-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, IY5sjg8sNprl4r6U/ATEl/FPa9SSteuRJ74xRigtqfeJffEn7lxWzG4h3RVBOiik iOnkCeoMEoof/dsVXDecHA== 0000316709-02-000042.txt : 20021112 0000316709-02-000042.hdr.sgml : 20021111 20021112141216 ACCESSION NUMBER: 0000316709-02-000042 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 20020930 FILED AS OF DATE: 20021112 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SCHWAB CHARLES CORP CENTRAL INDEX KEY: 0000316709 STANDARD INDUSTRIAL CLASSIFICATION: SECURITY BROKERS, DEALERS & FLOTATION COMPANIES [6211] IRS NUMBER: 943025021 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-09700 FILM NUMBER: 02816613 BUSINESS ADDRESS: STREET 1: 120 KEARNY STREET CITY: SAN FRANCISCO STATE: CA ZIP: 94104 BUSINESS PHONE: 4156277000 MAIL ADDRESS: STREET 1: 101 MONTGOMERY ST STREET 2: (SF120KNY-9) CITY: SAN FRANCISCO STATE: CA ZIP: 94104 10-Q 1 body.txt BODY, 10-Q, SEPTEMBER 30, 2002 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2002 Commission file number 1-9700 THE CHARLES SCHWAB CORPORATION (Exact name of Registrant as specified in its charter) Delaware 94-3025021 (State or other jurisdiction (I.R.S. Employer Identification No.) of incorporation or organization) 120 Kearny Street, San Francisco, CA 94108 (Address of principal executive offices and zip code) Registrant's telephone number, including area code: (415) 627-7000 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No --- --- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. 1,343,647,397 shares of $.01 par value Common Stock Outstanding on October 31, 2002 THE CHARLES SCHWAB CORPORATION Quarterly Report on Form 10-Q For the Quarter Ended September 30, 2002 Index Page ---- Part I - Financial Information Item 1. Condensed Consolidated Financial Statements: Statement of Income 1 Balance Sheet 2 Statement of Cash Flows 3 Notes 4 - 10 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11 - 27 Item 3. Quantitative and Qualitative Disclosures About Market Risk 27 - 29 Item 4. Controls and Procedures 29 Part II - Other Information Item 1. Legal Proceedings 29 - 30 Item 2. Changes in Securities and Use of Proceeds 30 Item 3. Defaults Upon Senior Securities 30 Item 4. Submission of Matters to a Vote of Security Holders 30 Item 5. Other Information 31 Item 6. Exhibits and Reports on Form 8-K 31 Signature 32 Certifications 33 - 35
Part I - FINANCIAL INFORMATION Item 1. Condensed Consolidated Financial Statements THE CHARLES SCHWAB CORPORATION Condensed Consolidated Statement of Income (In millions, except per share amounts) (Unaudited) Three Months Ended Nine Months Ended September 30, September 30, 2002 2001 2002 2001 ----------------------------------------------------------------------------------------------------------------------------------- Revenues Asset management and administration fees $ 434 $ 420 $1,325 $1,239 Commissions 309 276 906 1,025 Interest revenue 295 431 920 1,509 Interest expense (86) (201) (272) (790) ------- ------- ------- ------- Net interest revenue 209 230 648 719 Principal transactions 47 42 147 192 Other 32 55 113 119 ----------------------------------------------------------------------------------------------------------------------------------- Total 1,031 1,023 3,139 3,294 ----------------------------------------------------------------------------------------------------------------------------------- Expenses Excluding Interest Compensation and benefits 472 461 1,413 1,433 Other compensation - merger retention programs 14 22 44 Occupancy and equipment 113 127 349 372 Communications 63 79 200 264 Depreciation and amortization 79 85 243 252 Advertising and market development 51 41 156 185 Professional services 42 38 138 144 Commissions, clearance and floor brokerage 20 20 55 71 Goodwill amortization 17 49 Restructuring and other charges 160 99 190 244 Other 36 16 92 72 ----------------------------------------------------------------------------------------------------------------------------------- Total 1,036 997 2,858 3,130 ----------------------------------------------------------------------------------------------------------------------------------- Income (loss) before taxes on income (loss) and extraordinary gain (5) 26 281 164 Tax expense (benefit) on income (loss) (1) 13 105 73 ----------------------------------------------------------------------------------------------------------------------------------- Income (loss) before extraordinary gain (4) 13 176 91 Extraordinary gain on sale of corporate trust business, net of tax 12 121 ----------------------------------------------------------------------------------------------------------------------------------- Net Income (Loss) $ (4) $ 13 $ 188 $ 212 =================================================================================================================================== Weighted-Average Common Shares Outstanding - Diluted 1,358 1,395 1,382 1,403 =================================================================================================================================== Earnings Per Share - Basic Income (loss) before extraordinary gain $ .00 $ .01 $ .13 $ .07 Extraordinary gain, net of tax $ .01 $ .08 Net income (loss) $ .00 $ .01 $ .14 $ .15 Earnings Per Share - Diluted Income (loss) before extraordinary gain $ .00 $ .01 $ .13 $ .07 Extraordinary gain, net of tax $ .01 $ .08 Net income (loss) $ .00 $ .01 $ .14 $ .15 =================================================================================================================================== Dividends Declared Per Common Share $.0110 $.0110 $.0330 $.0330 =================================================================================================================================== See Notes to Condensed Consolidated Financial Statements. - 1 -
THE CHARLES SCHWAB CORPORATION Condensed Consolidated Balance Sheet (In millions, except share and per share amounts) (Unaudited) September 30, December 31, 2002 2001 - ------------------------------------------------------------------------------------------------------------------------------------ Assets Cash and cash equivalents $ 2,502 $ 4,407 Cash and investments segregated and on deposit for federal or other regulatory purposes(1) (including resale agreements of $15,163 in 2002 and $14,811 in 2001) 19,216 17,741 Securities owned - at market value (including securities pledged of $406 in 2002 and $185 in 2001) 1,883 1,700 Receivables from brokers, dealers and clearing organizations 197 446 Receivables from brokerage clients - net 7,051 9,620 Loans to banking clients - net 4,334 4,046 Equipment, office facilities and property - net 917 1,058 Goodwill - net 627 628 Other assets 841 818 - ------------------------------------------------------------------------------------------------------------------------------------ Total $ 37,568 $ 40,464 ==================================================================================================================================== Liabilities and Stockholders' Equity Deposits from banking clients $ 4,700 $ 5,448 Drafts payable 218 396 Payables to brokers, dealers and clearing organizations 1,101 833 Payables to brokerage clients 24,776 26,989 Accrued expenses and other liabilities 1,218 1,327 Short-term borrowings 760 578 Long-term debt 652 730 - ------------------------------------------------------------------------------------------------------------------------------------ Total liabilities 33,425 36,301 - ------------------------------------------------------------------------------------------------------------------------------------ Stockholders' equity: Preferred stock - 9,940,000 shares authorized; $.01 par value per share; none issued Common stock - 3 billion shares authorized; $.01 par value per share; 1,391,990,776 and 1,391,673,494 shares issued in 2002 and 2001, respectively 14 14 Additional paid-in capital 1,737 1,726 Retained earnings 2,882 2,794 Treasury stock - 41,531,809 and 23,110,972 shares in 2002 and 2001, respectively, at cost (431) (295) Unamortized stock-based compensation (37) (39) Accumulated other comprehensive loss (22) (37) - ------------------------------------------------------------------------------------------------------------------------------------ Total stockholders' equity 4,143 4,163 - ------------------------------------------------------------------------------------------------------------------------------------ Total $ 37,568 $ 40,464 ==================================================================================================================================== (1) Amounts included represent actual balances on deposit, whereas cash and investments required to be segregated for federal or other regulatory purposes were $19,151 million and $18,261 million at September 30, 2002 and December 31, 2001, respectively. On October 2, 2002, the Company deposited an additional $309 million into its segregated cash portfolio. As of January 3, 2002, the Company had deposited $710 million to meet its segregated cash requirement. See Notes to Condensed Consolidated Financial Statements. - 2 -
THE CHARLES SCHWAB CORPORATION Condensed Consolidated Statement of Cash Flows (In millions) (Unaudited) Nine Months Ended September 30, 2002 2001 - ------------------------------------------------------------------------------------------------------------------------------------ Cash Flows from Operating Activities Net income $ 188 $ 212 Adjustments to reconcile net income to net cash used for operating activities: Depreciation and amortization 243 252 Goodwill amortization 49 Compensation payable in common stock 19 25 Deferred income taxes 44 (25) Tax benefits from stock options exercised and other stock-based compensation 3 27 Non-cash restructuring and other charges 17 49 Net gain on sale of an investment (26) Extraordinary gain on sale of corporate trust business, net of tax (12) (121) Other (4) 7 Net change in: Cash and investments segregated and on deposit for federal or other regulatory purposes (1,531) (6,231) Securities owned (excluding securities available for sale) 42 36 Receivables from brokers, dealers and clearing organizations 245 7 Receivables from brokerage clients 2,540 7,000 Other assets (61) (11) Drafts payable (177) (264) Payables to brokers, dealers and clearing organizations 269 (263) Payables to brokerage clients (2,134) (1,314) Accrued expenses and other liabilities (69) (162) - ------------------------------------------------------------------------------------------------------------------------------------ Net cash used for operating activities (378) (753) - ------------------------------------------------------------------------------------------------------------------------------------ Cash Flows from Investing Activities Purchases of securities available for sale (1,085) (871) Proceeds from sales of securities available for sale 578 399 Proceeds from maturities, calls and mandatory redemptions of securities available for sale 275 377 Net increase in loans to banking clients (483) (657) Proceeds from sale of banking client loans 196 Purchase of equipment, office facilities and property - net (114) (266) Cash payments for business combinations and investments, net of cash received (24) Proceeds from sales of investments 49 Proceeds from sale of Canadian operations 26 Proceeds from sale of corporate trust business 273 - ------------------------------------------------------------------------------------------------------------------------------------ Net cash used for investing activities (607) (720) - ------------------------------------------------------------------------------------------------------------------------------------ Cash Flows from Financing Activities Net change in deposits from banking clients (748) 64 Net increase in short-term borrowings 182 668 Proceeds from long-term debt 100 Repayment of long-term debt (203) (35) Dividends paid (45) (46) Purchase of treasury stock (230) (315) Proceeds from stock options exercised 23 21 - ------------------------------------------------------------------------------------------------------------------------------------ Net cash provided by (used for) financing activities (921) 357 - ------------------------------------------------------------------------------------------------------------------------------------ Effect of exchange rate changes on cash and cash equivalents 1 1 - ------------------------------------------------------------------------------------------------------------------------------------ Decrease in Cash and Cash Equivalents (1,905) (1,115) Cash and Cash Equivalents at Beginning of Period 4,407 4,876 - ------------------------------------------------------------------------------------------------------------------------------------ Cash and Cash Equivalents at End of Period $ 2,502 $ 3,761 ==================================================================================================================================== See Notes to Condensed Consolidated Financial Statements. - 3 -
THE CHARLES SCHWAB CORPORATION Notes to Condensed Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Amounts and Ratios) (Unaudited) 1. Basis of Presentation The Charles Schwab Corporation (CSC) is a financial holding company engaged, through its subsidiaries, in securities brokerage and related financial services. Charles Schwab & Co., Inc. (Schwab) is a securities broker-dealer with 394 domestic branch offices in 48 states, as well as a branch in the Commonwealth of Puerto Rico. U.S. Trust Corporation (USTC, and with its subsidiaries collectively referred to as U.S. Trust) is a wealth management firm that through its subsidiaries also provides fiduciary services and private banking services with 34 offices in 12 states. Other subsidiaries include Charles Schwab Europe, a retail securities brokerage firm located in the United Kingdom, Charles Schwab Investment Management, Inc., the investment advisor for Schwab's proprietary mutual funds, Schwab Capital Markets L.P. (SCM), a market maker in Nasdaq and other securities providing trade execution services primarily to broker-dealers and institutional clients, and CyberTrader, Inc. (CyberTrader), an electronic trading technology and brokerage firm providing services to highly active, online investors. The accompanying unaudited condensed consolidated financial statements include CSC and its majority-owned subsidiaries (collectively referred to as the Company). These financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission and, in the opinion of management, reflect all adjustments necessary to present fairly the financial position, results of operations, and cash flows for the periods presented in conformity with accounting principles generally accepted in the U.S. All adjustments were of a normal recurring nature, except as discussed in Note "2 - Accounting Change." Certain items in prior periods' financial statements have been reclassified to conform to the 2002 presentation. All material intercompany balances and transactions have been eliminated. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's 2001 Annual Report to Stockholders on Form 10-K and the Company's Quarterly Report on Form 10-Q for the periods ended March 31, 2002 and June 30, 2002. The Company's results for any interim period are not necessarily indicative of results for a full year or any other interim period. 2. Accounting Change Statement of Financial Accounting Standards (SFAS) No. 142 - Goodwill and Other Intangible Assets, was issued in June 2001. Under the provisions of SFAS No. 142, companies are no longer permitted to amortize goodwill and certain intangible assets with an indefinite useful life. Instead, these assets must be reviewed at least annually for possible impairment under new criteria. The Company adopted SFAS No. 142 and accordingly discontinued the amortization of goodwill as of January 1, 2002. During the second quarter of 2002, the Company completed the transitional goodwill impairment test as required and did not record any impairment charges. Except for the cessation of goodwill amortization, the adoption of SFAS No. 142 did not have a material impact on the Company's financial position, results of operations, earnings per share (EPS), or cash flows. The decrease in goodwill during the first nine months of 2002 was primarily due to the sale of the Company's Canadian operations, partially offset by the effects of foreign currency translation adjustments. The carrying amount of goodwill, net of accumulated amortization, attributable to each of the Company's reportable segments is presented in the following table: - -------------------------------------------------------------------------------- September 30, December 31, 2002 2001 - -------------------------------------------------------------------------------- Individual Investor $ 438 $ 440 Institutional Investor 5 5 Capital Markets 25 25 U.S. Trust 159 158 - -------------------------------------------------------------------------------- Total $ 627 $ 628 ================================================================================ The following table compares net income and EPS for the three and nine months ended September 30, 2002, which excludes goodwill amortization, with net income and EPS for the three and nine months ended September 30, 2001, which has been adjusted to exclude goodwill amortization. - 4 - - -------------------------------------------------------------------------------- Three Months Ended Nine Months Ended September 30, September 30, 2002 2001 2002 2001 (Reported) (Adjusted)(Reported)(Adjusted) - -------------------------------------------------------------------------------- Net income: Reported income (loss) before extraordinary gain $ (4) $ 13 $ 176 $ 91 Add: Goodwill amortization, net of tax 17 49 - -------------------------------------------------------------------------------- Reported/adjusted income (loss) before extraordinary gain (4) 30 176 140 Extraordinary gain, net of tax 12 121 - -------------------------------------------------------------------------------- Reported/adjusted net income (loss) $ (4) $ 30 $ 188 $ 261 ================================================================================ Basic and diluted EPS: Reported EPS before extraordinary gain $ .00 $ .01 $ .13 $ .07 Add: Goodwill amortization .01 .03 - -------------------------------------------------------------------------------- Reported/adjusted EPS before extraordinary gain .00 .02 .13 .10 Extraordinary gain, net of tax .01 .08 - -------------------------------------------------------------------------------- Reported/adjusted EPS $ .00 $ .02 $ .14 $ .18 ================================================================================ 3. New Accounting Standards Long-Lived Assets: SFAS No.144 - Accounting for the Impairment or Disposal of Long-Lived Assets was issued in August 2001 and addresses the financial accounting and reporting for the impairment or disposal of long-lived assets (e.g., equipment and office facilities). This statement supersedes SFAS No. 121 - - Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and certain accounting and reporting provisions of Accounting Principles Board Opinion No. 30 - Reporting the Results of Operations. The Company adopted this statement on January 1, 2002. The adoption of SFAS No. 144 did not have a material impact on the Company's financial position, results of operations, EPS, or cash flows. SFAS No. 146 - Accounting for Costs Associated with Exit or Disposal Activities was issued in June 2002 and addresses accounting for restructuring and similar costs. SFAS No. 146 supersedes previous accounting guidance, principally Emerging Issues Task Force Issue No. 94-3 - Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). SFAS No. 146 may affect the timing of recognizing future restructuring costs, as well as the amounts recognized. The Company is required to adopt this statement for exit or disposal activities initiated after December 31, 2002. 4. Restructuring The Company recorded pre-tax restructuring charges for the third quarter of 2002 and the nine months ended September 30, 2002 as follows: - -------------------------------------------------------------------------------- Three Nine Period ended September 30, 2002 Months Months - -------------------------------------------------------------------------------- 2002 Initiatives $ 94 $ 94 2001 Initiatives 66 96 - -------------------------------------------------------------------------------- Total restructuring charges $ 160 $ 190 ================================================================================ 2002 Initiatives In the third quarter of 2002, the Company commenced additional restructuring initiatives due to continued difficult market conditions. These initiatives are intended to reduce operating expenses and adjust the Company's organizational structure to improve productivity, enhance efficiency, and increase profitability. The restructuring initiatives include further reductions in workforce and facilities. The Company recorded pre-tax restructuring charges of $94 million in the third quarter of 2002 related to these restructuring initiatives. The Company expects to recognize additional restructuring charges during the fourth quarter of 2002 as it completes these restructuring initiatives. The actual costs of these restructuring initiatives could differ from the estimated costs, depending primarily on the Company's ability to sublease properties. Workforce: During the third quarter of 2002, the Company closed its telephone service center in Austin, Texas, eliminating 300 jobs, and also eliminated 70 support and administrative positions across its four other service centers located in Denver, Indianapolis, Orlando, and Phoenix. The Company recorded charges of $12 million related to these workforce reductions in the third quarter of 2002. Additionally, the Company expects that reductions in full-time equivalent employees in the fourth quarter of 2002 will total approximately 1,900, including approximately 1,750 through mandatory staff reductions and approximately 150 related to a reduction in contractors. The workforce reduction encompasses employees from all of the Company's segments. In the third quarter of 2002, the Company recorded charges of $32 million related to the 60-day notice period provided to these impacted employees (excluding contractors). The remaining severance pay and benefits, which become contractual obligations only when the impacted employee signs a severance agreement, will be recorded in the fourth quarter of 2002. - 5 - Facilities: The restructuring charges recognized in the third quarter of 2002 include facility exit costs which are net of estimated sublease income. The restructuring charges also include write-downs of leasehold improvements, telecommunications infrastructure, and fixed assets removed from service at these facilities. A summary of pre-tax restructuring charges related to the Company's 2002 restructuring initiatives for the third quarter of 2002 and the nine months ended September 30, 2002 is as follows: - -------------------------------------------------------------------------------- Three and nine months ended September 30, 2002 - -------------------------------------------------------------------------------- Workforce reduction: Severance pay and benefits $ 43 Non-cash compensation expense for officers' stock options 1 - -------------------------------------------------------------------------------- Total workforce reduction 44 - -------------------------------------------------------------------------------- Facilities reduction: Non-cancelable lease costs, net of estimated sublease income 37 Write-downs of leasehold improvements, telecommunications infrastructure, and fixed assets removed from service 13 - -------------------------------------------------------------------------------- Total facilities reduction 50 - -------------------------------------------------------------------------------- Total restructuring charges $ 94 ================================================================================ A summary of the activity in the restructuring liability related to the Company's 2002 restructuring initiatives for the third quarter of 2002 and the nine months ended September 30, 2002 is as follows: - -------------------------------------------------------------------------------- Three and nine months Workforce Facilities ended September 30, 2002 Reduction Reduction Total - -------------------------------------------------------------------------------- Restructuring charges $ 44 $ 50 $ 94 Utilization: Cash payments (8) (8) Non-cash charges (1) (1) (13) (14) - -------------------------------------------------------------------------------- Balance at September 30, 2002 $ 35 (2) $ 37 (3) $ 72 ================================================================================ (1) Primarily includes charges for write-downs of leasehold improvements, telecommunications infrastructure, and fixed assets removed from service, as well as officers' stock-based compensation. (2) The Company expects to substantially utilize the remaining workforce reduction liability through cash payments for severance pay and benefits over the respective severance periods through 2003. (3) The Company expects to substantially utilize the remaining facilities reduction liability through cash payments for the net lease expense over the respective lease terms through 2013. 2001 Initiatives In the second quarter of 2001, the Company initiated a restructuring plan to reduce operating expenses. The restructuring plan included a workforce reduction, a reduction in operating facilities, and the removal of certain systems hardware, software, and equipment from service. Included in these initiatives are costs associated with the withdrawal from certain international operations. In the third quarter of 2002, the Company recorded pre-tax restructuring charges related to its 2001 restructuring initiatives of $66 million, virtually all of which resulted from changes in estimates of sublease income due to a continued deterioration of the commercial real estate market. Total pre-tax restructuring charges related to the Company's 2001 restructuring initiatives for the first nine months of 2002 were $96 million. The actual costs of these initiatives could differ from the estimated costs, depending primarily on the Company's ability to sublease properties. A summary of the activity in the restructuring liability related to the Company's 2001 restructuring initiatives for the third quarter of 2002 and the nine months ended September 30, 2002 is as follows: - -------------------------------------------------------------------------------- Three months ended Workforce Facilities Systems September 30, 2002 Reduction Reduction Removal Total - -------------------------------------------------------------------------------- Balance at June 30, 2002 $ 31 $ 79 $ 1 $ 111 Restructuring charges 1 65 (1) 66 Utilization: Cash payments (14) (9) (1) (24) - -------------------------------------------------------------------------------- Balance at September 30, 2002 $ 18 (2) $ 135 (3) $ 153 ================================================================================ - -------------------------------------------------------------------------------- Nine months ended Workforce Facilities Systems September 30, 2002 Reduction Reduction Removal Total - -------------------------------------------------------------------------------- Balance at December 31, 2001 $ 74 $ 97 $ 4 $ 175 Restructuring charges 19 76 (1) 1 96 Utilization: Cash payments (72) (38) (5) (115) Non-cash charges (4) (3) (3) - -------------------------------------------------------------------------------- Balance at September 30, 2002 $ 18 (2) $ 135 (3) $ 153 ================================================================================ (1) Includes $65 million primarily due to changes in estimates of sublease income resulting from a continued deterioration of the commercial real estate market. (2) The Company expects to substantially utilize the remaining workforce reduction liability through cash payments for severance pay and benefits over the respective severance periods through 2003. (3) The Company expects to substantially utilize the remaining facilities reduction liability through cash payments for the net lease expense over the respective lease terms through 2017. (4) Primarily includes charges for officers' stock-based compensation. - 6 - 5. Sale of Corporate Trust Business In June 2001, U.S. Trust sold its Corporate Trust business to The Bank of New York Company, Inc. The Company recorded an extraordinary gain of $221 million, or $121 million after tax, on this sale in the second quarter of 2001. During the first quarter of 2002, the Company recorded an extraordinary gain of $22 million, or $12 million after tax, which represented the remaining proceeds from this sale that were realized upon satisfaction of certain client retention requirements. 6. Allowance for Credit Losses on Banking Loans and Nonperforming Assets Loans to banking clients of $4.3 billion at September 30, 2002 and $4.0 billion at December 31, 2001 are presented net of the related allowance for credit losses. The allowance for credit losses on banking loans was $23 million at September 30, 2002 and $21 million at December 31, 2001. Recoveries and charge-offs were not material for each of the three- and nine-month periods ended September 30, 2002 and 2001. Nonperforming assets consisted of non-accrual loans of $1 million at September 30, 2002 and $5 million at December 31, 2001. 7. Loan Securitization During the second quarter of 2002, U.S. Trust securitized and sold residential mortgage loans originated through its private banking business. This transaction was accounted for as a sale under the requirements of SFAS No. 140 - Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. U.S. Trust received $196 million in proceeds from the sale and recognized a gain of $1 million. The senior mortgage pass-through certificates that were created by the securitization process were sold to third parties. U.S. Trust retained all other securities created by the process, primarily comprised of subordinated securities with total par value of $5 million. Any credit losses on the securitized loans will be assigned to U.S. Trust, as holder of the subordinated securities, up to the $5 million par value. The estimated fair value of the retained securities was $6 million at September 30, 2002 and was included in securities owned on the Company's condensed consolidated balance sheet. U.S. Trust has not guaranteed the mortgage loans as this transaction was structured without recourse to U.S. Trust or the Company. 8. Comprehensive Income Comprehensive income includes net income and changes in equity except those resulting from investments by, or distributions to, stockholders. Comprehensive income is presented in the following table: - -------------------------------------------------------------------------------- Three Nine Months Ended Months Ended September 30, September 30, 2002 2001 2002 2001 - -------------------------------------------------------------------------------- Net income (loss) $ (4) $ 13 $ 188 $ 212 Other comprehensive income (loss): Cumulative effect of accounting change for adoption of SFAS No. 133 (12) Net loss on cash flow hedging instruments (8) (17) (10) (24) Foreign currency translation adjustment 2 1 8 (5) Change in net unrealized gain on securities available for sale 10 13 17 16 - -------------------------------------------------------------------------------- Total comprehensive income, net of tax $ 10 $ 203 $ 187 ================================================================================ - 7 - 9. Earnings Per Share Basic EPS excludes dilution and is computed by dividing net income by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential reduction in EPS that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. EPS under the basic and diluted computations are presented in the following table: - -------------------------------------------------------------------------------- Three Nine Months Ended Months Ended September 30, September 30, 2002 2001 2002 2001 - -------------------------------------------------------------------------------- Net income (loss) $ (4) $ 13 $188 $212 ================================================================================ Weighted-average common shares outstanding - basic 1,358 1,373 1,364 1,376 Common stock equivalent shares related to stock incentive plans 22 18 27 - -------------------------------------------------------------------------------- Weighted-average common shares outstanding - diluted 1,358 1,395 1,382 1,403 ================================================================================ Basic EPS: Income (loss) before extraordinary gain $.00 $.01 $.13 $.07 Extraordinary gain, net of tax $.01 $.08 Net income (loss) $.00 $.01 $.14 $.15 ================================================================================ Diluted EPS: Income (loss) before extraordinary gain (1) $.00 $.01 $.13 $.07 Extraordinary gain, net of tax $.01 $.08 Net income (loss) $.00 $.01 $.14 $.15 ================================================================================ (1) For the three months ended September 30, 2002 this computation excludes common stock equivalent shares related to stock incentive plans of 14 million because inclusion of such shares would be antidilutive. The computation of diluted EPS for the nine months ended September 30, 2002 and 2001, respectively, excludes outstanding stock options to purchase 114 million and 84 million shares, respectively, because the exercise prices for those options were greater than the average market price of the common shares, and therefore the effect would be antidilutive. 10. Regulatory Requirements CSC is a financial holding company, which is a type of bank holding company subject to supervision and regulation by the Board of Governors of the Federal Reserve System (the Federal Reserve Board) under the Bank Holding Company Act of 1956, as amended (the Act). Under the Act, the Federal Reserve Board has established consolidated capital requirements for bank holding companies. CSC is subject to those requirements. The regulatory capital and ratios of the Company, U.S. Trust, and United States Trust Company of New York (U.S. Trust NY) are presented in the following table: - 8 - - -------------------------------------------------------------------------------- 2002 2001 -------------- -------------- September 30, Amount Ratio(1) Amount Ratio(1) - -------------------------------------------------------------------------------- Tier 1 Capital: Company $ 3,574 23.5% $ 3,662 20.5% U.S. Trust $ 618 17.5% $ 572 16.9% U.S. Trust NY $ 381 13.4% $ 333 12.5% Total Capital: Company $ 3,601 23.7% $ 3,689 20.6% U.S. Trust $ 641 18.2% $ 593 17.6% U.S. Trust NY $ 401 14.1% $ 351 13.2% Tier 1 Leverage: Company $ 3,574 9.6% $ 3,662 10.2% U.S. Trust $ 618 9.5% $ 572 9.6% U.S. Trust NY $ 381 7.3% $ 333 7.2% - -------------------------------------------------------------------------------- (1) Minimum tier 1 capital, total capital, and tier 1 leverage ratios are 4%, 8%, and 3%-5%, respectively, for bank holding companies and banks. Well-capitalized tier 1 capital, total capital, and tier 1 leverage ratios are 6%, 10%, and 5%, respectively. Each of CSC's other depository institution subsidiaries exceed the well-capitalized standards set forth by the banking regulatory authorities. Based on their respective regulatory capital ratios at September 30, 2002 and 2001, the Company, U.S. Trust, and U.S. Trust NY are considered well capitalized (the highest category). There are no conditions or events that management believes have changed the Company's, U.S. Trust's, or U.S. Trust NY's well-capitalized status. Schwab and SCM are subject to the Uniform Net Capital Rule under the Securities Exchange Act of 1934 (the Rule). Schwab and SCM compute net capital under the alternative method permitted by the Rule. This method requires the maintenance of minimum net capital, as defined, of the greater of 2% of aggregate debit balances arising from client transactions or a minimum dollar requirement, which is based on the type of business conducted by the broker-dealer. The minimum dollar requirement for both Schwab and SCM is $1 million. Under the alternative method, a broker-dealer may not repay subordinated borrowings, pay cash dividends, or make any unsecured advances or loans to its parent or employees if such payment would result in net capital of less than 5% of aggregate debit balances or less than 120% of its minimum dollar requirement. At September 30, 2002, Schwab's net capital was $1.2 billion (17% of aggregate debit balances), which was $1.0 billion in excess of its minimum required net capital and $825 million in excess of 5% of aggregate debit balances. At September 30, 2002, SCM's net capital was $67 million, - 8 - which was $66 million in excess of its minimum required net capital. 11. Commitments and Contingent Liabilities During 2001, the Company began occupying and making lease payments on a newly renovated office building. The lease for the building was arranged by working with a bank to create an unconsolidated special purpose trust (Trust). The Trust, through an agent, raised the $245 million needed to acquire and renovate the building by issuing long-term debt ($235 million) and raising equity capital ($10 million). The Company's lease payments to the Trust vary with fluctuations in interest rates and are structured to cover the interest on the debt obligations and a specified return on the equity (defined in the Trust Agreement as 1.75% above the one-month LIBOR rate). This financing arrangement is known as a synthetic lease. Upon the expiration of the lease in June 2005, the Company may renew the lease for an additional five years subject to certain approvals and conditions, or arrange a sale of the office building to a third party. The Company also has an option to purchase the office building for $245 million at any time after June 18, 2003. The Company has provided the Trust with a residual value guarantee, which means that if the building is sold to a third party the Company is responsible for making up any shortfall between the actual sales price and the $245 million funded by the Trust, up to a maximum of $202 million. In March 2002, the Company secured an appraisal of the estimated fair value of the building at the end of the initial lease term in June 2005. On the basis of this appraisal, the Company determined that it was probable that the value of the property at the end of the lease term would be less than the residual value guaranteed by approximately $45 million. This deficiency of $45 million is being amortized as rent expense on a straight-line basis over the period from January 2002 to June 2005. Adjustments to this amortization will be made on a prospective basis if it is determined that the estimate of the probable deficiency has changed. The nature of the Company's business subjects it to claims, lawsuits, regulatory examinations, and other proceedings in the ordinary course of business. The results of these matters cannot be predicted with certainty. There can be no assurance that these matters will not have a material adverse effect on the Company's results of operations in any future period, depending partly on the results for that period, and a substantial judgment could have a material adverse impact on the Company's financial condition, results of operations, and cash flows. However, it is the opinion of management, after consultation with legal counsel, that the ultimate outcome of existing claims and proceedings will not have a material adverse impact on the financial condition, results of operations, or cash flows of the Company. For further discussion of legal proceedings, see Part II - Other Information, Item 1 - Legal Proceedings. 12. Segment Information The Company structures its segments according to its various types of clients and the services provided to those clients. These segments have been aggregated, based on similarities in economic characteristics, types of clients, services provided, distribution channels, and regulatory environment, into four reportable segments - Individual Investor, Institutional Investor, Capital Markets, and U.S. Trust. Financial information for the Company's reportable segments is presented in the following table. The Company periodically reallocates certain revenues and expenses among the segments to align them with the changes in the Company's organizational structure. Previously-reported segment information has been revised to reflect changes during the year in the Company's internal organization. The Company evaluates the performance of its segments based on adjusted operating income before taxes, which excludes restructuring and other charges, merger- and acquisition-related charges, and extraordinary gains. Intersegment revenues are not material and are therefore not disclosed. Total revenues, income before taxes on income and extraordinary gain, and net income are equal to the Company's consolidated amounts as reported in the condensed consolidated statement of income. - 9 - - -------------------------------------------------------------------------------- Three Nine Months Ended Months Ended September 30, September 30, 2002 2001 2002 2001 - ------------------------------------------------------------------------------- Revenues: Individual Investor $ 593 $ 576 $1,804 $1,893 Institutional Investor 214 200 638 616 Capital Markets 64 58 194 264 U.S. Trust 160 163 503 495 - -------------------------------------------------------------------------------- Operating revenues 1,031 997 3,139 3,268 Non-operating revenues (1) 26 26 - -------------------------------------------------------------------------------- Total $1,031 $1,023 $3,139 $3,294 ================================================================================ Operating income before taxes: Individual Investor $ 64 $ 35 $ 193 $ 147 Institutional Investor 61 64 182 203 Capital Markets (1) (2) 12 28 U.S. Trust (2) 31 33 111 95 - -------------------------------------------------------------------------------- Operating income before taxes 155 130 498 473 Non-operating revenues (1) 26 26 Restructuring and other charges (3) (160) (99) (190) (244) Merger- and acquisition-related charges (4) (31) (27) (91) - -------------------------------------------------------------------------------- Income (loss) before taxes on income (loss) and extraordinary gain (5) 26 281 164 Tax expense (benefit) on income (1) 13 105 73 Extraordinary gain on sale of corporate trust business, net of tax 12 121 - -------------------------------------------------------------------------------- Net Income (Loss) $ (4) $ 13 $ 188 $ 212 ================================================================================ (1) Primarily consists of a gain on the sale of an investment. (2) Excludes an extraordinary pre-tax gain of $22 million for the nine months ended September 30, 2002 and $221 million for the nine months ended September 30, 2001. (3) Restructuring charges include costs relating to workforce, facilities, systems hardware, software, and equipment reductions. In 2001, other charges include a regulatory fine, professional service fees for operational and risk management remediation, and the write-off of certain software development costs. (4) Includes retention program compensation related to the merger with USTC, and intangible asset amortization and retention program compensation related to the acquisition of CyberTrader. The retention programs related to the acquisition of CyberTrader and the merger with USTC ended in March 2002 and May 2002, respectively. For 2001, amount also includes goodwill amortization, which ceased on January 1, 2002 upon the adoption of SFAS No. 142 (see note "2 - Accounting Change"). 13. Supplemental Cash Flow Information Certain information affecting the cash flows of the Company is presented in the following table: - -------------------------------------------------------------------------------- Nine Months Ended September 30, 2002 2001 - -------------------------------------------------------------------------------- Income taxes paid $ 81 $ 84 ================================================================================ Interest paid: Brokerage client cash balances $ 143 $ 614 Deposits from banking clients 65 104 Long-term debt 51 56 Stock-lending activities 3 19 Short-term borrowings 19 15 Other 5 - -------------------------------------------------------------------------------- Total interest paid $ 281 $ 813 ================================================================================ Non-cash investing and financing activities: Common stock and options issued for purchase of businesses $ 4 $ 36 ================================================================================ - 10 - Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Description of Business The Company: The Charles Schwab Corporation (CSC) and its subsidiaries (collectively referred to as the Company) provide securities brokerage and related financial services for 8.0 million active client accounts(a). Client assets in these accounts totaled $726.8 billion at September 30, 2002. Charles Schwab & Co., Inc. (Schwab) is a securities broker-dealer with 394 domestic branch offices in 48 states, as well as a branch in the Commonwealth of Puerto Rico. U.S. Trust Corporation (USTC, and with its subsidiaries collectively referred to as U.S. Trust) is a wealth management firm that through its subsidiaries also provides fiduciary services and private banking services with 34 offices in 12 states. Other subsidiaries include Charles Schwab Europe, a retail securities brokerage firm located in the United Kingdom, Charles Schwab Investment Management, Inc., the investment advisor for Schwab's proprietary mutual funds, Schwab Capital Markets L.P. (SCM), a market maker in Nasdaq and other securities providing trade execution services primarily to broker-dealers and institutional clients, and CyberTrader, Inc. (CyberTrader), an electronic trading technology and brokerage firm providing services to highly active, online investors. The Company provides financial services to individuals, institutional clients, and broker-dealers through four segments - Individual Investor, Institutional Investor, Capital Markets, and U.S. Trust. The Individual Investor segment includes the Company's domestic and international retail operations. The Institutional Investor segment provides custodial, trading, and support services to independent financial advisors, serves company 401(k) plan sponsors and third-party administrators, and supports company stock option plans and stock purchase programs. The Capital Markets segment provides trade execution services in Nasdaq, exchange-listed, and other securities primarily to broker-dealers, including Schwab, and institutional clients. The U.S. Trust segment provides investment and wealth management, fiduciary services, and private banking services to individual and institutional clients. Business Strategy: The Company's infrastructure and resources are focused on pursuing six strategic priorities: - - providing the spectrum of affluent investors with the advice, relationships, and choices that support their desired investment outcomes; - - delivering the information, technology, service, and pricing needed to remain a leader in serving active traders; - - continuing to provide high quality service to clients with smaller investment portfolios; - - providing individual investing services through employers, including retirement and option plans as well as personal brokerage accounts; - - offering selected banking services and developing investment products that give clients greater control and understanding of their finances; and - - retaining a strong capital markets business to address investors' financial product and trade execution needs. For further discussion of the Company's business strategy, see "Management's Discussion and Analysis of Results of Operations and Financial Condition - Description of Business - Business Strategy" in the Company's 2001 Annual Report to Stockholders, which is filed as Exhibit 13.1 to the Company's Form 10-K for the year ended December 31, 2001. See also Item 1 - Business - Narrative Description of Business - "Products, Services, and Advice Offerings" in the Company's Form 10-K for the year ended December 31, 2001. Significant recent developments relating to certain of these strategic priorities, as well as other significant developments, follows: Services for Affluent Investors: Schwab Private Client is a fee-based service designed to help clients who want access to an ongoing, one-on-one advice relationship with a designated Schwab consultant while retaining control over their investment decisions. Schwab Private Client was expanded nationwide in May 2002. In the third quarter of 2002, 3,000 clients signed up for this service, bringing the total number of participants to over 5,000 as of September 30, 2002. The Schwab Private Client service includes over 150 designated Schwab consultants and their support teams, serving 360 branch offices nationwide, at September 30, 2002. For self-directed affluent investors, the Company introduced Schwab Signature Platinum(R), the successor to the Schwab Signature Services(TM) program. Schwab Signature Platinum enables Schwab to provide a select group of its larger clients with a tailored set of benefits and services, including priority access, an enhanced suite of investing resources, and preferred pricing. The Schwab Advisor Network(TM) is the successor to the Schwab AdvisorSource(R) referral program, with over 330 participating independent, fee-based investment advisors (IAs) at September 30, 2002. These IAs provide customized and personalized portfolio management and financial planning services to investors who prefer to delegate their financial management responsibilities to an independent - -------- (a) Accounts with balances or activity within the preceding eight months. - 11 - professional. During the third quarter of 2002, Schwab conducted advisor education workshops on operational, trading, and technology solutions to help IAs grow their businesses efficiently. These workshops were held in 18 cities and attracted 1,100 attendees. Services for Active Traders: The Company made several technological, pricing, and service improvements to its offerings for actively trading investors in the third quarter of 2002. The Company enhanced its CyberTrader(R) Web Trading platform to include real-time market data, direct access technology, intelligent order routing, options trading, and premium stock research. The Company also reduced pricing across all of CyberTrader's platforms; prices now range from $9.95 for trades executed through the CyberTrader Web site to $12.95 for trades executed through the CyberX2(TM) platform. Additionally, the CyberTrader offering was expanded to include a broader client base - the enhanced pricing and technology are available to clients who trade as few as ten times per month. To support representatives' conversations with actively trading clients, the Company introduced Active Trader Street, an internal Web site that provides Schwab representatives with a comprehensive suite of investing perspectives, trading strategies, and educational tools. Corporate Services: In the third quarter of 2002, the Company introduced a monthly online report that allows retirement plan sponsors to monitor activity and investment performance in their plans against customized criteria and benchmarks. If a fund deviates from the pre-established criteria, plan sponsors receive an email alert automatically. The report also provides plan asset allocations and trend data, market commentary, industry data, fund summaries and the most recent mutual fund Schwab Focus List(TM), which is specifically designed for retirement plan sponsors. Banking and Other Financial Products: In the second quarter of 2002, the Company filed applications with the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation to establish a national bank and to obtain deposit insurance for the bank. The Company is awaiting preliminary approval from the Comptroller of the Currency in order to file applications with the Board of Governors of the Federal Reserve System (Federal Reserve Board). Subject to regulatory approvals, the Company expects to commence banking operations in early 2003. Capital Markets: The Company expanded its Schwab BondSource(TM) platform in the third quarter of 2002 to provide additional information, new analytical tools, and enhanced fixed income securities price quotes to support more efficient client service. Client assets in fixed income securities were a record $117.5 billion at September 30, 2002, an increase of $19.3 billion, or 20%, from a year ago. Other Significant Developments: The Company continued to combine people and technology through several important technology-based initiatives during the third quarter of 2002. Representatives from the Schwab Center for Investment Research(R), Schwab Equity Research, and Schwab Investment Center hosted a Webcast designed to help investors navigate the current markets. Along with advice on investment objectives, diversification, and risk management, the representatives shared their perspectives on the current downturn and possible investment opportunities. Also, Schwab added a feature to its Web site to guide prospective clients to selected service offerings, based on their individual investing behavior and needs. In the third quarter of 2002, Schwab expanded its proprietary funds offering by introducing the Schwab Hedged Equity Fund(TM), which invests in both long and short positions and is designed to provide investors with long-term capital appreciation with less volatility than the broad market. This fund, along with the Schwab Core Equity Fund(TM) introduced in the second quarter of 2002, combines the equity selection capabilities of Schwab Equity Ratings(TM) with the diversification and convenience of a mutual fund. Restructuring: The Company recorded pre-tax restructuring charges for the third quarter of 2002 and the nine months ended September 30, 2002 as follows (in millions): - -------------------------------------------------------------------------------- Three Nine Period ended September 30, 2002 Months Months - -------------------------------------------------------------------------------- 2002 Initiatives: Workforce reduction $ 44 $ 44 Facilities reduction 50 50 - -------------------------------------------------------------------------------- Total 2002 Initiatives 94 94 - -------------------------------------------------------------------------------- 2001 Initiatives: Workforce reduction 1 19 Facilities reduction 65 76 Systems removal 1 - -------------------------------------------------------------------------------- Total 2001 Initiatives 66 96 - -------------------------------------------------------------------------------- Total restructuring charges $ 160 $ 190 ================================================================================ 2002 Initiatives In the third quarter of 2002, the Company commenced additional restructuring initiatives due to continued difficult market conditions. These initiatives are intended to reduce operating expenses and adjust the Company's organizational structure to improve productivity, enhance efficiency, and increase profitability. The restructuring initiatives include further reductions in workforce and facilities. The Company recorded pre-tax restructuring charges of $94 million in the third quarter of 2002 related to these restructuring initiatives. This amount includes - 12 - $12 million for workforce reductions related to the closure of the Company's telephone service center in Austin, Texas, in the third quarter of 2002, and a reduction of phone-based client support staff at the remaining four service centers. Additionally, the Company expects that reductions in full-time equivalent employees in the fourth quarter of 2002 will total approximately 1,900, including approximately 1,750 through mandatory staff reductions and approximately 150 related to a reduction in contractors. In the third quarter of 2002, the Company recorded charges of $32 million related to the 60-day notice period provided to these impacted employees (excluding contractors). The remaining severance pay and benefits, which become contractual obligations only when the impacted employee signs a severance agreement, will be recorded in the fourth quarter of 2002. The Company expects to recognize additional pre-tax restructuring charges in the fourth quarter of 2002 of approximately $90 million for workforce reductions. As the Company works toward completing these restructuring initiatives and assesses the impact of its workforce reductions, additional charges for further reductions in operating facilities are possible. The Company estimates that its 2002 restructuring initiatives will reduce pre-tax operating expenses for full-year 2003 by approximately $250 million compared to annualized second quarter 2002 operating expenses. Expected reductions include approximately $150 million in compensation and benefits for mandatory staff reductions, approximately $50 million in professional services and other expenses, and approximately $50 million in spending for development projects and advertising. A portion of these reductions in operating expenses, however, will likely be used to enhance employee bonuses. 