant to Section 12(g) of the Act:

None

          Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes o         No þ

         Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes o         No þ

         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 it was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes þ         No o

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

         Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (Check one):

         Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.    Yes o         No þ

         As of March 15, 2006, there were 62,286,194 shares of optionsXpress Common Stock $0.0001 par value outstanding. The aggregate market value of the voting stock held by non-affiliates of the registrant was approximately $633 million based on the closing sale price of such stock as reported by the Nasdaq National Market on March 15, 2006, assuming that all shares beneficially held by executive officers and members of the registrant’s Board of Directors are shares owned by “affiliates,” a status which each of the executive officers and directors may individually disclaim.

DOCUMENTS INCORPORATED BY REFERENCE

           Portions of the Definitive Proxy Statement relating to the registrant’s 2006 Annual Meeting of Stockholders to be filed hereafter (incorporated into Part III hereof).

TABLE OF CONTENTS

Forward Looking Statements

      This Annual Report on Form 10-K, including the sections “Additional Factors That Might Affect Future Results,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business,” contains forward-looking statements. These statements relate to future events or our future financial performance and involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements. You are urged to carefully consider these risks and factors included in this Form 10-K Annual Report. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “intends,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” “continue” or the negative of these terms or other comparable terminology. These statements are only predictions. Actual events or results may differ materially. The forward-looking statements made in this Form 10-K Annual Report relate only to events as of the date on which the statements are made, and we undertake no ongoing obligation, other than any imposed by law, to update these statements. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements.

      Forward-looking statements include, but are not limited to, the following:

      The forward-looking statements made in this Annual Report relate only to events as of the date on which the statements are made. as required by law, we assume no obligation to update any forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in any forward-looking statements, even if new information becomes available in the future.

PART I

Overview

      We offer a comprehensive suite of brokerage services for option, stock, futures, mutual fund, and fixed-income investors. While our initial focus was on the rapidly expanding listed equity options market, we have been recognized as offering the leading online retail brokerage platform for the rapidly expanding listed equity options market, based on the quality of our proprietary technology and our customer experience. We were selected by Barron’s as “Best Online Broker” in 2003, 2004 and 2005, by Forbes as “Best of the Web, Favorite Options Site” in 2004, and by SmartMoney as “Best Discount Broker” in 2004. We commenced doing business as optionsXpress, Inc. in February 2000 and opened our first customer account in December 2000. Since that time, we have grown to over 160,000 customer accounts.

Market Opportunity

      Approximately 15 million households have online brokerage accounts (13% of all U.S. households), although nearly 70% of such households execute fewer than five trades per year. The number of

households with online brokerage accounts is forecasted to increase by 11.9% per year to approximately 26 million by 2008 (22% of all U.S. households). The total U.S. listed options market has grown by 22.5% per year over the past 10 years. Despite this growth, it is estimated that only 9% of online accounts are authorized to trade options.

      Our option trades represented approximately 3% of all listed U.S. options volume for the year ended December 31, 2005. We believe this makes us one of the largest retail online options brokers. Our revenue consists primarily of commissions from customers’ trades of options, stocks, mutual funds and fixed-income products. For the year ended December 31, 2005, our daily average revenue trades, which are our total revenue-generating trades for a period divided by the number of trading days in that period, were approximately 19,600, compared to approximately 13,600 for the year ended December 31, 2004. Option trades represent approximately 76% of our customers’ trades, with approximately 23% coming from stocks and 1% from futures, mutual funds and fixed-income products.

Platform

      Our cost efficient and scalable brokerage platform reflects the combination of our advanced technology and highly-responsive customer service. Our innovative browser-based technology delivers an array of differentiating trading tools, allowing both retail and professional investors to identify, analyze and execute a wide range of investment strategies. Many of these internally developed tools, which enhance our customers’ experience, are not available from other online or full service brokers. In addition, our real-time customer service approach, featuring what we call “point of contact resolution,” is designed to ensure that customer questions are answered quickly and during the initial contact, yields a high degree of customer satisfaction and loyalty.

      Our business generates strong cash flows and wide margins compared to many of our competitors. Our expense structure is largely variable based on commissions generated and benefits from our low-cost platform, relatively low account acquisition cost and loyal customer base. In addition, all of our tools and services are offered online, eliminating the cost of maintaining retail locations. The option trading portion of our business generates a recurring revenue stream because when options expire, investors need to acquire new positions if they wish to stay invested. We have experienced growth in revenue and market share every year since inception and have been net income and cash flow positive since the first quarter of 2002. We generated $129.0 million of revenue for the year ended December 31, 2005 with $80.3 million of income before income taxes and $48.7 million of net income.

Growth Strategy

      We continue to substantially increase our number of brokerage accounts, average daily trading volume and total assets in client accounts. The key elements of our growth strategy are as follows:

      We have generated rapid growth since inception by appealing to the growing retail options market. We aim to continue to expand our customer base by both gaining market share and accelerating the growth of retail options trading generally. Our strategy for gaining market share includes making effective use of our customer-driven online brokerage platform and implementing our targeted marketing strategy. To accelerate the growth of options trading, we will continue to cultivate new retail options investors by making options trading more intuitive and accessible and through our educational initiatives.

