Edgar Filing: FALCONSTOR SOFTWARE INC

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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

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.
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(Name of Registrant as Specified in Charter)

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(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.

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FALCONSTOR SOFTWARE, INC.

April 3, 2007

To Our Stockholders:

We invite you to attend our annual stockholders' meeting on Tuesday, May
8, 2007 at our worldwide headquarters located at 2 Huntington Quadrangle, Suite
2S01, Melville, New York 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 you will be asked to elect two
directors, to approve an amendment to our incentive stock plan, to approve an
equity compensation plan for our outside directors, and to ratify the
appointment of our independent registered public accounting firm. 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 20, 2007
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 8, 2007
----------------

To Our Stockholders:

The 2007 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,
commencing at 9:00 a.m. (EDT) on Tuesday, May 8, 2007, 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;

2) To approve an amendment to the FalconStor Software, Inc., 2006
Incentive Stock Plan;

3) To approve the FalconStor Software, Inc., 2007 Outside Directors
Equity Compensation Plan;

4) To ratify the appointment of KPMG LLP as our independent registered
public accounting firm for fiscal 2007; and

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

At the Annual Meeting, the Company intends to nominate ReiJane Huai and
Lawrence Dolin for election to the Board of Directors. Mr. Huai is currently
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 20, 2007
as the record date for determination of stockholders entitled to vote at the
Annual Meeting or any adjournment thereof, and only record holders of common
stock at the close of business on that day will be entitled to vote. At the
record date, 49,173,142 shares of common stock were 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 3, 2007

FALCONSTOR SOFTWARE, INC.
2 HUNTINGTON QUADRANGLE
MELVILLE, NEW YORK 11747
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2007 PROXY STATEMENT

GENERAL INFORMATION

This proxy statement contains information related to the annual meeting of
stockholders of FalconStor Software, Inc., to be held on Tuesday, May 8, 2007,
beginning at 9:00 a.m. (EDT), at the Company's headquarters at 2 Huntington
Quadrangle, Suite 2S01, Melville, New York, 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;

2) To approve an amendment to the FalconStor Software, Inc., 2006
Incentive Stock Plan;

3) To approve the FalconStor Software, Inc., 2007 Outside Directors
Equity Compensation Plan;

4) To ratify the appointment of KPMG LLP as our independent registered
public accounting firm for fiscal 2007; and

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

WHO MAY VOTE; DATE OF MAILING

Stockholders of FalconStor Software, Inc., as recorded in our stock
register on March 20, 2007 (the "Record Date"), may vote at the meeting. As of
this date, we had 49,173,142 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. It is anticipated that this Proxy Statement will
be mailed to stockholders on or about April 5, 2007.

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 amendment to the FalconStor Software, Inc., 2006 Incentive Stock Plan, in
favor of the FalconStor Software, Inc., 2007 Outside Directors Equity
Compensation Plan, and in favor of the ratification of the appointment of KPMG
LLP as our independent registered public accounting firm.

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, Suite 2S01, 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 that 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 and the ratification of the
auditors.

ATTENDING IN PERSON

Only stockholders, their proxy holders, and our invited guests may attend
the meeting. For security purposes, all persons attending the meeting must bring
identification with photo. 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 to the meeting. For example, you could bring an account
statement showing that you owned FalconStor Software, Inc., shares as of March
20, 2007 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 20, 2007, 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 Named Executive Officers identified in the summary compensation
table, and (iv) all directors, nominees for director and Named 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) 10,481,760 21.3%
c/o FalconStor Software, Inc.
2 Huntington Quadrangle
Melville, NY 11747

Barry Rubenstein (4) 6,448,512 13.1%
68 Wheatley Road
Brookville, NY 11545

Irwin Lieber (5) 4,568,518 9.3%
80 Cuttermill Road Suite 311
Great Neck, NY 11021

Eli Oxenhorn (6) 2,725,406 5.5%
56 The Intervale
Roslyn Estates, NY 11576

Barry Fingerhut (7) 3,157,664 6.4%
767 Fifth Avenue, 45th Floor
New York, NY 10153

Seth Lieber (8) 3,031,174 6.2%
200 East 72 Street, PH N
New York, NY 10021

Jonathan Lieber (9) 2,964,052 6.0%
271 Hamilton Road
Chappaqua, NY 10514

Marilyn Rubenstein (10) 2,475,424 5.0%
c/o Barry Rubenstein
68 Wheatley Road
Brookville, NY 11545

Steven L. Bock (11) 42,221 *

Patrick B. Carney (12) 70,099 *

Lawrence S. Dolin (13) 139,999 *

Steven R. Fischer (14) 94,999 *

Alan W. Kaufman (15) 36,666 *

Wayne Lam (16) 615,180 1.2%

James Weber (17) 203,979 *

Bernard Wu (18) 459,370 *

All Directors, Nominees for Director
and Executive Officers as a Group (19)
(9 persons) 12,144,273 24.0%

*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, or upon the
lapse or the removal of all restrictions on shares of restricted stock.
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, March
20, 2007, of 49,173,142.

(3) Based upon information contained in a report on Schedule 13D filed March
1, 2007 by Mr. Huai and certain other information. Consists of (i)
10,440,760 shares of Common Stock held by Mr. Huai and (ii) 41,000 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) 1,301,103

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) 698,242 shares of common stock held by Woodland
Partners and (xi) 743,513 shares of common stock held by Woodland Venture.
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) 1,892,634 shares of Common Stock held by
Irwin Lieber, (ii) 7,900 shares of Common stock held by Mr. Lieber's
daughter, (iii) 484,051 shares of Common Stock held by Wheatley, (iv)
41,008 shares of Common Stock held by Wheatley Foreign, (v) 180,089 shares
of Common Stock held by Wheatley II, (vi) 1,370,015 shares of Common Stock
held by Wheatley III, (vii) 293,012 shares of Common Stock held by
Wheatley Foreign III, and (viii) 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 upon information contained in a report on Schedule 13G filed jointly
on January 24, 2007 by Eli Oxenhorn and the Eli Oxenhorn Family Limited
Partnership (the "EOFLP"). Consists of (i) 2,514,329 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) 211,077 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) 469,680 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, (vii) 299,809 shares of Common Stock held by
Wheatley Associates, and (viii) 20,000 shares held by a partnership in
which Mr. Fingerhut is a general partner. 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) 82,522 shares of Common Stock held by Seth
Lieber, (ii) 20,800 shares of Common Stock held by the Irwin Lieber 1996

Grandfather Trust (the "Grandfather Trust") for which Seth Lieber is a
co-trustee, (iii) 484,051 shares of Common Stock held by Wheatley, (iv)
41,008 shares of Common Stock held by Wheatley Foreign, (v) 180,089 shares
of Common Stock held by Wheatley II, (vi) 1,370,015 shares of Common Stock
held by Wheatley III, (vii) 293,012 shares of Common Stock held by
Wheatley Foreign III, (viii) 299,809 shares of Common Stock held by
Wheatley Associates and (ix) 259,868 shares of Common Stock held by
Applegreen. Mr. Lieber disclaims beneficial ownership of the securities
held by the Grandfather Trust, 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) 15,400 shares of Common Stock held by
Jonathan Lieber, (ii) 20,800 shares of Common Stock held by the
Grandfather Trust for which Jonathan Lieber is a co-trustee, (iii) 484,051
shares of Common Stock held by Wheatley, (iv) 41,008 shares of Common
Stock held by Wheatley Foreign, (v) 180,089 shares of Common Stock held by
Wheatley II, (vi) 1,370,015 shares of Common Stock held by Wheatley III,
(vii) 293,012 shares of Common Stock held by Wheatley Foreign III, (viii)
299,809 shares of Common Stock held by Wheatley Associates and (ix)
259,868 shares of Common Stock held by Applegreen Partners. Mr. Lieber
disclaims beneficial ownership of the securities held by the Grandfather
Trust, 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 1,401,103 shares of Common Stock held by Mrs.
Rubenstein's spouse, Barry Rubenstein.

(11) Based on information contained in a Form 3 and a Form 4 filed by Mr. Bock
and certain other information. Consists of 42,221 shares of Common Stock
issuable upon exercise of options that are currently exercisable or that
will be exercisable within 60 days of March 20, 2007.

(12) Based on information contained in a Form 3 and Forms 4 filed by Mr. Carney
and certain other information. Consists of (i) 100 shares held by Mr.
Carney and (ii) 69,999 shares of Common Stock issuable upon exercise of
options that are currently exercisable or that will be exercisable within
60 days of March 20, 2007.

(13) Based on information contained in Forms 4 filed by Mr. Dolin and certain
other information. Consists of (i) 40,000 shares held by Northern Union
Club and (ii) 99,999 shares of Common Stock issuable upon exercise of
options that are currently exercisable or that will be exercisable within
60 days of March 20, 2007. 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.

(14) Based on information contained in Forms 4 filed by Mr. Fischer and certain
other information. Consists of (i) 10,000 shares held by Mr. Fischer and
(ii) 84,999 shares of Common Stock issuable upon exercise of options that
are currently exercisable or that will be exercisable within 60 days of
March 20, 2007. 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.

(15) Based on information contained in a Form 3 and Forms 4 filed by Mr.
Kaufman and certain other information. Consists of 36,666 shares of Common
Stock issuable upon exercise of options that are currently exercisable or
that will be exercisable within 60 days of March 20, 2007.

(16) Based on information contained in Forms 4 filed by Mr. Lam and certain
other information. Consists of (i) 48,003 shares held by Mr. Lam, (ii)
1,234 shares of Common Stock held by Mr. Lam's spouse, and (iii) 565,943
shares of Common Stock issuable upon exercise of options that are
currently exercisable or that will be exercisable within 60 days of March
20, 2007.

(17) Based on information contained in a Form 3 and Forms 4 filed by Mr. Weber
and certain other information. Consists of 203,979 shares of Common Stock
issuable upon exercise of options that are currently exercisable or that
will be exercisable within 60 days of March 20, 2007.

(18) Based on information contained in a Form 3 and Forms 4 filed by Mr. Wu and
certain other information. Consists of (i) 202,836 shares held by Mr. Wu
and (ii) 256,534 shares of Common Stock issuable upon exercise of options
that are currently exercisable or that will be exercisable within 60 days
of March 20, 2007.

(19) Consists of (i) 10,783,933 shares held by all directors, nominees for
director and executive officers as a group and (ii) 1,360,340 shares of
Common Stock issuable upon exercise of options that are currently
exercisable or that will be exercisable within 60 days of March 20, 2007.

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 $100,000 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 stockholder
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 six directors, five of whom,
Messrs. Bock, Carney, Dolin, Fischer, and Kaufman are independent. Mr. Huai is a
non-independent management director who does not sit on any of our Board
committees.

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.
Currently, the number of members of the Board of Directors is six.

The Company's nominating procedures, including procedures for director
candidates proposed to be nominated by stockholders, 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. Each would be
elected for a full three-year term. It is proposed that Mr. Huai and Mr. Dolin
be elected to serve until the Annual Meeting of Stockholders to be held in 2010
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 2010 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 48 2001
Lawrence S. Dolin...................... Director Nominee 63 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. Mr. Huai has been a director of the Company since August, 2001.