2001 Initiatives In addition, the Company recorded pre-tax restructuring charges related to the Company's 2001 restructuring initiatives of $66 million in the third quarter of 2002, virtually all of which resulted from changes in estimates of sublease income due to a continued deterioration of the commercial real estate market. For further information on the Company's restructuring initiatives, see note "4 - Restructuring" in the Notes to Condensed Consolidated Financial Statements. Risk Management For discussion on the Company's principal risks and some of the policies and procedures for risk identification, assessment, and mitigation, see "Management's Discussion and Analysis of Results of Operations and Financial Condition - Risk Management" in the Company's 2001 Annual Report to Stockholders, which is filed as Exhibit 13.1 to the Company's Form 10-K for the year ended December 31, 2001. See Liquidity and Capital Resources of this report for a discussion on liquidity risk; and see Item 3 - Quantitative and Qualitative Disclosures About Market Risk for additional information relating to market risk. The Company entered into a number of new insurance policies during the quarter ended September 30, 2002 to replace and renew policies that were expiring. Given the current state of the insurance market, the Company was confronted with higher levels of rates and deductibles for coverages similar to those which were replaced. These rates and deductibles were comparable to those available to other participants in the insurance market. The increases in deductibles could have a material adverse effect on the Company's results of operations in any future period, depending partly on the results for that period. Given the nature of the Company's revenues, expenses, and risk profile, the Company's earnings and CSC's common stock price have been and may continue to be subject to significant volatility from period to period. The Company's results for any interim period are not necessarily indicative of results for a full year or any other interim period. Risk is inherent in the Company's business. Consequently, despite the Company's attempts to identify areas of risk, oversee operational areas involving risk, and implement policies and procedures designed to mitigate risk, there can be no assurance that the Company will not suffer unexpected losses due to operating or other risks. Forward-Looking Statements This Quarterly Report on Form 10-Q contains "forward-looking statements" within the meaning of Section 27A of the Securities Act, and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements are identified by words such as "believe," "expect," "intend," "plan," "will," "may," and other similar expressions. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. These forward-looking statements, which reflect management's beliefs, objectives, and expectations as of the date hereof, are necessarily estimates based on the best judgment of the Company's senior management. These statements relate to, among other things, the Company's ability to achieve its strategic priorities (see Description of Business - Business Strategy), the impact of the restructuring plan on the Company's results of operations (see Description of Business - Restructuring), insurance coverage (see Description of Business - Risk Management), sources of liquidity and capital (see Liquidity and Capital Resources - Liquidity and - Commitments), the Company's cash position, cash flows, capital expenditures, and development spending (see Liquidity and Capital Resources - 13 - - - Cash Flows and Capital Resources), net interest expense under interest rate swaps (see Item 3 - Quantitative and Qualitative Disclosures About Market Risk - Financial Instruments Held For Purposes Other Than Trading - Interest Rate Swaps), and contingent liabilities (see Part II - Other Information, Item 1 - Legal Proceedings). Achievement of the expressed expectations is subject to certain risks and uncertainties that could cause actual results to differ materially from the expressed expectations described in these statements. Important factors that may cause such differences are noted in this interim report and include, but are not limited to: the effect of client trading patterns on Company revenues and earnings; changes in revenues and profit margin due to cyclical securities markets and fluctuations in interest rates; the level and continuing volatility of equity prices; a significant downturn in the securities markets over a short period of time or a sustained decline in securities prices, trading volumes, and investor confidence; the size and number of the Company's insurance claims; and a significant decline in the real estate market, including the Company's ability to sublease certain properties. Other more general factors that may cause such differences include, but are not limited to: the Company's inability to attract and retain key personnel; the timing and impact of changes in the Company's level of investments in personnel, technology, or advertising; changes in technology; computer system failures and security breaches; evolving legislation, regulation, accounting pronouncements, and changing industry practices adversely affecting the Company; adverse results of litigation; the inability to obtain external financing at acceptable rates; the effects of competitors' pricing, product, and service decisions; and intensified industry competition and consolidation. Critical Accounting Policies Certain of the Company's accounting policies that involve a higher degree of judgment and complexity are discussed in "Management's Discussion and Analysis of Results of Operations and Financial Condition - Critical Accounting Policies" in the Company's 2001 Annual Report to Stockholders, which is filed as Exhibit 13.1 to the Company's Form 10-K for the year ended December 31, 2001. There have been no material changes to these critical accounting policies during the first nine months of 2002. Three Months Ended September 30, 2002 Compared To Three Months Ended September 30, 2001 All references to earnings per share information in this report reflect diluted earnings per share unless otherwise noted. FINANCIAL OVERVIEW The Company's financial performance in the third quarter of 2002 was adversely affected by decreases in client trading activity as investor confidence continued to be weighed down by persistent securities market declines, concerns about corporate governance, and geopolitical developments. Despite the difficult market environment that prevailed during the third quarter of 2002, the Company's trading revenues increased 12% from the third quarter of 2001. The increase in trading revenues was partially due to a higher number of trading days in the third quarter of 2002, as well as higher revenue per share traded (reflected in commission revenues) and higher client fixed income securities trading activity (reflected in principal transactions revenues). Non-trading revenues, which include asset management and administration fees, interest revenue, net of interest expense (referred to as net interest revenue), and other revenues, decreased 4% in the third quarter of 2002 compared to the year-ago level. The decrease in non-trading revenues was primarily due to a 42% decrease in other revenue and a 9% decrease in net interest revenue, partially offset by a 3% increase in asset management and administration fees. The decrease in other revenues was primarily due to a gain on the sale of an investment recorded in the third quarter of 2001. Average margin loans to clients in the third quarter of 2002 decreased 33% from year-ago levels, which primarily caused the decline in net interest revenue. The increase in asset management and administration fees primarily resulted from higher account fees. Total expenses excluding interest during the third quarter of 2002 were $1.0 billion, up 4% from the third quarter of 2001. This increase resulted primarily from higher restructuring charges in the third quarter of 2002, partially offset by decreases in certain expenses as a result of the Company's continued expense reduction measures. In evaluating the Company's financial performance, management uses adjusted operating income, which excludes non-operating items as detailed in the following table. Management believes that operating income is a useful indicator of its ongoing financial performance, and a tool that can provide meaningful insight into financial performance without the effects of certain material items that are not expected to be an ongoing part of operations (e.g., extraordinary gains, restructuring and other charges, and merger- and acquisition-related charges). In this - 14 - manner, operating income assists both management and investors in assessing the Company's financial performance over extended periods of time. The Company's after-tax operating income for the third quarter of 2002 was $96 million, up 19% from the third quarter of 2001, and its after-tax operating profit margin for the third quarter of 2002 was 9.4%, up from 8.2% for the third quarter of 2001. A reconciliation of the Company's operating income to net income is shown in the following table (in millions): - -------------------------------------------------------------------------------- Three Months Ended September 30, Percent 2002 2001 Change - -------------------------------------------------------------------------------- Operating income, after tax $ 96 $ 81 19% Non-operating items: Other income (1) 26 Restructuring charges (2) (160) (99) 62 Merger- and acquisition-related charges (3) (31) - -------------------------------------------------------------------------------- Total non-operating items (160) (104) 54 Tax effect 60 36 67 - -------------------------------------------------------------------------------- Total non-operating items, after tax (100) (68) 47 - -------------------------------------------------------------------------------- Net income (loss) $ (4) $ 13 n/m ================================================================================ (1) Primarily consists of a gain on the sale of an investment. (2) Restructuring charges include costs relating to workforce, facilities, systems hardware, software, and equipment reductions. (3) Includes retention program compensation related to the merger with USTC, and intangible asset amortization and retention program compensation related to the acquisition of CyberTrader. The retention programs related to the acquisition of CyberTrader and the merger with USTC ended in March 2002 and May 2002, respectively. For the three months ended September 30, 2001, amount also includes goodwill amortization, which ceased on January 1, 2002 upon the adoption of Statement of Financial Accounting Standards No. 142. n/m Not meaningful The Company's operating income before taxes for the third quarter of 2002 was $155 million, up $25 million, or 19%, from the third quarter of 2001 primarily due to an increase of $29 million, or 83%, in the Individual Investor segment, partially offset by a decrease of $3 million, or 5%, in the Institutional Investor segment. The increase in the Individual Investor segment was primarily due to lower expenses resulting from the Company's workforce reduction under its restructuring plan. As certain technology, corporate, and general administrative expenses are allocated to segments based upon their full-time equivalent employees, a proportionately larger allocation of expenses was assigned to the Institutional Investor segment for the third quarter of 2002, which, along with an increase in certain direct costs, resulted in the operating income decline in that segment. The Company recognized a net loss of $4 million for the third quarter of 2002, compared to net income of $13 million, or $.01 per share, for the third quarter of 2001. The Company's after-tax profit margin for the third quarter of 2002 was (.3%), down from 1.3% for the third quarter of 2001. The annualized return on stockholders' equity for the third quarter of 2002 was 0%, down from 1% for the third quarter of 2001. REVENUES Revenues increased by $8 million, or 1%, to $1.0 billion in the third quarter of 2002 compared to the third quarter of 2001, due to a $33 million, or 12%, increase in commission revenues, a $14 million, or 3%, increase in asset management and administration fees and a $5 million, or 12%, increase in principal transaction revenues. These increases were partially offset by a $21 million, or 9%, decrease in net interest revenue and a $23 million, or 42%, decrease in other revenues. The Company's non-trading revenues represented 65% of total revenues for the third quarter of 2002, as compared to 69% for the third quarter of 2001 as shown in the following table: - -------------------------------------------------------------------------------- Three Months Ended September 30, Composition of Revenues 2002 2001 - -------------------------------------------------------------------------------- Commissions 30% 27% Principal transactions 5 4 - -------------------------------------------------------------------------------- Total trading revenues 35 31 - -------------------------------------------------------------------------------- Asset management and administration fees 42 41 Net interest revenue 20 22 Other 3 6 - -------------------------------------------------------------------------------- Total non-trading revenues 65 69 - -------------------------------------------------------------------------------- Total 100% 100% ================================================================================ While the Individual Investor and Institutional Investor segments generate both trading and non-trading revenues, the Capital Markets segment generates primarily trading revenues and the U.S. Trust segment generates primarily non-trading revenues. The $8 million increase in revenues from the third quarter of 2001 was due to increases in operating revenues of $17 million, or 3%, in the Individual Investor segment, $14 million, or 7%, in the Institutional Investor segment, and $6 million, or 10%, in the Capital Markets segment, partially offset by a decrease of $3 million, or 2%, in the U.S. Trust segment. Additionally, the Company had non-operating revenues of $26 million in the third quarter of 2001, consisting primarily of a gain on the sale of an investment. See note "12 - Segment Information" in the Notes to Condensed Consolidated Financial Statements for financial information by segment. - 15 - Asset Management and Administration Fees Asset management and administration fees include mutual fund service fees, as well as fees for other asset-based financial services provided to individual and institutional clients. The Company earns mutual fund service fees for recordkeeping and shareholder services provided to third-party funds, and for transfer agent services, shareholder services, administration, and investment management provided to its proprietary funds. These fees are based upon the daily balances of client assets invested in third-party funds and upon the average daily net assets of the Company's proprietary funds. Mutual fund service fees are earned through the Individual Investor, Institutional Investor, and U.S. Trust segments. The Company also earns asset management and administration fees for financial services, including investment management and consulting, trust and fiduciary services, financial and estate planning, and private banking services, provided to individual and institutional clients. These fees are primarily based on the value and composition of assets under management and are earned through the U.S. Trust, Individual Investor, and Institutional Investor segments. Asset management and administration fees were $434 million for the third quarter of 2002, up $14 million, or 3%, from the third quarter of 2001, as shown in the following table (in millions): - -------------------------------------------------------------------------------- Three Months Ended Asset Management September 30, Percent and Administration Fees 2002 2001 Change - -------------------------------------------------------------------------------- Mutual fund service fees: Proprietary funds (SchwabFunds(R)and Excelsior(R)) $218 $209 4% Mutual Fund OneSource(R) 61 69 (12) Other 10 13 (23) Asset management and related services 145 129 12 - -------------------------------------------------------------------------------- Total $434 $420 3% ================================================================================ The increase in asset management and administration fees was primarily due to higher account fees and increases in assets in Schwab's proprietary funds (collectively referred to as the SchwabFunds), which led to an increase in service fees, partially offset by a decrease in assets in Schwab's Mutual Fund OneSource service. Assets in client accounts were $726.8 billion at September 30, 2002, a decrease of $41.6 billion, or 5%, from a year ago as shown in the following table. This decrease from a year ago included net new client assets of $51.0 billion, offset by net market losses of $92.6 billion related to client accounts. - -------------------------------------------------------------------------------- Change in Client Assets and Accounts (In billions, at quarter end, September 30, Percent except as noted) 2002 2001 Change - -------------------------------------------------------------------------------- Assets in client accounts Schwab One(R), other cash equivalents and deposits from banking clients $ 29.0 $ 28.1 3% Proprietary funds (SchwabFunds(R) and Excelsior(R)): Money market funds 129.2 130.0 (1) Equity and bond funds 26.8 27.5 (3) - -------------------------------------------------------------------------------- Total proprietary funds 156.0 157.5 (1) - -------------------------------------------------------------------------------- Mutual Fund Marketplace(R)(1): Mutual Fund OneSource(R) 70.0 76.6 (9) Mutual fund clearing services 19.8 18.2 9 All other 68.5 66.8 3 - -------------------------------------------------------------------------------- Total Mutual Fund Marketplace 158.3 161.6 (2) - -------------------------------------------------------------------------------- Total mutual fund assets 314.3 319.1 (2) - -------------------------------------------------------------------------------- Equity and other securities (1) 272.9 332.0 (18) Fixed income securities (2) 117.5 98.2 20 Margin loans outstanding (6.9) (9.0) 23 - -------------------------------------------------------------------------------- Total client assets $ 726.8 $ 768.4 (5%) ================================================================================ Net change in assets in client accounts (for the quarter ended) Net new client assets $ 10.6 $ 17.9 Net market losses (80.8) (107.8) - ------------------------------------------------------------------ Net decline $ (70.2) $ (89.9) ================================================================== New client accounts (in thousands, for the quarter ended) 159.6 184.2 (13%) Active client accounts (in millions) (3) 8.0 7.8 3% - -------------------------------------------------------------------------------- Active online Schwab client accounts (in millions) (4) 4.1 4.3 (5%) Online Schwab client assets $ 270.1 $ 306.3 (12%) - -------------------------------------------------------------------------------- (1) Excludes money market funds and all proprietary money market, equity, and bond funds. (2) Includes $15.1 billion and $15.7 billion at September 30, 2002 and 2001, respectively, of other securities serviced by Schwab's fixed income division, including exchange-traded unit investment trusts, real estate investment trusts, preferred debt, and preferred equities. (3) Active accounts are defined as accounts with balances or activity within the preceding eight months. (4) Active online accounts are defined as all accounts within a household that has had at least one online session within the past twelve months. - 16 - Commissions The Company earns revenues by executing client trades primarily through the Individual Investor and Institutional Investor segments. These revenues are affected by the number of accounts that trade, the average number of revenue-generating trades per account, and the average revenue earned per trade. Commission revenues for the Company were $309 million for the third quarter of 2002, up $33 million, or 12%, from the third quarter of 2001. This increase was primarily due to higher revenue per trade and trading days, partially offset by lower daily average trades. The Company's client trading activity is shown in the following table (in thousands): - -------------------------------------------------------------------------------- Three Months Ended September 30, Percent Daily Average Trades 2002 2001 Change - -------------------------------------------------------------------------------- Revenue Trades (1) Online 107.3 109.3 (2%) TeleBroker(R)and Schwab by PhoneTM 5.4 6.6 (18) Regional client telephone service centers, branch offices, and other 16.4 17.9 (8) - -------------------------------------------------------------------------------- Total 129.1 133.8 (4%) ================================================================================ Mutual Fund OneSource(R) and Other Asset-Based Trades Online 47.9 33.3 44% TeleBroker and Schwab by Phone .3 .4 (25) Regional client telephone service centers, branch offices, and other 8.3 20.3 (59) - -------------------------------------------------------------------------------- Total 56.5 54.0 5% ================================================================================ Total Daily Average Trades Online 155.2 142.6 9% TeleBroker and Schwab by Phone 5.7 7.0 (19) Regional client telephone service centers, branch offices, and other 24.7 38.2 (35) - -------------------------------------------------------------------------------- Total 185.6 187.8 (1%) ================================================================================ (1) Includes all client trades (both individuals and institutions) that generate either commission revenue or revenue from principal markups (i.e., fixed income). As shown in the following table, the total number of revenue trades executed by the Company has increased 4% as the client trading activity per account that traded has increased. - -------------------------------------------------------------------------------- Three Months Ended September 30, Percent Trading Activity 2002 2001 Change - -------------------------------------------------------------------------------- Total revenue trades (in thousands) (1) 8,263 7,908 4% Accounts that traded during the quarter (in thousands) 1,284 1,339 (4) Average revenue trades per account that traded 6.4 5.9 8 Trading frequency proxy (2) 3.9 3.8 3 Number of trading days 64 59 8 Average revenue earned per revenue trade $39.71 $36.35 9 - -------------------------------------------------------------------------------- (1) Includes all client trades (both individuals and institutions) that generate either commission revenue or revenue from principal markups (i.e., fixed income). (2) Represents annualized revenue trades per $100,000 in client assets. Net Interest Revenue Net interest revenue is the difference between interest earned on assets (mainly margin loans to clients, investments required to be segregated for clients, private banking loans, and securities available for sale) and interest paid on liabilities (mainly brokerage client cash balances and banking deposits). Net interest revenue is affected by changes in the volume and mix of these assets and liabilities, as well as by fluctuations in interest rates and hedging strategies. Substantially all of the Company's net interest revenue is earned through the Individual Investor, Institutional Investor, and U.S. Trust segments. - 17 - Net interest revenue was $209 million for the third quarter of 2002, down $21 million, or 9%, from the third quarter of 2001 as shown in the following table (in millions): - -------------------------------------------------------------------------------- Three Months Ended September 30, Percent 2002 2001 Change - -------------------------------------------------------------------------------- Interest Revenue Margin loans to clients $ 108 $ 185 (42%) Investments, client-related 87 128 (32) Private banking loans 59 61 (3) Securities available for sale 21 20 5 Other 20 37 (46) - -------------------------------------------------------------------------------- Total 295 431 (32) - -------------------------------------------------------------------------------- Interest Expense Brokerage client cash balances 43 147 (71) Deposits from banking clients 26 29 (10) Long-term debt 10 13 (23) Short-term borrowings 6 8 (25) Stock-lending activities 1 3 (67) Other 1 n/m - -------------------------------------------------------------------------------- Total 86 201 (57) - -------------------------------------------------------------------------------- Net interest revenue $ 209 $ 230 (9%) ================================================================================ n/m Not meaningful Client-related and other daily average balances, interest rates, and average net interest spread for the third quarters of 2002 and 2001 are summarized in the following table (dollars in millions): - -------------------------------------------------------------------------------- Three Months Ended September 30, 2002 2001 - -------------------------------------------------------------------------------- Interest-Earning Assets (client-related and other): Investments (client-related): Average balance outstanding $ 18,973 $ 13,751 Average interest rate 1.83% 3.71% Margin loans to clients: Average balance outstanding $ 7,346 $ 10,910 Average interest rate 5.79% 6.73% Private banking loans: Average balance outstanding $ 4,139 $ 3,645 Average interest rate 5.69% 6.65% Securities available for sale: Average balance outstanding $ 1,568 $ 1,365 Average interest rate 5.29% 5.80% Average yield on interest-earning assets 3.40% 5.28% Funding Sources (client-related and other): Interest-bearing brokerage client cash balances: Average balance outstanding $ 22,917 $ 21,883 Average interest rate .73% 2.66% Interest-bearing banking deposits: Average balance outstanding $ 3,908 $ 3,259 Average interest rate 2.62% 3.57% Other interest-bearing sources: Average balance outstanding $ 1,021 $ 972 Average interest rate 2.18% 3.57% Average noninterest-bearing portion $ 4,180 $ 3,557 Average interest rate on funding sources .91% 2.47% Summary: Average yield on interest-earning assets 3.40% 5.28% Average interest rate on funding sources .91% 2.47% - -------------------------------------------------------------------------------- Average net interest spread 2.49% 2.81% ================================================================================ The decrease in net interest revenue from the third quarter of 2001 was primarily due to lower levels of, and lower rates received on, margin loans to clients, as well as lower rates received on client-related investments, partially offset by lower rates paid on brokerage client cash balances and higher average balances of client-related investments. Principal Transactions Principal transaction revenues are primarily comprised of revenues from client fixed income securities trading activity, which are included in the Individual Investor and Institutional Investor segments, and net gains from market-making activities in Nasdaq and other equity securities, which are included in the Capital Markets segment. Factors that influence principal transaction revenues include the volume of client trades, market price volatility, average - 18 - revenue per share traded, and changes in regulations and industry practices. Principal transaction revenues were $47 million for the third quarter of 2002, up $5 million, or 12%, from the third quarter of 2001, as shown in the following table (in millions): - -------------------------------------------------------------------------------- Three Months Ended September 30, Percent Principal Transactions 2002 2001 Change - -------------------------------------------------------------------------------- Fixed income securities $ 25 $ 18 39% Nasdaq and other equity securities 19 22 (14) Other 3 2 50 - -------------------------------------------------------------------------------- Total $ 47 $ 42 12% ================================================================================ The increase in principal transaction revenues was primarily due to higher revenues from client fixed income securities trading activity and higher equity share volume handled by SCM, partially offset by lower average revenue per equity share traded. Other Revenues Other revenues were $32 million for the third quarter of 2002, down $23 million, or 42%, from the third quarter of 2001. This decrease was primarily due to a gain recorded on the sale of an investment in 2001. EXPENSES EXCLUDING INTEREST Total expenses excluding interest for the third quarter of 2002 increased $39 million, or 4%, from the third quarter of 2001, primarily due to restructuring charges, partially offset by decreases in certain expenses as a result of the Company's continued expense reduction measures. The Company recorded total pre-tax restructuring charges of $160 million in the third quarter of 2002. In the third quarter of 2001, the Company recorded total pre-tax restructuring charges of $99 million. Compensation and benefits expense was $472 million for the third quarter of 2002, up $11 million, or 2%, from the third quarter of 2001 primarily due to the accrual of discretionary bonuses to employees and higher incentive compensation and employee benefits, partially offset by a reduction in full-time equivalent employees in the third quarter of 2002. The following table shows a comparison of certain compensation and benefits components and employee data (dollars in millions, except as noted): - -------------------------------------------------------------------------------- Three Months Ended September 30, Percent 2002 2001 Change - -------------------------------------------------------------------------------- Compensation and benefits: Salaries and wages $ 326 $ 345 (6%) Incentive and variable compensation 73 52 40 Employee benefits and other 73 64 14 - -------------------------------------------------------------------------------- Total compensation and benefits $ 472 $ 461 2% - -------------------------------------------------------------------------------- Compensation and benefits expense as a % of total revenues 46% 45% Incentive and variable compensation as a % of compensation and benefits expense 15% 11% Compensation for temporary employees, contractors and overtime hours as a % of compensation and benefits expense 6% 6% Full-time equivalent employees (at end of quarter, in thousands) (1) 18.8 21.9 (14%) Revenues per average full-time equivalent employee (in thousands) $54.5 $46.3 18% - -------------------------------------------------------------------------------- (1) Includes full-time, part-time, and temporary employees, and persons employed on a contract basis. Employee benefits and other expenses increased by $9 million, or 14%, from the third quarter of 2001 primarily due to an increase in the obligations under the Company's deferred compensation plan, and higher health insurance costs and employee claims. Additionally, employee benefits and other expense includes net pension expense (income) related to U.S. Trust's defined benefit pension plan, which totaled less than $1 million and ($3) million in the third quarters of 2002 and 2001, respectively. The increase in pension expense from the third quarter of 2001 was primarily due to a decline in the fair value of pension plan assets, as well as an increase in the service cost resulting from a greater number of employees covered under the pension plan, and a lower assumed discount rate used in the expense calculation. Goodwill amortization expense for the third quarter of 2001 was $17 million. On January 1, 2002, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 142 - Goodwill and Other Intangible Assets. Upon adoption of SFAS No. 142, amortization of the existing goodwill ceased and therefore there was no such expense in the third quarter of 2002. The Company's effective income tax benefit rate was 34.2% for the third quarter of 2002, compared to an effective income tax expense rate of 49.4% for the third quarter of 2001. The decrease was primarily due to the - 19 - cessation of goodwill amortization, which was nondeductible for tax purposes, upon the adoption of SFAS No. 142 in 2002. Nine Months Ended September 30, 2002 Compared To Nine Months Ended September 30, 2001 FINANCIAL OVERVIEW In the difficult market environment that prevailed during the first nine months of 2002, daily average revenue trades decreased 18% and average revenue per equity share traded in the Capital Markets segment decreased 44% from year-earlier levels. As a result of these two factors, the Company's trading revenues in the first nine months of 2002 decreased 13% from the first nine months of 2001 and total revenues decreased 5% for the same period. Non-trading revenues in the first nine months of 2002 were comparable to the year-ago level. Asset management and administration fees increased 7% in the first nine months of 2002 compared to the year-ago level, primarily resulting from an increase in assets in, and service fees earned on, SchwabFunds, as well as higher account fees. This increase was substantially offset by a 10% decrease in net interest revenue, as average margin loans to clients in the first nine months of 2002 decreased 30% from year-ago levels, as well as a 5% decrease in other revenues. Total expenses excluding interest during the first nine months of 2002 were $2.9 billion, down 9% from $3.1 billion during the first nine months of 2001. This decrease resulted primarily from the Company's continued expense reduction measures, including the restructuring initiatives implemented during 2001. In June 2001, U.S. Trust sold its Corporate Trust business to The Bank of New York Company, Inc. (Bank of NY). The Company recorded an extraordinary gain of $221 million, or $121 million after tax, on this sale in the second quarter of 2001. During the first quarter of 2002, the Company recorded an extraordinary gain of $22 million, or $12 million after tax, which represented the remaining proceeds from this sale that were realized upon satisfaction of certain client retention requirements. The Company's after-tax operating income for the first nine months of 2002 was $310 million, up 4% from the first nine months of 2001, and its after-tax operating profit margin for the first nine months of 2002 was 9.9%, up from 9.1% for the first nine months of 2001. A reconciliation of the Company's operating income to net income is shown in the following table (in millions): - -------------------------------------------------------------------------------- Nine Months Ended September 30, Percent 2002 2001 Change - -------------------------------------------------------------------------------- Operating income, after tax $ 310 $ 298 4% Non-operating items: Extraordinary gain (1) 22 221 (90) Other income(2) 26 Restructuring charges (3) (190) (216) (12) Other charges (4) (28) Merger- and acquisition-related charges (5) (27) (91) (70) - -------------------------------------------------------------------------------- Total non-operating items (195) (88) 122 Tax effect 73 2 n/m - -------------------------------------------------------------------------------- Total non-operating items, after tax (122) (86) 42 - -------------------------------------------------------------------------------- Net income $ 188 $ 212 (11%) ================================================================================ (1) The Company recorded an extraordinary pre-tax gain, net of closing and exit costs, from the sale of USTC's Corporate Trust business to The Bank of New York Company, Inc. in June 2001. In March 2002, the Company recorded an extraordinary pre-tax gain for the remaining proceeds related to client retention requirements for this sale. (2) Primarily consists of a gain on the sale of an investment. (3) Restructuring charges include costs relating to workforce, facilities, systems hardware, software, and equipment reductions. (4) Includes a regulatory fine, professional service fees for operational and risk management remediation, and the write-off of certain software development costs. (5) Includes retention program compensation related to the merger with USTC, and intangible asset amortization and retention program compensation related to the acquisition of CyberTrader. The retention programs related to the acquisition of CyberTrader and the merger with USTC ended in March 2002 and May 2002, respectively. For the nine months ended September 30, 2001, amount also includes goodwill amortization, which ceased on January 1, 2002 upon the adoption of SFAS No. 142. n/m Not meaningful The Company's operating income before taxes for the first nine months of 2002 was $498 million, up $25 million, or 5%, from the first nine months of 2001 due to increases of $46 million, or 31%, in the Individual Investor segment and $16 million, or 17%, in the U.S. Trust segment, partially offset by decreases of $21 million, or 10%, in the Institutional Investor segment and $16 million, or 57%, in the Capital Markets segment. These fluctuations were primarily due to the factors described in the comparison between the three-month periods, as well as higher net interest revenue in the U.S. Trust segment due to an increase in loans to banking clients, and lower average revenue per equity share traded and lower levels of trading activity in the Capital Markets segment. - 20 - The Company's net income for the first nine months of 2002 was $188 million, or $.14 per share, compared to $212 million, or $.15 per share, for the first nine months of 2001. The Company's after-tax profit margin for the first nine months of 2002 was 6.0%, down from 6.4% for the first nine months of 2001. The annualized return on stockholders' equity for the first nine months of 2002 was 6%, down from 7% for the first nine months of 2001. REVENUES Revenues declined $155 million, or 5%, to $3.1 billion in the first nine months of 2002 compared to the first nine months of 2001, due to a $119 million, or 12%, decrease in commission revenues, a $71 million, or 10%, decrease in net interest revenue, a $45 million, or 23%, decrease in principal transaction revenues, and a $6 million, or 5%, decrease in other revenues. These declines were partially offset by an $86 million, or 7%, increase in asset management and administration fees. As trading volumes decreased during the first nine months of 2002, the Company's non-trading revenues represented 66% of total revenues as compared to 63% for the first nine months of 2001 as shown in the following table: - -------------------------------------------------------------------------------- Nine Months Ended September 30, Composition of Revenues 2002 2001 - -------------------------------------------------------------------------------- Commissions 29% 31% Principal transactions 5 6 - -------------------------------------------------------------------------------- Total trading revenues 34 37 - -------------------------------------------------------------------------------- Asset management and administration fees 42 38 Net interest revenue 21 22 Other 3 3 - -------------------------------------------------------------------------------- Total non-trading revenues 66 63 - -------------------------------------------------------------------------------- Total 100% 100% ================================================================================ The $155 million decline in revenues from the first nine months of 2001 was primarily due to decreases in revenues of $89 million, or 5%, in the Individual Investor segment and $70 million, or 27%, in the Capital Markets segment. The decrease in the Capital Markets segment was primarily due to lower average revenue per equity share traded and lower equity share volume handled by SCM, partially offset by higher revenues from client fixed income securities trading activity. See note "12 - Segment Information" in the Notes to Condensed Consolidated Financial Statements for financial information by segment. Asset Management and Administration Fees Asset management and administration fees were $1.3 billion for the first nine months of 2002, up $86 million, or 7%, from the first nine months of 2001, as shown in the following table (in millions): - -------------------------------------------------------------------------------- Nine Months Ended Asset Management September 30, Percent and Administration Fees 2002 2001 Change - -------------------------------------------------------------------------------- Mutual fund service fees: Proprietary funds (SchwabFunds(R)and Excelsior(R)) $ 655 $ 599 9% Mutual Fund OneSource(R) 204 214 (5) Other 30 30 Asset management and related services 436 396 10 - -------------------------------------------------------------------------------- Total $ 1,325 $ 1,239 7% ================================================================================ The increase in asset management and administration fees was due to the factors described in the comparison between the three-month periods. During the first nine months of 2002, net new client assets and new accounts decreased from the first nine months of 2001 as shown in the following table. - -------------------------------------------------------------------------------- Nine Months Ended Change in Client Assets and Accounts September 30, Percent (In billions, except as noted) 2002 2001 Change - -------------------------------------------------------------------------------- Net change in assets in client accounts Net new client assets $ 37.5 $ 60.1 Net market losses (156.6) (163.4) - ----------------------------------------------------------------- Net decline $(119.1) $(103.3) ================================================================= New client accounts (in thousands) 616.5 730.5 (16%) ================================================================================ Commissions Commission revenues for the Company were $906 million for the first nine months of 2002, down $119 million, or 12%, from the first nine months of 2001. - 21 - The Company's client trading activity is shown in the following table (in thousands): - -------------------------------------------------------------------------------- Nine Months Ended September 30, Percent Daily Average Trades 2002 2001 Change - -------------------------------------------------------------------------------- Revenue Trades (1) Online 112.8 136.9 (18%) TeleBroker(R)and Schwab by PhoneTM 5.9 7.7 (23) Regional client telephone service centers, branch offices, and other 16.2 19.2 (16) - -------------------------------------------------------------------------------- Total 134.9 163.8 (18%) ================================================================================ Mutual Fund OneSource(R) and Other Asset-Based Trades Online 47.0 35.7 32% TeleBroker and Schwab by Phone .4 .5 (20) Regional client telephone service centers, branch offices, and other 10.2 18.6 (45) - -------------------------------------------------------------------------------- Total 57.6 54.8 5% ================================================================================ Total Daily Average Trades Online 159.8 172.6 (7%) TeleBroker and Schwab by Phone 6.3 8.2 (23) Regional client telephone service centers, branch offices, and other 26.4 37.8 (30) - -------------------------------------------------------------------------------- Total 192.5 218.6 (12%) ================================================================================ (1) Includes all client trades (both individuals and institutions) that generate either commission revenue or revenue from principal markups (i.e., fixed income). As shown in the following table, the total number of revenue trades executed by the Company has decreased 16% as the number of accounts that traded and client trading activity per account that traded have declined. - -------------------------------------------------------------------------------- Nine Months Ended September 30, Percent Trading Activity 2002 2001 Change - -------------------------------------------------------------------------------- Total revenue trades (1) (in thousands) 25,367 30,155 (16%) Accounts that traded during the period (in thousands) 2,474 2,642 (6) Average revenue trades per account that traded 10.3 11.4 (10) Trading frequency proxy (2) 3.8 4.3 (12) Number of trading days 188 184 2 Average revenue earned per revenue trade $37.87 $34.71 9 - -------------------------------------------------------------------------------- (1) Includes all client trades (both individuals and institutions) that generate either commission revenue or revenue from principal markups (i.e., fixed income). (2) Represents annualized revenue trades per $100,000 in client assets. Net Interest Revenue Net interest revenue was $648 million for the first nine months of 2002, down $71 million, or 10%, from the first nine months of 2001 as shown in the following table (in millions): - -------------------------------------------------------------------------------- Nine Months Ended September 30, Percent 2002 2001 Change - -------------------------------------------------------------------------------- Interest Revenue Margin loans to clients $ 370 $ 698 (47%) Investments, client-related 255 448 (43) Private banking loans 178 177 1 Securities available for sale 59 62 (5) Other 58 124 (53) - -------------------------------------------------------------------------------- Total 920 1,509 (39) - -------------------------------------------------------------------------------- Interest Expense Brokerage client cash balances 141 606 (77) Deposits from banking clients 72 104 (31) Long-term debt 37 42 (12) Short-term borrowings 19 18 6 Stock-lending activities 3 17 (82) Other 3 n/m - -------------------------------------------------------------------------------- Total 272 790 (66) - -------------------------------------------------------------------------------- Net interest revenue $ 648 $ 719 (10%) ================================================================================ n/m Not meaningful - 22 - Client-related and other daily average balances, interest rates, and average net interest spread for the first nine months of 2002 and 2001 are summarized in the following table (dollars in millions): - -------------------------------------------------------------------------------- Nine Months Ended September 30, 2002 2001 - -------------------------------------------------------------------------------- Interest-Earning Assets (client-related and other): Investments (client-related): Average balance outstanding $ 18,112 $ 13,367 Average interest rate 1.89% 4.48% Margin loans to clients: Average balance outstanding $ 8,507 $ 12,203 Average interest rate 5.78% 7.64% Private banking loans: Average balance outstanding $ 4,099 $ 3,328 Average interest rate 5.81% 7.12% Securities available for sale: Average balance outstanding $ 1,524 $ 1,341 Average interest rate 5.22% 6.15% Average yield on interest-earning assets 3.57% 6.12% Funding Sources (client-related and other): Interest-bearing brokerage client cash balances: Average balance outstanding $ 23,142 $ 22,209 Average interest rate .82% 3.65% Interest-bearing banking deposits: Average balance outstanding $ 3,857 $ 3,296 Average interest rate 2.48% 4.20% Other interest-bearing sources: Average balance outstanding $ 1,035 $ 1,189 Average interest rate 2.23% 4.36% Average noninterest-bearing portion $ 4,208 $ 3,545 Average interest rate on funding sources .96% 3.31% Summary: Average yield on interest-earning assets 3.57% 6.12% Average interest rate on funding sources .96% 3.31% - -------------------------------------------------------------------------------- Average net interest spread 2.61% 2.81% ================================================================================ The decrease in net interest revenue from the first nine months of 2001 was due to the factors described in the comparison between the three-month periods. Principal Transactions Principal transaction revenues were $147 million for the first nine months of 2002, down $45 million, or 23%, from the first nine months of 2001, as shown in the following table (in millions): - -------------------------------------------------------------------------------- Nine Months Ended September 30, Percent Principal Transactions 2002 2001 Change - -------------------------------------------------------------------------------- Fixed income securities $ 72 $ 47 53% Nasdaq and other equity securities 66 131 (50) Other 9 14 (36) - -------------------------------------------------------------------------------- Total $147 $192 (23%) ================================================================================ The decrease in principal transaction revenues was due to the change to decimal pricing, which was fully implemented in the second quarter of 2001, and lower equity share volume handled by SCM, partially offset by higher revenues from client fixed income securities trading activity. Other Revenues Other revenues were $113 million for the first nine months of 2002, down $6 million, or 5%, from the first nine months of 2001. This decrease was due to lower investment gains, partially offset by higher trade-related service fees. EXPENSES EXCLUDING INTEREST Total expenses excluding interest for the first nine months of 2002 declined $272 million, or 9%, from the first nine months of 2001. The Company's initiatives under its restructuring plan and other expense reduction measures have resulted in decreases in most expense categories during the first nine months of 2002 when compared to the first nine months of 2001. The Company recorded total pre-tax charges of $190 million in the first nine months of 2002 for restructuring charges under its restructuring initiatives. In the first nine months of 2001, the Company recorded total pre-tax restructuring and other charges of $244 million. Compensation and benefits expense was $1.4 billion for the first nine months of 2002, down $20 million, or 1%, from the first nine months of 2001 primarily due to a reduction in full-time equivalent employees, partially offset by the accrual of discretionary bonuses to employees in the first nine months of 2002, and higher incentive compensation and employee benefits. The following table shows a comparison of certain compensation and benefits components and employee data (dollars in millions, except as noted): - 23 - - -------------------------------------------------------------------------------- Nine Months Ended September 30, Percent 2002 2001 Change - -------------------------------------------------------------------------------- Compensation and benefits: Salaries and wages $ 974 $1,062 (8%) Incentive and variable compensation 204 154 32 Employee benefits and other 235 217 8 - -------------------------------------------------------------------------------- Total compensation and benefits $1,413 $1,433 (1%) - -------------------------------------------------------------------------------- Compensation and benefits expense as a % of total revenues 45% 44% Incentive and variable compensation as a % of compensation and benefits expense 14% 11% Compensation for temporary employees, contractors and overtime hours as a % of compensation and benefits expense 6% 6% Full-time equivalent employees (at end of period, in thousands) (1) 18.8 21.9 (14%) Revenues per average full-time equivalent employee (in thousands) $163.3 $139.5 17% - -------------------------------------------------------------------------------- (1) Includes full-time, part-time, and temporary employees, and persons employed on a contract basis. Employee benefits and other expenses increased by $18 million, or 8%, from the first nine months of 2001 primarily due to the factors discussed in the comparison between the three-month periods. Additionally, employee benefits and other expense includes net pension income related to U.S. Trust's defined benefit pension plan, which totaled less than $1 million and $9 million for the first nine months of 2002 and 2001, respectively. The decrease in net pension income from the prior period was primarily due to the factors described in the comparison between the three-month periods. Communications expense was $200 million for the first nine months of 2002, down $64 million, or 24%, from the first nine months of 2001. This decrease was primarily due to lower client trading volumes and the Company's expense reduction measures. Goodwill amortization expense for the first nine months of 2001 was $49 million. Upon adoption of SFAS No. 142 on January 1, 2002, amortization of the existing goodwill ceased and therefore there was no such expense in the first nine months of 2002. The Company did not record any goodwill impairment charges in the first nine months of 2002 upon completion of the initial transitional impairment test under SFAS No. 142. The Company's effective income tax rate was 37.8% for the first nine months of 2002, down from 44.9% for the first nine months of 2001. The decrease was primarily due to the factors described in the comparison between the three-month periods. Liquidity and Capital Resources CSC is a financial holding company, which is a type of bank holding company subject to supervision and regulation by the Federal Reserve Board under the Bank Holding Company Act of 1956, as amended. CSC conducts virtually all business through its wholly owned subsidiaries. The capital structure among CSC and its subsidiaries is designed to provide each entity with capital and liquidity consistent with its operations. See note "10 - Regulatory Requirements" in the Notes to Condensed Consolidated Financial Statements. Liquidity CSC CSC's liquidity needs are generally met through cash generated by its subsidiaries, as well as cash provided by external financing. As discussed below, Schwab, CSC's depository institution subsidiaries, and SCM are subject to regulatory requirements that may restrict them from certain transactions with CSC. Management believes that funds generated by the operations of CSC's subsidiaries will continue to be the primary funding source in meeting CSC's liquidity needs, meeting CSC's depository institution subsidiaries' capital guidelines, and maintaining Schwab's and SCM's net capital. Based on their respective regulatory capital ratios at September 30, 2002, the Company and its depository institution subsidiaries are considered well capitalized. CSC has liquidity needs that arise from its issued and outstanding $577 million Senior Medium-Term Notes, Series A (Medium-Term Notes), as well as from the funding of cash dividends, acquisitions, and other investments. The Medium-Term Notes have maturities ranging from 2002 to 2010 and fixed interest rates ranging from 6.04% to 8.05% with interest payable semiannually (see Item 3 - - Quantitative and Qualitative Disclosures About Market Risk - Interest Rate Swaps). The Medium-Term Notes are rated A2 by Moody's Investors Service (Moody's), A- by Standard & Poor's Ratings Group (S&P), and A by Fitch IBCA, Inc. (Fitch). CSC has a prospectus supplement on file with the Securities and Exchange Commission enabling CSC to issue up to $750 million in Senior or Senior Subordinated Medium-Term Notes, Series A. At September 30, 2002, all of these notes remained unissued. CSC has authorization from its Board of Directors to issue up to $1.0 billion in commercial paper. At September 30, 2002, no commercial paper has been issued. CSC's ratings for these short-term borrowings are P-1 by Moody's, A-2 by S&P, and F1 by Fitch. CSC maintains a $1.0 billion committed, unsecured credit facility with a group of twenty-two banks which is - 24 - scheduled to expire in June 2003. This facility was unused during the first nine months of 2002. Any issuances under CSC's commercial paper program will reduce the amount available under this facility. The funds under this facility are available for general corporate purposes and CSC pays a commitment fee on the unused balance of this facility. The financial covenants in this facility require CSC to maintain a minimum level of tangible net worth, and Schwab and SCM to maintain specified levels of net capital, as defined. Management believes that these restrictions will not have a material effect on its ability to meet foreseeable dividend or funding requirements. CSC also has direct access to $670 million of the $770 million uncommitted, unsecured bank credit lines, provided by eight banks that are primarily utilized by Schwab to manage short-term liquidity. The amount available to CSC under these lines is lower than the amount available to Schwab because the credit line provided by one of these banks is only available to Schwab. These lines were not used by CSC during the first nine months of 2002. Schwab Liquidity needs relating to client trading and margin borrowing activities are met primarily through cash balances in brokerage client accounts, which were $23.3 billion and $25.0 billion at September 30, 2002 and December 31, 2001, respectively. Management believes that brokerage client cash balances and operating earnings will continue to be the primary sources of liquidity for Schwab in the future. Schwab is subject to regulatory requirements that are intended to ensure the general financial soundness and liquidity of broker-dealers. These regulations prohibit Schwab from repaying subordinated borrowings to CSC, paying cash dividends, or making unsecured advances or loans to its parent or employees if such payment would result in net capital of less than 5% of aggregate debit balances or less than 120% of its minimum dollar requirement of $1 million. At September 30, 2002, Schwab's net capital was $1.2 billion (17% of aggregate debit balances), which was $1.0 billion in excess of its minimum required net capital and $825 million in excess of 5% of aggregate debit balances. Schwab has historically targeted net capital to be at least 10% of its aggregate debit balances, which primarily consist of client margin loans. To manage Schwab's regulatory capital position, CSC provides Schwab with a $1.4 billion subordinated revolving credit facility which is scheduled to expire in September 2003. The amount outstanding under this facility at September 30, 2002 was $220 million. At quarter end, Schwab also had outstanding $25 million in fixed-rate subordinated term loans from CSC maturing in 2004. Borrowings under these subordinated lending arrangements qualify as regulatory capital for Schwab. To manage short-term liquidity, Schwab main tains uncommitted, unsecured bank credit lines with a group of eight banks totaling $770 million at September 30, 2002 (as noted previously, $670 million of these lines are also available for CSC to use). The need for short-term borrowings arises primarily from timing differences between cash flow requirements and the scheduled liquidation of interest-bearing investments. Schwab used such borrowings for 11 days during the first nine months of 2002, with the daily amounts borrowed averaging $39 million. There were no borrowings outstanding under these lines at September 30, 2002. To satisfy the margin requirement of client option transactions with the Options Clearing Corporation (OCC), Schwab had unsecured letter of credit agreements with nine banks in favor of the OCC aggregating $630 million at September 30, 2002. Schwab pays a fee to maintain these letters of credit. No funds were drawn under these letters of credit at September 30, 2002. U.S. Trust U.S. Trust's liquidity needs are generally met through earnings generated by its operations. U.S. Trust is subject to the Federal Reserve Board's risk-based and leverage capital guidelines. These regulations require banks and bank holding companies to maintain minimum levels of capital. In addition, CSC's depository institution subsidiaries are subject to limitations on the amount of dividends they can pay to USTC. In addition to traditional funding sources such as deposits, federal funds purchased, and repurchase agreements, CSC's depository institution subsidiaries have established their own external funding sources. At September 30, 2002, U.S. Trust had $50 million in Trust Preferred Capital Securities outstanding with a fixed interest rate of 8.41%. Certain of CSC's depository institution subsidiaries have established credit facilities with the Federal Home Loan Bank System (FHLB) totaling $699 million. There were no borrowings outstanding under these facilities at September 30, 2002. Additionally, at September 30, 2002, U.S. Trust had $362 million of federal funds purchased and $387 million of repurchase agreements outstanding. CSC provides U.S. Trust with a $300 million short-term credit facility maturing in 2003. Borrowings under this facility do not qualify as regulatory capital for U.S. Trust. The amount outstanding under this facility was $35 million at September 30, 2002. SCM SCM's liquidity needs are generally met through earnings generated by its operations. Most of SCM's assets are liquid, consisting primarily of cash and cash - 25 - equivalents, receivables from brokers, dealers and clearing organizations, and marketable securities. SCM's liquidity is affected by the same net capital regulatory requirements as Schwab (see discussion above). At September 30, 2002, SCM's net capital was $67 million, which was $66 million in excess of its minimum required net capital. SCM may borrow up to $150 million under a subordinated lending arrangement with CSC which is scheduled to expire in August 2003. Borrowings under this arrangement qualify as regulatory capital for SCM. The amount outstanding under this facility at September 30, 2002 was $60 million. The advances under this facility satisfy increased intra-day capital needs at SCM to support the expansion of its institutional equities and trading businesses. In addition, CSC provides SCM with a $50 million short-term credit facility. Borrowings under this arrangement do not qualify as regulatory capital for SCM. No funds were drawn under this facility at September 30, 2002. Liquidity Risk Factors Specific risk factors which may affect the Company's liquidity position are discussed in "Management's Discussion and Analysis of Results of Operations and Financial Condition - Liquidity and Capital Resources - Liquidity Risk Factors" in the Company's 2001 Annual Report to Stockholders, which is filed as Exhibit 13.1 to the Company's Form 10-K for the year ended December 31, 2001. There have been no material changes to these liquidity risk factors in the first nine months of 2002. Cash Flows and Capital Resources Net income plus depreciation and amortization including goodwill amortization was $431 million for the first nine months of 2002, down 16% from $513 million for the first nine months of 2001. Depreciation and amortization expense related to equipment, office facilities and property was $234 million for the first nine months of 2002, as compared to $244 million for the first nine months of 2001, or 7% of revenues for both periods. Amortization expense related to intangible assets was $9 million for the first nine months of 2002 and $8 million for the first nine months of 2001. Goodwill amortization expense was $49 million for the first nine months of 2001. The Company's cash position (reported as cash and cash equivalents on the condensed consolidated balance sheet) and cash flows are affected by changes in brokerage client cash balances and the associated amounts required to be segregated under federal or other regulatory guidelines. Timing differences between cash and investments actually segregated on a given date and the amount required to be segregated for that date may arise in the ordinary course of business and are addressed by the Company in accordance with applicable regulations. Other factors which affect the Company's cash position and cash flows include investment activity in securities owned, levels of capital expenditures, banking client deposit and loan activity, financing activity in short-term borrowings and long-term debt, and repurchases of CSC's common stock. In the first nine months of 2002, cash and cash equivalents decreased $1.9 billion, or 43%, to $2.5 billion primarily due to movements of brokerage client-related funds to meet segregation requirements, decreases in brokerage client cash balances, increases in investments in securities available for sale, and decreases in deposits from banking clients. Management does not believe that this decline in cash and cash equivalents is an indication of a trend. The Company's capital expenditures were $114 million in the first nine months of 2002 and $266 million in the first nine months of 2001, or 4% and 8% of revenues for each period, respectively. Capital expenditures in the first nine months of 2002 were for software and equipment relating to the Company's information technology systems and certain facilities. Capital expenditures as described above include the capitalized costs for developing internal-use software of $53 million in the first nine months of 2002 and $62 million in the first nine months of 2001. As discussed in the Company's 2001 Annual Report to Stockholders, which is filed as Exhibit 13.1 to the Company's Form 10-K for the year ended December 31, 2001, management anticipated that 2002 capital expenditures would be approximately 10% to 20% lower than 2001 spending of $301 million. Additionally, management anticipated that 2002 development spending (i.e., media and project spending) would be approximately 5% to 10% lower than 2001 spending of $406 million. Due to a continued economic slowdown and management's continued focus on cost containment, the Company further reduced its capital expenditures and development spending in the first nine months of 2002. Management currently anticipates that full-year 2002 capital expenditures will be approximately 45% to 55% lower than 2001 levels and that full-year 2002 development spending will be approximately 15% to 25% lower than 2001 levels. During the first nine months of 2002, 4 million of the Company's stock options, with a weighted-average exercise price of $6.53, were exercised with cash proceeds received by the Company of $23 million and a related tax benefit of $3 million. The cash proceeds are recorded as an increase in cash and a corresponding increase in stockholders' equity. The tax benefit is recorded as a reduction in income taxes payable and a corresponding increase in stockholders' equity. The Company borrowed $100 million and repaid $203 million of long-term debt during the first nine months of 2002. - 26 - During the first nine months of 2002, CSC repurchased 24 million shares of its common stock for $230 million. During the first nine months of 2001, CSC repurchased 23 million shares of its common stock for $315 million. At September 30, 2002, the authorization granted by the Board of Directors allows for future repurchases of CSC's common stock totaling up to $169 million of the original $500 million authorization. During the first nine months of 2002 and 2001, the Company paid common stock cash dividends of $45 million and $46 million, respectively. The Company monitors both the relative composition and absolute level of its capital structure. The Company's total financial capital (long-term debt plus stockholders' equity) at September 30, 2002 was $4.8 billion, down $98 million, or 2%, from December 31, 2001 due to a net decline in long-term debt. At September 30, 2002, the Company had long-term debt of $652 million, or 14% of total financial capital, that bears interest at a weighted-average rate of 7.37%. At September 30, 2002, the Company's stockholders' equity was $4.1 billion, or 86% of total financial capital. Commitments A summary of the Company's principal contractual obligations and other commitments as of September 30, 2002 is shown in the following table (in millions). Management believes that funds generated by its operations, as well as cash provided by external financing, will continue to be the primary funding sources in meeting these obligations and commitments. - -------------------------------------------------------------------------------- Less than 1 - 3 4 - 5 After 5 1 Year Years Years Years Total - -------------------------------------------------------------------------------- Operating leases (1) $ 102 $ 889 $ 267 $ 773 $2,031 Long-term debt (2) 11 237 106 273 627 Short-term borrowings 760 760 Credit-related financial instruments (3) 599 120 719 Other commitments (4) 6 6 - -------------------------------------------------------------------------------- Total $1,478 $1,246 $ 373 $1,046 $4,143 ================================================================================ (1) Includes minimum rental commitments and maximum guaranteed residual values under noncancelable leases for office space and equipment. (2) Excludes the effect of interest rate swaps, see Item 3 - Quantitative and Qualitative Disclosures About Market Risk - Interest Rate Swaps. (3) Includes U.S. Trust firm commitments to extend credit primarily for mortgage loans to private banking clients and standby letters of credit. (4) Includes committed capital contributions to venture capital funds. In addition to the commitments summarized above, in the ordinary course of its business the Company has entered into various agreements with third-party vendors, including agreements for advertising, sponsorships of sporting events, data processing equipment purchases, licensing, and software installation. These agreements typically can be canceled by the Company if notice is given within the terms specified in the agreements. Item 3. Quantitative and Qualitative Disclosures About Market Risk Financial Instruments Held For Trading Purposes The Company holds municipal, other fixed income and government securities, and certificates of deposit in inventory to meet clients' trading activities. The fair value of such inventory was approximately $59 million and $36 million at September 30, 2002 and December 31, 2001, respectively. These securities, and the associated interest rate risk, are not material to the Company's financial position, results of operations, or cash flows. The Company maintains inventories in exchange-listed, Nasdaq, and other equity securities on both a long and short basis. The fair value of these securities at September 30, 2002 and December 31, 2001 are shown in the following table (in millions): - -------------------------------------------------------------------------------- September 30, December 31, Equity Securities 2002 2001 - -------------------------------------------------------------------------------- Long positions $ 69 $167 Short positions 12 27 - -------------------------------------------------------------------------------- Net long positions $ 57 $140 ================================================================================ Using a hypothetical 10% increase or decrease in prices, the potential loss or gain in fair value is estimated to be approximately $6 million and $14 million at September 30, 2002 and December 31, 2001. In addition, the Company generally enters into exchange-traded futures and options contracts based on equity market indices to hedge potential losses in equity inventory positions. The notional amounts and fair values of these futures and options contracts are shown in the following table (in millions): - -------------------------------------------------------------------------------- September 30, December 31, Exchange-traded Contracts 2002 2001 - -------------------------------------------------------------------------------- Net Short Futures (1): Notional Amount $ 59 $125 Fair Value $ 55 $125 Long Put Options: Notional Amount $ 8 $ 23 Fair Value (2) - -------------------------------------------------------------------------------- (1) Notional amount represents original contract price of the futures. Fair value represents the index price. The difference between the notional and fair value amounts are settled daily in accordance with futures market requirements. (2) Amount was less than $1 million at both September 30, 2002 and December 31, 2001. - 27 - Using a hypothetical 10% increase or decrease in the underlying indices, the potential loss or gain in fair value is estimated to be approximately $6 million and $13 million at September 30, 2002 and December 31, 2001, respectively, which would substantially offset the potential loss or gain on the equity securities previously discussed. Financial Instruments Held For Purposes Other Than Trading Deferred Compensation The Company maintains investments in mutual funds related to its deferred compensation plan, which is available to certain employees. These investments were approximately $46 million and $61 million at September 30, 2002 and December 31, 2001, respectively. These securities, and the associated market risk, are not material to the Company's financial position, results of operations, or cash flows. Debt Issuances At September 30, 2002, CSC had $577 million aggregate principal amount of Medium-Term Notes, with fixed interest rates ranging from 6.04% to 8.05%. At December 31, 2001, CSC had $679 million aggregate principal amount of Medium-Term Notes, with fixed interest rates ranging from 6.04% to 8.05%. See "Interest Rate Swaps" below. At September 30, 2002 and December 31, 2001, U.S. Trust had $50 million Trust Preferred Capital Securities outstanding, with a fixed interest rate of 8.41%. In addition at December 31, 2001, U.S. Trust had $1 million FHLB long-term debt outstanding with a fixed interest rate of 6.69%. The Company has fixed cash flow requirements regarding these long-term debt obligations due to the fixed rate of interest. The fair value of these obligations at September 30, 2002 and December 31, 2001, based on estimates of market rates for debt with similar terms and remaining maturities, approximated their carrying amount. Interest Rate Swaps As part of its consolidated asset and liability management process, the Company utilizes interest rate swaps (Swaps) to manage interest rate risk. U.S. Trust uses Swaps to hedge the interest rate risk associated with its variable rate deposits from banking clients. These Swaps call for U.S. Trust to receive a variable rate of interest and pay a fixed rate of interest. At September 30, 2002, these Swaps had a weighted-average variable interest rate of 1.84%, a weighted-average fixed interest rate of 6.36%, a weighted-average maturity of 1.9 years, and an aggregate notional principal amount of $880 million. At December 31, 2001, the notional principal amount of such Swaps totaled $905 million, and they carried a weighted-average variable interest rate of 2.15%, a weighted-average fixed interest rate of 6.37%, and a weighted-average maturity of 2.6 years. These Swaps have been designated as cash flow hedges under SFAS No. 133 - Accounting for Derivative Instruments and Hedging Activities, and are recorded on the condensed consolidated balance sheet, with changes in their fair values primarily recorded in other comprehensive income (loss), a component of stockholders' equity. At September 30, 2002 and December 31, 2001, U.S. Trust recorded a derivative liability of $69 million and $54 million, respectively, for these Swaps. Based on current interest rate assumptions and assuming no additional swap agreements are entered into, U.S. Trust expects to reclassify approximately $21 million, or $14 million after tax, from other comprehensive loss to interest expense over the next twelve months. Using Swaps to hedge variable rate deposits enables U.S. Trust to fund long-term fixed-rate financial instruments with a fixed-rate source, effectively creating a positive interest rate spread over the life of the Swaps. As a result, U.S. Trust expects that the long-term fixed-rate financial instruments will generate interest income that will offset the amount of interest expense that is anticipated to be reclassified from other comprehensive loss over the period. During the second quarter of 2002, CSC entered into Swaps with an aggregate notional principal amount of $293 million that effectively alter the interest rate characteristics of a like amount of its Medium-Term Notes. These Swaps call for CSC to receive a fixed rate of interest and pay a variable rate of interest based on the three-month LIBOR rate. At September 30, 2002, the net effect of the Swaps converted the Medium-Term Notes from a weighted-average fixed interest rate of 7.57% to a weighted-average variable interest rate of 4.26%. The variable interest rates reset every three months. These Swaps have been designated as fair value hedges under SFAS No. 133, and are recorded on the condensed consolidated balance sheet. Changes in fair value of the Swaps are completely offset by changes in fair value of the hedged Medium-Term Notes, resulting in no effect on earnings. At September 30, 2002, CSC recorded a derivative asset of $25 million for these Swaps. Concurrently, the carrying value of the Medium-Term Notes was increased by $25 million. Net Interest Revenue Simulation The Company uses net interest revenue simulation modeling techniques to evaluate and manage the effect of changing interest rates. The simulation model (the model) includes all interest-sensitive assets and liabilities, as well as Swaps utilized by the Company to hedge its interest rate risk. Key variables in the model include assumed margin - 28 - loan and brokerage client cash balance growth or decline, changes to the level and term structure of interest rates, the repricing of financial instruments, prepayment and reinvestment assumptions, loan, banking deposit, and brokerage client cash balance pricing and volume assumptions. The simulations involve assumptions that are inherently uncertain and as a result, the simulations cannot precisely estimate net interest revenue or precisely predict the impact of changes in interest rates on net interest revenue. Actual results may differ from simulated results due to the timing, magnitude, and frequency of interest rate changes as well as changes in market conditions and management strategies, including changes in asset and liability mix. As demonstrated by the simulations presented below, the Company is positioned so that the consolidated balance sheet produces an increase in net interest revenue when interest rates rise and, conversely, a decrease in net interest revenue when rates fall (i.e., interest-earning assets are repricing more quickly than interest-bearing liabilities). The Swaps entered into during the second quarter of 2002 have the effect of increasing the repricing frequency of interest-bearing liabilities, thereby reducing the Company's consolidated interest-rate sensitivity. The simulations in the following table assume that the asset and liability structure of the consolidated balance sheet would not be changed as a result of the simulated changes in interest rates. As the Company actively manages its consolidated balance sheet and interest rate exposure, in all likelihood the Company would take steps to manage any additional interest rate exposure that could result from changes in the interest rate environment. The following table shows the effect of a gradual 100 basis point increase or decrease in interest rates relative to the Company's current base rate forecast on simulated net interest revenue over the next twelve months at September 30, 2002 and December 31, 2001. - -------------------------------------------------------------------------------- Impact on Net Interest Revenue September 30, December 31, Percentage Increase (Decrease) 2002 2001 - -------------------------------------------------------------------------------- Increase of 100 basis points 2.3% 3.8% Decrease of 100 basis points (2.6%) (7.0%) - -------------------------------------------------------------------------------- The impact of the Company's hedging activities upon net interest revenue for the quarters ended September 30, 2002 and December 31, 2001 was immaterial to the Company's results of operations. Item 4. Controls and Procedures An evaluation was performed under the supervision and with the participation of the Company's management, including the Co-Chief Executive Officers and Chief Financial Officer, of the effectiveness of the design, maintenance, and operation of the Company's disclosure controls and procedures within 90 days before the filing date of this quarterly report. Based on that evaluation, the Company's management, including the Co-Chief Executive Officers and Chief Financial Officer, concluded that the Company's disclosure controls and procedures were effective. There have been no significant changes in the Company's internal controls or in other factors that could significantly affect internal controls subsequent to their evaluation. PART II - OTHER INFORMATION Item 1. Legal Proceedings In March 2000, three purported class action complaints were filed against U.S. Trust Company, N.A. (USTC N.A.) in U.S. District Court in Louisiana. All three suits are brought on behalf of participants in an employee stock ownership plan (UC ESOP) sponsored by United Companies Financial Corporation (United Companies), which is currently in bankruptcy proceedings in Delaware. Plaintiffs allege that USTC N.A., as directed trustee of the UC ESOP, breached its fiduciary duties under the Employee Retirement Income Security Act of 1974 by failing to diversify the assets of the UC ESOP. In December 2001, plaintiffs and USTC N.A. reached a tentative settlement of $10 million. Under the terms of this settlement, plaintiffs would release USTC N.A. of all liability. Other than an insignificant deductible, the settlement would be paid from insurance coverage. The parties are in the process of finalizing the proposed settlement documentation and are preparing to file a motion for a preliminary approval of the settlement with the U. S. District Court in Louisiana. If and when preliminary approval is granted, notice of the settlement will be distributed to members of the class and a final fairness hearing will be held for final approval of the settlement. In January 2001, three purported class action complaints and a number of related individual cases were filed against U.S. Trust NY and other defendants. In some of these cases, USTC N.A. was also named as a defendant. The plaintiffs in all of these cases are former personal injury plaintiffs (Payees) who are entitled to future payments under "structured settlement" agreements. The settlement payments are obligations of Stanwich Financial Services Corp. (Stanwich), as Trustor of certain Trusts, and Stanwich has defaulted on certain of those obligations. USTC N.A. - 29 - served as Trustee of the Trusts from approximately December 1992 to March 1994, and U.S. Trust NY served as Trustee from approximately September 1998 until its resignation in April 2001. During the period from March 1994 to September 1998, while an unrelated trust company was the Trustee of the Trusts, the U.S. Treasury securities held by the trusts were pledged as collateral for a loan or loans and then lost through foreclosure. The class actions and all but two of the individual cases have been filed in California (the California cases), and have been consolidated. The other two individual cases have been filed in Montana. In the complaints now applicable to these cases, the plaintiffs allege that, as Trustee during their respective tenures, U.S. Trust NY and USTC N.A. owed certain duties to the Payees, and breached those duties in various ways. The plaintiffs in these cases seek unspecified compensatory damages, punitive damages and other relief. In the cases, U.S. Trust NY and USTC N.A. have answered the complaints, denying the allegations and raising certain affirmative defenses, and have filed cross-complaints for indemnity against other defendants in the cases. In the California cases, the Court ordered the class certified on February 13, 2002. U.S. Trust NY and USTC N.A. intend to defend the cases vigorously. In October 2001, partnership and individual plaintiffs filed a complaint against U.S. Trust Company of Texas, N.A. (U.S. Trust Texas), USTC and other defendants, relating to defaults that have occurred under bonds issued in a series of eleven bond offerings (Heritage Bonds). The proceeds of the Heritage Bonds, issued between December 1996 and March 1999, were for the purpose of financing the acquisition and/or renovation of a long-term care facility or hospital. U.S. Trust Texas was indenture trustee under various trust indentures executed in connection with the Heritage Bonds. Although U.S. Trust sold its corporate trust business in 2001, under the sale agreement, U.S. Trust retains responsibility for certain litigation, including these cases. The first Heritage Bond complaint was followed by the filing of five more complaints, four of them purported class actions. Five of the six actions, including the four class actions, have been filed in state or federal courts in California (the California cases); the remaining action has been filed in federal court in Illinois (the Illinois case). In these complaints, the plaintiffs allege that, as indenture trustee, U.S. Trust Texas owed certain duties to the plaintiffs, and breached those duties in various ways. In the California cases, the putative plaintiff class seeks compensatory damages in excess of $100 million, punitive damages and other relief. In the Illinois case, the plaintiff seeks compensatory damages in excess of $4.8 million, punitive damages and other relief. U.S. Trust Texas and/or USTC have filed motions seeking dismissal of two of the five California cases and the Illinois case. U.S. Trust Texas and USTC filed a motion with the Judicial Panel on Multidistrict Litigation to consolidate the Illinois case and the federal California cases and that motion was granted. U.S. Trust Texas and USTC intend to defend all of these cases vigorously. U.S. Trust NY was Escrow Agent and Indenture Trustee in connection with an offering of approximately $130 million in senior secured redeemable notes issued in July 1998 by Epic Resorts, LLC (Epic Notes). In January 2002, certain noteholders filed a complaint in the Supreme Court of New York, New York County against U.S. Trust NY alleging that U.S. Trust NY failed to comply with its obligations as Escrow Agent and Indenture Trustee for the Epic Notes. Although USTC sold its Corporate Trust business in 2001, under the sale agreement, USTC retains responsibility for certain litigation, including this case. The plaintiff noteholders claim that as a result of the alleged breaches, they suffered financial losses, including losing their investment in the Epic Notes, in the amount of $88 million. U.S. Trust NY has answered the complaint, denying plaintiffs' allegations and asserting affirmative defenses, and intends to vigorously defend the lawsuit. The nature of the Company's business, including its new products and services, subjects it to claims, lawsuits, regulatory examinations, and other proceedings in the ordinary course of business. The results of these matters cannot be predicted with certainty. There can be no assurance that these matters will not have a material adverse effect on the Company's results of operations in any future period, depending partly on the results for that period, and a substantial judgment could have a material adverse impact on the Company's financial condition, results of operations, and cash flows. However, it is the opinion of management, after consultation with legal counsel, that the ultimate outcome of existing claims and proceedings will not have a material adverse impact on the financial condition, results of operations, or cash flows of the Company. Item 2. Changes in Securities and Use of Proceeds None. Item 3. Defaults Upon Senior Securities None. Item 4. Submission of Matters to a Vote of Security Holders None. - 30 - Item 5. Other Information Effective October 1, 2002, the Board of Directors of U.S. Trust Corporation (U.S. Trust) appointed Alan J. Weber as Chief Executive Officer of U.S. Trust. Mr. Weber succeeds Jeffrey S. Maurer, who will remain as Chairman of U.S. Trust for a transitional period and will become chairman of Schwab's Affluent Client Strategy and Policy Committee. Mr. Maurer will also remain on the Company's Executive Committee. In addition to his role as chief executive of U.S. Trust, Mr. Weber will serve on the Company's Executive Committee. Item 6. Exhibits and Reports on Form 8-K (a) The following exhibits are filed as part of this quarterly report on Form 10-Q. - -------------------------------------------------------------------------------- Exhibit Number Exhibit - -------------------------------------------------------------------------------- 10.242 The Charles Schwab Corporation 1987 Stock Option Plan, amended and restated as of September 25, 2002, with form of Non-Qualified Stock Option Agreement attached (supersedes Exhibit 10.222). 10.243 The Charles Schwab Corporation 1987 Executive Officer Stock Option Plan, amended and restated as of September 25, 2002, with form of Non-Qualified Stock Option Agreement attached (supersedes Exhibit 10.223). 10.244 The Charles Schwab Corporation 1992 Stock Incentive Plan, amended and restated as of September 25, 2002 (supersedes Exhibit 10.224). 10.245 The Charles Schwab Corporation 2001 Stock Incentive Plan, amended and restated as of September 25, 2002 (supersedes Exhibit 10.225). 10.246 Executive Employment Agreement by and among The Charles Schwab Corporation, Schwab Capital Markets L.P., and Lon Gorman, and Supplemental Agreement thereto. 10.247 The Charles Schwab Severance Pay Plan, restated as of August 1, 2002. 12.1 Computation of Ratio of Earnings to Fixed Charges. - -------------------------------------------------------------------------------- (b) Reports on Form 8-K On August 13, 2002, the Registrant filed a Current Report on Form 8-K which included sworn statements under oath executed by the Chairman of the Board and Co-Chief Executive Officer, President and Co-Chief Executive Officer, and Executive Vice President and Chief Financial Officer in accordance with the Securities and Exchange Commission Order No. 4-460 Requiring the Filing of Sworn Statements Pursuant to Section 21(a)(1) of the Securities Exchange Act of 1934. SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. THE CHARLES SCHWAB CORPORATION (Registrant) Date: November 12, 2002 /s/ Christopher V. Dodds -------------------- ------------------------------ Christopher V. Dodds Executive Vice President and Chief Financial Officer - 32 - CERTIFICATION I, Charles R. Schwab, certify that: 1. I have reviewed this quarterly report on Form 10-Q of The Charles Schwab Corporation; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the Evaluation Date); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 12, 2002 /s/ Charles R. Schwab ----------------- ---------------------------------------------------- Charles R. Schwab Chairman of the Board and Co-Chief Executive Officer - 33 - CERTIFICATION I, David S. Pottruck, certify that: 1. I have reviewed this quarterly report on Form 10-Q of The Charles Schwab Corporation; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the Evaluation Date); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 12, 2002 /s/ David S. Pottruck ----------------- ---------------------------------------- David S. Pottruck President and Co-Chief Executive Officer - 34 - CERTIFICATION I, Christopher V. Dodds, certify that: 1. I have reviewed this quarterly report on Form 10-Q of The Charles Schwab Corporation; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the Evaluation Date); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 12, 2002 /s/ Christopher V. Dodds ----------------- ----------------------------------------------------- Christopher V. Dodds Executive Vice President and Chief Financial Officer - 35 - EX-10 3 exh10_242.txt EXHIBIT 10_242 Exhibit 10.242 THE CHARLES SCHWAB CORPORATION 1987 STOCK OPTION PLAN (Restated to include Amendments through September 25, 2002) Article 1. Introduction. The purpose of the 1987 Stock Option Plan, as Amended and Restated (the "Plan") is to enable The Charles Schwab Corporation and its subsidiaries to attract and retain directors, officers, and other key employees and to provide such persons with additional incentive to advance the interests of the Company. The Plan was initially adopted on March 24, 1987, and was amended on July 29, 1987, April 17, 1989, September 17, 1996 and October 22, 1997. The Plan is hereby restated and amended as of October 22, 1997, and the terms of this Restatement shall apply to all awards granted under the Plan on or after such date. The Plan shall terminate not more than ten (10) years from the date the Plan initially was adopted. The Plan will provide for Awards in the form of Restricted Shares, Performance Share Awards or Options, which may constitute incentive stock options or nonstatutory stock options. The Plan shall be governed by, and construed in accordance with, the laws of the State of Delaware. Article 2. Administration. 2.1 The Committee. The Plan shall be administered by the Committee. The Committee shall consist of two or more Non-Employee Directors, who shall be appointed by the Board. 2.2 Committee Responsibilities. The Committee shall select the Key Employees who are to receive Awards under the Plan, determine the amount, vesting requirements and other conditions of such Awards, may interpret the Plan, and make all other decisions relating to the operation of the Plan. The Committee may adopt such rules or guidelines as it deems appropriate to implement the Plan. The Committee's determinations under the Plan shall be final and binding on all persons. Article 3. Limitation on Awards. The aggregate number of Restricted Shares, Performance Share Awards and Options awarded under the Plan shall not exceed 1,616,000 (including those shares awarded prior to the amendment of the Plan). If any Restricted Shares, Performance Share Awards or Options are forfeited, or if any Performance Share Awards terminate for any other reason without the associated Common Shares being issued, or if any Options terminate for any other reason before being exercised, then such Restricted Shares, Performance Share Awards or Options shall again become available for Awards under the Plan. The limitation of this Article 3 shall be subject to adjustment pursuant to Article 10. Any Common Shares issued pursuant to the Plan may be authorized but unissued shares or treasury shares. Article 4. Eligibility. 4.1 General Rule. Key Employees shall be eligible for designation as Participants by the Committee. 4.2 Ten-Percent Stockholders. A Key Employee who owns more than 10 percent of the total combined voting power of all classes of outstanding stock of the Company or any of its Subsidiaries shall not be eligible for the grant of an ISO unless (a) the Exercise price under such ISO is at least 110 percent of the Fair Market Value of a Common Share on the date of grant and (b) such ISO by its terms is not exercisable after the expiration of five years from the date of grant. 4.3 Attribution Rules. For purposes of Section 4.2, in determining stock ownership, a Key Employee shall be deemed to own the stock owned, directly or indirectly, by or for his or her brothers, sisters, spouse, ancestors or lineal descendants. Stock owned, directly or indirectly, by or for a corporation, partnership, estate or trust shall be deemed to be owned proportionately by or for its stockholders, partners or beneficiaries. Stock with respect to which the Key Employee holds an option shall not be counted. 4.4 Outstanding Stock. For purposes of Section 4.2, "outstanding stock" shall include all stock actually issued and outstanding immediately after the grant of the ISO to the Key Employee. "Outstanding stock" shall not include treasury shares or shares authorized for issuance under outstanding options held by the Key Employee or by any other person. Article 5. Options. 5.1 Stock Option Agreement. Each grant of an Option under the Plan shall be evidenced by a Stock Option Agreement between the Optionee and the Company. Such Option shall be subject to all applicable terms and conditions of the Plan, and may be subject to any other terms and conditions which are not inconsistent with the Plan and which the Committee deems appropriate for inclusion in a Stock Option Agreement. The provisions of the various Stock Option Agreements entered into under the Plan need not be identical. The Committee may designate all or any part of an Option as an ISO. The Committee may designate all or any part of an Option as an ISO (or, in the case of a Key Employee who is subject to the tax laws of a foreign jurisdiction, as an option qualifying for favorable tax treatment under the laws of such foreign jurisdiction). 5.2 Options Nontransferability. No Option granted under the Plan shall be transferable by the Optionee other than by will or the laws of descent and distribution. An Option may be exercised during the lifetime of the Optionee only by him or her. No Option or interest therein may be transferred, assigned, pledged or hypothecated by the Optionee during his or her lifetime, whether by operation of law or otherwise, or be made subject to execution, attachment or similar process. 5.3 Number of Shares. Each Stock Option Agreement shall specify the number of Common Shares subject to the Option and shall provide for the adjustment of such number in accordance with Article 10. Each Stock Option Agreement shall also specify whether the Option is an ISO or an NSO. 5.4 Exercise Price. Each Stock Option Agreement shall specify the Exercise Price. The Exercise Price under an Option shall not be less than 100 percent of the Fair Market Value of a Common Share on the date of grant, except as otherwise provided in Section 4.2. Subject to the preceding sentence, the Exercise Price under any Option shall be determined by the Committee. The Exercise Price shall be payable in accordance with Article 6. 5.5 Exercisability and Term. Each Stock Option Agreement shall specify the date when all or any installment of the Option is to become exercisable. The Stock Option Agreement shall also specify the term of the Option. The term of an ISO shall in no event exceed 10 years from the date of grant, and Section 4.2 may require a shorter term. Subject to the preceding sentence, the Committee shall determine when all or any part of an Option is to become exercisable and when such Option is to expire; provided that, in appropriate cases, the Company shall have the discretion to extend the term of an Option or the time within which, following termination of employment, an Option may be exercised, or to accelerate the exercisability of an Option. A Stock Option Agreement may provide for expiration prior to the end of its term in the event of the termination of the Optionee's employment and shall provide for the suspension of vesting when an employee is on a leave of absence for a period in excess of six months in appropriate cases, as determined by the Company; provided that the exercisability of Options shall be accelerated in the event of the Participant's death or Disability and, in the case of Retirement, the exercisability of all outstanding Options shall be accelerated, other than any Options that had been granted within two years of the date of the Optionee's Retirement. NSOs may also be awarded in combination with Restricted Shares, and such an Award may provide that the NSOs will not be exercisable unless the related Restricted Shares are forfeited. In addition, NSOs granted under this Section 5 may be granted subject to forfeiture provisions which provide for forfeiture of the Option upon the exercise of tandem awards, the terms of which are established in other programs of the Company. 5.6 Limitation on Amount of ISOs. The aggregate fair market value (determined at the time the ISO is granted) of the Common Shares with respect to which ISOs are exercisable for the first time by the Optionee during any calendar year (under all incentive stock option plans of the Company) shall not exceed $100,000; provided, however, that all or any portion of an Option which cannot be exercised as an ISO because of such limitation shall be treated as an NSO. 5.7 Effect of Change in Control. The Committee (in its sole discretion) may determine, at the time of granting an Option, that such Option shall become fully exercisable as to all Common Shares subject to such Option immediately preceding any Change in Control with respect to the Company. 5.8 Restrictions on Transfer of Common Shares. Any Common Shares issued upon exercise of an Option shall be subject to such special forfeiture conditions, rights of repurchase, rights of first refusal and other transfer restrictions as the Committee may determine. Such restrictions shall be set forth in the applicable Stock Option Agreement and shall apply in addition to any general restrictions that may apply to all holders of Common Shares. 5.9 Authorization of Replacement Options. Concurrently with the grant of any Option to a Participant, the Committee may authorize the grant of Replacement Options. If Replacement Options have been authorized by the Committee with respect to a particular award of Options (the "Underlying Options"), the Option Agreement with respect to the Underlying Options shall so state, and the terms and conditions of the Replacement Options shall be provided therein. The grant of any Replacement Options shall be effective only upon the exercise of the Underlying Options through the use of Common Shares pursuant to Section 6.2 or Section 6.3. The number of Replacement Options shall equal the number of Common Shares used to exercise the Underlying Options, and, if the Option Agreement so provides, the number of Common Shares used to satisfy any tax withholding requirements incident to the exercise of the Underlying Options in accordance with Section 12.2. Upon the exercise of the Underlying Options, the Replacement Options shall be evidenced by an amendment to the Underlying Option Agreement. Notwithstanding the fact that the Underlying Option may be an ISO, a Replacement Option is not intended to qualify as an ISO. The Exercise Price of a Replacement Option shall be no less than the Fair Market Value of a Common Share on the date the grant of the Replacement Option becomes effective. The term of each Replacement Option shall be equal to the remaining term of the Underlying Option. No Replacement Options shall be granted to Optionees when Underlying Options are exercised pursuant to the terms of the Plan and the Underlying Option Agreement following termination of the Optionee's employment. The Committee, in its sole discretion, may establish such other terms and conditions for Replacement Options as it deems appropriate. 5.10 Options Granted to Non-United States Key Employees. In the case of Key Employees who are subject to the tax laws of a foreign jurisdiction, the Company may issue Options to such Key Employees that contain terms required to conform with any requirements for favorable tax treatment imposed by the laws of such foreign jurisdiction, or as otherwise may be required by the laws of such foreign jurisdiction. The terms of any such Options shall be governed by the Plan, subject to the terms of any Addendum to the Plan specifically applicable to such Options. 5.11 Effect of Job Elimination. Notwithstanding anything to the contrary contained in the Plan or in any Stock Option Agreement or Stock Award Agreement entered into with respect to an Award pursuant to the Plan, in the case of a Participant who is an Officer, and who becomes entitled to receive payments with respect to a Severance Period pursuant to the Charles Schwab Severance Pay Plan (the "Severance Plan") on account of a Job Elimination, the terms of the Plan and any Stock Option Agreement or Stock Award Agreement entered into with respect to an Award shall be applied by treating the Participant as if the Participant had terminated employment on the Participant's Termination Date. For purposes of applying this Section, the terms Officer, Severance Period, Termination Date, and Job Elimination shall have the meanings set forth in the Severance Plan. Article 6. Payment for Option Shares. 6.1 General Rule. The entire Exercise Price of Common Shares issued upon exercise of Options shall be payable in cash at the time when such Common Shares are purchased, except as follows: (a) In the case of an ISO granted under the Plan, payment shall be made only pursuant to the express provisions of the applicable Stock Option Agreement. However, the Committee may specify in the Stock Option Agreement that payment may be made pursuant to Section 6.2 or 6.3. (b) In the case of an NSO, the Committee may at any time accept payment pursuant to Section 6.2 or 6.3. 6.2 Surrender of Stock. To the extent that this Section 6.2 is applicable, payment for all or any part of the Exercise Price may be made with Common Shares which are surrendered to the Company. Such Common Shares shall be valued at their Fair Market Value on the date when the new Common Shares are purchased under the Plan. In the event that the Common Shares being surrendered are Restricted Shares that have not yet become vested, the same restrictions shall be imposed upon the new Common Shares being purchased. 6.3 Exercise/Sale. To the extent this Section 6.3 is applicable, payment may be made by the delivery (on a form prescribed by the Company) of an irrevocable direction to Charles Schwab & Co., Inc. to sell Common Shares (including the Common Shares to be issued upon exercise of the Options) and to deliver all or part of the sales proceeds to the Company in payment of all or part of the Exercise Price and any withholding taxes. Article 7. Restricted Shares and Performance Share Awards. 7.1 Time, Amount and Form of Awards. The Committee may grant Restricted Shares or Performance Share Awards with respect to an Award Year during such Award Year or at any time thereafter. Each such Award shall be evidenced by a Stock Award Agreement between the Award recipient and the Company. The amount of each Award of Restricted Shares or Performance Share Awards shall be determined by the Committee. Awards under the Plan may be granted in the form of Restricted Shares or Performance Share Awards or in any combination thereof, as the Committee shall determine at its sole discretion at the time of the grant. Restricted Shares or Performance Share Awards may also be awarded in combination with NSOs, and such an Award may provide that the Restricted Shares or Performance Share Awards will be forfeited in the event that the related NSOs are exercised. 7.2 Payment for Restricted Share Awards. To the extent that an Award is granted in the form of Restricted Shares, the Award recipient, as a condition to the grant of such Award, shall be required to pay the Company in cash an amount equal to the par value of such Restricted Shares. 7.3 Vesting or Issuance Conditions. Each Award of Restricted Shares shall become vested, in full or in installments, upon satisfaction of the conditions specified in the Stock Award Agreement. Common Shares shall be issued pursuant to Performance Share Awards in full or in installments upon satisfaction of the issuance conditions specified in the Stock Award Agreement. The Committee shall select the vesting conditions in the case of Restricted Shares, or issuance conditions in the case of Performance Share Awards, which may be based upon the Participant's service, the Participant's performance, the Company's performance or such other criteria as the Committee may adopt; provided that, in the case of an Award of Restricted Shares where vesting is based entirely on the Participant's service, (i) vesting shall be accelerated in the event of the Participant's death or Disability; (ii) in the case of Retirement, vesting shall be accelerated for all Restricted Shares that had been granted more than two years prior to the date of the Participant's Retirement; and (iii) vesting shall be suspended when an employee is on a leave of absence for a period in excess of six months in appropriate cases, as determined by the Company. The Committee, in its sole discretion, may determine, at the time of making an Award of Restricted Shares, that such Award shall become fully vested in the event that a Change in Control occurs with respect to the Company. The Committee, in its sole discretion, may determine, at the time of making a Performance Share Award, that the issuance conditions set forth in such Award shall be waived in the event that a Change in Control occurs with respect to the Company. 7.4 Form of Settlement of Performance Share Awards. Settlement of Performance Share Awards shall only be made in the form of Common Shares. Until a Performance Share Award is settled, the number of Performance Share Awards shall be subject to adjustment pursuant to Article 10. 7.5 Death of Recipient. Any Common Shares that are to be issued pursuant to a Performance Share Award after the recipient's death shall be delivered or distributed to the recipient's beneficiary or beneficiaries. Each recipient of a Performance Share Award under the Plan shall designate one or more beneficiaries for this purpose by filing the prescribed form with the Company. A beneficiary designation may be changed by filing the prescribed form with the Company at any time before the Award recipient's death. If no beneficiary was designated or if no designated beneficiary survives the Award recipient, then any Common Shares that are to be issued pursuant to a Performance Share Award after the recipient's death shall be delivered or distributed to the recipient's estate. The Committee, in its sole discretion, shall determine the form and time of any distribution(s) to a recipient's beneficiary or estate. Article 8. Claims Procedures. Claims for benefits under the Plan shall be filed in writing with the Committee on forms supplied by the Committee. Written notice of the disposition of a claim shall be furnished to the claimant within 90 days after the claim is filed. If the claim is denied, the notice of disposition shall set forth the specific reasons for the denial, citations to the pertinent provisions of the Plan, and, where appropriate, an explanation as to how the claimant can perfect the claim. If the claimant wishes further consideration of his or her claim, the claimant may appeal a denied claim to the Committee (or to a person designated by the Committee) for further review. Such appeal shall be filed in writing with the Committee on a form supplied by the Committee, together with a written statement of the claimant's position, no later than 90 days following receipt by the claimant of written notice of the denial of his or her claim. If the claimant so requests, the Committee shall schedule a hearing. A decision on review shall be made after a full and fair review of the claim and shall be delivered in writing to the claimant no later than 60 days after the Committee's receipt of the notice of appeal, unless special circumstances (including the need to hold a hearing) require an extension of time for processing the appeal, in which case a written decision on review shall be delivered to the claimant as soon as possible but not later than 120 days after the Committee's receipt of the appeal notice. The claimant shall be notified in writing of any such extension of time. The written decision on review shall include specific reasons for the decision, written in a manner calculated to be understood by the claimant, and shall specifically refer to the pertinent Plan provisions on which it is based. All determinations of the Committee shall be final and binding on Participants and their beneficiaries. Article 9. Voting Rights and Dividends. 