FalconStor Software DEF 14A Definitive proxy

SCHEDULE 14A
(RULE 14a-101)

INFORMATION REQUIRED IN PROXY STATEMENT

SCHEDULE 14A INFORMATION

PROXY STATEMENT PURSUANT TO SECTION 14(a)
OF THE SECURITIES EXCHANGE ACT OF 1934 (AMENDMENT NO. )

Filed by the registrant /X/

Filed by a party other than the registrant / /

Check the appropriate box:

/ / Preliminary Proxy Statement

/ / Confidential, for Use of the Commission Only (as permitted by Rule
14a-6(e)2))

/X/ Definitive Proxy Statement

/ / Definitive Additional Materials

/ / Soliciting Material Pursuant to Rule 14a-11(c) or Rule 14(a)-12

FALCONSTOR SOFTWARE, INC.
- --------------------------------------------------------------------------------
(Name of Registrant as Specified in Charter)

Kenneth A. Schlesinger, Esq.
- --------------------------------------------------------------------------------
(Name of Person(s) filing Proxy Statement, if other than Registrant)

Payment of filing fee (check the appropriate box):

/X/ No fee required.

/ / Fee computed on table below per Exchange Act Rules 14a-6(i)(1) and
0-11.

(1) Title of each class of securities to which transaction applies:

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(2) Aggregate number of securities to which transaction applies:

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(3) Exchange Act Rule 0-11 (Set forth the amount on which the filing fee
is calculated and state how it was determined):

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(4) Proposed maximum aggregate value of transaction:

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(5) Total fee paid:

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/ / Fee paid previously with preliminary materials.

/ / Check box if any part of the fee is offset as provided by Exchange
Act Rule 0-11(a)(2) and identify the filing for which the offsetting
fee was paid previously. Identify the previous filing by
registration statement number, or the form or schedule and the date
of its filing.

(1) Amount Previously Paid:

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(2) Form, Schedule or Registration Statement no.:

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(4) Date Filed:

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FALCONSTOR SOFTWARE,INC.

April 8, 2004

To Our Stockholders:

We invite you to attend our annual stockholders' meeting on Friday,
May 14, 2004 at our worldwide headquarters located at 2 Huntington Quadrangle,
Suite 2S01, Melville, New York 11747 at 9:00 a.m.

At the meeting, you will hear an update on our operations, have a
chance to meet our directors and executives, and will be asked to elect two
directors, approve a new stock option plan for our outside directors, approve an
amendment to our stock option plan, and ratify the appointment of our auditors.
Your Board of Directors recommends a vote "FOR" each of the nominees and
proposals.

This booklet includes a formal notice of the meeting and the proxy
statement. The proxy statement tells you more about the agenda and procedures
for the meeting. It also describes how our Board of Directors operates and gives
personal information about our director nominees.

Only stockholders of record at the close of business on March 26,
2004 will be entitled to vote at the annual meeting. Even if you only own a few
shares, we want your shares to be represented at the annual meeting. I urge you
to complete, sign, date, and return your proxy card promptly in the enclosed
envelope.

Sincerely yours,

/s/ ReiJane Huai
ReiJane Huai
Chairman and Chief Executive Officer

FALCONSTOR SOFTWARE, INC.
2 HUNTINGTON QUADRANGLE
MELVILLE, NY 11747
-----------------
NOTICE OF ANNUAL MEETING OF STOCKHOLDERS
TO BE HELD MAY 14, 2004
----------------

To Our Stockholders:

The 2004 Annual Meeting of Stockholders ("Annual Meeting") of
FalconStor Software, Inc. (the "Company"), a Delaware corporation, will be held
at the Company's headquarters at 2 Huntington Quadrangle, Suite 2S01, Melville,
NY 11747, commencing at 9:00 a.m. (EDT) on Friday, May 14, 2004, to consider and
vote on the following matters described in this notice and the accompanying
Proxy Statement:

1) To elect two directors to the Company's Board of Directors to
three-year terms and until the directors' successors are elected
and qualified; and

2) To approve a 2004 Outside Director Stock Option Plan; and

3) To approve an amendment to our 2000 Stock Option Plan to
increase the number of shares of Common Stock reserved for
issuance thereunder by 1,500,000 from 12,662,296 to 14,162,296;
and

4) To ratify the appointment of KPMG LLP as our independent
accountants for fiscal 2004; and

5) Any other matters that properly come before the meeting.

At the Annual Meeting, the Company intends to nominate ReiJane Huai
and Lawrence S. Dolin for election to the Board of Directors. Mr. Huai is
currently the Chairman of the Company's Board of Directors and Mr. Dolin is
currently a member of the Company's Board of Directors. For more information
concerning Mr. Huai and Mr. Dolin, please see the Proxy Statement.

The Board of Directors has fixed the close of business on March 26,
2004 as the record date for determination of stockholders entitled to vote at
the Annual Meeting or any adjournment thereof, and only recordholders of common
stock at the close of business on that day will be entitled to vote. At the
record date, 46,692,341 shares of common stock were issued and outstanding.

TO ASSURE REPRESENTATION AT THE ANNUAL MEETING, STOCKHOLDERS ARE
URGED TO RETURN A PROXY AS PROMPTLY AS POSSIBLE BY SIGNING, DATING AND RETURNING
THE ENCLOSED PROXY CARD IN THE ENCLOSED POSTAGE-PREPAID ENVELOPE. ANY
STOCKHOLDER ATTENDING THE ANNUAL MEETING MAY VOTE IN PERSON EVEN IF HE OR SHE
PREVIOUSLY RETURNED A PROXY.

If you plan to attend the Annual Meeting in person, we would
appreciate your response by indicating so when returning the proxy.

By Order of the Board of Directors,

/s/ Seth R. Horowitz

Seth R. Horowitz
Secretary

Melville, NY
April 8, 2004

FALCONSTOR SOFTWARE, INC.
2 HUNTINGTON QUADRANGLE
MELVILLE, NEW YORK 11747
-----------------

2004 PROXY STATEMENT

GENERAL INFORMATION

This proxy statement contains information related to the annual
meeting of stockholders of FalconStor Software, Inc. to be held on Friday, May
14, 2004, beginning at 9:00 a.m. (EDT), at the Company's headquarters at 2
Huntington Quadrangle, Suite 2S01, Melville, New York 11747, and at any
postponements or adjournments thereof.

ABOUT THE MEETING

WHAT IS THE PURPOSE OF THE ANNUAL MEETING?

At the Company's annual meeting, stockholders will hear an update on
the Company's operations, have a chance to meet some of its directors and
executives and will act on the following matters:

1) To elect two directors to the Company's Board of Directors to
three-year terms and until the directors' successors are elected
and qualified; and

2) To approve a 2004 Outside Director Stock Option Plan; and

3) To approve an amendment to our 2000 Stock Option Plan to
increase the number of shares of Common Stock reserved for
issuance thereunder by 1,500,000 from 12,662,296 to 14,162,296;
and

4) To ratify the appointment of KPMG LLP as our independent
accountants for fiscal 2004; and

5) Any other matters that properly come before the meeting.

WHO MAY VOTE

Stockholders of FalconStor Software, Inc., as recorded in our stock
register on March 26, 2004 (the "Record Date"), may vote at the meeting. As of
this date, we had 46,692,341 shares of common stock eligible to vote. We have
only one class of voting shares. All shares in this class have equal voting
rights of one vote per share.

HOW TO VOTE

You may vote in person at the meeting or by proxy. We recommend that
you vote by proxy even if you plan to attend the meeting. You can always change
your vote at the meeting.

HOW PROXIES WORK

Our Board of Directors is asking for your proxy. Giving us your
proxy means you authorize us to vote your shares at the meeting in the manner
you direct. You may vote for or against the proposals or abstain from voting.

Proxies submitted will be voted by the individuals named on the
proxy card in the manner you indicate. If you give us your proxy but do not
specify how you want your shares voted, they will be voted in accordance with
the Board of Directors recommendations, i.e., in favor of our director nominees,
in favor of the 2004 Outside Directors Stock Option plan, in favor of an
increase in the Common Stock reserved for issuance under the 2000 Stock Option
Plan, and in favor of the ratification of the appointment of KPMG LLP as our
independent accountants.

You may receive more than one proxy or voting card depending on how
you hold your shares. If you hold shares through someone else, such as a
stockbroker, you may get materials from them asking how you want to vote. The
latest proxy card we receive from you will determine how we will vote your
shares.

REVOKING A PROXY

There are three ways to revoke your proxy. First, you may submit a
new proxy with a later date up until the existing proxy is voted. Second, you
may vote in person at the meeting. Last, you may notify our Chief Financial
Officer in writing at 2 Huntington Quadrangle, Melville, New York 11747.

QUORUM

In order to carry on the business of the meeting, we must have a
quorum. This means at least a majority of the outstanding shares eligible to
vote must be represented at the meeting, either by proxy or in person. Shares
that we own are not voted and do not count for this purpose.

VOTES NEEDED

The director nominees receiving a majority of the votes cast during
the meeting will be elected to fill the seats of our directors. For the other
proposals to be approved, we require the favorable vote of a majority of the
votes cast. Only votes for or against a proposal count. Votes which are withheld
from voting on a proposal will be excluded entirely and will have no effect in
determining the quorum or the majority of votes cast. Abstentions and broker
non-votes count for quorum purposes only and not for voting purposes. Broker
non-votes occur when a broker returns a proxy but does not have the authority to
vote on a particular proposal. Brokers that do not receive instructions are
entitled to vote on the election of the directors, the 2004 Outside Directors
plan, the amendment to the 2000 Plan and the ratification of the auditors.

ATTENDING IN PERSON

Only stockholders, their proxy holders, and our invited guests may
attend the meeting. If you wish to attend the meeting in person but you hold
your shares through someone else, such as a stockbroker, you must bring proof of
your ownership and an identification with a photo to the meeting. For example,
you could bring an account statement showing that you owned FalconStor Software,
Inc., shares as of March 26, 2004 as acceptable proof of ownership.

SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT

The following table sets forth information concerning ownership of
the Common Stock of FalconStor Software, Inc., outstanding at March 26, 2004, by
(i) each person known by the Company to be the beneficial owner of more than
five percent of its Common Stock, (ii) each director and nominee for director,
(iii) each of the current officers named in the summary compensation table, and
(iv) all directors, nominees for director and executive officers of the Company
as a group.

SHARES BENEFICIALLY PERCENTAGE
NAME AND ADDRESS OF BENEFICIAL OWNER (1) OWNED OF CLASS (2)
- ----------------------------------------- ----- ------------
ReiJane Huai (3) 10,824,260 23.2%
c/o FalconStor Software, Inc.
2 Huntington Quadrangle
Melville, NY 11747

Barry Rubenstein (4) 6,643,053 14.2%
68 Wheatley Road
Brookville, NY 11545

Irwin Lieber (5) 4,602,689 9.9%
80 Cuttermill Road Suite 311
Great Neck, NY 11021

Eli Oxenhorn (6) 3,205,009 6.9%
56 The Intervale
Roslyn Estates, NY 11576

Barry Fingerhut (7) 3,000,164 6.4%
767 Fifth Avenue, 45th Floor
New York, NY 10153

Seth Lieber (8) 3,014,474 6.5%
200 East 72 Street, PH N
New York, NY 10021

Jonathan Lieber (9) 2,927,852 6.3%
271 Hamilton Road
Chappaqua, NY 10514

Marilyn Rubenstein (10) 2,475,424 5.3%
c/o Barry Rubenstein
68 Wheatley Road
Brookville, NY 11545

Lawrence S. Dolin (11) 75,311 *

Steven R. Fischer (12) 39,811 *

Steven H. Owings (13) 93,341 *

Patrick B. Carney (14) 19,600 *

James Weber (15) 91,323 *

Wayne Lam (16) 355,744 *

All Directors, Nominees for Director
and Executive Officers as a Group (17)
(7 persons) 11,499,390 24.4%

*Less than one percent

(1) A person is deemed to be the beneficial owner of voting securities that
can be acquired by such person within 60 days after the record date upon
the exercise of options, warrants or convertible securities. Each
beneficial owner's percentage ownership is determined by assuming that
options, warrants or convertible securities that are held by such person
(but not those held by any other person) and that are currently
exercisable (i.e., that are exercisable within 60 days from the date
hereof) have been exercised. Unless otherwise noted, we believe that all
persons named in the table have sole voting and investment power with
respect to all shares beneficially owned by them.

(2) Based upon shares of Common Stock outstanding at the Record Date of
46,692,341.

(3) Based upon information contained in a Form 4 and a report on Schedule 13D
filed by Mr. Huai and certain other information. Consists of (i)
10,774,260 shares of Common Stock held by Mr. Huai and (ii) 50,000 shares
of Common Stock held by The 2002 ReiJane Huai Revocable Trust, of which
Mr. Huai is a trustee. Mr. Huai disclaims beneficial ownership of the
securities held by The 2002 ReiJane Huai Revocable Trust, except to the
extent of his equity interest therein.

