more than 18% since 1990,1992, and held over $6 trillion in assets at December 31, 2000.2002. The following table presents U.S. financial assets, including mutual funds as follows (Dollars in billions):

Source: Federal Reserve Bank

        Consolidation and Outsourcing Trends.    Another important factor affecting the industry is the consolidation in the number of asset servicing providers. DuringSince the past ten years,early 1990s, a number of small and mid-size asset servicers have consolidated with larger service providers or divested their asset servicing operations to focus their finite resources on their core businesses. Since the early 1990's, more than 25Also, numerous service providers have consolidatedcombined their operations with other companies. This ongoing consolidation has concentrated the industry around a smaller number of providers and presents us with opportunities for growth as clients review their relationships with existing service providers andproviders. In addition, as consolidated financial institutions dispose of businesses that do not fit with their core services.services, we may see opportunities to acquire those business lines.

        Asset servicing is viewed differently byThe unique operational philosophy of a particular asset management organizations depending on their operational philosophy.organization determines its view of asset servicing. The majority of asset managers hire third parties to provide custody services. Some use more than one custodian to foster cost reduction through competition. Large asset managers may have enough assets to justify the cost of providing in-house facilities to handle accounting, administration and transfer agency services. Smaller asset managers generally hire third parties to provide accounting, administration and transfer agency services in addition to custody services. Keeping abreast of developments like Internet data delivery, Y2K, the Euro,regulatory changes, decimalization of stock prices and compressed settlement cycles has forced significant increases in technology spending across the financial services industry. We believe that this increase in spending requirements has accelerated the pace at which asset managers outsource back office operations to asset servicers.

        Technology.    Information technology is a driving force in the financial services industry. Asset managers are able to create innovative investment products using technological tools including:

•

Access to data from world markets as a result of more powerful and affordable information processing power.



•

The ability to send and receive large volumes of information almost instantly through widely dispersed communication networks.



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Timely on-line access to electronic information on security positions, prices and price shifts that facilitates on-line currency trading, indexing of assets, real time arbitrage, and hedging through the use of derivative securities.

        Asset servicers use technology as a competitive tool to deliver precise and functional information to asset managers. Technology also allows asset servicers to offer more value-added services such as performance measurement. Examples of analytical tools used in performance measurement include reports showing time-weighted return, performance by sector, and time-weighted return by sector.

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        Complex Investment Products.    Asset managers create different investment structures in an effort to capture efficiencies of larger pools of assets. One innovative example of this is the master-feeder

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structure. In the master-feeder structure, one or more investment vehicles (the "feeder funds") with identical investment objectives pool their assets in the common portfolio of a separate investment vehicle (the "master fund"). This structure permits each of the feeder funds to be sold to a separate target market or through a different distribution channel. The feeder fund, if it were a stand-alone fund, might not be large enough to support its operating costs. The feeder funds benefit from the economies of scale available to the larger pool of assets invested in the master fund.

        In addition, a growing number of mutual funds have been structured as multi-tieredmulti-class funds or as multi-manager funds in order to address the differing requirements and preferences of potential investors. Multi-tieredMulti-class arrangements allow an investment company to sell interests in a single investment portfolio to separate classes of stockholders. In this environment, investors have the option of purchasing multi-tieredmulti-class fund shares with the sales loadcommission structure that best meets their short-term and long-term investment strategy. Multi-manager funds have two or more investment managers, who may have different investing styles, managing the assets of one fund. Multi-manager funds allow an investor to invest along multiple style lines with a single investment.

        Another innovation in the mutual fund industry is the advent of exchange traded funds, or ETFs. ETFs are securities that replicate an index and are traded on a national securities exchange, usually the American Stock Exchange. Unlike investing in a conventional index mutual fund, investing in an ETF allows investors to buy and sell shares throughout the trading day at market prices. ETFs also offer potential tax efficiencies. According to an industry source, globally, ETF assets grew by $30.5 billion39% from approximately $74.3$142 billion at year end in 2002 to $198 billion at year-end in 2000 to $104.8 billion in 2001.2003.

        Asset managers have also expanded their reach in the global marketplace to capitalize on cross-border and multi-national marketing opportunities. This creates demand for asset servicing around the world and particular demand for value addedvalue-added services like foreign exchange.

Our Strategy

        We believe that asset servicing companies operate most efficiently when bundling core services such as custody and accounting with value-added services such as securities lending and foreign exchange. We also believe that efficient integration of these services is critical to both service quality and profitability. In order to continue to grow our business, we pursue our core strategies.

        Maintain Our Technological Expertise.    One of our core strategies is to commit the necessary capital and resources to maintain our technological expertise. The asset servicing industry requires the technological capability to support a wide range of global security types, currencies, and complex portfolio structures. Asset servicers must also maintain the telecommunications flexibility to support the diversity of global communications standards. Technological change creates opportunities for product differentiation and cost reduction.

        Our Fund Accounting and Custody Tracking System, or FACTS,FACTS™, is a single integrated technology platform that combines our productsservice offerings into one solution for customers and can accommodate rapid growth in net assets processed. FACTS provides the following functions in a single information system:

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Custody



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Securities movement and control



•

Portfolio accounting



•

Multicurrency general ledger accounting

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•

Pricing



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Net asset value calculation



•

Multi-tierMulti-class and multi-manager processing



•

ETF processing

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        By consolidating these functions, we have eliminated redundancy in data capture and for the services we offer reduced the opportunity for clerical error.

        The consolidation of functions available through FACTS allows us to assign a dedicated client team to provide a full suite of services to each account. We believe that this approach helps us to provide high quality service and to maintain better overall relationships with our clients.

        The FACTS architecture also enables us to modify the system quickly. SwiftRapid modifications result in increased processing quality, efficiency, and an increased ability to implement service innovations for our clients. We believe that the integrated nature of FACTS provides us with a competitive advantage by allowing us to respond quickly to the continuously changing technological demands of the financial services industry. The separate systems used for different tasks by many other asset servicing providers may not provide the same advantages.

        We outsource our mainframe processing and network monitoring to Electronic Data Systems so that we can focus our resources on software and internal systems development. This arrangement also allows us to minimize our capital investment in large-scale computer hardware. It also gives us access to state-of-the-art mainframe technology, virtually unlimited capacity, disaster recovery services and assures greater predictability of our processing expenses.

        Maintain Our Expertise in Complex Products.    Another of our core strategies is to maintain our strength in the rapidly growing area of complex investment products. We have developed expertise in servicing master-feeder and multi-managed funds, limited partnerships and most recently, ETFs. We also have expertise in servicing the more complicated fund of funds and offshore fund structures. Because the design of FACTS allows us to effect modifications or enhancements quickly, we are able to respond rapidly to the systems requirements of complex structures.

•

We service the Barclays Global Investors iShares, a family of exchange traded funds launched in May 2000 that held approximately $16 billion in assets as of December 31, 2001.



•

We service over $31 billion of assets managed by The Commonfund for Nonprofit Organizations, which uses a multi-manager structure. The Commonfund's structure includes 65 managers covering 48 funds.



•

We also service the Eaton Vance Tax Managed Portfolio, a five-tiered structure composed of twenty-one entities, including registered investment companies, registered partnerships, private partnerships, limited liability companies and other pooled entities.

        Deliver Superior Service.    We strive to deliver superior and innovative client service. We believe service quality in client relationships is the key to maintaining and expanding existing business as well as attracting new clients. The consolidation of functions available through FACTS allows us to take an integrated approach to servicing. We believe this approach is different from that employed by many of our competitors. We dedicate a single operations team to handle all work for a particular account or fund. In addition, each client is assigned a client manager, independent of the operations team, to anticipate the client's needs, to coordinate service delivery, and to provide consulting support.

        Cross-Sell Our Services.    We believe that our strong client relationships provide opportunities to cross-sell value-added services to broaden our customer relationships. Many of our clients have multiple pools of assets that they manage. Once a mutual fund complex becomes a client, we believe that complex is more likely to select us to service more funds, provide additional services, or both. For example, a mutual fund company may manage two or more families of mutual funds or an insurance company may manage a family of retail mutual funds and a series of mutual funds to offer variable annuity products. If we are engaged to provide services for only some of the pools of assets managed by our clients, we strive to expand the relationship to include more asset pools by providing superior quality client service. Also, some of our clients engage us to provide the core services of global custody

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and multicurrency accounting, but do not use us for value-added services like foreign exchange or cash management. We target expanding these relationships by increasing the number of services provided for each client.

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Service Offerings

        We provide a broad range of services to financial asset managers, such as mutual fund complexes, investment advisors, family offices, banks and insurance companies. We think of these services in two groupings: core services and value-added services. The core asset services we provide to our clients are global custody, multicurrency accounting, and mutual fund administration. The primary value-added services that we provide to clients, based upon their individual needs, include:

•

Securities lending



•

Foreign exchange



•

Cash management



•

Performance measurement



•

Institutional transfer agency



•

Investment advisory services



•

Lines of credit

        Our value-added services help support clients in developingdevelop and executingexecute their strategies, enhancing their returns, and evaluating and managing risk. We strive to maximize the use of our value-added services and increase the size ofby our client base.

        Fees charged for core services vary from client to client based on the volumevalue of assets under custody,processed, the number of securities held and portfolio transactions. Generally, fees are billed to the clientour clients monthly in arrears and, upon their approval, charged directly to their account. Fees charged for core services reflect the price-sensitivityprice sensitivity of the market for such services. Fees charged for value-added services reflect a more favorable pricing environment for us, and we can increase activity in these areas without a necessarily proportionate increase in personnel or other resources. We also derive net interest income by investing cash balances that our clients leave on deposit with us. Our share of earnings from these investments is viewed as part of the total compensation that our clients pay us for servicing their assets.

        The following is a description of the various services we offer:

Core Services

        Global Custody.    Global custody entails overseeing the safekeeping of securities for clients and settlement of portfolio transactions. Our domestic net assets under custodyprocessed have grown from $22 billion at October 31, 1990 to $730 billion$1.1 trillion at December 31, 2001.2003. At December 31, 2001,2003, our foreign net assets under custodyprocessed totaled approximately $84$177 billion.

        In order to service our clients worldwide, we have established a network of global subcustodians in 9399 markets. Since we do not have our own branches in these countries, we are able to operate in the foreign custody arena with minimal fixed costs, while our clients benefit from the ability to use a single custodian, Investors Bank, for all of their international investment needs.

        Multicurrency Accounting.    Multicurrency accounting entails the daily recordkeeping for each account or investment vehicle, including the calculation of net asset value per share. In addition to providing these services to domestic-based accounts and investment vehicles, we also provide offshore fund accounting. We view the offshore market as a significant business opportunity and will continue to invest in expansion to support client demand.

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        Mutual Fund Administration.    Mutual fund administration services include management reporting, regulatory reporting, compliance monitoring, tax accounting and return preparation, and partnership administration. In addition to these ongoing services, we also provide mutual fund start-up consulting services, which typically includesinclude assistance with product definition, service provider selection, and fund structuring and registration. We have worked with a number of investment advisors to assist them in the development of new mutual funds and other pooled investment vehicles.