9.1 Restricted Shares. (a) All holders of Restricted Shares who are not Named Executive Officers shall have the same voting, dividend, and other rights as the Company's other stockholders. (b) During the period of restriction, Named Executive Officers holding Restricted Shares granted hereunder shall be credited with all regular cash dividends paid with respect to all Restricted Shares while they are so held. If a dividend is paid in the form of cash, such cash dividend shall be credited to Named Executive Officers subject to the same restrictions on transferability and forfeitability as the Restricted Shares with respect to which they were paid. If any dividends or distributions are paid in shares of Common Stock, the shares of Common Stock shall be subject to the same restrictions on transferability and forfeitability as the Restricted Shares with respect to which they were paid. Subject to the succeeding paragraph, and to the restrictions on vesting and the forfeiture provisions, all dividends credited to a Named Executive Officer shall be paid to the Named Executive Officer within forty-five (45) days following the full vesting of the Restricted Shares with respect to which such dividends were earned. In the event that any dividend constitutes a "derivative security" or an "equity security" pursuant to Rule 16(a) under the Exchange Act, such dividend shall be subject to a vesting period equal to the longer of: (i) the remaining vesting period of the Restricted Shares with respect to which the dividend is paid; or (ii) six (6) months. The Committee shall establish procedures for the application of this provision. Named Executive Officers holding Restricted Shares shall have the same voting rights as the Company's other stockholders. 9.2 Performance Share Awards. The holders of Performance Share Awards shall have no voting or dividend rights until such time as any Common Shares are issued pursuant thereto, at which time they shall have the same voting, dividend and other rights as the Company's other stockholders. Article 10. Protection Against Dilution; Adjustment of Awards. 10.1 General. In the event of a subdivision of the outstanding Common Shares, a declaration of a dividend payable in Common Shares, a declaration of a dividend payable in a form other than Common Shares, a combination or consolidation of the outstanding Common Shares (by reclassification or otherwise) into a lesser number of Common Shares, a recapitalization, a spinoff or a similar occurrence, the Committee shall make appropriate adjustments in one or more of (a) the number of Options, Restricted Shares and Performance Share Awards available for future Awards under Article 3, (b) the number of Performance Share Awards included in any prior Award which has not yet been settled, (c) the number of Common Shares covered by each outstanding Option or (d) the Exercise Price under each outstanding Option. 10.2 Reorganizations. In the event that the Company is a party to a merger or other reorganization, outstanding Options, Restricted Shares and Performance Share Awards shall be subject to the agreement of merger or reorganization. Such agreement may provide, without limitation, for the assumption of outstanding Awards by the surviving corporation or its parent, for their continuation by the Company (if the Company is a surviving corporation), for accelerated vesting or for settlement in cash. 10.3 Reservation of Rights. Except as provided in this Article 10, a Participant shall have no rights by reason of any subdivision or consolidation of shares of stock of any class, the payment of any stock dividend or any other increase or decrease in the number of shares of stock of any class. Any issue by the Company of shares of stock of any class, or securities convertible into shares of stock of any class, shall not affect, and no adjustment by reason thereof shall be made with respect to, the number or Exercise Price of Common Shares subject to an Option. The grant of an Award pursuant to the Plan shall not affect in any way the right or power of the Company to make adjustments, reclassifications, reorganizations or changes of its capital or business structure, to merge or consolidate or to dissolve, liquidate, sell or transfer all or any part of its business or assets. Article 11. Limitation of Rights. 11.1 Employment Rights. Neither the Plan nor any Award granted under the Plan shall be deemed to give any individual a right to remain employed by the Company or any Subsidiary. The Company and its Subsidiaries reserve the right to terminate the employment of any employee at any time, with or without cause, subject only to a written employment agreement (if any). 11.2 Stockholders' Rights. A Participant shall have no dividend rights, voting rights or other rights as a stockholder with respect to any Common Shares covered by his or her Award prior to the issuance of a stock certificate for such Common Shares. No adjustment shall be made for cash dividends or other rights for which the record date is prior to the date when such certificate is issued, except as expressly provided in Articles 7, 9 and 10. 11.3 Creditors' Rights. A holder of Performance Share Awards shall have no rights other than those of a general creditor of the Company. Performance Share Awards represent unfunded and unsecured obligations of the Company, subject to the terms and conditions of the applicable Stock Award Agreement. 11.4 Government Regulations. Any other provision of the Plan notwithstanding, the obligations of the Company with respect to Common Shares to be issued pursuant to the Plan shall be subject to all applicable laws, rules and regulations, and such approvals by any governmental agencies as may be required. The Company reserves the right to restrict, in whole or in part, the delivery of Common Shares pursuant to any Award until such time as: (a) Any legal requirements or regulations have been met relating to the issuance of such Common Shares or to their registration, qualification or exemption from registration or qualification under the Securities Act of 1933, as amended, or any applicable state securities laws; and (b) Satisfactory assurances have been received that such Common Shares, when issued, will be duly listed on the New York Stock Exchange or any other securities exchange on which Common Shares are then listed. Article 12. Withholding Taxes. 12.1 General. To the extent required by applicable federal, state, local or foreign law, the recipient of any payment or distribution under the Plan shall make arrangements satisfactory to the Company for the satisfaction of any withholding tax obligations that arise by reason of such payment or distribution. The Company shall not be required to make such payment or distribution until such obligations are satisfied. 12.2 Nonstatutory Options, Restricted Shares or Performance Share Awards. The Committee may permit an Optionee who exercises NSOs, or who receives Awards of Restricted Shares, or who receives Common Shares pursuant to the terms of a Performance Share Award, to satisfy all or part of his or her withholding tax obligations by having the Company withhold a portion of the Common Shares that otherwise would be issued to him or her under such Awards. Such Common Shares shall be valued at their Fair Market Value on the date when taxes otherwise would be withheld in cash. The payment of withholding taxes by surrendering Common Shares to the Company, if permitted by the Committee, shall be subject to such restrictions as the Committee may impose, including any restrictions required by rules of the Securities and Exchange Commission. Article 13. Assignment or Transfer of Award. 13.1 General Rule. Any Award granted under the Plan shall not be anticipated, assigned, attached, garnished, optioned, transferred or made subject to any creditor's process, whether voluntarily, involuntarily or by operation of law, except to the extent specifically permitted by Section 13.2. 13.2 Exceptions to General Rule. Notwithstanding Section 13.1, this Plan shall not preclude (i) a Participant from designating a beneficiary to succeed, after the Participant's death, to those of the Participant's Awards (including without limitation, the right to exercise any unexercised Options) as may be determined by the Company from time to time in its sole discretion, (ii) a transfer of any Award hereunder by will or the laws of descent or distribution, or (iii) a voluntary transfer of an Award (other than an ISO) to a trust, partnership or limited liability company for the benefit of one or more members of the Participant's family, subject to the prior approval of the Committee or its designee; provided that, in the case of an Award granted prior to September 25, 2002, such approval shall not be required for a transfer to a trust or partnership if the Participant has sole investment control over such trust or partnership. Article 14. Future of Plans. 14.1 Term of the Plan. The Plan, as set forth herein, shall become effective on February 26, 1997. The Plan shall remain in effect until it is terminated under Section 15.2, except that no Awards shall be made after March 24, 1997. 14.2 Amendment or Termination. The Board may at any time terminate this Plan, and the Board or the Committee make such modifications of the Plan as it shall deem advisable; provided, however, that any amendment of the Plan shall be subject to the approval of the Company's stockholders to the extent required by applicable laws, regulations or rules. 14.3 Effect of Amendment or Termination. No Award shall be made under the Plan after the termination thereof. The termination of the Plan, or any amendment thereof, shall not affect any Option, Restricted Share or Performance Share Award previously granted under the Plan. Article 15. Definitions. 15.1 "Award" means any award of an Option, a Restricted Share or a Performance Share Award under the Plan. 15.2 "Award Year" means a fiscal year beginning January 1 and ending December 31 with respect to which an Award may be granted. 15.3 "Board" means the Company's Board of Directors, as constituted from time to time. 15.4 "Change in Control" means the occurrence of any of the following events after the effective date of the Plan as set out in Section 15.1: (a) A change in control required to be reported pursuant to Item 6(e) of Schedule 14A of Regulation 14A under the Exchange Act; (b) A change in the composition of the Board, as a result of which fewer than two-thirds of the incumbent directors are directors who either (i) had been directors of the Company 24 months prior to such change or (ii) were elected, or nominated for election, to the Board with the affirmative votes of at least a majority of the directors who had been directors of the Company 24 months prior to such change and who were still in office at the time of the election or nomination; (c) Any "person" (as such term is used in sections 13(d) and 14(d) of the Exchange Act) becomes the beneficial owner, directly or indirectly, of securities of the Company representing 20 percent or more of the combined voting power of the Company's then outstanding securities ordinarily (and apart from rights accruing under special circumstances) having the right to vote at elections of directors (the "Base Capital Stock"); provided, however, that any change in the relative beneficial ownership of securities of any person resulting solely from a reduction in the aggregate number of outstanding shares of Base Capital Stock, and any decrease thereafter in such person's ownership of securities, shall be disregarded until such person increases in any manner, directly or indirectly, such person's beneficial ownership of any securities of the Company. 15.5 "Code" means the Internal Revenue Code of 1986, as amended. 15.6 "Committee" means the Compensation Committee of the Board, as constituted from time to time. 15.7 "Common Share" means one share of the common stock of the Company. 15.8 "Company" means The Charles Schwab Corporation, a Delaware corporation. 15.9 "ERISA" means the Employee Retirement Income Security Act of 1974, as amended. 15.10 "Exchange Act" means the Securities Exchange Act of 1934, as amended. 15.11 "Exercise Price" means the amount for which one Common Share may be purchased upon exercise of an Option, as specified by the Committee in the applicable Stock Option Agreement. 15.12 "Fair Market Value" means the market price of a Common Share, determined by the committee as follows: (a) If the Common Share was traded on a stock exchange on the date in question, then the Fair Market Value shall be equal to the closing price reported by the applicable composite-transactions report for such date; (b) If the Common Share was traded over-the-counter on the date in question and was classified as a national market issue, then the Fair Market Value shall be equal to the last transaction price quoted by the NASDAQ system for such date; (c) If the Common Share was traded over-the-counter on the date in question but was not classified as a national market issue, then the Fair Market Value shall be equal to the mean between the last reported representative bid and asked prices quoted by the NASDAQ system for such date; and (d) If none of the foregoing provisions is applicable, then the Fair Market Value shall be determined by the Committee in good faith on such basis as it deems appropriate. 15.13 "ISO" means an incentive stock option described in section 422(b) of the Code. 15.14 "Key Employee" means a key common-law employee of the Company or any Subsidiary, as determined by the Committee. 15.15 "Named Executive Officer" means a Participant who, as of the date of vesting of an Award is one of a group of "covered employees," as defined in the Regulations promulgated under Code Section 162(m), or any successor statute. 15.16 "Non-Employee Director" means a member of the Board who is not a common-law employee. 15.17 "NSO" means an employee stock option not described in sections 422 through 424 of the Code. 15.18 "Option" means an ISO or NSO or, in the case of a Key Employee who is subject to the tax laws of a foreign jurisdiction, an option qualifying for favorable tax treatment under the laws of such jurisdiction, including a Replacement Option, granted under the Plan and entitling the holder to purchase one Common Share. 15.19 "Optionee" means an individual, or his or her estate, legatee or heirs at law that holds an Option. 15.20 "Participant" means a Non-Employee Director or Key Employee who has received an Award. 15.21 "Performance Share Award" means the conditional right to receive in the future one Common Share, awarded to a Participant under the Plan. 15.22 "Plan" means this 1987 Stock Option Plan of The Charles Schwab Corporation, as it may be amended from time to time. 15.23 "Replacement Option" means an Option that is granted when a Participant uses a Common Share held or to be acquired by the Participant to exercise an Option and/or to satisfy tax withholding requirements incident to the exercise of an Option. 15.24 "Restricted Share" means a Common SIhare awarded to a Participant under the Plan. 15.25 "Stock Award Agreement" means the agreement between the Company and the recipient of a Restricted Share or Performance Share Award which contains the terms, conditions and restrictions pertaining to such Restricted Share or Performance Share Award. 15.26 "Stock Option Agreement" means the agreement between the Company and an Optionee which contains the terms, conditions and restrictions pertaining to his or her option. 15.27 "Subsidiary" means any corporation, if the Company and/or one or more other Subsidiaries own not less than 50 percent of the total combined voting power of all classes of outstanding stock of such corporation. A corporation that attains the status of a Subsidiary on a date after the adoption of the Plan shall be considered a Subsidiary commencing as of such date. 15.28. "Retirement" shall mean any termination of employment of an Optionee for any reason other than death at any time after the Optionee has attained fifty (50), but only if, at the time of such termination, the Participant has been credited with at least seven (7) Years of Service under the Charles Schwab Profit Sharing and Employee Stock Ownership Plan. The foregoing definition shall apply to all Stock Option Agreements entered into pursuant to the Plan, irrespective of any definition to the contrary contained in any such Stock Option Agreement. 15.29 "Disability" means the inability to engage in any substantial gainful activity considering the Participant's age, education and work experience by reason of any medically determined physical or mental impairment that has continued without interruption for a period of at least six months and that can be expected to be of long, continued and indefinite duration. All determinations as to whether a Participant has incurred a Disability shall be made by the Employee Benefits Administration Committee of the Company, the findings of which shall be final, binding and conclusive. ADDENDUM A The provisions of the Plan, as amended by the terms of this Addendum A, shall apply to the grant of Approved Options to Key U.K. Employees. 1. For purposes of this Addendum A, the following definitions shall apply in addition to those set out in section 16 of the Plan: Approved Option Means a stock option designed to qualify as an approved executive share option under the Taxes Act; Inland Revenue means the Board of the Inland Revenue in the United Kingdom. Key U.K. Employee means a designated employee of Sharelink Investment Services plc or any subsidiary (as that term is defined in the Companies Act 1985 of the United Kingdom, as amended) of which Sharelink Investment Services plc has control for the purposes of section 840 of the Taxes Act; Taxes Act means the Income and Corporation Taxes Act 1988 of the United Kingdom. 2. An Approved Option may only be granted to a Key U.K. Employee who: (i) is employed on a full-time basis; and (ii) does not fall within the provisions of paragraph 8 of Schedule 9 to the Taxes Act. For purposes of this section 2(i) of Addendum A, "full-time" shall mean an employee who is required to work 20 hours per week, excluding meal breaks. 3. No Approved Option may be granted to a Key U.K. Employee if it would cause the aggregate of the exercise price of all subsisting Approved Options granted to such employee under the Plan, or any other subsisting options granted to such employee under any other share option scheme approved under Schedule 9 of the Taxes Act and established by the Company or an associated company, to exceed the higher of (a) one hundred thousand pounds sterling and (b) four times such employee's relevant emoluments for the current or preceding year of assessment (whichever is greater); but where there were no relevant emoluments for the previous year of assessment, the limit shall be the higher of one hundred thousand pounds sterling) or four times such employee's relevant emoluments for the period of twelve months beginning with the first day during the current year of assessment in respect of which there are relevant emoluments. For the purpose of this section 3 of Addendum A, "associated company" means an associated company within the meaning of section 416 of the Taxes Act; "relevant emoluments" has the meaning given by paragraph 28(4) of Schedule 9 to the Taxes Act and "year of assessment" means a year beginning on any April 6 and ending on the following April 5. 4. Common Shares issued pursuant to the exercise of Approved Options must satisfy the conditions specified in paragraphs 10 to 14 of Schedule 9 to the Taxes Act. 5. Notwithstanding the provisions of Section 5.4 of the Plan, the exercise price of an Approved Option shall not be less than 100 percent of the closing price of a Common Share as reported in the New York Stock Exchange Composite Index on the date of grant. 6. No Approved Option may be exercised at any time by a Key U.K. Employee when that Key U.K. Employee falls within the provisions of paragraph 8 of Schedule 9 to the Taxes Act. If at any time the shares under an Approved Option cease to comply with the conditions in paragraphs 10 to 14 of Schedule 9 to the Taxes Act, then all Approved Options then outstanding shall lapse and cease to be exercisable from the date of the shares ceasing so to comply, and no optionee shall have any cause of action against the Company, Sharelink Investment Services plc or any subsidiary of the Company or any other person in respect thereof. 7. An Approved Option may contain such other terms, provisions and conditions as may be determined by the Committee consistent with the Plan, provided that the approved option otherwise complies with the requirements for approved executive option schemes specified in Schedule 9 of the Taxes Act. 8. In relation to an Approved Option, notwithstanding the terms of section 10.1 of the Plan, no adjustment shall be made pursuant to section 10.1 of the Plan to any outstanding Approved Options without the prior approval of the Inland Revenue. 9. In relation to an Approved Option any Key U.K. Employee shall make arrangements satisfactory to the Company for the satisfaction of any tax withholding or deduction -- at -- source obligations that arise by reason of the grant to him or her of such option, or its subsequent exercise. 10. In relation to an Approved Option, in addition to the provisions set out in section 15.2 of the Plan, no amendment which affects any of the provisions of the Plan relating to Approved Options shall be effective until approved by the Inland Revenue, except for such amendment as are required to obtain and maintain the approval of Inland Revenue pursuant to Schedule 9 to the Taxes Act. NON-OUALIFIED STOCK OPTION AGREEMENT (1987 Stock Option Plan, as first amended) THIS AGREEMENT, made as of this _____ of _________, 19__, by and between The Charles Schwab Corporation a Delaware corporation ("Company"), and _______________ ("Optionee"). WITNESSETH: WHEREAS, there has been granted to Optionee, effective as of _________ __, 19____, a non-qualified stock option under the 1987 Stock Option Plan, as first amended, of the Company ("Option Plan"); NOW, THEREFORE, it is mutually agreed as follows: 1. The Optionee shall have a non-qualified stock option to acquire _____ shares of common stock of the Company (the "Shares"), at a price of $_______ per share. 2. Optionee acknowledges that paragraph 5(a) of the Option Plan imposes significant restrictions on Optionee's ability to exercise this option. 3. This is a non-statutory stock option and the provisions of paragraph 5(b) of the Option Plan are inapplicable to this Option. With that exception and except as provided in paragraphs 4, 5 and 6 below, the other terms of this option shall be the same as without limitation, vesting of Shares, limitations on exercise and transfer, and other restrictions. The Option Plan is attached hereto as Exhibit A and is incorporated herein by this reference. Optionee has read the Option Plan and, other than for the provisions of paragraph 5(b) of the Option Plan and as provided in paragraphs 4, 5 and 6 below, agrees to be bound by its terms. Without limitation, Optionee specifically acknowledges the representations, warranties and agreements contained in paragraph 6(e) of the Option Plan. 4. Notwithstanding paragraph 6(b) of the Option Plan, in the event Optionee's employment, service as a director or provision of independent contractor services with or for the Company and its subsidiaries terminates by reason of Optionee's death or permanent disability, all shares then not deemed to be Vested thereupon will be deemed immediately Vested. For this purpose, "permanent disability" will mean the reasonable determination by a qualified physician acceptable to the Company that the Optionee has an illness or incapacity that has disabled, or will disable, the Optionee from rendering his or her normal services to the company and its subsidiaries for a period of more than six (6) consecutive months in any consecutive twelve (12) month period. 5. If the Company fails to timely exercise its right to repurchase Unvested Shares, those Shares will be treated as Vested Shares. Options underlying Unvested Shares may not be exercised once vesting ceases. 6. Any notice to be given by the Optionee under the terms of the Option Plan shall be deemed to have been duly given, and effective upon receipt, if sent by Certified Mail, postage and certification prepaid, to The Charles Schwab Corporation, 101 Montgomery Street, San Francisco, California 94104, Attention: Corporate Secretary, except as superseded by a different address noticed to Optionee. IN WITNESS WHEREOF, the parties have caused this Agreement to be executed as of the day and year referred to above. BY: -------------------------------------- on Behalf of The Charles Schwab Corporation ("Company") -------------------------------------- Optionee Attachments: (1) Spousal Consent (2) Exhibit A: 1987 Stock Option Plan, as first amended. EX-10 4 exh10_243.txt EXHIBIT 10_243 Exhibit 10.243 THE CHARLES SCHWAB CORPORATION 1987 EXECUTIVE OFFICER STOCK OPTION PLAN (Restated to include Amendments through September 25, 2002) Article 1. Introduction. The purpose of the 1987 Executive Stock Option Plan, as Amended and Restated (the "Plan") is to enable The Charles Schwab Corporation and its subsidiaries to attract and retain directors, officers, and other key employees and to provide such persons with additional incentive to advance the interests of the Company. The Plan was initially adopted on March 24, 1987, and was amended on September 17, 1996 and October 22, 1997. The Plan is hereby restated and amended as of October 22, 1997, and the terms of this Restatement shall apply to all awards granted under the Plan on or after such date. The Plan shall terminate not more than ten (10) years from the date the Plan initially was adopted. The Plan will provide Awards in the form of Restricted Shares, Performance Share Awards or Options. The Plan shall be governed by, and construed in accordance with, the laws of the State of Delaware. Article 2. Administration. 2.1 The Committee. The Plan shall be administered by the Committee. The Committee shall consist of two or more Non-Employee Directors, who shall be appointed by the Board. 2.2 Committee Responsibilities. The Committee shall select the Key Employees who are to receive Awards under the Plan, determine the amount, vesting requirements and other conditions of such Awards, may interpret the Plan, and make all other decisions relating to the operation of the Plan. The Committee may adopt such rules or guidelines as it deems appropriate to implement the Plan. The Committee's determinations under the Plan shall be final and binding on all persons. Article 3. Limitation on Awards. The aggregate number of Restricted Shares, Performance Share Awards and Options awarded under the Plan shall not exceed 1,284,000 (including those shares awarded prior to the amendment of the Plan). If any Restricted Shares, Performance Share Awards or Options are forfeited, or if any Performance Share Awards terminate for any other reason without the associated Common Shares being issued, or if any Options terminate for any other reason before being exercised, then such Restricted Shares, Performance Share Awards or Options shall again become available for Awards under the Plan. The limitation of this Article 3 shall be subject to adjustment pursuant to Article 10. Any Common Shares issued pursuant to the Plan may be authorized but unissued shares or treasury shares. Article 4. Eligibility. 4.1 General Rule. Key Employees shall be eligible for designation as Participants by the Committee. Article 5. Options. 5.1 Stock Option Agreement. Each grant of an Option under the Plan shall be evidenced by a Stock Option Agreement between the Optionee and the Company. Such Option shall be subject to all applicable terms and conditions of the Plan, and may be subject to any other terms and conditions which are not inconsistent with the Plan and which the Committee deems appropriate for inclusion in a Stock Option Agreement. The provisions of the various Stock Option Agreements entered into under the Plan need not be identical. 5.2 Options Nontransferability. No Option granted under the Plan shall be transferable by the Optionee other than by will or the laws of descent and distribution. An Option may be exercised during the lifetime of the Optionee only by him or her. No Option or interest therein may be transferred, assigned, pledged or hypothecated by the Optionee during his or her lifetime, whether by operation of law or otherwise, or be made subject to execution, attachment or similar process. 5.3 Number of Shares. Each Stock Option Agreement shall specify the number of Common Shares subject to the Option and shall provide for the adjustment of such number in accordance with Article 10. 5.4 Exercise Price. Each Stock Option Agreement shall specify the Exercise Price. The Exercise Price under an Option shall not be less than 100 percent of the Fair Market Value of a Common Share on the date of grant. Subject to the preceding sentence, the Exercise Price under any Option shall be determined by the Committee. The Exercise Price shall be payable in accordance with Article 6. 5.5 Exercisability and Term. Each Stock Option Agreement shall specify the date when all or any installment of the Option is to become exercisable. The Stock Option Agreement shall also specify the term of the Option. Subject to the preceding sentence, the Committee shall determine when all or any part of an Option is to become exercisable and when such Option is to expire; provided that, in appropriate cases, the Company shall have the discretion to extend the term of an Option or the time within which, following termination of employment, an Option may be exercised, or to accelerate the exercisability of an Option. A Stock Option Agreement may provide for expiration prior to the end of its term in the event of the termination of the Optionee's employment and shall provide for the suspension of vesting when an employee is on a leave of absence for a period in excess of six months in appropriate cases, as determined by the Company; provided that the exercisability of Options shall be accelerated in the event of the Participant's death or Disability and, in the case of Retirement, the exercisability of all outstanding Options shall be accelerated, other than any Options that had been granted within two years of the date of the Optionee's Retirement. Options may also be awarded in combination with Restricted Shares, and such an Award may provide that the Options will not be exercisable unless the related Restricted Shares are forfeited. In addition, Options granted under this Section 5 may be granted subject to forfeiture provisions which provide for forfeiture of the Option upon the exercise of tandem awards, the terms of which are established in other programs of the Company. 5.6 Effect of Change in Control. The Committee (in its sole discretion) may determine, at the time of granting an Option, that such Option shall become fully exercisable as to all Common Shares subject to such Option immediately preceding any Change in Control with respect to the Company. 5.7 Restrictions on Transfer of Common Shares. Any Common Shares issued upon exercise of an Option shall be subject to such sIpecial forfeiture conditions, rights of repurchase, rights of first refusal and other transfer restrictions as the Committee may determine. Such restrictions shall be set forth in the applicable Stock Option Agreement and shall apply in addition to any general restrictions that may apply to all holders of Common Shares. 5.8 Authorization of Replacement Options. Concurrently with the grant of any Option to a Participant, the Committee may authorize the grant of Replacement Options. If Replacement Options have been authorized by the Committee with respect to a particular award of Options (the "Underlying Options"), the Option Agreement with respect to the Underlying Options shall so state, and the terms and conditions of the Replacement Options shall be provided therein. The grant of any Replacement Options shall be effective only upon the exercise of the Underlying Options through the use of Common Shares pursuant to Section 6.2 or Section 6.3. The number of Replacement Options shall equal the number of Common Shares used to exercise the Underlying Options, and, if the Option Agreement so provides, the number of Common Shares used to satisfy any tax withholding requirements incident to the exercise of the Underlying Options in accordance with Section 12.2. Upon the exercise of the Underlying Options, the Replacement Options shall be evidenced by an amendment to the Underlying Option Agreement. The Exercise Price of a Replacement Option shall be no less than the Fair Market Value of a Common Share on the date the grant of the Replacement Option becomes effective. The term of each Replacement Option shall be equal to the remaining term of the Underlying Option. No Replacement Options shall be granted to Optionees when Underlying Options are exercised pursuant to the terms of the Plan and the Underlying Option Agreement following termination of the Optionee's employment. The Committee, in its sole discretion, may establish such other terms and conditions for Replacement Options as it deems appropriate. 5.9 Effect of Job Elimination. Notwithstanding anything to the contrary contained in the Plan or in any Stock Option Agreement or Stock Award Agreement entered into with respect to an Award pursuant to the Plan, in the case of a Participant who is an Officer, and who becomes entitled to receive payments with respect to a Severance Period pursuant to the Charles Schwab Severance Pay Plan (the "Severance Plan") on account of a Job Elimination, the terms of the Plan and any Stock Option Agreement or Stock Award Agreement entered into with respect to an Award shall be applied by treating the Participant as if the Participant had terminated employment on the Participant's Termination Date. For purposes of applying this Section, the terms Officer, Severance Period, Termination Date, and Job Elimination shall have the meanings set forth in the Severance Plan. Article 6. Payment for Option Shares. 6.1 General Rule. The entire Exercise Price of Common Shares issued upon exercise of Options shall be payable in cash at the time when such Common Shares are purchased, except that the Committee may at any time accept payment pursuant to Section 6.2 or 6.3. 6.2 Surrender of Stock. To the extent that this Section 6.2 is applicable, payment for all or any part of the Exercise Price may be made with Common Shares which are surrendered to the Company. Such Common Shares shall be valued at their Fair Market Value on the date when the new Common Shares are purchased under the Plan. In the event that the Common Shares being surrendered are Restricted Shares that have not yet become vested, the same restrictions shall be imposed upon the new Common Shares being purchased. 6.3 Exercise/Sale. To the extent this Section 6.3 is applicable, payment may be made by the delivery (on a form prescribed by the Company) of an irrevocable direction to Charles Schwab & Co., Inc. to sell Common Shares (including the Common Shares to be issued upon exercise of the Options) and to deliver all or part of the sales proceeds to the Company in payment of all or part of the Exercise Price and any withholding taxes. Article 7. Restricted Shares and Performance Share Awards. 7.1 Time, Amount and Form of Awards. The Committee may grant Restricted Shares or Performance Share Awards with respect to an Award Year during such Award Year or at any time thereafter. Each such Award shall be evidenced by a Stock Award Agreement between the Award recipient and the Company. The amount of each Award of Restricted Shares or Performance Share Awards shall be determined by the Committee. Awards under the Plan may be granted in the form of Restricted Shares or Performance Share Awards or in any combination thereof, as the Committee shall determine at its sole discretion at the time of the grant. Restricted Shares or Performance Share Awards may also be awarded in combination with Options, and such an Award may provide that the Restricted Shares or Performance Share Awards will be forfeited in the event that the related Options are exercised. 7.2 Payment for Restricted Share Awards. To the extent that an Award is granted in the form of Restricted Shares, the Award recipient, as a condition to the grant of such Award, shall be required to pay the Company in cash an amount equal to the par value of such Restricted Shares. 7.3 Vesting or Issuance Conditions. Each Award of Restricted Shares shall become vested, in full or in installments, upon satisfaction of the conditions specified in the Stock Award Agreement. Common Shares shall be issued pursuant to Performance Share Awards in full or in installments upon satisfaction of the issuance conditions specified in the Stock Award Agreement. The Committee shall select the vesting conditions in the case of Restricted Shares, or issuance conditions in the case of Performance Share Awards, which may be based upon the Participant's service, the Participant's performance, the Company's performance or such other criteria as the Committee may adopt; provided that, in the case of an Award of Restricted Shares where vesting is based entirely on the Participant's service, (i) vesting shall be accelerated in the event of the Participant's death or Disability; (ii) in the case of Retirement, vesting shall be accelerated for all Restricted Shares that had been granted more than two years prior to the date of the Participant's Retirement; and (iii) vesting shall be suspended when an employee is on a leave of absence for a period in excess of six months in appropriate cases, as determined by the Company. The Committee, in its sole discretion, may determine, at the time of making an Award of Restricted Shares, that such Award shall become fully vested in the event that a Change in Control occurs with respect to the Company. The Committee, in its sole discretion, may determine, at the time of making a Performance Share Award, that the issuance conditions set forth in such Award shall be waived in the event that a Change in Control occurs with respect to the Company. 7.4 Form of Settlement of Performance Share Awards. Settlement of Performance Share Awards shall only be made in the form of Common Shares. Until a Performance Share Award is settled, the number of Performance Share Awards shall be subject to adjustment pursuant to Article 10. 7.5 Death of Recipient. Any Common Shares that are to be issued pursuant to a Performance Share Award after the recipient's death shall be delivered or distributed to the recipient's beneficiary or beneficiaries. Each recipient of a Performance Share Award under the Plan shall designate one or more beneficiaries for this purpose by filing the prescribed form with the Company. A beneficiary designation may be changed by filing the prescribed form with the Company at any time before the Award recipient's death. If no beneficiary was designated or if no designated beneficiary survives the Award recipient, then any Common Shares that are to be issued pursuant to a Performance Share Award after the recipient's death shall be delivered or distributed to the recipient's estate. The Committee, in its sole discretion, shall determine the form and time of any distribution(s) to a recipient's beneficiary or estate. Article 8. Claims Procedures. Claims for benefits under the Plan shall be filed in writing with the Committee on forms supplied by the Committee. Written notice of the disposition of a claim shall be furnished to the claimant within 90 days after the claim is filed. If the claim is denied, the notice of disposition shall set forth the specific reasons for the denial, citations to the pertinent provisions of the Plan, and, where appropriate, an explanation as to how the claimant can perfect the claim. If the claimant wishes further consideration of his or her claim, the claimant may appeal a denied claim to the Committee (or to a person designated by the Committee) for further review. Such appeal shall be filed in writing with the Committee on a form supplied by the Committee, together with a written statement of the claimant's position, no later than 90 days following receipt by the claimant of written notice of the denial of his or her claim. If the claimant so requests, the Committee shall schedule a hearing. A decision on review shall be made after a full and fair review of the claim and shall be delivered in writing to the claimant no later than 60 days after the Committee's receipt of the notice of appeal, unless special circumstances (including the need to hold a hearing) require an extension of time for processing the appeal, in which case a written decision on review shall be delivered to the claimant as soon as possible but not later than 120 days after the Committee's receipt of the appeal notice. The claimant shall be notified in writing of any such extension of time. The written decision on review shall include specific reasons for the decision, written in a manner calculated to be understood by the claimant, and shall specifically refer to the pertinent Plan provisions on which it is based. All determinations of the Committee shall be final and binding on Participants and their beneficiaries. Article 9. Voting Rights and Dividends. 9.1 Restricted Shares. (a) All holders of Restricted Shares who are not Named Executive Officers shall have the same voting, dividend, and other rights as the Company's other stockholders. (b) During the period of restriction, Named Executive Officers holding Restricted Shares granted hereunder shall be credited with all regular cash dividends paid with respect to all Restricted Shares while they are so held. If a dividend is paid in the form of cash, such cash dividend shall be credited to Named Executive Officers subject to the same restrictions on transferability and forfeitability as the Restricted Shares with respect to which they were paid. If any dividends or distributions are paid in shares of Common Stock, the shares of Common Stock shall be subject to the same restrictions on transferability and forfeitability as the Restricted Shares with respect to which they were paid. Subject to the succeeding paragraph, and to the restrictions on vesting and the forfeiture provisions, all dividends credited to a Named Executive Officer shall be paid to the Named Executive Officer within forty-five (45) days following the full vesting of the Restricted Shares with respect to which such dividends were earned. In the event that any dividend constitutes a "derivative security" or an "equity security" pursuant to Rule 16(a) under the Exchange Act, such dividend shall be subject to a vesting period equal to the longer of: (i) the remaining vesting period of the Restricted Shares with respect to which the dividend is paid; or (ii) six (6) months. The Committee shall establish procedures for the application of this provision. Named Executive Officers holding Restricted Shares shall have the same voting rights as the Company's other stockholders. 9.2 Performance Share Awards. The holders of Performance Share Awards shall have no voting or dividend rights until such time as any Common Shares are issued pursuant thereto, at which time they shall have the same voting, dividend and other rights as the Company's other stockholders. Article 10. Protection Against Dilution; Adjustment of Awards. 10.1 General. In the event of a subdivision of the outstanding Common Shares, a declaration of a dividend payable in Common Shares, a declaration of a dividend payable in a form other than Common Shares, a combination or consolidation of the outstanding Common Shares (by reclassification or otherwise) into a lesser number of Common Shares, a recapitalization, a spinoff or a similar occurrence, the Committee shall make appropriate adjustments in one or more of (a) the number of Options, Restricted Shares and Performance Share Awards available for future Awards under Article 3, (b) the number of Performance Share Awards included in any prior Award which has not yet been settled, (c) the number of Common Shares covered by each outstanding Option or (d) the Exercise Price under each outstanding Option. 10.2 Reorganizations. In the event that the Company is a party to a merger or other reorganization, outstanding Options, Restricted Shares and Performance Share Awards shall be subject to the agreement of merger or reorganization. Such agreement may provide, without limitation, for the assumption of outstanding Awards by the surviving corporation or its parent, for their continuation by the Company (if the Company is a surviving corporation), for accelerated vesting or for settlement in cash. 10.3 Reservation of Rights. Except as provided in this Article 10, a Participant shall have no rights by reason of any subdivision or consolidation of shares of stock of any class, the payment of any stock dividend or any other increase or decrease in the number of shares of stock of any class. Any issue by the Company of shares of stock of any class, or securities convertible into shares of stock of any class, shall not affect, and no adjustment by reason thereof shall be made with respect to, the number or Exercise Price of Common Shares subject to an Option. The grant of an Award pursuant to the Plan shall not affect in any way the right or power of the Company to make adjustments, reclassifications, reorganizations or changes of its capital or business structure, to merge or consolidate or to dissolve, liquidate, sell or transfer all or any part of its business or assets. Article 11. Limitation of Rights. 11.1 Employment Rights. Neither the Plan nor any Award granted under the Plan shall be deemed to give any individual a right to remain employed by the Company or any Subsidiary. The Company and its Subsidiaries reserve the right to terminate the employment of any employee at any time, with or without cause, subject only to a written employment agreement (if any). 11.2 Stockholders' Rights. A Participant shall have no dividend rights, voting rights or other rights as a stockholder with respect to any Common Shares covered by his or her Award prior to the issuance of a stock certificate for such Common Shares. No adjustment shall be made for cash dividends or other rights for which the record date is prior to the date when such certificate is issued, except as expressly provided in Articles 7, 9 and 10. 11.3 Creditors' Rights. A holder of Performance Share Awards shall have no rights other than those of a general creditor of the Company. Performance Share Awards represent unfunded and unsecured obligations of the Company, subject to the terms and conditions of the applicable Stock Award Agreement. 11.4 Government Regulations. Any other provision of the Plan notwithstanding, the obligations of the Company with respect to Common Shares to be issued pursuant to the Plan shall be subject to all applicable laws, rules and regulations, and such approvals by any governmental agencies as may be required. The Company reserves the right to restrict, in whole or in part, the delivery of Common Shares pursuant to any Award until such time as: (a) Any legal requirements or regulations have been met relating to the issuance of such Common Shares or to their registration, qualification or exemption from registration or qualification under the Securities Act of 1933, as amended, or any applicable state securities laws; and (b) Satisfactory assurances have been received that such Common Shares, when issued, will be duly listed on the New York Stock Exchange or any other securities exchange on which Common Shares are then listed. Article 12. Withholding Taxes. 12.1 General. To the extent required by applicable federal, state, local or foreign law, the recipient of any payment or distribution under the Plan shall make arrangements satisfactory to the Company for the satisfaction of any withholding tax obligations that arise by reason of such payment or distribution. The Company shall not be required to make such payment or distribution until such obligations are satisfied. 12.2 Nonstatutory Options, Restricted Shares or Performance Share Awards. The Committee may permit an Optionee who exercises Options, or who receives Awards of Restricted Shares, or who receives Common Shares pursuant to the terms of a Performance Share Award, to satisfy all or part of his or her withholding tax obligations by having the Company withhold a portion of the Common Shares that otherwise would be issued to him or her under such Awards. Such Common Shares shall be valued at their Fair Market Value on the date when taxes otherwise would be withheld in cash. The payment of withholding taxes by surrendering Common Shares to the Company, if permitted by the Committee, shall be subject to such restrictions as the Committee may impose, including any restrictions required by rules of the Securities and Exchange Commission. Article 13. Assignment or Transfer of Award. 13.1 General Rule. Any Award granted under the Plan shall not be anticipated, assigned, attached, garnished, optioned, transferred or made subject to any creditor's process, whether voluntarily, involuntarily or by operation of law, except to the extent specifically permitted by Section 13.2. 13.2 Exceptions to General Rule. Notwithstanding Section 13.1, this Plan shall not preclude (i) a Participant from designating a beneficiary to succeed, after the Participant's death, to those of the Participant's Awards (including without limitation, the right to exercise any unexercised Options) as may be determined by the Company from time to time in its sole discretion, (ii) a transfer of any Award hereunder by will or the laws of descent or distribution, or (iii) a voluntary transfer of an Award (other than an ISO) to a trust, partnership or limited liability company for the benefit of one or more members of the Participant's family, subject to the prior approval of the Committee or its designee; provided that, in the case of an Award granted prior to September 25, 2002, such approval shall not be required for a transfer to a trust or partnership if the Participant has sole investment control over such trust or partnership. Article 14. Future of Plans. 14.1 Term of the Plan. The Plan, as set forth herein, shall become effective on February 26, 1997. The Plan shall remain in effect until it is terminated under Section 14.2, except that no Awards shall be granted after March 24, 1997. 14.2 Amendment or Termination. The Board may at any time terminate this Plan, and the Board or the Committee make such modifications of the Plan as it shall deem advisable; provided, however, that any amendment of the Plan shall be subject to the approval of the Company's stockholders to the extent required by applicable laws, regulations or rules. 14.3 Effect of Amendment or Termination. No Award shall be made under the Plan after the termination thereof. The termination of the Plan, or any amendment thereof, shall not affect any Option, Restricted Share or Performance Share Award previously granted under the Plan. Article 15. Definitions. 15.1 "Award" means any award of an Option, a Restricted Share or a Performance Share Award under the Plan. 15.2 "Award Year" means a fiscal year beginning January 1 and ending December 31 with respect to which an Award may be granted. 15.3 "Board" means the Company's Board of Directors, as constituted from time to time. 15.4 "Change in Control" means the occurrence of any of the following events after the effective date of the Plan as set out in Section 14.1: (a) A change in control required to be reported pursuant to Item 6(e) of Schedule 14A of Regulation 14A under the Exchange Act; (b) A change in the composition of the Board, as a result of which fewer than two-thirds of the incumbent directors are directors who either (i) had been directors of the Company 24 months prior to such change or (ii) were elected, or nominated for election, to the Board with the affirmative votes of at least a majority of the directors who had been directors of the Company 24 months prior to such change and who were still in office at the time of the election or nomination; (c) Any "person" (as such term is used in sections 13(d) and 14(d) of the Exchange Act) becomes the beneficial owner, directly or indirectly, of securities of the Company representing 20 percent or more of the combined voting power of the Company's then outstanding securities ordinarily (and apart from rights accruing under special circumstances) having the right to vote at elections of directors (the "Base Capital Stock"); provided, however, that any change in the relative beneficial ownership of securities of any person resulting solely from a reduction in the aggregate number of outstanding shares of Base Capital Stock, and any decrease thereafter in such person's ownership of securities, shall be disregarded until such person increases in any manner, directly or indirectly, such person's beneficial ownership of any securities of the Company. 15.5 "Code" means the Internal Revenue Code of 1986, as amended. 15.6 "Committee" means the Compensation Committee of the Board, as constituted from time to time. 15.7 "Common Share" means one share of the common stock of the Company. 15.8 "Company" means The Charles Schwab Corporation, a Delaware corporation. 15.9 "ERISA" means the Employee Retirement Income Security Act of 1974, as amended. 15.10 "Exchange Act" means the Securities Exchange Act of 1934, as amended. 15.11 "Exercise Price" means the amount for which one Common Share may be purchased upon exercise of an Option, as specified by the Committee in the applicable Stock Option Agreement. 15.12 "Fair Market Value" means the market price of a Common Share, determined by the committee as follows: (a) If the Common Share was traded on a stock exchange on the date in question, then the Fair Market Value shall be equal to the closing price reported by the applicable composite-transactions report for such date; (b) If the Common Share was traded over-the-counter on the date in question and was classified as a national market issue, then the Fair Market Value shall be equal to the last transaction price quoted by the NASDAQ system for such date; (c) If the Common Share was traded over-the-counter on the date in question but was not classified as a national market issue, then the Fair Market Value shall be equal to the mean between the last reported representative bid and asked prices quoted by the NASDAQ system for such date; and (d) If none of the foregoing provisions is applicable, then the Fair Market Value shall be determined by the Committee in good faith on such basis as it deems appropriate. 15.13 "Key Employee" means a key common-law employee of the Company or any Subsidiary, as determined by the Committee. 15.14 "Named Executive Officer" means a Participant who, as of the date of vesting of an Award is one of a group of "covered employees," as defined in the Regulations promulgated under Code Section 162(m), or any successor statute. 15.15 "Non-Employee Director" means a member of the Board who is not a common-law employee. 