A counter should be named the same as the environment.
\newcounter{exercise}
\newenvironment{exercise}[1]%
{\refstepcounter{exercise}\vspace{10pt}\par\noindent
\textbf{Exercise \theexercise\ (#1)}
\begin{itshape}\par\noindent\vspace{10pt}}%
{\end{itshape}\vspace{10pt}\par}
Example of use
Exercise~\ref{ex:simple} is a simple exercise.
\begin{exercise}{Simple Exercise}%
\label{ex:simple}%
This is a simple exercise.
\end{exercise}
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