Value-Added Services

        Securities Lending.    Securities lending involves the lending of clients' securities to brokers and other institutions for a fee. Receipt of securities lending fees improves a client's return on the underlying securities. We act as agent for our clients for both international and domestic securities lending services. We retain as compensation a portion of the lending fee due to the client as owner of the borrowed securities.

        Foreign Exchange.    We provide foreign exchange services to facilitate settlement of international securities transactions for U.S. dollar denominated mutual funds and other accounts and to convert income payments denominated in a non-U.S.non-base currency to U.S.base dollars. By using us rather than a third partythird-party foreign exchange bank to perform these functions, clients can reduce the amount of time spent coordinating currency delivery and monitoring delivery failures and claims.

        Cash Management.    We provide a number of investment options for cash balances held by our clients. Typically, we have a standing arrangement to sweep client balances into one or more investments, including deposit accounts, short termshort-term funds and repurchase agreements. This allows our clients to conveniently maximize their earnings on idle cash balances.

        Investment Advisory Services.    The Bank acts as investment advisor to the Merrimac Master Portfolio, an open-end investment management company registered under the Investment Company Act of 1940. The portfolio currently consists of a series of six master funds in a master-feeder structure. The Merrimac Cash Portfolio, the Merrimac Prime Portfolio and the Merrimac U.S. Government Portfolio are subadvised by Lincoln Capital Fixed Income Management Company, LLC. The Merrimac Treasury Portfolio and the Merrimac Treasury Plus Portfolio are subadvised by M&I Investment Management Corp. The Merrimac Municipal Portfolio is subadvised by ABN AMRO Asset Management (USA) LLC. At December 31, 2003, the total net assets of the portfolio approximated $7.0 billion. The portfolio's master funds serve as investment vehicles for seven domestic feeder funds and two offshore feeder funds whose shares are sold to institutional investors.

        Middle Office Outsourcing.    We also provide middle office outsourcing services to clients. Middle office outsourcing services represent the tasks that need to be performed for financial asset managers after they have initiated a particular trade to ensure accurate and timely trade processing and communications to any party who needs to receive the trades. We perform some or all of the following functions for our outsourcing clients: trade operations management, settlements, portfolio and fund accounting, fund administration, cash management, reconciliation, corporate actions, tax reclaims and tax filings, performance measurement, broker performance, and vendor data management.

        Performance Measurement.    Performance measurement services involve the creation of systems and databases that enable asset managers to construct, manage, and analyze their portfolios. Services include portfolio profile analysis, portfolio return analysis, and customized benchmark construction. Performance measurement uses data already captured by FACTS to calculate statistics and report them to asset managers.managers in a customized format.

        Institutional Transfer Agency.    Transfer agency encompasses shareholder recordkeeping and communications. We provide these services only to institutional clients with a small number of shareholder accounts or omnibus positions of retail shareholders.

        Investment Advisory Services.    The Bank acts as investment adviser to the Merrimac Master Portfolio, an open-end management investment company registered under the Investment Company Act of 1940. The portfolio currently consists of a series of five master funds in a master-feeder structure. The Merrimac Cash Portfolio and the Merrimac U.S. Government Portfolio are sub-advised by Allmerica Asset Management, Inc. The Merrimac Treasury Portfolio and the Merrimac Treasury Plus Portfolio are sub-advised by M&I Investment Management Corp. The Merrimac Municipal Portfolio is sub-advised by ABN AMRO Asset Management (USA) LLC. At December 31, 2001, the total net assets of the portfolio approximated $6.4 billion. The portfolio's master funds serve as investment vehicles for six domestic feeder funds and one offshore feeder fund, which we have created and whose shares are sold to institutional investors.7

        Lines of Credit.    We offer credit lines to our clients for the purpose of leveraging portfolios, and covering overnight cash shortfalls.shortfalls and other borrowing needs. We do not conduct consumer-bankingretail banking operations. At December 31, 2001,2003, we had gross loans outstanding to clients of approximately $232$200 million, which represented approximately 4%2% of our total assets. The interest rates charged on the Bank's loans are indexed to either the Prime rate or the Federal Funds rate. We have never had a loan loss. Other than a loan

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made to a non-profit association for purposes of the Community Reinvestment Act, allAll loans are secured, or may be secured, by marketable securities and virtually all loans to individually managed account customers are due on demand.

        Brokerage and Transition Management Services.    In 2002, we began offering introducing broker-dealer services to clients by accepting customer orders, which we have elected to clear through a clearing broker-dealer. The clearing broker-dealer processes and settles customer transactions and maintains detailed customer records. This allows us to use the back office processing of the clearing broker-dealer while earning a commission on trades executed on behalf of clients. Transition management services are designed to assist the process of moving a portfolio from one asset manager to another in as seamless a manner as possible. Components of these services include planning and customizing a strategy for the transition, conducting performance analysis, and executing the transition in an efficient, risk-managed fashion. The brokerage services we offer do not include margin accounts, short selling or market making activities.

Sales, Marketing and Client Support

        We employ a direct sales staff that targets potential market opportunities, including investment management companies, insurance companies, family offices, banks and investment advisors. Sales personnel are primarily based at our headquarters in Boston, and are given geographic area sales responsibility. We also have two sales personnel located in Dublin who are responsible for international markets. Included in the sales staff are individuals who are dedicated to marketing services to institutional accounts. Senior managers from all functional areas are directly involved in obtaining new clients, frequently working as a team with a sales professional.

        In order to service existing clients, client management staff based in our Boston, New York and Dublin offices provide client support. Each client is assigned a client manager responsible for the client's overall satisfaction. The client manager is usually a senior professional with extensive industry experience and works with the client on designing new products and specific systems requirements, providing consulting support, anticipating the client's needs and coordinating service delivery.

        Financial information regarding our geographic reporting can be found in Note 21 of our Notes to Consolidated Financial Statements included in this Report.

Significant Clients

        Barclays Global Investors, N.A. ("BGI") accounted for approximately 13%16.4% of our consolidated net operating revenues for each of the yearyears ended December 31, 2001.2003 and 2002. No single client of ours representedother than BGI accounted for more than 10%5% of our net operating revenues for the years ended December 31, 20002003 and 1999.2002.

Software Systems and Data Center

        Our business requires that we provide daily and periodic reports of asset accounting and performance, and provide measurement and analytical data to asset managers on-line on a real time basis. To help us meet these requirements, our asset servicing operations are supported by sophisticated computer technology. We receive vast amounts of information across a worldwide computer network. That information covers a wide range of global security types and complex portfolio structures in various currencies. The information must be processed and then used for system-wide updating and reporting.

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        Our proprietary system, FACTS, is multi-tiered. FACTS uses personal computers linked to mainframe processing by means of local and wide area networks. This configuration combines the best features of each platform. FACTS uses the power and capacity of the mainframe, the data distribution capabilities of the network and the independence of personal computers. The fully functional microcomputer component of FACTS works independently of the mainframe throughout the processing cycle. This minimizes the amount of system-wide delay inherent in data processing. The FACTS configuration also allows for fully distributed processing capabilities within multiple geographic locations in an effective and efficient manner.

        The integrated nature of the FACTS architecture allows us to effect modifications and enhancements quickly. Swift modifications and enhancements result in increased processing quality and efficiency for our clients. TheyThese modifications and enhancements also help us implement service innovations for our clients. This integrated architecture helps differentiate us from our competitors. Technological enhancements and upgrades are an ongoing part of asset servicing. Continuous enhancements and upgradesservicing that are necessary for asset administrators to remain competitive and to create information delivery mechanisms that add value to the information available as part of clearing and settling transactions. We have met and continue to meet these needs through standardized data extracts and automated interfaces developed over the past several years.

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        These abilities help us add value to the custody and fund accounting information.information we gather by processing client assets. We have developed a comprehensive suite of standardized data extracts and reports and created automated interfaces that allow our clients to access the full range of custody and fund accounting data. We have also developed interfaces that allow our clients to connect electronically with our host computersystems and access data collected from clearance and settlement transactions in multiple currencies. Through these information-sharing tools, we are better equipped to supplement our custody and accounting services with foreign exchange services, and asset and transaction reporting and monitoring services. Electronic linkages also position us to respond quickly to client requests.

        We use the Internet as a means to communicate with clients and external parties. Through the implementation of our strategic Internet plan, our goal is to position ourselves to take advantage of Internet technologies while providing secure value-added services to our clients over the Internet.clients. We utilize a secure extranet environment that provides the authentication, access controls, intrusion detection, encryption and firewalls needed to assure the protection of client information and assets. Internet-based applications provide our clients with secure access to their data over the Internet as well as additional flexible ad-hoc data query and reporting tools.

        Our mainframe processing is provided by Electronic Data Systems, or EDS, located in Plano, Texas. By outsourcing mainframe processing, we focus our resources on systems development and minimize our capital investment in large-scale computer equipment. EDS offers us state-of-the-art computer products and services, access to which we could not otherwise afford, while removing the risk of product obsolescence. Due to its diverse customer base, EDS can invest in the latest computer technology and spread the related costs over multiple users. We also receive the benefit of the continuing investment by EDS in its computer hardware.

        Our current agreement with EDS obligates EDS to provide us with comprehensive data processing services and obligates us to utilize EDS' services for substantially alla significant amount of our data processing requirements. We are billed monthly for these services on an as-used basis in accordance with a predetermined pricing schedule for specific products and services. EDS began providing services for us in December 1990. Our current agreement with EDS is scheduled to expire on December 31, 2005. EDS also provides us with mainframe disaster recovery services.

        Each year we spend approximately 18-20% of revenue on technology. Because of our relationship with EDS and our system architecture, we are able to focus the majority of our technology spend on development, rather than support or infrastructure.

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        Our trust processing services are provided by SEI Investments Company, located in Oaks, Pennsylvania. SEI is a global provider of asset management and investment technology solutions. We maintainpay certain monthly service fees based upon usage. Our current agreement with SEI is scheduled to expire on December 31, 2005.

        Investors Bank maintains a comprehensive disasterBusiness Continuity Plan ("BCP"). The program has been developed to comply with guidelines issued by various regulatory and industry bodies such as the Federal Financial Institutions Examination Council ("FFIEC"). The planning process begins with a business impact analysis which isolates critical business processes and determines their recoverability under various disruption scenarios. In addition to maintaining regional backup facilities for all offices, Bank locations are geographically diverse in order to allow recovery plan. The plan identifies teamsof essential functions to manage disaster situationsanother location in the event of a wide spread disruption. In 2003, BCP staff conducted over 80 different tests to ensure technology infrastructure, facilities, and re-establishstaff could respond and recover in a functioning operational environment. The plan provides for us to be able to relocate employees and resume operations quickly, if necessary.disaster.

        The securities industry is moving to a Trade Date +1 (T+1) settlement cyclestraight-through-processing environment where all trades will be settled on the next business day.flow directly from a client's trading platform to our own system to produce a net asset value calculation. We have begun makingmade substantial progress in completing the systems infrastructure and functional modifications required to provide straight-through-processing capabilities in a T+1 environment. A comprehensive development and implementation plan is in place to assure that all industry imposed deadlines are met.capabilities. We believe that we can accomplish the transition to the T+1a full straight-through-processing environment without adversely affecting our financial results, operations or the services we provide to our clients.