LAWRENCE S. DOLIN has been Chairman, President and Chief Executive
Officer of Noteworthy Medical Systems, Inc. ("Noteworthy"), a provider of
computerized patient record software, since January 2000. 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 2008 and 2009 Annual
Meetings of Stockholders of the Company, who are currently serving their terms,
are set forth below:

Director
Name Position Age Since
---- -------- --- -----
Steven L. Bock ........................ Director 53 2005
Patrick B. Carney...................... Director 42 2003
Steven R. Fischer...................... Director 61 2001
Alan W. Kaufman........................ Director 68 2005

STEVEN L. BOCK has been CEO and President of Rotobrush International
LLC, a leading provider of air duct cleaning systems to a range of service
contractors, since October 2005. He is also a member of Rotobrush's
Supervisory Committee. Mr. Bock was Chairman of the Board and CEO of Unger
Software Corporation December from 2002 until January 2007. He was also the
President of Unger Software from October 2002 to October 2005. Prior to
joining Unger Software, Mr. Bock was a consultant to early-stage companies.
He served as a Director and Interim Chief Operating Officer of B2BVideo
Network from November 2001 to May 2002. From December 1990 through July
2000, Mr. Bock was Chairman, Chief Executive Officer and President of
Specialty Catalog Corp., a direct marketer targeting niche consumer product
categories through a variety of catalogs and E-commerce web sites. Prior to
joining Specialty Catalog, Mr. Bock was an officer at investment holding and
management firms and was a partner of a law firm. Mr. Bock holds a B.S. from

the State University of New York at Albany, and a J.D. from Harvard Law
School. Mr. Bock has been a Director of the Company since January 2005 and
his term as a director of the Company expires in 2009.

PATRICK B. CARNEY has been a Vice President of Melillo Consulting, Inc., a
solutions oriented systems integrator, since October, 2006, and a General
Manager since April 1, 2005. From November, 2004, through March, 2005, Mr.
Carney was an independent consultant to senior management and senior IT
executives. From October 2003, through October 2004, Mr. Carney was the Chief
Technology Officer for Barr Laboratories Inc., a specialty pharmaceutical
company. 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. 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 2009.

STEVEN R. FISCHER has been President of North Fork Business Capital, a
provider of asset based and structured finance loans of up to $150 million for
corporate mergers and acquisitions, recapitalizations, and for general working
capital purposes, since July 2004. From February 2004 until July 2004, he was a
consultant to financial institutions. From 1992 to February, 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 2008.

ALAN W. KAUFMAN has been a director of Appfluent Technologies since
October, 2002, and has been a member of the Advisory Board of GridApp Systems
since March, 2006. He was a director of NetIQ Corporation from August, 1997
until its merger with Attachment Corporation in August, 2006. Mr. Kaufman served
as a director of QueryObject Systems Corp. from October 1997 to March 2002. He
also served as QueryObject Systems' Chairman of the Board from May 1998 to
October 1999, and as President and Chief Executive Officer from October 1997 to
December 1998, when he retired. From December 1996 to October 1997, Mr. Kaufman
was an independent consultant. From April 1986 to December 1996, Mr. Kaufman
held various positions at Cheyenne Software, most recently as Executive Vice
President of Worldwide Sales. Mr. Kaufman was the founding president of, and
currently serves on the Board of Directors of, the New York Software Industry
Association. He is on the Advisory Board of the CUNY (City University of New
York) Institute for Software Design and Development. Mr. Kaufman holds a B.S. in
electrical engineering from Tufts University. Mr. Kaufman has been a director of
the Company since May, 2005, and his term as a director of the Company expires
in 2008.

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 sixteen occasions during the fiscal year
ended December 31, 2006. 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 currently has three committees: the Audit
Committee; the Compensation Committee; and the Nominating and Corporate
Governance Committee. Each of these committees has a charter. These charters
are available on the Company's website at
http://www.falconstor.com/en/company/?pg=Governance&sb=Committees.

AUDIT COMMITTEE

The Audit Committee consists of Messrs. Bock, Dolin, and Fischer (Chair).
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
qualifications and independence of the independent registered public accounting
firm engaged to audit the Company's consolidated financial statements, (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, as
amended. 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, 2006. All members of the Audit Committee attended at least 75% of the
meetings of the committee during the times they were members of the Audit
Committee.

The Company's Board of Directors has adopted, and annually reviews, an
Audit Committee Charter and Guidelines for Pre-Approval of Independent Auditor
Services.

COMPENSATION COMMITTEE

The Compensation Committee consists of Messrs. Carney, Dolin (Chair) and
Kaufman. The Compensation Committee is appointed by the Board (i) to discharge
the responsibilities of the Board relating to compensation of the Company's
executives, (ii) to produce the annual report that is required by the rules of
the Securities and Exchange Commission to be included in the Company's annual
proxy statement, and (iii) to administer, and to approve awards under, the
Company's equity-based compensation plans for employees. Under the Compensation
Committee Charter adopted in January 2005, 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 met eight times during the fiscal year ended
December 31, 2006. All members of the Compensation Committee attended at least
75% of the meetings of the committee during the times they were members of the
Compensation Committee. The Compensation Committee also took action by unanimous
written consent in lieu of a meeting seven times during the fiscal year ended
December 31, 2006.

NOMINATING AND CORPORATE GOVERNANCE COMMITTEE

The Nominating and Corporate Governance Committee consists of Messrs.
Bock, Carney (Chair), Fischer and Kaufman. 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 met two times during the
fiscal year ended December 31, 2006. All members of the Nominating and Corporate
Governance Committee attended at least 75% of the meetings of the committee
during the times they were members of the Nominating and Corporate Governance
Committee.

The Nominating and Corporate Governance Committee's charter is
available on the Company's website at
http://www.falconstor.com/en/company/?pg=governance&sb=committees.

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 Stockholders

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

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

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

2. The stockholder'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 stockholder revealing whether the proposed
nominee has assented to the submission of her/his name by the
stockholder.

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

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

The stockholder should submit the required information to:

Nominating and Corporate Governance Committee
c/o General Counsel
FalconStor Software, Inc.
2 Huntington Quadrangle
Suite 2S01
Melville, NY 11747

With a copy to:

Director Human Resources
FalconStor Software, Inc.
2 Huntington Quadrangle
Suite 2S01
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 stockholders 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 The highest level of personal and professional ethics, integrity and
values;

o An inquiring and independent mind;

o Practical wisdom and mature judgment;

o Expertise that is useful to the Company and complementary to the
background and experience of other Board members, so that an optimal
balance of Board members can be achieved and maintained;

o Willingness to devote the required time to carrying out the duties and
responsibilities of Board membership;

o Commitment to serve on the Board for several years to develop knowledge
about the Company's business;

o Willingness to represent the best interests of all stockholders and
objectively appraise management performance; and

o Involvement only in activities or interests that do not conflict with the
director's responsibilities to the Company and its stockholders.

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 stockholders.

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.

DIRECTOR COMPENSATION

Fees Earned or Option
Paid in Cash Awards
Name (1) (2) (3) Total
--------------------------- ------------- ------- -------
Steven L. Bock (4) $5,000 $38,300 $43,300

Patrick B. Carney (5) $5,000 $57,450 $62,450

Lawrence S. Dolin (6) $5,000 $57,450 $62,450

Steven R. Fischer (7) $5,000 $57,450 $62,450

Alan W. Kaufman (8) $5,000 $38,300 $43,300

(1) Fees were earned in 2006 and paid in 2007.

(2) All amounts represent options to purchase common stock which vest
one third on the first anniversary of the date of grant, and one
twenty-fourth of the remainder vests each month thereafter for
twenty four months.

(3) All options are valued at grant date fair value in accordance with
FAS 123(R), which was $3.83 on May 17, 2006.

(4) As of December 31, 2006, the option awards outstanding for Mr. Bock
total 60,000 shares.

(5) As of December 31, 2006, the option awards outstanding for Mr.
Carney total 100,000 shares.

(6) As of December 31, 2006, the option awards outstanding for Mr. Dolin
total 115,000 shares.

(7) As of December 31, 2006, the option awards outstanding for Mr.
Fischer total 100,000 shares.

(8) As of December 31, 2006, the option awards outstanding for Mr.
Kaufman total 60,000 shares

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 2004 Outside Directors Stock Option Plan (the "2004
Plan"), 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 of Stockholders 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. A director who served as
Chairperson of a committee of the Board of Directors for at least six months
during a fiscal year was entitled to receive an additional grant of options to
acquire 5,000 shares on the date of the next Annual Meeting of Stockholders.
One-third of the options vest on the first anniversary of the date of grant, and
one twenty-fourth of the remainder vests each month thereafter for twenty-four
months.

In May 2006, each of Messrs. Carney, Dolin and Fischer received options to
purchase 15,000 shares of Common Stock at an exercise price of $6.40 per share
and a grant date fair value price of $3.83 (in accordance with Statement of
Financial Accounting Standards 123(R)) as their annual grants under the 2004
Plan. Additionally, Messrs. Kaufman and Bock received options to purchase 10,000
shares of Common Stock at an exercise price of $6.40 per share and a grant date
fair value price of $3.83 (in accordance with FAS 123(R)) as their annual grants
under the 2004 Plan.

During the fourth quarter of 2006, the Company undertook a project that
required attention from the directors above and beyond their normal duties. In
recognition of the unusual demand on their time, the Company paid to each
director $1,000 for each of five meetings that each director participated in
during November and December 2006. These amounts were paid to the directors in
2007.

The 2004 Plan expired in March 2007. The Company is proposing a new
compensation structure for its outside directors going forward.

From 2001 through 2006, the Company's outside directors were compensated
for regular activities solely with options to purchase Company Common Stock.
Based on a review it recently conducted, the Company's Compensation Committee
believes it is appropriate to make a change in the types of compensation payable
to the outside directors.

The Compensation Committee has proposed that, for the year 2007 and going
forward, outside directors should receive a combination of cash, stock options
and restricted stock grants. For the year 2007, outside directors will receive
base cash fees in the amount of $26,500. The chairperson of the Audit Committee
will received an additional $10,000 per annum and the chairpersons of any other
Board committee will receive an additional $5,000 per annum. In addition,
outside directors will receive $3,000 per annum for each committee on which they
serve in a capacity other than chairperson. Cash director fees will be paid
quarterly in arrears. Because all directors are expected, absent unusual
circumstances, to attend all meetings of the Board and all meetings of the
committees on which they serve, outside directors will not receive any payment
based on attendance at meetings.

In addition to cash fees, it is proposed that, subject to stockholder
approval of Proposal No. 3, commencing with the 2007 Annual Meeting of
Stockholders, outside directors receive annual grants of 5,000 options to
purchase Company Common Stock and 5,000 shares of restricted Company Common

Stock. Both the options and the restricted stock will be granted on the date of
the Company's Annual Meeting of Stockholders and will vest 33% on the first
anniversary of grant, 33% on the second anniversary of grant, and 34% on the
third anniversary of grant, as long as the director has served the full period
between Annual Meetings of Stockholders. Further details of these equity grants
may be found under the heading "Proposal No. 3" of this Proxy Statement.

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, Suite 2S01
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/en/company/?pg=Governance.

Communications directed to the Board of Directors are screened by the
Company's Legal and/or Investor Relations departments. Routine 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.

ATTENDANCE AT ANNUAL MEETINGS

The Company's policy is that, except for unusual circumstances, all board
members should attend the Company's Annual Meetings of Stockholders. All board
members attended the Company's 2006 Annual Meeting of Stockholders.

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
---- -------- ---
Wayne Lam Vice President, Co-Founder 43
James Weber Chief Financial Officer, Treasurer and Vice 36
President
Bernard Wu Vice President, Business Development 49

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.

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 Chief Financial Officer,
Mr. Weber served as worldwide Corporate Controller of the Company and its
predecessor entity 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.