      We plan to continue penetrating the much larger stock, mutual fund and fixed-income markets. The key components of our platform that have made us successful in the options markets are also applicable to these other markets. Furthermore, since customers who trade options often trade the underlying securities,

we have ample opportunity to cross-sell stocks, mutual funds and fixed-income products. We have seen the percentage of our trades from products other than options increase in each of the last 2 years.

      In 2005, we launched a web-based retail futures trading platform. Our customers can now trade futures side-by-side with equity positions, from one account at optionsXpress. Based on the continued growth and innovation in the various futures exchanges, we believe retail investors will continue their adoption of using futures as a part of their investing strategy. In addition, there are significant opportunities for us to expand into other areas of specialty brokerage, including foreign exchange and other derivative markets where our technologies can be easily adapted.

      Launched in March 2004, our brokersXpress subsidiary has allowed us to expand beyond the self-directed investor market. brokersXpress offers an extension of our optionsXpress platform geared towards independent registered representatives and registered investment advisors. We offer these professionals a complete, easy-to-set-up account and execution management platform, including all of the features of our retail platform.

      We believe this business represents a significant growth opportunity, as brokersXpress provides access to the non-self-directed retail investor base via financial advisors. Industry-wide, total assets under management by independent registered representatives and registered investment advisors have grown at a rate of approximately 19% per year in the last six years to the current level of over $800 billion. In addition, the number of licensed registered representatives at the top 25 independent broker-dealers has grown at an annual rate of approximately 14% over the last five years to over 60,000 representatives today. While still at an early stage, we aim to continue to expand the distribution of our platform to institutional investors such as hedge funds and money managers.

      In 2004, we purchased a minority interest in an Australian registered broker and in 2005 we obtained a license to perform brokerage services in Canada. We intend to continue expanding our international customer base through cost-effective targeting of online customers in economically and legally compatible foreign jurisdictions where there is an interest in accessing U.S. markets.

Our Brokerage Platform

      We have developed an award-winning, comprehensive and technologically advanced, yet easy-to-use brokerage platform. Our brokerage platform caters to both novice and expert investors. Novice investors are provided with, among other things, both educational and research material and comprehensive customer support all via a customer-friendly interface. Trading features more relevant to expert traders include data streaming, charting services and advanced order services.

      Our software is efficient and user-friendly:

      The end result is a highly customizable platform best represented by our “Three E’s” customer-centric approach:

      Our efficient, in-house development capabilities allow us to continuously innovate and improve our platform with frequent enhancements such as:

Customer Service

      Our customer service approach, which is embedded in our culture, has been a significant factor in our success. We strive to provide excellent service during the customer’s entire investing experience, from education to evaluation to execution to post-trade monitoring.

      Our customer-friendly website contains a self-help library of user guides and customer message boards. For customers requiring more personalized attention, customer service is available via live individual web chat, e-mail and telephone. We have over 72 dedicated customer service employees located in Chicago, Illinois and El Paso, Texas. New customer service employees attend a three-week training program, and we also provide ongoing training for all customer service employees.

      We are responsive to our customers, aiming for a real-time response to all customer inquiries. We respond to over 50% of customer inquiries via the Internet, facilitating individualized service in a timely and cost-effective manner. Customer e-mail inquiries are routed by managers to the appropriate business area for timely and accurate response. Communications with customers are continually reviewed and critiqued for quality assurance. The result is what we call “point-of-contact resolution,” which we define as providing each customer with an answer without having to speak to multiple people, repeat the question or call back.

      We also continually update our technology to maximize the customer’s experience. Customer questions are tracked and, if repeated, analyzed to determine how best to clarify the point or answer the inquiry during the customer’s online experience. This analysis is used to improve and enhance our website.

Marketing

      The goal of our marketing programs is to cost-effectively attract new customers, while further developing the optionsXpress brand. Our marketing targets long-term investors, rather than the daytrader. To employ our marketing strategy, we use a mix of “grass roots,” online and traditional advertising targeted at the types of customers we seek to attract. This strategy has enabled us to attract loyal customers at a significantly lower cost per account than our major competitors. We believe that the rapid growth in our accounts and industry accolades evidence the powerful brand we have built.

      Our “grass roots” marketing strategy, which has been crucial to our success, consists of a strategic public and media relations program and channel partnerships. Our public and media relations initiative has been very successful in positioning us as an expert industry resource and broadening our customer base. We use channel partnerships, such as relationships with securities exchanges, options educators, investment publishers, software vendors and financial portals, to distribute our product to new customers. These relationships also allow us to reach existing retail options investors through a source that is familiar to them. In addition, we frequently appear at various industry events, trade conferences and investor clubs.

These events further contribute to our “grass-roots” marketing by allowing us to discuss new applications and functionality available to investors on our website in a large forum.

      Our advertising strategy focuses on our unique online trading tools and industry awards we have received. Our advertising is primarily conducted through third-party websites, though we also place print advertisements in a broad range of business, technology and financial publications, including The Wall Street Journal, Barron’s, Investors’ Business Daily and Forbes. To keep costs low, our advertising is highly targeted to the types of investors we believe will be most profitable.