Competition

        We operate in a highly competitive environment in all areas of our business. Many of our competitors, including State Street Bank and Trust Company, JP Morgan Chase, and The Bank of New York, Citigroup, Mellon, and PNC, possess substantially greater financial and marketing resources than we do and process a greater amount of financial assets. Moreover, under the Gramm-Leach-Bliley Act of 1999, securities firms, insurance companies and other financial services providers may now elect to become financial holding companies. Financial holding companies may acquire banks and other financial institutions. The Gramm-Leach-Bliley Act may significantly change theOther competitive environment in which we conduct business. Competitive factors include technological advancement and flexibility, breadth of services provided and quality of service. We believe that we compete favorably in these categories.

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        Competition in the asset servicing industry, especially over the past decade, has compressedimpacted both pricing and margins ofin core services like global custody services and trustee services. Partially offsetting this trendmore competitive pricing environment is the development of new services that have higher margins. Our continuous investment in technology has permitted us to offer value-added services to clients, such as middle office outsourcing, performance measurement, securities lending and foreign exchange, at competitive pricesall on a global basis.basis and at competitive prices. Technological evolution and service innovation have enabled us to generate additional revenue to offset price pressurecompetitive pricing in maturing service lines.

        We believe that our size, commitment to technology development and enhancement, and responsiveness to client needs provide the asset management industry with ana very attractive asset servicing alternative to superregional andlarge money center banks and other administration providers.asset servicers. As our competitors grow even larger through acquisition, we believe that our customized and highly responsive service offerings become even more attractive. While consolidation within the industry may adversely affect our ability to retain clients that have been acquired, consolidationit also creates opportunity for us as prospective clients review their relationships with existing service providers. In addition, consolidation among large financial institutions may enable us to acquire, at a reasonable price, asset servicing businesses that do not fit within the core focus of these new, consolidated financial institutions.

Intellectual Property

        Our success is dependent upon our software development methodology and other intellectual property rights that we have developed and own, including FACTS. We rely on trade secret, copyright and trademark laws and confidentiality agreements with employees and third parties to protect our proprietary technology, all of which offer only limited protection. There can be no assurance that the

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steps we take in this regard will be adequate to deter misappropriation of our proprietary information or that we will be able to detect unauthorized use. Furthermore, our intellectual property rights may be invalidated or our competitors may develop similar technology independently. In addition, effective copyright, trademark and other trade protection may not be available in certain international markets that we service.

Employees

        On December 31, 2001,2003, we had 2,6182,413 employees. We maintain a four-week professional development program for entry level staff. Successful completion of the program is required of most newly hired employees. This training program is supplemented by ongoing education on systems and technological developments and innovations, the industry and our client base.

        None of our employees isare covered by collective bargaining agreements and we believe our relations with our employees are good.

Regulation and Supervision

        In addition to the generally applicable state and federal laws governing businesses and employers, we are further regulated by federal and state laws and regulations applicable to financial institutions and their parent companies. Furthermore, the operations of our securities broker affiliate, Investors Securities Services, Inc., are subject to federal and state securities laws, as well as the rules of both the Securities and Exchange Commission and the National Association of Securities Dealers, Inc. ("NASD"). Virtually all aspects of our operations are subject to specific requirements or restrictions and general regulatory oversight. State and federal banking laws have as their principal objective either the maintenance of the safety and soundness of financial institutions and the federal deposit insurance system, or the protection of consumers or classes of consumers or the furtherance of broad public policy goals, rather than the specific protection of stockholders of a bank or its parent company. To

        Several of the extent the following material describesmore significant statutory orand regulatory provisions itapplicable to banks and bank holding companies ("BHC") to which Investors Financial and its subsidiaries are subject are described more fully below, together with certain statutory and regulatory matters concerning Investors Financial and its subsidiaries. The description of these statutory and regulatory provisions does not purport to be complete and is qualified in its entirety by reference to the particular statutestatutory or regulation.regulatory provision. Any change in applicable law or regulation may have a material effect on Investors Financial's business, prospects and operations, as well as those of its subsidiaries.

Investors Financial

        General.    As a bank holding company ("BHC"),registered BHC, Investors Financial is subject to regulation under the Bank Holding Company Act of 1956, as amended ("BHCA"), and to inspection, examination and supervision by the Board of Governors of the Federal Reserve Board (the "FRB"System ("FRB") and by the Massachusetts Commissioner of Banks (the "Commissioner"("Commissioner."). We are required to file annually a report of our operations with, and are

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subject to examination by, the FRB and the Commissioner. The FRB has the authority to issue orders to BHCs to cease and desist from unsound banking practices and violations of conditions imposed by, or violations of agreements with, the FRB. The FRB is also empowered to assess civil money penalties against companies or individuals who violate the BHC Act of 1956, as amended, (the "BHCA")BHCA or orders or regulations thereunder, to order termination of non-bankingnonbanking activities of non-bankingnonbanking subsidiaries of BHCs and to order termination of ownership and control of a non-bankingnonbanking subsidiary by a BHC.

        BHCA—Activities and Other Limitations.    The BHCA prohibits a BHC from acquiring substantially all the assets of a bank or acquiring direct or indirect ownership or control of more than 5% of the voting shares of any bank, BHC or savings association, or increasing such ownership or control of any bank, BHC or savings association, or merging or consolidating with any BHC without prior approval of

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the FRB. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Interstate Act") generally authorizes adequately capitalized and managed BHCs, as determined by the FRB, to acquire banks located in any state, possibly subject to certain state-imposed age and deposit concentration limits, and also generally authorizes interstate mergers and to a lesser extent, interstate branching. In addition, as discussed more fully below, Massachusetts law imposes certain approval requirements with respect to acquisitions by a BHC of certain banking institutions and to mergers of BHCs.

        Unless a BHC becomes a "financialfinancial holding company"company ("FHC") under the Gramm-Leach-Bliley Act of 1999 ("GLBA") (as discussed below), the BHCA also prohibits a BHC from acquiring a direct or indirect interest in or control of more than 5% of the voting sharessecurities of any company whichthat is not a bank or a BHC and from engaging directly or indirectly in activities other than those of banking, managing or controlling banks or furnishing services to its subsidiary banks, except that it may engage in and may own shares of companies engaged in certain activities the FRB determined to be so closely related to banking or managing and controlling banks as to be a proper incident thereto. Before permitting a BHC to make such an investment, the FRB is required to weigh the expected benefit to the public, such as greater convenience, increased competition or gains in efficiency, against the possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interests or unsound banking practices.

        The GLBA established a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms, and other financial service providers by revising and expanding the BHCA framework to permit BHCs that qualify and elect to be treated as FHCs to engage in a range of financial activities broader than would be permissible for traditional BHCs, such as Investors Financial, that have not elected to be treated as FHCs. "Financial activities" is broadly defined to include not only banking, insurance and securities activities, but also merchant banking and additional activities that the FRB, in consultation with the Secretary of the Treasury, determines to be financial in nature or incidental to such financial activities, or that the FRB determines to be complementary activities that do not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally. In sum, the GLBA permits a BHC that qualifies and elects to be treated as a FHC to engage in a significantly broader range of financial activities than BHCs, such as Investors Financial, that have not elected FHC status.

        In order to elect to become ana FHC and thus engage in a broader range of financial activities, a BHC, such as Investors Financial, must meet certain tests and file an election form with the FRB. To qualify, all of a BHC's subsidiary banks must be well-capitalized (as discussed below under "Investors Bank") and well-managed, as measured by regulatory guidelines. In addition, to engage in the new activities, each of the BHC's banks must have been rated "satisfactory" or better in its most recent federal Community Reinvestment Act ("CRA") evaluation.

        A BHC that elects to be treated as ana FHC may face significant consequences if its banks fail to maintain the required capital and management ratings, including entering into an agreement with the FRB which imposes limitations on its operations and may even require divestitures. Such possible ramifications may limit the ability of a bank subsidiary to significantly expand or acquire less than well-capitalized and well-managed institutions. At this time, Investors Financial has not elected, and has not otherwise determined whether it will elect, to become a FHC.

        Capital Requirements.    The FRB has adopted capital adequacy guidelines, pursuant to which it assessesuses in assessing the adequacy of capital in examining and supervising a BHC and in analyzing applications toupon which it under the BHCA. Theseacts. The FRB's capital adequacy guidelines generally require BHCs to maintain total capital equal to 8% of total risk-adjusted assets and off-balance sheet items (the "Total Risk-Based Capital Ratio"), with at least one-half50% of that amount consisting of Tier I1 or core capital and the remaining amount consisting of Tier II2 or supplementary capital. Tier I1 capital for BHCs generally consists of the sum of common stockholders' equity and perpetual preferred stock (subject in the case

12

of the latter to limitations on the kind and amount of such stocks which may be included as Tier I1 capital), less

11

goodwill and other non-qualifyingnonqualifying intangible assets. Tier II2 capital generally consists of hybrid capital instruments;instruments, perpetual debt and mandatory convertible debt securities; perpetual preferred stock, which is not eligible to be included as Tier I1 capital; term subordinated debt and intermediate-term preferred stock; and, subject to limitations, general allowances for loan and lease losses. Assets are adjusted under the risk-based guidelines to take into account different risk characteristics.

        In addition to the risk-based capital requirements, the FRB requires BHCs to maintain a minimum leverage capital ratio of Tier I1 capital (defined by reference to the risk-based capital guidelines) to its average total averageconsolidated assets (the "Leverage Ratio") of 3.0%. Total average consolidated assets for this purpose does not include, for example, goodwill and any other intangible assets and investments that the FRB determines should be deducted from Tier I1 capital. The FRB has announced that the 3.0% Leverage Ratio requirement is the minimum for the top-rated BHCs without any supervisory, financial or operational weaknesses or deficiencies or those, which are not experiencing or anticipating significant growth. All other BHCs are required to maintain a minimum Leverage Ratio of 4.0%. BHCs with supervisory, financial, operational or managerial weaknesses, as well as BHCs that are anticipating or experiencing significant growth, are expected to maintain capital ratios well above the minimum levels. Because we anticipate significant future growth, we will be required to maintain a Leverage RatiosRatio of at least 4.0% to 5.0% or more.higher.

        We currently are in compliance with both the Risk BasedTotal Risk-Based Capital Ratio and the Leverage Ratio requirements.requirements, and our management expects these ratios to remain in compliance with the FRB's capital adequacy guidelines. (Separate, but substantially similar, capital adequacy guidelines under Federal Deposit Insurance Corporation ("FDIC") regulations apply to the Bank, as discussed more fully below.) At December 31, 2001, we had a Tier I Risk Based2003, our Total Risk-Based Capital Ratio equal to 16.76% and a Total Risk Based Capital Ratio equal to 16.77% and a Leverage Ratio equal to 5.88%.were 17.60% and 5.35%, respectively.