BERNARD WU has served as Vice President of Business Development of the
Company and its predecessor entity since November 2000. From 1998 to October
2000, Mr. Wu was Senior Vice President of sales and marketing for the Internet
Outsourcing Division of Trend Micro, a leading Internet security software
company. Mr. Wu had worldwide responsibility for defining, launching, and
managing OEM, service, and alliance partnerships with ISPs, ASPs,
telecommunication carriers, and other software companies for the purpose of
offering network-based security services. Prior to that, Mr. Wu had 15 years'
experience in various executive and managerial positions at companies such as
Intel, Seagate, Conner Peripherals, and Computer Associates/Cheyenne in areas
including product development, marketing, and OEM/channel sales of RAID,
optical, and tape-based storage management software and subsystems. In 1996 he
co-authored a patent in the area of SCSI enclosure management services which has
been widely adopted in the industry. Mr. Wu has a BS/MS in engineering from the
University of California at Berkeley and an MBA from University of California at
Los Angeles Anderson School of Management.

EXECUTIVE COMPENSATION

SUMMARY COMPENSATION TABLE. The following table sets forth, for the fiscal
year indicated, all compensation awarded to, paid to or earned by the Company's
principal executive officer, principal financial 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 year indicated.

SUMMARY COMPENSATION TABLE

Non-Equity
Incentive
Name and Stock Compensation
Principal Awards Plan
Position Year Salary (1) (2) Total
------------------ ------ ----------- ----------- ------------ -----------

ReiJane Huai... 2006 $275,000 -- $109,723 $384,723
Chairman and
Chief
Executive Officer
(Principal
Executive Officer)

James Weber.... 2006 $190,000 $137,600 $30,000 $357,600
Vice President and
Chief Financial
Officer
(Principal Financial
Officer)

Wayne Lam .... 2006 $190,000 $137,600 $25,000 $352,600
Vice President

Bernard Wu .... 2006 $190,000 $137,600 $30,000 $357,600
Vice President-
Business
Development

(1) The Company granted restricted stock awards on August 7, 2006. Messrs.
Lam, Weber, and Wu were each granted 20,000 restricted shares. The shares
were granted on a discretionary basis and are subject to a three-year
vesting period. Please refer to footnote 8 of the Company's 2006 annual
report filed on Form 10-K for further information relating to all
share-based awards.

(2) Messrs Weber, Lam and Wu earned cash bonuses for 2006 of $30,000, $25,000
and $30,000, respectively, under the incentive compensation program
established by the Compensation Committee of the Company's Board of
Directors on August 7, 2006. Mr. Huai's cash bonus for 2006 was awarded in
accordance with the criteria set forth in Mr. Huai's employment agreement,
dated November 7, 2005.

GRANTS OF PLAN-BASED AWARDS FOR 2006

The following table provides information related to grants of plan-based
awards granted to the Company's Named Executive Officers. The Company currently
does not have any plans providing for the grant of stock appreciation rights.

All Other
Stock Awards: Grant Date
Number of Fair Value of
Shares of Stock and
Grant Stock or Units Option Awards
Name Date (#) (1) ($/Share)
------------------------------------- --------- ---------------- ----------------

ReiJane Huai ........................ -- -- --
Chairman and Chief
Executive Officer
(Principal
Executive Officer)

James Weber ......................... 8/7/06 20,000 6.88
Vice President and
Chief Financial
Officer
(Principal
Financial Officer)

Wayne Lam ........................... 8/7/06 20,000 6.88
Vice President

Bernard Wu .......................... 8/7/06 20,000 6.88
Vice President -
Business Development

(1) Reflects restricted stock awards granted. The award vests ratably
33%, 33%, and 34% per year on each anniversary of the date of grant.

OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END 2006

The following table provides information related to the aggregate
outstanding equity awards which were granted to the Company's Named Executive
Officers as of December 31, 2006.

Option Awards Stock Awards
----------------------------------------------------------- ------------------------
Number of Number of Number Market
Securities Securities of Shares Value of
Underlying Underlying or Units Shares or
Unexercised Unexercised of Stock Units of
Options Options That Stock That
Have Not Have Not
(#) (#) Option Option Vested Vested
Exercise Expiration
Name Exercisable Unexercisable Price Date (#) ($)
--------------------------------------- ----------- ------------- -------- ---------- --------- -----------
ReiJane Huai .......................... -- -- -- -- -- --
Chairman and Chief
Executive Officer
(Principal Executive
Officer)

James Weber ........................... 54,139(1) -- $ 0.35 10/31/2010 -- --
Vice President and Chief
Financial Officer 5,000(2) -- $ 6.20 11/4/2011 -- --
(Principal Financial
Officer) 11,340(3) -- $ 5.07 5/6/2012 -- --

30,000(4) -- $ 4.04 11/10/2012 -- --

50,000(5) -- $ 5.33 5/14/2013 -- --

41,250(6) 83,750 $ 8.20 1/5/2015 -- --

-- -- -- -- 20,000(7) $173,000(8)

Wayne Lam ............................. 108,213(9) -- $ 0.35 4/30/2010 -- --
Vice President
50,530(1) -- $ 0.35 10/31/2010 -- --

75,000(3) -- $ 5.07 5/6/2012 -- --

150,000(4) -- $ 4.04 11/10/2012 -- --

100,000(10) -- $ 8.43 12/22/2013 -- --

56,100(6) 113,900 $ 8.20 1/5/2015 -- --

-- -- -- -- 20,000(7) $173,000(8)

Bernard Wu ............................ 20,100(3) -- $ 5.07 5/6/2012 -- --
Vice President-Business
Development 80,000(4) -- $ 4.04 11/10/2012 -- --

100,000(10) -- $ 8.43 12/22/2013 -- --

41,250(6) 83,750 $ 8.20 1/5/2015 -- --

24,750(11) 50,250 $ 6.80 11/6/2015 -- --

-- -- -- -- 20,000(7) $173,000(8)

(1) Award fully vested on October 31, 2003

(2) Award fully vested on November 4, 2004

(3) Award fully vested on May 6, 2005

(4) Award fully vested on November 10, 2005

(5) Award fully vested on May 14, 2006

(6) Award was granted on January 6, 2005. The award vests 33%, 33% and 34%
on each anniversary over a three year period

(7) Messrs. Lam, Weber, and Wu were each awarded 20,000 restricted stock units
on August 7, 2006, which vest 33%, 33% and 34% on each anniversary over a
three year period

(8) The closing price of the Company's stock on December 29, 2006 (last
trading day of 2006) was $8.65 per share

(9) Award fully vested on April 30, 2003

(10) Award fully vested on December 22, 2006

(11) Award was granted on November 7, 2005. The award vests 33%, 33% and 34% on
each anniversary over a three year period

SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

Based solely upon a review of Forms 3, 4, and 5, and amendments thereto
furnished to the Company during the fiscal year ended December 31, 2006, the
Company is not aware of any director, officer, or beneficial owner of more than
10 percent of any class of Company equities who failed to file on a timely basis
reports required by Section 16(a) of the Exchange Act, during the fiscal year
ended December 31, 2006.

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 Weighted Remaining Available
be Issued upon -Average for Future Issuance
Exercise of exercise Price Under Equity
Outstanding of Outstanding Compensation Plans
Options, Options, (Excluding
Warrants and Warrants and Securities Reflected
Rights (1) Rights (1) in Column (a)(1))

Plan Category (a) (b) (c)
------------- --- --- ---
Equity compensation
plans approved by
security holders ................ 10,835,975 $ 5.62 794,573

(1) As of December 31, 2006.

EMPLOYMENT AGREEMENTS

The Company has an employment agreement with ReiJane Huai, as discussed in
the Compensation Discussion and Analysis, below. The Company does not have an
employment agreement with any other Named Executive Officer.

SEVERANCE AND CHANGE IN CONTROL AGREEMENTS

SEVERANCE AGREEMENT

The Second Amended and Restated Employment Agreement between the Company
and Mr. Huai (the "Employment Agreement") provides for the payment of an amount
equal to Mr. Huai's base salary ($275,000) if the Company and Mr. Huai do not
enter into a new employment agreement for a term of at least two years, with an
effective date of January 1, 2008, on similar terms and conditions to the
Employment Agreement. The payment is to be made semi-monthly, in arrears, for
the calendar year 2008. No severance is due if: (1) Mr. Huai breached the
confidentiality, non-compete, or any other material provision of the employment
agreement; (2) Mr. Haui is terminated for cause (as defined in the Employment
Agreement); (3) the Company has offered a new agreement with a term of at least
two years, on similar terms and conditions, and Mr. Huai has declined to sign
the new agreement; or (4) Mr. Huai has received a change of control payment at
least equal to his base salary.

CHANGE IN CONTROL AGREEMENTS

The Company's 2005 Key Executive Severance Protection Plan (the "2005
Plan") provides for payments to certain officers and employees of the Company,
including all Named Executive Officers, in the event that there is a change in
control of the Company and the individual's employment is terminated within
twenty-four months of the change in control. These agreements were entered into
to ensure the continued service of the Named Executive Officers in the event of
a change in control.

For purposes of the 2005 Plan, a "Change in Control" is deemed to have
occurred if:

o more than fifty percent of the Company's voting securities, or the
power to vote more than fifty percent of the Company's voting
securities, is acquired;

o the members of the Company's board of directors cease to be a
majority of the board of directors following a merger;

o a merger, consolidation or reorganization (a) with or into the
Company, or (b) in which securities of the Company are issued;

o a complete liquidation or dissolution of the Company; or

o the sale or other disposition of all or substantially all of the
assets of the Company.

In the event a Change in Control occurs, and a Named Executive Officer is
terminated within two years of the Change in Control, the Named Executive
Officer is entitled to certain severance benefits ("Severance Benefits"). The
Named Executive Officer is not entitled to severance benefits if the Named
Executive Officer is terminated: (a) for cause; (b) by reason of permanent
disability; (c) voluntarily by the Named Executive Officer other than for
certain defined reasons; or (d) by death.

The Severance Benefits to which each of the Named Executive Officers would
be entitled are:

a. a payment equal to three times the Named Executive Officer's base
salary, on an annualized basis, at the time of the Change in Control
or, if greater, at any time after the Change in Control;

b. a payment equal to three times the highest annual bonus paid or
payable to the Named Executive Officer during the three years
preceding the Change in Control;

c. the continuation for three years for the Named Executive Officer and
his dependents and beneficiaries of basic life insurance, flexible
spending account, medical and dental benefits which were being
provided immediately prior to the Change in Control (or, if greater,
at any time thereafter); and

d1. replacement of all stock options granted by the Company, whether or
not vested, with an equal number of fully vested options to purchase
shares of the Company's common stock; or

d2. if the Company's board of directors approves at the time, the
surrender of all options, whether vested or not, in return for a
cash payment equal to the difference between the full exercise
price of each option surrendered and the greater of: (1) the
average price per share paid in connection with the acquisition
of control of the Company; (2) the price per share paid in
connection with any tender offer leading to control of the
Company; and (3) the mean between the high and the low selling
price of Company common stock on the relevant market on the date
on which the Named Executive Officer became entitled to receive
Severance Benefits.

In addition, each of the Named Executive Officers is entitled to: (1) at the
time any such tax is due, a lump sum payment equal to the amount of any income
tax payable by the Named Executive Officer and attributable to the benefits set
forth in (c); and (2) in the event that any of the Severance Benefits is subject
to an excise tax, a payment in an amount grossed up so that the net payment,
after taxes, is equal to the excise tax.