15.16 "Option" means an employee stock option not described in sections 422 through 424 of the Code, including a Replacement Option, granted under the Plan and entitling the holder to purchase one Common Share. 15.17 "Optionee" means an individual, or his or her estate, legatee or heirs at law that holds an Option. 15.18 "Participant" means a Non-Employee Director or Key Employee who has received an Award. 15.19 "Performance Share Award" means the conditional right to receive in the future one Common Share, awarded to a Participant under the Plan. 15.20 "Plan" means this 1987 Executive Stock Option Plan of The Charles Schwab Corporation, as it may be amended from time to time. 15.21 "Replacement Option" means an Option that is granted when a Participant uses a Common Share held or to be acquired by the Participant to exercise an Option and/or to satisfy tax withholding requirements incident to the exercise of an Option. 15.22 "Restricted Share" means a Common Share awarded to a Participant under the Plan. 15.23 "Stock Award Agreement" means the agreement between the Company and the recipient of a Restricted Share or Performance Share Award which contains the terms, conditions and restrictions pertaining to such Restricted Share or Performance Share Award. 15.24 "Stock Option Agreement" means the agreement between the Company and an Optionee which contains the terms, conditions and restrictions pertaining to his or her option. 15.25 "Subsidiary" means any corporation, if the Company and/or one or more other Subsidiaries own not less than 50 percent of the total combined voting power of all classes of outstanding stock of such corporation. A corporation that attains the status of a Subsidiary on a date after the adoption of the Plan shall be considered a Subsidiary commencing as of such date. 15.26. "Retirement" shall mean any termination of employment of an Optionee for any reason other than death at any time after the Optionee has attained fifty (50), but only if, at the time of such termination, the Participant has been credited with at least seven (7) Years of Service under the Charles Schwab Profit Sharing and Employee Stock Ownership Plan. The foregoing definition shall apply to all Stock Option Agreements entered into pursuant to the Plan, irrespective of any definition to the contrary contained in any such Stock Option Agreement. 15.27 "Disability" means the inability to engage in any substantial gainful activity considering the Participant's age, education and work experience by reason of any medically determined physical or mental impairment that has continued without interruption for a period of at least six months and that can be expected to be of long, continued and indefinite duration. All determinations as to whether a Participant has incurred a Disability shall be made by the Employee Benefits Administration Committee of the Company, the findings of which shall be final, binding and conclusive. NON-QUALIFIED STOCK OPTION AGREEMENT (Executive Officer Stock Option Plan (1987)) THIS AGREEMENT made as of this ____ day of _________, 19____, by and between The Charles Schwab Corporation, a Delaware corporation ("Company") and ______________________________ ("Optionee"). WITNESSETH: WHEREAS, there has been granted to Optionee, effective as of __________, 19___, a non-qualified stock option under the Executive Officer Stock Option Plan (1987) of the Company ("Option Plan"); NOW THEREFORE, it is mutually agreed as follows: 1. The Optionee shall have a non-qualified stock option to acquire ________ shares of common stock of the company (the "Shares"), at a price of $_______ per share. 2. Except as provided in paragraphs 3 and 4 below, the other terms of this option shall be the same as all of those provided for in the Option Plan, which include, without limitation, vesting of Shares, limitations on exercise and transfer, and other restrictions. The Option Plan is attached hereto as Exhibit A and is incorporated herein by this reference. Optionee has read the Option Plan and, other than as provided in paragraphs 3 and 4 below, agrees to be bound by its terms. Without limitation, Optionee specifically acknowledges the representations, warranties and agreements contained in paragraph 6(e) of the Option Plan. 3. Notwithstanding paragraph 6(b) of the Option Plan, in the event Optionee's employment or service as a director with or for the Company and its subsidiaries terminates by reason of Optionee's death or permanent disability, all Shares then not deemed to be Vested thereupon will be deemed immediately Vested. For this purpose, "permanent disability" will mean the reasonable determination by a qualified physician acceptable to the company that the Optionee has an illness or incapacity that has disabled, or will disable, the Optionee from rendering his or her normal services to the Company and its subsidiaries for a period of more than six (6) consecutive months in any consecutive twelve (12) month period. 4. Upon exercise of this Option, the Company will extend to the Optionee rights under that certain Registration Rights and Stock Restriction Agreement dated as of March 31, 1987, as amended, subject to the Optionee's agreement to be bound by the terms thereof. 5. Any notice to be given by the Optionee under the terms of the Option Plan shall be deemed to have been duly given, and effective upon the receipt, if sent by Certified Mail, postage and certification prepaid, to The Charles Schwab Corporation, 101 Montgomery, San Francisco, California 94104, Attention: Corporate Secretary, except as superseded by a different address noticed to Optionee. IN WITNESS WHEREOF, the parties have caused this Agreement to be executed as of the day and year referred to above. THE CHARLES SCHWAB CORPORATION ("Company") By: -------------------------------------------- -------------------------------------------- "Optionee" Attachment (1) Spousal Consent (2) Exhibit A: 1987 Stock Option Plan EX-10 5 exh10_244.txt EXHIBIT 10_244 Exhibit 10.244 THE CHARLES SCHWAB CORPORATION 1992 STOCK INCENTIVE PLAN (Restated to include Amendments through September 25, 2002) Article 1. Introduction. The Plan was adopted by the Board of Directors on March 26, 1992. The purpose of the Plan is to promote the long-term success of the Company and the creation of incremental stockholder value by (a) encouraging Non-Employee Directors and Key Employees to focus on long-range objectives, (b) encouraging the attraction and retention of Non-Employee Directors and Key Employees with exceptional qualifications and (c) linking Non-Employee Directors and Key Employees directly to stockholder interests. The Plan seeks to achieve this purpose by providing for Awards in the form of Restricted Shares, Performance Share Awards or Options, which may constitute incentive stock options or nonstatutory stock options. The Plan shall be governed by, and construed in accordance with, the laws of the State of Delaware. Article 2. Administration. 2.1 The Committee. The Plan shall be administered by the Committee. The Committee shall consist of two or more Non-Employee Directors, who shall be appointed by the Board. 2.2 Committee Responsibilities. The Committee shall select the Key Employees who are to receive Awards under the Plan, determine the amount, vesting requirements and other conditions of such Awards, may interpret the Plan, and make all other decisions relating to the operation of the Plan. The Committee may adopt such rules or guidelines as it deems appropriate to implement the Plan. The Committee's determinations under the Plan shall be final and binding on all persons. Article 3. Limitations on Awards. The aggregate number of Restricted Shares, Performance Share Awards and Options awarded under the Plan shall not exceed 29,150,000 (including those shares awarded prior to the amendment of the Plan). If any Restricted Shares, Performance Share Awards or Options are forfeited, or if any Performance Share Awards terminate for any other reason without the associated Common Shares being issued, or if any Options terminate for any other reason before being exercised, then such Restricted Shares, Performance Share Awards or Options shall again become available for Awards under the Plan. Subject to the overall limit on the aggregate shares set forth above, the following limitations shall apply: (a) The maximum number of Common Shares which may be granted subject to an Option to any one Participant in any one fiscal year shall be 2,250,000; and (b) The maximum number of Restricted Shares or Performance Share Awards which may be granted to any one Participant in any one fiscal year shall be 900,000. The limitations set forth in the preceding sentence shall be subject to adjustment pursuant to Article 10; and The limitations of this Article 3 shall each be subject to adjustment pursuant to Article 10. Any Common Shares issued pursuant to the Plan may be authorized but unissued shares or treasury shares. Article 4. Eligibility. 4.1 General Rule. Key Employees and Non-Employee Directors shall be eligible for designation as Participants by the Committee. 4.2 Non-Employee Directors. In addition to any awards pursuant to Section 4.1, Non-Employee Directors shall be entitled to receive the automatic NSOs described in this Section 4.2. (a) Each Non-Employee Director shall receive a Non-Officer Stock Option covering 3,500 Common Shares for each Award Year with respect to which he or she serves as a Non-Employee Director on the grant date described in subsection (b) below; provided that the Non-Officer Stock Option shall cover 2,500 shares if the Exercise Price determined as of the grant date, is $35 or more; (b) The NSO for a particular Award Year shall be granted to each Non-Employee Director as of May 15 of each Award Year, and if May 15 is not a business day, then the grant shall be made on and as of the next succeeding business day; (c) Each NSO shall be exercisable in full at all times during its term; (d) The term of each NSO shall be 10 years; provided, however, that any unexercised NSO shall expire on the earlier of the date 10 years after the date of grant or three (3) months following the date that the Optionee ceases to be a Non-Employee Director or a Key Employee for any reason other than death or disability. If an Optionee ceases to be a Non-Employee Director or Key Employee on account of death or disability, any unexercised NSO shall expire on the earlier of the date 10 years after the date of grant or one year after the date of death or disability of such Director; and (e) The Exercise Price under each NSO shall be equal to the Fair Market Value on the date of grant and shall be payable in any of the forms described in Article 6. 4.3 Ten-Percent Stockholders. A Key Employee who owns more than 10 percent of the total combined voting power of all classes of outstanding stock of the Company or any of its Subsidiaries shall not be eligible for the grant of an ISO unless (a) the Exercise price under such ISO is at least 110 percent of the Fair Market Value of a Common Share on the date of grant and (b) such ISO by its terms is not exercisable after the expiration of five years from the date of grant. 4.4 Attribution Rules. For purposes of Section 4.3, in determining stock ownership, a Key Employee shall be deemed to own the stock owned, directly or indirectly, by or for his or her brothers, sisters, spouse, ancestors or lineal descendants. Stock owned, directly or indirectly, by or for a corporation, partnership, estate or trust shall be deemed to be owned proportionately by or for its stockholders, partners or beneficiaries. Stock with respect to which the Key Employee holds an option shall not be counted. 4.5 Outstanding Stock. For purposes of Section 4.3, "outstanding stock" shall include all stock actually issued and outstanding immediately after the grant of the ISO to the Key Employee. "Outstanding stock" shall not include treasury shares or shares authorized for issuance under outstanding options held by the Key Employee or by any other person. 4.6 Options Issued To Non-Employee Directors In Lieu of Fee Deferrals. In addition to any awards pursuant to Sections 4.1 and 4.2, a Non-Employee Director who elects to defer the receipt of amounts pursuant to Section 5.1 of The Charles Schwab Corporation Directors' Deferred Compensation Plan (the "Directors Deferred Compensation Plan") and elects to receive stock options in lieu of a Deferral Account balance pursuant to Section 5.4(2) of the Directors Deferred Compensation Plan, shall be entitled to receive a grant of NSOs hereunder on the date the amounts would have been payable to the Non-Employee Director if the Non-Employee Director had not made such deferral election. Any NSOs issued pursuant to this Section shall be issued pursuant to the terms set forth in subsections (c), (d) and (e) of Section 4.2 hereof. 4.7 Performance Shares Issued To Non-Employee Directors Pursuant to Fee Deferrals. In addition to any awards pursuant to Sections 4.1 and 4.2, a Non-Employee Director who elects to defer the receipt of amounts pursuant to Section 5.1 of The Directors' Deferred Compensation Plan and elects to receive payment in Shares pursuant to Section 5.4(1) of the Directors Deferred Compensation Plan, shall be entitled to receive a grant of Performance Shares hereunder on the date the amounts would have been payable to the Non-Employee Director if the Non-Employee Director had not made such deferral election. For purposes of this section, the term Non-Employee Director shall also include non-employee directors of any Subsidiary, if the Committee has approved participation in the Directors Deferred Compensation Plan for such Subsidiary's non-employee directors. Article 5. Options. 5.1 Stock Option Agreement. Each grant of an Option under the Plan shall be evidenced by a Stock Option Agreement between the Optionee and the Company. Such Option shall be subject to all applicable terms and conditions of the Plan, and may be subject to any other terms and conditions which are not inconsistent with the Plan and which the Committee deems appropriate for inclusion in a Stock Option Agreement. The provisions of the various Stock Option Agreements entered into under the Plan need not be identical. The Committee may designate all or any part of an Option as an ISO (or, in the case of a Key Employee who is subject to the tax laws of a foreign jurisdiction, as an option qualifying for favorable tax treatment under the laws of such foreign jurisdiction), except for Options granted to Non-Employee Directors. 5.2 Options Nontransferability. No Option granted under the Plan shall be transferable by the Optionee other than by will or the laws of descent and distribution. An Option may be exercised during the lifetime of the Optionee only by him or her. No Option or interest therein may be transferred, assigned, pledged or hypothecated by the Optionee during his or her lifetime, whether by operation of law or otherwise, or be made subject to execution, attachment or similar process. 5.3 Number of Shares. Each Stock Option Agreement shall specify the number of Common Shares subject to the Option and shall provide for the adjustment of such number in accordance with Article 10. Each Stock Option Agreement shall also specify whether the Option is an ISO or an NSO. 5.4 Exercise Price. Each Stock Option Agreement shall specify the Exercise Price. The Exercise Price under an Option shall not be less than 100 percent of the Fair Market Value of a Common Share on the date of grant, except as otherwise provided in Section 4.3. Subject to the preceding sentence, the Exercise Price under any Option shall be determined by the Committee. The Exercise Price shall be payable in accordance with Article 6. 5.5 Exercisability and Term. Each Stock Option Agreement shall specify the date when all or any installment of the Option is to become exercisable. The Stock Option Agreement shall also specify the term of the Option. The term of an ISO shall in no event exceed 10 years from the date of grant, and Section 4.3 may require a shorter term. Subject to the preceding sentence, the Committee shall determine when all or any part of an Option is to become exercisable and when such Option is to expire; provided that, in appropriate cases, the Company shall have the discretion to extend the term of an Option or the time within which, following termination of employment, an Option may be exercised, or to accelerate the exercisability of an Option. A Stock Option Agreement may provide for expiration prior to the end of its term in the event of the termination of the Optionee's employment and shall provide for the suspension of vesting when an employee is on a leave of absence for a period in excess of six months in appropriate cases, as determined by the Company; provided that, except to the extent otherwise specified by the Committee at the time of grant, (i) the exercisability of Options shall be accelerated in the event of the Participant's death or Disability and (ii) in the case of Retirement, the exercisability of all outstanding Options shall be accelerated, other than any Options that had been granted within two years of the date of the Optionee's Retirement. Except as provided in Section 4.2, NSOs may also be awarded in combination with Restricted Shares, and such an Award may provide that the NSOs will not be exercisable unless the related Restricted Shares are forfeited. In addition, NSOs granted under this Section 5 may be granted subject to forfeiture provisions which provide for forfeiture of the Option upon the exercise of tandem awards, the terms of which are established in other programs of the Company. 5.6 Limitation on Amount of ISOs. The aggregate fair market value (determined at the time the ISO is granted) of the Common Shares with respect to which ISOs are exercisable for the first time by the Optionee during any calendar year (under all incentive stock option plans of the Company) shall not exceed $100,000; provided, however, that all or any portion of an Option which cannot be exercised as an ISO because of such limitation shall be treated as an NSO. 5.7 Effect of Change in Control. The Committee (in its sole discretion) may determine, at the time of granting an Option, that such Option shall become fully exercisable as to all Common Shares subject to such Option immediately preceding any Change in Control with respect to the Company. 5.8 Restrictions on Transfer of Common Shares. Any Common Shares issued upon exercise of an Option shall be subject to such special forfeiture conditions, rights of repurchase, rights of first refusal and other transfer restrictions as the Committee may determine. Such restrictions shall be set forth in the applicable Stock Option Agreement and shall apply in addition to any general restrictions that may apply to all holders of Common Shares. 5.9 Authorization of Replacement Options. Concurrently with the grant of any Option to a Participant (other than NSOs granted pursuant to Section 4.2), the Committee may authorize the grant of Replacement Options. If Replacement Options have been authorized by the Committee with respect to a particular award of Options (the "Underlying Options"), the Option Agreement with respect to the Underlying Options shall so state, and the terms and conditions of the Replacement Options shall be provided therein. The grant of any Replacement Options shall be effective only upon the exercise of the Underlying Options through the use of Common Shares pursuant to Section 6.2 or Section 6.3. The number of Replacement Options shall equal the number of Common Shares used to exercise the Underlying Options, and, if the Option Agreement so provides, the number of Common Shares used to satisfy any tax withholding requirements incident to the exercise of the Underlying Options in accordance with Section 13.2. Upon the exercise of the Underlying Options, the Replacement Options shall be evidenced by an amendment to the Underlying Option Agreement. Notwithstanding the fact that the Underlying Option may be an ISO, a Replacement Option is not intended to qualify as an ISO. The Exercise Price of a Replacement Option shall be no less than the Fair Market Value of a Common Share on the date the grant of the Replacement Option becomes effective. The term of each Replacement Option shall be equal to the remaining term of the Underlying Option. No Replacement Options shall be granted to Optionees when Underlying Options are exercised pursuant to the terms of the Plan and the Underlying Option Agreement following termination of the Optionee's employment. The Committee, in its sole discretion, may establish such other terms and conditions for Replacement Options as it deems appropriate. 5.10 Options Granted to Non-United States Key Employees. In the case of Key Employees who are subject to the tax laws of a foreign jurisdiction, the Company may issue Options to such Key Employees that contain terms required to conform with any requirements for favorable tax treatment imposed by the laws of such foreign jurisdiction, or as otherwise may be required by the laws of such foreign jurisdiction. The terms of any such Options shall be governed by the Plan, subject to the terms of any Addendum to the Plan specifically applicable to such Options. 5.11 Effect of Job Elimination. Notwithstanding anything to the contrary contained in the Plan or in any Stock Option Agreement or Stock Award Agreement entered into with respect to an Award pursuant to the Plan, in the case of a Participant who is an Officer, and who becomes entitled to receive payments with respect to a Severance Period pursuant to the Charles Schwab Severance Pay Plan (the "Severance Plan") on account of a Job Elimination, the terms of the Plan and any Stock Option Agreement or Stock Award Agreement entered into with respect to an Award shall be applied by treating the Participant as if the Participant had terminated employment on the Participant's Termination Date. For purposes of applying this Section, the terms Officer, Severance Period, Termination Date, and Job Elimination shall have the meanings set forth in the Severance Plan. Article 6. Payment for Option Shares. 6.1 General Rule. The entire Exercise Price of Common Shares issued upon exercise of Options shall be payable in cash at the time when such Common Shares are purchased, except as follows: (a) In the case of an ISO granted under the Plan, payment shall be made only pursuant to the express provisions of the applicable Stock Option Agreement. However, the Committee may specify in the Stock Option Agreement that payment may be made pursuant to Section 6.2 or 6.3. (b) In the case of an NSO, the Committee may at any time accept payment pursuant to Section 6.2 or 6.3. 6.2 Surrender of Stock. To the extent that this Section 6.2 is applicable, payment for all or any part of the Exercise Price may be made with Common Shares which are surrendered to the Company. Such Common Shares shall be valued at their Fair Market Value on the date when the new Common Shares are purchased under the Plan. In the event that the Common Shares being surrendered are Restricted Shares that have not yet become vested, the same restrictions shall be imposed upon the new Common Shares being purchased. 6.3 Exercise/Sale. To the extent this Section 6.3 is applicable, payment may be made by the delivery (on a form prescribed by the Company) of an irrevocable direction to Charles Schwab & Co., Inc. to sell Common Shares (including the Common Shares to be issued upon exercise of the Options) and to deliver all or part of the sales proceeds to the Company in payment of all or part of the Exercise Price and any withholding taxes. Article 7. Restricted Shares and Performance Share Awards. 7.1 Time, Amount and Form of Awards. The Committee may grant Restricted Shares or Performance Share Awards with respect to an Award Year during such Award Year or at any time thereafter. Each such Award shall be evidenced by a Stock Award Agreement between the Award recipient and the Company. The amount of each Award of Restricted Shares or Performance Share Awards shall be determined by the Committee. Awards under the Plan may be granted in the form of Restricted Shares or Performance Share Awards or in any combination thereof, as the Committee shall determine at its sole discretion at the time of the grant. Restricted Shares or Performance Share Awards may also be awarded in combination with NSOs, and such an Award may provide that the Restricted Shares or Performance Share Awards will be forfeited in the event that the related NSOs are exercised. 7.2 Payment for Restricted Share Awards. To the extent that an Award is granted in the form of Restricted Shares, the Award recipient, as a condition to the grant of such Award, shall be required to pay the Company in cash an amount equal to the par value of such Restricted Shares. 7.3 Vesting or Issuance Conditions. Each Award of Restricted Shares shall become vested, in full or in installments, upon satisfaction of the conditions specified in the Stock Award Agreement. Common Shares shall be issued pursuant to Performance Share Awards in full or in installments upon satisfaction of the issuance conditions specified in the Stock Award Agreement. The Committee shall select the vesting conditions in the case of Restricted Shares, or issuance conditions in the case of Performance Share Awards, which may be based upon the Participant's service, the Participant's performance, the Company's performance or such other criteria as the Committee may adopt; provided that, in the case of an Award of Restricted Shares where vesting is based entirely on the Participant's service (except to the extent otherwise specified by the Committee at the time of grant), (i) vesting shall be accelerated in the event of the Participant's death or Disability; (ii) in the case of Retirement, vesting shall be accelerated for all Restricted Shares that had been granted more than two years prior to the date of the Participant's Retirement; and (iii) vesting shall be suspended when an employee is on a leave of absence for a period in excess of six months in appropriate cases, as determined by the Company. The Committee, in its sole discretion, may determine, at the time of making an Award of Restricted Shares, that such Award shall become fully vested in the event that a Change in Control occurs with respect to the Company. The Committee, in its sole discretion, may determine, at the time of making a Performance Share Award, that the issuance conditions set forth in such Award shall be waived in the event that a Change in Control occurs with respect to the Company. 7.4 Form of Settlement of Performance Share Awards. Settlement of Performance Share Awards shall only be made in the form of Common Shares. Until a Performance Share Award is settled, the number of Performance Share Awards shall be subject to adjustment pursuant to Article 10. 7.5 Death of Recipient. Any Common Shares that are to be issued pursuant to a Performance Share Award after the recipient's death shall be delivered or distributed to the recipient's beneficiary or beneficiaries. Each recipient of a Performance Share Award under the Plan shall designate one or more beneficiaries for this purpose by filing the prescribed form with the Company. A beneficiary designation may be changed by filing the prescribed form with the Company at any time before the Award recipient's death. If no beneficiary was designated or if no designated beneficiary survives the Award recipient, then any Common Shares that are to be issued pursuant to a Performance Share Award after the recipient's death shall be delivered or distributed to the recipient's estate. The Committee, in its sole discretion, shall determine the form and time of any distribution(s) to a recipient's beneficiary or estate. Article 8. Claims Procedures. Claims for benefits under the Plan shall be filed in writing with the Committee on forms supplied by the Committee. Written notice of the disposition of a claim shall be furnished to the claimant within 90 days after the claim is filed. If the claim is denied, the notice of disposition shall set forth the specific reasons for the denial, citations to the pertinent provisions of the Plan, and, where appropriate, an explanation as to how the claimant can perfect the claim. If the claimant wishes further consideration of his or her claim, the claimant may appeal a denied claim to the Committee (or to a person designated by the Committee) for further review. Such appeal shall be filed in writing with the Committee on a form supplied by the Committee, together with a written statement of the claimant's position, no later than 90 days following receipt by the claimant of written notice of the denial of his or her claim. If the claimant so requests, the Committee shall schedule a hearing. A decision on review shall be made after a full and fair review of the claim and shall be delivered in writing to the claimant no later than 60 days after the Committee's receipt of the notice of appeal, unless special circumstances (including the need to hold a hearing) require an extension of time for processing the appeal, in which case a written decision on review shall be delivered to the claimant as soon as possible but not later than 120 days after the Committee's receipt of the appeal notice. The claimant shall be notified in writing of any such extension of time. The written decision on review shall include specific reasons for the decision, written in a manner calculated to be understood by the claimant, and shall specifically refer to the pertinent Plan provisions on which it is based. All determinations of the Committee shall be final and binding on Participants and their beneficiaries. Article 9. Voting Rights and Dividends. 9.1 Restricted Shares. (a) All holders of Restricted Shares who are not Named Executive Officers shall have the same voting, dividend, and other rights as the Company's other stockholders. (b) During the period of restriction, Named Executive Officers holding Restricted Shares granted hereunder shall be credited with all regular cash dividends paid with respect to all Restricted Shares while they are so held. If a dividend is paid in the form of cash, such cash dividend shall be credited to Named Executive Officers subject to the same restrictions on transferability and forfeitability as the Restricted Shares with respect to which they were paid. If any dividends or distributions are paid in shares of Common Stock, the shares of Common Stock shall be subject to the same restrictions on transferability and forfeitability as the Restricted Shares with respect to which they were paid. Subject to the succeeding paragraph, and to the restrictions on vesting and the forfeiture provisions, all dividends credited to a Named Executive Officer shall be paid to the Named Executive Officer within forty-five (45) days following the full vesting of the Restricted Shares with respect to which such dividends were earned. In the event that any dividend constitutes a "derivative security" or an "equity security" pursuant to Rule 16(a) under the Exchange Act, such dividend shall be subject to a vesting period equal to the longer of: (i) the remaining vesting period of the Restricted Shares with respect to which the dividend is paid; or (ii) six (6) months. The Committee shall establish procedures for the application of this provision. Named Executive Officers holding Restricted Shares shall have the same voting rights as the Company's other stockholders. 9.2 Performance Share Awards. The holders of Performance Share Awards shall have no voting or dividend rights until such time as any Common Shares are issued pursuant thereto, at which time they shall have the same voting, dividend and other rights as the Company's other stockholders. Article 10. Protection Against Dilution; Adjustment of Awards. 10.1 General. In the event of a subdivision of the outstanding Common Shares, a declaration of a dividend payable in Common Shares, a declaration of a dividend payable in a form other than Common Shares, a combination or consolidation of the outstanding Common Shares (by reclassification or otherwise) into a lesser number of Common Shares, a recapitalization, a spinoff or a similar occurrence, the Committee shall make appropriate adjustments in one or more of (a) the number of Options, Restricted Shares and Performance Share Awards available for future Awards under Article 3, (b) the maximum number of Common Shares which may be granted under Article 3 to any one Participant in any one fiscal year either subject to an Option or as Restricted Shares or Performance Share Awards, (c) the number of Performance Share Awards included in any prior Award which has not yet been settled, (d) the number of Common Shares covered by each outstanding Option or (e) the Exercise Price under each outstanding Option. 10.2 Reorganizations. In the event that the Company is a party to a merger or other reorganization, outstanding Options, Restricted Shares and Performance Share Awards shall be subject to the agreement of merger or reorganization. Such agreement may provide, without limitation, for the assumption of outstanding Awards by the surviving corporation or its parent, for their continuation by the Company (if the Company is a surviving corporation), for accelerated vesting or for settlement in cash. 10.3 Reservation of Rights. Except as provided in this Article 10, a Participant shall have no rights by reason of any subdivision or consolidation of shares of stock of any class, the payment of any stock dividend or any other increase or decrease in the number of shares of stock of any class. Any issue by the Company of shares of stock of any class, or securities convertible into shares of stock of any class, shall not affect, and no adjustment by reason thereof shall be made with respect to, the number or Exercise Price of Common Shares subject to an Option. The grant of an Award pursuant to the Plan shall not affect in any way the right or power of the Company to make adjustments, reclassifications, reorganizations or changes of its capital or business structure, to merge or consolidate or to dissolve, liquidate, sell or transfer all or any part of its business or assets. Article 11. Limitation of Rights. 11.1 Employment Rights. Neither the Plan nor any Award granted under the Plan shall be deemed to give any individual a right to remain employed by the Company or any Subsidiary. The Company and its Subsidiaries reserve the right to terminate the employment of any employee at any time, with or without cause, subject only to a written employment agreement (if any). 11.2 Stockholders' Rights. A Participant shall have no dividend rights, voting or other rights as a stockholder with respect to any Common Shares covered by his or her Award prior to the issuance of such Common Shares, whether by issuance of a certificate, book entry or other procedure. No adjustment shall be made for cash dividends or other rights for which the record date is prior to the date when such certificate is issued, except as expressly provided in Articles 7, 9 and 10. 11.3 Creditors' Rights. A holder of Performance Share Awards shall have no rights other than those of a general creditor of the Company. Performance Share Awards represent unfunded and unsecured obligations of the Company, subject to the terms and conditions of the applicable Stock Award Agreement. 11.4 Government Regulations. Any other provision of the Plan notwithstanding, the obligations of the Company with respect to Common Shares to be issued pursuant to the Plan shall be subject to all applicable laws, rules and regulations, and such approvals by any governmental agencies as may be required. The Company reserves the right to restrict, in whole or in part, the delivery of Common Shares pursuant to any Award until such time as: (a) Any legal requirements or regulations have been met relating to the issuance of such Common Shares or to their registration, qualification or exemption from registration or qualification under the Securities Act of 1933, as amended, or any applicable state securities laws; and (b) Satisfactory assurances have been received that such Common Shares, when issued, will be duly listed on the New York Stock Exchange or any other securities exchange on which Common Shares are then listed. Article 12. Limitation of Payments. 12.1 Basic Rule. Any provision of the Plan to the contrary notwithstanding, in the event that the independent auditors most recently selected by the Board (the "Auditors") determine that any payment or transfer in the nature of compensation to or for the benefit of a Participant, whether paid or payable (or transferred or transferable) pursuant to the terms of this Plan or otherwise (a "Payment"), would be nondeductible for federal income tax purposes because of the provisions concerning "excess parachute payments" in section 280G of the Code, then the aggregate present value of all Payments shall be reduced (but not below zero) to the Reduced Amount; provided, however, that the Committee, at the time of making an Award under this Plan or at any time thereafter, may specify in writing that such Award shall not be so reduced and shall not be subject to this Article 12. For purposes of this Article 12, the "Reduced Amount" shall be the amount, expressed as a present value, which maximizes the aggregate present value of the Payments without causing any Payment to be nondeductible by the Company because of section 280G of the Code. 12.2 Reduction of Payments. If the Auditors determine that any Payment would be nondeductible because of section 280G of the Code, then the Company shall promptly give the Participant notice to that effect and a copy of the detailed calculation thereof and of the Reduced Amount, and the Participant may then elect, in his or her sole discretion, which and how much of the Payments shall be eliminated or reduced (as long as after such election, the aggregate present value of the Payments equals the Reduced Amount) and shall advise the Company in writing of his or her election within 10 days of receipt of notice. If no such election is made by the Participant within such 10-day period, then the Company may elect which and how much of the Payments shall be eliminated or reduced (as long as after such election the aggregate present value of the Payments equals the Reduced Amount) and shall notify the Participant promptly of such election. For purposes of this Article 12, present value shall be determined in accordance with section 280G(d)(4) of the Code. All determinations made by the Auditors under this Article 12 shall be binding upon the Company and the Participant and shall be made within 60 days of the date when a Payment becomes payable or transferable. As promptly as practicable following such determination and the elections hereunder, the Company shall pay or transfer to or for the benefit of the Participant such amounts as are then due to him or her under the Plan, and shall promptly pay or transfer to or for the benefit of the Participant in the future such amounts as become due to him or her under the Plan. 12.3 Overpayments and Underpayments. As a result of uncertainty in the application of section 280G of the Code at the time of an initial determination by the Auditors hereunder, it is possible that Payments will have been made by the Company which should not have been made (an "Overpayment") or that additional Payments which will not have been made by the Company could have been made (an "Underpayment"), consistent in each case with the calculation of the Reduced Amount hereunder. In the event that the Auditors, based upon the assertion of a deficiency by the Internal Revenue Service against the Company or the Participant which the Auditors believe has a high probability of success, determine that an Overpayment has been made, such Overpayment shall be treated for all purposes as a loan to the Participant which he or she shall repay to the Company on demand, together with interest at the applicable federal rate provided in section 7872(f)(2) of the Code; provided, however, that no amount shall be payable by the Participant to the Company if and to the extent that such payment would not reduce the amount which is subject to taxation under section 4999 of the Code. In the event that the Auditors determine that an Underpayment has occurred, such Underpayment shall promptly be paid or transferred by the Company to or for the benefit of the Participant, together with interest at the applicable federal rate provided in section 7872(f)(2) of the Code. 12.4 Related Corporations. For purposes of this Article 12, the term "Company" shall include affiliated corporations to the extent determined by the Auditors in accordance with section 280G(d)(5) of the Code. Article 13. Withholding Taxes. 13.1 General. To the extent required by applicable federal, state, local or foreign law, the recipient of any payment or distribution under the Plan shall make arrangements satisfactory to the Company for the satisfaction of any withholding tax obligations that arise by reason of such payment or distribution. The Company shall not be required to make such payment or distribution until such obligations are satisfied. 13.2 Nonstatutory Options, Restricted Shares or Performance Share Awards. The Committee may permit an Optionee who exercises NSOs, or who receives Awards of Restricted Shares, or who receives Common Shares pursuant to the terms of a Performance Share Award, to satisfy all or part of his or her withholding tax obligations by having the Company withhold a portion of the Common Shares that otherwise would be issued to him or her under such Awards. Such Common Shares shall be valued at their Fair Market Value on the date when taxes otherwise would be withheld in cash. The payment of withholding taxes by surrendering Common Shares to the Company, if permitted by the Committee, shall be subject to such restrictions as the Committee may impose, including any restrictions required by rules of the Securities and Exchange Commission. Article 14. Assignment or Transfer of Award. 14.1 General Rule. Any Award granted under the Plan shall not be anticipated, assigned, attached, garnished, optioned, transferred or made subject to any creditor's process, whether voluntarily, involuntarily or by operation of law, except to the extent specifically permitted by Section 14.2. 14.2 Exceptions to General Rule. Notwithstanding Section 14.1, this Plan shall not preclude (i) a Participant from designating a beneficiary to succeed, after the Participant's death, to those of the Participant's Awards (including without limitation, the right to exercise any unexercised Options) as may be determined by the Company from time to time in its sole discretion, (ii) a transfer of any Award hereunder by will or the laws of descent or distribution, or (iii) a voluntary transfer of an Award (other than an ISO) to a trust, partnership or limited liability company for the benefit of one or more members of the Participant's family, subject to the prior approval of the Committee or its designee; provided that, in the case of an Award granted prior to September 25, 2002, such approval shall not be required for a transfer to a trust or partnership if the Participant has sole investment control over such trust or partnership. Article 15. Future of Plans. 15.1 Term of the Plan. The Plan, as set forth herein, shall become effective on May 8, 1992. The Plan shall remain in effect until it is terminated under Section 15.2, except that no ISOs shall be granted after May 7, 2002. 15.2 Amendment or Termination. The Committee may, at any time and for any reason, amend or terminate the Plan; provided, however, that any amendment of the Plan shall be subject to the approval of the Company's stockholders to the extent required by applicable laws, regulations or rules. 15.3 Effect of Amendment or Termination. No Award shall be made under the Plan after the termination thereof. The termination of the Plan, or any amendment thereof, shall not affect any Option, Restricted Share or Performance Share Award previously granted under the Plan. Article 16. Definitions. 16.1 "Award" means any award of an Option, a Restricted Share or a Performance Share Award under the Plan. 16.2 "Award Year" means a fiscal year beginning January 1 and ending December 31 with respect to which an Award may be granted. 16.3 "Board" means the Company's Board of Directors, as constituted from time to time. 16.4 "Change in Control" means the occurrence of any of the following events after the effective date of the Plan as set out in Section 15.1: (a) A change in control required to be reported pursuant to Item 6(e) of Schedule 14A of Regulation 14A under the Exchange Act; (b) A change in the composition of the Board, as a result of which fewer than two-thirds of the incumbent directors are directors who either (i) had been directors of the Company 24 months prior to such change or (ii) were elected, or nominated for election, to the Board with the affirmative votes of at least a majority of the directors who had been directors of the Company 24 months prior to such change and who were still in office at the time of the election or nomination; (c) Any "person" (as such term is used in sections 13(d) and 14(d) of the Exchange Act) becomes the beneficial owner, directly or indirectly, of securities of the Company representing 20 percent or more of the combined voting power of the Company's then outstanding securities ordinarily (and apart from rights accruing under special circumstances) having the right to vote at elections of directors (the "Base Capital Stock"); provided, however, that any change in the relative beneficial ownership of securities of any person resulting solely from a reduction in the aggregate number of outstanding shares of Base Capital Stock, and any decrease thereafter in such person's ownership of securities, shall be disregarded until such person increases in any manner, directly or indirectly, such person's beneficial ownership of any securities of the Company. 16.5 "Code" means the Internal Revenue Code of 1986, as amended. 16.6 "Committee" means the Compensation Committee of the Board, as constituted from time to time. 16.7 "Common Share" means one share of the common stock of the Company. 16.8 "Company" means The Charles Schwab Corporation, a Delaware corporation. 16.9 "ERISA" means the Employee Retirement Income Security Act of 1974, as amended. 16.10 "Exchange Act" means the Securities Exchange Act of 1934, as amended. 16.11 "Exercise Price" means the amount for which one Common Share may be purchased upon exercise of an Option, as specified by the Committee in the applicable Stock Option Agreement. 16.12 "Fair Market Value" means the market price of a Common Share, determined by the committee as follows: (a) If the Common Share was traded on a stock exchange on the date in question, then the Fair Market Value shall be equal to the closing price reported by the applicable composite-transactions report for such date; (b) If the Common Share was traded over-the-counter on the date in question and was classified as a national market issue, then the Fair Market Value shall be equal to the last transaction price quoted by the NASDAQ system for such date; (c) If the Common Share was traded over-the-counter on the date in question but was not classified as a national market issue, then the Fair Market Value shall be equal to the mean between the last reported representative bid and asked prices quoted by the NASDAQ system for such date; and (d) If none of the foregoing provisions is applicable, then the Fair Market Value shall be determined by the Committee in good faith on such basis as it deems appropriate. 16.13 "ISO" means an incentive stock option described in section 422(b) of the Code. 16.14 "Key Employee" means (1) a key common-law employee of the Company or any Subsidiary, as determined by the Committee, or (2) a non-employee director of any Subsidiary, as determined by the Committee. 16.15 "Named Executive Officer" means a Participant who, as of the date of vesting of an Award is one of a group of "covered employees," as defined in the Regulations promulgated under Code Section 162(m), or any successor statute. 16.16 "Non-Employee Director" means a member of the Board who is not a common-law employee. 16.17 "NSO" means an employee stock option not described in sections 422 through 424 of the Code. 16.18 "Option" means an ISO or NSO or, in the case of a Key Employee who is subject to the tax laws of a foreign jurisdiction, an option qualifying for favorable tax treatment under the laws of such jurisdiction, including a Replacement Option, granted under the Plan and entitling the holder to purchase one Common Share. 16.19 "Optionee" means an individual, or his or her estate, legatee or heirs at law that holds an Option. 16.20 "Participant" means a Non-Employee Director or Key Employee who has received an Award. 16.21 "Performance Share Award" means the conditional right to receive in the future one Common Share, awarded to a Participant under the Plan. 16.22 "Plan" means this 1992 Stock Incentive Plan of The Charles Schwab Corporation, as it may be amended from time to time. 16.23 "Replacement Option" means an Option that is granted when a Participant uses a Common Share held or to be acquired by the Participant to exercise an Option and/or to satisfy tax withholding requirements incident to the exercise of an Option. 16.24 "Restricted Share" means a Common Share awarded to a Participant under the Plan. 16.25 "Stock Award Agreement" means the agreement between the Company and the recipient of a Restricted Share or Performance Share Award which contains the terms, conditions and restrictions pertaining to such Restricted Share or Performance Share Award. 16.26 "Stock Option Agreement" means the agreement between the Company and an Optionee which contains the terms, conditions and restrictions pertaining to his or her option. 16.27 "Subsidiary" means any corporation or other entity, if the Company and/or one or more other Subsidiaries own not less than 50 percent of the total combined voting power of all classes of outstanding stock of such corporation (or ownership interest of such other entity). A corporation or other entity that attains the status of a Subsidiary on a date after the adoption of the Plan shall be considered a Subsidiary commencing as of such date. 16.28. "Retirement" shall mean any termination of employment of an Optionee for any reason other than death at any time after the Optionee has attained fifty (50), but only if, at the time of such termination, the Participant has been credited with at least seven (7) Years of Service under the Charles Schwab Profit Sharing and Employee Stock Ownership Plan. The foregoing definition shall apply to all Stock Option Agreements entered into pursuant to the Plan, irrespective of any definition to the contrary contained in any such Stock Option Agreement. 16.29 "Disability" means the inability to engage in any substantial gainful activity considering the Participant's age, education and work experience by reason of any medically determined physical or mental impairment that has continued without interruption for a period of at least six months and that can be expected to be of long, continued and indefinite duration. All determinations as to whether a Participant has incurred a Disability shall be made by the Employee Benefits Administration Committee of the Company, the findings of which shall be final, binding and conclusive. ADDENDUM A The provisions of the Plan, as amended by the terms of this Addendum A, shall apply to the grant of Approved Options to Key U.K. Employees. 1. For purposes of this Addendum A, the following definitions shall apply in addition to those set out in section 16 of the Plan: Approved Option Means a stock option designed to qualify as an approved executive share option under the Taxes Act; Inland Revenue means the Board of the Inland Revenue in the United Kingdom. Key U.K. Employee means a designated employee of Sharelink Investment Services plc or any subsidiary (as that term is defined in the Companies Act 1985 of the United Kingdom, as amended) of which Sharelink Investment Services plc has control for the purposes of section 840 of the Taxes Act; Taxes Act means the Income and Corporation Taxes Act 1988 of the United Kingdom. 2. An Approved Option may only be granted to a Key U.K. Employee who: (i) is employed on a full-time basis; and (ii) does not fall within the provisions of paragraph 8 of Schedule 9 to the Taxes Act. For purposes of this section 2(i) of Addendum A, "full-time" shall mean an employee who is required to work 20 hours per week, excluding meal breaks. 3. No Approved Option may be granted to a Key U.K. Employee if it would cause the aggregate of the exercise price of all subsisting Approved Options granted to such employee under the Plan, or any other subsisting options granted to such employee under any other share option scheme approved under Schedule 9 of the Taxes Act and established by the Company or an associated company, to exceed the higher of (a) one hundred thousand pounds sterling and (b) four times such employee's relevant emoluments for the current or preceding year of assessment (whichever is greater); but where there were no relevant emoluments for the previous year of assessment, the limit shall be the higher of one hundred thousand pounds sterling or four times such employee's relevant emoluments for the period of twelve months beginning with the first day during the current year of assessment in respect of which there are relevant emoluments. For the purpose of this section 3 of Addendum A, "associated company" means an associated company within the meaning of section 416 of the Taxes Act; "relevant emoluments" has the meaning given by paragraph 28(4) of Schedule 9 to the Taxes Act and "year of assessment" means a year beginning on any April 6 and ending on the following April 5. 4. Common Shares issued pursuant to the exercise of Approved Options must satisfy the conditions specified in paragraphs 10 to 14 of Schedule 9 to the Taxes Act. 5. Notwithstanding the provisions of Section 5.4 of the Plan, the exercise price of an Approved Option shall not be less than 100 percent of the closing price of a Common Share as reported in the New York Stock Exchange Composite Index on the date of grant. 6. No Approved Option may be exercised at any time by a Key U.K. Employee when that Key U.K. Employee falls within the provisions of paragraph 8 of Schedule 9 to the Taxes Act. If at any time the shares under an Approved Option cease to comply with the conditions in paragraphs 10 to 14 of Schedule 9 to the Taxes Act, then all Approved Options then outstanding shall lapse and cease to be exercisable from the date of the shares ceasing so to comply, and no optionee shall have any cause of action against the Company, Sharelink Investment Services plc or any subsidiary of the Company or any other person in respect thereof. 7. An Approved Option may contain such other terms, provisions and conditions as may be determined by the Committee consistent with the Plan, provided that the approved option otherwise complies with the requirements for approved executive option schemes specified in Schedule 9 of the Taxes Act. 8. In relation to an Approved Option, notwithstanding the terms of section 10.1 of the Plan, no adjustment shall be made pursuant to section 10.1 of the Plan to any outstanding Approved Options without the prior approval of the Inland Revenue. 9. In relation to an Approved Option any Key U.K. Employee shall make arrangements satisfactory to the Company for the satisfaction of any tax withholding or deduction -- at -- source obligations that arise by reason of the grant to him or her of such option, or its subsequent exercise. 