        U.S. bank regulatory authorities and international bank supervisory organizations, principally the Basel Committee on Banking Supervision ("Basel Committee"), currently are considering changes to the risk-based capital adequacy framework, which ultimately could affect the appropriate capital guidelines, including changes (such as those relating to lending to registered broker-dealers) that are of particular relevance to banks, such as the Bank, that engage in significant securities activities. Among other things, the Basel Committee rules, which are expected to become effective around 2006, would add operational risk as a third component to the denominator of the risk-capital calculation, in addition to credit and market risks. We are monitoring the status and progress of the Basel Committee rules and the related impact, if any, on our operations and are preparing for their implementation.

        Limitations on Acquisitions of Common Stock.    The Federalfederal Change in Bank Control Act prohibits a person or group of persons from acquiring "control" of a BHCdepository institution or a depository institution holding company unless the FRB has been given at least 60 days to review, public notice has been provided, and the FRB does not object to the proposal. Under a rebuttable presumption established by the FRB, the acquisition of 10% or more of a class of voting stocksecurities of a BHC,depository institution or depository institution holding company, such as us, with a class of securities registered under Section 12 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), would, under the circumstances set forth in the presumption, constitute the acquisition of control.

control of the depository institution or a depository institution holding company. In addition, any company, as that term is broadly defined in the statute, would be required to obtain the approval of the FRB under the BHCA before acquiring 25% (5% in the case of an acquirer that is a BHC) or more of any class of voting securities of a bank or BHC or a savings association, or otherwise obtaining control or a controlling influence over such lesser percentage of our outstanding common stock as the FRB deems to constitute control over us.an institution.

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        Massachusetts Law.    Investors Financial is deemedalso considered a bank holding companyBHC for purposes of Massachusetts law due to the manner in which it acquired the Bank. Accordingly, we have registered with the Commissioner and are obligated to make reports to the Commissioner. Further, as a Massachusetts bank holding company,BHC, Investors Financial may not acquire all or substantially all of the stock or assets of a banking institution, or merge or consolidate with another bank holding companyany other BHC or acquire direct or indirect ownership or control of any voting stock in any other banking institution if it will own or control more than 5% thereof without the prior consent of the Massachusetts Board of Bank Incorporation (the "BBI").Incorporation. As a general matter, however, the Commissioner does not rule upon or regulate the activities in which a BHC or its nonbank subsidiaries engage.

        Cash Dividends.    FRB policy provides that a bank or a BHC generally should not maintain its existing rate of cash dividends on common stock unless the organization's net income available to common shareholders over the past year has been sufficient to fully fund the dividends and the prospective rate of earnings retention appears consistent with the organization's capital needs, asset quality and overall financial condition. FRB policy further provides that a BHC should not maintain a level of cash dividends to its shareholders that places undue pressure on the capital of bank subsidiaries, or that can be funded only through additional borrowings or other arrangements that may undermine the BHC's ability to serve as a source of strength.

        Source of Strength.    FRB policy requires BHCs to serve as sources of financial and managerial strength to their subsidiary banks and, in connection therewith, to stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity and to maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks in a manner consistent with FRB policy. This support may be required at times when the bank holding company may not have the resources to provide it. Similarly, under the cross-guarantee provisions of the Federal Deposit Insurance Act ("FDIA"), the FDIC can hold any FDIC-insured depository institution liable for any loss suffered or anticipated by the FDIC in connection with (1) the "default" of a commonly controlled FDIC-insured depository institution; or (2) any assistance provided by the FDIC to a commonly controlled FDIC-insured depository institution "in danger of default." Accordingly, Investors Financial is expected to commit resources to the Bank in circumstances where it might not do so absent such policy.

        Disclosure Controls and Procedures.    The Sarbanes-Oxley Act of 2002, ("Sarbanes-Oxley") implements a broad range of corporate governance and accounting measures for public companies (including publicly-held bank holding companies such as the Company) designed to promote honesty and transparency in corporate America. Sarbanes-Oxley's principal provisions, many of which have been interpreted through regulations released in 2003, provide for and include, among other things:

•

The creation of an independent accounting oversight board;



•

Auditor independence provisions which restrict nonaudit services that accountants may provide to their audit clients;



•

Additional corporate governance and responsibility measures, including the requirement that the chief executive officer and chief financial officer of a public company certify financial statements;



•

The forfeiture of bonuses or their nonbank subsidiaries engage.other incentive-based compensation and profits from the sale of an issuer's securities by directors and senior officers in the twelve-month period following initial publication of any financial statements that later require restatement;



•

An increase in the oversight of, and enhancement of certain requirements relating to, audit committees of public companies and how they interact with the Company's independent auditors;

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•

Requirements that audit committee members must be independent and are barred from accepting consulting, advisory or other compensatory fees from the issuer;



•

Requirements that companies disclose whether at least one member of the audit committee is a "financial expert" (as such term is defined by the SEC) and if not, why not;



•

Expanded disclosure requirements for corporate insiders, including accelerated reporting of stock transactions by insiders and a prohibition on insider trading during pension blackout periods;



•

A prohibition on personal loans to directors and officers, except certain loans made by insured financial institutions, such as the Bank, on nonpreferential terms and in compliance with other bank regulatory requirements;



•

Disclosure of a code of ethics and filing a Form 8-K for a change or waiver of such code; and



•

A range of enhanced penalties for fraud and other violations.

        We are monitoring the status of other related ongoing rulemaking by the SEC and other regulatory entities. Currently, management believes that we are in compliance with the rulemaking promulgated to date.

Investors Bank

        General.    The Bank is subject to extensive regulation and examination by the Commissioner and by the Federal Deposit Insurance Corporation (the "FDIC"),FDIC, which insures itsthe Bank's deposits to the maximum extent permitted by law, and to certain requirements established by the FRB. The federal and state laws and regulations which are applicable to banks regulate among other things, the scope of their business, their investments, their reserves against deposits, the timing of the availability of certain deposited funds and the nature and amount of and collateral for certain loans.

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        FDIC Insurance Premiums.    The Bank pays deposit insurance premiums to the FDIC based on an assessment rate established by the FDIC for Bank Insurance Fund-member institutions. The FDIC has established a risk-based assessmentpremium system under which the FDIC classifies institutions are classified,based on their capital ratios and on other relevant information and generally pay premiums accordingassesses higher rates on those institutions that tend to their perceived riskpose greater risks to the federal deposit insurance funds. FDIA does not require the FDIC to charge all banks deposit insurance premiums when the ratio of deposit insurance reserves to insured deposits is maintained above specified levels. However, as a result of general economic conditions and recent bank failures, it is possible that the ratio of deposit insurance reserves to insured deposits could fall below the minimum ratio that FDIA requires, which would result in the FDIC setting deposit insurance assessment rates sufficient to increase deposit insurance reserves to the required ratio. We cannot predict whether the FDIC will be required to increase deposit insurance assessments above their current levels

        Capital Requirements.    The FDIC has promulgated regulations and adopted a statement of policy regarding the capital adequacy of state-chartered banks, which, like the Bank, are not members of the Federal Reserve System. These requirements are substantially similar to those adopted by the FRB regarding BHCs, as described above.

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        Moreover, the federal banking agencies have promulgated substantially similar regulations to implement the system of prompt corrective action established by Section 38 of the FDIA. Under the regulations, a bank generally shall be deemed to be:

•

"well capitalized" if it has a Total Risk Based Capital Ratiototal risk-based capital ratio of 10.0% or more,greater, has a Tier I Risk Based Capital Ratio1 risk-based capital ratio of 6.0% or more,greater, has a Leverage Ratioleverage ratio of 5.0% or moregreater and is not subject to any written agreement, order, capital orderdirective or prompt corrective action directive;



•

"adequately capitalized" if it has a total Risk Based Capital Ratiorisk-based capital ratio of 8.0% or more,greater, a Tier I Risk Based Capital Ratio1 risk-based capital ratio of 4.0% or more, andgreater, a Leverage Ratioleverage ratio of 4.0% or moregreater (3.0% under certain circumstances) and does not meet the definition of a "well capitalized,"capitalized" bank;



•

"undercapitalized" if it has a Total Risk Based Capital Ratiototal risk-based capital ratio that is less than 8.0%, a Tier I Risk Based Capital Ratio1 risk-based capital ratio that is less than 4.0% or a Leverage Ratioleverage ratio that is less than 4.0% (3.0% under certain circumstances),;



•

"significantly undercapitalized" if it has a Total Risk Based Capital Ratiototal risk-based capital ratio that is less than 6.0%, a Tier I Risk Based Capital Ratio1 risk-based capital ratio that is less than 3.0% or a Leverage Ratioleverage ratio that is less than 3.0%,; and



•

"critically undercapitalized" if it has a ratio of tangible equity to total assets that is equal to or less than 2.0%.

        An institution generally must file a written capital restoration plan which meets specified requirements with an appropriate federal banking agencyFDIC regional director within 45 days of the date that the institution receives notice or is deemed to have notice that it is undercapitalized, significantly undercapitalized or critically undercapitalized. An institution, which is required to submit a capital restoration plan, must concurrently submit a performance guaranty by each company that controls the institution. A critically undercapitalized institution generally is to be placed in conservatorship or receivership within 90 days unless the FDIC formally determines that forbearance from such action would better protect the deposit insurance fundfund.

        Immediately upon becoming undercapitalized, an institution becomes subject to the provisions of Section 38 of the FDIA, including for example, (i) restricting payment of capital distributions and management fees, (ii) requiring that the appropriate federal banking agencyFDIC monitor the condition of the institution and its efforts to restore its capital, (iii) requiring submission of a capital restoration plan, (iv) restricting the growth of the institution's assets and (v) requiring prior approval of certain expansion proposals.

        At December 31, 2001,2003, the Bank was deemed to be a well capitalizedwell-capitalized institution for the above purposes. Bank regulators may raise capital requirements applicable to banking organizations beyond current levels. We are unable to predict whether higher capital requirements will be imposed and, if so, at what levels and on what schedules. Therefore, we cannot predict what effect such higher requirements may have on us. As is discussed above, the Bank would be required to remain a well-capitalized institution at all times if we elected to be treated as ana FHC.

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        Brokered Deposits.    TheSection 29 of the FDIA restrictsand FDIC regulations generally limit the useability of an insured depository institution to accept, renew or roll over any brokered deposits by certain depository institutions.deposit depending on the institution's capital category. These restrictions have not had a material impact on the Bank's operations of the Bank because the Bank historically has not relied upon brokered deposits as a source of funding. At December 31, 2001,2003, the Bank did not have any brokered deposits.