      Our advertising directs interested prospects to our website for additional information, as opposed to generating primarily telephone-based inquiries. At our website, prospective customers can get detailed information on our services and fees, use an interactive demonstration system, request additional information and complete an account application online. As the final step in our marketing process, we improve the conversion rate of prospective customers into funded accounts by mailing registration kits to investors who have registered online. In addition, customers can print a pre-paid Federal Express label at the end of their registration process for easy submission of their applications.

Broker-Dealer Operations

      We aim to provide customers with the best execution of each trade, which we define as the fastest fill at the best price. We believe we differentiate ourselves from our major competitors by incorporating our dynamic technology into our order management and execution review process. For example, we have designed monitors that warn us of any instances where an order can be filled on another exchange or the best price was not achieved on a particular trade. These real-time alerts allow us to proactively represent orders, seek adjustments on orders that were not completed at the best available price, and recognize exchange issues that might warrant a routing change.

      We receive the vast majority of our customer orders through the Internet. Market orders for exchange-listed securities, other than those with special qualifiers or that are outside of market size limitations, are executed at the National Best Bid and Offer (“NBBO”), or better at the time of receipt by the relevant market maker or exchange. Eligible orders are exposed to the marketplace for possible price improvement or enhanced liquidity, subject to the NBBO. Limit orders are executed based on an indicated price and time priority. Market orders for Nasdaq securities, other than those that are outside of market size limitations, are executed at the Best Bid/ Offer (inside market) or better at the time of receipt by the relevant market center. Eligible orders are subject to possible price improvement in the marketplace.

      We introduce securities accounts to our clearing agents on a “fully disclosed” basis. This means that the clearing agents hold customer cash and equities in accounts unique to each customer, receive and deliver securities after execution, settle and administer transactions, extend credit for margin and leverage, generate customer statements, arrange for or directly provide any related banking services and perform other back-office functions. We reconcile account and trade information with the clearing agents on a daily basis. We do not rely on our clearing agents with respect to the operation of our website, our real-time account, trade and market data, or our execution routing.

      In September 2004, we entered into a clearing agreement with GSEC, a wholly owned subsidiary of The Goldman Sachs Group, Inc., pursuant to which GSEC acts as our primary clearing agent. GSEC is regulated by the New York Stock Exchange, the Options Clearing Corporation, the NASD, the Commodity Futures Trading Commission (“CFTC”), and other self-regulatory organizations (“SROs). We believe that GSEC’s financial position and operational capabilities are very strong. We also clear through Legent Clearing, LLC (“Legent”). As clearing brokers, GSEC and Legent are subject to regulation by the Securities and Exchange Commission (“SEC”) and other regulatory requirements,

including those imposed by clearing organizations of which it is a member. The financial requirements imposed by such clearing organizations can exceed those imposed by the SEC. We may, later this year, begin self-clearing of securities trades using Sungard Financial System’s Phase3 trade processing and settlement software system to support those operations.

      We provide eligible customers with the ability to receive margin credit and leverage from our clearing brokers. Margin credit involves the use of securities as collateral for a loan from the broker in order to purchase other securities. Leverage involves securing a large potential future obligation with a proportional amount of cash or securities. Margin credit and leverage-related minimum requirements are set by the SEC and SROs. We rely on our clearing broker to support the margin credit and leverage needs of our customers in accordance with applicable regulatory requirements. Since we introduce our accounts to a clearing brokers, we do not bear the burden of the capital requirements of the customer protection rule. See “Regulation.”

      Under the terms of our clearing agreements, we are responsible if a customer defaults on any obligation owed to our clearing brokers. As such, we have input into the margin credit and leverage process, we make decisions regarding margin credit and leverage levels, and we are largely responsible for the notification to customers of margin calls. We also take responsibility for supervising the risks associated with leverage and we monitor our customers’ margin positions to identify customer accounts that may need additional collateral or liquidation. In general, our minimum margin credit requirements are more stringent than the SEC’s and SROs’ requirements.

      Payment for order flow occurs when exchanges, options specialists, market makers, and other market centers make payments to broker-dealers in return for receiving customer orders. Like other retail brokerage firms, we receive payment for order flow from exchanges and liquidity providers where our customers’ orders are routed. Our automatic order routing software ensures that payment for order flow does not affect the routing of orders in a manner detrimental to our customers. In addition, customers can either rely on our automatic order routing or designate where to route their orders. We disclose our payment for order flow policies on our website.

      The role of our compliance department is to provide education, supervision, surveillance, mediation and communication review. Many of our employees are NASD-registered principals with supervisory responsibility over options trading or other aspects of our business. In addition, over half of our non-technology employees have successfully completed NASD licensing exams required for registered representatives. Each of these employees is trained and responsible for complying with securities regulations.

      Our anti-money laundering screening is conducted using a mix of automated and manual review and has been structured to comply with recent regulations. We collect required information through our new account process and then screen accounts with two third-party databases for the purposes of identity verification and for review of negative information and appearance on the Office of Foreign Assets and Control, Specially Designated Nationals and Blocked Persons lists. Additionally, we have developed proprietary methods for risk control and continue to add upon specialized processes, queries and automated reports designed to identify money laundering, fraud and other suspicious activities.