(4) Based upon information contained in a Form 4 and a report on Schedule 13D,
as amended (the "Wheatley 13D") filed jointly by Barry Rubenstein,
Brookwood Partners, L.P. ("Brookwood"), Seneca Ventures ("Seneca"),
Wheatley Associates III, L.P. ("Wheatley Associates"), Wheatley Foreign
Partners, L.P. ("Wheatley Foreign"), Wheatley Foreign Partners III, L.P.
("Wheatley Foreign III"), Wheatley Partners, L.P. ("Wheatley"), Wheatley
Partners II, L.P. ("Wheatley II"), Wheatley Partners III, L.P. ("Wheatley
III"), Woodland Partners, Woodland Venture Fund ("Woodland Fund"), and
certain other entities with the Securities and Exchange Commission
("SEC"), as well as certain other information. Consists of (i) 1,500,903
shares of Common Stock held by Mr. Rubenstein, (ii) 395,217 shares of

common stock held by Brookwood, (iii) 642,453 shares of common stock held
by Seneca, (iv) 299,809 shares of common stock held by Wheatley
Associates, (v) 41,008 shares of common stock held by Wheatley Foreign,
(vi) 293,012 shares of common stock held by Wheatley Foreign III, (vii)
484,051 shares of common stock held by Wheatley, (viii) 180,089 shares of
common stock held by Wheatley II, (ix) 1,370,015 shares of common stock
held by Wheatley III, (x) 692,983 shares of common stock held by Woodland
Partners and (xi) 743,513 shares of common stock held by Woodland Fund.
Does not include 1,258 shares of common stock held by Mr. Rubenstein's
spouse, Marilyn Rubenstein. Mr. Rubenstein disclaims beneficial ownership
of the securities held by Wheatley, Wheatley Foreign, Wheatley II,
Wheatley III, Wheatley Foreign III, Wheatley Associates, Seneca, Woodland
Fund, Woodland Partners and Brookwood, except to the extent of his
respective equity interest therein.

(5) Based upon information contained in the Wheatley 13D and certain other
information. Consists of (i) 1,934,705 shares of Common Stock held by
Irwin Lieber, (ii) 484,051 shares of Common Stock held by Wheatley, (iii)
41,008 shares of Common Stock held by Wheatley Foreign, (iv) 180,089
shares of Common Stock held by Wheatley II, (v) 1,370,015 shares of Common
Stock held by Wheatley III, (vi) 293,012 shares of Common Stock held by
Wheatley Foreign III, and (vii) 299,809 shares of Common Stock held by
Wheatley Associates. Mr. Lieber disclaims beneficial ownership of the
securities held by Wheatley, Wheatley Foreign, Wheatley II, Wheatley III,
Wheatley Foreign III and Wheatley Associates, except to the extent of his
respective equity interests therein.

(6) Based on information contained in a report on Schedule 13G filed jointly
on February 13, 2004 by Eli Oxenhorn and the Eli Oxenhorn Family Limited
Partnership (the "EOFLP"). Consists of (i) 2,898,932 shares of Common
Stock held by Mr. Oxenhorn (including 3,500 shares held by the Eli
Oxenhorn SEP IRA account and 8,000 shares held by the Eli Oxenhorn
Rollover IRA Account) and (ii) 306,077 shares of Common Stock held by the
EOFLP. Mr. Oxenhorn disclaims beneficial ownership of the securities held
by the EOFLP, except to the extent of his respective equity interests
therein.

(7) Based upon information contained in the Wheatley 13D and certain other
information. Consists of (i) 332,180 shares of Common Stock held by Barry
Fingerhut, (ii) 484,051 shares of Common Stock held by Wheatley, (iii)
41,008 shares of Common Stock held by Wheatley Foreign, (iv) 180,089
shares of Common Stock held by Wheatley II, (v) 1,370,015 shares of Common
Stock held by Wheatley III, (vi) 293,012 shares of Common Stock held by
Wheatley Foreign III, and (vii) 299,809 shares of Common Stock held by
Wheatley Associates. Mr. Fingerhut disclaims beneficial ownership of the
securities held by Wheatley, Wheatley Foreign, Wheatley II, Wheatley III,
Wheatley Foreign III and Wheatley Associates, except to the extent of his
respective equity interests therein.

(8) Based upon information contained in the Wheatley 13D and certain other
information. Consists of (i) 86,622 shares of Common Stock held by Seth
Lieber, (ii) 484,051 shares of Common Stock held by Wheatley, (iii) 41,008
shares of Common Stock held by Wheatley Foreign, (iv) 180,089 shares of
Common Stock held by Wheatley II, (v) 1,370,015 shares of Common Stock
held by Wheatley III, (vi) 293,012 shares of Common Stock held by Wheatley
Foreign III, (vii) 299,809 shares of Common Stock held by Wheatley

Associates and (viii) 259,868 shares of Common Stock held by Applegreen.
Mr. Lieber disclaims beneficial ownership of the securities held by
Wheatley, Wheatley Foreign, Wheatley II, Wheatley III, Wheatley Foreign
III, Wheatley Associates and Applegreen, except to the extent of his
respective equity interests therein.

(9) Based upon information contained in the Wheatley 13D and certain other
information. Consists of (i) 484,051 shares of Common Stock held by
Wheatley, (ii) 41,008 shares of Common Stock held by Wheatley Foreign,
(iii) 180,089 shares of Common Stock held by Wheatley II, (iv) 1,370,015
shares of Common Stock held by Wheatley III, (v) 293,012 shares of Common
Stock held by Wheatley Foreign III, (vi) 299,809 shares of Common Stock
held by Wheatley Associates and (vii) 259,868 shares of Common Stock held
by Applegreen Partners. Mr. Lieber disclaims beneficial ownership of the
securities held by Wheatley, Wheatley Foreign, Wheatley II, Wheatley III,
Wheatley Foreign III, Wheatley Associates and Applegreen, except to the
extent of his respective equity interests therein.

(10) Based upon information contained in the Wheatley 13D and certain other
information. Consists of (i) 1,258 shares of Common Stock held by Marilyn
Rubenstein, (ii) 642,453 shares of Common Stock held by Seneca, (iii)
743,513 shares of Common Stock held by Woodland Fund, (iv) 692,983 shares
of Common Stock held by Woodland Partners and (v) 395,217 shares of Common
Stock held by Brookwood. Mrs. Rubenstein disclaims beneficial ownership of
the securities held by Seneca, Woodland Fund, Woodland Partners and
Brookwood, except to the extent of her respective equity interests
therein. Does not include 1,500,903 shares of Common Stock held by Mrs.
Rubenstein's spouse, Barry Rubenstein.

(11) Based on information contained in a Form 4 filed by Mr. Dolin and certain
other information. Consists of (i) 40,000 shares held by Northern Union
Club and (ii) 35,311 shares of Common Stock issuable upon exercise of
options that are currently exercisable or will be exercisable within 60
days of March 26, 2004. Mr. Dolin is a general partner of Mordo Partners,
which is a general partner of Northern Union Club. Mr. Dolin disclaims
beneficial ownership of the securities held by Northern Union Club, except
to the extent of his equity interest therein.

(12) Based on information contained in a Form 4 filed by Mr. Fischer and
certain other information. Consists of (i) 4,500 shares held by Mr.
Fischer and (ii) 35,311 shares of Common Stock issuable upon exercise of
options that are currently exercisable or will be exercisable within 60
days of March 26, 2004. Excludes 1,000 shares of Common Stock held by Mr.
Fischer as a custodian for his daughter. Mr. Fischer disclaims beneficial
ownership of the securities held as a custodian for his daughter, except
to the extent of his equity interest therein.

(13) Based on information contained in a Form 4 filed by Mr. Owings and certain
other information. Consists of (i) 58,030 shares held by Mr. Owings and
(ii) 35,311 shares of Common Stock issuable upon exercise of options that
are currently exercisable or will be exercisable within 60 days of March
26, 2004.

(14) Based on information contained in a Form 3 and a Form 4 filed by Mr.
Carney and certain other information. Consists of (i) 500 shares held by
Mr. Carney and (ii) 19,100 shares of Common Stock issuable upon exercise

of options that are currently exercisable or will be exercisable within 60
days of March 26, 2004.

(15) Based on information contained in a Form 3 filed by Mr. Weber and certain
other information. Consists of 91,323 shares of Common Stock issuable upon
exercise of options that are currently exercisable or will be exercisable
within 60 days of March 26, 2004.

(16) Based on information contained in a Form 4 filed by Mr. Lam and certain
other information. Consists of (i) 48,003 shares held by Mr. Lam and (ii)
307,741 shares of Common Stock issuable upon exercise of options that are
currently exercisable or will be exercisable within 60 days of March 26,
2004.

(17) Consists of (i) 10,975,293 shares held by all directors, nominees for
director and executive officers as a group and (ii) 524,097 shares of
Common Stock issuable upon exercise of options that are currently
exercisable or will be exercisable within 60 days of March 26, 2004.

BOARD OF DIRECTORS

INDEPENDENCE

In accordance with the Company's Corporate Governance Guidelines,
and the Nasdaq Stock Market corporate governance listing standards (the "Nasdaq
Standards"), a majority of the Company's directors must be independent as
determined by the Board. In making its independence determinations for
directors, the Board looks to the Nasdaq Standards.

Under the Nasdaq Standards, a director is independent if: the
director is not employed, nor is the director a family member of anyone
employed, by the Company or any parent or subsidiary; the director is not, and
does not have a family member who is, a partner of the Company's outside auditor
or a former partner or employee of the outside auditor who worked on the
Company's audit during the past three years; the director has not, and does not
have a family member who has, accepted more than $60,000 during the current or
past three fiscal years from the Company or any of its affiliates; the director
is not, nor is any family member of the director, a partner in, or a controlling
shareholder or an executive officer of, any organization to which the Company
made, or from which the Company received, payments for property or services that
exceed five percent of the recipient's consolidated gross revenues or $200,000,
whichever is more; and the director is not, and does not have any family member
who is, an executive officer of another company where any of the Company's
executive officers serve on the other company's compensation committee.

The Board of Directors currently consists of five directors, four of
whom, Messrs. Carney, Dolin, Fischer and Owings, are independent. Mr. Huai is a
non-independent management director.

PROPOSAL NO. 1
ELECTION OF DIRECTORS

The Company's bylaws authorize the Board of Directors to fix the
number of directors and provide that the directors shall be divided into three
classes, with the classes of directors serving for staggered, three-year terms.
From October, 2001 until March, 2003, the number of directors was fixed at four.
In March, 2003, the Company's directors voted to increase the number of members
of the Board of Directors to five. The Company's nominating procedures,
including procedures for director candidates proposed to be nominated by
shareholders, and director qualifications, are set forth below.

ReiJane Huai and Lawrence S. Dolin were nominated by the Company's
Nominating and Corporate Governance Committee as the Board of Directors'
nominees for director. Mr. Huai is currently the Chairman of the Company's Board
of Directors and Mr. Dolin is currently a director of the Company. All directors
are chosen for a full three-year term to succeed those whose terms expire. It is
proposed that Mr. Huai and Mr. Dolin be elected to serve until the Annual
Meeting of Stockholders to be held in 2007 and until their successors are
elected and shall have qualified.

Unless authority is specifically withheld, proxies will be voted for
the election of each of the nominees below to serve as a director of the Company
for a term which will expire at the Company's 2007 Annual Meeting of
Stockholders and until a successor is elected and qualified. If any one or more

of such nominees should for any reason become unavailable for election, the
persons named in the accompanying form of proxy may vote for the election of
such substitute nominees as the Board of Directors may propose. The accompanying
form of proxy contains a discretionary grant of authority with respect to this
matter.

DIRECTOR
NAME POSITION AGE SINCE
- ---- -------- --- -----
ReiJane Huai Director Nominee 45 2000
Lawrence S. Dolin Director Nominee 60 2001

REIJANE HUAI has served as President and Chief Executive Officer of
the Company and its predecessor since December 2000 and has served as Chairman
of the Board of the Company since August 2001. Mr. Huai also served as a
director of the Company's predecessor from July 2000 to August 2001. Mr. Huai
came to the Company with a career in software development and management. As
executive vice president and general manager, Asia, for Computer Associates
International, Inc., he was responsible for sales, marketing and the development
of strategic joint ventures in the region. Mr. Huai joined Computer Associates
in 1996 with its acquisition of Cheyenne Software, Inc., where he was president
and chief executive officer. Mr. Huai joined Cheyenne Software, Inc., in 1985 as
manager of research and development of ARCserve, the industry's first storage
management solution for the client/server environment. Mr. Huai received a
master's degree in computer science from the State University of New York at
Stony Brook in 1985.

LAWRENCE S. DOLIN has held several positions with Noteworthy Medical
Systems, Inc. ("Noteworthy"), a provider of computerized patient record
software, since July 1998. He is currently serving as Noteworthy's chairman,
president and chief executive officer. Since January 1996, Mr. Dolin has been a
general partner of Mordo Partners, an investment management partnership. Since
1981, Mr. Dolin has served as a director of Morgan's Foods, Inc., which owns,
through wholly-owned subsidiaries, KFC restaurants, Taco Bell restaurants and
Pizza Hut restaurants. Mr. Dolin holds a B.A. from Case Western Reserve
University and a J.D. from Case Western Reserve University. Mr. Dolin has been a
director of the Company since August 2001.