        Transactions with Affiliates.    The FDIA restrictsSections 23A and 23B of the rangeFederal Reserve Act, which apply to the Bank, are designed primarily to protect against a depository institution suffering losses in certain transactions with affiliates, which includes Investors Financial and other subsidiaries of permissible transactions between a bank and an affiliated company. TheInvestors Financial. For example, the Bank is subject to certain restrictions on loans to us, on investment in the stock or securities thereof, on the taking of such stock or securities as collateral for loans to any

16

borrower and on the issuance of a guarantee or letter of credit on our behalf. InvestorsThe Bank also is subject to certain restrictions on most types of transactions with us, requiring that the terms of such transactions be substantially equivalent to terms to similar transactions with non-affiliates.nonaffiliates. The GLBAFRB recently adopted a final rule, which became effective April 1, 2003, to implement comprehensively Sections 23A and 23B of the Federal Reserve Act. This new rule, among other things, specifies that derivative transactions are subject to Section 23B (including use of daily marks and two way collateralization) but generally not to Section 23A, except derivatives in which the bank provides credit protection to a nonbank affiliate on behalf of an affiliate will be treated as a guarantee for purposes of Section 23A, and requires banks to establish policies and procedures (which the FRBBank has established) to promulgate rules addressingmonitor credit exposure relating to derivatives transactions between banks and their affiliates. The FRB has adopted interim rules addressing such transactions, and it has solicited comments onrule treats derivatives in which a bank provides credit protection to a nonaffiliate with respect to an obligation of an affiliate as a guarantee of an obligation of an affiliate subject to regulation under the types of restrictions that should apply to derivatives transaction between banks and their affiliates.rule.

        Activities and Investments of Insured State-Chartered Banks.    Section 24 of the FDIA generally limits the activities as principal and equity investments of FDIC-insured, state-chartered banks, such as the Bank, to those that are permissible for national banks. In 1999, the FDIC substantially revised its regulations implementing Section 24 of the FDIA to ease the ability of stateFDIC-insured, state-chartered banks to engage in certain activities not permissible for national banks, and to expedite FDIC review of bank applications and notice to engage in such activities.

        Further, the GLBA permits national banks and state banks, to the extent permitted under state law, to establish a financial subsidiary to engage in certain new activities which are permissible for subsidiaries of an FHC. Further, it expressly preserves the ability of national banks and state banks to retain all existing subsidiaries. In order to form a financial subsidiary, a national bank or state bank and each of its depository institution affiliates must be well-capitalized and suchwell-managed. Such banks would bethat establish a financial subsidiary will become subject to certain capital deduction, risk management and affiliate transaction rules.rules, among other requirements. Also, the FDIC's final rules governing the establishment of financial subsidiaries adopt the position that activities that a national bank could only engage in through a financial subsidiary, such as securities underwriting, only may be conducted in a financial subsidiary by a state nonmember bank. However, activities that a national bank could not engage in through a financial subsidiary, such as real estate development or investment, continue to be governed by the FDIC's standard activities rules. Moreover, to mirror the FRB's actions with respect to state member banks, the final rules provide that a state bank subsidiary that engages only in activities that the bank could engage in directly (regardless of the nature of the activities) will not be deemed to be a financial subsidiary.

        Community Reinvestment Act.CRA.    The Community Reinvestment Act ("CRA")CRA requires the FDIC to evaluate the Bank's performance inassess an institution's record of helping to meet the credit needs of the community.local communities in which the institution is chartered, consistent with the institution's safe and sound operation, and to take this record into account when evaluating certain applications.

        Massachusetts has also enacted a similar statute that requires the Commissioner to evaluate the Bank's performance in helping to meet the credit needs of its entire community credit needs. Theand to take that record into account in considering certain applications. For purposes of the CRA, the Bank has been designated as a "wholesale institution" for CRA purposes by the Commissioner and has been designated as a "special purpose" institution by the FDIC. The wholesale institution designation reflects the nature of our business as other than a retail financial institution and prescribes CRA review criteria applicable to the Bank's particular type of business. As a part of the CRA program, the Bank is subject to periodic CRA examinations by the Commissioner (but not the FDIC because special purpose institutions are exempt from such FDIC review) and maintains comprehensive records of its CRA activities for this purpose. Management believes the Bank is currently in compliance with all CRA requirements. Because the Bank is deemed a special purpose institution by the FDIC, it is exempt from CRA review by the FDIC.

        Customer Information Security.    The FRB, the FDIC and other bank regulatory agencies have adopted final guidelines for establishing standards for safeguarding nonpublic personal information about customers that implement provisions of the GLBA (the "Guidelines") for safeguarding confidential customer information. The. Among other things, the Guidelines

17

require each financial institution, under the supervision and ongoing oversight of its Board of Directors or an appropriate committee thereof, to createdevelop, implement and maintain a comprehensive written information security program designed to ensure the

14

security and confidentiality of customer information, to protect against any anticipated threats or hazards to the security or integrity of such information; and to protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer.

        Privacy.    The FDIC and other regulatory agencies have published final privacy rules pursuant to provisions of the GLBA requires financial institutions to implement policies and procedures regarding("Privacy Rules"). The Privacy Rules, which govern the disclosuretreatment of nonpublic personal information about consumers by financial institutions, require a financial institution to provide notice to customers (and other consumers in some circumstances) about its privacy policies and practices, describe the conditions under which a financial institution may disclose nonpublic personal information to nonaffiliated third parties. In general, the statute requires usparties and provide a method for consumers to explain to consumers our policies and procedures regarding the disclosure of such nonpublic personal information, and, except as otherwise required by law, we are prohibitedprevent a financial institution from disclosing suchthat information except as provided in our policies and procedures.to most nonaffiliated third parties by "opting-out" of that disclosure, subject to certain exceptions.

        USA Patriot Act.    The USA Patriot Act of 2001 (the "Patriot"USA Patriot Act"), designed to deny terrorists and others the ability to obtain anonymous access to the United StatesU.S. financial system, has significant implications for depository institutions, brokers, dealersbroker-dealers and other businesses involved in the transfer of money. The USA Patriot Act, mandates or willtogether with the implementing regulations of various federal regulatory agencies, require financial institutions, including the Bank, to implement additional or amend existing policies and procedures with respect to, or additional measures designed to address, any or all of the following matters, among others: money laundering;other things, anti-money laundering compliance, suspicious activitiesactivity and currency transaction reporting;reporting and currency crimes.due diligence on customers. They also permit information sharing for counter-terrorist purposes between federal law enforcement agencies and financial institutions, as well as among financial institutions, subject to certain conditions, and require the FRB (and other federal banking agencies) to evaluate the effectiveness of an applicant in combating money laundering activities when considering applications filed under Section 3 of the BHCA or the Bank Merger Act. Management believes that we are currently in compliance with all currently effective requirements prescribed by the USA Patriot Act and all applicable final implementing regulations.

        Massachusetts Law—Dividends.Law-Dividends.    Under Massachusetts law, the board of directors of a trust companiescompany, such as the Bank, may paydeclare from "net profits" cash dividends no more often than quarterly, and only out of "net profits" andprovided that there is no impairment to the extent that such payments will not impair the Bank'strust company's capital stock and surplus account.stock. Moreover, prior Commissioner approval is required if the total of all dividends fordeclared by a trust company in any calendar year would exceed the total of its net profits for that year combined with its retained net profits for the previous two years.years, less any required transfer to surplus or a fund for the retirement of any preferred stock. These restrictions on the Bank's ability of the Bankto declare and to pay dividends may restrictlimit Investors Financial's ability to pay dividends to ourits stockholders. We cannot predict future dividend payments of the Bank at this time.

        Regulatory Enforcement Authority.    The enforcement powers available to federal and state banking regulators include, among other things, the ability to assess civil money penalties, to issue cease-and-desist or removal orders and to initiate injunctive actions against banking organizations and institution-affiliated parties, as defined. In general, these enforcement actions may be initiated for violations of law and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with regulatory authorities. Federal law requires, except underUnder certain circumstances publicfederal and state law require disclosure and reports of certain criminal offenses and also final enforcement actions by the federal banking agencies.

        Transfer Agency.    In order to serve as transfer agent to our clients that execute transactions in publicly tradedpublicly-traded securities, we must register with the SEC as a transfer agent under the Exchange Act. As a registered transfer agent, we are subject to certain reporting and record keepingrecordkeeping requirements.

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Currently, management believes that we are in compliance with these registration, reporting and record keepingrecordkeeping requirements.

        Regulation of Investment Companies.    Certain of our mutual fund and unit investment trust clients are regulated as "investment companies" as that term is defined under the Investment Company Act of 1940, as amended (the "ICA"), and are subject to examination and reporting requirements applicable to the services we provide.

        The provisions of the ICA and the regulations promulgated thereunder prescribe the type of institution which may act as a custodian of investment company assets, as well as the manner in which a custodian administers the assets in its custody. Because we serve as custodian for a number of our investment company clients, these regulations require, among other things, that we maintain certain minimum aggregate capital, surplus, and undivided profits. Additionally, arrangements between us and clearing agencies or other securities depositories must meet ICA requirements for segregation of assets, identification of assets and client approval. Future legislative and regulatory changes in the existing laws and regulations governing custody of investment company assets, particularly with respect to custodian

15

qualifications, may have a material and adverse impact on us. Currently, management believes we are in compliance with all minimum capital and securities depository requirements. Further, we are not aware of any proposed or pending regulatory developments, which, if approved, would adversely affect the ability of us to act as custodian to an investment company.

        Investment companies are also subject to extensive record keepingrecordkeeping and reporting requirements. These requirements dictate the type, volume and duration of the record keepingrecordkeeping we undertake, either in our role as custodian for an investment company or as a provider of administrative services to an investment company. Further, we must follow specific ICA guidelines when calculating the net asset value of a client mutual fund. Consequently, changes in the statutes or regulations governing record keepingrecordkeeping and reporting or valuation calculations will affect the manner in which we conduct our operations.

        New legislation or regulatory requirements could have a significant impact on the information reporting requirements applicable to our clients and may in the short term adversely affect our ability to service those clients at a reasonable cost. Any failure by us to provide such support could cause the loss of customers and have a material adverse effect on our financial results. Additionally, legislation or regulations may be proposed or enacted to regulate us in a manner which may adversely affect our financial results.

        Other Securities Laws Issues.    The GLBA also amended the federal securities laws to eliminate the blanket exceptions that banks traditionally have had from the definition of broker dealer"broker" and investment adviser. With respect"dealer" for a "bank." In February 2003, the SEC extended the temporary exemption from the definition of "dealer" for banks until September 30, 2003 and, in April 2003, it extended the temporary exemption from the definition of "broker" until November 12, 2004. In February 2003, the SEC also issued final rules that, among other things, adopt amendments to brokerits rule granting an exemption to banks from dealer registration forde minimis riskless principal transactions, and to its rule that defines terms used in the SEC has extendedbank exception to dealer registration for asset-backed transactions and it adopted a new exemption for banks from the date by which banks must comply with new broker-dealer registration requirements until May 12, 2002.definition of broker and dealer under the Exchange Act for certain securities lending transactions. Banks not falling within the specific exemptions provided by the new law may have to register with the SEC as a broker-dealerbroker or a dealer or both and become subject to SEC jurisdiction. We are currently evaluating alternativesdo not expect these new rules to ensurehave a material effect on us, as we recently formed a registered broker-dealer subsidiary.

        The GLBA also amended the federal securities laws to eliminate the blanket exceptions that banks traditionally have had from the Bank will not be required to register as a broker-dealer.definition of "investment adviser." With respect to investment adviser registration, the GLBA requires a bank that acts as investment adviser to a registered investment company to register as an investment adviser or to conduct such advisory activities through a separately

19

identifiable department or division of the bank so registered. Accordingly, the Bank furnishes investment advice to registered investment companies through a separately identifiable department or division of the Bank that is registered with the SEC as an investment adviser. Federal and state laws impose onerous obligations on registered investment advisers, including fiduciary duties, record keepingrecordkeeping requirements and disclosure obligations. Currently, management believes that we are in compliance with these requirements.