The following table sets forth the value of the severance benefits each
Named Executive Officer would be entitled to receive assuming that a Change in
Control and the entitlement to receive Severance Benefits occurred on December
31, 2006:

Severance Benefit Reijane Wayne James Bernard
Component Huai Lam Weber Wu
------------------------------------------ -------------------- ------------------ ------------------- -------------------

3 x Base Salary $ 825,000.00 $ 570,000.00 $ 570,000.00 $ 570,000.00

3 x Bonus $ 329,169.00 $ 75,000.00 $ 90,000.00 $ 90,000.00

3 x Value of Benefits (1), (2) $ 32,894.64 $ 32,894.64 $ 32,894.64 $ 38,700.36

Benefits Income Tax Gross-Up (2), (3) $ 13,767.00 $ 13,767.00 $ 13,767.00 $ 17,144.00

Excise Tax Gross-Up (2), (4) $ 486,384.00 $ 277,299.00 $ 318,785.00 $ 368,215.00

Stock Options -- Unvested and
Accelerated (5) -- $ 51,255.00 $ 37,688.00 $ 130,650.00

Total $ 1,687,214.64 $ 1,020,215.64 $ 1,063,134.64 $ 1,214,709.36

(1) Benefits include medical and dental benefits.

(2) Assumes that the Named Executive Officer receives three full years of
benefits.

(3) Assumes an effective federal income tax rate of 35% for all Named Executive
Officer, an effective 6.85% New York state tax rate for Messrs. Huai, Lam and
Weber, and an effective 9.3% California state tax rate for Mr. Wu.

(4) Assumes an effective federal income tax rate of 35% and an effective FICA
rate of 1.45% for all Named Executive Officer, an effective 6.85% New York state
tax rate for Messrs. Huai, Lam and Weber, and an effective 9.3% California state
tax rate for Mr. Wu.

(5) The value of unvested and accelerated stock options is the difference
between the exercise price of each option and $8.65, the closing price the
Company's common stock on the Nasdaq Global Market on December 29, 2006. If the
Company's Board of Directors is assumed to have approved the cashing out of
options on December 31, 2006, the value of unvested and accelerated options
would have been: Mr. Lam, $55,950; Mr. Weber, $41,875; and Mr. Wu, $137,350,
based on a mean value of the Company's common stock of $8.70 on December 29,
2007.

COMPENSATION DISCUSSION AND ANALYSIS

COMPENSATION OBJECTIVES

For all Named Executive Officers, compensation is intended to be
performance-based. Our Compensation Committee believes that compensation paid to
executive officers should be closely aligned with our performance on both a
short-term and long-term basis to create value for shareholders, and that such
compensation should assist us in attracting and retaining key executives
critical to our long-term success.

In establishing compensation for our Named Executive Officers, the
following are the Compensation Committee's objectives:

o Attract and retain individuals of superior ability and managerial
talent;

o Ensure officers' compensation is aligned with our corporate
strategies and business objectives, and the long-term interests of
our stockholders; and

o Enhance the officers' incentive to maximize stockholder value, as
well as promote retention of key people, by providing a portion of
total compensation for management in the form of direct ownership in
us through stock options and grants of restricted stock.

To achieve these objectives, our overall compensation program aims to pay
our Named Executive Officers competitively, consistent with our success and
their contribution to that success. To accomplish this we rely on programs that
provide compensation in the form of both cash and equity. Although our
Compensation Committee has not adopted any formal guidelines for allocating
total compensation between cash and equity, the Compensation Committee considers
the balance between providing short-term incentives and long-term parallel
investment with stockholders to align the interests of management with
stockholders.

We have not retained a compensation consultant to review our policies and
procedures with respect to executive compensation, although the Compensation
Committee may elect to retain such a consultant in the future if it determines
that so doing would be helpful in developing, implementing or maintaining
compensation plans.

The Compensation Committee conducts an annual review of the aggregate
level of our executive compensation, as well as the mix of elements used to
compensate our Named Executive Officers. In addition, the Compensation Committee
has historically taken into account input from other independent members of our
board of directors and, to the extent available, publicly available data
relating to the compensation practices and policies of other companies within
and outside our industry. The Compensation Committee compares our executive
compensation against the compensation paid by these peer companies. While such
comparisons may not always be appropriate as a stand-alone tool for setting
compensation due to the aspects of our business and objectives that may be
unique to us, we generally believe that gathering this information is an
important part of our compensation-related decision-making process.

Although generally we believe that executive base salaries should be
targeted taking into consideration the median of the range of salaries for
executives in similar positions at comparable companies, we recognize that, to
attract, retain and motivate key individuals, such as the Named Executive
Officers, the Compensation Committee may determine that it is in our best
interests to negotiate total compensation packages with our Named Executive
Officers that may deviate from the general principle of targeting total
compensation at the median level for the peer group. Actual pay for each Named
Executive Officer is determined around this structure, driven by the performance
of the Named Executive Officer over time, as well as our annual performance.

DETERMINATION OF COMPENSATION AWARDS

CHIEF EXECUTIVE OFFICER

The compensation of the Chief Executive Officer of the Company is
determined by the Compensation Committee. The Committee's determinations
regarding compensation are based on a number of factors including, in order of
importance:

o Consideration of the operating and financial performance of the
Company, primarily its operating income during the preceding fiscal
year, as compared with prior operating periods;

o Attainment of a level of compensation designed to retain a superior
executive in a highly competitive environment; and

o Consideration of the individual's overall contribution to the
Company.

In addition, due to Mr. Huai's substantial equity position in the Company, the
Compensation Committee has determined that it is appropriate to compensate Mr.
Huai in cash, rather than through equity grants.

Due to Mr. Huai's unique qualifications, and his position in the Company,
we have an employment agreement with Mr. Huai. We entered into a Second Amended
and Restated Employment with Mr. Huai dated as of November 7, 2005 (the
"Employment Agreement"), providing for the employment of Mr. Huai as 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

$275,000. The Employment Agreement further provides for the potential payment of
bonuses to Mr. Huai for the periods ending December 31, 2005, December 31, 2006,
and December 31, 2007. The Employment Agreement contains non-competition,
confidentiality and non-solicitation provisions that apply for twenty-four
months after cessation of employment. The Employment Agreement expires on
December 31, 2007.

OTHER NAMED EXECUTIVE OFFICERS

Compensation for the Named Executive Officers other than the Chief
Executive Officer is determined by the Compensation Committee based upon
consultation with the Chief Executive Officer, taking into account the same
factors considered in determining the Chief Executive Officer's compensation as
described above. Except as set forth below, 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 salaried compensation in
excess of $1 million per annum to any employee. Under the 2000 Plan, no
recipient of options may be granted more than the fifteen percent of the options
to shares of Common Stock in any calendar year. Therefore, compensation received
as a result of options granted under the 2000 Plan qualify as
"performance-based" for purposes of Section 162(m) of the Code. In addition,
under the 2006 Plan, no recipient of options may be granted options to purchase
more than fifteen percent of the shares of Common Stock in any calendar year
(and, if Proposal No. 2 is adopted, such limitation shall be no more than
300,000 shares of the Common Stock available to be granted in any calendar
year). Therefore, compensation received as a result of options granted under the
2006 Plan, qualify as "performance-based" for purposes of Section 162(m) of the
Code (the options exercised by the Named Executive Officers in fiscal 2006 were
granted under either the 2000 Plan or the 2006 Plan. The Named Executive
Officers other than Mr. Huai received grants of restricted shares under the 2006
Plan in 2006. No stock options were granted to these Named Executive Officers in
2006.

The Company applies a consistent approach to compensation for all
employees, including senior management. This approach is based on the belief
that the achievements of the Company result from the coordinated efforts of all
employees working toward common objectives.

ELEMENTS OF COMPENSATION

BASE SALARY

Base salaries for our executive officers are established based on the
scope of their responsibilities and individual experience, taking into account
competitive market compensation paid by companies in our industry. Base salaries
are reviewed annually, and adjusted from time to time to realign salaries with
market levels after taking into account individual responsibilities, performance
and experience. Base salaries are also adjusted annually to take into account
performance-based compensation.

PERFORMANCE-BASED COMPENSATION

We structure our annual incentive program to reward executive officers
based on our performance and the individual executive's contribution to that
performance. This allows executive officers to receive such compensation based
on the results that they helped us to achieve in the previous year.

Mr. Huai's performance-based compensation is determined based on a formula
found in the Employment Agreement, as follows:

The Employee shall be entitled to receive a cash bonus (i) for the period
from September 1, 2004 through December 31, 2005 (the "First Bonus
Period") in an amount equal to 2.50% of the Corporation's net operating
income for such period as determined by reference to the Corporation's
income statements, but without giving effect to (a) Statement of Financial
Accounting Standard 123R, or (b) such other extraordinary, non-recurring
and/or other unusual items as determined by the Compensation Committee of
the Company's Board of Directors and agreed by a majority of the
independent directors of the Company's Board of Directors (hereinafter
referred to as the "Operating Income") during the First Bonus Period, (ii)
for the fiscal year of the Corporation ending December 31, 2006 (the
"Second Bonus Period") in an amount equal to the product of (A) the
Applicable Percentage (as defined below) and (B) the Operating Income for
the Second Bonus Period and (iii) for the fiscal year of the Corporation
ending December 31, 2007 (the "Third Bonus Period") in an amount equal to
the product of (A) the Applicable Percentage and (B) the Operating Income
for the Third Bonus Period. Each bonus payable to the Employee shall be
paid within 75 days after the last day of the applicable Bonus Period. For
purposes hereof, "Applicable Percentage" shall mean (I) 1.50%, if the
percentage obtained by dividing (x) the Operating Income for the Second
Bonus Period or the Third Bonus Period, as the case may be, by (y) the
shareholders equity of the Corporation during the Second Bonus Period or
the Third Bonus Period, as the case may be, as determined by reference to
the annual audited balance sheet of the Corporation for the year ending as
of the end of such Bonus Period (hereinafter referred to as "Shareholders
Equity") is less than or equal to 5%, (II) 2.00%, if the percentage
obtained by dividing (x) the Operating Income for the Second Bonus Period
or the Third Bonus Period, as the case may be, by (y) the Shareholders
Equity is more than 5% but less than or equal to 10%, (III) 2.25%, if the
percentage obtained by dividing (x) the Operating Income for the Second
Bonus Period or the Third Bonus Period, as the case may be, by (y) the
Shareholders Equity is more than 10% but less than or equal to 15%, (IV)
2.50%, if the percentage obtained by dividing (x) the Operating Income for
the Second Bonus Period or the Third Bonus Period, as the case may be, by
(y) the Shareholders Equity is more than 15% but less than or equal to 20%
and (V) 3.00%, if the percentage obtained by dividing (x) the Operating
Income for the Second Bonus Period or the Third Bonus Period, as the case
may be, by (y) the Shareholders Equity is more than 20%.

In order to determine the formula, the Compensation Committee considered the
Company's anticipated operating income over the term of the Employment Agreement
and the appropriate level of bonus that would incentivize Mr. Huai to lead the
Company to meet or to beat the anticipated operating income. The Compensation
Committee also considered Mr. Huai's base salary and the total compensation
appropriate for someone in Mr. Huai's position with Mr. Huai's qualifications.