10. In relation to an Approved Option, in addition to the provisions set out in section 15.2 of the Plan, no amendment which affects any of the provisions of the Plan relating to Approved Options shall be effective until approved by the Inland Revenue, except for such amendment as are required to obtain and maintain the approval of Inland Revenue pursuant to Schedule 9 to the Taxes Act. EX-10 6 exh10_245.txt EXHIBIT 10_245 Exhibit 10.245 THE CHARLES SCHWAB CORPORATION 2001 STOCK INCENTIVE PLAN as Amended September 25, 2002 Article 1. Introduction. The Plan was adopted by the Board of Directors on February 28, 2001. The purpose of this Plan is to promote the long-term success of the Company and the creation of incremental stockholder value by (a) encouraging Non-Employee Directors and Key Employees to focus on long-range objectives, (b) encouraging the attraction and retention of Non-Employee Directors and Key Employees with exceptional qualifications and (c) linking Non-Employee Directors and Key Employees directly to stockholder interests. The Plan seeks to achieve this purpose by providing for Awards in the form of Restricted Shares, Performance Share Awards or Options, which may constitute incentive stock options or nonstatutory stock options. The Plan shall be governed by, and construed in accordance with, the laws of the State of Delaware. Article 2. Administration. 2.1 The Committee. The Plan shall be administered by the Committee. The Committee shall consist of two or more Directors, who shall be appointed by the Board. 2.2 Committee Responsibilities. The Committee shall select the Key Employees who are to receive Awards under the Plan, determine the amount, vesting requirements and other conditions of such Awards, may interpret the Plan, and make all other decisions relating to the operation of the Plan. The Committee may adopt such rules or guidelines as it deems appropriate to implement the Plan. The Committee's determinations under the Plan shall be final and binding on all persons. Article 3. Limitations on Awards. The aggregate number of Restricted Shares, Performance Share Awards and Options awarded under the Plan shall not exceed 70,000,000. If any Restricted Shares, Performance Share Awards or Options are forfeited, or if any Performance Share Awards terminate for any other reason without the associated Common Shares being issued, or if any Options terminate for any other reason before being exercised, then such Restricted Shares, Performance Share Awards or Options shall again become available for Awards under the Plan. Subject to the overall limit on the aggregate shares set forth above, the following limitations shall apply: (a) The maximum number of Common Shares which may be granted subject to an Option to any one Participant in any one fiscal year shall be 5,000,000; and (b) The maximum number of Restricted Shares or Performance Share Awards which may be granted to any one Participant in any one fiscal year shall be 1,000,000. The limitations set forth in the preceding sentence shall be subject to adjustment pursuant to Article 10; and The limitations of this Article 3 shall each be subject to adjustment pursuant to Article 10. Any Common Shares issued pursuant to the Plan may be authorized but unissued shares or treasury shares. Article 4. Eligibility. 4.1 General Rule. Key Employees and Non-Employee Directors shall be eligible for designation as Participants by the Committee. 4.2 Non-Employee Directors. In addition to any awards pursuant to Section 4.1, Non-Employee Directors shall be entitled to receive the automatic NQSOs described in this Section 4.2. (a) Each Non-Employee Director shall receive an NQSO covering a number of Common Shares for each Award Year with respect to which he or she serves as a Non-Employee Director on the grant date described in subsection (b) below, to be calculated by dividing $150,000 by the Fair Market Value of the Common Shares on the grant date described in subsection (b) below; and (b) The NQSO for a particular Award Year shall be granted to each Non-Employee Director as of May 15 of each Award Year, and if May 15 is not a business day, then the grant shall be made on and as of the next succeeding business day; (c) Each NQSO shall be exercisable in full at all times during its term; (d) The term of each NQSO shall be 10 years; provided, however, that any unexercised NQSO shall expire on the earlier of the date 10 years after the date of grant or three (3) months following the date that the Optionee ceases to be a Non-Employee Director or a Key Employee for any reason other than death or disability. If an Optionee ceases to be a Non-Employee Director or Key Employee on account of death or disability, any unexercised NQSO shall expire on the earlier of the date 10 years after the date of grant or one year after the date of death or disability of such Director; and (e) The Exercise Price under each NQSO shall be equal to the Fair Market Value on the date of grant and shall be payable in any of the forms described in Article 6. 4.3 Ten-Percent Stockholders. A Key Employee who owns more than 10 percent of the total combined voting power of all classes of outstanding stock of the Company or any of its Subsidiaries shall not be eligible for the grant of an ISO unless (a) the Exercise price under such ISO is at least 110 percent of the Fair Market Value of a Common Share on the date of grant and (b) such ISO by its terms is not exercisable after the expiration of five years from the date of grant. 4.4 Attribution Rules. For purposes of Section 4.3, in determining stock ownership, a Key Employee shall be deemed to own the stock owned, directly or indirectly, by or for his or her brothers, sisters, spouse, ancestors or lineal descendants. Stock owned, directly or indirectly, by or for a corporation, partnership, estate or trust shall be deemed to be owned proportionately by or for its stockholders, partners or beneficiaries. Stock with respect to which the Key Employee holds an option shall not be counted. 4.5 Outstanding Stock. For purposes of Section 4.3, "outstanding stock" shall include all stock actually issued and outstanding immediately after the grant of the ISO to the Key Employee. "Outstanding stock" shall not include treasury shares or shares authorized for issuance under outstanding options held by the Key Employee or by any other person. 4.6 Options Issued To Non-Employee Directors In Lieu of Fee Deferrals. In addition to any awards pursuant to Sections 4.1 and 4.2, a Non-Employee Director who elects to defer the receipt of amounts pursuant to Section 5.1 of The Charles Schwab Corporation Directors' Deferred Compensation Plan (the "Directors Deferred Compensation Plan") and elects to receive stock options in lieu of a Deferral Account balance pursuant to Section 5.4(2) of the Directors Deferred Compensation Plan, shall be entitled to receive a grant of NQSOs hereunder on the date the amounts would have been payable to the Non-Employee Director if the Non-Employee Director had not made such deferral election. Any NQSOs issued pursuant to this Section shall be issued pursuant to the terms set forth in subsections (c), (d) and (e) of Section 4.2 hereof. 4.7 Performance Shares Issued To Non-Employee Directors Pursuant to Fee Deferrals. In addition to any awards pursuant to Sections 4.1 and 4.2, a Non-Employee Director who elects to defer the receipt of amounts pursuant to Section 5.1 of The Directors' Deferred Compensation Plan and elects to receive payment in Shares pursuant to Section 5.4(1) of the Directors Deferred Compensation Plan, shall be entitled to receive a grant of Performance Shares hereunder on the date the amounts would have been payable to the Non-Employee Director if the Non-Employee Director had not made such deferral election. For purposes of this section, the term Non-Employee Director shall also include non-employee directors of any Subsidiary, if the Committee has approved participation in the Directors Deferred Compensation Plan for such Subsidiary's non-employee directors. Article 5. Options. 5.1 Stock Option Agreement. Each grant of an Option under the Plan shall be evidenced by a Stock Option Agreement between the Optionee and the Company. Such Option shall be subject to all applicable terms and conditions of the Plan, and may be subject to any other terms and conditions which are not inconsistent with the Plan and which the Committee deems appropriate for inclusion in a Stock Option Agreement. The provisions of the various Stock Option Agreements entered into under the Plan need not be identical. The Committee may designate all or any part of an Option as an ISO (or, in the case of a Key Employee who is subject to the tax laws of a foreign jurisdiction, as an option qualifying for favorable tax treatment under the laws of such foreign jurisdiction), except for Options granted to Non-Employee Directors. 5.2 Options Nontransferability. Subject to the provisions of Section 14.2, no Option granted under the Plan shall be transferable by the Optionee other than by will or the laws of descent and distribution. An Option may be exercised during the lifetime of the Optionee only by him or her. No Option or interest therein may be transferred, assigned, pledged or hypothecated by the Optionee during his or her lifetime, whether by operation of law or otherwise, or be made subject to execution, attachment or similar process. 5.3 Number of Shares. Each Stock Option Agreement shall specify the number of Common Shares subject to the Option and shall provide for the adjustment of such number in accordance with Article 10. Each Stock Option Agreement shall also specify whether the Option is an ISO or an NQSO. 5.4 Exercise Price. Each Stock Option Agreement shall specify the Exercise Price. The Exercise Price under an Option shall not be less than 100 percent of the Fair Market Value of a Common Share on the date of grant, except as otherwise provided in Section 4.3. Subject to the preceding sentence, the Exercise Price under any Option shall be determined by the Committee. The Exercise Price shall be payable in accordance with Article 6. 5.5 Exercisability and Term. Each Stock Option Agreement shall specify the date when all or any installment of the Option is to become exercisable. The Stock Option Agreement shall also specify the term of the Option. The term of an ISO shall in no event exceed 10 years from the date of grant, and Section 4.3 may require a shorter term. Subject to the preceding sentence, the Committee shall determine when all or any part of an Option is to become exercisable and when such Option is to expire; provided that, in appropriate cases, the Company shall have the discretion to extend the term of an Option or the time within which, following termination of employment, an Option may be exercised, or to accelerate the exercisability of an Option. A Stock Option Agreement may provide for expiration prior to the end of its term in the event of the termination of the Optionee's employment and shall provide for the suspension of vesting when an employee is on a leave of absence for a period in excess of six months in appropriate cases, as determined by the Company; provided that, except to the extent otherwise specified by the Committee at the time of grant, (i) the exercisability of Options shall be accelerated in the event of the Participant's death or Disability; (ii) in the case of Retirement, the exercisability of all outstanding Options shall be accelerated, other than any Options that had been granted within two years of the date of the Optionee's Retirement; and (iii) vesting shall be suspended when an employee is on a leave of absence for a period in excess of six months in appropriate cases, as determined by the Company. Except as provided in Section 4.2, NQSOs may also be awarded in combination with Restricted Shares, and such an Award may provide that the NQSOs will not be exercisable unless the related Restricted Shares are forfeited. In addition, NQSOs granted under this Section 5 may be granted subject to forfeiture provisions which provide for forfeiture of the Option upon the exercise of tandem awards, the terms of which are established in other programs of the Company. 5.6 Limitation on Amount of ISOs. The aggregate fair market value (determined at the time the ISO is granted) of the Common Shares with respect to which ISOs are exercisable for the first time by the Optionee during any calendar year (under all incentive stock option plans of the Company) shall not exceed $100,000; provided, however, that all or any portion of an Option which cannot be exercised as an ISO because of such limitation shall be treated as an NQSO. 5.7 Effect of Change in Control. The Committee (in its sole discretion) may determine, at the time of granting an Option, that such Option shall become fully exercisable as to all Common Shares subject to such Option immediately preceding any Change in Control with respect to the Company. 5.8 Restrictions on Transfer of Common Shares. Any Common Shares issued upon exercise of an Option shall be subject to such special forfeiture conditions, rights of repurchase, rights of first refusal and other transfer restrictions as the Committee may determine. Such restrictions shall be set forth in the applicable Stock Option Agreement and shall apply in addition to any general restrictions that may apply to all holders of Common Shares. 5.9 Authorization of Replacement Options. Concurrently with the grant of any Option to a Participant (other than NQSOs granted pursuant to Section 4.2), the Committee may authorize the grant of Replacement Options. If Replacement Options have been authorized by the Committee with respect to a particular award of Options (the "Underlying Options"), the Option Agreement with respect to the Underlying Options shall so state, and the terms and conditions of the Replacement Options shall be provided therein. The grant of any Replacement Options shall be effective only upon the exercise of the Underlying Options through the use of Common Shares pursuant to Section 6.2 or Section 6.3. The number of Replacement Options shall equal the number of Common Shares used to exercise the Underlying Options, and, if the Option Agreement so provides, the number of Common Shares used to satisfy any tax withholding requirements incident to the exercise of the Underlying Options in accordance with Section 13.2. Upon the exercise of the Underlying Options, the Replacement Options shall be evidenced by an amendment to the Underlying Option Agreement. Notwithstanding the fact that the Underlying Option may be an ISO, a Replacement Option is not intended to qualify as an ISO. The Exercise Price of a Replacement Option shall be no less than the Fair Market Value of a Common Share on the date the grant of the Replacement Option becomes effective. The term of each Replacement Option shall be equal to the remaining term of the Underlying Option. No Replacement Options shall be granted to Optionees when Underlying Options are exercised pursuant to the terms of the Plan and the Underlying Option Agreement following termination of the Optionee's employment. The Committee, in its sole discretion, may establish such other terms and conditions for Replacement Options as it deems appropriate. 5.10 Options Granted to Non-United States Key Employees. In the case of Key Employees who are subject to the tax laws of a foreign jurisdiction, the Company may issue Options to such Key Employees that contain terms required to conform with any requirements for favorable tax treatment imposed by the laws of such foreign jurisdiction, or as otherwise may be required by the laws of such foreign jurisdiction. The terms of any such Options shall be governed by the Plan, subject to the terms of any Addendum to the Plan specifically applicable to such Options. 5.11 Effect of Job Elimination. Notwithstanding anything to the contrary contained in the Plan or in any Stock Option Agreement or Stock Award Agreement entered into with respect to an Award pursuant to the Plan, in the case of a Participant who is an Officer, and who becomes entitled to receive payments with respect to a Severance Period pursuant to the Charles Schwab Severance Pay Plan (the "Severance Plan") on account of a Job Elimination, the terms of the Plan and any Stock Option Agreement or Stock Award Agreement entered into with respect to an Award shall be applied by treating the Participant as if the Participant had terminated employment on the Participant's Termination Date. For purposes of applying this Section, the terms Officer, Severance Period, Termination Date, and Job Elimination shall have the meanings set forth in the Severance Plan. Article 6. Payment for Option Shares. 6.1 General Rule. The entire Exercise Price of Common Shares issued upon exercise of Options shall be payable in cash at the time when such Common Shares are purchased, except that the Company may at any time accept payment pursuant to Section 6.2 or 6.3. 6.2 Surrender of Stock. To the extent that this Section 6.2 is applicable, payment for all or any part of the Exercise Price may be made with Common Shares which are surrendered to the Company. Such Common Shares shall be valued at their Fair Market Value on the date when the new Common Shares are purchased under the Plan. In the event that the Common Shares being surrendered are Restricted Shares that have not yet become vested, the same restrictions shall be imposed upon the new Common Shares being purchased. 6.3 Exercise/Sale. To the extent this Section 6.3 is applicable, payment may be made by the delivery (in a manner prescribed by the Company) of an irrevocable direction to Charles Schwab & Co., Inc. to sell Common Shares (including the Common Shares to be issued upon exercise of the Options) and to deliver all or part of the sales proceeds to the Company in payment of all or part of the Exercise Price and any withholding taxes. Article 7. Restricted Shares and Performance Share Awards. 7.1 Time, Amount and Form of Awards. The Committee may grant Restricted Shares or Performance Share Awards with respect to an Award Year during such Award Year or at any time thereafter. Each such Award shall be evidenced by a Stock Award Agreement between the Award recipient and the Company. The amount of each Award of Restricted Shares or Performance Share Awards shall be determined by the Committee. Awards under the Plan may be granted in the form of Restricted Shares or Performance Share Awards or in any combination thereof, as the Committee shall determine at its sole discretion at the time of the grant. Restricted Shares or Performance Share Awards may also be awarded in combination with NQSOs, and such an Award may provide that the Restricted Shares or Performance Share Awards will be forfeited in the event that the related NQSOs are exercised. 7.2 Payment for Restricted Share Awards. To the extent that an Award is granted in the form of Restricted Shares, the Award recipient, as a condition to the grant of such Award, shall be required to pay the Company in cash an amount equal to the par value of such Restricted Shares. 7.3 Vesting or Issuance Conditions. Each Award of Restricted Shares shall become vested, in full or in installments, upon satisfaction of the conditions specified in the Stock Award Agreement. Common Shares shall be issued pursuant to Performance Share Awards in full or in installments upon satisfaction of the issuance conditions specified in the Stock Award Agreement. The Committee shall select the vesting conditions in the case of Restricted Shares, or issuance conditions in the case of Performance Share Awards, which may be based upon the Participant's service, the Participant's performance, the Company's performance or such other criteria as the Committee may adopt; provided that, in the case of an Award of Restricted Shares where vesting is based entirely on the Participant's service (except to the extent otherwise specified by the Committee at the time of grant), (i) vesting shall be accelerated in the event of the Participant's death or Disability; (ii) in the case of Retirement, vesting shall be accelerated for all Restricted Shares that had been granted more than two years prior to the date of the Participant's Retirement; and (iii) vesting shall be suspended when an employee is on a leave of absence for a period in excess of six months in appropriate cases, as determined by the Company. The Committee, in its sole discretion, may determine, at the time of making an Award of Restricted Shares, that such Award shall become fully vested in the event that a Change in Control occurs with respect to the Company. The Committee, in its sole discretion, may determine, at the time of making a Performance Share Award, that the issuance conditions set forth in such Award shall be waived in the event that a Change in Control occurs with respect to the Company. 7.4 Form of Settlement of Performance Share Awards. Settlement of Performance Share Awards shall only be made in the form of Common Shares. Until a Performance Share Award is settled, the number of Performance Share Awards shall be subject to adjustment pursuant to Article 10. 7.5 Death of Recipient. Any Common Shares that are to be issued pursuant to a Performance Share Award after the recipient's death shall be delivered or distributed to the recipient's beneficiary or beneficiaries. Each recipient of a Performance Share Award under the Plan shall designate one or more beneficiaries for this purpose by filing the prescribed form with the Company. A beneficiary designation may be changed by filing the prescribed form with the Company at any time before the Award recipient's death. If no beneficiary was designated or if no designated beneficiary survives the Award recipient, then any Common Shares that are to be issued pursuant to a Performance Share Award after the recipient's death shall be delivered or distributed to the recipient's estate. The Committee, in its sole discretion, shall determine the form and time of any distribution(s) to a recipient's beneficiary or estate. Article 8. Claims Procedures. Claims for benefits under the Plan shall be filed in writing with the Committee on forms supplied by the Committee. Written notice of the disposition of a claim shall be furnished to the claimant within 90 days after the claim is filed. If the claim is denied, the notice of disposition shall set forth the specific reasons for the denial, citations to the pertinent provisions of the Plan, and, where appropriate, an explanation as to how the claimant can perfect the claim. If the claimant wishes further consideration of his or her claim, the claimant may appeal a denied claim to the Committee (or to a person designated by the Committee) for further review. Such appeal shall be filed in writing with the Committee on a form supplied by the Committee, together with a written statement of the claimant's position, no later than 90 days following receipt by the claimant of written notice of the denial of his or her claim. If the claimant so requests, the Committee shall schedule a hearing. A decision on review shall be made after a full and fair review of the claim and shall be delivered in writing to the claimant no later than 60 days after the Committee's receipt of the notice of appeal, unless special circumstances (including the need to hold a hearing) require an extension of time for processing the appeal, in which case a written decision on review shall be delivered to the claimant as soon as possible but not later than 120 days after the Committee's receipt of the appeal notice. The claimant shall be notified in writing of any such extension of time. The written decision on review shall include specific reasons for the decision, written in a manner calculated to be understood by the claimant, and shall specifically refer to the pertinent Plan provisions on which it is based. All determinations of the Committee shall be final and binding on Participants and their beneficiaries. Article 9. Voting Rights and Dividends. 9.1 Restricted Shares. All holders of Restricted Shares shall have the same voting, dividend, and other rights as the Company's other stockholders. 9.2 Performance Share Awards. The holders of Performance Share Awards shall have no voting or dividend rights until such time as any Common Shares are issued pursuant thereto, at which time they shall have the same voting, dividend and other rights as the Company's other stockholders. Article 10. Protection Against Dilution; Adjustment of Awards. 10.1 General. In the event of a subdivision of the outstanding Common Shares, a declaration of a dividend payable in Common Shares, a declaration of a dividend payable in a form other than Common Shares, a combination or consolidation of the outstanding Common Shares (by reclassification or otherwise) into a lesser number of Common Shares, a recapitalization, a spinoff or a similar occurrence, the Committee shall make appropriate adjustments in one or more of (a) the number of Options, Restricted Shares and Performance Share Awards available for future Awards under Article 3, (b) the maximum number of Common Shares which may be granted under Article 3 to any one Participant in any one fiscal year either subject to an Option or as Restricted Shares or Performance Share Awards, (c) the number of Performance Share Awards included in any prior Award which has not yet been settled, (d) the number of Common Shares covered by each outstanding Option or (e) the Exercise Price under each outstanding Option. 10.2 Reorganizations. Subject to the provisions of Section 5.7, in the event that the Company is a party to a merger or other reorganization, outstanding Options, Restricted Shares and Performance Share Awards shall be subject to the agreement of merger or reorganization. Such agreement may provide, without limitation, for the assumption of outstanding Awards by the surviving corporation or its parent, for their continuation by the Company (if the Company is a surviving corporation), for accelerated vesting or for settlement in cash. 10.3 Reservation of Rights. Except as provided in this Article 10, a Participant shall have no rights by reason of any subdivision or consolidation of shares of stock of any class, the payment of any stock dividend or any other increase or decrease in the number of shares of stock of any class. Any issue by the Company of shares of stock of any class, or securities convertible into shares of stock of any class, shall not affect, and no adjustment by reason thereof shall be made with respect to, the number or Exercise Price of Common Shares subject to an Option. The grant of an Award pursuant to the Plan shall not affect in any way the right or power of the Company to make adjustments, reclassifications, reorganizations or changes of its capital or business structure, to merge or consolidate or to dissolve, liquidate, sell or transfer all or any part of its business or assets. Article 11. Limitation of Rights. 11.1 Employment Rights. Neither the Plan nor any Award granted under the Plan shall be deemed to give any individual a right to remain employed by the Company or any Subsidiary. The Company and its Subsidiaries reserve the right to terminate the employment of any employee at any time, with or without cause, subject only to a written employment agreement (if any). 11.2 Stockholders' Rights. A Participant shall have no dividend rights, voting or other rights as a stockholder with respect to any Common Shares covered by his or her Award prior to the issuance of such Common Shares, whether by issuance of a certificate, book entry or other procedure. No adjustment shall be made for cash dividends or other rights for which the record date is prior to the date when such certificate is issued, except as expressly provided in Articles 7, 9 and 10. 11.3 Creditors' Rights. A holder of Performance Share Awards shall have no rights other than those of a general creditor of the Company. Performance Share Awards represent unfunded and unsecured obligations of the Company, subject to the terms and conditions of the applicable Stock Award Agreement. 11.4 Government Regulations. Any other provision of the Plan notwithstanding, the obligations of the Company with respect to Common Shares to be issued pursuant to the Plan shall be subject to all applicable laws, rules and regulations, and such approvals by any governmental agencies as may be required. The Company reserves the right to restrict, in whole or in part, the delivery of Common Shares pursuant to any Award until such time as: (a) Any legal requirements or regulations have been met relating to the issuance of such Common Shares or to their registration, qualification or exemption from registration or qualification under the Securities Act of 1933, as amended, or any applicable state securities laws; and (b) Satisfactory assurances have been received that such Common Shares, when issued, will be duly listed on the New York Stock Exchange or any other securities exchange on which Common Shares are then listed. Article 12. Limitation of Payments. 12.1 Basic Rule. Any provision of the Plan to the contrary notwithstanding, in the event that the independent auditors most recently selected by the Board (the "Auditors") determine that any payment or transfer in the nature of compensation to or for the benefit of a Participant, whether paid or payable (or transferred or transferable) pursuant to the terms of this Plan or otherwise (a "Payment"), would be nondeductible for federal income tax purposes because of the provisions concerning "excess parachute payments" in section 280G of the Code, then the aggregate present value of all Payments shall be reduced (but not below zero) to the Reduced Amount; provided, however, that the Committee, at the time of making an Award under this Plan or at any time thereafter, may specify in writing that such Award shall not be so reduced and shall not be subject to this Article 12. For purposes of this Article 12, the "Reduced Amount" shall be the amount, expressed as a present value, which maximizes the aggregate present value of the Payments without causing any Payment to be nondeductible by the Company because of section 280G of the Code. 12.2 Reduction of Payments. If the Auditors determine that any Payment would be nondeductible because of section 280G of the Code, then the Company shall promptly give the Participant notice to that effect and a copy of the detailed calculation thereof and of the Reduced Amount, and the Participant may then elect, in his or her sole discretion, which and how much of the Payments shall be eliminated or reduced (as long as after such election, the aggregate present value of the Payments equals the Reduced Amount) and shall advise the Company in writing of his or her election within 10 days of receipt of notice. If no such election is made by the Participant within such 10-day period, then the Company may elect which and how much of the Payments shall be eliminated or reduced (as long as after such election the aggregate present value of the Payments equals the Reduced Amount) and shall notify the Participant promptly of such election. For purposes of this Article 12, present value shall be determined in accordance with section 280G(d)(4) of the Code. All determinations made by the Auditors under this Article 12 shall be binding upon the Company and the Participant and shall be made within 60 days of the date when a Payment becomes payable or transferable. As promptly as practicable following such determination and the elections hereunder, the Company shall pay or transfer to or for the benefit of the Participant such amounts as are then due to him or her under the Plan, and shall promptly pay or transfer to or for the benefit of the Participant in the future such amounts as become due to him or her under the Plan. 12.3 Overpayments and Underpayments. As a result of uncertainty in the application of section 280G of the Code at the time of an initial determination by the Auditors hereunder, it is possible that Payments will have been made by the Company which should not have been made (an "Overpayment") or that additional Payments which will not have been made by the Company could have been made (an "Underpayment"), consistent in each case with the calculation of the Reduced Amount hereunder. In the event that the Auditors, based upon the assertion of a deficiency by the Internal Revenue Service against the Company or the Participant which the Auditors believe has a high probability of success, determine that an Overpayment has been made, such Overpayment shall be treated for all purposes as a loan to the Participant which he or she shall repay to the Company on demand, together with interest at the applicable federal rate provided in section 7872(f)(2) of the Code; provided, however, that no amount shall be payable by the Participant to the Company if and to the extent that such payment would not reduce the amount which is subject to taxation under section 4999 of the Code. In the event that the Auditors determine that an Underpayment has occurred, such Underpayment shall promptly be paid or transferred by the Company to or for the benefit of the Participant, together with interest at the applicable federal rate provided in section 7872(f)(2) of the Code. 12.4 Related Corporations. For purposes of this Article 12, the term "Company" shall include affiliated corporations to the extent determined by the Auditors in accordance with section 280G(d)(5) of the Code. Article 13. Withholding Taxes. 13.1 General. To the extent required by applicable federal, state, local or foreign law, the recipient of any payment or distribution under the Plan shall make arrangements satisfactory to the Company for the satisfaction of any withholding tax obligations that arise by reason of such payment or distribution. The Company shall not be required to make such payment or distribution until such obligations are satisfied. 13.2 Nonstatutory Options, Restricted Shares or Performance Share Awards. The Committee may permit an Optionee who exercises NQSOs, or who receives Awards of Restricted Shares, or who receives Common Shares pursuant to the terms of a Performance Share Award, to satisfy all or part of his or her withholding tax obligations by having the Company withhold a portion of the Common Shares that otherwise would be issued to him or her under such Awards. Such Common Shares shall be valued at their Fair Market Value on the date when taxes otherwise would be withheld in cash. The payment of withholding taxes by surrendering Common Shares to the Company, if permitted by the Committee, shall be subject to such restrictions as the Committee may impose, including any restrictions required by rules of the Securities and Exchange Commission. Article 14. Assignment or Transfer of Award. 14.1 General Rule. Any Award granted under the Plan shall not be anticipated, assigned, attached, garnished, optioned, transferred or made subject to any creditor's process, whether voluntarily, involuntarily or by operation of law, except to the extent specifically permitted by Section 14.2. 14.2 Exceptions to General Rule. Notwithstanding Section 14.1, this Plan shall not preclude (i) a Participant from designating a beneficiary to succeed, after the Participant's death, to those of the Participant's Awards (including without limitation, the right to exercise any unexercised Options) as may be determined by the Company from time to time in its sole discretion, (ii) a transfer of any Award hereunder by will or the laws of descent or distribution, or (iii) a voluntary transfer of an Award (other than an ISO) to a trust, partnership or limited liability company for the benefit of one or more members of the Participant's family, subject to the prior approval of the Committee or its designee; provided that, in the case of an Award granted prior to September 25, 2002, such approval shall not be required for a transfer to a trust or partnership if the Participant has sole investment control over such trust or partnership Article 15. Future of Plans. 15.1 Term of the Plan. The Plan, as set forth herein, shall become effective on May 7, 2001. The Plan shall remain in effect until it is terminated under Section 15.2, except that no ISOs shall be granted after May 6, 2011. 15.2 Amendment or Termination. The Committee may, at any time and for any reason, amend or terminate the Plan; provided, however, that any amendment of the Plan shall be subject to the approval of the Company's stockholders to the extent required by applicable laws, regulations or rules. 15.3 Effect of Amendment or Termination. No Award shall be made under the Plan after the termination thereof. The termination of the Plan, or any amendment thereof, shall not affect any Option, Restricted Share or Performance Share Award previously granted under the Plan. Article 16. Definitions. 16.1 "Award" means any award of an Option, a Restricted Share or a Performance Share Award under the Plan. 16.2 "Award Year" means a fiscal year beginning January 1 and ending December 31 with respect to which an Award may be granted. 16.3 "Board" means the Company's Board of Directors, as constituted from time to time. 16.4 "Change in Control" means the occurrence of any of the following events after the effective date of the Plan as set out in Section 15.1: (a) A change in control required to be reported pursuant to Item 6(e) of Schedule 14A of Regulation 14A under the Exchange Act; (b) A change in the composition of the Board, as a result of which fewer than two-thirds of the incumbent directors are directors who either (i) had been directors of the Company 24 months prior to such change or (ii) were elected, or nominated for election, to the Board with the affirmative votes of at least a majority of the directors who had been directors of the Company 24 months prior to such change and who were still in office at the time of the election or nomination; (c) Any "person" (as such term is used in sections 13(d) and 14(d) of the Exchange Act) becomes the beneficial owner, directly or indirectly, of securities of the Company representing 20 percent or more of the combined voting power of the Company's then outstanding securities ordinarily (and apart from rights accruing under special circumstances) having the right to vote at elections of directors (the "Base Capital Stock"); provided, however, that any change in the relative beneficial ownership of securities of any person resulting solely from a reduction in the aggregate number of outstanding shares of Base Capital Stock, and any decrease thereafter in such person's ownership of securities, shall be disregarded until such person increases in any manner, directly or indirectly, such person's beneficial ownership of any securities of the Company. 16.5 "Code" means the Internal Revenue Code of 1986, as amended. 16.6 "Committee" means the Compensation Committee of the Board, as constituted from time to time. 16.7 "Common Share" means one share of the common stock of the Company. 16.8 "Company" means The Charles Schwab Corporation, a Delaware corporation. 16.9 "Disability" means the inability to engage in any substantial gainful activity considering the Participant's age, education and work experience by reason of any medically determined physical or mental impairment that has continued without interruption for a period of at least six months and that can be expected to be of long, continued and indefinite duration. All determinations as to whether a Participant has incurred a Disability shall be made by the Employee Benefits Administration Committee of the Company, the findings of which shall be final, binding and conclusive. 16.10 "ERISA" means the Employee Retirement Income Security Act of 1974, as amended. 16.11 "Exchange Act" means the Securities Exchange Act of 1934, as amended. 16.12 "Exercise Price" means the amount for which one Common Share may be purchased upon exercise of an Option, as specified by the Committee in the applicable Stock Option Agreement. 16.13 "Fair Market Value" means the market price of a Common Share, determined by the committee as follows: (a) If the Common Share was traded on a stock exchange on the date in question, then the Fair Market Value shall be equal to the closing price reported by the applicable composite-transactions report for such date; (b) If the Common Share was traded over-the-counter on the date in question and was classified as a national market issue, then the Fair Market Value shall be equal to the last transaction price quoted by the NASDAQ system for such date; (c) If the Common Share was traded over-the-counter on the date in question but was not classified as a national market issue, then the Fair Market Value shall be equal to the mean between the last reported representative bid and asked prices quoted by the NASDAQ system for such date; and (d) If none of the foregoing provisions is applicable, then the Fair Market Value shall be determined by the Committee in good faith on such basis as it deems appropriate. 16.14 "ISO" means an incentive stock option described in section 422(b) of the Code. 16.15 "Key Employee" means (1) a key common-law employee of the Company or any Subsidiary, as determined by the Committee, or (2) a non-employee director of any Subsidiary, as determined by the Committee. 16.16 "Named Executive Officer" means a Participant who, as of the date of vesting of an Award is one of a group of "covered employees," as defined in the Regulations promulgated under Code Section 162(m), or any successor statute. 16.17 "Non-Employee Director" means a member of the Board who is not a common-law employee. 16.18 "NQSO" means an employee stock option not described in sections 422 through 424 of the Code. 16.19 "Option" means an ISO or NQSO or, in the case of a Key Employee who is subject to the tax laws of a foreign jurisdiction, an option qualifying for favorable tax treatment under the laws of such jurisdiction, including a Replacement Option, granted under the Plan and entitling the holder to purchase one Common Share. 16.20 "Optionee" means an individual, or his or her estate, legatee or heirs at law that holds an Option. 16.21 "Participant" means a Non-Employee Director or Key Employee who has received an Award. 16.22 "Performance Share Award" means the conditional right to receive in the future one Common Share, awarded to a Participant under the Plan. 16.23 "Plan" means this 1992 Stock Incentive Plan of The Charles Schwab Corporation, as it may be amended from time to time. 16.24 "Replacement Option" means an Option that is granted when a Participant uses a Common Share held or to be acquired by the Participant to exercise an Option and/or to satisfy tax withholding requirements incident to the exercise of an Option. 16.25 "Restricted Share" means a Common Share awarded to a Participant under the Plan. 16.26 "Retirement" shall mean any termination of employment of an Optionee for any reason other than death at any time after the Optionee has attained Retirement Age. For this purpose, Retirement Age shall mean age fifty (50), but only if, at the time of such termination, the Participant has been credited with at least seven (7) Years of Service under the SchwabPlan Retirement Savings and Investment Plan; provided, however, that if at the time of grant of an Option an Optionee is a Participant in a qualified retirement plan maintained by a Subsidiary (other than the SchwabPlan Retirement Savings and Investment Plan), then Retirement Age shall have the same meaning as the Normal Retirement Date as defined in such plan. 16.27 "Stock Award Agreement" means the agreement between the Company and the recipient of a Restricted Share or Performance Share Award which contains the terms, conditions and restrictions pertaining to such Restricted Share or Performance Share Award. 16.28 "Stock Option Agreement" means the agreement between the Company and an Optionee which contains the terms, conditions and restrictions pertaining to his or her option. 16.29 "Subsidiary" means any corporation or other entity, if the Company and/or one or more other Subsidiaries own not less than 50 percent of the total combined voting power of all classes of outstanding stock of such corporation (or ownership interest of such other entity). A corporation or other entity that attains the status of a Subsidiary on a date after the adoption of the Plan shall be considered a Subsidiary commencing as of such date. ADDENDUM A The provisions of the Plan, as amended by the terms of this Addendum A, shall apply to the grant of Approved Options to Key U.K. Employees. 1. For purposes of this Addendum A, the following definitions shall apply in addition to those set out in section 16 of the Plan: Approved Option Means a stock option designed to qualify as an approved executive share option under the Taxes Act; Inland Revenue means the Board of the Inland Revenue in the United Kingdom. Key U.K. Employee means a designated employee of Sharelink Investment Services plc or any subsidiary (as that term is defined in the Companies Act 1985 of the United Kingdom, as amended) of which Sharelink Investment Services plc has control for the purposes of section 840 of the Taxes Act; Taxes Act means the Income and Corporation Taxes Act 1988 of the United Kingdom. 2. An Approved Option may only be granted to a Key U.K. Employee who: (i) is employed on a full-time basis; and (ii) does not fall within the provisions of paragraph 8 of Schedule 9 to the Taxes Act. For purposes of this section 2(i) of Addendum A, "full-time" shall mean an employee who is required to work 20 hours per week, excluding meal breaks. 3. No Approved Option may be granted to a Key U.K. Employee if it would cause the aggregate of the exercise price of all subsisting Approved Options granted to such employee under the Plan, or any other subsisting options granted to such employee under any other share option scheme approved under Schedule 9 of the Taxes Act and established by the Company or an associated company, to exceed the higher of (a) one hundred thousand pounds sterling and (b) four times such employee's relevant emoluments for the current or preceding year of assessment (whichever is greater); but where there were no relevant emoluments for the previous year of assessment, the limit shall be the higher of one hundred thousand pounds sterling or four times such employee's relevant emoluments for the period of twelve months beginning with the first day during the current year of assessment in respect of which there are relevant emoluments. For the purpose of this section 3 of Addendum A, "associated company" means an associated company within the meaning of section 416 of the Taxes Act; "relevant emoluments" has the meaning given by paragraph 28(4) of Schedule 9 to the Taxes Act and "year of assessment" means a year beginning on any April 6 and ending on the following April 5. 4. Common Shares issued pursuant to the exercise of Approved Options must satisfy the conditions specified in paragraphs 10 to 14 of Schedule 9 to the Taxes Act. 5. Notwithstanding the provisions of Section 5.4 of the Plan, the exercise price of an Approved Option shall not be less than 100 percent of the closing price of a Common Share as reported in the New York Stock Exchange Composite Index on the date of grant. 6. No Approved Option may be exercised at any time by a Key U.K. Employee when that Key U.K. Employee falls within the provisions of paragraph 8 of Schedule 9 to the Taxes Act. If at any time the shares under an Approved Option cease to comply with the conditions in paragraphs 10 to 14 of Schedule 9 to the Taxes Act, then all Approved Options then outstanding shall lapse and cease to be exercisable from the date of the shares ceasing so to comply, and no optionee shall have any cause of action against the Company, Sharelink Investment Services plc or any subsidiary of the Company or any other person in respect thereof. 7. An Approved Option may contain such other terms, provisions and conditions as may be determined by the Committee consistent with the Plan, provided that the approved option otherwise complies with the requirements for approved executive option schemes specified in Schedule 9 of the Taxes Act. 8. In relation to an Approved Option, notwithstanding the terms of section 10.1 of the Plan, no adjustment shall be made pursuant to section 10.1 of the Plan to any outstanding Approved Options without the prior approval of the Inland Revenue. 9. In relation to an Approved Option any Key U.K. Employee shall make arrangements satisfactory to the Company for the satisfaction of any tax withholding or deduction - at - source obligations that arise by reason of the grant to him or her of such option, or its subsequent exercise. 10. In relation to an Approved Option, in addition to the provisions set out in section 15.2 of the Plan, no amendment which affects any of the provisions of the Plan relating to Approved Options shall be effective until approved by the Inland Revenue, except for such amendment as are required to obtain and maintain the approval of Inland Revenue pursuant to Schedule 9 to the Taxes Act. ADDENDUM THE UNITED KINGDOM 2001 OFFICER SHARE OPTION SCHEME OF THE CHARLES SCHWAB CORPORATION This Addendum to The Charles Schwab Corporation 2001 Stock Incentive Plan (the "2001 Plan") shall constitute the rules of the United Kingdom 2001 Officer Share Option Scheme ("Scheme") of The Charles Schwab Corporation (the "Company"), as approved by the United Kingdom's Board of Inland Revenue ("Inland Revenue") under Schedule 9 to the United Kingdom's Income and Corporation Taxes Act 1988 (the "Act"). Definitions 1 Except as specifically set forth in this Addendum, the terms and conditions of the 2001 Plan shall apply to the scheme. In addition, the following definitions will apply to this Scheme: 1.1 References to the "Act" are to the United Kingdom's Income and Corporation Taxes Act 1998. 1.2 The expression "New Option" means an Option over shares in the Acquiring Company (as defined in rule 5.2) or some other company falling within paragraph 10(b) or 10(c) of Schedule 9 to the Act, meeting the requirements of sub-paragraphs 15(3)(a) to (d) of Schedule 9 to the Act, granted in consideration of the release of a subsisting Option within the "appropriate period" (as defined by paragraph 15(2) of Schedule 9 to the Act). 1.3 The expression "Option-holder" means the person to whom an option has been granted under this Scheme and references to "Optionee " in the 2001 Plan shall be construed accordingly. 1.4 The expression "Participating Company" means the Company and any company which is under the control of the Company, within the meaning of section 840 of the Act, and to which the Committee shall have resolved that this Scheme shall for the time being extend. 1.5 References to "Qualifying Shares" in this Addendum are references to Shares which satisfy the requirements of paragraphs 10 to 14 of Schedule 9 to the Act. 1.6 References to "Shares" in this addendum are references to shares or shares of Common Stock in the Company. Eligibility and Grant 2.1 Options may only be granted under the Scheme to a Key Employee who is an employee (other than one who is a director) or a full-time director of a Participating Company, and for this purpose a person shall be treated as a full-time director of a Participating Company if he is obliged to devote not less than 25 hours a week, excluding meal breaks, to the performance of the duties of his office or employment with that company (or with that company and any other company which is a Participating Company). References in the 2001 Plan to "employee" shall be construed accordingly. 2.2 No Options under this Scheme may be granted to, or exercised by, a person who is not eligible to participate by virtue of paragraph 8 of Schedule 9 to the Act, as modified by section 187 (3) (a) of the Act. 2.3 No Option may be granted at a time when the Shares over which it is granted are not Qualifying Shares. 2.4 For the purposes of Article 5.4, the Fair Market Value, as determined by the Committee in respect of any Option under this Scheme, shall be as defined in Article16.13(a) of the 2001 Plan if the Stock Exchange referred to in that Article is the New York Stock Exchange and the closing price referred to in that Article is the closing price on the New York Stock Exchange and in any other case shall be not less than the market value of the shares as agreed in advance with the United Kingdom Inland Revenue Shares Valuation Division. 2.5 Only Options (as defined in the 2001 Plan) shall be granted under this Scheme and no Replacement Options, Restricted Shares or Performance Share Awards as outlined in Articles 5.9 and 7 of the 2001 Plan shall be granted under this Scheme. Articles5.9, 7, 9 and 12 of the 2001 Plan shall not apply for the purposes of this Scheme and an Option granted under the Scheme need not comply with the requirement in the second sentence of Article 5.3. 2.6 No Option granted under this Scheme shall be exercisable more than ten years after the date the Option is granted. Limitation on Awards 3. For the purposes of Article 3 of the 2001 Plan, any Option granted under this Scheme to any person shall be limited and take effect so that the sterling equivalent of the amount payable on the exercise of such Option, when added to the aggregate sterling equivalent of Shares which are capable of being acquired under subsisting rights obtained by the Participant under this Scheme or any other share option scheme established by the Company or any associated company (within the meaning contained in section 416 of the Act) of the Company and approved under Schedule 9 to the Act (but excluding any rights obtained under a savings related share option scheme) shall not exceed the limit set out in paragraph 28 of Schedule 9 to the Act. For the purposes of this Scheme, the sterling equivalent of any amount payable on the exercise of an option shall be the amount converted into pounds sterling at the highest buying rate shown in the day's spread as published in the Financial Times for the date of grant of such option or at such other rate as may be agreed from time to time with the United Kingdom Inland Revenue Shares Valuation Division. Exercise 4.1 No Option may be exercised whilst this Scheme is and is intended to remain approved by the Inland Revenue unless the Shares which would be acquired are Qualifying Shares. 4.2 Any terms and conditions imposed by the Committee under Article 5.1 of the 2001 Plan for the exercise of Options granted under this Scheme shall be factual and objective, laid down at the time of grant, and shall not be amended or waived after the time of grant unless event or events have occurred such that the Committee reasonably believes that the original conditions as amended or waived will be a fairer measure and would not be less difficult to satisfy than the original condition. Any conditions imposed shall not be effective until approved by the United Kingdom Inland Revenue. Any other terms determined by the Company may only be imposed if they otherwise comply with the requirements set out in Schedule 9 to the Act. 4.3 Notwithstanding Article 5.2 of the 2001 Plan, no Option may be transferred by will, and on the death of the Option-holder any subsisting Option may be exercised by his personal representatives not later than one year after the date of his death. Article 14.2 of the 2001 Plan shall not apply. 4.4 Article 5.5 of the 2001 Plan shall not apply to this Scheme. Each Stock Option Agreement shall specify the date when all or any instalment of the Option is to become exercisable (the vesting of the Option). The Stock Option Agreement shall also specify the term of the Option. Any subsisting Options may be exercised by the Participant or, if deceased, by his personal representatives in whole or in part (including any unvested part) at the time of or, subject to rule 4.5, at any time following the occurrence of the earliest of the following events: (i) the death of the Participant; and (ii) upon the Participant ceasing to be a director or employee of a Participating Company or the Company or any Subsidiary as defined in Article 16.29 of the 2001 Plan where that cessation was by reason of Disability, injury or Retirement. 4.5 An Option shall lapse and become thereafter incapable of exercise on the earliest of the following events: (i) the tenth anniversary of the date the Option is granted; (ii) where a Participant ceases to be a director or employee of a Participating Company or the Company or any Subsidiary as defined in Article 16.29 of the 2001 Plan by reason of death, Disability or injury, the first anniversary following such cessation; (iii)where a Participant ceases to be a director or employee of a Participating Company or the Company or any Subsidiary as defined in Article 16.29 of the 2001 Plan by reason of Retirement, the second anniversary following such cessation; and (iv) the end of the period of exercisability determined in accordance with rule 5. 