        Future Legislation.    Changes to the laws and regulations in the states and countries where Investors Financial and its subsidiaries transact business can affect the operating environment of BHCs and their subsidiaries in substantial and unpredictable ways. We cannot accurately predict whether those changes in laws and regulations will occur, and, if they do occur, the ultimate effect they would have upon our financial condition or results of operation.

16Availability of Filings

        You may access, free of charge, copies of the following documents and related amendments, if any, in the Investor Relations section of our web site at www.ibtco.com:

1)

Our Annual Reports on Form 10-K;



2)

Our Quarterly Reports on Form 10-Q;



3)

Our Current Reports on Form 8-K; and



4)

Our Proxy Statement.

        You may also access, free of charge, copies of the following corporate governance documents in the Investor Relations section of our web site at www.ibtco.com.

1)

Our Code of Conduct;



2)

Our Corporate Governance Guidelines;



3)

Our Audit Committee Charter;



4)

Our Nominating and Corporate Governance Committee Charter; and



5)

Our Compensation Committee Charter.

        We post these documents on our web site as soon as reasonably practicable after we file or furnish them electronically with or to the Securities and Exchange Commission or, in the case of the corporate governance documents, as soon as reasonably practical after material amendment. The information contained on our web site is not incorporated by reference into this document and should not be considered a part of this Report. Our web site address is included in this document as an inactive textual reference only.

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ITEM 2.    PROPERTIES.

        The following table provides certain summary information with respect to the principal properties that we leased as of December 31, 2001:2003:

*

Pursuant to the terms of the contract, this lease can be terminated in 2013 by paying six months rent as compensation.

        SeeFor more information, see Note 1617 of the Notes to Consolidated Financial Statements.

ITEM 3.    LEGAL PROCEEDINGS.

        On January 16, 2001, Mopex, Inc.31, 2003, we were named in a class action lawsuit alleging, among other things, violations of California wage and hour laws at our Sacramento and Walnut Creek facilities. The lawsuit was filed an action entitledMopex, Inc. v. Chicago Stock Exchange, Inc., et al., Civil Action No. 01 C 0302 (the "Complaint"), in the United States DistrictSuperior Court for the Northern District of Illinois. In the action, Mopex alleges thatCalifornia, County of Sacramento. On July 23, 2003, we and numerous other entities, including Barclays Global Investors, State Street Bank and Trust Company, and Merrill Lynch, Pierce, Fenner & Smith, Inc., infringe U.S. Patent No. 6,088,685, entitled, "Open End Mutual Fund Securitization Process," assigned to Mopex. In particular, Mopex alleges that the '685 patent covers the creation and trading of certain securities, including the Barclays iShares exchange traded funds. The Complaint seeks injunctive relief, damages, and enhanced remedies (including attorneys' fees and treble damages). In a letter dated January 18, 2001, Mopex stated that it desired to license the patentreached agreement in suit "at a favorable royalty rate prior to substantial involvementprinciple with the Court." On April 3, 2001, we filed an answer and counterclaim, denying any liability on Mopex's claim and seeking a declaratory judgment that the '685 patent is invalid and not infringed. On April 26, 2001, Mopex filed a reply to our counterclaim, denying that the patent in suit is invalid and not infringed by our activities. We are indemnified by the iShares Trust for certain defense costs and damages resulting from Mopex's claim and believe the claim is without merit.

        While we do not offer or sell the securities discussed in the complaint, we provide certain custody, accounting or other administrative services for the Barclays iShares family of exchange traded funds. Barclays is onerepresentatives of the defendants named inplaintiffs to settle the complaint. We cannot be sure that wecase. As currently agreed, the settlement will prevail in the defense of this claim. Patent litigation can be costly and could divert the attention of management. If we were found to infringe the patent, we would have to pay damages and would be ordered to cease any infringing activity or seek a license under the patent. We cannot be sure that we will be able to obtain a license on a timely basis or on reasonable terms, if at all, or that we will be successful in obtaining indemnification from the iShares Trust. As a result, any determination of infringement couldnot have a material adverse effect uponimpact on our business, financial condition andor results of operations. The settlement is subject to proper administration of payments to the class members and final approval by the court. In anticipation of this settlement and related costs, we accrued a liability of approximately $1.0 million in the second quarter of 2003.

        On June 27, 2003, we and an individual employee of ours were named in a lawsuit alleging, among other things, that we breached an implied covenant of good faith and fair dealing in a subadvisory contract with Opus Investment Management, Inc. ("Opus") and that our individual employee engaged in a breach of fiduciary duties and tortious interference with a contract. Opus had been a subadviser to the Merrimac Funds, for which we act as investment adviser. Upon the expiration of Opus' contract on June 1, 2003, the Merrimac Funds elected not to re-appoint Opus as subadviser. The lawsuit was filed in Superior Court in Worcester, Massachusetts and seeks unspecified damages. We believe that the claims are without merit and intend to defend our rights vigorously. On September 22, 2003, we filed a motion to dismiss all claims against us under the complaint. A hearing on the motion to dismiss is currently scheduled for March 2004.

        In July 2000, two of our Dublin subsidiaries, Investors Trust & Custodial Services (Ireland) Ltd. (ITC)("ITC") and Investors Fund Services (Ireland) Ltd. (IFS)("IFS"), received a plenary summons in the High Court,

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Dublin, Ireland. The summons named ITC and IFS as defendants in an action brought by the FTF ForexConcept Fund Plc (the "Fund"), a former client. The summons also named as defendants FTF Forex Trading and Finance, S.A., the Fund's investment manager, Ernst & Young, LLP, the Fund's auditors, and Dresdner Bank-Kleinwort Benson (Suisse) S.A., a trading counterparty to the Fund. The Fund is an investment vehicle organized in Dublin to invest in foreign exchange contracts. A total of approximately $4.7 million had been invested in the Fund. Most of that money was lost prior to the Fund's closing to subscriptions in June 1999.

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        In January 2001, ITC, IFS and the other defendants named in the plenary summons received a statement of claim by the Fund seeking unspecified damages allegedly arising from breach of contract, misrepresentation and breach of warranty, negligence and breach of duty of care, and breach of fiduciary duty, among others. We have notified our insurers and intend to defend thethis claim vigorously. Based on our investigation through December 31, 2001, our management does2003, we do not expect this matter to have a material adverse effect on our business, financial condition or results of operations and financial condition.operations.

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

        No matters were submitted to a vote of our security holders during the quarter ended December 31, 2001.2003.

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PART II

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

PRICE RANGE OF COMMON STOCK AND DIVIDEND HISTORY AND POLICY

        Our common stock is quoted on the Nasdaq National Market under the symbol "IFIN". The following table sets forth, for the calendar periods indicated, the high and low sale prices for the common stock as reported by Nasdaq and dividends per share paid on the common stock. All information in the table below has been restated to reflect the two-for-one stock split paid June 14, 2002.

        As of January 31, 2002,2004, there were approximately 854835 stockholders of record.

        We currently intend to retain the majority of future earnings to fund the development and growth of our business. Our ability to pay dividends on our common stock may depend on the receipt of dividends from Investors Bank. In addition, we may not pay dividends on our common stock if we are in default under certain agreements that we entered into in connection with the sale of the 9.77% Capital Securities by Investors Capital Trust I. See "Management's Discussion and AnalysisNote 11 of our Notes to Consolidated Financial Condition and Results of Operations—Capital Resources."Statements included with this Report. Any dividend payments by Investors Bank are subject to certain restrictions imposed by the Massachusetts Commissioner of Banks. See "Business—Regulation and Supervision."Supervision" section for additional information. Subject to regulatory requirements, we expect to pay an annual dividend to our stockholders, currently estimated to be in an amount equal to $.10$0.07 per share of outstanding common stock (approximately $3.2$4.6 million based upon 31,971,40465,436,788 shares outstanding as of December 31, 2001)2003). We expect to declare and pay such dividend ratably on a quarterly basis.

19        The information required under this item regarding securities authorized for issuance under equity compensation plans is incorporated herein by reference to the section entitled "Stock Plans" contained in our definitive proxy statement pursuant to Regulation 14A, which proxy statement will be filed with the Securities and Exchange Commission not later than 120 days after the close of our fiscal year ended December 31, 2003.

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ITEM 6.    SELECTED FINANCIAL DATA.

        The following table contains certain of our consolidated financial and statistical information, and should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations," our Consolidated Financial Statements and Notes to Consolidated Financial Statements, and other financial information appearing elsewhere in this Annual Report. (Dollars in thousands, except per share and employee data).

(1)

Effective July 1, 2003, the Company adopted provisions of SFAS 150, which resulted in a reclassification of the trust preferred securities from mezzanine financing to liabilities. As such, interest expense associated with the trust preferred securities was reclassified to net interest income.

(2)

All numbers shown in this table have been restated to reflect reclassifications related to EITF No. 01-14.

(3)

All numbers shown in this table have been restated to reflect the two-for-one stock splits paid March 17, 1999, and June 15, 2000 and June 14, 2002, where applicable.

(2)(4)

Effective October 1, 2003, the Company adopted the provisions of FIN 46 (revised December 2003), which resulted in the deconsolidation of Investors Capital Trust I, the trust that holds the trust preferred securities.

(5)

We intend to retain the majority of future earnings to fund development and growth of our business. We currently expect to pay cash dividends at an annualized rate of $.10$0.07 per share subject to regulatory requirements. Refer to "Market Risk: Liquidity" included in Management's Discussion and Analysis of Financial Condition and Results of Operations for further information.

(3)(6)

Refer to "Capital Resources" included within Management's Discussion and Analysis of Financial Condition and Results of Operations for further information.

(4)(7)

Assets processed is the total dollar value of financial assets on the reported date for which we provide one or more of the following services: global custody, multicurrency accounting, mutual fund administration, securities lending, foreign exchange, cash management, performance measurement, institutional transfer agency, investment advisory services, and lines of credit.credit, middle office outsourcing and brokerage and transition management services.

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

Overview

        You should read the following discussion together with our Consolidated Financial Statements and related Notes to Consolidated Financial Statements, which are included elsewhere in this Annual Report. The following discussion contains forward-looking statements that reflect plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements.

        We provide a broad range ofasset administration services for the financial services industry through our wholly-owned subsidiary, Investors Bank & Trust Company. We provide core services and value-added services to a variety of financial asset managers. Thesemanagers, including mutual fund complexes, investment advisors, family offices, banks and insurance companies. Core services include our core services, global custody, multicurrency accounting and mutual fund administration, as well as our value-addedadministration. Value-added services such asinclude securities lending, foreign exchange, cash management, performance measurement, institutional transfer agency, and investment advisory services, lines of credit, middle office outsourcing and brokerage and transition management services. We have offices located in the United States, Ireland, Canada, and the Cayman Islands with a vast subcustodian global network established to accommodate the international needs of our clients. At December 31, 2001,2003, we provided services for approximately $814 billion$1.1 trillion in net assets, including approximately $84$177 billion ofin foreign net assets.