For 2006, the Compensation Committee determined that the $799,317 paid by
the Company in settlement of a litigation relating to our purchase of IP
Metrics, Inc., in 2002 should be excluded from net operating income. The
Compensation Committee determined that the fact that the settlement payment was
included in the Company's operating expenses for 2006 was simply a matter of
timing; the expense was actually related to events that occurred from 2002 to
2004. Therefore, the Compensation Committee decided that the exclusion of this
amount from Operating Income would yield an adjusted operating income that more
accurately reflected the Company's performance during 2006. In March, 2007, Mr.
Huai received a bonus in the amount of $109,723, calculated as set forth below,
in accordance with the terms of the Employment Agreement:

GAAP Operating Income ($ 4,706,339)

Excluded Items:

SFAS 123R Expense
$ 9,393,154
Litigation Settlement
$ 799,317
------------

Operating Income after excluded items
$ 5,486,132
Shareholders Equity
$ 55,043,247
------------
Operating Income/Shareholders Equity 9.97%

Applicable Percentage (per Employment Agreement) 2%

Bonus Amount (Applicable Percentage x Operating Income)
$ 109,723
============

Messrs. Lam, Weber and Wu are each eligible to receive quarterly cash
bonuses equal to a maximum of 35% of their respective annual salaries. The
quarterly amounts are determined by our Chief Executive Officer based on the
their individual performance and are approved by the Compensation Committee. The
Compensation Committee believes that the annual incentive program provides
incentives necessary to retain executive officers and to reward them for
short-term company performance.

From time to time, we will consider the payment of discretionary bonuses
to our executive officers on an annual basis after the close of each fiscal
year. Bonuses will be determined based, first, upon the level of achievement of
our strategic and operating goals and, second, upon the level of personal
achievement by participants. The achievement of our goals includes, among other
things, our performance as measured by the operating results of the Company and
the quality of our 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, other
individual contributions, the ability to manage and motivate employees and the
achievement of assigned projects. Despite achievement of personal goals, bonuses
might not be given based upon our performance. To date, we have not granted any
such discretionary bonuses.

DISCRETIONARY LONG-TERM EQUITY INCENTIVE AWARDS

The Compensation Committee is responsible for determining the individuals
who will be granted options and/or restricted shares, the number of options
and/or restricted shares each individual will receive, the option price per
share, and the terms of the options or restricted shares, including the exercise
period of each option, and the vesting period of each option and/or restricted
share. The number of stock options and/or restricted shares granted to each
executive officer is determined by the Compensation Committee based upon several
factors, including the executive officer's salary grade, performance and the
value of the stock options and/or restricted shares at the time of grant. We
grant options at the fair market value of the underlying stock on the date of
grant.

MEDICAL INSURANCE

We provide to each executive officer, and to the executive officer's
spouse and children, such medical and dental insurance as we may from time to
time make available to our other full-time employees. All officers and full-time
employees, regardless of position, receive medical and dental insurance on the
same terms.

LIFE AND DISABILITY INSURANCE

Prior to 2007, we provided long-term disability insurance to all of our
full-time employees. For 2007, we are providing both life insurance and long
term disability insurance. We provide each executive officer such disability
and/or life insurance as we in our sole discretion may from time to time make
available to our other full-time employees. All officers and full-time
employees, regardless of position, receive the life and long-term disability
insurance on the same terms.

SEVERANCE AND CHANGE IN CONTROL AGREEMENTS

The terms of our severance and change in control agreements are set out
earlier in this Proxy Statement.

We created the 2005 Key Executive Severance Protection Plan because we
wanted to insure the continuity of management if there was an actual or
potential change in control event. The 2005 Plan provides peace of mind for the
Named Executive Officers that their livelihoods will not be affected by the
actual or potential change in control. This means that they will not be
distracted by concerns for their own benefit during such an event. In addition,
the 2005 Plan helps to attract and to retain the Name Executive Officers.

2006 COMPENSATION COMMITTEE REPORT

The Compensation Committee has reviewed and discussed with management the
foregoing Compensation Discussion and Analysis section of the Company's 2007
Proxy Statement. Based on its review and discussions with management, the
Compensation Committee recommended to the Board of Directors that the
Compensation Discussion and Analysis be included in the Company's 2007 Proxy
Statement.

Compensation Committee:
-----------------------
Patrick B. Carney
Lawrence S. Dolin
Alan W. Kaufman

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 December 31,
2006.

COMPENSATION COMMITTEE INTERLOCK AND INSIDER PARTICIPATION. Messrs.
Patrick B. Carney, Lawrence S. Dolin, and Alan W. Kaufman served as members of
the Compensation Committee of the Board of Directors during the fiscal year
ended December 31, 2006. There were no relationships that require disclosure
under Item 407(e)(4) of Regulation S-K.

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.

PROPOSAL NO. 2

AMENDMENT TO THE

FALCONSTOR SOFTWARE, INC.,

2006 INCENTIVE STOCK PLAN

The Board of Directors proposes that the amendment to the FalconStor
Software, Inc., 2006 Incentive Stock Plan (the "2006 Plan") be approved.

The 2006 Plan is intended to assist the Company in securing and retaining
employees, officers, consultants and advisors (the "Participants") by allowing
them to participate in the ownership and growth of the Company through the grant
of incentive and nonqualified stock options and shares of restricted stock. The
granting of such options and restricted stock serves as partial consideration
for, and gives the Participants 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 2006 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, or to Participants with such
restrictions as determined by the Company.

The proposed amendment relates to the number of shares available to be
issued under the 2006 Plan upon the exercise of stock options or with such
restrictions as determined by the Company. It is proposed that the 2006 Plan be
amended so that if, on July 1st of any calendar year in which the Plan is in
effect (the "Calculation Date") the number of shares of Stock with respect to
which Options may be granted is less than five percent (5%) of the number of
outstanding shares of Stock, the number of shares of Stock available for
issuance under the Plan shall be increased so that the number equals five
percent (5%) of the shares of Stock outstanding on the Calculation Date, but in
no event shall the number of shares of Stock subject to the Plan in the
aggregate exceed twenty million shares, subject to adjustment as provided in the
2006 Plan. As of March 20, 2007, there were 693,250 options to purchase Common
Stock and 225,000 shares of restricted stock outstanding under the 2006 Plan.

The Board of Directors believes it is in the Company's and its
stockholders' best interests to approve the amendment to the 2006 Plan because
it would ensure that the Company is able to continue to grant options and to
grant restricted shares which facilitates the benefits of the additional
incentive inherent in the ownership of Common Stock by the Participants and
helps the Company retain the services of these Participants. The Board of
Directors also believes that because equity compensation is such a critical
component of the Company's compensation structure, it is important that the
Company have a sufficient number of shares available for issuance at all times
under the 2006 Plan. In addition, the proposed amendment would enable the
Company to avoid the time and the expense of seeking additional amendments to
approve increases of available shares under the 2006 Plan.

The proposed amendment to the 2006 Plan is attached as Exhibit A to this
Proxy Statement.

SUMMARY OF THE 2006 PLAN

The following summary of the 2006 Plan, assuming stockholder approval of
the above amendment, is qualified in its entirety by the specific language of
the 2006 Plan.

GENERAL. The 2006 Plan provides for the grant of incentive and
nonqualified stock options, and restricted stock, to employees, officers,
consultants and advisors of the Company.

SHARES SUBJECT TO PLAN. Initially, a maximum of 1,500,000 of the
authorized but unissued or treasury shares of the common stock of the Company
may be issued upon the grant of restricted shares or upon the exercise of
options granted under the 2006 Plan. Thereafter, if on July 1st of any calendar
year in which the Plan is in effect (the "Calculation Date") the number of
shares of Stock with respect to which Options may be granted is less than five
percent (5%) of the number of outstanding shares of Stock, the number of shares
of Stock available for issuance under the Plan shall be increased so that the
number equals five percent (5%) of the shares of Stock outstanding on the
Calculation Date, but in no event shall the number of shares of Stock subject to
the Plan in the aggregate exceed twenty million shares, subject to adjustment as
provided in the next paragraph.

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 2006 Plan and to outstanding restricted shares and
options. To the extent that (i) any outstanding restricted share or under the
2006 Plan expires or terminates prior to the termination of the restrictions on
restricted stock, (ii) any options expires prior to the exercise in full, or
(iii) 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 shall be returned to the 2006 Plan and again become
available for grant. No Participant may be granted, in total, options to
purchase more than 300,000 of the shares authorized under the plan in any year.

ADMINISTRATION. The 2006 Plan will be administered by a Committee,
consisting of two or more Non-Employee members of the Board of Directors
appointed by the Board of Directors. The Committee will approve option and
restricted share grants to employees, officers, consultants and advisors of the
Company, and will determine the terms of any restrictions on restricted shares,
subject to the provisions of the 2006 Plan. The Committee will also make any
other determinations necessary or advisable for the administration of the 2006
Plan. The determinations by the Committee will be final and conclusive.
Currently, the 2006 Plan is administered by the Compensation Committee.

ELIGIBILITY. Employees, officers, consultants and advisors of the Company
are eligible to participate in the 2006 Plan.

TERMS AND CONDITIONS OF OPTIONS. Each option granted under the 2006 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 2006 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 a

Participant 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 100% 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 Global 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 2006 Plan become exercisable at such time or
times and subject to such terms and conditions as shall be determined by the
Committee at the time of grant. The term of each option shall be determined by
the 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.

Upon a Change of Control of the Company, the Company will replace all
unexercised stock options with an equal number of unrestricted and fully vested
stock options to purchase shares of the Company's Common Stock. Alternatively,
upon a Change of Control, and subject to Board approval at the time, an optionee
may elect to surrender any unexercised options and to receive in return from the
Company a cash payment equal to the difference between the exercise price of
each option surrendered and the greater of (i) the average price per share paid
in connection with the acquisition of the Company, (ii) the price per share paid
in connection with any tender offer for shares of the Company's common stock
leading to control, and (iii) the mean between the high and the low selling
prices of such stock on the Nasdaq Global Market or other market on which the
Company's common stock is then traded on the date of the Change of Control.

Simultaneously with the granting of an option the Committee may also grant
dividend equivalent rights equal to the number of shares of common stock
underlying the option multiplied by the per-share cash dividend or per-share
market value of a non-cash dividend. This provision shall only apply to special
dividends of the Company.

makes payment to the Company in cash, or by check or other acceptable
instrument. Certificate(s) are issued in the grantee's name after acceptance of
the award by the grantee, but are not delivered to the Grantee until the shares
are free of any restrictions specified by the Committee at the time grant.

Shares of restricted stock are forfeitable until the terms of the
restricted stock grant have been satisfied. Shares of restricted stock are not
transferable until the date on which the Committee has specified such
restrictions have lapsed. Unless otherwise provided by the Committee at or after
grant, distributions in the form of dividends or otherwise of additional shares
or property in respect of shares of restricted stock shall be subject to the
same restrictions as such shares of restricted stock.

Upon the occurrence of a change in control of the Company, the Committee
may accelerate the vesting of outstanding restricted stock, in whole or in part,
as determined by the Committee, in its sole discretion.

Unless otherwise determined by the Committee at or after grant, in the
event the grantee ceases to be an employee or otherwise associated with the
Company for any other reason, all shares of restricted stock previously awarded
to him which are still subject to restrictions will be forfeited and the Company
will have the right to complete a blank stock power. The Committee may provide
(on or after grant) that restrictions or forfeiture conditions relating to
shares of restricted stock will be waived in whole or in part in the event of
termination resulting from specified causes, and the Committee may in other
cases waive in whole or in part restrictions or forfeiture conditions relating
to restricted stock.