Technology Systems and Architecture

      We place an emphasis on developing and building cost-effective, stable, scalable and redundant systems. Unlike a number of our direct competitors, we developed our platform to operate free from reliance on mainframe systems common in the brokerage industry. Our hardware and software have proven

reliable and versatile and we believe they can be expanded more economically than our major competitors’ systems. We maintain three production data centers. Each of these centers is capable of serving our website independently in the event of service interruptions to the other two data centers. Each center is also linked to the others via redundant communication to minimize the likelihood of a data center being unable to serve customers. We replicate and synchronize our primary databases, ensuring a current copy of all customer data at each center. Our technology includes encryption and protective features to ensure investor confidence and protect our customers’ assets and information. In addition, our servers are load balanced, which prevents the failure of a single server or components from having a significant impact on our customers and allows for the easy addition of servers, resulting in the ability to quickly and cost-efficiently scale our platform.

Intellectual Property

      Our success and ability to compete are dependent to a significant degree on our intellectual property, which includes our proprietary technology, trade secrets and client base. We rely on a combination of patent, trademark, copyright, unfair competition and trade secret laws in the United States and other jurisdictions as well as confidentiality procedures and contractual provisions to protect our proprietary technology, intellectual property and our brand. We also enter into confidentiality and invention assignment agreements with our employees and consultants and confidentiality agreements with other third parties, and we rigorously control access to proprietary technology.

      We have five formal patent applications pending relating to various technology components of our platform, but Internet-related software patents can be difficult to obtain, and there can be no assurance that we will obtain a patent or patents broad enough in scope to have value, or obtain a patent at all. We obtained copyright registration for the optionsXpress website in December, 2005. We also have obtained trademark registrations for the optionsXpress mark in the United States, Australia, Singapore, Hong Kong and the European Union and the brokersXpress mark in the United States, Australia, Singapore, Hong Kong, New Zealand and the European Union. We have a pending trademark registration for the optionsXpress mark in New Zealand and pending trademark registrations for the optionsXpress mark and the brokersXpress mark in Canada. We have obtained registrations or have pending registrations for numerous other marks both in the United States and in foreign jurisdictions.

Competition and Pricing

      The market for brokerage services, particularly electronic brokerage services, is rapidly evolving and highly competitive. Our direct competitors in the online marketplace take the form of larger-scale broker-dealers that offer online services, including Charles Schwab & Co., Inc., E*TRADE Group, Inc., TD Ameritrade, Inc., Scottrade, Inc., and smaller “niche-market” online or licensed software-based brokers, including TradeStation Group, Inc. and Interactivebrokers. We also encounter competition from full commission brokerage firms including Merrill Lynch and Smith Barney (a division of Citigroup), as well as financial institutions, mutual fund sponsors, including Fidelity, and other organizations, some of which provide online brokerage services.

      We attribute our competitive success to the overall customer experience we deliver, which results from our advanced technology and superior customer service. Although competition may increase if larger-scale online brokers become more aggressive in marketing options, we believe we will maintain a competitive advantage due to the strength and flexibility of our platform.

      We do not use price as a significant basis for competition and do not strive to be a deep-discount broker. We offer what we believe to be a competitive price for the services and tools we provide. Our options commissions are $1.50 per option contract with a minimum of $14.95. Our commissions on listed and NASDAQ stocks are $14.95 up to and including 1,000 shares and then $0.015 per share for 1,001 shares and above. Active traders receive a discount, such as a minimum commission of $12.95 for 1 to 9 option contracts and $9.95 for up to 1,000 shares of stock. There are no “hidden fees”; no monthly

minimum fees; no charges for non-activity; no volume requirements; no postage and handling charges; and no extra fees for placing telephone orders.

      brokersXpress has two components: a fixed charge per trade and a percentage of the broker’s commissions above that fixed charge per trade. Both components are negotiated with each broker and are based in part on the volume of trades produced.

Employees

      At December 31, 2005, we had 152 full-time and 7 part-time employees. Of these employees, 91 were engaged in brokerage operations, providing trade execution and customer support, 58 of which were licensed brokers, 34 were engaged in technology and development and 27 were engaged in general management, business development, finance, marketing and administration. None of our employees are covered by a collective bargaining agreement. We consider our relations with our employees to be excellent.

Available Information

      We are required to file reports with the SEC, including annual reports on Form 10-K, quarterly reports on Form 10-Q, and other reports from time to time. We are an electronic filer and the SEC maintains an Internet site at www.sec.gov that contains the reports, proxy and information statements, and other information filed electronically. Our website address is www.optionsXpress.com. Please note that these website addresses are provided as inactive textual references only. We make available free of charge through our website our Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. The information provided on our website is not part of this report, and is therefore not incorporated by reference unless such information is otherwise specifically referenced elsewhere in this report.