The names of the directors, whose terms expire at the 2005 and 2006
Annual Meetings of Stockholders of the Company, who are currently serving their
terms, are set forth below:

DIRECTOR
NAME POSITION AGE SINCE
- ---- -------- --- -----
Patrick B. Carney Director 39 2003
Steven R. Fischer Director 59 2001
Steven H. Owings Director 50 2001

PATRICK B. CARNEY has been the Chief Technology Officer for Barr
Laboratories Inc., a specialty pharmaceutical company, since September, 2003.
Mr. Carney is responsible for strategic technology planning and managing IT

operations throughout the firm and its subsidiaries. From August 2000 through
July 2003 he served as the Chief Information Officer for the North Shore - Long
Island Jewish Health System where he was responsible for strategic IS planning
and managing the IS and Telecommunications operations throughout the Health
System. From 1995 to July, 2000, Mr. Carney was the Vice President & Chief
Information Officer for Staten Island University Hospital, a multi-site
healthcare system serving the New York City communities of Staten Island and
Brooklyn. Mr. Carney's career also includes IT management experience in other
industries as he was also the Director of Information Systems for ABB Power
Generation Inc., a subsidiary of the Zurich-based Asea Brown Boveri, and also
held positions at KPMG Peat Marwick, Wang Laboratories, and IBM Corporation. Mr.
Carney received a BS degree from Manhattan College. Mr. Carney has been a
director of the Company since May 2003, and his term as a director of the
Company expires in 2006.

STEVEN R. FISCHER has been a financial consultant to middle market
corporations since February, 2004. From 1992 to 2004, he held multiple executive
management and financial positions, including most recently President, with
Transamerica Business Capital Corporation, a member of the Transamerica Finance
Corporation family of companies, specializing in secured lending for mergers,
acquisitions and restructurings. From 1981 to 1992, he served as vice president
and regional manager of Citibank, N.A. Since 1995, he has served as a director
of ScanSource, Inc., a value-added distributor of POS and bar code products.
Beginning in 2001 he served on the board of advisors of Keltic Financial LLC., a
privately held finance company that funds middle market companies. He holds a
B.S. in Economics and Accounting from Queens College and an M.B.A. from Baruch
College. Mr. Fischer has been a director of the Company since August 2001, and
his term as a director of the Company expires in 2005.

STEVEN H. OWINGS served as the chief executive officer of
ScanSource, Inc., a value-added distributor of POS and bar code products, from
1992 to early 2000. He has served as chairman of the board of directors of
ScanSource, Inc., since its inception in December 1992. From 1991 to 1992, Mr.
Owings served as chairman of the board of directors, chief executive officer and
the sole shareholder of Argent Technologies, Inc., a personal computer
manufacturer. From 1983 to 1991 he held various positions with Gates/FA
Distributing, Inc., and its predecessors ("Gates"), a computer distribution
company, including serving as president, chief executive officer and chairman of
the board of directors. From December 1987 to September 1994, Mr. Owings served
as a director of Gates. From July 1996 to April 1997, he served as a director of
Globelle Corporation, an international distributor of personal computer
products. He holds a B.A. from Clemson University. Mr. Owings has been a
director of the Company since August 2001, and his term as a director of the
Company expires in 2006.

RECOMMENDATION OF THE BOARD OF DIRECTORS

THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR THE ELECTION OF THE
NOMINEES.

MEETINGS

The Board of Directors met on twelve occasions during the fiscal
year ended December 31, 2003. In addition to the meetings, the members of the
Board of Directors sometimes take action by unanimous written consent in lieu of
a meeting, which is permitted. All Directors attended at least 75% of the
meetings of the Board of Directors.

COMMITTEES

The Board of Directors has four committees: the Audit Committee; the
Compensation Committee; the Nominating and Corporate Governance Committee; and
the Stock Option Committee. The charter of each committee is available on the
Company's website at www.falconstor.com/governance.asp.

AUDIT COMMITTEE

The Audit Committee consists of Messrs. Dolin, Fischer (Chair) and
Owings. The Audit Committee is appointed by the Board to assist the Board in
monitoring (1) the integrity of the financial statements of the Company, (2) the
independent auditor's qualifications and independence, (3) the performance of
the Company's internal audit function and independent auditors, (4) the
integrity of management and information systems and internal controls, and (5)
the compliance by the Company with legal and regulatory requirements.

Each member of the Audit Committee is required to be "independent"
as defined in the Nasdaq Standards and in Section 301of the Sarbanes-Oxley Act
of 2002 (the "Act") and Rule 10A-3 of the Securities Exchange Act of 1934. The
Board has determined that each member of the Audit Committee is "independent"
under these standards. In addition, the Board has determined that, as required
by the Nasdaq Standards, each member of the Audit Committee was able to read and
to understand financial statements at the time of his appointment to the Audit
Committee.

The Board has further determined that Mr. Fischer meets the
definition of "audit committee financial expert," and therefore meets comparable
Nasdaq Standard requirements, because he has an understanding of financial
statements and generally accepted accounting principles ("GAAP"); has the
ability to assess GAAP in connection with the accounting for estimates,
accruals, and reserves; has experience in analyzing and evaluating financial
statements that present a breadth and level of complexity of accounting issues
that are generally comparable to the breadth and complexity of issues that can
reasonably be expected to be raised by the Company's financial statements; has
an understanding of internal controls and procedures for financial reporting;
and has an understanding of audit committee functions. Mr. Fischer acquired
these attributes through education and experience consistent with the
requirements of the Act.

The Audit Committee met four times during the fiscal year ended
December 31, 2003. All members of the Audit Committee attended at least 75% of
the meetings of the committee.

During the fiscal year ended December 31, 2003, the Board of
Directors adopted a new Audit Committee Charter and Guidelines for Pre-Approval
of Independent Auditor Services. The Charter and Guidelines are attached to this
Proxy Statement as Exhibits A and B, respectively.

COMPENSATION COMMITTEE

The Compensation Committee consists of Messrs. Carney, Fischer and
Owings (Chair). Prior to May 15, 2003, it consisted of Messrs. Huai, Dolin and
Fischer. The Compensation Committee is appointed by the Board (i) to discharge
the responsibilities of the Board relating to compensation of the Company's
executives and (ii) to produce the annual report on executive compensation that
is required by the rules of the Securities and Exchange Commission to be
included in the Company's annual proxy statement. Under the Compensation
Committee Charter adopted in November, 2003, all members of the Compensation
Committee are required to be "independent" as defined in the Nasdaq Standards.
The Board has determined that all of the current members of the Compensation
Committee are "independent" under these standards.

The Compensation Committee did not hold a formal meeting in the
fiscal year ended December 31, 2003. Actions concerning executive compensation
were handled by the Company's independent directors during a meeting of the
Board of Directors.

NOMINATING AND CORPORATE GOVERNANCE COMMITTEE

The Nominating and Corporate Governance Committee was formed in
November, 2003, and consists of Messrs. Carney (Chair), Dolin, Fischer, and
Owings. The Nominating and Corporate Governance Committee is appointed by the
Board: (i) to identify individuals qualified to become Board members, (ii) to
recommend to the Board director candidates for each annual meeting of
stockholders or as necessary to fill vacancies and newly created directorships
and (iii) to perform a leadership role in shaping the Company's corporate
governance policies, including developing and recommending to the Board a set of
corporate governance principles. Under the Nominating and Corporate Governance
Committee Charter, all members of the Nominating and Corporate Governance
Committee are required to be "independent" as defined in the Nasdaq Standards.
The Board has determined that all of the current members of the Nominating and
Corporate Governance Committee are "independent" under these standards.

The Nominating and Corporate Governance Committee did not hold a
formal meeting in the fiscal year ended December 31, 2003.

STOCK OPTION COMMITTEE

The members of the Stock Option Committee are Messrs. Carney, Dolin
(Chair), and Owings. The Stock Option Committee is appointed by the Board to
administer, and to approve awards under, the Company's equity based-compensation
plans for employees. Under the Stock Option Committee Charter, all members of
the Stock Option Committee are required to be "independent" as defined in the
Nasdaq Standards. The Board has determined that all of the current members of
the Stock Option Committee are "independent" under these standards.

The Stock Option Committee met four times during the fiscal year
ended December 31, 2003, and also took action by unanimous written consent in
lieu of a meeting. All members of the Stock Option Committee attended at least
75% of the committee's meetings.

COMPENSATION

Directors who are also employees receive no compensation for serving
on the Company's Board of Directors. Non-employee directors are reimbursed for
all travel and other expenses incurred in connection with attending Board and
Committee meetings.

Pursuant to the 1994 Outside Directors Stock Option Plan (the "1994
Plan"), as amended, each non-employee director of the Company was entitled upon
becoming a non-employee director to receive an initial grant of options to
acquire 50,000 shares of Common Stock and an annual grant of options to acquire
10,000 shares of Common Stock on the date of each Annual Meeting of Stockholders
of the Company. These stock options were granted with per share exercise prices
equal to the fair market value of the Common Stock on the date of grant. A
director who received an initial grant of options to acquire 50,000 shares of
Common Stock within six months prior to an Annual Meeting was not entitled to
receive an annual grant of options to acquire 10,000 shares of Common Stock on
the date of the Annual Meeting.

In May 2003, each of Messrs. Dolin, Fischer and Owings received
options to purchase 10,000 shares of Common Stock at an exercise price of $5.33
per share as an annual grant under the 1994 Plan, as amended. Mr. Carney
received options to purchase 50,000 shares of Common Stock at an exercise price
of $5.33 per share as his initial grant of options upon becoming a director.

The Company's 1994 Plan expires in April, 2004. Stockholders are
being asked to vote on a 2004 Outside Directors Stock Option Plan to replace the
1994 Plan. A summary of the proposed 2004 Outside Directors Stock Option Plan is
set forth elsewhere in this Proxy Statement and a copy of the proposed plan is
attached as Exhibit C.

NOMINATING PROCEDURES AND DIRECTOR QUALIFICATIONS

The Nominating and Corporate Governance Committee has adopted the
following policies regarding nominations and director qualifications:

I. Consideration of Nominees Recommended by Shareholders

The Committee recognizes that qualified candidates for nomination
for Director can come from many different sources, including from the Company's
shareholders. The Committee will therefore consider any nominee who meets the
minimum qualifications set forth below.

To propose a nominee, a shareholder must provide the following
information:

1. The shareholder's name and, if different, the name of the holder
of record of the shares.

2. The shareholder's address and telephone number.

3. The name of the proposed nominee.

4. The address and phone number of the proposed nominee.

5. A listing of the proposed nominee's qualifications.

6. A statement by the shareholder revealing whether the proposed
nominee has assented to the submission of her/his name by the
shareholder.

7. A statement from the shareholder describing any business or
other relationship with the nominee.

8. A statement from the shareholder stating why the shareholder
believes the nominee would be a valuable addition to the
Company's Board of Directors.

The shareholder should submit the required information to:

Nominating and Corporate Governance Committee
c/o General Counsel
FalconStor Software, Inc.
2 Huntington Quadrangle
Melville, NY 11747

With a copy to:

Director Human Resources
FalconStor Software, Inc.
2 Huntington Quadrangle
Melville, NY 11747

If any information is missing, the proposed nominee will not be
considered.

II. Qualifications for Candidates

The Committee believes that the Company and its shareholders are
best served by having directors from diverse backgrounds who can bring different
skills to the Company. It is therefore not possible to create a rigid list of
qualifications for Director candidates. However, absent unique circumstances,
the Committee expects that each candidate should have the following minimum
qualifications:

o Substantial experience with technology companies. This
experience may be the result of employment with a technology
company or may be gained through other means, such as financial
analysis of technology companies.

o A current or former leadership role in a sophisticated
enterprise.

o The highest ethical standards.

o The ability to commit all time necessary to perform Board and
committee duties.

At any time, the Committee may be looking for director candidates
with certain qualifications or skills to replace departing directors or to
complement the skills of existing directors and to add to the value of the Board
of Directors.

III. Identification and Evaluation of Candidates

Candidates for director may come from many different sources
including, among others, recommendations from current directors, recommendations
from management, third-party search organizations, and shareholders.

In each instance, the Committee will perform a thorough examination
of the candidate. An initial screening will be performed to ensure that the
candidate meets the minimum qualifications set forth above and has skills that
would enhance the Board of Directors. Following the initial screening, if the
candidate is still viewed as a potential nominee, the Committee will perform
additional evaluations including, among other things, some or all of the
following: Detailed resume review; personal interviews; interviews with
employer(s); and interviews with peer(s).

All candidates will be reviewed to determine whether they meet the
independence standards of the Nasdaq Standards. Failure to meet the independence
standards may be a disqualifying factor based on the Board of Director's
composition at the time. Even if failure to meet the independence standards is
not by itself disqualifying, it will be taken into account by the Committee in
determining whether the candidate would make a valuable contribution to the
Board of Directors.

CONTACTING THE BOARD OF DIRECTORS

Stockholders and others may contact FalconStor's Board of Directors
by sending a letter to:

Board of Directors
FalconStor Software, Inc.
2 Huntington Quadrangle
Melville, NY 11747

or by clicking on the "Contact FalconStor's Board of Directors" link on the
FalconStor Corporate Governance home page at www.falconstor.com/governance.asp.

Communications directed to the Board of Directors are screened by
the Company's Legal and/or Investor Relations departments. Requests for Company
information are handled by the appropriate Company department. Other
communications are reviewed to determine if forwarding to the Board of Directors
is necessary or appropriate. The Board of Directors receives a quarterly summary
of all communications that are not forwarded to the Board's attention. All
communications are kept on file for two years for any Director who wishes to
view them.

MANAGEMENT

EXECUTIVE OFFICERS OF THE COMPANY

The following table contains the names, positions and ages of the
executive officers of the Company who are not directors.