TERMINATION OR AMENDMENT. Unless earlier terminated by the Board, the 2006
Plan will terminate on April 3, 2016. The 2006 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. In general, no taxable income for federal income
tax purposes will be recognized by an option holder upon receipt or exercise of
an incentive stock option, and the Company will not then be entitled to any tax
deduction. Assuming that the option holder does not dispose of the option shares
before the later of (i) two years after the date of grant or (ii) one year after
the exercise of the option, upon any such disposition, the option holder will
recognize capital gain equal to the difference between the sale price on
disposition and the exercise price.

If, however, the option holder disposes of his option shares prior to the
expiration of the required holding period, he will recognize ordinary income for
federal income tax purposes in the year of disposition equal to the lesser of
(i) the difference between the fair market value of the shares at the date of
exercise and the exercise price, or (ii) the difference between the sale price
upon disposition and the exercise price. Any additional gain on such
disqualifying disposition will be treated as capital gain. In addition, if such
a disqualifying disposition is made by the option holder, the Company will be
entitled to a deduction equal to the amount of ordinary income recognized by the
option holder provided that such amount constitutes an ordinary and reasonable
expense of ours.

NON-QUALIFIED STOCK OPTIONS. No taxable income will be recognized by an
option holder upon receipt of a nonqualified stock option, and the Company will
not be entitled to a tax deduction for such grant.

Upon the exercise of a nonqualified stock option, the option holder will
generally include in taxable income, for federal income tax purposes, the excess
in value on the date of exercise of the shares acquired pursuant to the
nonqualified stock option over the exercise price. Upon a subsequent sale of the
shares, the option holder will derive short-term or long-term gain or loss,
depending upon the option holder's holding period for the shares, commencing
upon the exercise of the option, and upon the subsequent appreciation or
depreciation in the value of the shares.

The Company generally will be entitled to a corresponding deduction at the
time that the participant is required to include the value of the shares in his
income.

RESTRICTED SHARES. Restricted stock may be granted under this Plan aside
from, or in association with, any other award. A participant shall have no
rights to an award of restricted stock unless and until the participant accepts
the award, and if the Committee shall deem it desirable, makes payments to the
Company of cash, or by check. After acceptance and the issuance of a stock
certificate, the participant shall have all the rights of a stockholder with
respect to the restricted stock.

The Company shall issue in the participant's name a certificate for the
shares of Common Stock associated with the award of restricted stock; however,
unless otherwise provided, the certificate shall not be delivered to the
participant until such shares are free of any restrictions specified by the
Committee at the time of grant. Shares of restricted stock are forfeitable until
the terms of the restricted stock grant have been satisfied, and shares of
restricted stock may not be transferred until all restrictions have lapsed. Upon
a Change of Control, the Committee may accelerate the vesting of outstanding
restricted stock, in its sole discretion.

DIVIDEND EQUIVALENTS. Assuming that the provisions relating to
nonqualified deferred compensation set forth in Section 409A of the Code are
inapplicable, no taxable income will be recognized by an option holder upon
receipt of a dividend equivalent right and the Company will not be entitled to a
tax deduction upon the grant of such right.

Upon the exercise of the stock option and receipt of cash or property with
respect to the dividend equivalent right, the option holder will include in
taxable income, for federal income tax purposes, the fair market value of the
cash and other property received with the respect to the dividend equivalent
right and the Company will generally be entitled to a corresponding tax
deduction.

As indicated above, the tax treatment of dividend equivalent rights is not
clear. The Act contains provisions applicable to nonqualified deferred
compensation plans, which, if certain conditions are not met, could result in
the immediate taxation of income and the imposition of interest and additional
tax.

AMENDED PLAN BENEFITS

The following table sets forth the stock option and stock awards outstanding
under the 2006 Plan as of the record date, March 20, 2007.

Name All Other Stock
Stock Option Awards Awards Outstanding:
Outstanding: Number Number of Shares of
of Shares or Options Stock or Units
(#) (#)
------------------------ -------------------- -------------------
ReiJane Huai -- --
Chairman and Chief
Executive Officer
(Principal Executive
Officer)

James Weber -- 20,000
Vice President and
Chief Financial Officer
(Principal Financial
Officer)

Wayne Lam -- 20,000
Vice President

Bernard Wu -- 20,000
Vice President -
Business Development

All Named Executive -- 60,000
Officers as a Group

Non-Executive -- --
Directors and Director
Nominees as Group (1)

Non-Executive Officer 693,250 165,000
Employees as a Group

(1) Does not include options to purchase 420,000 shares granted to
current non-employee Directors pursuant to the 1994 and 2004 Outside
Director Stock Option Plans.

RECOMMENDATION OF THE BOARD OF DIRECTORS

THE BOARD OF DIRECTORS RECOMMENDS A VOTE TO APPROVE THE AMENDMENT TO THE
FALCONSTOR SOFTWARE, INC., 2006 INCENTIVE STOCK PLAN.

PROPOSAL NO. 3

FALCONSTOR SOFTWARE, INC., 2007

OUTSIDE DIRECTORS EQUITY COMPENSATION PLAN

The Board of Directors proposes that the FalconStor Software, Inc.,
2007 Outside Directors Equity Compensation Plan (the "2007 Plan") be approved.

The 2007 Plan is intended to assist the Company in securing and retaining
qualified outside directors (the "Directors") by allowing them to participate in
the ownership and growth of the Company through the grant of incentive and
nonqualified stock options and shares of restricted stock. The granting of such
options and restricted stock serves as partial consideration for, and gives the
Directors 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 2007 Plan
upon the exercise of nonqualified stock options, or to Directors with such
restrictions as determined by the Company.

Beginning with the 2007 Annual Meeting of Stockholders, each Director will
receive an annual grant of 5,000 options to purchase Company Common Stock and
5,000 shares of restricted Company Common Stock. Both the options and the
restricted stock will be granted on the date of the Company's Annual Meeting of
Stockholders and will vest 33% on the first anniversary of grant, 33% on the
second anniversary of grant, and 34% on the third anniversary of grant, as long
as the director has served the full period between Annual Meetings of
Stockholders.

The Board of Directors believes it is in the Company's and its
stockholders' best interests to approve the 2007 Plan because it would allow the
Company to continue to grant options and to grant restricted shares which
facilitates the benefits of the additional incentive inherent in the ownership
of Common Stock by the Directors and helps the Company retain the services of
these Directors.

The proposed 2007 Plan is attached as Exhibit B to this Proxy Statement.

SUMMARY OF THE 2007 PLAN

The following summary of the 2007 Plan, assuming stockholder approval of
the 2007 Plan, is qualified in its entirety by the specific language of the 2007
Plan.

GENERAL. The 2007 Plan provides for the grant of nonqualified stock
options, and restricted stock, to outside 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 grant of restricted shares or upon the exercise of options granted
under the 2007 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 2007 Plan and to outstanding restricted shares and
options. To the extent that (i) any outstanding restricted share or under the

2007 Plan expires or terminates prior to the termination of the restrictions on
restricted stock, (ii) any options expires prior to the exercise in full, or
(iii) 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 shall be returned to the 2007 Plan and again become
available for grant. No Participant may be granted, in total, options to
purchase more than 15% of the shares authorized under the plan.

ADMINISTRATION. The 2007 Plan will be administered by the Board of
Directors. The Board will approve option and restricted share grants to
Directors and will determine the terms of any restrictions on restricted shares,
subject to the provisions of the 2007 Plan. The Board will also make any other
determinations necessary or advisable for the administration of the 2007 Plan.
The determinations by the Board will be final and conclusive.

ELIGIBILITY. Outside directors of the Company are eligible to participate
in the 2007 Plan.

TERMS AND CONDITIONS OF OPTIONS. Each option granted under the 2007 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 2007 Plan. The
purchase price of each share of Common Stock purchasable under a nonqualified
option shall not be less than 100% 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 Global 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 2007 Plan become exercisable at such time or
times and subject to such terms and conditions as shall be determined by the
Committee at the time of grant. The term of each option shall be determined by
the 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 2007 Plan provides
that, with the consent of the Committee, an optionee may transfer a nonqualified
option to: (i) an Immediate Family Member (as described in the 2007 Plan); (ii)
a trust for the exclusive benefit of the Director and/or one or more Immediate
Family Members; (iii) a partnership in which the Director and/or one or more
Immediate Family Members are the only partners; or (iv) such other person or
entity as the Board of Directors may permit.

may elect to surrender any unexercised options and to receive in return from the
Company a cash payment equal to the difference between the exercise price of
each option surrendered and the greater of (i) the average price per share paid
in connection with the acquisition of the Company, (ii) the price per share paid
in connection with any tender offer for shares of the Company's common stock
leading to control, and (iii) the mean between the high and the low selling
prices of such stock on the Nasdaq Global Market or other market on which the
Company's common stock is then traded on the date of the Change of Control.

TERMS AND CONDITIONS OF RESTRICTED STOCK. A grantee of restricted stock
has no right to an award of restricted stock until the grantee accepts the award
within the timeframe prescribed by the Committee and, if the Committee requires,
makes payment to the Company in cash, or by check or other acceptable
instrument. Certificate(s) are issued in the grantee's name after acceptance of
the award by the grantee, but are not delivered to the Grantee until the shares
are free of any restrictions specified by the Committee at the time grant.

TERMINATION OR AMENDMENT. Unless earlier terminated by the Board, the 2007
Plan will terminate on May 8, 2017. The 2007 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

The Company generally will be entitled to a corresponding deduction at the
time that the participant is required to include the value of the shares in his
income.

The Board believes it is in the Company's best interests to approve the
2007 Plan, which would allow the Company to continue to grant options, and to
grant restricted stock, to secure for the Company the benefits of the additional
incentive inherent in the ownership of shares of the Company's Common Stock by
outside directors and to help the Company secure and retain the services of
outside directors.

RECOMMENDATION OF THE BOARD OF DIRECTORS

THE BOARD OF DIRECTORS RECOMMENDS A VOTE TO APPROVE THE FALCONSTOR
SOFTWARE, INC., 2007 OUTSIDE DIRECTORS EQUITY COMPENSATION PLAN.

PROPOSAL NO. 4

INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The accounting firm of KPMG LLP has been selected as the independent
registered public accounting firm to audit the Company's consolidated financial
statements for the fiscal year ending December 31, 2007. 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 another independent registered
public accounting firm. A representative of KPMG LLP, which served as the
Company's independent registered public accounting firm for the fiscal year
ended December 31, 2006, 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 ACCOUNTANT FEES AND SERVICES

Fees for services rendered by KPMG LLP for the years 2006 and 2005 fell
into the following categories:

AUDIT FEES: Fees billed for professional services rendered by KPMG LLP for
the audit of the Company's consolidated financial statements as of and for the
fiscal years ended December 31, 2006 and 2005, and the reviews of the interim
condensed consolidated financial statements included in the Company's Form 10-Qs
during such fiscal years. These fees also include the audits of internal control
over financial reporting, required under Section 404 of the Sarbanes-Oxley Act
of 2002. The 2005 audit fees include $116,534 for additional audit fees related
to 2005, but billed and paid during 2006.

AUDIT RELATED FEES: Fees billed for professional services rendered by KPMG
LLP for audit related services, primarily including consents in connection with
registration statements filed by the Company.

TAX FEES: Fees billed for tax-related services rendered by KPMG LLP to the
Company.

ALL OTHER FEES: There were no other fees billed by KPMG LLP for the
years 2006 and 2005.

The approximate fees for each category were as follows:

Year Ended December 31,
---------------------------
Description 2006 2005
----------- ---- ----
Audit Fees $586,117 $680,634
Audit Related Fees $ 7,500 $ 7,000
Tax Fees $ 47,033 $ 55,250
All Other Fees -- --

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.