Regulation

      Our business and industry are highly regulated. As a matter of public policy, regulatory bodies in the United States are charged with safeguarding the integrity of the securities and other financial markets and with protecting the interest of customers participating in those markets, not with protecting the interests of creditors or stockholders of securities firms such as our broker-dealer subsidiaries. optionsXpress, Inc. is registered as a broker-dealer with the SEC and is a member of the NASD and the Chicago Board Options Exchange (“CBOE”). brokersXpress is also a registered broker-dealer with the SEC and is a member of the NASD, which serves as its designated examining authority. optionsXpress and brokersXpress are also registered in each of the fifty states, the District of Columbia and Puerto Rico. In December 2005, our subsidiary optionsXpress Canada Corp. obtained membership in Canada with the Investment Dealers Association and registered with the applicable provincial securities regulators. In addition, in January 2006, our subsidiary optionsXpress Singapore Pte Ltd. obtained a Capital Market Service License from the Monetary Authority of Singapore to deal in securities and provide securities financing.

      Broker-dealers are subject to laws, rules and regulations that cover all aspects of the securities business, including:

      The commodity futures and options industry in the United States is subject to regulation under the Commodity Exchange Act. The CFTC is the federal agency charged with the administration of this act and the related regulations. optionsXpress and brokersXpress are members of the National Futures Association, a self-regulatory organization. optionsXpress is registered with the CFTC as a non-clearing Futures Commission Merchant and brokersXpress is registered with the CFTC as an introducing broker.

      Our broker-dealer subsidiaries are subject to the SEC’s Net Capital Rule. The Net Capital Rule, which specifies minimum net capital requirements for registered broker-dealers, is designed to measure the general financial integrity and liquidity of a broker-dealer. The Net Capital Rule requires that at least a minimum part of a registered broker-dealer’s assets be kept in relatively liquid form. In general, net capital is defined as net worth, meaning assets minus liabilities, plus qualifying subordinated borrowings and discretionary liabilities, and less mandatory deductions that result from excluding assets that are not readily convertible into cash and from valuing conservatively other assets.

      If a firm fails to maintain the required net capital, the SEC and the SROs or other regulatory bodies may suspend the firm or revoke its registration and ultimately could require the firm’s liquidation. The Net Capital Rule prohibits the payment of dividends, the redemption of stock, the prepayment of subordinated indebtedness and the making of any unsecured advance or loan to a stockholder, employee or affiliate, if the payment would reduce the firm’s net capital below required levels.

      While optionsXpress and brokersXpress effect transactions solely in the United States, our customers access our services through the Internet. In any foreign jurisdiction in which we have customers, there is a possibility that a regulatory authority could assert jurisdiction over our activities and seek to subject us to the laws, rules and regulations of that jurisdiction. optionsXpress has obtained registration to conduct brokerage activities in Canada and Singapore. In addition, our Australian operations are conducted through an Australia registered subsidiary in which we have a minority interest.

      The laws, rules and regulations of each foreign jurisdiction differ. In the four jurisdictions other than Australia, Canada and Singapore where we have the most foreign customers, we believe we are exempt from registration due to our limited conduct and/or our lack of solicitation in those jurisdictions. In any jurisdiction where we are relying on an exemption from registration, there remains the risk that we could be required to register, and therefore be subject to regulation and enforcement action or, in the alternative, to reduce or terminate our activities in these jurisdictions.

      Registered broker-dealers traditionally have been subject to a variety of rules that require that they know their customers and monitor their customers’ transactions for suspicious financial activities. With the passage of the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001, or the Patriot Act, broker-dealers are now subject to even more stringent requirements. As required by the Patriot Act, we have established comprehensive anti-money laundering and customer identification procedures, designated an anti-money laundering compliance officer, trained our employees and conducted an independent audit of our program. There are significant criminal and civil penalties that can be imposed for violations of the Patriot Act. For more information, [see “Business — Broker-Dealer Operations — Supervision and Compliance.”]

ITEM 1A.     RISK FACTORS

      Important risk factors that could impact our ability to achieve our anticipated operating results and growth plan goals are presented below. You should read the following risk factors in conjunction with discussions of our business and the factors affecting our business located elsewhere in this Form 10-K Annual Report and in our other filings with the SEC.

We may be unable to effectively manage our rapid growth and retain our customers.

      Our rapid growth has placed significant demands on our management and other resources. Due to our rapid growth, we will need to attract, hire and retain highly skilled and motivated officers and employees. We cannot assure you that we will be able to attract or retain the officers and employees necessary to manage this growth effectively.

      In addition, we may not be able to accurately project the rate, timing or cost of any increases in our business. Failure to make necessary expansions and upgrades to our systems and infrastructure, expand and upgrade the reliability and scalability of our transaction processing systems, network infrastructure and other aspects of our technology and maintain our customer service levels could lead to failures and delays, which could cause a loss of customers or a reduction in the growth of our customer base, increased operating expenses, financial losses, additional litigation or customer claims, and regulatory sanctions or additional regulatory burdens.

We operate in a highly regulated industry and compliance failures could adversely affect our business.