4.6 Payment for Shares on the exercise of Options granted under this Scheme shall be in cash and not through the delivery of Shares of Common Stock or otherwise as described in Articles 6.2 and 6.3 of the 2001 Plan. 4.7 Shares shall be issued and the Option-holder registered as a shareholder within 30 days of receipt of a valid exercise notice. 4.8 Notwithstanding the provisions of Article 5.8 or 6.2 of the 2001 Plan, any Shares issued upon the exercise of an Option under this Scheme shall not be subject to any forfeiture conditions, rights of repurchase, rights of first refusal or any other transfer restrictions that do not apply to all holders of Shares. 4.9 Article 13 shall apply so that the Company shall not be obliged to issue the shares until the obligations are satisfied . 4.10 The Company shall keep available sufficient unissued Shares or Shares in the Treasury to satisfy the exercise in full of all Options granted under this Scheme and for the time being remaining capable of being exercised. Takeover, Change of Control 5.1 If any person obtains control of the Company (within the meaning of section 840 of the Act) as a result of making: (i) a general offer to acquire the whole of the issued share capital of the Company (other than that which is already owned by him) which is unconditional or which is made on a condition such that if it is satisfied the person making the offer will have control of the Company; or (ii) a general offer to acquire all the shares (other than shares which are already owned by him) in the Company which are of the same class as Shares subject to a subsisting Option, then the Committee shall notify all Participants as soon as is practicable after the change of control. Any subsisting Option may be exercised from the date of the receipt of that notification up to the expiry of a period ending six months from the time when the person making the offer has obtained control of the Company and any condition subject to which the offer is made has been satisfied. 5.2 If as a result of the events specified in rule 5.1 an "Acquiring Company" (as defined in paragraph 15 of Schedule 9 to the Act) has obtained control of the Company, the Participant may, if the Acquiring Company so agrees, release any subsisting Option he holds in consideration for the grant of a New Option. 5.3 Where the circumstances noted in rule 5.2 apply, New Options may be granted within the terms of paragraph 15(1) of Schedule 9 to the Act in consideration for the release of Options previously granted under this Scheme. Such New Options are deemed to be equivalent to the old Options and to have been granted within the terms of this Scheme, provided the New Options satisfy the conditions in paragraph 15(3) of Schedule 9 to the Act and the release of the Option takes place within six months of the date the Acquiring Company obtains control of the Company. A New Option issued in consideration of the release of an Option shall be evidenced by an option which shall import the relevant provisions of this Scheme. 5.4 A New Option shall, for all other purposes of this Scheme, be treated as having been acquired at the same time as the corresponding released Option. 5.5 If any person obtains control of the Company other than as a result of the events specified in rule 5.1, then the Committee shall notify all Participants as soon as practicable after the change of control. Any subsisting Option may be exercised from the date of the receipt of that notification up to the expiry of a period ending six months from the time when the person obtains control of the Company. 5.6 If, as a result of the events specified in rules 5.1 or 5.3, a company has obtained control of the Company, the Committee shall be entitled at any time to require all holders of subsisting Options to exercise those Options within 30 days by notice in writing to the Participant to this effect. 5.7 The periods of exercisability under this rule 5 and the date of lapse under rule 4.5 are those of whichever of the pre-conditions of rules 5.1, 5.3 or 5.4 are first achieved. The subsequent achievement of any other pre-conditions will not cause a period of exercisability to begin nor a date of lapse to arise. 5.8 For the purpose of this rule 5 other than rule 5.2, a person shall be deemed to have obtained control of the Company if he and others acting in concert with him have together obtained control of it. 5.9 The exercise of an Option pursuant to the preceding provisions of this rule 5 shall not be subject to any conditions imposed pursuant to Article 5.1 of the 2001 Plan as amended by rule 4.2. Employment Relationship 6. With respect to Options granted pursuant to the Scheme, Article 11 of the 2001 Plan shall be subject to the following: Any Participant or Employee shall waive any and all rights to compensation or damages on the termination of his office or employment with any past or present Participating Company or Subsidiary for any reason whatsoever insofar as those rights arise or may arise from his ceasing to have rights under or to be entitled to exercise any Option under this Scheme as a result of the termination. Neither the grant of an Option nor any benefit which may accrue to a Participant on the exercise of an Option shall form part of that Participant's remuneration entitlement from his office or employment, nor shall the grant of an Option create any right or entitlement on the Participant to have any further Options granted to him under this Scheme if at all. Protection Against Dilution: Variation of Share Capital 7. With respect to Options granted pursuant to the Scheme, Article 10.1 of the 2001 Plan shall apply, but (i) with the omission of the following words and phrases : "a declaration of a dividend payable in Common Shares", "a declaration of a dividend payable in a form other than Common Shares", "a spin-off or similar occurrence;" and (ii) as if the following words were added "or any other variation of the issued Common Shares" before the words "the Committee". Adjustments to Options, as described in Article 10 of the 2001 Plan, shall be at the discretion of the Committee and shall not be effective under this Scheme until approved by the United Kingdom Inland Revenue. Alteration of Scheme rules 8. The Committee may make such alterations to the provisions of this Scheme as may be permitted by Article 15.2 of the 2001 Plan, provided that any such alteration made at a time when this Scheme is to remain approved by the United Kingdom Inland Revenue shall not have effect unless and until the alteration has the prior approval in writing of the United Kingdom Inland Revenue. EX-10 7 exh10_246.txt EXHIBIT 10_246 Exhibit 10.246 EXECUTIVE EMPLOYMENT AGREEMENT This Executive Employment Agreement (the 'Agreement') is entered into as of this ___ day of __________, 2002 (the "Effective Date") by and among The Charles Schwab Corporation, a Delaware corporation ('TCSC'), Schwab Capital Markets, L.P., a New Jersey limited partnership ('SCM') and Lon Gorman, an individual ('Executive'). R E C I T A L S A. Executive commenced employment with TCSC as Executive Vice President on June 10, 1996 and since then has been serving TCSC and SCM in various capacities, including but not limited to serving as Vice Chairman - Enterprise President of SCM (the "SCM President") since August 1, 1999. B. Executive desires to continue to serve TCSC and SCM and TCSC and SCM desire to continue to so employ Executive and secure Executive's agreement, inter alia, not to compete with TCSC, SCM and/or their affiliates or subsidiaries for the period and on the terms and conditions set forth in this Agreement. NOW, THEREFORE, in consideration of the mutual premises set forth herein, and for other good and valuable consideration, the parties hereby agree as follows: AGREEMENT 1. Employment. TCSC hereby employs Executive as Vice Chairman and Executive Vice President and SCM hereby employs Executive as SCM President and Executive hereby agrees to serve in those positions or in such other comparable or higher officer position to which he may be appointed or assigned by the Co-Chief Executive Officers of TCSC during the Employment Term (as defined below). Executive shall report to the President & Co-Chief Executive Officer of TCSC, or to such other more senior person or persons within SCM, Charles Schwab & Co. ("Schwab") or TCSC as may be designated by the Board of Directors of TCSC ("the Board"). 2. Employment Term. The term of Executive's employment under this Agreement shall be for a period of five (5) years commencing on the Effective Date, unless earlier terminated pursuant to Section 7 of this Agreement (the "Employment Term"). 3. Duties and Responsibilities. During the Employment Term, Executive shall have responsibilities, duties and authority reasonably accorded to and expected of a Vice Chairman and Executive Vice President by TCSC and responsibilities, duties and authority reasonably accorded to and expected of the SCM President by SCM. During the Employment Term, Executive shall devote all of his business time, ability, attention, energy, knowledge and skill to performing all such duties and responsibilities as are reasonably assigned or delegated to him by the Co-Chief Executive Officers of TCSC, including but not limited to serving as the chief executive officer of SCM. Executive agrees to use his best efforts to perform such duties and responsibilities. Executive further agrees that during the Employment Term he shall not, without the prior written consent of the Co-Chief Executive Officers of TCSC and the Compliance Department of TCSC: (i) render to any other person or entity services of any kind or engage in any other business activity, whether for compensation or otherwise (except for services provided to Executive's friends and/or family members or non-profit, educational, charitable or religious organizations), or (ii) serve on any board of directors; provided that Executive may serve on the boards of directors of non-profit, educational, charitable or religious organizations without such prior written consent, so long as the fact of any such board service is disclosed by Executive in writing to the Co-Chief Executive Officers of TCSC and so long as the extent of any such service does not violate any material SCM, Schwab or TCSC policy applicable to such practices, or materially interfere with Executive's performance of his duties and responsibilities under this Agreement, or conflict in any way with the business of SCM, Schwab, TCSC and/or any of their respective affiliates and subsidiaries. 4. Compensation. For all services rendered by Executive during the Employment Term in any capacity to SCM, Schwab, TCSC and/or any of their respective affiliates or subsidiaries, including, without limitation, services as an officer, director, or member of any committee (including, without limitation, services as a member of the Executive Committee of TCSC), Executive shall be compensated as follows: (a) Base Salary. During the Employment Term, Executive shall receive a gross base salary of $560,000 on an annualized basis to be paid in equal installments twice every month (or otherwise in accordance with changes to SCM's payroll practices), from which SCM shall withhold and deduct all applicable federal and state taxes and authorized deductions as required or permitted by applicable laws ("Base Salary"). Executive's Base Salary shall be reviewed and is subject to adjustment annually by the Co-Chief Executive Officers of TCSC and the Compensation Committee of the Board, in their sole and absolute discretion, provided that Executive's Base Salary shall not be reduced below $560,000 except to the extent consistent with adjustments made to the base salaries of the other current Vice Chair-level members of the Executive Committee of TCSC. (b) Executive Committee Bonus. During the Employment Term, Executive shall be eligible to participate in TCSC's Corporate Executive Bonus Plan and Annual Individual Incentive Performance Plan (collectively, the "Executive Committee Bonus Plans"), as such plans may be amended from time to time by TCSC in its sole and absolute discretion, on a basis comparable to the other Vice Chair-level members of the Executive Committee of TCSC. Pursuant to the terms and conditions of the current Executive Committee Bonus Plans, true and correct copies of which are attached hereto as Exhibits A-1 and A-2, respectively, Executive shall be eligible to earn an aggregate annual bonus under such plans with a current target of 125% of his Base Salary, from which SCM shall withhold and deduct all applicable federal and state taxes and authorized deductions as required or permitted by applicable laws (the "Executive Committee Bonus"). The amount of the Executive Committee Bonus, if any, awarded to Executive for any calendar year during the Employment Term will be determined by the Co-Chief Executive Officers of TCSC and the Compensation Committee of the Board, in their sole and absolute discretion, on the basis of: (A) Executive's performance in managing the non-SCM business units for which he is responsible and (B) Executive's contribution to the overall management of TCSC as a member of the Executive Committee. The Executive Committee Bonus paid to Executive, if any, for any calendar year during the Employment Term will be paid on or before February 28th of the following year, on the condition Executive is actively employed with TCSC and SCM on that date, except as otherwise specifically provided in Section 7, below. Executive acknowledges and agrees that nothing in the Executive Committee Bonus Plans, this Section 4(b) or elsewhere in this Agreement, or in any other agreement between Executive and SCM, Schwab, TCSC and/or any of their respective affiliates or subsidiaries is intended to or does guarantee Executive any minimum Executive Committee Bonus during the Employment Term (except as otherwise specifically provided in Section 7, below) and nothing in the Executive Committee Bonus Plans, this Section 4(b) or elsewhere in this Agreement, or in any other agreement between Executive and SCM, Schwab, TCSC and/or any of their respective affiliates or subsidiaries is intended to or does affect the manner in which Executive's Executive Committee Bonus is determined under the Executive Committee Plans, other than to specify a current target bonus of 125% of Executive's Base Salary for purposes of the Executive Committee Bonus Plans. In no event shall Executive's target bonus percentage of base salary be reduced below 125% unless the other current Vice-Chair-level member of the Executive Committee of TSCS receive comparable reductions. (c) SCM Incentive. Subject to the TCSC stockholder approval described in Section 4(f), below, during the Employment Term Executive shall be eligible to participate in the Schwab Capital Markets Incentive Plan ("SCM Incentive Plan"), which shall be reviewed on an annual basis and which may be amended by TCSC with the written consent of Executive, which shall not be unreasonably withheld, to reflect SCM's current business plan, financial goals or other business objectives. TCSC agrees to submit the SCM Incentive Plan for the Employment Term to the 2003 annual meeting of TCSC stockholders for their approval. Pursuant to the terms and conditions of the current SCM Incentive Plan, a summary of which is attached hereto as Exhibit B, Executive shall be eligible to earn additional annual incentive compensation based on the financial performance of SCM and other related capital markets businesses for which Executive is responsible, from which SCM shall withhold and deduct all applicable federal and state taxes and authorized deductions as required or permitted by applicable laws (the "SCM Incentive"). The SCM Incentive, if any, awarded to Executive in any calendar year during the Employment Term will be awarded by the Compensation Committee of the Board, currently calculated in the manner described on Exhibit C on the basis of SCM's financial performance as measured by its Actual Adjusted Pre-Tax Contribution Margin for the combined performance of all related capital markets businesses for which Executive is responsible. For purposes of illustration and for calendar year 2002 only (as baselines necessarily will change, upwards or downwards, as reasonably determined by the parties hereto, for purposes of calculating Actual Adjusted Pre-Tax Contribution Margins in subsequent years), an SCM Incentive Illustration is attached hereto as Exhibit C. As set forth more fully on Exhibit C, Executive's current target SCM Incentive is $3 million; provided, however, that: (i) no SCM Incentive will be paid to Executive with respect to any calendar year in which SCM fails to attain the applicable threshold percentage of its financial goal (currently, 80% of its Adjusted Pre-Tax Contribution Margin goal of $138.8 million); (ii) any SCM Incentive paid to Executive shall be pro-rated by the Compensation Committee of the Board in its sole and absolute discretion for Actual Adjusted Pre-Tax Contribution Margin between stated levels and for partial years worked by Executive, except that 2002 shall not be considered a partial year and should not be pro-rated as a result of this Agreement's execution date; and, (iii) the maximum gross amount of SCM Incentive payable to Executive in any calendar year during the Employment Term is $7 million. The SCM Incentive payable to Executive, if any, with respect to any calendar year during the Employment Term shall be paid and/or granted on or before February 28th of the following year, on the condition Executive is actively employed with TCSC and SCM on that date, except as otherwise specifically provided in Section 7, below. The initial $1 million gross of any SCM Incentive payable to Executive in any calendar year during the Employment Term shall be paid entirely in cash; any amount of SCM Incentive payable to Executive in any calendar year during the Employment Term above $1 million gross shall be paid 50% in cash and 50% in equivalent grants of restricted shares of TCSC common stock. The number of restricted shares so granted to Executive, if any, shall be determined by TCSC on the date of grant by dividing the applicable gross dollar value of Executive's SCM Incentive by the average of the high and low price of TCSC common stock on the date of grant. Fifty percent (50%) of the restricted shares subject to any such grant shall vest on the second anniversary of the date of the grant and the remaining 50% shall vest on the third anniversary of the date of the grant, provided in each case that Executive is actively employed by TCSC and SCM on such date, except as otherwise specifically provided in Section 7, below. SCM, TSCS and Executive hereby acknowledge and agree that if SCM's financial performance attains the applicable threshold percentage of the adjusted pre-tax contribution margin goal specified in the SCM Incentive Plan, as it may be amended during the Employment Term in accordance with this Section 4(c), then he shall be entitled to the corresponding SCM Incentive amount specifically allocated thereto; provided, however, that, except as provided in this sentence or in Section 7 below, nothing in the SCM Incentive Plan, this Section 4(c) or elsewhere in this Agreement, or in any other agreement between Executive and SCM, Schwab, TCSC and/or any of their respective affiliates or subsidiaries otherwise is intended to or does guarantee him any minimum SCM Incentive during the Employment Term. Notwithstanding any other provision of this Agreement, in no event shall the SCM Incentive Plan, the manner in which the SCM Incentive Bonus is calculated (as described in Exhibit C), including the threshold percentages listed on Exhibit C, or the Executive's target SCM Incentive be altered, amended, terminated or changed in any way without the Executive's written consent (which shall not be unreasonably withheld). (d) Participation in The Charles Schwab Corporation Stock Programs. Subject to the approval of, and on the terms and conditions set out by, the Compensation Committee of the Board, Executive may be granted options to purchase common stock of TCSC from time to time during the Employment Term pursuant to the stock plans, agreements and programs applicable to Executive Committee members at the same corporate title and grade level. Any such option granted shall have a ten-year term, an exercise price equal to the closing price of TCSC common stock on the date of grant, and a vesting schedule consistent with similar options granted to other Executive Committee members. Any options granted shall be pursuant to and governed by the terms of the stock plans, agreements and programs then in effect and applicable to Executive Committee members at the same corporate title and grade level. (e) Reimbursement of Expenses. During the Employment Term, Executive shall be entitled to receive prompt reimbursement for all properly documented travel, entertainment and other expenses properly incurred by him in connection with his employment by TCSC and SCM in accordance with their policies. (f) SCM Incentive Subject to TCSC Stockholder Approval. Executive acknowledges and agrees that notwithstanding anything to the contrary in the SCM Incentive Plan, this Section 4 or elsewhere in this Agreement, or in any other agreement between Executive and SCM, Schwab, TCSC and/or any of their respective affiliates or subsidiaries, the Executive's eligibility for and/or receipt of (and any obligation of SCM, Schwab, TCSC and/or any of their respective affiliates or subsidiaries to pay or otherwise provide to Executive) any SCM Incentive pursuant to Section 4(c) above with respect to any calendar year after 2002 is expressly contingent upon the approval by a majority of TCSC's stockholders at TCSC's 2003 annual meeting, of a proposal to approve the SCM Incentive Plan and payments for the Employment Term which may become payable to Executive as described in Section 4(c) above. SCM, TCSC and Executive also acknowledge and agree that, if a majority of TCSC's stockholders fails to approve such a proposal at the TCSC 2003 annual meeting, then, other than with respect to the payments provided in Section 7 below, the SCM Incentive Plan and Section 4(c), above, shall be null and void and of no further force and effect with respect to any calendar year after 2002 and that the compensation (but not the severance) payable to Executive under this Agreement after 2002 for all services rendered by Executive during the Employment Term in any capacity to SCM, Schwab, TCSC and/or any of their respective affiliates or subsidiaries shall be determined without regard to the SCM Incentive Plan or Section 4(c), above. 5. Benefits. (a) Employee Benefits and Perquisites. During the Employment Term, Executive shall be eligible to participate in those employee benefit plans and perquisites of Schwab or TCSC comparable to those available to other Vice Chair-level members of the Executive Committee of TCSC, provided that such benefits and perquisites may be amended, revised or eliminated by Schwab or TCSC from time to time in its sole and absolute discretion. (b) Vacation and Sick Leave. During the Employment Term, Executive shall be entitled to accrue paid vacation and sick leave consistent with policies of Schwab or TCSC applicable to other Vice Chair-level members of the Executive Committee of TCSC, provided that such policies may be amended, revised or eliminated by Schwab or TCSC from time to time in its sole and absolute discretion. 6. Non-Competition, Non-Solicitation, Confidentiality and Assignment of Developments. As a material inducement to cause TCSC and SCM to employ Executive hereunder and in consideration of TCSC's and SCM's employment of Executive hereunder, Executive hereby covenants and agrees as follows: (a) At all times during Executive's employment with SCM and/or TCSC and for a period of one (1) year subsequent to the termination of Executive's employment with SCM and/or TCSC for any reason, Executive shall not, directly or indirectly, alone or with others, on his own behalf or on behalf of another: (i) enter the employ of or render any services to any person, joint venture, partnership, firm, corporation, limited liability company or other entity other than SCM, Schwab, TCSC or any of their respective affiliates or subsidiaries (each, a "Schwab Entity"; collectively, the "Schwab Entities"), engaged in the business or businesses of the trading, sales, research and/or underwriting of equity and/or equity-related instruments, including without limitation option trading, market-making activities and/or electronic program trading, and/or fixed income trading, sales and/or underwriting, including without limitation UIT's and/or exchange-traded funds ("Competitive Business"); (ii) engage in, participate in, assist in or otherwise benefit from any Competitive Business; or (iii) continue to be or become interested in any Competitive Business, directly or indirectly, in any capacity or in any relationship with any other person or entity (other than any Schwab Entity) whether as an individual, partner, member, shareholder, director, officer, principal, agent, employee, trustee, or consultant; provided, however, that nothing contained in this Agreement shall be deemed to prohibit Executive from acquiring, solely as an investment, shares of capital stock of any corporation which are publicly traded so long as Executive does not thereby own more than five percent (5%) of the outstanding shares of such corporation. (b) At all times during Executive's employment with TCSC and/or SCM and for a period of one (1) year subsequent to the termination of Executive's employment with TCSC and/or SCM for any reason, Executive shall not, directly or indirectly, alone or with others, on his own behalf or on behalf of another: (i) contact or solicit any person or entity who at such time is or, during the twelve (12) months prior to such time was, employed by or engaged as a consultant under contract to any Schwab Entity for the purpose of hiring that person or entity on behalf of any person or entity other than a Schwab Entity, or otherwise encouraging that person or entity to leave the employment of any Schwab Entity; (ii) hire on behalf of any person or entity other than a Schwab Entity any person or entity who at such time is, or during the 12 months prior to such time was, employed by or engaged as a consultant under contract to any Schwab Entity; or (iii) solicit for the benefit or account of any person or entity other than a Schwab Entity, any person or entity who at such time is, or during the 12 months prior to such time was, a customer of any Schwab Entity. (c) During and at all times following the Employment Term, Executive shall keep secret and retain in the strictest confidence all confidential matters and information relating to the Schwab Entities and/or any of their respective customers, including, without limitation, trade secrets, proprietary information, "know-how", "show-how", customer identities, information or lists, pricing policies, account and pricing valuation methods, operating methods or procedures, marketing plans or strategies, product development techniques or plans, designs or design projects, technical processes, formulae, source codes, inventions and research projects learned by him prior to and during his employment with TCSC and/or SCM ("Confidential Information"). Executive shall not disclose such Confidential Information to anyone other than authorized personnel of the Schwab Entities, or use such Confidential Information for his own benefit or for the benefit of any person or entity other than the Schwab Entities, except as required in the course of performing his duties as an employee of SCM and/or TCSC or as required by law, or if such matters become generally available to the public other than by (i) disclosure by Executive or anyone else owing a duty of confidentiality to any Schwab Entity, provided Executive has or reasonably should have actual or constructive knowledge that such disclosure was made in breach of such other person's duty of confidentiality, or (ii) Executive's failure to put in place adequate protections to prevent disclosure of Confidential Information. In the event that Executive is ordered to disclose any Confidential Information, whether in a legal or regulatory proceeding or otherwise, Executive shall provide TCSC and SCM, to the extent permitted by law, with prompt notice of such request or order so that TCSC and SCM or any of the other Schwab Entities may seek to prevent such disclosure. In the case of any disclosure required by law, Executive shall disclose only that portion of the Confidential Information he is required to disclose. (d) Executive agrees that any and all inventions, ideas, discoveries, improvements, processes, developments, designs, "know-how", "show-how", data, computer programs, algorithms, formulae, works of authorship, work modifications, trademarks, trade names, documentation, techniques, designs, methods, trade secrets, technical specifications, technical data, concepts, expressions and all other intellectual property rights or other developments whatsoever (collectively, "Developments"), whether or not patentable or registrable under copyright, trademark, or similar statutes or subject to analogous protection, made, authored, discovered, reduced to practice, conceived, developed or otherwise obtained by Executive (alone or jointly with others, whether during business hours or otherwise and whether on any Schwab Entity's premises or otherwise) during his employment with TCSC and/or SCM, and arising from or relating to such employment or the business of any Schwab Entity, or made using any Schwab Entity's time, materials or facilities (including, without limitation, all such information relating to corporate opportunities, research, financial and sales data, pricing and trading terms, evaluations, opinions, interpretations, acquisition prospects, the identity of customers or their requirements, the identity of key contacts within the customer's organizations or within the organization of acquisition prospects, or marketing and merchandising techniques, prospective names and marks) shall be promptly and fully disclosed to TCSC and/or SCM and to no one else and are and shall be the sole property of TCSC and/or SCM and/or its or their nominees or assigns as "works made for hire" (as that term is used under U.S. copyright law) or otherwise, and TCSC and/or SCM and/or its or their nominees or assigns shall be the sole owner of all patents, copyrights, and other rights in or connected with such Developments. Executive agrees that all drawings, memoranda, notes, records, files, correspondence, manuals, models, specifications, computer programs, maps and all other writings or materials of any type embodying any Developments are and shall be the sole and exclusive property of TCSC and/or SCM. To the extent any Developments are not or are deemed not to be works made for hire, Executive hereby assigns to TCSC and SCM without further compensation all right, title and interest he has or may have in any Developments at that time or thereafter and agrees that he shall acquire no rights during the course of his employment with TCSC and SCM with respect to Developments. During and after his employment with TCSC and SCM, Executive shall assist TCSC and SCM and/or their nominees or assigns (without charge but at no expense to Executive) to obtain and maintain or enforce any patents, copyrights, mask works or other rights or protections relating to such Developments in all countries. Executive irrevocably designates and appoints TCSC, SCM and their duly authorized officers and agents as his agent and attorney-in-fact to execute and file any and all applications and other necessary documents and to do all other lawfully permitted acts to further the prosecution, issuance or enforcement of patents, copyrights, trade secrets and similar protections related to such Developments with the same legal force and effect as if Executive had executed them himself. Executive represents and agrees that Exhibit D hereto sets forth all inventions (whether patentable or not), patents, trade secrets, trademarks, trade names, copyrights, and other intellectual property owned by Executive before entering into employment with TCSC and SCM hereunder. Executive will not assert any rights in or to any inventions, patents, trade secrets, trade names, copyrights and other intellectual property unless they are identified on Exhibit D. (e) Executive acknowledges and agrees that the restrictions contained in this Section 6 are material inducements to TCSC's and SCM's employment of Executive hereunder. Executive further acknowledges that the restrictions contained in this Section 6 are reasonable in scope and duration, will not prevent him from earning a livelihood during the applicable period of restriction, are necessary to protect the legitimate interests of the Schwab Entities, and that any breach by Executive of any provision contained in this Section 6 will result in immediate irreparable injury to TCSC, SCM and/or the other Schwab Entities for which a remedy at law would be inadequate. Accordingly, Executive acknowledges that TCSC, SCM and/or such other Schwab Entity, shall be entitled to seek permanent injunctive relief against Executive in the event of any breach or threatened breach by Executive of the provisions of this Section 6, in addition to any other remedy that may be available to TCSC, SCM and/or such other Schwab Entities whether at law or in equity. The provisions of this Section 6 shall remain unmodified and in full force and effect following the termination of Executive's employment. It is the intention of the parties to this Agreement that the covenants and restrictions set forth in this Section 6 be given the broadest interpretation permitted by law. 7. Termination of Employment. (a) Expiration of the Employment Term. Unless earlier terminated in accordance with this Section 7, the Employment Term shall automatically terminate on that date which is five (5) years from the Effective Date. In such event, the sole liability (other than as provided in Section 7(i) below) of TCSC, SCM and the other Schwab Entities shall be to pay (or, as the case may be, provide) to Executive: (i) Executive's Base Salary through the last day of the Employment Term, (ii) any bonuses not yet paid to Executive, if any, under Sections 4(b) and 4(c), above, in respect of TCSC's fiscal year ended prior to Executive's termination and any pro-rated bonus payable to Executive under Sections 4(b) and 4(c), above, as determined by the Compensation Committee of the Board in a manner consistent with TCSC policies applicable to Executive Committee members, (iii) all unreimbursed out-of-pocket business expenses of the type described in Section 4(e) above, properly incurred and documented by Executive, (iv) all unused vacation days accrued through the last day of the Employment Term, and (v) any other benefits to which Executive is entitled under applicable employee benefit plans in which he participated. In addition, if and only if Executive retires effective as of the last day of the Employment Term ("Retirement Date") and fully complies with the restrictions and covenants set forth in Section 6, above, then TCSC and/or SCM shall: (A) continue to pay Executive his Base Salary in effect on the last day of the Employment Term for a one-year period following the Retirement Date; (B) pay Executive his annual target Executive Committee Bonus as soon as practicable after the one year anniversary of the Retirement Date; and (C) vest all of the then-unvested shares of restricted stock granted to Executive during the Employment Term pursuant to Section 4(c), above, if any, effective upon the one year anniversary of the Retirement Date. (For the avoidance of doubt, all unvested stock options and equity based awards held by Executive other than the restricted stock granted to Executive during the Employment Term pursuant to Section 4(c), above, if any, shall cease to vest effective as of the Retirement Date, unless otherwise specified in the applicable stock plans, agreements and programs). In the event Executive fails to retire and/or fails to comply in any respect with his obligations under Section 6, above, then neither TCSC, SCM or any other Schwab Entity shall have any obligation to make any such additional post-employment payments or benefits to Executive but rather shall be entitled to reimbursement by Executive in full for any such additional payments or benefits already made. All payments and benefits provided to Executive pursuant to this Section 7(a) shall be in lieu of any and all other compensation, benefits, perquisites and claims of any kind, excepting only such additional amounts as may be required by law. (b) Death. The Employment Term shall terminate upon the death of Executive. In such event, the sole liability (other than as provided in Section 7(i) below) of TCSC, SCM and the other Schwab Entities shall be to pay (or, as the case may be, provide) to Executive's estate: (i) Executive's Base Salary through the last day of the month in which the death of Executive occurs, (ii) any bonuses not yet paid to Executive, if any, under Sections 4(b) and 4(c), above, in respect of TCSC's fiscal year ended prior to Executive's death and any pro-rated bonus payable to Executive under Sections 4(b) and 4(c), above, as determined by the Compensation Committee of the Board in a manner consistent with TCSC policies applicable to Executive Committee members, (iii) all unreimbursed out-of-pocket business expenses of the type described in Section 4(e) above, properly incurred and documented by Executive, (iv) all unused vacation days accrued to the date of Executive's death, (v) full and immediate vesting of all then outstanding stock options, restricted stock grants and other equity-based awards, which, in the case of stock options, shall remain exercisable by the legal representative of Executive's estate for one (1) year following the date of Executive's death (but not beyond their original term) or as otherwise specified in the applicable stock plans, agreements and programs, and (vi) any other benefits to which Executive, his beneficiaries, or his estate is entitled under applicable employee benefit plans in which Executive participated including, but not limited to payments under any plan providing life insurance benefits to Executive, his beneficiaries or his estate. All payments and benefits provided to Executive pursuant to this Section 7(b) shall be in lieu of any and all other compensation, benefits, perquisites and claims of any kind, excepting only such additional amounts as may be required by law. (c) Disability. If Executive is deemed to be disabled within the meaning of The Charles Schwab Disability Plan, then TCSC/SCM and/or Executive may terminate Executive's employment and their obligations hereunder. TCSC/SCM and/or Executive shall provide the other written notice of their intent to terminate Executive's employment pursuant to this Section 7(c) at least fourteen (14) days before the effective date of such termination. In the event of such a termination, subject to and in consideration of Executive's execution of a waiver of liability and general release of all claims against the Schwab Entities and their respective officers, directors, employees and agents in a form acceptable to TCSC and SCM, the sole liability (other than as provided in Section 7(i) below) of TCSC, SCM and the other Schwab Entities shall be to pay (or, as the case may be, provide) to Executive: (i) Executive's Base Salary through the effective date of termination, (ii) any bonuses not yet paid to Executive, if any, under Sections 4(b) and 4(c), above, in respect of TCSC's fiscal year ended prior to Executive's termination and any pro-rated bonus payable to Executive under Sections 4(b) and 4(c), above, as determined by the Compensation Committee of the Board in a manner consistent with TCSC policies applicable to Executive Committee members, (iii) all unreimbursed out-of-pocket business expenses of the type described in Section 4(e) above incurred by Executive prior to the effective date of Executive's termination, (iv) all unused vacation days accrued up to and including the effective date of Executive's termination, (v) full and immediate vesting of all then outstanding stock options, restricted stock grants and other equity-based awards, which, in the case of stock options, shall remain exercisable by the Executive or the legal representative of Executive for one (1) year following the date of Executive's termination (but not beyond their original term) or as otherwise specified in the applicable stock plans, agreements and programs, and (vi) any other benefits to which Executive is entitled under applicable employee benefits plans in which he participated including, but not limited to, payments under any plan providing disability insurance benefits to Executive. In the event Executive fails to execute the waiver of liability and general release described above, then neither TCSC, SCM nor any other Schwab Entity shall have any obligation to make any such post-employment payments or benefits to Executive, with the exception of those payments or benefits described in subsections (i), (iii), (iv), (v) and (vi) herein, but rather shall be entitled to reimbursement by Executive in full for any such payments or benefits already made. All payments and benefits provided to Executive pursuant to this Section 7(c) shall be in lieu of any and all other compensation, benefits, perquisites and claims of any kind, excepting only such additional amounts as may be required by law. (d) Termination of Executive for Cause. TCSC and SCM may terminate Executive's employment and their obligations hereunder at any time during the Employment Term for Cause (as defined below), provided that TCSC and SCM have given Executive written notice of the event or events constituting Cause and a reasonable opportunity (not to exceed fourteen (14) calendar days) for Executive to cure such event or events, provided such event or events are capable of being cured. In the event of such a termination, the sole liability (other than as provided in Section 7(i) below) of TCSC, SCM and the other Schwab Entities shall be to pay (or, as the case may be, provide) to Executive: (i) Executive's Base Salary through the effective date of termination, (ii) payment of all unreimbursed out-of-pocket business expenses of the type described in Section 4(e) incurred by Executive prior to the effective date of Executive's termination, (iii) all unused vacation days accrued up to and including the effective date of Executive's termination, and (iv) any other benefits to which Executive is entitled under applicable employee benefit plans in which he participated. The effect of a termination under this Section 7(d) on Executive's outstanding stock options, restricted stock grants and other equity-based awards shall be determined in accordance with the applicable stock plans, agreements and programs. For purposes of this Agreement, an event or occurrence constituting "Cause" shall mean any one or more of the following: (i) Executive's failure or refusal to substantially perform his duties, responsibilities, agreements or covenants as set forth or referenced herein, or Executive's continued neglect to perform such duties, responsibilities, agreements or covenants to the full extent of his abilities for reasons other than death, physical or mental incapacity; (ii) Executive's gross negligence or willful misconduct in the performance of his duties, responsibilities, agreements and covenants as set forth or referenced herein, or conduct which is materially adverse, monetarily or otherwise, to SCM or its shareholders; (iii) A finding by a court or other governmental body that an act or acts of Executive constituted a felony or other crime involving theft or fraud under the laws of the United States or any state thereof, or any other event that would operate as a statutory disqualification under applicable securities laws, rules or regulations; (iv) Executive's violation of federal or state laws or regulations, or Executive's violation of the regulations of any self-regulatory organization, and a good faith determination by the Co-Chief Executive Officers of TCSC that the continued employment of Executive would be seriously detrimental to TCSC, SCM or their respective businesses; (v) Executive's refusal, unwillingness or failure to substantially comply with compliance or risk management rules, policies, directions and/or restrictions of SCM, Schwab or TCSC, or Executive's refusal, unwillingness or failure to substantially comply with human resources rules, policies, directions and/or restrictions of SCM, Schwab or TCSC relating to harassment and/or discrimination, as such rules, policies, directions and/or restrictions are and/or may be established by SCM, Schwab or TCSC from time to time; (vi) An uncurable loss by Executive of any license or registration that is necessary for Executive to perform the duties of SCM President, or the imposition by a self-regulatory organization of special supervision or other special requirements as prerequisites for maintaining any license or registration that is necessary for Executive to perform the duties of SCM President, or the commission of any act or occurrence of any event that could result in the statutory disqualification of Executive from being employed or otherwise associated with a broker-dealer; or (vii) a material breach by Executive of this Agreement. (e) Termination of Executive Without Cause. TCSC and SCM may terminate the employment of Executive and their obligations hereunder at any time during the Employment Term without Cause upon not less than fourteen (14) days written notice to Executive. In the event of such a termination, subject to and in consideration of Executive's execution of a waiver of liability and general release of all claims against the Schwab Entities and their respective officers, directors, employees and agents in a form acceptable to TCSC and SCM and Executive's full compliance with the restrictions and covenants set forth in Section 6, above, the sole liability (other than as provided in Section 7(i) below) of TCSC, SCM and the other Schwab Entities shall be to pay (or, as the case may be, provide) to Executive: (i) Executive's Base Salary for the three-year period immediately following the effective date of Executive's termination, payable at TCSC/SCM's option in a lump sum discounted to present value by a compounded six percent (6%) interest rate or in substantially equal installments biweekly, from which TCSC/SCM shall withhold and deduct in either event all applicable federal, state and city income, social security and disability taxes as required by applicable law, (ii) an additional $10 million, (iii) any bonuses not yet paid to Executive, if any, under Sections 4(b) and 4(c), above, in respect of TCSC's fiscal year ended prior to Executive's termination and any pro-rated bonus payable to Executive under Sections 4(b) and 4(c) above, calculated by the Compensation Committee of the Board in a manner consistent with TCSC policies applicable to Executive Committee members; (iv) an amount equivalent to three years of bonuses payable to Executive under Section 4(b) above, based on Executive's target bonus levels under the plans described in Sections 4(b) above, (v) continued vesting of all of Executive's then outstanding stock options, restricted stock grants and other equity-based awards for the three-year period commencing on the effective date of Executive's termination (TCSC agrees that notwithstanding any provision in the applicable stock plans, agreements or programs to the contrary regarding when a vested stock option may be exercised, Executive shall be treated as having his employment terminated on the third anniversary of the date of termination permitting him to exercise any vested stock options for up to three (3) years and three (3) months following the effective date of Executive's termination under this Section 7(e), and Executive acknowledges and agrees that any such exercise by him more than three (3) months after the effective date of his termination shall preclude the treatment of any such stock option as an incentive stock option for tax purposes), (vi) continuation of the medical, dental and life insurance coverage provided to Executive immediately prior to the effective date of Executive's termination for the three-year period commencing on the effective date of Executive's termination, at the end of which period Executive shall be entitled to group health continuation coverage in accordance with Section 4980B of the Code or other benefits equivalent thereto; (vii) payment of all unreimbursed out-of-pocket business expenses of the type described in Section 4(e) incurred by Executive prior to the effective date of Executive's termination, (viii) all unused vacation days accrued up to and including the effective date of Executive's termination, and (ix) any other benefits to which Executive is entitled under applicable employee benefit plans in which he participated. In the event Executive fails to execute the waiver of liability and general release described above and/or fails to comply in any respect with his obligations under Section 6, above, then neither TCSC, SCM nor any other Schwab Entity shall have any obligation to make any such post-employment payments or benefits to Executive, with the exception of those payments or benefits described in subsections (vii), (viii) and (ix) herein, but rather shall be entitled to reimbursement by Executive in full for any such payments or benefits already made. All payments and benefits provided to Executive pursuant to this Section 7(e) shall be in lieu of any and all other compensation, benefits, perquisites and claims of any kind, excepting only such additional amounts as may be required by law. (f) Termination by Executive with Good Reason. Executive may resign his employment with TCSC and SCM with Good Reason (as defined below), provided that Executive has given TCSC and SCM written notice of the event or events constituting Good Reason and a reasonable opportunity (not to exceed fourteen (14) calendar days) for TCSC and SCM to cure such event or events, provided such event or events are capable of being cured. In the event of such a resignation, subject to and in consideration of Executive's execution of a waiver of liability and general release of all claims against the Schwab Entities and their respective officers, directors, employees and agents in a form acceptable to TCSC and SCM and Executive's full compliance with the restrictions and covenants set forth in Section 6, above, the sole liability (other than as provided in Section 7(i) below) of TCSC, SCM and the other Schwab Entities shall be to pay (or, as the case may be, provide) to Executive: (i) Executive's Base Salary for the three-year period immediately following the effective date of Executive's resignation, payable at TCSC/SCM's option in a lump sum discounted to present value by a compounded six percent (6%) interest rate or in substantially equal installments biweekly, from which TCSC/SCM shall withhold and deduct in either event all applicable federal, state and city income, social security and disability taxes as required by applicable law, (ii) an additional $10 million, (iii) any bonuses not yet paid to Executive, if any, under Sections 4(b) and 4(c), above, in respect of TCSC's fiscal year ended prior to Executive's resignation and any pro-rated bonus payable to Executive under Sections 4(b) and 4(c) above, calculated by the Compensation Committee of the Board in a manner consistent with TCSC policies applicable to Executive Committee members; (iv) an amount equivalent to three years of bonuses payable to Executive under Section 4(b) above, based on Executive's target bonus levels under the plans described in Section 4(b) above, (v) continued vesting of all of Executive's then outstanding stock options, restricted stock grants and other equity-based awards for the three-year period commencing on the effective date of Executive's resignation (TCSC agrees that notwithstanding any provision in the applicable stock plans, agreements or programs to the contrary regarding when a vested stock option may be exercised, Executive shall be treated as having his employment terminated on the third anniversary of the date of termination permitting him to exercise any vested stock options for up to three (3) years and three (3) months following the effective date of Executive's termination under this Section 7(f), and Executive acknowledges and agrees that any such exercise by him more than three (3) months after the effective date of his termination shall preclude the treatment of any such stock option as an incentive stock option for tax purposes), (vi) continuation of the medical, dental and life insurance coverage provided to Executive immediately prior to the effective date of Executive's resignation for the three-year period commencing with the effective date of resignation, at the end of which period Executive shall be entitled to group health continuation coverage in accordance with Section 4980B of the Code or other benefits equivalent thereto; (vii) payment of all unreimbursed out-of-pocket business expenses of the type described in Section 4(e) incurred by Executive prior to the effective date of Executive's termination, (viii) all unused vacation days accrued up to and including the effective date of Executive's termination, and (ix) any other benefits to which Executive is entitled under applicable employee benefit plans in which he participated. In the event Executive fails to execute the waiver of liability and general release described above and/or fails to comply in any respect with his obligations under Section 6, above, then neither TCSC, SCM nor any other Schwab Entity shall have any obligation to make any such post-employment payments or benefits to Executive, with the exception of those payments or benefits described in subsections (vii), (viii) and (ix) herein, but rather shall be entitled to reimbursement by Executive in full for any such payments or benefits already made. All payments and benefits provided to Executive pursuant to this Section 7(f) shall be in lieu of any and all other compensation, benefits, perquisites and claims of any kind, excepting only such additional amounts as may be required by law. For purposes of this Agreement, an event or occurrence constituting "Good Reason" shall mean any one or more of the following: (i) a material breach of this Agreement by TCSC or SCM; (ii) a substantial diminution in the title, duties or responsibilities of Executive as SCM President, or a substantial diminution in the titles of Executive as Vice Chairman and/or Executive Vice President of TCSC; (iii) the relocation of Executive's principal place of business to a location more than 25 miles from Jersey City, New Jersey without his cIonsent, which shall not be unreasonably withheld; (iv) (A) a reduction in Executive's bonus opportunity as described in Section 4(c) above, and Exhibits B and C hereto, or (B) the failure of the Board to recommend for approval the SCM Incentive Plan for the Employment Term at the 2003 annual meeting of TCSC's stockholders, or the taking of any action by the Board, after having recommended for approval the SCM Incentive Plan for the Employment Term at the 2003 annual meeting of TCSC's stockholders, to rescind such recommendation; (C) the failure of the Board to recommend or present for approval the SCM Incentive Plan for the Employment Term at the 2003 annual meeting of TCSC's stockholders, or (D) the failure of a majority of TCSC's stockholders to approve the SCM Incentive Plan at that 2003 annual meeting; (v) a reduction in Executive's Base Salary or bonus opportunity as described in section 4(b), above, and Exhibit A hereto, unless such reduction similarly affects all other Vice-Chair level members of the Executive Committee of TCSC; or (vi) the failure by TCSC or SCM to obtain the express written assumption of this agreement by an successor to TCSC or SCM. (g) Resignation by Executive. Executive may resign from his employment without Good Reason during the Employment Term and effective upon fourteen (14) days written notice to TCSC and SCM. In the event of such a resignation, subject to and in consideration of Executive's execution of a waiver of liability and general release of all claims against the Schwab Entities and their respective officers, directors, employees and agents in a form acceptable to TCSC and SCM and Executive's full compliance with the restrictions and covenants set forth in Section 6, above, the sole liability (other than as provided in Section 7(i) below) of TCSC, SCM and the other Schwab Entities shall be to pay (or, as the case may be, provide) to Executive: (i) Executive's Base Salary for the one-year period immediately following the effective date of Executive's resignation, payable at TCSC/SCM's option in a lump sum discounted to present value by a compounded six percent (6%) interest rate or in substantially equal installments biweekly, from which TCSC/SCM shall withhold and deduct in either event all applicable federal, state and city income, social security and disability taxes as required by applicable law, (ii) continuation of the medical, dental and life insurance coverage provided to Executive immediately prior to the date of Executive's resignation for the one-year period immediately following the effective date of resignation, at the end of which period Executive shall be entitled to group health continuation coverage in accordance with Section 4980B of the Code or other benefits equivalent thereto, (iii) payment of all unreimbursed out-of-pocket business expenses of the type described in Section 4(e) incurred by Executive prior to the effective date of Executive's resignation, (iv) all unused vacation days accrued up to and including the effective date of Executive's resignation; and (v) any other benefits to which Executive is entitled under applicable employee benefit plans in which is participated. The effect of a resignation under this Section 7(g) on Executive's outstanding stock options, restricted stock grants and other equity-based awards shall be determined in accordance with the applicable stock plans, agreements and programs. In the event Executive fails to execute the waiver of liability and general release described above and/or fails to comply in any respect with his obligations under Section 6, above, then neither TCSC, SCM nor any other Schwab Entity shall have any obligation to make any such post-employment payments or benefits to Executive, with the exception of those payments or benefits described in subsections (iii), (iv) and (v) herein, but rather shall be entitled to reimbursement by Executive in full for any such payments or benefits already made. All payments and benefits provided to Executive pursuant to this Section 7(g) will be in lieu of any and all other compensation, benefits, perquisites and claims of any kind, excepting only such additional amounts as may be required by law. (h) Resignation of Positions. Upon the effective date of any termination or resignation of Executive's employment for any reason whatsoever, Executive shall be deemed to have resigned from any and all offices and directorships then held with SCM, Schwab, TCSC, and/or any of their respective affiliates or subsidiaries. (i) Retirement Eligibility. TCSC acknowledges and agrees that Executive will have satisfied the requisite criteria for retirement eligibility under the terms and conditions of the SchwabPlan Retirement Savings and Investment Plan, the TCSC Deferred Compensation Plan, the TCSC 1992 Stock Incentive Plan, and the TCSC 2001 Stock Incentive Plan as of June 1, 2002, because he was actively employed by SCM and TCSC on that date. As a result, Executive is entitled to have all options granted become fully exercisable and all restricted shares granted become fully vested, but only if such retirement occurs at least two (2) years after the date of grant. For purposes of this retirement eligibility, his "retirement" shall be deemed to be on the date on which his base salary payments cease, calculated assuming the company does not elect to pay the Executive in a lump sum. Nothing in this Agreement shall limit Executive's ability to "retire" for purposes of these plans upon any termination of his employment and his "retiring" for purposes of these plans shall not affect his entitlement to any severance resulting from his termination of employment. 