RECOMMENDATION OF THE BOARD OF DIRECTORS

THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR THE SELECTION OF THE INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM.

AUDIT COMMITTEE PRE-APPROVAL PROCEDURES. The Audit Committee has adopted
the following guidelines regarding the engagement of the Company's independent
registered public accounting firm to perform services for the Company:

For audit services (including statutory audit engagements as required
under local country laws), the independent registered public accounting firm
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 a meeting
of the Audit Committee.

The independent registered public accounting firm 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 registered public accounting firm to provide for the fiscal year.
Company management and the independent registered public accounting firm 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 registered public accounting firm 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 registered public accounting firm 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 registered public accounting firm fees against the budget for such
services and report at least annually to the Audit Committee.

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 KPMG LLP (the Company's independent
registered public accounting firm) and reviews the scope of their audit, report
and recommendations. The Audit Committee members reviewed and discussed the
audited consolidated financial statements as of and for the fiscal year ended
December 31, 2006 with management. The Audit Committee also discussed all
matters required to be discussed by Statement of Auditing Standards No. 61,
Communication With Audit Committees, as currently in effect, with KPMG LLP. The
Audit Committee received the written disclosures and the letter from KPMG LLP as
required by Independence Standards Board Standard No. 1 Independence Discussions
With Audit Committees, as currently in effect, 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
consolidated financial statements be included in the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 2006, to be filed with the SEC.

Audit Committee
---------------
Steven L. Bock
Lawrence S. Dolin
Steven R. Fischer

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 7, 2007.

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 2008 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 20,
2008 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 20, 2007 a copy of its Annual Report for the
fiscal year ended December 31, 2006. Such report contains the Company's audited
consolidated financial statements for the fiscal year ended December 31, 2006.

By Order of the Board of Directors,

/s/ Seth R. Horowitz
-----------------------------------
Seth R. Horowitz
Secretary

Dated: Melville, New York
April 3, 2007

THE COMPANY WILL FURNISH A FREE COPY OF ITS ANNUAL REPORT ON FORM 10-K FOR
THE FISCAL YEAR ENDED DECEMBER 31, 2006 (WITHOUT EXHIBITS) TO ALL OF ITS
STOCKHOLDERS OF RECORD AS OF MARCH 20, 2007 WHO WILL MAKE A WRITTEN REQUEST TO
MR. JAMES WEBER, CHIEF FINANCIAL OFFICER, FALCONSTOR SOFTWARE, INC., 2
HUNTINGTON QUADRANGLE, SUITE 2S01, MELVILLE, NEW YORK 11747.

EXHIBIT A

AMENDMENT TO THE

FALCONSTOR SOFTWARE, INC.

2006 INCENTIVE STOCK PLAN

Section Four of the 2006 Incentive Stock Plan is hereby amended to read in
its entirety as follows:

4. STOCK RESERVED FOR THE PLAN.

An initial total of 1,500,000 shares of the Company's Common Stock, par
value $0.001 per share (the "Stock"), shall be subject to the Plan. Subject to
adjustment as provided in Section 8 hereof, if on July 1st of any calendar year
in which the Plan is in effect (the "Calculation Date") the number of shares of
Stock with respect to which Options may be granted is less than five percent
(5%) of the number of outstanding shares of Stock, the number of shares of Stock
available for issuance under the Plan shall be increased so that the number
equals five percent (5%) of the shares of Stock outstanding on the Calculation
Date, but in no event shall the total number of shares of Stock subject to the
Plan in the aggregate exceed twenty million shares, subject to adjustment as
provided in Section 8 hereof. The maximum number of shares of Stock that may be
subject to Options granted under the Plan to any individual in any calendar year
shall not exceed three hundred thousand shares and the method of counting such
shares shall conform to any requirements applicable to performance-based
compensation under Section 162(m) of the Code, if qualification as
performance-based compensation under Section 162(m) of the Code is intended. The
shares of Stock subject to the Plan shall consist of unissued shares, treasury
shares or previously issued shares held by any Subsidiary 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 unissued 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 or share of Restricted Stock expire
or be canceled prior to its exercise or vesting in full or should the number of
shares of Stock to be delivered upon the exercise or vesting in full of an
Option or share of Restricted Stock be reduced for any reason, the shares of
Stock theretofore subject to such Option or share of Restricted Stock may be
subject to future Options or shares of Restricted Stock under the Plan, except
where such reissuance is inconsistent with the provisions of Section 162(m) of
the Code where qualification as performance-based compensation under Section
162(m) of the Code is intended.

A-1

EXHIBIT B

FALCONSTOR SOFTWARE, INC.

2007 OUTSIDE DIRECTORS EQUITY COMPENSATION PLAN

1. PURPOSE. The FalconStor Software, Inc. 2007 Outside Directors Equity
Compensation Plan (the "Plan") is established effective as of the 26th day
of March, 2007, (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 or be granted shares of restricted stock
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, to determine the number of shares
of restricted stock to be granted or the time at which such shares of
restricted stock are to be granted 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, of any options granted under the Plan (an "Option") or of any
restricted stock granted under the plan ("Restricted Stock" and together
with the Options, an "Award") 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 Award. 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 AWARDS. Awards 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". A person granted
Restricted Stock is hereinafter referred to as a "Grantee" (and together
with the Optionees, the "Directors"). Notwithstanding anything contained
herein, no Participant may take any action that is 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.

B-1

4. SHARES SUBJECT TO AWARDS. 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 be issued or
granted under the Plan shall be Three Hundred Thousand (300,000) shares.
Should any Option or share of Restricted Stock expire or be canceled prior
to its exercise or vesting in full or should the number of shares of Stock
to be delivered upon the exercise or vesting in full of an Option or share
of Restricted Stock be reduced for any reason, the shares of Stock
theretofore subject to such Option or share of Restricted Stock may be
subject to future Options or shares of Restricted Stock under the Plan.

5. 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 Five Thousand
(5,000) 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 5(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 the 2007 Annual Meeting of Stockholders, 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
5(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 lieu

B-2

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 5(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 Global Market or a securities exchange, the
fair market value per share of Stock shall be the closing price on
such Global Market 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 Global Market
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, provided the 1/3
Optionee's Service has not terminated
prior to such date:

B-3

Plus

(ii) For each full year of the Optionee's
continuous Service from the Initial
Vesting Date until the Vested Ratio
equals 1/1, an additional: 1/3

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 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 which have been owned by the holder
of the Option for more than 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. Notwithstanding any provision in this Plan, in
the event there IS a Change in Control (as defined below), the
Company -- shall, at no cost to the Participant, replace any and all
stock options granted by the Company and held by the Participant at
the time of the Change in Control, whether or not vested, with an
equal number of unrestricted and fully vested stock options to
purchase shares of the Company's Common Stock (the "Option
Replacement"). With respect to the Option Replacement, all options
will become fully vested. Alternatively, in the event of a Change in
Control, in lieu of the Option Replacement, a Participant may,
subject to Board approval at the time, prior to the consummation of

B-4

the Change in Control, elect to surrender the Participant's rights
to such options, and upon such surrender, the Company shall pay to
the Participant an amount in cash per stock option (whether vested
or unvested) then held, which is the difference between the full
exercise price of each option surrendered and the greater of (i) the
average price per share paid in connection with the acquisition of
control of the Company if such control was acquired by the payment
of cash or the then fair market value of the consideration paid for
such shares if such control was acquired for consideration other
than cash, (ii) the price per share paid in connection with any
tender offer for shares of the Company's Common Stock leading to
control, or (iii) the mean between the high and low selling price of
such stock on the Nasdaq Global Market or other market on which the
Company's Common Stock is then traded on the date of the Change in
Control.

For purposes of the Plan, a Change in Control shall be deemed to have
occurred if:

i. An acquisition (other than directly from the Company) of any voting
securities of the Company (the "Voting Securities") by any "Person"
(as the term "person" is used for purposes of Section 13(d) or 14(d)
of the Securities Exchange Act of 1934, as amended (the "Exchange
Act")), immediately after which such Person has "Beneficial
Ownership" (within the meaning of Rule 13d-3 promulgated under the
Exchange Act) of more than fifty percent (50%) of (1) the
then-outstanding shares of common stock of the Company (or any other
securities into which such shares of common stock are changed or for
which such shares of common stock are exchanged) (the "Shares") or
(2) the combined voting power of the Company's then-outstanding
Voting Securities; provided, however, that in determining whether a
Change in Control has occurred pursuant to this paragraph (i), the
acquisition of Shares or Voting Securities in a "Non-Control
Acquisition" (as hereinafter defined) shall not constitute a Change
in Control. A "Non-Control Acquisition" shall mean an acquisition by
(a) an employee benefit plan (or a trust forming a part thereof)
maintained by (A) the Company or (B) any corporation or other Person
the majority of the voting power, voting equity securities or equity
interest of which is owned, directly or indirectly, by the Company
(for purposes of this definition, a "Related Entity"), (b) the
Company or any Related Entity, or (c) any Person in connection with
a "Non-Control Transaction" (as hereinafter defined);

ii. The individuals who, as of the Effective Date, are members of the
board of directors of the Company (the "Incumbent Board"), cease for
any reason to constitute at least a majority of the members of the
board of directors of the Company or, following a Merger (as
hereinafter defined), the board of directors of (x) the corporation
resulting from such Merger (the "Surviving Corporation"), if fifty
percent (50%) or more of the combined voting power of the
then-outstanding voting securities of the Surviving Corporation is
not Beneficially Owned, directly or indirectly, by another Person (a
"Parent Corporation") or (y) if there is one or more than one Parent
Corporation, the ultimate Parent Corporation; provided, however,
that, if the election, or nomination for election by the Company's
common stockholders, of any new director was approved by a vote of
at least two-thirds of the Incumbent Board, such new director shall,
for purposes of the Plan, be considered a member of the Incumbent
Board; and provided, further, however, that no individual shall be
considered a member of the Incumbent Board if such individual

B-5

initially assumed office as a result of an actual or threatened
solicitation of proxies or consents by or on behalf of a Person
other than the board of directors of the Company (a "Proxy
Contest"), including by reason of any agreement intended to avoid or
settle any Proxy Contest; or

iii. The consummation of:

1. A merger, consolidation or reorganization (1) with or into the
Company or (2) in which securities of the Company are issued
(a "Merger"), unless such Merger is a "Non-Control
Transaction." A "Non-Control Transaction" shall mean a Merger
in which:

a. the stockholders of the Company immediately before such
Merger own directly or indirectly immediately following
such Merger at least fifty percent (50%) of the combined
voting power of the outstanding voting securities of (x)
the Surviving Corporation, if there is no Parent
Corporation or (y) if there is one or more than one
Parent Corporation, the ultimate Parent Corporation;

b. the individuals who were members of the Incumbent Board
immediately prior to the execution of the agreement
providing for such Merger constitute at least a majority
of the members of the board of directors of (x) the
Surviving Corporation, if there is no Parent
Corporation, or (y) if there is one or more than one
Parent Corporation, the ultimate Parent Corporation; and

c. (no Person other than (1) the Company, (2) any Related
Entity, or (3) any employee benefit plan (or any trust
forming a part thereof) that, immediately prior to the
Merger, was maintained by the Company or any Related
Entity, or (4) any Person who, immediately prior to the
Merger had Beneficial Ownership of twenty percent (20%)
or more of the then outstanding Shares or Voting
Securities, has Beneficial Ownership, directly or
indirectly, of twenty percent (20%) or more of the
combined voting power of the outstanding voting
securities or common stock of (x) the Surviving
Corporation, if fifty percent (50%) or more of the
combined voting power of the then outstanding voting
securities of the Surviving Corporation is not
Beneficially Owned, directly or indirectly by a Parent
Corporation, or (y) if there is one or more than one
Parent Corporation, the ultimate Parent Corporation;

2. A complete liquidation or dissolution of the Company; or

3. The sale or other disposition of all or substantially all of
the assets of the Company and its subsidiaries taken as a
whole to any Person (other than (x) a transfer to a Related
Entity, (y) a transfer under conditions that would constitute
a Non-Control Transaction, with the disposition of assets
being regarded as a Merger for this purpose or (z) the
distribution to the Company's stockholders of the stock of a
Related Entity or any other assets).