      We operate under extensive regulation, which increases our cost of doing business and is a limiting factor on the operations and development of our business. Our business and operations are subject to regulation by the SEC, the NASD, the CBOE, other SROs, and state securities commissions. Outside the United States, we are subject to regulation in those countries where we have sought and received licenses from the applicable regulatory bodies and we also may be subject to regulation by securities regulatory authorities in other foreign countries where our customers are located. The securities industry in the United States covers all aspects of the securities business, including:

      Failure to comply with any of the laws, rules or regulations applicable to us, even inadvertently, could lead to adverse consequences including censure, fine, the issuance of cease-and-desist orders or the suspension or disqualification of directors, officers or employees. Any of these consequences could adversely affect our business. It is also possible that any noncompliance could subject us to criminal penalties and civil lawsuits. An adverse ruling against us or our officers or other employees could cause our subsidiaries or our officers and other employees to pay a substantial fine or settlement, and could result in their suspension or expulsion. Any of these events could have a material adverse effect on our business.

Changes in legislation or regulations may affect our ability to conduct our business or reduce our profitability.

      The regulatory environment in which we operate may change. These changes may affect our ability to conduct our business or reduce our profitability. Our activities may be affected not only by legislation or regulations of general applicability, but also by industry-specific legislation or regulations. The SEC, other

U.S. or foreign governmental authorities, the NASD or other SROs may adopt new or revised regulations which affect our business. Changes in the interpretation or enforcement of existing laws and rules by those entities may also affect our business. For example, in early 2004, the SEC issued “Concept Release: Competitive Developments in the Options Markets,” which addressed recent developments in the options marketplace. The SEC’s goal in issuing this concept release is to improve the functioning of the options marketplace for the benefit of the investing public. The SEC has not yet issued any formal statements or proposed changes in response to the comments it has received.

      The SEC is also considering whether to continue to permit “payment for order flow” in the options markets. Payment for order flow is a practice in accordance with which specialists and exchanges pay broker-dealers to route customer orders to them. We benefit from payment for order flow because we earn revenue by directing orders to specific locations. Payment for order flow represented approximately 19% of our revenue for the year ended December 31, 2005. If the SEC or other authorities were to prohibit payment to broker-dealers for order flow, this would decrease our income and materially adversely affect our profitability. In addition, changes to the options marketplace, the primary marketplace in which we conduct business, could, if adopted, reduce or eliminate payment for order flow which could materially adversely affect our business.

      In addition, we use the Internet as the distribution channel to provide services to our customers. A number of regulatory agencies have recently adopted regulations regarding customer privacy and the use of customer information by service providers. Additional laws and regulations relating to the Internet may be adopted in the future, including regulations regarding the pricing, taxation, content and quality of products and services delivered over the Internet. Complying with these laws and regulations is expensive and time consuming and could limit our ability to use the Internet as a distribution channel.

Servicing customers outside the United States involves special challenges that we may not be able to meet, which could negatively impact our financial results.

      Since our services are available over the Internet in foreign countries and we have customers residing in foreign countries, foreign jurisdictions may claim that we are required to qualify to do business in their country. We believe that the number of our customers residing outside of the United States will increase over time. We are required to comply with the laws and regulations of each country in which we conduct business, including laws and regulations currently in place or which may be enacted related to Internet services available to their citizens from service providers located elsewhere. In addition, we have become licensed by applicable regulatory bodies in several foreign countries and are subject to their laws and regulations. Any failure to develop effective compliance and reporting systems could result in regulatory penalties in the applicable jurisdiction, which could have a material adverse effect on our business, financial condition and operating results. For more information, see “Regulation — Foreign Jurisdictions and Regulation.”

      In addition, we currently offer foreign securities brokerage services in Australia and may in the future choose to do so in additional countries. There are certain risks inherent in doing so. Among other risks, we may face less developed technological infrastructures, less developed automation in exchanges, depositories and national clearing systems, exchange rate fluctuations, increased credit risk and unexpected changes in regulatory requirements, tariffs and other trade barriers. If we choose to do business through an international entity, we may also face barriers to repatriation of foreign earnings. Any of these could have a material adverse effect on our future international operations and consequently on our business, financial condition and operating results.

Substantial competition could reduce our market share and harm our financial performance.

      The market for electronic brokerage services is rapidly evolving and intensely competitive. We expect the competitive environment to continue in the future. We face direct competition from numerous online and software-based brokerage firms, including Charles Schwab & Co., Inc., Fidelity Brokerage Services, LLC, E*TRADE Group, Inc., TD Ameritrade, Inc. and TradeStation Group, Inc. We also encounter

competition from the broker-dealer affiliates of established full commission brokerage firms as well as from financial institutions, mutual fund sponsors and other organizations, some of which provide online brokerage services. Some of our competitors have greater financial, technical, marketing and other resources, and have greater name recognition and a more extensive customer base than we do.

      This intense competition has resulted in several trends that may adversely affect our financial condition and results of operation, including the implementation of new pricing strategies; the development by our competitors of products and services and enhancements; consolidation in the industry and increased emphasis on advertising and promotional efforts. In addition, some of our competitors are actively pursuing a larger share of the options trading market.

      We believe that the general financial success of companies within the online securities industry will continue to attract new competitors to the industry, such as banks, software development companies, insurance companies, providers of online financial information and others. These companies may provide a more comprehensive suite of services than we do. We may not be able to compete effectively with our current or future competitors.