NAME POSITION AGE
- ---- -------- ---
James Weber Chief Financial Officer, Treasurer and Vice President 33
Wayne Lam Vice President, Marketing 40

JAMES WEBER has served as Chief Financial Officer, Treasurer and a
Vice President since February, 2004. Mr. Weber has over 10 years of financial,
accounting and management experience. Prior to becoming CFO, Mr. Weber served as
worldwide Corporate Controller of FalconStor since April 2001. From 1998 through
2001, Mr. Weber served as Corporate Controller for theglobe.com, an Internet
community. Before joining theglobe.com, Mr. Weber had been an audit manager with
KPMG and had several years of public accounting experience. Mr. Weber is a
Certified Public Accountant in the State of New York and received his Bachelor
of Science degree in accounting from Fordham University.

WAYNE LAM has served as a vice president of the Company and its
predecessor entity since April 2000. Mr. Lam has more than 15 years of software
development and corporate management experience. As vice president at Computer
Associates, he held various roles in product marketing, business development and
product development. Mr. Lam joined Computer Associates in 1996 with its
acquisition of Cheyenne Software, where he held various positions including
general manager of Cheyenne Software Netware Division, director of business
development, and head of Cheyenne Communications, a business development unit
focusing on communication software. From 1989 to 1993 he was co-founder and
chief executive officer of Applied Programming Technologies, where he managed
all aspects of its operations and development projects. From 1987 to 1989 he was
vice president of engineering at Advanced Graphic Applications, where he managed
the development of PC-based document management systems and optical storage
device drivers. Mr. Lam has a B.E. in Electrical Engineering from Cooper Union,
where he was involved with a privately funded research project studying the
feasibility of building paperless offices using optical storage devices. The
success of the project led to the formation of Advanced Graphic Applications.

EXECUTIVE COMPENSATION

SUMMARY COMPENSATION TABLE. The following table sets forth, for the
fiscal years indicated, all compensation awarded to, paid to or earned by the
Company's chief executive officer and the Company's other executive officers
(collectively, the "Named Executive Officers"). The executive compensation
provided below reflects the executive compensation information of the Company
for the years indicated.

SUMMARY COMPENSATION TABLE

Name and Principal Long Term
Position Annual Compensation Compensation
- --------------------------- ----------------------------------------------------- --------------------

Other Annual Securities All Other
Salary Bonus Compensation Underlying Compensation
Year ($) ($) ($)(3) Options (#) ($)(4)
---- --------- ----------- ------------- -------------------- --------------

ReiJane Huai............... 2003 $150,000 -- $24,000 -- --
Chairman and Chief 2002 $150,000 -- $24,000 -- --
Executive Officer 2001 $170,833 -- $ 8,000 -- $ 239,924

Jacob Ferng (1)........... 2003 $120,000 -- -- -- --
Former Chief Financial Officer 2002 $100,000 -- -- 175,000 --
and Vice President 2001 $ 95,833 $ 20,000 (2) -- -- --

Wayne Lam............... 2003 $120,000 -- -- 100,000 --
Vice President-Marketing 2002 $100,000 -- -- 225,000 --
2001 $ 96,667 $ 10,000 (2) -- -- --

(1) Mr. Ferng resigned as Chief Financial Officer and Vice President on
February 4, 2004.
(2) Bonuses of $20,000 and $10,000 for Mr. Ferng and Mr. Lam, respectively
were paid in 2002 for services rendered in 2001.
(3) Mr. Huai was given automobile allowances of $24,000 in 2003 and 2002 and
$8,000 in 2001.
(4) Mr. Huai was reimbursed $239,924 in June 2001 for the payment of
Hart-Scott-Rodino filing fees as well as all taxes that were due as a
result of this reimbursement. The filing fees were incurred in connection
with FalconStor's merger with Network Peripherals, Inc.

OPTION GRANTS DURING 2003 FISCAL YEAR

The following table provides information related to options to
purchase Common Stock granted to the Company's Named Executive Officers. The
Company currently does not have any plans providing for the grant of stock
appreciation rights.

POTENTIAL REALIZABLE VALUE AT
ASSUMED RATES OF STOCK PRICE
APPRECIATION FOR OPTION
INDIVIDUAL GRANTS TERM(2)
- ---------------------------------------------------------------------------------------------------------------------------
% OF TOTAL
NUMBER OF OPTIONS EXERCISE
SECURITIES GRANTED TO OR BASE
UNDERLYING EMPLOYEES IN PRICE
NAME OPTION(#) FISCAL YEAR ($/SH)(1) EXPIRATION DATE 5% 10%
- --------------------------------------------------------------------------------------------------------------------------

Wayne Lam 100,000(3) 4% $8.43 December 22, 2013 $530,158.17 $1,343,524.89

(1) The option exercise price must be paid in cash. The exercise price is equal
to or greater than the fair market value of the Common Stock on the date of
grant.

(2) The potential realizable value portion of the foregoing table illustrates
values that might be realized upon exercise of the options immediately prior to
the expiration of their term, assuming the specified compounded rates of
appreciation on the Company's Common Stock over the term of the options. These
numbers do not take into account provisions of certain op tions providing for
termination of the option following termination of employment,
non-transferability or differences in vesting periods. Regardless of the
theoretical value of an option, its ultimate value will depend upon the market
value of the Common Stock at a future date, and that value will depend on a
variety of factors, including the overall condition of the stock market and the
Company's results of operations and financial condition. There can be no
assurance that the values reflected in this table will be achieved.

(3) These options become exercisable with respect to 33% of the shares indicated
on December 22 in each of 2004 and 2005 and 34% in 2006.

AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION VALUES

The following table sets forth certain information concerning the
number of options exercised during 2003 and unexercised stock options held by
the Named Executive Officers as of December 31, 2003.

Shares Number of Securities Value of Unexercised In-
Acquired Underlying Unexercised the-Money Options at
on Value Options at 2003 Fiscal 2003 Fiscal Year-End
Exercise Realized Year-End (#) ($)(2)
Name (#) ($)(1) Exercisable/Unexercisable Exercisable/Unexercisable
- ---- ---- ------ ------------------------- -------------------------

ReiJane Huai -- -- 0/0 0/0

Jacob Ferng -- -- 251,206/368,458 $1,869,753/$499,326

Wayne Lam 80,000 $337,066 282,991/250,752 $2,075,600/$687,776

- -------------------

(1) Represents the fair value of the underlying securities on the date of
exercise, less the exercise price of such options.

(2) On December 31, 2003, the last reported sales price of the Common Stock as
reported on The Nasdaq National Market was $8.74.

EQUITY COMPENSATION PLAN INFORMATION

The Company currently does not have any equity compensation plans not approved
by security holders.

Number of Number of Securities
Securities to be Weighted - Remaining Available for
Issued upon Average exercise Future Issuance Under
Exercise of Price of Equity Compensation
Outstanding Outstanding Plans (Excluding
Options, Warrants Options, Warrants Securities Reflected in
and Rights and Rights Column (a))
Plan Category (a) (b) (c)
- ------------- --- --- ---

Equity compensation
plans approved by
security holders...... 9,860,425 $ 4.29 1,410,855

EMPLOYMENT AGREEMENTS

The Company has entered into an employment agreement with ReiJane
Huai dated as of September 2001, providing for the employment of Mr. Huai as
Chairman, President and Chief Executive Officer. The employment agreement
provides that Mr. Huai shall devote substantially all of his professional time
to the business of the Company. The employment agreement provides a base salary
in the amount of $150,000, subject to an increase of $15,000 per annum, provided
that the Company's earnings were higher than the previous year, as certified by
either the Company's Chief Financial Offer or its independent auditors and such
other increases as determined by the Board of Directors. The agreement contains
non-competition, confidentiality and non-solicitation provisions that apply for
twenty-four months after cessation of employment.

SEVERANCE AGREEMENTS

The Company has entered into Change of Control Contracts with each
of ReiJane Huai and Wayne Lam, dated as of December 2001, and with James Weber,
dated as of February 2004, that provide for severance pay and incidental
benefits if there is a change in control of the Company (as defined in the
Change of Control Contracts). The payment for Messrs. Huai and Lam is a lump sum
payment equal to 4.0 times one year's annual compensation. The payment for Mr.
Weber is a lump sum payment equal to 3.0 times one year's annual compensation.
The agreements also provide such individuals with the right to replace all stock

options whether vested or not with fully vested stock options, or alternatively
the right to receive a cash payment for surrendering the options equal to the
difference between the full exercise price of each option surrendered and the
greater of the price per share paid by the acquirer in the change of control
transaction or the market price of the Company's Common Stock on the date of the
change of control. Finally, the agreements provide that if any excise taxes are
imposed on Messrs. Huai, Lam and Weber by Section 4999 of the Internal Revenue
Code of 1986, as amended, the Company will make them whole.

REPORT ON REPRICING OF OPTIONS. None of the stock options granted
under any of the Company's plans was repriced in the fiscal year ended 2003.

COMPENSATION COMMITTEE INTERLOCK AND INSIDER PARTICIPATION. Messrs.
ReiJane Huai, Patrick B. Carney, Lawrence S. Dolin, Steven R. Fischer, and
Steven H. Owings served as members of the Compensation Committee of the Board of
Directors at various times during the fiscal year ended December 31, 2003. For
information relating to transactions involving the Company and such individuals,
please see "Certain Relationships and Related Transactions."

AUDIT COMMITTEE REPORT

The Board of Directors appoints an Audit Committee each year to
review the Company's financial matters. Please see the "Audit Committee"
discussion in the "Board of Directors" section, above, for a discussion of the
Audit Committee.

The Audit Committee meets with the Company's independent accountants
and reviews the scope of their audit, report and recommendations. The Audit
Committee members reviewed and discussed the audited financial statements for
the fiscal year ending December 31, 2003 with management. The Audit Committee
also discussed all the matters required to be discussed by Statement of Auditing
Standard No. 61 with the Company's independent auditors, KPMG LLP. The Audit
Committee received the written disclosures and the letter from KPMG LLP as
required by Independence Standards Board Standard No. 1 and has discussed the
independence of KPMG LLP with representatives of such firm.

Based on their review and the discussions described above, the Audit
Committee recommended to the Board of Directors that the Company's audited
financial statements be included in the Company's Annual Report on Form 10-K to
be filed with the SEC.

Audit Committee
---------------
Lawrence S. Dolin
Steven H. Owings
Steven R. Fischer

2003 COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION:

GENERAL

During the fiscal year ended December 31, 2003, the Compensation
Committee determined the cash and other incentive compensation, if any, to be
paid to the Company's executive officers and key employees. Please see the
"Compensation Committee" discussion in the "Board of Directors" section, above,
for a discussion of the Compensation Committee.

COMPENSATION PHILOSOPHY

The Compensation Committee's executive compensation philosophy is to
base management's compensation, in part, on achievement of the Company's annual
and long-term performance goals, to provide competitive levels of compensation,
to recognize individual initiative, achievement and length of service to the
Company, and to assist the Company in attracting and retaining qualified
management. The Compensation Committee also believes that the potential for
equity ownership by management is beneficial in aligning management's and
stockholders' interests in the enhancement of stockholder value. The Company has
not established a policy with regard to Section 162(m) of the Internal Revenue
Code of 1986, as amended (the "Code"), since the Company has not paid and does
not currently anticipate paying compensation in excess of $1 million per annum
to any employee. The Company believes, however, that any compensation received
by executive officers pursuant to the exercise of options granted under the 2000
Plan qualifies as "performance-based" compensation.

SALARIES

Base salaries for the Company's executive officers are determined
initially by evaluating the responsibilities of the position held and the
experience of the individual, and by reference to the competitive marketplace
for management talent, including a comparison of base salaries for comparable
positions at other comparable companies. Base salary compensation of executive
officers is reviewed annually by the Compensation Committee, and recommendations
of the Compensation Committee in that regard are acted upon by the Board of
Directors. Annual salary adjustments are determined by evaluating the
competitive marketplace; the performance of the Company, which includes
operating results of the Company and cash management; quality of products; the
performance of the executive; and the length of the executive's service to the
Company and any increased responsibilities assumed by the executive. The Company
places itself between the low and medium levels in determining salaries compared
to the other comparable storage software companies.

INCENTIVE COMPENSATION

The Company from time to time will consider the payment of
discretionary bonuses to its executive officers. Bonuses would be determined
based, first, upon the level of achievement by the Company of its strategic and
operating goals and, second, upon the level of personal achievement by
participants. The achievement of goals by the Company includes, among other
things, the performance of the Company as measured by the operating results of
the Company and quality of products. The achievement of personal goals includes
the actual performance of the department of the Company for which the executive
officer has responsibility as compared to the planned performance thereof, other
individual contributions, the ability to manage and motivate employees and the
achievement of assigned projects. Bonuses are determined annually after the
close of each fiscal year. Despite achievement of personal goals, bonuses might
not be given based upon the performance of the Company as a whole.

COMPENSATION OF CHIEF EXECUTIVE OFFICER

Mr. Huai's salary in 2003 was $150,000. Mr. Huai's salary is based
upon the factors described in the "Salaries" paragraph above. His base salary is
set forth in his employment contract.

STOCK OPTION AND OTHER PLANS

The Company awarded options to the Named Executive Officers in 2003
as set forth in the table, above. It is the philosophy of the Compensation
Committee that stock options should be awarded to employees of the Company to
promote long-term interests between such employees and the Company's
stockholders through an equity interest in the Company and to assist in the
retention of such employees. The Compensation Committee also considered the
amount and terms of options previously granted to Named Executive Officers. The
Compensation Committee believes the potential for equity ownership by management
is beneficial in aligning management's and stockholders' interest in the
enhancement of stockholder value.