Notwithstanding the foregoing, a Change in Control shall not be deemed to
occur solely because any Person (the "Subject Person") acquired Beneficial
Ownership of more than the permitted amount of the then outstanding Shares

B-6

or Voting Securities as a result of the acquisition of Shares or Voting
Securities by the Company which, by reducing the number of Shares or
Voting Securities then outstanding, increases the proportional number of
shares Beneficially Owned by the Subject Persons; provided, that if a
Change in Control would occur (but for the operation of this sentence) as
a result of the acquisition of Shares or Voting Securities by the Company
and, after such share acquisition by the Company, the Subject Person
becomes the Beneficial Owner of any additional Shares or Voting Securities
and such Beneficial Ownership increases the percentage of the then
outstanding Shares or Voting Securities Beneficially Owned by the Subject
Person, then a Change in Control shall occur.

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

h. TRANSFERABILITY OF OPTIONS.

(i) Except as provided in paragraph 5(h)(ii), 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.

(ii) 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
5(h)(ii) "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 5(h)(i).

i. 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.

B-7

j. DIVIDEND EQUIVALENTS. Simultaneously with the grant of any Option
and under such terms and conditions as the Board deems appropriate
and subject to Section 10 herein, the Board may grant special
dividend equivalent rights ("Dividend Equivalents") which amount
shall be determined by multiplying the number of shares of Stock
subject to an Option by the per-share cash dividend, or the
per-share fair market value (as determined by the Board) of any
dividend in consideration other than cash, paid by the Company on
its Stock on a dividend payment date (other than the regular
quarterly cash dividends of the Company, if any). Unless otherwise
determined by the Board at grant, the Dividend Equivalents (i) shall
have the same vesting schedule, if any, as the Options to which the
Dividend Equivalents relate and (ii) shall be payable upon exercise
of the Options to which the Dividend Equivalents relate. At the
discretion of the Board, Dividend Equivalents shall be credited to
accounts on the Company's records for purposes of the Plan. Dividend
Equivalents may be accrued as a cash obligation, or may be converted
to shares of Stock for the Participant. The Board shall determine
whether any deferred Dividend Equivalents will accrue interest. The
Board may provide that an Optionee may use Dividend Equivalents to
pay the purchase price. Dividend Equivalents may be payable in cash
or shares of Stock or in a combination of the two, as determined by
the Board.

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

6. TERMS AND CONDITIONS OF RESTRICTED STOCK: Restricted Stock awarded
pursuant to the Plan shall be evidenced by written agreements specifying
the number of shares of Restricted Stock covered thereby, in substantially
the form attached hereto in Exhibit B (the "Restricted Stock Agreement").
Grants of Restricted Stock shall be subject to the following conditions
and shall contain such additional terms and conditions (including
provisions relating to the acceleration of vesting of Restricted Stock
upon a Change of Control), not inconsistent with the terms of the Plan, as
the Board shall deem desirable:

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

i. On the date of each Annual Meeting of Stockholders of the
Company occurring after the Effective Date, each Outside
Director shall be granted Five Thousand (5,000) shares of
Restricted 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 5(a)(i) above within six months prior to the
Annual Meeting of Stockholders, that Outside Director shall be
ineligible to receive any Restricted Stock with respect to
such Annual Meeting of Stockholders. Such Restricted Stock
shall have the same Vested Ratio as is provided under Section
5(b) hereto.

ii. Notwithstanding any other provision of the Plan to the
contrary, no Restricted Stock 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-8

b GRANTEE RIGHTS. A Grantee shall have no rights to an award of
Restricted Stock unless and until Grantee accepts the award within
the period prescribed by the Board. After acceptance and issuance of
a certificate or certificates, as provided for below, the Grantee
shall have the rights of a stockholder with respect to Restricted
Stock subject to the non-transferability and forfeiture restrictions
described in Section 6(e) below.

c ISSUANCE OF CERTIFICATES. The Company shall issue, in the Grantee's
name, a certificate or certificates for the shares of Restricted
Stock associated with the award promptly after the Grantee accepts
such award.

d DELIVERY OF CERTIFICATES. Unless otherwise provided, any certificate
or certificates issued evidencing shares of Restricted Stock shall
not be delivered to the Grantee until such shares are free of any
restrictions specified by the Board at the time of grant.

e FORFEITABILITY, NON-TRANSFERABILITY OF RESTRICTED STOCK. Shares of
Restricted Stock are forfeitable until the terms of the Restricted
Stock grant have been satisfied. Shares of Restricted Stock are not
transferable until the date on which the Board has specified such
restrictions have lapsed. Unless otherwise provided by the Board at
or after grant, distributions in the form of dividends or otherwise
of additional shares or property in respect of shares of Restricted
Stock shall be subject to the same restrictions as such shares of
Restricted Stock.

f TRANSFER OF CONTROL. Upon the occurrence of a Change of Control as
defined in Section 5(f), the Board may accelerate the vesting of
outstanding Restricted Stock, in whole or in part, as determined by
the Board, in its sole discretion.

g TERMINATION OF GRANTEE. In the event the Grantee ceases to be an
Outside Director or otherwise associated with the Company for any
other reason, all shares of Restricted Stock theretofore awarded to
him which are still subject to restrictions shall be forfeited and
the Company shall have the right to complete a blank stock power.
The Board may provide (on or after grant) that restrictions or
forfeiture conditions relating to shares of Restricted Stock will be
waived in whole or in part in the event of termination resulting
from specified causes, and the Board may in other cases waive in
whole or in part restrictions or forfeiture conditions relating to
Restricted Stock.

7. AUTHORITY TO VARY TERMS. The Board shall have the authority from time to
time to vary the terms of the Option and Restricted Stock Agreements
either in connection with the grant of an individual Option or Restricted
Stock or in connection with the authorization of a new standard form or
forms of Awards; 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 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 Participant on exercise of an
Option in the event such Participant's service as director of the Company
is terminated for any reason.

B-9

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 or shares of Restricted Stock 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. 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 Participant. It is the intention of the Board that the Plan
comply strictly with the provisions of Section 409A of the Code and
Treasury Regulations and other Internal Revenue Service guidance
promulgated thereunder (the "Section 409A Rules") and the Board shall
exercise its discretion in granting awards hereunder (and the terms of
such awards), accordingly. The Plan and any grant of an award hereunder
may be amended from time to time (without, in the case of an award, the
consent of the Participant) as may be necessary or appropriate to comply
with the Section 409A Rules.

10. TAXES.

a. The Company may make such provisions as it may deem appropriate,
consistent with applicable law, in connection with any Options or
Restricted Stock granted under the Plan with respect to the
withholding of any taxes (including income or employment taxes) or
any other tax matters.

b. If any Grantee, in connection with the acquisition of Restricted
Stock, makes the election permitted under Section 83(b) of the Code
(that is, an election to include in gross income in the year of
transfer the amounts specified in Section 83(b)), such Grantee shall
notify the Company of the election with the Internal Revenue Service
pursuant to regulations issued under the authority of Code Section
83(b).

11. GOVERNMENT REGULATIONS. The Plan, and the grant and exercise of Options or
Restricted Stock hereunder, and the obligation of the Company to sell and
deliver shares under such Options and Restricted Stock shall be subject to
all applicable laws, rules and regulations, and to such approvals by any
governmental agencies, national securities exchanges and interdealer
quotation systems as may be required.

12. GENERAL PROVISIONS.

a. CERTIFICATES. All certificates for shares of Stock delivered under
the Plan shall be subject to such stop transfer orders and other
restrictions as the Board may deem advisable under the rules,
regulations and other requirements of the Securities and Exchange

B-10

Commission, or other securities commission having jurisdiction, any
applicable Federal or state securities law, any stock exchange or
interdealer quotation system upon which the Stock is then listed or
traded and the Board may cause a legend or legends to be placed on
any such certificates to make appropriate reference to such
restrictions.

b. EMPLOYMENT MATTERS. Neither the adoption of the Plan nor any grant
or award under the Plan shall confer upon any Participant who is a
director, continued service as a director, with the Company or a
Subsidiary, as the case may be, nor shall it interfere in any way
with the right of the Company or any Subsidiary to terminate the
service of any of its directors at any time.

c. LIMITATION OF LIABILITY. No member of the Board, or any officer or
employee of the Company acting on behalf of the Board, shall be
personally liable for any action, determination or interpretation
taken or made in good faith with respect to the Plan, and all
members of the Board and each and any officer or employee of the
Company acting on their behalf shall, to the extent permitted by
law, be fully indemnified and protected by the Company in respect of
any such action, determination or interpretation.

d. REGISTRATION OF STOCK. Notwithstanding any other provision in the
Plan, no Option may be exercised unless and until the Stock to be
issued upon the exercise thereof has been registered under the
Securities Act of 1933, as amended, and applicable state securities
laws, or are, in the opinion of counsel to the Company, exempt from
such registration in the United States. The Company shall not be
under any obligation to register under applicable federal or state
securities laws any Stock to be issued upon the exercise of an
Option granted hereunder in order to permit the exercise of an
Option and the issuance and sale of the Stock subject to such
Option, although the Company may in its sole discretion register
such Stock at such time as the Company shall determine. If the
Company chooses to comply with such an exemption from registration,
the Stock issued under the Plan may, at the direction of the
Committee, bear an appropriate restrictive legend restricting the
transfer or pledge of the Stock represented thereby, and the Board
may also give appropriate stop transfer instructions with respect to
such Stock to the Company's transfer agent.

13. GOVERNING LAW. The validity, construction, and effect of the Plan and any
rules and regulations relating to the Plan shall be determined in
accordance with the internal laws of the State of Delaware, without giving
effect to principles of conflicts of laws, and applicable federal law.

B-11

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, on Tuesday, May 8, 2007, 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 2010 Annual Meeting of Stockholders
of the Company and until successors have been duly elected and qualified.

01 - ReiJane Huai

FOR WITHHOLD
----------- -----------

02 - Lawrence S. Dolin

FOR WITHHOLD
----------- -----------

2. To approve an amendment to the FalconStor Software, Inc., 2006 Incentive
Stock Plan.

FOR AGAINST ABSTAIN
----------- ----------- -----------

3. To approve the FalconStor Software, Inc., 2007 Outside Director Equity
Compensation Plan.

FOR AGAINST ABSTAIN
----------- ----------- -----------

4. To ratify the appointment of KPMG LLP as the independent registered public
accounting firm of the Company for the fiscal year ending December 31,
2007.

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 THIS BOX WITH AN X IF YOU HAVE MADE CHANGES TO YOUR NAME OR ADDRESS
DETAILS ABOVE
-----

MARK THIS BOX WITH AN X 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
------------------ --------------