Our business is primarily transaction-based, and decreases in trading or other changes in our revenue base could harm our business.

      Our revenues are derived primarily from securities brokerage services, and we expect this business to continue to account for almost all of our revenues. We are directly affected by economic and political conditions, broad trends in business and finance and changes in the conditions of the securities markets in which our customers trade. Over the past several years, volume in the securities market in the United States has fluctuated considerably. During periods of low trading volume, our revenues are adversely affected. Severe decreases in market prices could also have an impact on our business because of the adverse impact on investor sentiment and losses in investor portfolios. In addition, a portion of our revenue is derived from payment for order flow. By custom in the industry, these cash payments are not the subject of any written agreement. As a result, they could be changed or eliminated at any time. If these payments were to be reduced or eliminated for competitive or other reasons, our business could be materially adversely affected.

Our strong dependence upon revenues derived from commissions from option trades may place us at a competitive disadvantage.

      Our revenue is derived primarily from commissions from options, stock, mutual fund and fixed-income product trades, but option trades represent approximately 76% of our customers’ trades. The revenues of some of our major competitors may be more diversified than ours, and they may withstand a downturn in the securities industry better than we could.

If we fail to attract customers in a cost-effective manner, our profitability and growth may be impaired.

      Our profitability and growth depends on increasing our customer base in a cost-effective manner. For the years ended December 31, 2003, 2004 and 2005, we incurred advertising expenses of $3.0 million, $6.7 million and $5.7 million, respectively. Although we have spent significant financial resources on advertising and related expenses and plan to continue to do so, there are no assurances that these efforts will be cost-effective at attracting new customers. In particular, we believe that rates for desirable advertising and marketing placements are likely to increase in the foreseeable future, and we may be disadvantaged relative to our larger competitors in our ability to expand or maintain our advertising and marketing commitments. Additionally, filter software programs that limit or prevent our advertisements and other communications from being displayed on or delivered to our current and potential customers’ computers are becoming increasingly available. If this type of software becomes widely accepted, it would negatively affect our Internet advertising. Finally, our sales and marketing methods are subject to regulation by the CBOE and the NASD. The rules and regulations of these organizations impose specific

limitations on our sales methods, including our advertising and payments to non-broker-dealers. If we do not achieve our advertising objectives, our profitability and growth may be impaired.

We are subject to various forms of credit risk, and those risks could have a material adverse effect on our financial situation.

      Many of our customer accounts are margin accounts. In margin transactions, we may be obligated for credit extended to our customers by our clearing firms, subject to various regulatory and clearing firm margin requirements. Margin credit is collateralized by cash and securities in the customers’ accounts. We also execute customer transactions involving the sale of securities not yet purchased which result in us extending leverage to our customers. Leverage involves securing a large potential future obligation with a proportional amount of cash or securities. The risks associated with margin credit and leverage increase during periods of fast market movements or in cases where leverage or collateral is concentrated and market movements occur. During such times, customers who utilize margin credit or leverage and who have collateralized their obligations with securities may find that the securities have a rapidly depreciating value and may not be sufficient to cover their obligations in the event of liquidation. When we extend margin or our customers use leverage, we may be exposed to significant off-balance-sheet credit risk in the event customer collateral is not sufficient to fully cover losses that customers may incur. In the event customers fail to satisfy their obligations, we may be required to purchase or sell financial instruments at prevailing market prices to fulfill the customers’ obligations.

      We expect this kind of exposure to increase with growth in our overall business. Because we indemnify and hold harmless our clearing firms from certain liabilities or claims, the use of margin credit, leverage and short sales may expose us to significant off-balance-sheet risk in the event that collateral requirements are not sufficient to fully cover losses that customers may incur and those customers fail to satisfy their obligations. As of December 31, 2005, we had $115.9 million in margin credit extended to our customers through our clearing firms. The amount of risk to which we are exposed from the leverage we extend to our customers and from short sale transactions by our customers is unlimited and not quantifiable as the risk is dependent upon analysis of a potential significant and undeterminable rise or fall in stock prices.

Our risk management policies and procedures may not be effective and may leave us exposed to unidentified or unexpected risks.

      Our policies, procedures and practices used to identify, monitor and control a variety of risks may fail to be effective. As a result, we face the risk of losses, including losses resulting from firm errors, customer defaults, market movements, fraud and money-laundering. Our risk management methods rely on a combination of technical and human controls and supervision that are subject to error and failure. Some of our methods of managing risk are based on internally developed controls and observed historical market behavior, and also involve reliance on industry standard practices. These methods may not adequately prevent future losses, particularly as they relate to extreme market movements, which may be significantly greater than the historical measures indicate. These methods also may not adequately prevent losses due to technical errors if our testing and quality control practices are not effective in preventing technical software or hardware failures.

We may suffer losses if our reputation is harmed.

      Our ability to attract and retain customers and employees may be adversely affected to the extent our reputation is damaged. If we fail, or appear to fail, to deal with various issues that may give rise to reputational risk, we could harm our business prospects. These issues include, but are not limited to, appropriately dealing with potential conflicts of interest, legal and regulatory requirements, ethical issues, money-laundering, privacy, record-keeping, sales and trading practices, and the proper identification of the legal, credit, liquidity, and market risks inherent in our business. Failure to appropriately address these issues could also give rise to additional legal risk to us, which could, in turn, increase the size and number

of claims and damages asserted against us or subject us to regulatory enforcement actions, fines, and penalties.