        On October 1, 1998,We grow our business by selling our services to new clients and by further penetrating our existing clients. We believe that we acquired the domestic institutional trust and custody business of BankBoston, N.A. Under the termsservice less than 10% of the purchase agreement,assets managed by our existing clients, and we paid approximately $48 millionhave traditionally achieved significant success in growing client relationships. Our ability to BankBoston asservice new clients and expand our relationships with existing clients depends on our provision of superior client service. Our growth is also affected by overall market conditions, the closingregulatory environment for us and subsequently paid an additional $4.9 million based upon client retention. The acquired business provides master trust and custody services to endowments, pension funds, municipalities, mutual funds and other financial institutions. The acquisition was accounted for using the purchase method of accounting. In connection with the acquisition, we also entered into an outsourcing agreement with BankBoston under which we provided custodial services for BankBoston's private banking and institutional asset management businesses. In 2000, the outsourcing agreement and a custody agreement with the BankBoston-sponsored 1784 Funds were terminated. As a result of the early termination of the outsourcing agreementour clients and the 1784 Funds custody agreement, we received a totalsuccess of $11.4 million in termination fees. We have not experienced a material impact on net income due to the termination of either agreement. We were informed by BankBoston that its decision to terminate both of the agreements was not related in any way to our quality of service, but was made as part of the integration process undertaken in connection with the merger of BankBoston with Fleet.

        On February 16, 1999, our board of directors declared a two-for-one stock split in the form of a 100% stock dividend payable on March 17, 1999. All numbers in this Report have been restated to reflect the two-for-one stock split paid March 17, 1999, where applicable.

        On March 26, 1999, we completed the issuance and sale of 1,800,000 shares of common stock at $14.50 per share in a private placement to one investor. The net capital raised in the private placement was used to support our balance sheet growth.

        On March 10, 2000, we acquired the right to provide institutional custody and related services for accounts managed by the Trust Company of the West, formerly serviced by Sanwa Bank California. The accounts subject to the agreement totaled approximately $4.6 billion in assets.

        On May 15, 2000, our board of directors declared a two-for-one stock split in the form of a 100% stock dividend payable on June 15, 2000. All numbers in this Report have been restated to reflect the two-for-one stock split paid June 15, 2000, where applicable.

        On January 1, 2001, we adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," and the corresponding amendments and SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities." On adoption of these new accounting standards, we recorded a transition adjustment recognizing an after tax reduction in Other Comprehensive Income ("OCI") of $3.9 million. In conjunction with the adoption, we elected to reclassify approximately $402 million of securities from held to maturity to available for sale, which further reduced OCI, net of tax, by approximately $1.4 million.

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        On February 1, 2001, we completed the issuance and sale of 1,624,145 shares of Common Stock at $71.62 per share in a public offering. A portion of the proceeds was used to fund the acquisition of the advisor custody unit of The Chase Manhattan Bank. The remaining proceeds were used for the assumption of the U.S. asset administration unit of Barclays Global Investors, N.A. and working capital.

        On February 1, 2001, we purchased the advisor custody unit of The Chase Manhattan Bank. This unit provided institutional custody services to individual accounts holding approximately $27 billion in assets as of February 1, 2001. These accounts consist of individual accounts, trusts, endowments and corporate accounts whose assets are managed by third-party investment advisors. Pursuant to the terms of the asset purchase agreement, we paid to Chase at the closing of the transaction approximately $31.5 million of the total purchase price, plus another $39.8 million in exchange for the book value of loans to clients. In 2002, we are obligated to pay another $10.5 million contingent upon client retention. The transaction was accounted for as a purchase.

        On May 1, 2001, we assumed the operations of the U.S. asset administration unit of Barclays Global Investors, N.A. ("BGI"), a large international institutional investment manager. The unit, located in Sacramento, California, provides custody, fund accounting and other operations functions for BGI's clients. The transaction was accounted for as a purchase.

        The events of September 11, 2001 did not have a material effect on our financial condition or results of operations.

Revenue and Expense Overviewclients marketing their products.

        We derive our asset servicing revenue from financial asset servicing. Althoughproviding these core and value-added services. We derive our net interest income and non-interest income are reported separately for financial statement presentation purposes,by investing the cash balances our clients view the pricing of our service offeringsleave on a bundled basis. In establishing a fee structure for a specific client, management analyzes all expected revenue and related expenses, as opposed to separately analyzing fee income and interest income and related expenses for each from the relationship. Accordingly, we believe net operating revenue (net interest income plus non-interest income) and net income are the most meaningful measures of our financial results. Net operating revenue increased 60% to $353 million in 2001 from $221 million in 2000. Net income increased 49% to $50.2 million from $33.6 million in 2000.

        Non-interest income consists primarily of fees for financial asset servicing and is principally derived from global custody, multicurrency accounting, mutual fund administration and institutional transfer agency services for financial asset managers and the assets they control. Our clients pay fees based on the volume of assets under custody, portfolio transactions, income collected and whether other value-added services such as foreign exchange, securities lending and performance measurement are needed. Asset-based fees are usually charged on a sliding scale and are subject to minimum fees. As such, when the assets in a portfolio under custody grow as a result of changes in market values or cash inflows, our fees may be a smaller percentage of those assets. If the value of equity assets held by our clients were to increase or decrease by 10%, we estimate that this, by itself, would currently cause a corresponding change of approximately 3% in our earnings per share. If the value of fixed income assets held by our clients were to increase or decrease by 10%, we estimate that this, by itself, would currently cause a corresponding change of approximately 2% in our earnings per share.

        Net interest income represents the difference between income generated from interest-earning assets and expense on interest-bearing liabilities. Interest-bearing liabilities are generated by our clients who, in the course of their financial asset management, generate cash balances which they deposit on a short-term basis with us. We invest these cash balances and remit a portion of the earnings on these investments to our clients. Our share of earnings from these investments is viewed as part of the total package of compensation paid to us fromthat our clients pay us for performingservicing their assets. Our service offerings are priced on a bundled basis. In establishing a fee structure for a specific client, we analyze all expected revenue and expenses. We believe net operating revenue (net interest income plus noninterest income) and net income are the most meaningful measures of our financial results.

        As an asset servicing.administration services company, the amount of net operating revenue that we generate is impacted by overall market conditions, client activity, and the prevailing interest rate environment. Over the course of the past year, we have benefited from the appreciation of the market values of assets we service for our clients. A significant portion of our core services revenue is based upon the amount of assets under administration. As market values of underlying assets fluctuate, so will our revenue. We have managed this volatility by offering a tiered pricing structure for our asset-based fees. As asset values increase, the basis point fee is reduced for the incremental assets. Many of our value-added services are transactional based, and we receive a fee for each transaction processed. We have also continued to experience net interest margin compression in this low interest rate environment because we have little room to reduce further the rates we pay on our interest-bearing liabilities, yet high volumes of prepayments in our investment portfolio have caused us to reinvest these cash flows in lower-yielding assets.

22        In 2003, we settled a tax assessment with the Commonwealth of Massachusetts. In March 2003, a retroactive change in the Commonwealth of Massachusetts tax law disallowed a dividends received deduction taken by the Bank on dividends it had received since 1999 from a wholly-owned real estate investment trust. During the second quarter of 2003, we settled this disputed tax assessment with the

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        Operating expenses consistMassachusetts Department of costs incurred in supportRevenue, agreeing to pay approximately 50% of our business activities. As a service provider, our largest expenditures are staffing costs, including compensation and benefits. We also rely heavily on technological tools and services for processing, communicating and storing data.the liability. As a result of this change in tax law, we recorded an additional state tax expense of approximately $7.2 million, net of federal income tax benefit, in 2003. Despite the additional tax expense, we were still able to generate a 33% growth in net income for the year ended December 31, 2003 when compared to the same period in the prior year.

        We continue to remain focused on our technologysales efforts, prudent expense management and telecommunication expense is alsoincreasing efficiency. These goals are complicated by the need to build infrastructure to support our rapid growth, by the need to maintain state-of-the-art systems and by the need to retain and motivate our high caliber workforce.

        In our 2003 earnings releases, we reported operating income and per share information that exclude the effect of the state tax assessment settlement previously discussed above. We believe that operating earnings provide a large percentagemore meaningful presentation of the results of operations because they do not include the one-time tax charge which was unrelated to our operations. The following table presents a reconciliation between earnings presented on the face of our Statement of Income and the non-GAAP measure of net operating expenses.income referenced in our earnings releases (Dollars in thousands, except per share data):

SignificantGAAP Earnings

Pro Forma Operating Earnings

(1)

Provision for income taxes for the year ended December 31, 2003 excludes a $7.2 million charge, net of federal income tax benefit, that resulted from a retroactive change in the Commonwealth of Massachusetts tax law enacted in the first quarter of 2003 and the Company's subsequent settlement of the resulting tax assessment with the Massachusetts Department of Revenue. The effect of the exclusions is an increase in diluted and basic earnings per share of $0.11.

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Critical Accounting Policies

        TheOur consolidated financial statements are prepared in accordance with accounting principles generally accepted in the U.S.,United States of America, which require us to make estimates and assumptions. We have identified the following accounting policies that, as a result of the complexities of the underlying accounting standards and operations involved, could result in significant changes to our consolidated financial condition or results of operations under different conditions or using different assumptions. Senior management has discussed these critical accounting policies with the audit committee.

Derivative Financial Instruments—We do not purchase derivative financial instruments for trading purposes. Interest rate swap agreements are matched with specific financial instruments reported on the consolidated balance sheet. We use derivative instruments to manage exposures to interest rate risks. We routinely enter into interest rate swap agreements in which we pay a fixed interest rate and receive a floating interest rate. These transactions are designed to hedge a portion of our liabilities in connection with securities sold under repurchase agreements. By entering into a pay-fixed/receive-floating interest rate swap, a portion of these liabilities is effectively converted to a fixed rate liability for the term of the interest rate swap agreement.

        On January 1, 2001, we adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended and interpreted, which established accounting and reporting standards for derivative instruments. We also adopted SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities." All derivatives, whether designated in hedging relationships or not, are required to be recorded on the balance sheet at fair value. If the derivative is designated as a fair value hedge, the change in the fair value of the derivative and the item being hedged will be recognized in earnings. If the derivative is designated as a cash flow hedge, the effective portions of changes in the fair value of the derivative are recorded in OCI. Ineffective portions of changes, as determined in accordance with SFAS No. 133, in the fair value of the cash flow hedges are recognized in earnings. For derivatives that do not qualify as hedges, changes in their fair value are recognized in earnings.

Hedge accounting requires that we measure the changes in fair value of derivatives designated as hedges as compared to changes in expected cash flows of the underlying hedged transactions for each reporting period. This process involves the estimation of the expected future cash flows of hedged transactions. Interest rate swaps are valued using a nationally recognized swap valuation model. The LIBOR (London InterBank Offered Rate) curve in this model serves as the basis for computing the market value of the swap portfolio. If interest rates increase, the swaps would gain in value. Conversely, if interest rates decrease, there would be a corresponding decline in the market value of the swaps portfolio. Changes in conditions or the occurrence of unforeseen events could affect the timing of the recognition of changes in fair value of certain hedging derivatives. The measurement of fair value is based upon market values, however, in the absence of quoted market values, measurement involves valuation estimates. These estimates are based on methodologies deemed appropriate in theunder existing circumstances. However, the use of alternative assumptions could have a significant effect on estimated fair value.