Compensation Committee:
-----------------------
Patrick B. Carney
Steven R. Fischer
Steven H. Owings

COMMON STOCK PERFORMANCE: The following graph compares, for each of the periods
indicated, the percentage change in the Company's cumulative total stockholder
return on the Company's Common Stock with the cumulative total return of a) an
index consisting of Computer Software and Services companies, a peer group
index, and b) the Russell 3000 Index, a broad equity market index. The stock
price information for the Company at fiscal year ends prior to fiscal year ended
December 31, 2001, reflects the stock price of Network Peripherals, Inc.

[OBJECT OMITTED]

ASSUMES $100 INVESTED ON DEC. 31, 1998
ASSUMES DIVIDEND REINVESTED
FISCAL YEAR ENDING DEC. 31, 2003

Fiscal year ending

12/31/98 12/31/99 12/31/00 12/31/01 12/31/02 12/31/03

FalconStor Software, Inc. 100.00 1,050.00 143.07 201.33 86.22 194.22

MG Group Computer
Software & Services Index 100.00 171.61 103.11 91.35 62.22 80.45

Russell 3000 Index 100.00 119.36 109.18 95.39 73.63 94.79

There can be no assurance that the Common Stock's performance will
continue with the same or similar trends depicted in the graph above.

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

None.

PROPOSAL NO. 2

APPROVAL OF THE 2004 OUTSIDE DIRECTORS STOCK OPTION PLAN

The Board of Directors proposes that the 2004 Outside Directors
Stock Option Plan (the "2004 Plan") be approved. The 2004 Plan was adopted by
the Board of Directors on March 29, 2004.

The Board of Directors believes it is in the Company's and its
stockholders' best interests to approve the 2004 Plan. The 2004 Plan, as
proposed, is intended to assist the Company in securing and retaining directors
by allowing them to participate in the ownership and growth of the Company
through the grant of nonqualified stock options. The granting of such options
serves as partial consideration for and gives optionees an additional inducement
to remain in the service of the Company and its subsidiaries and provides them
with an increased incentive to work towards the Company's success.

On April 26, 1994, the Board of Directors of NPI, the Company's
predecessor, adopted the 1994 Outside Directors Stock Option Plan (the "1994
Plan"). The 1994 Plan was approved at the 1994 Annual Meeting of NPI
stockholders. The 1994 Plan expires on April 26, 2004.

The proposed 2004 Plan is attached as Exhibit C to this Proxy
Statement.

SUMMARY OF THE 2004 PLAN

The following summary of the 2004 Plan, assuming stockholder
approval, is qualified in its entirety by the specific language of the 2004
Plan.

General. The 2004 Plan provides for the automatic grant of
nonstatutory stock options to nonemployee directors of the Company.

Shares Subject to Plan. A maximum of 300,000 of the authorized but
unissued or treasury shares of the common stock of the Company may be issued
upon the exercise of options granted under the 2004 Plan. Upon any stock
dividend, stock split, reverse stock split, recapitalization, combination,
reclassification, or similar change in the capital structure of the Company,
appropriate adjustments will be made to the shares subject to the 2004 Plan, to
the terms of the automatic grant of options described below, and to outstanding
options. To the extent that any outstanding option under the 2004 Plan expires
or terminates prior to exercise in full or if shares issued upon the exercise of
an option are repurchased by the Company, the shares of Common Stock for which
such option is not exercised or the repurchased shares are returned to the plan
and again become available for grant.

Administration. The 2004 Plan is intended to operate automatically
without discretionary administration. To the extent administration is necessary,
it will be performed by the Board of Directors or a duly appointed committee of
the Board (hereinafter referred to collectively as the "Board"). However, the
Board has no discretion to select the nonemployee directors of the Company who
are granted options under the 2004 Plan, to set the exercise price of such
options, to determine the number of shares for which or the time at which
particular options are granted or to establish the duration of such options. The
Board is authorized to interpret the 2004 Plan and options granted thereunder,

and all determinations of the Board will be final and binding on all persons
having an interest in the 2004 Plan or any option.

Eligibility. Only directors of the Company who, at the time of
grant, are not employees of the Company or of any parent or subsidiary
corporation of the Company (the "Outside Directors") are eligible to participate
in the 2004 Plan. Currently, the Company has four Outside Directors.

Automatic Grant of Options. Each person first elected or appointed
as an Outside Director is granted automatically, on the date of such initial
election or appointment, an option (an "Initial Option") to purchase 50,000
shares of Common Stock. On the date of each annual meeting of stockholders of
the Company, an additional option (an "Annual Option") to purchase 10,000 shares
of Common Stock is granted automatically to each Outside Director, other than an
Outside Director who received an Initial Option within six months prior to the
annual meeting. In addition, on the date of each annual meeting of stockholders
of the Company, each Outside Director who served as the Chairperson of any
Committee of the Company's Board of Directors for at least six months during the
most recent fiscal year is granted automatically an option (the "Chair Option")
to purchase 5,000 shares of Common Stock. Any options granted under the Plan
must be granted within three years of the Plan's effective date.

Terms and Conditions of Options. Each option granted under the 2004
Plan is evidenced by a written agreement between the Company and the Outside
Director specifying the number of shares subject to the option and the other
terms and conditions of the option, consistent with the requirements of the 2004
Plan. The exercise price per share of any option granted under the 2004 Plan
must equal the fair market value, as determined pursuant to the plan, of a share
of the Company's Common Stock on the date of grant. Generally, the fair market
value of the Common Stock will be the closing price per share on the date of
grant as reported on The Nasdaq National Market. The exercise price may be paid
in cash, by check, or in cash equivalent, by tender of shares of the Company's
Common Stock owned by the optionee (other than shares obtained through the
exercise of options within the prior six months) having a fair market value not
less than the exercise price to an independent broker, by the assignment of the
proceeds of a sale of some or all of the shares of Common Stock being acquired
upon the exercise of the option, or by any combination of these.

Options granted under the 2004 Plan become exercisable at a rate of
33 1/3% one year after the date of grant and then ratably in monthly
installments over the succeeding two years of service. The term of each option
is 10 years after the date of grant, subject to earlier termination in the event
the optionee's service with the Company ceases or in the event of a Change in
Control of the Company, as discussed below. Options remain exercisable for 90
days following an optionee's termination of service, unless such termination
results from the optionee's death or disability, in which case the option
remains exercisable for 3 years following the optionee's termination of service,
provided that in any event the option must be exercised no later than its
expiration date. "Service" for purposes of the 2004 Plan means service to the
Company in any capacity, whether as a director, employee or consultant.

of the Board, the optionee may transfer all or a portion of the option to (i) an
immediate family member, (ii) a trust for the exclusive benefit of the optionee
and/or one or more immediate family members, (iii) a partnership in which the
optionee and/or one or more immediate family members are the only partners, or
(iv) such other person or entity as the Board permits. For this purpose,
"immediate family member" means the optionee's spouse, former spouse, children
or grandchildren, whether natural or adopted.

Change in Control. The 2004 Plan provides that, in the event of (i)
a merger or consolidation in which the Company is not the surviving corporation
or in which the stockholders of the Company before such transaction do not
retain after such transaction, directly or indirectly, at least a majority of
the beneficial interest in the voting stock of the Company, (ii) the sale,
exchange or transfer of all or substantially all of the assets of the Company
other than to one or more subsidiary corporations, (iii) the direct or indirect
sale or exchange by the stockholders of the Company of all or substantially all
of the stock of the Company where the stockholders of the Company before such
transaction do not retain after such transaction, directly or indirectly, at
least a majority of the beneficial interest in the voting stock of the Company,
or (iv) a liquidation or dissolution of the Company (a "Change in Control"), all
options outstanding under the 2004 Plan will become immediately exercisable and
vested in full as of the date ten days prior to the Change in Control. In
addition, the acquiring or successor corporation may assume or substitute
substantially equivalent options for the options outstanding under the 2004
Plan. To the extent that the options outstanding under the 2004 Plan are not
assumed, substituted for, or exercised prior to the Change in Control, they will
terminate.

Repricing. The 2004 Plan provides that Options granted may not be
repriced or replaced without the approval of the holders of a majority of the
Company's common stock.

Termination or Amendment. The 2004 Plan provides that it may be
terminated or amended by the Board at any time, subject to stockholder approval
only if such amendment would increase the total number of shares of Common Stock
reserved for issuance thereunder.

SUMMARY OF UNITED STATES FEDERAL INCOME TAX CONSEQUENCES

Non-Qualified Stock Options. Upon exercise of a non-qualified stock
option granted under the 2004 Plan, the grantee will recognize ordinary income
in an amount equal to the excess of the fair market value of the shares received
over the exercise price of such shares. That amount increases the grantee's
basis in the stock acquired pursuant to the exercise of the non-qualified
option. Upon a subsequent sale of the stock, the grantee will incur short-term
or long-term gain or loss depending upon his holding period for the shares and
upon the shares' subsequent appreciation or depreciation in the value. The
Company will be allowed a federal income tax deduction for the amount recognized
as ordinary income by the grantee upon the grantee's exercise of the option.

Summary of Tax Consequences. This outline is no more than a summary
of the federal income tax provisions relating to the grant and exercise of
options and stock appreciation rights under the 2004 Plan and the sale of shares
acquired under the 2004 Plan. Individual circumstances may vary these results.
The federal income tax laws and regulations are constantly being amended, and
each participant should rely upon his own tax counsel for advice concerning the
federal income tax provisions applicable to the 2004 Plan.

The Board believes it is in the Company's best interests to approve
the 2004 Plan, which would allow the Company to grant options to secure for the
Company the benefits of the additional incentive inherent in the ownership of
shares of the Company's Common Stock by directors.

RECOMMENDATION OF THE BOARD OF DIRECTORS

THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR THE ADOPTION OF THE 2004 OUTSIDE
DIRECTORS STOCK OPTION PLAN.

PROPOSAL NO. 3

APPROVAL OF AMENDMENT TO THE 2000 STOCK OPTION PLAN

The Board of Directors proposes that the amendment to the 2000 Plan
(the "2000 Plan Amendment") be approved, whereby the number of shares issuable
upon the exercise of options under the 2000 Plan would be increased from
12,662,296 to 14,162,296.

As of the Record Date, options to purchase 1,261,271 shares were
available for grant under the 2000 Plan and options to purchase 9,231,747 shares
were issued and outstanding, with a weighted average exercise price of
approximately $4.30 per share. All such issued options vest over a three-year
period.

The 2000 Plan is intended to assist the Company in securing and
retaining employees, officers, consultants and advisors (the "Optionees") by
allowing them to participate in the ownership and growth of the Company through
the grant of incentive and nonqualified stock options. The granting of such
options serves as partial consideration for and gives the Optionees an
additional inducement to remain in the service of the Company and its
subsidiaries and provides them with an increased incentive to work towards the
Company's success. Shares of Common Stock may be issued under the 2000 Plan upon
the exercise of incentive stock options, as defined in Section 422 of the
Internal Revenue Code of 1986, as amended (the "Code"), and nonqualified stock
options.

The Board of Directors believes it is in the Company's and its
stockholders' best interests to approve the 2000 Plan Amendment because it would
allow the Company to continue to grant options under the 2000 Plan which
facilitates the benefits of the additional incentive inherent in the ownership
of Common Stock by the Optionees and helps the Company retain the services of
these Optionees.

The proposed Amendment to the 2000 Plan is attached as Exhibit D to
this Proxy Statement.

SUMMARY OF THE 2000 PLAN, AS AMENDED

The following summary of the 2000 Plan, assuming stockholder
approval of the above amendment, is qualified in its entirety by the specific
language of the 2000 Plan.

General. The 2000 Plan provides for the grant of incentive and
nonqualified stock options to employees, officers, consultants and advisors of
the Company.

Shares Subject to Plan. A maximum of 14,162,296 of the authorized
but unissued or treasury shares of the common stock of the Company may be issued
upon the exercise of options granted under the 2000 Plan. Upon any stock
dividend, stock split, reverse stock split, recapitalization, combination,
reclassification, or similar change in the capital structure of the Company,
appropriate adjustments will be made to the shares subject to the 2000 Plan and
to outstanding options. To the extent that any outstanding option under the 2000
Plan expires or terminates prior to exercise in full or if shares issued upon
the exercise of an option are repurchased by the Company, the shares of Common
Stock for which such option is not exercised or the repurchased shares are

returned to the 2000 Plan and again become available for grant. No optionee may
be granted, in total, options to purchase more than 15% of the shares authorized
under the plan.

Administration. The 2000 Plan will be administered by a Stock Option
Committee, consisting of two or more members of the Board of Directors appointed
by the Board of Directors. The Stock Option Committee will approve option grants
to employees, officers, consultants and advisors of the Company, subject to the
provisions of the 2000 Plan. The Stock Option Committee will also make any other
determinations necessary or advisable for the administration of the 2000 Plan.
The determinations by the Stock Option Committee will be final and conclusive.

Eligibility. Employees, officers, consultants and advisors of the
Company are eligible to participate in the 2000 Plan.