Systems failures and delays could harm our business.

      We receive and process trade orders through a variety of electronic channels. Our online trading services are heavily dependent on the integrity of the systems supporting them. Our systems and operations, including our Web servers, and those of our third-party service providers are vulnerable to damage or interruption from human error, sabotage, encryption failures, break-ins, intentional acts of vandalism, earthquakes, terrorist attacks, floods, fires, power loss, telecommunications failures, computer viruses, computer denial of service attacks or other attempts to harm our systems and operations, and similar events. Our disaster recovery planning cannot account for all eventualities. In addition, extraordinary trading volumes could cause our computer systems to operate at an unacceptably low speed or even fail. While we have invested significant amounts to upgrade the reliability and scalability of our systems, there can be no assurance that our systems will be sufficient to handle such extraordinary trading volumes.

      Systems failures or delays may occur in the future and could cause, among other things, unanticipated disruptions in service to our customers, slower system response time resulting in transactions not being processed as quickly as our customers desire, decreased levels of customer service and customer satisfaction and harm to our reputation. If any of these events were to occur, we could suffer:

      Our business also depends on the continued reliability of the Internet infrastructure. This includes maintenance of a reliable network backbone with the necessary speed, data capacity and security for providing reliable Internet services. Internet infrastructure may be unable to support the demands placed on it if the number of Internet users continues to increase, or if existing or future Internet users access the Internet more often or increase their bandwidth requirements. In addition, viruses, worms and similar programs may harm the performance of the Internet. The Internet has experienced a variety of outages and other delays as a result of damage to portions of its infrastructure, and it could face outages and delays in the future. These outages and delays could reduce the level of Internet usage and our business could be materially adversely affected.

Our networks and those of our third-party service providers may be vulnerable to security risks.

      The secure transmission of confidential information over public networks is a critical element of our operations. Our networks and those of our third-party service providers may be vulnerable to unauthorized access, computer viruses and other security problems. Persons who circumvent security measures could wrongfully use our confidential information or our customers’ confidential information or cause interruptions or malfunctions in our operations. We or our service providers may be required to expend significant additional resources to protect against the threat of security breaches or to alleviate problems caused by any breaches. We or our service providers may not be able to implement security measures that will protect against all security risks.

We will need to introduce new products and services to remain competitive.

      Our future success depends in part on our ability to develop and enhance our products and services. The financial services industry is characterized by rapid technological change and the emergence of new industry standards and practices that could render our existing technology and systems obsolete. There are

significant technical and financial risks in the development of new or enhanced products and services, including the risk that we will be unable to effectively use new technologies or adapt our services to emerging industry standards, or develop, introduce and market enhanced or new products and services. In addition, the adoption of new Internet, networking or telecommunications technologies or other technological changes could require us to incur substantial expenditures to modify or adapt our services or infrastructure.

Our inability to protect our intellectual property rights or our infringement of the intellectual property rights of others could adversely affect our business.

      Patents of third parties may have an important bearing on our ability to offer certain of our products and services. Our major competitors as well as other companies and individuals may obtain and may have obtained patents related to the technologies for trading the types of products and providing the services we offer or plan to offer. We cannot assure you that we are or will be aware of all patents containing claims that may pose a risk of infringement by our products and services. In addition, some patent applications in the United States are confidential until a patent is issued and, therefore, we cannot evaluate the extent to which technology concerning our products and services may be covered or asserted to be covered by claims contained in pending patent applications. In general, if one or more of our products or services were found by a court to infringe patents held by others, we may be required to stop developing or marketing the products or services, to obtain licenses to develop and market the services from the holders of the patents or to redesign the products or services in such a way as to avoid infringing those patents. An adverse ruling arising out of any intellectual property dispute could also subject us to significant liability for damages.

      We cannot assess the extent to which we may be required in the future to obtain licenses with respect to patents held by others, whether such licenses would be available or, if available, whether we would be able to obtain such licenses on commercially reasonable terms. If we are unable to obtain licenses with respect to patents held by others, and are unable to redesign our products or services to avoid infringement of any such patents, this could materially adversely affect our business, financial condition and operating results.

      Also, protection may not be available for our intellectual property. Although we have patents and registered trademarks in the United States and other countries, there can be no assurance that we will be able to secure significant protection for this intellectual property. It is possible that our competitors will adopt technology or product or service names similar to ours, thereby impeding our ability to distinguish our technology and build brand identity, possibly leading to customer confusion. Our inability to adequately protect our marks would have a material adverse effect on our business, financial condition and operating results.

We may make acquisitions, and we may be unable to successfully integrate those acquisitions with our business, impairing our financial performance.

      If appropriate opportunities present themselves, we may acquire businesses, products or technologies that we believe are strategic. If we do succeed in acquiring a business, product or technology, we have limited experience in integrating an acquisition into our business. The process of integration may produce unforeseen operating diffic