        Defined Benefit Pension Assumptions—Each fiscal year, we must assess and select the discount rate, compensation increase percentage and average return on plan assets assumptions in order to project our benefit obligations under our defined benefit plans. The discount rate is based on the weighted-average yield on high quality fixed income investments that are expected to match the plan's projected cash flows. The compensation increase percentage is based upon management's current and expected salary increases. The average return on plan assets is based on the expected return on the plan's current investment portfolio, which can reflect the historical returns of the various asset classes. For the fiscal year ended December 31, 2003, the discount rate, compensation increase and average return on plan assets were 6.25%, 3.75% and 8.50%, respectively. The discount rate at December 31, 2003 was lower than that at December 31, 2002 by 0.50% due to a decline in interest rates, and the compensation increase percentage was equal to the prior year as assumptions on compensation increases remain consistent. The rate of return on plan assets of 8.50% has remained consistent with the prior year as the historical long-term return on plan assets has been consistent with the estimated rate. In addition, this increase in expense is expected to be partially offset by the incremental return on our additional $3.0 million contribution made in 2003. Net periodic pension expense for 2003 was $1.0 million and is expected to be approximately $1.4 million in fiscal year 2004.

        Hedge ineffectiveness, determinedThe discount rate and compensation increase percentage assumptions for our nonqualified, unfunded, supplemental retirement plan, which covers certain employees, are the same as those of our defined benefit pension plan. The net periodic expense for 2003 for the supplemental retirement plan was $2.4 million and is expected to be approximately $2.5 million in accordancefiscal year 2004.

New Accounting Principles

        In April 2003, the Financial Accounting Standards Board ("FASB") issued SFAS No. 149,Amendment of Statement 133 on Derivative Instruments and Hedging Activities. SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133,Accounting for Derivative Instruments and Hedging Activities, resulting in more consistent reporting of contracts as

27

either derivatives or hybrid instruments. SFAS No. 149 was effective for contracts entered into or modified after June 30, 2003, and is applied on a prospective basis. We have evaluated our financial accounting and reporting for all derivative instruments and found them to be consistent with SFAS No. 133, had an insignificant impact on earnings for the twelve months ended December 31, 2001. No cash flow hedges were dedesignated or discontinued for the twelve months ended December 31, 2001.149.

        We enter into foreign exchange contracts with clients and strive to enter into a matched position with another bank. These contracts are subject to market value fluctuations in foreign currencies. Gains and losses from such fluctuations are netted and recorded as an adjustment of asset servicing fees. Unrealized gains (losses) resulting from purchases and sales of foreign exchange contracts are included within the respective other assets and other liabilities categories on our consolidated balance sheet. The

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foreign exchange contracts have been reduced by balances with the same counterparty where a master netting agreement exists.

New Accounting Principles—In June 2001,May 2003, the FASB issued SFAS No. 141, "Business Combinations," which supersedes APB Opinion No. 16, "Business Combinations,"150,Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and FASB Statement No. 38, "Accounting for Preacquisiton Contingencies of Purchased Enterprises."Equity. SFAS No. 141150 requires an issuer to classify financial instruments within its scope as a liability (or an asset in some circumstances). This Statement provides that all business combinationsthese instruments must be accounted for by a single method—classified as liabilities in the purchase method. This statement requires that intangible assets that can be identified and named be recognized as assets apart from goodwill under certain criteria. This statement also requires disclosure of the primary reasons for a business combination and the allocation of the purchase price paid to the assets acquired and liabilities assumed by majorconsolidated balance sheet caption. Whenand recorded at fair value. We adopted the amounts of goodwill and intangible assets acquired are significant in relation to the purchase price paid, additional disclosures about those assets are required. The provisions of SFAS No. 141 apply to all business combinations initiated after June 30, 2001. We dothis Statement effective July 1, 2003. The adoption of this Statement did not anticipatehave a significantmaterial impact on the consolidatedour financial statements.position.

        In June 2001,January 2003, the FASB issued SFASInterpretation No. 142, "Goodwill and Other Intangible Assets," which supersedes APB No. 17, "Intangible Assets." SFAS No. 14246 (revised December 2003),Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin ("ARB") 51. This interpretation addresses how intangible assetsconsolidation by business enterprises of variable interest entities ("VIE"). This interpretation requires a VIE to be consolidated by a company if that company is subject to a majority of the risk of loss from the VIE's activities or entitled to receive a majority of the entity's residual returns, or both. The provisions are effective for any new entities that are acquired individuallyoriginated subsequent to January 31, 2003. For entities that were originated prior to February 1, 2003, the provisions of this interpretation were to be effective October 1, 2003. We have adopted the provisions of this interpretation. In 1997, Investors Capital Trust I ("ICTI"), a wholly-owned subsidiary of the Company, issued mandatorily redeemable preferred securities, or withCapital Securities. At the same time, in order to support payments under the Capital Securities, the Company issued junior subordinated debentures to ICTI. As a groupresult of the adoption of this interpretation, we were required to deconsolidate ICTI. Therefore, in its consolidated financial statements, the Company presents the junior subordinated debentures underlying the Capital Securities as a liability and its investment in ICTI as a component of other assets (but not those acquired in a business combination) should be accounted for in financial statements upon their acquisition. This statement also addresses how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. This statement affects the accountingassets. The income of premiums, includes guidelinesICTI for the determination, measurement and testing of impairment, and requires disclosure of information about goodwill and other intangible assets in the years subsequent to their acquisitionthree months that ICTI was not previously required. The provisions of SFAS No. 142 are required to be applied starting with fiscal years beginning after December 15, 2001. This Statement eliminates the amortization of goodwill, and requires that goodwill be reviewed at least annually for impairment. This Statement affects all goodwill recognized on our consolidated balance sheet, regardless of when the goodwill was initially recorded.is considered immaterial.

Certain Factors That May Affect Future Results

        From time to time, information provided by us, statements made by our employees, or information included in our filings with the SECSecurities and Exchange Commission (including this Form 10-K) may contain statements which are not historical facts, so-called "forward-looking statements," and which involve risks and uncertainties. These statements relate to future events or our future financial performance and are identified by words such as "may," "will," "could," "should," "expect," "plan," "intend," "seek," "anticipate," "believe," "estimate," "potential," or "continue" or other comparable terms or the negative of those terms. Forward-looking statements in this Form 10-K include certain statements regarding liquidity, annual dividend payments, interest rate conditions, interest rate sensitivity, loss exposure on lines of credit, the timing and effect on earnings of derivative gains and losses, securities lending revenue, compensation expense, depreciation expense, effective tax rate, the effect on earnings of declineschanges in equity values and the effect of certain legal claims against us. Our actual future results may differ significantly from those stated in any forward-looking statements. Factors that may cause such differences include, but are not limited to, the factors discussed below. Each of these factors, and others, are discussed from time to time in our filings with the SEC.

The failure to properly manage our growth could adversely affect the quality of our services and result in the loss of clients.

        We have been experiencing a period of rapid growth that has required the dedication of significant management and other resources, including the recent assumption of the U.S. asset administration unit of BGI. Continued rapid growth could place a strain on our management and other resources. To manage future growth effectively, we must continue to invest in our operational, financial and other internal systems, and our human resources. Also, we must continue to expand our office space at reasonable rates in a competitive real estate market.

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Our future results depend, in part, on successful integration of pending and possible future acquisitions and outsourcing transactions.

        The integration of the BGI asset administration unit presents us with challenges and demands management attention that has to be diverted from other matters. Integration of acquisitions and outsourcing transactions is complicated and frequently presents unforeseen difficulties and expenses which can affect whether and when a particular acquisition will be accretive to our earnings per share. Any future acquisitions will present similar challenges.

We must hire and retain skilled personnel in order to succeed.

        Qualified personnel, in particular managers and other senior personnel, are in great demand throughout the financial services industry. We could find it increasingly difficult to continue to attract and retain sufficient numbers of these highly skilled employees.

Our operating results are subject to fluctuations in interest rates and the securities markets.

        We base someA significant portion of our fees is based on the market value of the assets we process. Accordingly, our operating results are subject to fluctuations in interest rates or theand securities markets as these fluctuations affect the market value of assets processed. Current market conditions, including the recent volatility in the equity markets, can have a material effect on our asset-based fees. While reductions in asset servicing fees may be offset by increases in other sources of revenue, a sustained downward movement of the broad equity markets will likely have an adverse impact on our earnings. Fluctuations in interest rates or the securities markets can also lead to investors seeking alternatives to the investment offerings of our clients, which could result in a lesser amount of assets processed and correspondingly lower fees. Also, our net interest income is earned by investing depositors' funds in our investment portfolio and secondarily making loans. Rapid changes in interest rates and/or changes in the relationship between different indexshort-term and long-term interest rates could adversely affect the market value of, or the earnings produced by, our investment and loan portfolios.portfolios, and thus could adversely affect our operating results.

A material portion of our revenue is derived from our relationship with Barclays Global Investors, N.A. ("BGI") and related entities.

        As a result of our selection to service assets for Barclays Global Investors Canada, Ltd., our assumption of the operations of the U.S. asset administration unit of BGI in 2001 and our ongoing relationship with BGI's iShares and Master Investment Portfolios, BGI accounted for approximately 16% of our net operating revenue during the year ended December 31, 2003. We expect that BGI will continue to account for a significant portion of our net operating revenue. While we provide services to BGI under long-term contracts, those contracts may be terminated for certain regulatory and fiduciary reasons. The loss of BGI's business would cause our net operating revenue to decline significantly and may have an adverse effect on our quarterly and annual results.

We may incur losses due to operational errors.

        The services that we provide require complex processes and interaction with numerous third parties. While we maintain sophisticated computer systems and a comprehensive system of internal controls, and our operational history has been excellent, from time to time we may make operational errors for which we are responsible to our clients. In addition, even though we maintain appropriate errors and omissions and other insurance policies, an operational error could result in a significant liability to us and may have a material adverse effect on our results of operations.

We face significant competition from other financial services companies, which could negatively affect our operating results.

        We are part of an extremely competitive asset servicing industry. Many of our current and potential competitors have longer operating histories, greater name recognition and substantially greater financial, marketing and other resources than we do. These greater resources could, for example, allow our competitors to develop technology superior to our own. In addition, we face the risk that large mutual fund complexes may build in-house asset servicing capabilities and no longer outsource these services to us. As a result, we may not be able to compete effectively with current or future competitors.competitors, which could result in a loss of existing clients or difficulty in gaining new clients.

A material portion of our revenues is derived from our relationship with Barclays Global Investors, N.A.We may incur significant costs defending legal claims.

        AsWe have been named in a resultlawsuit in Massachusetts state court alleging, among other things, violations of a covenant of good faith and fair dealing in a contract. While we believe this claim is without merit, we cannot be sure that we will prevail in the defense of this claim. We are also party to

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