Terms and Conditions of Options. Each option granted under the 2000
Plan is evidenced by a written agreement between the Company and the optionee
specifying the number of shares subject to the option and the other terms and
conditions of the option, consistent with the requirements of the 2000 Plan. The
purchase price of each share of Common Stock purchasable under an incentive
option shall be determined by the Stock Option Committee at the time of grant,
but shall not be less than 100% of the fair value of such share of Common Stock
on the date the option is granted; provided, however, that with respect to an
optionee who, at the time such incentive option is granted, owns (within the
meaning of Section 424(d) of the Code) more than 10% of the total combined
voting power of all classes of stock of the Company or of any Subsidiary, the
purchase price per share of Common Stock shall be at least 110% of the fair
market value per share of Common Stock on the date of grant. The purchase price
of each share of Common Stock purchasable under a nonqualified option shall not
be less than 80% of the fair market value of such share of Common Stock on the
date the option is granted. Generally, the fair market value of the Common Stock
will be the closing price per share on the date of grant as reported on The
Nasdaq National Market. The exercise price may be paid in cash, by check, or in
cash equivalent, by tender of shares of the Company's Common Stock owned by the
optionee having a fair market value not less than the exercise price, by the
assignment of the proceeds of a sale of some or all of the shares of Common
Stock being acquired upon the exercise of the option, or by any combination of
these. Not withstanding the foregoing, an optionee may not take any actions
which are prohibited by the Sarbanes-Oxley Act of 2002 and the rules and
regulations promulgated by the Securities and Exchange Commission or any other
agency thereunder.

Options granted under the 2000 Plan become exercisable at such time
or times and subject to such terms and conditions as shall be determined by the
Stock Option Committee at the time of grant. The term of each option shall be
determined by the Stock Option Committee (but shall not be more than 10 years
after the date of grant), subject to earlier termination in the event the
optionee's service with the Company ceases.

In general, during the lifetime of the optionee, the option may be
exercised only by the optionee and may not be transferred or assigned, except by
will or the laws of descent and distribution. However, the 2000 Plan provides
that, with the consent of the Stock Option Committee, an optionee may transfer a
nonqualified option to (i) a trust for the exclusive benefit of the optionee or
(ii) a member of the optionee's immediate family (or a trust for his or her
benefit).

Termination or Amendment. Unless earlier terminated by the Board,
the 2000 Plan will terminate on May 1, 2010. The 2000 Plan provides that it may
be terminated or amended by the Board at any time, subject to stockholder
approval only if such amendment would increase the total number of shares of
Common Stock reserved for issuance thereunder.

SUMMARY OF UNITED STATES FEDERAL INCOME TAX CONSEQUENCES

INCENTIVE STOCK OPTIONS. Incentive stock options granted under the
2000 Option Plan are intended to be "incentive stock options" as defined by
Section 422 of the Code. Under present law, the grantee of an incentive stock
option will not realize taxable income upon the grant or the exercise of the
incentive stock option and the Company will not receive an income tax deduction
at either such time. If the grantee does not sell the shares acquired upon
exercise of an incentive stock option within either (i) two years after the
grant of the incentive stock option or (ii) one year after the date of exercise
of the incentive stock option, the gain upon a subsequent sale of the shares
will be taxed as long-term capital gain. If the grantee, within either of the
above periods, disposes of the shares acquired upon exercise of the incentive
stock option, the grantee will recognize as ordinary income an amount equal to
the lesser of (i) the gain realized by the grantee upon such disposition or (ii)
the difference between the exercise price and the fair market value of the
shares on the date of exercise. In such event, the Company would be entitled to
a corresponding income tax deduction equal to the amount recognized as ordinary
income by the grantee. The gain in excess of such amount recognized by the
grantee as ordinary income would be taxed as a long-term capital gain or
short-term capital gain (subject to the holding period requirements for
long-term or short-term capital gain treatment).

Unless the shares subject to an incentive stock option are subject
to a risk of forfeiture at the time the option is exercised, the exercise of the
incentive stock option will result in the excess of the stock's fair market
value on the date of exercise over the exercise price being included in the
optionee's alternative minimum taxable income (AMTI). If the shares are subject
to a risk of forfeiture and are nontransferable, the excess described above will
be included in AMTI when the risk of forfeiture lapses or the shares become
transferable, whichever occurs sooner. Liability for the alternative minimum tax
is complex and depends upon an individual's overall tax situation. Before
exercising an incentive stock option, a grantee should discuss the possible
application of the alternative minimum tax with his tax advisor in order to
determine the tax's impact.

Non-Qualified Stock Options. Upon exercise of a non-qualified stock
option granted under the 2000 Plan, the grantee will recognize ordinary income
in an amount equal to the excess of the fair market value of the shares received
over the exercise price of such shares. That amount increases the grantee's
basis in the stock acquired pursuant to the exercise of the non-qualified
option. Upon a subsequent sale of the stock, the grantee will incur short-term
or long-term gain or loss depending upon his holding period for the shares and
upon the shares' subsequent appreciation or depreciation in the value. The
Company will be allowed a federal income tax deduction for the amount recognized
as ordinary income by the grantee upon the grantee's exercise of the option.

Summary of Tax Consequences. This outline is no more than a summary
of the federal income tax provisions relating to the grant and exercise of
options and stock appreciation rights under the 2000 Plan and the sale of shares
acquired under the 2000 Plan. Individual circumstances may vary these results.
The federal income tax laws and regulations are constantly being amended, and

each participant should rely upon his own tax counsel for advice concerning the
federal income tax provisions applicable to the 2000 Plan.

The Board believes it is in the Company's best interests to approve
the 2000 Plan Amendment, which would allow the Company to continue to grant
options under the 2000 Plan to secure for the Company the benefits of the
additional incentive inherent in the ownership of shares of the Company's Common
Stock by employees, officers, consultants and advisors and to help the Company
secure and retain the services of employees, officers, consultants and advisors.

AMENDED PLAN BENEFITS

The following table sets forth the stock options outstanding under
the 2000 Plan as of the Record Date.

Stock Options Outstanding

ReiJane Huai -0-

James Weber 150,479

Jacob Ferng 368,458

Wayne Lam 533,743

All Executive Officers as a Group 1,052,680

Non-Executive Directors and Director Nominees as a Group 10,000(1)

Non-Executive Officer Employees as a Group 8,093,521

(1) Does not include options to purchase 260,000 shares granted to current
non-employee Directors pursuant to the 1994 Outside Directors Stock Option Plan.

RECOMMENDATION OF THE BOARD OF DIRECTORS

THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR THE 2000 STOCK OPTION
PLAN AMENDMENT.

PROPOSAL NO. 4

INDEPENDENT PUBLIC ACCOUNTANTS

The accounting firm of KPMG LLP has been selected as the independent
public accountants for the Company for the fiscal year ending December 31, 2004.
Although the selection of accountants does not require ratification, the Audit
Committee of the Board of Directors has directed that the appointment of KPMG
LLP be submitted to stockholders for ratification due to the significance of
their appointment by the Company. If stockholders do not ratify the appointment
of KPMG LLP, the Audit Committee will consider the appointment of other
certified public accountants. A representative of that firm, which served as the
Company's independent public accountants for the fiscal year ended December 31,
2003, is expected to be present at the Meeting and, if he so desires, will have
the opportunity to make a statement, and in any event will be available to
respond to appropriate questions.

PRINCIPAL ACCOUNTING FEES AND SERVICES

Fees for services rendered by KPMG LLP for the years 2003 and 2002
fell into the following categories:

AUDIT FEES: Fees billed for professional services rendered by KPMG
LLP for the audit of the Company's annual financial statements for the fiscal
years ended December 31, 2003 and 2002 and the reviews of the financial
statements included in the Company's Form 10-Qs for such fiscal years.

AUDIT RELATED FEES: Fees billed for professional services rendered
by KPMG LLP for audit related services.

TAX FEES: Fees billed for tax related services rendered by KPMG LLP
to the Company. These fees consisted primarily of tax compliance services.

ALL OTHER FEES: Fees billed for non-audit related services rendered
by KPMG LLP to the Company. These fees consisted primarily of reviews of SEC
filings and services related to an acquisition.

The approximate fees for each category were as follows:

Year Ended December 31,
Description 2003 2002
Audit Fees $204,600 $188,700
Audit Related Fees $4,000 $6,000
Tax Fees $52,450 $59,350
Other Fees $3,500 $6,000

The Audit Committee has considered whether the provision by KPMG LLP
of the services covered by the fees other than the audit fees is compatible with
maintaining KPMG LLP's independence and believes that it is compatible.

AUDIT COMMITTEE PRE-APPROVAL PROCEDURES. The Audit Committee's
Pre-Approval Procedures are attached to this Proxy Statement as Exhibit B.

RECOMMENDATION OF THE BOARD OF DIRECTORS

THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR THE SELECTION OF THE INDEPENDENT
PUBLIC ACCOUNTANTS.

SOLICITATION STATEMENT

The Company will bear all expenses in connection with the
solicitation of proxies. In addition to the use of the mail, solicitations may
be made by the Company's regular employees, by telephone, telegraph or personal
contact, without additional compensation. The Company will, upon their request,
reimburse brokerage houses and persons holding shares of Common Stock in the
names of the Company's nominees for their reasonable expenses in sending
solicited material to their principals.

STOCKHOLDER PROPOSALS

In order to be considered for inclusion in the proxy materials to be
distributed in connection with the next annual meeting of stockholders of the
Company, stockholder proposals for such meeting must be submitted to the Company
no later than December 9, 2004.

On May 21, 1998 the SEC adopted an amendment to Rule 14a-4, as
promulgated under the Securities and Exchange Act of 1934, as amended. The
amendment to Rule 14a-4(c)(1) governs the Company's use of its discretionary
proxy voting authority with respect to a stockholder proposal, which is not
addressed in the Company's proxy statement. The amendment provides that if the
Company does not receive notice of the proposal at least 45 days prior to the
first anniversary of the date of mailing of the prior year's proxy statement,
then the Company will be permitted to use its discretionary voting authority
when the proposal is raised at the annual meeting, without any discussion of the
matter in the proxy statement.

With respect to the Company's 2005 Annual Meeting of Stockholders,
if the Company is not provided notice of a stockholder proposal, which has not
been timely submitted, for inclusion in the Company's proxy statement by
February 22, 2005 the Company will be permitted to use its discretionary voting
authority as outlined above.

OTHER MATTERS

So far as now known, there is no business other than that described
above to be presented for action by the stockholders at the Annual Meeting, but
it is intended that the proxies will be voted upon any other matters and
proposals that may legally come before the Annual Meeting or any adjournment
thereof, in accordance with the discretion of the persons named therein.

ANNUAL REPORT

The Company has sent, or is concurrently sending, to all of its
stockholders of record as of March 26, 2004 a copy of its Annual Report for the
fiscal year ended December 31, 2003. Such report contains the Company's audited
consolidated financial statements for the fiscal year ended December 31, 2003.

By Order of the Board of Directors,

/s/ Seth R. Horowitz

Seth R. Horowitz
Secretary

Dated: Melville, New York
April 8, 2004

THE COMPANY WILL FURNISH A FREE COPY OF ITS ANNUAL REPORT ON FORM
10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003 (WITHOUT EXHIBITS) TO ALL OF
ITS STOCKHOLDERS OF RECORD AS OF MARCH 26, 2004 WHO WILL MAKE A WRITTEN REQUEST
TO MR. JAMES WEBER, CHIEF FINANCIAL OFFICER, FALCONSTOR SOFTWARE, INC., 2
HUNTINGTON QUADRANGLE, MELVILLE, NEW YORK 11747.

EXHIBIT A

AUDIT COMMITTEE CHARTER

PURPOSE

The Audit Committee of the Board of Directors is appointed by the Board to
assist the Board in monitoring (1) the integrity of the financial statements of
the Company, (2) the independent auditor's qualifications and independence, (3)
the performance of the Company's internal audit function and independent
auditors, (4) the integrity of management and information systems and internal
controls, and (5) the compliance by the Company with legal and regulatory
requirements.

The Audit Committee shall prepare the report required by the rules of the
Securities and Exchange Commission (the "Commission") to be included in the
Company's annual proxy statement.

COMMITTEE MEMBERSHIP

The Audit Committee shall consist of no fewer than three members. The members of
the Audit Committee shall meet the independence and experience requirements of
the NASDAQ, Section 10A(m)(3) of the Securities Exchange Act of 1934 (the
"Exchange Act") and the rules and regulations of the Commission. At least one
member of the Audit Committee shall be an "audit committee financial expert" as
defined by the Commission. Audit Committee members shall not simultaneously
serve on the audit committees of more than two other public companies. The
members of the Audit Committee shall be appointed by the Board. Audit Committee
members may be replaced by the Board.

MEETINGS

The Audit Committee shall meet as often as it determines, but not less
frequently than quarterly. The Audit Committee shall meet periodically with
management and the independent auditor in separate executive sessions. The Audit
Committee may request any officer or employee of the Company or the Company's
outside counsel or independent auditor to attend a meeting of the Committee or
to meet with any members of, or consultants to, the Committee.

COMMITTEE AUTHORITY AND RESPONSIBILITIES

The Audit Committee shall have the sole authority to appoint or replace the
independent auditor (subject, if applicable, to shareholder ratification). The
Audit Committee shall be directly responsible for the compensation and oversight
of the work of the independent auditor (including resolution of disagreements
between management and the independent auditor regarding financial reporting)
for the purpose of preparing or issuing an audit report or related work. The
independent auditor shall report directly to the Audit Committee.

A-1

The Audit Committee shall preapprove all auditing services and permitted
non-audit services (including the fees and terms thereof) to be performed for
the Company by its independent auditor, subject to the de minimis exceptions for
non-audit services described in Section 10A(i)(1)(B) of the Exchange Act which
are approved by the Audit Committee prior to the completion of the audit. The
Audit Committee may form and delegate authority to subcommittees consisting of
one or more members when appropriate, including the authority to grant
preapprovals of audit and permitted non-audit services, provided that decisions
of such subcommittee to grant preapprovals shall be presented to the full Audit
Committee at its next scheduled meeting.

The Audit Committee shall review and pre-approve all related-party transactions.

The Audit Committee shall establish procedures for the receipt, retention, and
treatment of complaints received by the Company regarding accounting, internal
accounting controls or auditing matters. The Audit Committee shall ensure that
such complaints are treated confidentially and anonymously.

The Audit Committee shall have the authority, to the extent it deems necessary
or appropriate, to retain independent legal, accounting or other advisors. The
Company shall provide for appropriate funding, as determined by the Audit
Committee, for payment of compensation to the independent auditor for the
purpose of rendering or issuing an audit report and to any advisors employed by
the Audit Committee.

The Audit Committee shall make regular reports to the Board. The Audit Committee
shall review and reassess the adequacy of this Charter annually and recommend
any proposed changes to the Board for approval. The Audit Committee shall
annually review the Audit Committee's own performance.

The Audit Committee, to the extent it deems necessary or appropriate, shall:

Financial Statement and Disclosure Matters
- ------------------------------------------

1. Review and discuss with management and the independent auditor the
annual audited financial statements, including disclosures made in
management's discussion and analysis, and recommend to the Board
whether the audited financial statements should be included in the
Company's Form 10-K. This includes reviewing management's and the
independent auditor's judgment about the quality, not just the
acceptability, of accounting principles, the reasonableness of
significant judgments and the clarity of the disclosures in the
financial statements.

2. Review and discuss with management and the independent auditor the
Company's quarterly financial statements prior to the filing of its
Form 10-Q, including the results of the independent auditor's review of
the quarterly financial statements.

3. Discuss with management and the independent auditor significant
financial reporting issues and judgments made in connection with the
preparation of the Company's financial statements, including any
significant changes in the Company's selection or application of

A-2

accounting principles, any major issues as to the adequacy of the
Company's internal controls and any special steps adopted in light of
material control deficiencies.

4. Review and discuss quarterly reports from the independent auditors on:

a. All critical accounting policies and practices to be used.

b. All alternative treatments of financial information within
generally accepted accounting principles that have been discussed
with management, ramifications of the use of such alternative
disclosures and treatments, and the treatment preferred by the
independent auditor.

c. Other material written communications between the independent
auditor and management, such as any management letter or schedule
of unadjusted differences.

5. Discuss with management the Company's earnings press releases,
including the use of "pro forma" or "adjusted" non-GAAP information, as
well as financial information and earnings guidance provided to
analysts and rating agencies. Such discussion may be done generally
(consisting of discussing the types of information to be disclosed and
the types of presentations to be made).

6. Discuss with management and the independent auditor the effect of
regulatory and accounting initiatives as well as off-balance sheet
structures, if any, on the Company's financial statements.

7. Discuss with management the Company's major financial risk exposures
and the steps management has taken to monitor and control such
exposures, including the Company's risk assessment and risk management
policies

8. Discuss with the independent auditor the matters required to be
discussed by Statement on Auditing Standards No. 61 relating to the
conduct of the audit, including any difficulties encountered in the
course of the audit work, any restrictions on the scope of activities
or access to requested information, and any significant disagreements
with management.

9. Review disclosures made to the Audit Committee by the Company's CEO and
CFO during their certification process for the Form 10-K and Form 10-Q
about any significant deficiencies in the design or operation of
internal controls or material weaknesses therein and any fraud
involving management or other employees who have a significant role in
the Company's internal controls.

A-3

Oversight of the Company's Relationship with the Independent Auditor
- -------------------------- -----------------------------------------

1. Review and evaluate the lead partner of the independent auditor team.

2. Obtain and review a report from the independent auditor at least
annually regarding (a) the independent auditor's internal
quality-control procedures, (b) any material issues raised by the most
recent internal quality-control review, or peer review, of the firm, or
by any inquiry or investigation by governmental or professional
authorities within the preceding five years respecting one or more
independent audits carried out by the firm, (c) any steps taken to deal
with any such issues, and (d) all relationships between the independent
auditor and the Company. Evaluate the qualifications, performance and
independence of the independent auditor, including considering whether
the auditor's quality controls are adequate and the provision of
permitted non-audit services is compatible with maintaining the
auditor's independence, taking into account the opinions of management
and internal auditors. The Audit Committee shall present its
conclusions with respect to the independent auditor to the Board.

3. Ensure the rotation of the audit partners as required by law. Consider
whether, in order to assure continuing auditor independence, it is
appropriate to adopt a policy of rotating the independent auditing firm
on a regular basis.

4. Recommend to the Board policies for the Company's hiring of employees
or former employees of the independent auditor who participated in any
capacity in the audit of the Company.

5. Discuss with the national office of the independent auditor issues on
which they were consulted by the Company's audit team and matters of
audit quality and consistency.

6. Meet with the independent auditor prior to the audit to discuss the
planning and staffing of the audit.

Compliance Oversight Responsibilities
- -------------------------------------

1. Obtain from the independent auditor assurance that Section 10A(b) of
the Exchange Act has not been implicated.

2. Obtain reports from management and the Company's senior internal
auditing executive that the Company and its subsidiary/foreign
affiliated entities are in conformity with applicable legal
requirements and the Company's Code of Business Conduct and Ethics.
Review reports and disclosures of insider and affiliated party
transactions. Advise the Board with respect to the Company's policies
and procedures regarding compliance with applicable laws and
regulations and with the Company's Code of Business Conduct and Ethics.

3. Establish procedures for the receipt, retention and treatment of
complaints received by the Company regarding accounting, internal

A-4

accounting controls or auditing matters, and the confidential,
anonymous submission by employees of concerns regarding questionable
accounting or auditing matters.

4. Discuss with management and the independent auditor any correspondence
with regulators or governmental agencies and any published reports
which raise material issues regarding the Company's financial
statements or accounting policies.

5. Discuss with the Company's General Counsel legal matters that may have
a material impact on the financial statements or the Company's
compliance policies.

LIMITATION OF AUDIT COMMITTEE'S ROLE
While the Audit Committee has the responsibilities and powers set forth in this
Charter, it is not the duty of the Audit Committee to plan or conduct audits or
to determine that the Company's financial statements and disclosures are
complete and accurate and are in accordance with generally accepted accounting
principles and applicable rules and regulations. These are the responsibilities
of management and the independent auditor.

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EXHIBIT B

AUDIT COMMITTEE PRE-APPROVAL PROCEDURES

Guidelines of the FalconStor Software, Inc., Audit Committee
for Pre-Approval of Independent Auditor Services

The Audit Committee has adopted the following guidelines regarding
the engagement of the Company's independent auditor to perform services for the
Company:

For audit services (including statutory audit engagements as
required under local country laws), the independent auditor will provide the
Audit Committee with an engagement letter during the first quarter of each year
outlining the scope of the audit services proposed to be performed during the
fiscal year. If agreed to by the Audit Committee, this engagement letter will be
formally accepted by the Audit Committee at its first quarter meeting.

The independent auditor will submit to the Audit Committee for
approval an audit services fee proposal after acceptance of the engagement
letter.

For non-audit services, Company management will submit to the Audit
Committee for approval (during the second quarter of each fiscal year) the list
of non-audit services that it recommends the Audit Committee engage the
independent auditor to provide for the fiscal year. Company management and the
independent auditor will each confirm to the Audit Committee that each non-audit
service on the list is permissible under all applicable legal requirements. In
addition to the list of planned non-audit services, a budget estimating
non-audit service spending for the fiscal year will be provided. The Audit
Committee will approve both the list of permissible non-audit services and the
budget for such services. The Audit Committee will be informed routinely as to
the non-audit services actually provided by the independent auditor pursuant to
this pre-approval process.

To ensure prompt handling of unexpected matters, the Audit Committee
delegates to the Chair the authority to amend or modify the list of approved
permissible non-audit services and fees. The Chair will report action taken to
the Audit Committee at the next Audit Committee meeting.

The independent auditor must ensure that all audit and non-audit
services provided to the Company have been approved by the Audit Committee. The
Company Controller will be responsible for tracking all independent auditor fees
against the budget for such services and report at least annually to the Audit
Committee.

B-1

EXHIBIT C

2004 OUTSIDE DIRECTORS STOCK OPTION PLAN

1. PURPOSE. The FalconStor Software, Inc. 2004 Outside Directors Stock
Option Plan (the "Plan") is established effective as of the 29th day of
March, 2004, (the "Effective Date") to create additional incentive for
the non employee directors of FalconStor Software, Inc., a Delaware
corporation, and any successor corporation thereto (collectively
referred to as the "Company") to promote the financial success and
progress of the Company and any present or future parent and/or
subsidiary corporations of the Company. For purposes of the Plan, a
parent corporation and a subsidiary corporation shall be as defined in
sections 424(e) and 424(f) of the Internal Revenue Code of 1986, as
amended (the "Code").

2. ADMINISTRATION. The Plan shall be administered by the Board of
Directors of the Company (the "Board") and/or by a duly appointed
committee of the Board having such powers as shall be specified by the
Board. Any subsequent references herein to the Board shall also mean
the committee if such committee has been appointed and, unless the
powers of the committee have been specifically limited, the committee
shall have all of the powers of the Board granted herein, including,
without limitation, the power to terminate or amend the Plan at any
time subject to the terms of the Plan and any applicable limitations
imposed by law. The Board shall have no authority, discretion or power
to select the non-employee directors of the Company who will receive
options under the Plan, to set the exercise price of the options
granted under the Plan, to determine the number of shares of common
stock to be granted under option or the time at which such options are
to be granted, to establish the duration of option grants, or to alter
other terms or conditions specified in the Plan, except in the sense of
administering the Plan subject to the provisions of the Plan. All
questions of interpretation of the Plan or of any options granted under
the Plan (an "Option") shall be determined by the Board, and such
determinations shall be final and binding upon all persons having an
interest in the Plan and/or any Option. Any officer of the Company
shall have the authority to act on behalf of the Company with respect
to any matter, right, obligation, or election which is the
responsibility of or which is allocated to the Company herein, provided
the officer has apparent authority with respect to such matter, right,
obligation, or election.

3. ELIGIBILITY AND TYPE OF OPTION. Options may be granted only to
directors of the Company who, at the time of such grant, are not
employees of the Company or of any parent or subsidiary corporation of
the Company ("Outside Directors"). Options granted to Outside Directors
shall be nonqualified stock options; that is, options that are not
treated as having been granted under section 422(b) of the Code. A
person granted an Option is hereinafter referred to as an "Optionee".

4. SHARES SUBJECT TO OPTION. Options shall be for the purchase of shares
of authorized but unissued common stock or treasury shares of common
stock of the Company (the "Stock"), subject to adjustment as provided
in paragraph 8 below. The maximum number of shares of Stock which may

C-1

be issued under the Plan shall be Three Hundred Thousand (300,000)
shares. In the event that any outstanding Option for any reason expires
or is terminated and/or shares of Stock subject to repurchase are
repurchased by the Company, the shares allocable to the unexercised
portion of such Option, or such repurchased shares, may again be
subject to an Option grant.

5. TIME FOR GRANTING OPTIONS. All Options shall be granted, if at all,
within three years from the Effective Date.

6. TERMS, CONDITIONS AND FORM OF OPTIONS. Options granted pursuant to the
Plan shall be evidenced by written agreements specifying the number of
shares of Stock covered thereby, in substantially the form attached
hereto as Exhibit A (the "Option Agreement"), which written agreement
may incorporate all or any of the terms of the Plan by reference and
shall comply with and be subject to the following terms and conditions:

a. AUTOMATIC GRANT OF OPTIONS. Subject to execution by an Outside
Director of an appropriate Option Agreement, Options shall be
granted automatically and without further action of the Board, as
follows:

i. Each person who is newly elected or appointed as an Outside
Director on or after the Effective Date shall be granted an
Option on the day of such initial election or appointment to
purchase Fifty Thousand (50,000) shares of Stock.
ii. On the date of each Annual Meeting of Stockholders of the
Company occurring after the Effective Date, each Outside
Director shall be granted an Option to purchase Ten Thousand
(10,000) shares of Stock; provided, however, that in the
event an Outside Director was elected or appointed as an
Outside Director and was granted an Option pursuant to the
provisions of subparagraph 6(a)(i) above within six months
prior to the Annual Meeting of Stockholders, that Outside
Director shall be ineligible to receive an Option with
respect to such Annual Meeting of Stockholders.
iii. On the date of each Annual Meeting of Stockholders of the
Company, each Outside Director who served as the Chairperson
of any committee of the Company's Board of Directors for at
least six months during the Company's most recently
concluded fiscal year shall be granted an Option to purchase
Five Thousand (5,000) shares of Stock. In the event an
Outside Director served as the Chairperson for two or more
Committees, such Outside Director shall be granted an option
to purchase Five Thousand (5,000) shares of Stock for each
committee for which the Outside Director served as
Chairperson.
iv. Notwithstanding the foregoing, any person may elect not to
receive an Option to be granted pursuant to this paragraph
6(a) by delivering written notice of such election to the
Board no later than the day prior to the date on which such
Option would otherwise be granted. A person so declining an
Option shall receive no payment or other consideration in

C-2

lieu of such declined Option. A person who has declined an
Option may revoke such election by delivering written notice
of such revocation to the Board no later than the day prior
to the date on which such Option would be granted pursuant
to paragraph 6(a).

v. Notwithstanding any other provision of the Plan to the
contrary, no Option shall be granted to any individual on a
day when he or she is no longer serving as an Outside
Director of the Company.

b. OPTION EXERCISE PRICE. The exercise price per share of Stock
subject to an Option shall be the fair market value of a share of
the Stock on the close of business on the date of the granting of
the Option. Where there is a public market for the common stock of
the Company, the fair market value per share of Stock shall be the
mean of the bid and asked prices of the common stock of the
Company on the date of the granting of the Option, as reported in
the Wall Street Journal (or, if not so reported, as otherwise
reported by the National Association of Securities Dealers
Automated Quotation ("NASDAQ") System) or, in the event the common
stock of the Company is listed on the NASDAQ National Market
System or a securities exchange, the fair market value per share
of Stock shall be the closing price on such National Market System
or exchange on the date of granting of the Option, as reported in
the Wall Street Journal. If the date of the granting of an Option
does not fall on a day on which the common stock of the Company is
trading on NASDAQ, the NASDAQ National Market System or securities
exchange, the date on which the Option exercise price shall be
established shall be the last day on which the common stock of the
Company was so traded prior to the date of the granting Option.

c. EXERCISE PERIOD AND EXERCISABILITY OF OPTIONS. An Option granted
pursuant to the Plan shall be exercisable for a term of ten years.
Options granted pursuant to the Plan shall first become
exercisable on the day (the "Initial Vesting Date") which is one
year from the date on which the Option was granted. The Option
shall first be exercisable on and after the Initial Vesting Date
and prior to termination of the Option in an amount equal to the
number of Option Shares multiplied by the Vested Ratio (as
hereinafter defined) as set forth below, less the number of shares
previously acquired upon exercise of any portion of the Option.

The "Vested Ratio" shall mean, on any relevant date, except as
otherwise provided herein, the ratio determined as follows:

Vested Ratio
------------

(i) Prior to Initial Vesting Date: 0

On Initial Vesting Date, 1/3
provided the Optionee's Service has not
terminated prior to such date:

Plus

C-3

(ii) For each full month
of the Optionee's continuous Service
from the Initial Vesting Date until the Vested
Ratio equals 1/1, an additional: 1/24

For purposes of the Plan, "Service" shall mean the Optionee's
service with the Company, whether in the capacity of an employee, a director or
a consultant. The Optionee's Service shall not be deemed to have terminated
merely because of a change in the capacity in which the Optionee renders Service
to the Company, provided that there is no interruption or termination of the
Optionee's Service.

d. TERMINATION OF OPTIONEE. In the event of an Optionee's
termination of Service for any reason other than as a result of
death or disability of the Optionee, in which case all Options
that have become vested will remain exercisable for the earlier
of 36 months or the expiration date of the Options, all Options
that have not become vested and exercisable as of the date of
such cessation of Service shall be forfeited and to the extent
that such Options have become vested and exercisable as of such
date, such Options must be exercised, if at all, within ninety
(90) days after the Optionee's termination of Service, after
which time such Options shall automatically terminate; provided,
however, in the event an Optionee ceases being a director because
the Optionee's Service was terminated for cause, all Options
granted hereunder (whether vested or unvested) shall terminate
immediately.

e. PAYMENT OF OPTION EXERCISE. Payment of the exercise price for the
number of shares of Stock being purchased pursuant to any Option
shall be made (i) in cash, by check, or cash equivalent, (ii) by
the assignment of the proceeds of a sale, through an independent
broker, of some or all of the shares being acquired upon the
exercise of an Option (including, without limitation, through an
exercise complying with the provisions of Regulation T as
promulgated from time to time by the Board of Governors of the
Federal Reserve System), (iii) by the delivery to the Company of
shares of Stock owned by the holder of the Option (other than
shares of stock obtained through the exercise of an Option during
the preceding six months) and which have an aggregate value equal
to such exercise price, or (iv) by any combination thereof. The
Company reserves, at any and all times, the right, in the
Company's sole and absolute discretion, to establish, decline to
approve and/or terminate any program and/or procedure for the
exercise of Options by means of an assignment of the proceeds of
a sale of some or all the shares of Stock to be acquired upon
such exercise or the delivery of previously owned shares of
Stock.

f. TRANSFER OF CONTROL. A "Transfer of Control" shall be deemed to
have occurred in the event any of the following occurs with
respect to the Company:

(i) a merger or consolidation in which the Company is not the
surviving corporation;

C-4

(ii) a merger or consolidation in which the Company is the
surviving corporation where the stockholders of the Company
before such merger or consolidation do not retain, directly
or indirectly, at least a majority of the beneficial
interest in the voting stock of the Company after such
merger or consolidation;

(iii) the sale, exchange, or transfer of all or substantially all
of the assets of the Company other than a sale, exchange, or
transfer to one or more subsidiary corporations (as defined
in paragraph 1 above) of the Company;

(iv) the direct or indirect sale or exchange by the stockholders
of the Company of all or substantially all of the stock of
the Company where the stockholders of the Company before
such sale or exchange do not retain, directly or indirectly,
at least a majority of the beneficial interest in the voting
stock of the Company after such sale or exchange; or

(v) a liquidation or dissolution of the Company.

In the event of a Transfer of Control, any unexercisable or
unvested portion of the outstanding Options shall be immediately
exercisable and vested in full as of the date ten (10) days
prior to the expected date of the Transfer of Control. The
exercise or vesting of any Option that was permissible solely by
reason of this paragraph 6(f) shall be conditioned upon the
consummation of the Transfer of Control. In addition, the
surviving, continuing, successor, or purchasing corporation or
parent corporation thereof, as the case may be (the "Acquiring
Corporation"), may either assume the Company's rights and
obligations under outstanding Options or substitute for
outstanding Options substantially equivalent options for the
Acquiring Corporation's stock. For purposes of this paragraph
6(e), an Option shall be deemed assumed if, following the
Transfer of Control, the Option confers the right to acquire in
accordance with its terms and conditions, for each share of
Stock subject to the Option immediately prior to the Transfer of
Control, the consideration (whether stock, cash or other
securities or property) to which a holder of a share of Stock on
the effective date of the Transfer of Control was entitled. Any
Options which are neither assumed nor substituted for by the
Acquiring Corporation in connection with the Transfer of Control
nor exercised as of the date of the Transfer of Control shall
terminate and cease to be outstanding effective as of the date
of the Transfer of Control.

g. STOCKHOLDER APPROVAL. No Option may be granted pursuant to the
Plan prior to obtaining stockholder approval of the Plan.

7. AUTHORITY TO VARY TERMS. The Board shall have the authority from time
to time to vary the terms of the Option Agreements either in connection
with the grant of an individual Option or in connection with the
authorization of a new standard form or forms of Option; provided,
however, that the terms and conditions of such revised or amended
standard form or forms of stock option agreement shall be in accordance
with the terms of the Plan. Such authority shall include, but not be

C-5

limited to, the authority to grant Options which are immediately
exercisable subject to the Company's right to repurchase any unvested
shares of Stock acquired by the Optionee on exercise of an Option in
the event such Optionee's service as director of the Company is
terminated for any reason.

8. EFFECT OF CHANGE IN STOCK SUBJECT TO PLAN. Appropriate adjustments
shall be made in the number and class of shares of Stock subject to the
Plan, the number of shares to be granted under the Plan and to any
outstanding Options and in the Option exercise price of any outstanding
Options in the event of a stock dividend, stock split,
recapitalization, reverse stock split, combination, reclassification,
or like change in the capital structure of the Company.

9. TRANSFERABILITY OF OPTIONS.

a. Except as provided in paragraph 9(b), an Option may be exercised
during the lifetime of the Optionee only by the Optionee or the
Optionee's guardian or legal representative and may not be assigned
or transferred in any manner except by will or by the laws of
descent and distribution.

b. Notwithstanding the foregoing, with the consent of the Board, in its
sole discretion, an Optionee may transfer all or a portion of the
Option to: (i) an Immediate Family Member (as defined below), (ii) a
trust for the exclusive benefit of the Optionee and/or one or more
Immediate Family Members, (iii) a partnership in which the Optionee
and/or one or more Immediate Family Members are the only partners,
or (iv) such other person or entity as the Board may permit
(individually, a "Permitted Transferee"). For purposes of this
paragraph 9(b) "Immediate Family Members" shall mean the Optionee's
spouse, former spouse, children or grandchildren, whether natural or
adopted. As a condition to such transfer, each Permitted Transferee
to whom the Option or any interest therein is transferred shall
agree in writing (in a form satisfactory to the Company) to be bound
by all of the terms and conditions of the Option Agreement
evidencing such Option and any additional restrictions or conditions
as the Company may require. Following the transfer of an Option, the
term "Optionee" shall refer to the Permitted Transferee, except
that, with respect to any requirements of continued Service or
provision for the Company's tax withholding obligations, such term
shall refer to the original Optionee. The Company shall have no
obligation to notify a Permitted Transferee of any termination of
the transferred Option, including an early termination resulting
from the termination of Service of the Original Optionee. A
Permitted Transferee shall be prohibited from making a subsequent
transfer of a transferred Option except to the original Optionee or
to another permitted Transferee or as provided in paragraph 9(a).

10. RE-PRICING OF OPTIONS / REPLACEMENT OPTIONS. The Company shall not
re-price any Options or issue any replacement Options unless the
Option re-pricing or Option replacement shall have been approved by
the holders of a majority of the outstanding shares of the Company.

C-6

11. TERMINATION OR AMENDMENT OF PLAN. The Board, including any duly
appointed committee of the Board, may terminate or amend the Plan at
any time; provided, however, that without the approval of the
stockholders of the Company, there shall be no increase in the total
number of shares of Stock covered by the Plan (except by operation
of the provisions of paragraph 8 above). In any event, no amendment
may adversely affect any then outstanding Option, or any unexercised
portion thereof, without the consent of the Optionee.

C-7

EXHIBIT D

AMENDMENT TO 2000 STOCK OPTION PLAN

If approved by Stockholders, paragraph 4 of the FalconStor Software,
Inc., 2000 Stock Option Plan shall read in its entirety as follows:

4. STOCK RESERVED FOR THE PLAN. Subject to adjustment as provided in Section 7
hereof, a total of 14,162,296 shares of the Company's Common Stock, $.001 par
value per share (the "Stock"), shall be subject to the Plan. The shares of Stock
subject to the Plan shall consist of unissued shares or previously issued shares
held by any Subsidiary or Affiliate of the Company, and such amount of shares of
Stock shall be and is hereby reserved for such purpose. Any of such shares of
Stock that may remain unsold and that are not subject to outstanding Options at
the termination of the Plan shall cease to be reserved for the purposes of the
Plan, but until termination of the Plan the Company shall at all times reserve a
sufficient number of shares of Stock to meet the requirements of the Plan.
Should any Option expire or be canceled prior to its exercise in full or should
the number of shares of Stock to be delivered upon the exercise in full of an
Option be reduced for any reason, the shares of Stock theretofore subject to
such Option may be subject to future Options under the Plan.

D-1

PROXY

FALCONSTOR SOFTWARE, INC.

Proxy for Annual Meeting of Stockholders
Solicited by the Board of Directors

The undersigned hereby appoints ReiJane Huai and James Weber, and
each of them, with full power of substitution to represent the undersigned and
to vote all of the shares of common stock of FalconStor Software, Inc.
("FalconStor") which the undersigned is entitled to vote at the Annual Meeting
of Stockholders of FalconStor to be held at FalconStor Software, Inc., 2
Huntington Quadrangle, Suite 2S01, Melville, New York 11747, on Friday, May 14,
2004, at 9:00 a.m., local time, and at any adjournment thereof, (1) as
hereinafter specified upon the proposals listed below and (2) in their
discretion, upon such other matters as may properly come before the meeting.

IMPORTANT: PLEASE DATE, SIGN AND MAIL PROMPTLY THIS PROXY IN THE
ENCLOSED RETURN ENVELOPE TO ASSURE THAT YOUR SHARES ARE REPRESENTED AT THE
MEETING. IF YOU ATTEND THE MEETING, YOU MAY VOTE IN PERSON SHOULD YOU WISH TO DO
SO EVEN THOUGH YOU HAVE ALREADY SENT IN YOUR PROXY.

1. To elect the following directors: (01) ReiJane Huai and (02)
Lawrence S. Dolin, to serve as directors until the 2007 Annual
Meeting of Stockholders of the Company and until successors have
been duly elected and qualified.

____________ FOR ALL NOMINEES __________ WITHHELD FROM ALL NOMINEES

_______________________________________________________________
FOR ALL NOMINEES EXCEPT AS NOTED ABOVE

2. To approve the 2004 Outside Directors Stock Option Plan.

FOR ___________ AGAINST ___________ ABSTAIN ___________

3. To approve an amendment to our 2000 Stock Option Plan.

FOR ___________ AGAINST ___________ ABSTAIN ___________

4. To ratify the appointment of KPMG LLP as the independent public
accountants of the Company for the fiscal year ending December 31,
2004.

FOR ___________ AGAINST ___________ ABSTAIN ___________

5. With discretionary authority, upon such other matters as may
properly come before the meeting. At this time, the persons making
this solicitation know of no other matters to be presented at the
meeting.

MARK HERE FOR ADDRESS CHANGE AND NOTE AT LEFT _____

MARK HERE IF YOU PLAN TO ATTEND THE MEETING ____

Please sign your name exactly as it appears on the stock certificate
representing your shares. If signing for estates, trusts or corporations, title
or capacity should be stated. If shares are held jointly, both should sign.

Signature: __________________ Date______________

FalconStor Software (FALC) DEF 14ADefinitive proxy