8. Effect of Termination of Employment. Upon the termination of Executive's employment, the parties' obligations under this Agreement shall terminate, except for those rights and obligations set forth in Sections 6, 7, 8, 10, 11, 12, 16, 20 and 23 hereof, which shall survive such termination. The benefits and payments provided to Executive under Section 7 are expressly in lieu of any eligibility for or entitlement to severance benefits under any severance plan or policy of SCM, Schwab, TCSC, or any of their respective affiliates or subsidiaries. 9. Representations and Warranties. (a) TCSC and SCM represent and warrant that they have the requisite corporate power to enter into this Agreement and to carry out the obligations hereunder. The execution and delivery of this Agreement have been duly authorized by all necessary corporate action on the part of TCSC and SCM. (b) Executive represents and warrants that he has the legal capacity to enter into this Agreement, is under no employment contract, bond, confidentiality agreement, non-competition agreement, or any other obligation that would violate or be in conflict with the terms and conditions of this Agreement or encumber his performance of duties assigned to him by SCM or TCSC. Executive further represents and warrants that he has not signed or committed to any employment or consultant duties or other obligations that would divert his full attention or conflict with from the duties assigned to him by SCM or TCSC under this Agreement. 10. Indemnification. Executive shall be indemnified by TCSC for his acts or omissions occurring during the Employment Term to the same extent TCSC indemnifies all other employees at the Executive Committee level. 11. Governing Law/Jurisdiction. Any and all actions arising out of this Agreement or Executive's employment with TCSC and/or SCM, including, without limitation, tort and contract claims, shall be governed by and construed in accordance with the laws of the State of New Jersey, without reference to the choice of law principles thereof. Subject to Section 12 below, any and all actions arising out of this Agreement or Executive's employment with TCSC and/or SCM shall be brought only and heard in the state and federal courts of the State of New Jersey, and Executive hereby irrevocably submits to the exclusive jurisdiction of such courts. Executive hereby irrevocably consents to the jurisdiction and proper venue of any such courts in any such suit, action or proceeding and irrevocably waives any claim that any such suit, action or proceeding brought in any such court has been brought in an inconvenient forum. Executive and SCM and TCSC each hereby agree to waive their respective rights to a trial by jury. 12. Dispute Resolution. (a) Except as otherwise provided herein, Executive and TCSC and SCM agree that any and all disputes between Executive and SCM, Schwab, TCSC and/or any of their respective affiliates or subsidiaries, or their respective employees, officers, directors, agents or assigns, which relate to, arise out of or pertain to Executive's employment, separation from employment or the construction or interpretation of this Agreement shall be submitted to and resolved by final and binding arbitration. The arbitration shall be instead of any civil litigation; this means that Executive, SCM and TCSC are each waiving any rights to a jury trial. Executive and TCSC and SCM expressly understand and agree that consistent with the foregoing, no party to this Agreement shall institute a proceeding in any court or administrative agency to resolve a dispute arising under or in connection with this Agreement. (b) Executive and SCM and TCSC expressly understand and agree that there will be no court or jury trial of disputes between them arising out of or in connection with this Agreement, Executive's employment or separation from employment, including, but not limited to, claims under federal, state or local laws prohibiting employment discrimination. The only disputes not covered by this agreement to arbitrate are actions for injunctive relief brought by either the Executive or SCM, Schwab, TCSC and/or any of their respective affiliates or subsidiaries concerning the rights and obligations set forth in Section 6 above. Furthermore, claims for unemployment insurance benefits, for workers' compensation insurance benefits, and for benefits under any ERISA-governed employee benefit plan(s), shall be resolved pursuant to the claims procedures under such benefit plans. (c) All disputes between the parties which are covered by the agreement to arbitrate and which cannot be resolved within two weeks after a demand for direct negotiation between the parties shall be settled exclusively by binding arbitration in Newark, New Jersey under the Commercial Arbitration Rules of the American Arbitration Association before a panel of three (3) neutral arbitrators selected under said Rules. The arbitrators shall award the prevailing party its attorneys fees, arbitration costs, expert fees, and all other costs and expenses incurred in connection with the arbitration, including any fees and costs incurred in confirming and enforcing the award. In the event a dispute concerning or arising out of this Agreement involves regulatory matters or compliance with applicable securities laws, rules or regulations, SCM and/or TCSC or Executive at its or his option may elect to pursue arbitration of all issues between the parties under the arbitration rules of the National Association of Securities Dealers ("NASD") or the New York Stock Exchange ("NYSE") in accordance with the applicable rules. Executive and SCM and TCSC expressly understand and agree that any limitations in the NASD or NYSE arbitration rules excluding statutory discrimination from the scope of the arbitration clause shall not apply and that it is the parties' desire to include statutory discrimination claims within the scope of arbitration. Executive and SCM and TCSC knowingly and voluntarily agree to this arbitration provision. A decision in arbitration shall be final and binding. (d) Judgment may be entered on the arbitrators' award in any court having jurisdiction. The arbitration filing fee expenses shall be borne according to the rules of the NASD or NYSE, as the case may be; provided that if and only if the arbitration involves statutory discrimination claims, SCM and/or TCSC shall pay all types of costs that are unique to arbitration, such as the arbitrator's fees. 13. Nonwaiver of Rights of Parties. No right or power of any party under this Agreement shall be deemed to have been waived by any act or conduct on the part of such party, or by any neglect to exercise that right or power, or by any delay in so doing; and, except as otherwise provided herein, every right or power shall continue in full force and effect until specifically waived or released by an instrument in writing executed by such party. 14. Headings. The headings of the several sections of this Agreement are inserted for reference only and not intended to affect the meaning or interpretation of this Agreement. 15. Binding Effect. This Agreement shall be binding upon and inure to the benefit of Executive, his heirs, executors, administrators, distributes, devisees and legatees and to the benefit of TCSC, SCM and their successors and assigns. With respect to the obligations, representations and warranties of Executive under Sections 6 and 9(b) this Agreement shall also inure to the benefit of all of the Schwab Entities and their respective successors and assigns. 16. Assignment. This Agreement is a personal contract and the rights and interests of Executive herein may not be sold, transferred, assigned, pledged or hypothecated. The rights and obligations of TCSC, SCM and the other Schwab Entities, as applicable, hereunder shall be binding upon and run in favor of the successors and permitted assigns of TCSC, SCM and/or the other Schwab Entities, as applicable. This Agreement may not be assigned by either party without the prior written consent of the other; except that, without such prior written consent, TCSC and/or SCM may assign their rights and obligations hereunder to any entity owned, directly or indirectly, by SCM, Schwab or TCSC on the condition that TCSC remains liable to perform the obligations of any such assignee in the event such assignee fails to so perform. TCSC and/or SCM shall require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of its business and/or assets of TCSC and/or SCM, as the case may be, to expressly assume and agree to perform this Agreement in the same manner and to the same extent that TCSC and/or SCM is required to perform it. 17. Entire Agreement. This Agreement, together with its Exhibits, constitutes the entire agreement among the parties hereto with respect to the subject matter hereof and supersedes all prior agreements, understandings, negotiations and discussions, whether oral or written, of the parties with respect thereto. No amendment, modification or rescission of this Agreement shall be effective unless set forth in writing signed by Executive, on the one hand, and by the President & Co-Chief Executive Officer of TCSC and the Executive Vice-President, General Counsel and Corporate Secretary of TCSC on the other hand. 18. No Mitigation. Executive shall not be required to mitigate the amount of any payment provided for under this Agreement by seeking other employment or otherwise, and compensation earned from such employment or otherwise shall not reduce the amounts otherwise payable under this Agreement. 19. Further Assurances. Each party hereto shall, whenever and as often as reasonably requested to do so by any party hereto, do, execute, acknowledge, and deliver, or cause to be done, executed, acknowledged, delivered, filed or recorded, all such further acts, deeds, assignments, transfers, conveyances, powers of attorney, instruments, and assurances as such other party may reasonably request in order to carry out fully the terms and provisions of this Agreement. 20. Severability and Enforceability. If any one or more of the provisions contained in this Agreement should be held to be invalid, illegal or unenforceable as to any party or in any jurisdiction, then such provision or provisions only shall be deemed invalid, illegal or unenforceable without affecting or otherwise impairing the enforceability of the remaining provisions contained herein and without affecting or otherwise impairing the enforceability of the same provisions in this Agreement with respect to any other party or in any other jurisdiction. If any of the covenants contained in Sections 6 or 12 of this Agreement are held to be invalid, illegal or unenforceable for any reason, the parties agree that the judicial body making such determination shall have the power to reform that provision only to the limited extent required to make the provision enforceable, and as reformed, such provision shall then be enforceable and shall be enforced. 21. Counterparts. This Agreement may be executed in separate counterparts, each of which shall be an original and all of which together shall constitute one and the same instrument. 22. Legal Fees. SCM and/or TCSC shall promptly pay, or if Executive has already paid such amounts reimburse Executive for all properly documented attorneys fees and expenses, including disbursements, reasonably incurred by Executive in connection with the review and negotiation of this Agreement, subject to a maximum of $25,000. 23. Notices. Any notice or other communication to be given hereunder by any party to another shall be in writing and delivered to the following addresses personally, by facsimile transmission, by postage prepaid registered or certified mail, or by a national overnight carrier: (a) Schwab Capital Markets, L.P. and The Charles Schwab Corporation: David S. Pottruck President & Co-Chief Executive Officer The Charles Schwab Corporation 120 Kearny Street San Francisco, Ca 94108 Facsimile No.: (415) 636-5431 with copies to: Carrie E. Dwyer, Esq. Executive Vice President, General Counsel and Corporate Secretary The Charles Schwab Corporation 120 Kearny Street San Francisco, Ca 94108 Facsimile No.: (415) 667-3596 and Lawrence B. Rabkin, Esq. Howard, Rice, Nemerovski, Canady, Falk & Rabkin, A Professional Corporation 3 Embarcadero Center, 6th Floor San Francisco, CA 94111 Facsimile: 415/217-5910 Executive: Lon Gorman -------------------- -------------------- -------------------- Facsimile No.: (___) __________ with a copy to: Charles J. Conroy, Jr. Milbank, Tweed, Hadley & McCloy, LLP 1 Chase Manhattan Plaza New York, NY 10005 Facsimile No.: (212) 530-5219 or such other persons or such other addresses as may be designated in writing by the parties, by a notice given as aforesaid. [REMAINDER OF PAGE INTENTIONALLY LEFT BLANK] IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first written above. Schwab Capital Markets L.P.: By: /s/ James Leonard ------------------------------ Its: SVP of General Partner ------------------------------ The Charles Schwab Corporation: By: /s/ David S. Pottruck ------------------------------ Its: ------------------------------ EXECUTIVE: /s/ Lon Gorman ---------------------------------- Lon Gorman EXHIBIT A-1 The Charles Schwab Corporation Corporate Executive Bonus Plan (As Amended February 27, 2002) I. Purposes The purposes of this Corporate Executive Bonus Plan (the "Plan") are: (a) to provide greater incentive for key executives continually to exert their best efforts on behalf of The Charles Schwab Corporation (the "Company") by rewarding them for services rendered with compensation that is in addition to their regular salaries; (b) to attract and to retain in the employ of the Company persons of outstanding competence; and (c) to further the identity of interests of such employees with those of the Company's stockholders through a strong performance-based reward system. II. Form of Awards 1. Incentive compensation awards under this Plan shall be generally granted in cash, less any applicable withholding taxes; provided that the Committee may determine, from time to time, that all or a portion of any award may be paid in the form of an equity based incentive, including without limitation stock options, restricted shares, or outright grants of Company stock. The number of shares and stock options granted in any year, when added to the number of shares and stock options granted for such year pursuant to the Company's Annual Executive Individual Performance Plan, shall in no event exceed .5% of the outstanding shares of the Company. III. Determination of Awards 1. Incentive awards for participants other than the President/Co-Chief Executive Officer shall be determined quarterly according to a Corporate Performance Payout Matrix that shall be adopted at the beginning of each year by the Compensation Committee of the Board of Directors (the "Committee"). The Executive Committee Corporate Performance Payout Matrix shall be based on corporate performance criteria to be selected by the Committee from among the following: revenue growth, operating revenue growth, consolidated pretax profit margin, consolidated pretax operating margin, customer net new asset growth, stockholder return, return on net assets, earnings per share, return on equity, and return on investment. Awards shall be defined by reference to a target percentage of base salary determined, from time to time, by the Committee. Payouts described in this subsection shall be calculated and paid on a quarterly basis, based on year-to-date performance compared with the comparable period in the preceding year. 2. With respect to payments made pursuant to Section III.1, the amount of base salary included in the computation of incentive awards shall not exceed 250% of the base salary in effect for the officer holding the same or substantially similar position on March 31, 2000. In addition, for all participants other than the President/Co-Chief Executive Officer, (i) the maximum target incentive percentage shall be 100% of base salary and (ii) the maximum award shall be 400% of the participant's target award. 3. Incentive awards for the President/Co-Chief Executive Officer shall be determined in accordance with a Corporate Performance Payout Matrix that shall be adopted at the beginning of each year by the Committee. The Committee shall determine the President/Co-Chief Executive Officer's award each year, up to the maximum amount defined by the matrix for a given level of performance. This matrix may, if the Committee deems appropriate, differ from that described in Subsection III.1. However, the performance criteria shall be the same as referred to above. Payouts for the President/Co-Chief Executive Officer shall be made on an annual basis, based on the Company's results for the full year. 4. The maximum award payable for the President/Co-Chief Executive Officer under this plan shall be no more than 500% of his target incentive award. The target incentive amount shall be determined each year by the Committee, but may not exceed 500% of base salary. The amount of base salary taken into account for purposes of computing the target incentive award may not exceed 250% of the President/Co-Chief Executive Officer's base salary as of March 31, 2000. 5. Notwithstanding anything to the contrary contained in this Plan, the Committee shall have the power, in its sole discretion, to reduce the amount payable to any Participant (or to determine that no amount shall be payable to such Participant) with respect to any award prior to the time the amount otherwise would have become payable hereunder. In the event of such a reduction, the amount of such reduction shall not increase the amounts payable to other participants under the Plan. IV. Administration 1. Except as otherwise specifically provided, the Plan shall be administered by the Committee. The Committee members shall be appointed pursuant to the Bylaws of the Company, and the members thereof shall be ineligible for awards under this Plan for services performed while serving on said Committee. 2. The decision of the Committee with respect to any questions arising as to interpretation of the Plan, including the severability of any and all of the provisions thereof, shall be, in its sole and absolute discretion, final, conclusive and binding. V. Eligibility for Awards 1. Awards under the Plan may be granted by the Committee to those employees who have contributed the most in a general way to the Company's success by their ability, efficiency, and loyalty, consideration being given to ability to succeed in more important managerial responsibility in the Company. This is intended to include the President/Co-Chief Executive Officer, Vice Chairmen, Executive Vice Presidents, and from time to time, certain other officers having comparable positions. No award may be granted to a member of the Company's Board of Directors except for services performed as an employee of the Company. 2. Except in the event of retirement, death, or disability, to be eligible for an award an employee shall be employed by the Company as of the date awards are calculated and approved by the Committee under this Plan. 3. For purposes of this Plan, the term "employee" shall include an employee of a corporation or other business entity in which this Company shall directly or indirectly own 50% or more of the outstanding voting stock or other ownership interest. VI. Awards 1. The Committee shall determine each year the payments, if any, to be made under the Plan. Awards for any calendar year shall be granted not later than the end of the first quarter of the calendar year, and payments pursuant to the Plan shall be made as soon as practicable after the close of each calendar quarter (or, in the case of the President/Co-Chief Executive Officer, as soon as practicable after the close of each calendar year). 2. Upon the granting of awards under this Plan, each participant shall be informed of his or her award by his or her direct manager and that such award is subject to the applicable provisions of this Plan. VII. Deferral of Awards 1. A participant in this Plan who is also eligible to participate in The Charles Schwab Corporation Deferred Compensation Plan may elect to defer payments pursuant to the terms of that plan. VIII. Recommendations and Granting of Awards 1. Recommendations for awards shall be made to the Committee by the Co-Chief Executive Officers, except that, with respect to the President/Co-Chief Executive Officer, recommendations for awards shall be made solely by the Chairman/Co-Chief Executive Officer. 2. Any award shall be made in the sole discretion of the Committee, which shall take final action on any such award. No person shall have a right to an award under this Plan until final action has been taken granting such award. IX. Amendments and Expiration Date While it is the present intention of the Company to grant awards annually, the Committee reserves the right to modify this Plan from time to time or to repeal the Plan entirely, or to direct the discontinuance of granting awards either temporarily or permanently; provided, however, that no modification of this plan shall operate to annul, without the consent of the beneficiary, an award already granted hereunder; provided, also, that no modification without approval of the stockholders shall increase the maximum amount which may be awarded as hereinabove provided. X. Miscellaneous All expenses and costs in connection with the operation of this Plan shall be borne by the Company and no part thereof shall be charged against the awards anticipated by the Plan. Nothing contained herein shall be construed as a guarantee of continued employment of any participant hereunder. This Plan shall be construed and governed in accordance with the laws of the State of California. EXHIBIT A-2 The Charles Schwab Corporation Annual Executive Individual Performance Plan (As Amended February 27, 2002) I. Purposes The purposes of this Annual Executive Individual Performance Plan (the "Plan") are: (a) to provide greater incentive for key executives to continually exert their best efforts on behalf of The Charles Schwab Corporation (the "Company") by rewarding them for services rendered with incentive compensation that is in addition to their regular salaries; (b) to attract and to retain in the employ of the Company persons of outstanding competence; and (c) to further align the interests of such employees with those of the Company's stockholders through a strong performance-based reward system. II. Form of Awards Incentive compensation awards under this Plan shall be generally granted in cash, less any applicable withholding taxes; provided that the Committee may determine, from time to time, that all or a portion of any award may be paid in the form of an equity based incentive, including without limitation stock options, restricted shares, or outright grants of Company stock. The number of shares and stock options granted in any year, when added to the number of shares and stock options granted for such year pursuant to the Company's Corporate Executive Bonus Plan, shall in no event exceed .5% of the outstanding shares of the Company. III. Determination of Awards 1. Incentive awards for participants shall be determined annually. The participants in the Plan shall be the executive officers who are selected by the Compensation Committee of the Board of Directors (the "Committee") to participate in the Charles Schwab Corporate Executive Bonus Plan (the "CEB Plan"), except that the President and Co-Chief Executive Officer shall not be eligible to participate in the Plan. Payouts under the CEB Plan are defined by reference to a target percentage of base salary determined, from time to time, by the Committee and pursuant to a payout matrix, adopted from time to time by the Committee, that uses corporate performance criteria, to be selected by the Committee from among the following: revenue growth, operating revenue growth, consolidated pretax profit margin, consolidated pretax operating margin, customer net new asset growth, stockholder return, return on net assets, earnings per share, return on equity, and return on investment. Each participant shall have a bonus target under the Plan equal to such Participant's bonus target under the CEB Plan, multiplied by 160%. Payouts described in this subsection shall be calculated and paid on an annual basis. 2. With respect to payments made pursuant to Section III.1, the amount of base salary included in the computation of incentive awards pursuant to the CEB Plan shall not exceed 250% of the base salary in effect for the officer holding the same or substantially similar position on March 31, 2000. In addition, (i) the maximum target incentive percentage pursuant to the CEB Plan shall be 100% of base salary and (ii) the maximum award pursuant to the CEB Plan shall be 400% of the participant's target award. 3. Notwithstanding anything to the contrary contained in this Plan, the Committee shall have the power, in its sole discretion, to reduce the amount payable to any Participant (or to determine that no amount shall be payable to such Participant) with respect to any award prior to the time the amount otherwise would have become payable hereunder. In the event of such a reduction, the amount of such reduction shall not increase the amounts payable to other participants under the Plan. IV. Administration 1. Except as otherwise specifically provided, the Plan shall be administered by the Committee. The Committee members shall be appointed pursuant to the Bylaws of the Company, and the members thereof shall be ineligible for awards under this Plan for services performed while serving on said Committee. 2. The decision of the Committee with respect to any questions arising as to interpretation of the Plan, including the severability of any and all of the provisions thereof, shall be, in its sole and absolute discretion, final, conclusive and binding. V. Eligibility for Awards 1. Awards under the Plan shall be granted by the Committee to those employees who are eligible to participate in the CEB Plan. This is intended to include the Vice Chairmen, Executive Vice Presidents, and other officers having comparable positions. No award may be granted to a member of the Company's Board of Directors except for services performed as an employee of the Company. 2. Except in the event of retirement, death, or disability, to be eligible for an award an employee must be employed by the Company as of the date awards are calculated and approved by the Committee under this Plan. 3. For purposes of this Plan, the term "employee" shall include an employee of a corporation or other business entity in which this Company shall directly or indirectly own 50% or more of the outstanding voting stock or other ownership interest. VI. Awards 1. The Committee shall determine each year the payments, if any, to be made under the Plan. Awards for any calendar year shall be granted not later than the end of the first quarter of the calendar year, and payments pursuant to the Plan shall be made as soon as practicable after the close of the calendar year. 2. Upon the granting of awards under this Plan, each participant shall be informed of his or her award by his or her direct manager and that such award is subject to the applicable provisions of this Plan. VII. Deferral of Awards 1. A participant in this Plan who is also eligible to participate in The Charles Schwab Corporation Deferred Compensation Plan may elect to defer payments pursuant to the terms of that plan. VIII. Recommendations and Granting of Awards 1. Recommendations for awards shall be made to the Committee by the Co-Chief Executive Officers. 2. Any award shall be made in the sole discretion of the Committee, which shall take final action on any such award. No person shall have a right to an award under this Plan until final action has been taken granting such award. IX. Amendments and Expiration Date While it is the present intention of the Company to grant awards annually, the Committee reserves the right to modify this Plan from time to time or to repeal the Plan entirely, or to direct the discontinuance of granting awards either temporarily or permanently; provided, however, that no modification of this plan shall operate to annul, without the consent of the beneficiary, an award already granted hereunder; provided, also, that no modification without approval of the stockholders shall increase the maximum amount which may be awarded as hereinabove provided. X. Miscellaneous All expenses and costs in connection with the operation of this Plan shall be borne by the Company and no part thereof shall be charged against the awards anticipated by the Plan. Nothing contained herein shall be construed as a guarantee of continued employment of any participant hereunder. This Plan shall be construed and governed in accordance with the laws of the State of California. EXHIBIT B SUMMARY OF SCM INCENTIVE PLAN Schwab Capital Markets Incentive ("SCM Incentive") As a participant in the SCM Incentive Plan, Mr. Gorman will be eligible for annual incentive compensation on the basis of the performance of Schwab Capital Markets and other related capital markets businesses under his authority. The SCM Incentive will fund on the basis of the financial performance of SCM as measured by the actual adjusted pretax contribution margin for the combined performance of all capital markets-related businesses that report to Mr. Gorman. The target SCM Incentive for Mr. Gorman is $3 million and the maximum SCM Incentive payable to Mr. Gorman is $7 million. No bonus payment from this plan will be made unless SCM attains the threshold of 80% of its financial goals and Mr. Gorman is employed by SCM on the date of payment. SCM performance vs. plan and the resulting SCM Incentive, if any, will be pro-rated for performance between levels ( e.g., performance at 110% of goal would result in a bonus of between $3 million and $4 million, as calculated by Corporate Finance based on the matrix in Exhibit C (which matrix may be revised each year as specified in Section 4(c) of the Agreement)) and for partial years worked by Mr. Gorman. Form Of SCM Incentive Payment The first $1 million in annual SCM Incentive payable under this Plan, if any, shall be paid entirely in cash. Any amount earned above $1 million will be paid 50% in cash and 50% in restricted shares (e.g., if an SCM Incentive of $3 million is payable, $2 million will be paid in cash and $1 million in restricted shares). The restricted share grant amount will be determined by TCSC on the date of grant, so that the total dollar value of restricted shares is converted into TCSC shares by dividing the total dollar value by the average of the high and low price of TCSC stock on the date of grant. E.g., if a $1 million value is to be granted in restricted shares, an average TCSC stock price of $13 on the date of grant, would result in a restricted share grant of 76,923 shares (rounded). Restricted shares grants in lieu of cash incentive will vest following the below vesting schedule: Time Annual Cumulative Period Vesting % Vesting % 1st year 0% 0% 2nd year 50% 50% 3rd year 50% 100% Timing Of SCM Incentive Payment The cash portion of any SCM Incentive will be paid by the end of February of each year, based on performance for the prior year (e. g., incentive for year 2002 will be paid in February, 2003), unless Mr. Gorman elects to defer the payment under Schwab's Officer Deferred Compensation Plan. Assuming that the cash portion of any SCM Incentive is determined prior to the February Compensation Committee meeting of TCSC Board of Directors, then any restricted grant portion of the SCM Incentive payable to Mr. Gorman will be granted at the February meeting of the Committee. In 2002, this meeting was held February 27. SCM Incentive Plan Subject to TCSC Stockholder Approval in 2003 The SCM Incentive Plan (and any payments payable to Mr. Gorman under said plan) with respect to any calendar year after 2002 are expressly contingent upon the approval by a majority of TCSC's stockholders at TCSC's 2003 annual meeting, of a proposal to approve the potential SCM Incentive payments which may be payable to Mr. Gorman under said plan. If a majority of TCSC's stockholders fails to approve such a proposal at the TCSC 2003 annual meeting the SCM Incentive Plan shall be null and void and of no further force and effect with respect to any calendar year after 2002. EXHIBIT C
SCM INCENTIVE MATRIX ILLUSTRATION - ----------------------------------------------------------------------------------------------------------------------------- SCM Bonus Bonus Paid As: ------------------------------------------ If Actual Adjusted Pretax Payout as % of Shares Contribution Margin is: SCM Performance SCM Bonus Target Bonus Cash Shares $ Value $13.00* - ---------------------------- ----------------- -------------- -------------------- -------------- --------------- ----------- Less than $111.1mm <80% $ 0 0% $ 0 $ 0 0 - ---------------------------- ----------------- -------------- -------------------- -------------- --------------- ----------- $111.1 mm 80% $1,000,000 33% $1,000,000 $ 0 0 - ---------------------------- ----------------- -------------- -------------------- -------------- --------------- ----------- $124.9 mm 90% $2,000,000 67% $1,500,000 $ 500,000 38,462 - ---------------------------- ----------------- -------------- -------------------- -------------- --------------- ----------- $138.8 mm 100% $3,000,000 100% $2,000,000 $1,000,000 76,923 - ---------------------------- ----------------- -------------- -------------------- -------------- --------------- ----------- $156.2 mm 112.5% $4,000,000 133% $2,500,000 $1,500,000 115,385 - ---------------------------- ----------------- -------------- -------------------- -------------- --------------- ----------- $173.5 mm 125% $5,000,000 167% $3,000,000 $2,000,000 153,846 - ---------------------------- ----------------- -------------- -------------------- -------------- --------------- ----------- $190.9 mm 137.5% $6,000,000 200% $3,500,000 $2,500,000 192,308 - ---------------------------- ----------------- -------------- -------------------- -------------- --------------- ----------- $208.2 mm 150%** $7,000,000 233% $4,000,000 $3,000,000 230,769 - ---------------------------- ----------------- -------------- -------------------- -------------- --------------- ----------- * In this example, the dollar amount represents the number of shares granted by dividing the shares' dollar value by the appropriate SCH stock price. **150% or greater; the plan payout is capped at $7 million
The plan is based on a SCM 2002 revenue goal of $437 million and an adjusted 2002 pretax contribution margin goal of $138.8 million, or 31.77%. These figures do not include AMPS. The adjusted pretax contribution margin goal is derived by starting with an unadjusted pretax contribution margin of 34.3% and subtracting the cost of equity applied to the equity capital maintained in SCM and the equity capital required by the Securities Lending business. At the end of 2001, SCM's equity capital was $66.9 million and the equity implied in the Securities Lending business was $7.5 million (i.e., loan balance of $602 million multiplied by an equity requirement of 1.25%). TCSC's cost of equity at the end of 2001 was about 15%; thus, the pretax contribution margin has been adjusted down by $11.2 million, or 15% of $74.4 million (i.e., $66.9 million plus $7.5 million). The adjusted actual pretax contribution margin calculated to determine the achieved performance measure will also include an adjustment to cover the cost of equity required to support any acquisition by SCM. EXHIBIT D EXECUTIVE'S INVENTIONS [to be inserted] SUPPLEMENTAL AGREEMENT This Supplemental Agreement (the "Agreement") is entered into as of August 30, 2002 by and among the Charles Schwab Corporation, a Delaware corporation ("TCSC"), Schwab Capital Markets, L.P., a New Jersey Limited partnership ("SCM") and Lon Gorman, an individual ("Executive"). WHEREAS TCSC, SCM and Executive entered into an Executive Employment Agreement (the "Employment Agreement") in July, 2002 but inadvertently failed to fill in the Effective Date for the Employment Agreement when executing it; and WHEREAS, TCSC, SCM and Executive wish to avoid any misunderstanding and confirm the Effective Date of the Employment Agreement. NOW, THEREFORE, in consideration of the mutual premises set forth herein, and for other good and valuable consideration, the parties hereby agree as follows: AGREEMENT 1. Defined Terms Any term used in this Agreement that is defined in the Employment Agreement shall have the same meaning as set forth in the Employment Agreement. 2. Effective Date The parties acknowledge and agree that the Effective Date of the Employment Agreement is July 16, 2002. 3. No Other Addition or Deletion Except as set forth herein, no addition or deletion to the Employment Agreement has been made. 4. Other Provisions Sections 11, 12, 13, 14, 15(other than second sentence), 16, 17, 19, 20(other than reference to Sections 6 and 12) , 21, 22(other than reference to $25,000) and 23 of the Employment Agreement shall be deemed to be set forth in this Agreement mutatis mutandis. IN WITNESS WHEREOF, the parties have executed the Agreement as of the date first written above. Schwab Capital Markets, L.P.: By: /s/ James Leonard ----------------------- Its: SVP of General Partner ----------------------- The Charles Schwab Corporation: By: /s/ David S. Pottruck ----------------------- Its: President & Co-CEO ----------------------- By: /s/ Carrie E. Dwyer ----------------------- Carrie E. Dwyer Its: ----------------------- Executive Vice-President, General Counsel and Corporate Secretary Executive: /s/ Lon Gorman -------------------------- Lon Gorman EX-10 8 exh10_247.txt EXHIBIT 10_247 Exhibit 10.247 THE CHARLES SCHWAB SEVERANCE PAY PLAN Restated As of August 1, 2002 ARTICLE 1 - PURPOSE OF PLAN The purpose of this Plan is to set forth the terms and conditions under which severance pay and other severance benefits will be provided to certain employees of the Company and/or its Affiliates. This Plan is intended to constitute an employee welfare benefit plan within the meaning of Section 3(1) of ERISA, and is intended to memorialize the provisions of the Company's severance pay program. ARTICLE 2 - DEFINITIONS A. "Administrator" means Schwab or such person or committee as may be appointed from time to time by Schwab to supervise the administration of the Plan. B. "Affiliate" means any company which is a member of a controlled group of corporations (within the meaning of Code Section 414(b)) or a group of trades or businesses under common controIl (within the meaning of Code Section 414(c)) that includes the Company. As of the Restated Effective Date, "affiliates" include the following: Affiliates: Schwab Holdings, Inc. Charles Schwab & Co., Inc. Charles Schwab Investment Management, Inc. Schwab Capital Markets, LP Mayer & Schweitzer, Inc. The Charles Schwab Trust Company Performance Technologies, Inc. TrustMark, Inc. Schwab Retirement Plan Services, Inc. Charles Schwab International Holdings, Inc. Schwab (SIS) Holdings, Inc. I Charles Schwab, Cayman, Ltd. CyberTrader, Inc. CyBerCorp Holdings, Inc. U.S. Trust Company National Association U.S. Trust Company of Delaware U.S. Trust Company of Florida Savings Bank U.S. Trust Company of New Jersey U.S. Trust Company of North Carolina U.S. Trust Company of Texas National Association U.S. Trust Mortgage Services Company UST Financial Services Corporation UST Fiduciary Services LTD UST LPO Corp. UST Securities Corporation United States Trust Company of New York C. "Base Salary" means the Participant's rate of regular annual base pay, determined as of the date of Participant's Notice of Eligibility. Base Salary excludes amounts such as bonuses, overtime, commissions, shift differential, incentive pay, and the value of any employee benefits. D. "Code" means the Internal Revenue Code of 1986, as amended. E. "Company" means The Charles Schwab Corporation, a Delaware corporation, and (unless the context requires otherwise) any Participating Company. F. "Eligible Employee" means any Employee who is classified by the Company as a "regular" full time or "regular" part-time employee, or "seasonal" employee, other than any individuals employed pursuant to the terms of a collective bargaining agreement between the Company or an Affiliate and a bargaining unit representing such Employee; provided that an Employee shall not be considered an Eligible Employee if the Employee is on an unpaid leave of absence and is not guaranteed a job upon completion of the leave. In addition, an Employee will not be eligible to participate in the Plan if the Employee has entered into a written employment or service agreement with the Company that sets forth terms and conditions of employment and specifies the payments to which that Employee may be entitled in the event of termination of employment, or who is otherwise not entitled to Severance Benefits pursuant to the terms of this Plan. G. "Employee" means any individual directly employed by the Company or a Participating Company and on whose behalf the Company withholds income tax from his or her compensation. "Employee" does not include independent contractors or consultants, persons who have signed independent contractor agreement(s) or vendor or consultant agreement(s) or have been performing services for the Company as an independent contractor, consultant or vendor or pursuant to an independent contractor, consultant or vendor agreement or any type of third party agreement; irrespective of whether any such individuals are determined by any third party (including without limitation any court, arbitrator or governmental or regulatory agency) to constitute employees of the Company any kind, including but not limited to, a common law employee, an agency temporary, a joint employee or a leased employee. H. "Job Elimination" means an involuntary termination of employment on account of changes in the Company's operations or organization, as determined by the Company in its sole discretion, including, without limitation, reorganizations, staffing changes, job elimination, or job force reductions. Circumstances that result in Job Elimination may include, without limitation, (i) a relocation or dissolution of a portion of the business of the Company, (ii) a withdrawal by the Company from a segment of a market served by the Company; (iii) the elimination of one or more Company product lines; (iv) an elimination, reduction, or change in the Company's need for one or more specialized skills provided by the Employee; (v) an organizational change in the Company, including without limitation a business redesign, reorganization or consolidation; (vi) a significant change in the Company's systems or technology; (vii) a reduction in the Company's staffing levels; (viii) a sale of any portion of a business, following which an Employee is not offered a position by the acquiring organization at substantially the same salary level; (ix) a significant involuntary decrease by the Company in the number of hours in the Employee's regularly scheduled workweek; and (x) an involuntary decrease by the Company in the Employee's regularly scheduled workweek or in the Employee's employment classification which causes the Employee's loss of eligibility for medical benefits. Notwithstanding anything to the contrary contained herein, a Job Elimination shall not result (i) from an Employee's termination of employment on account of voluntary resignation, retirement or death prior to notice to the Employee of eligibility for Severance Benefits due to Job Elimination; (ii) if the Company has offered the Employee a comparable replacement position (which determination will be made by the Company, within its sole discretion, taking into account, for example, the similarity of duties, similarity of exempt or nonexempt status and salary range; provided that a new position will not be considered "comparable" if it is not within reasonable commuting distance from the employee's home, offers a salary less than the employee's former position, or is of a grade more than one grade below the employee's former position); (iii) from a termination on account of the Employee's substandard performance or failure of condition of employment prior to or after Notice of Eligibility; (iv) from a termination resulting from an Employee's violation of law or of Company policy(ies), including without limitation, the failure to obtain a required license, absenteeism, fraud, theft, conflict of interest, or misconduct (including, but not limited to, dishonesty or harassment); (v) where, following the sale or outsourcing of any portion of a business, an Employee is offered by the successor organization a position at a base salary rate not significant lower than that for the Employee's former position, or of a grade not more than one grade lower than the Employee's former position; (vi) the Employee's failure to return to work within the time required following an approved leave of absence (vii) a change in employment that results from a natural disaster, unforeseeable governmental action, act of war, or other similar unanticipated business disaster; or (viii) a transfer of employment among the Company and any of its Affiliates. I. "Non-Officer" means an Eligible Employee who is not an Officer. J. "Notice of Eligibility" means a written notice, in a form approved by the Company, provided to an Eligible Employee that (1) there will be a Job Elimination and that the employee is eligible to obtain Severance Benefits under the Plan or (2) the employee's participation in the Voluntary Separation Program has been approved by the Company and that the employee is eligible to obtain Severance Benefits under the Plan. An Eligible Employee who has been provided a Notice of Eligibility is considered a Participant. K. "Notice Period" means a sixty (60) calendar day period typically commencing on the next day following the date of the Notice of Eligibility, or on such later date as the Company shall determine in its sole discretion. Participants are relieved from job responsibilities during the Notice Period and generally are not required to report work unless notified otherwise by the Company. Also during the Notice Period, all Compliance, Human Resources and Information Security policies and procedures that applied to Participants before receiving Notice of Eligibility continue in full force and effect and Participants remain subject to those policies and procedure. Participants will continue to receive Base Salary, participate in certain employee benefits, be eligible for consideration for bonus and other incentive compensation etc. during the Notice Period as though working pursuant to their regular schedule (except with regard to any period that would otherwise be a "furlough" period for a Participant who is a seasonal Employee, for which period seasonal Employee Participants will not receive pay or the other benefits but will continue to be considered Employees until the end of the furlough period), in accordance with normal Company policy and the terms of the applicable plans. L. "Notice Period Date" means the first day of the Notice Period. M. "Officer" means an Eligible Employee who has been elected an Officer of the Company or Schwab or who has a job grade/designation level "E1" or above with a Participating Company. N. "Participant" means any Eligible Employee who has been provided a Notice of Eligibility. O. "Participating Company" means the Company and any Affiliate that participates in the Plan, as determined by the Company in its sole discretion. P. "Plan" means The Charles Schwab Severance Pay Plan. Q. "Plan Year" means the calendar year. R. "Regular Employee" means any Employee with regular full-time or part-time employment or seasonal employment with the Company, who is considered and classified by the Company as a "regular" or "seasonal" employee." "Regular Employee" does not include, without limitation, any of the following: (i) Schwab Temps or floaters; (ii)Agency Temporaries or other temporary workers (iii)Employees on an unpaid leave of absence who do not have a job guarantee upon completion of the leave; (iv)Consultants/Independent contractors, persons who have signed Independent Contractor, consultant or vendor Agreement(s) or provide services to the Company pursuant to an Independent Contractor, consultant or vendor Agreement, or pursuant to an agreement with any third party, irrespective of whether any such individuals are determined by any third party (including without limitation any court, arbitrator or governmental or regulatory agency) to constitute an employee of the Company or any Affiliate (including but not limited to, a common law employee, a joint employee or a lease employee); and (v) Persons (including but not limited to those identified in subparagraphs (i) through (iv)) not otherwise considered by the Company to be a "regular employee," irrespective of whether any such individuals are deemed by a court. arbitrator or government agency to be an employee of the Company or any Affiliate (including but not limited to, a common law employee, a joint employee or a lease employee). S. "Restated Effective Date" means August 1, 2002. T. "Return Date" means the date by which a Participant must sign and return a Severance Agreement where required to do so in order to obtain Severance Benefits in addition to participation in and payment for the Notice Period under this Plan. Except as otherwise determined by the Company in its sole discretion, the Return Date is the date twenty one (21) calendar days following the date the Participant is provided with Notice of Eligibility; provided however that: 1) the Return Date will be on the next business day if the twenty-first calendar day is not a business day; and 2) if the Participant is at least forty years old, and the Job Elimination and/or the Voluntary Separation Program affects two or more Participants at least forty years old, the Return Date will be on the forty-fifth (45) calendar day following the date the Participant is provided with Notice of Eligibility (or the next business day if the forty-fifth calendar day is not a business day); and 3) if the Participant is under forty years old and is otherwise entitled, under applicable state or local fair employment practice law, to more than twenty-one (21) calendar days in which to consider whether to execute the Severance Agreement, the Return Date will be a date determined by reference to applicable state or local fair employment practices law. A Severance Agreement returned to the Company that is signed and physically received by the Return Date, or, if mailed, is addressed properly for delivery, postmarked by the United State Postal Service no later than the Return Date, and actually received by the Company no later than 10 calendar days from the Return Date, will be considered timely. Severance Agreements which are not signed and/or returned as provided here will not be accepted by the Company, unless the Company decides to accept it on a case-by-case basis, in its sole discretion. U. "Revocation Period" means the seven calendar day (or other longer legally required calendar day) period immediately following the date the Participant signs the Severance Agreement, as defined in ARTICLE 2W below, during which a Participant who is either: (i) at least forty (40) years old; or (ii) is under forty (40) years old and is employed in a state that requires a specific Revocation Period, may revoke his or her signed Severance Agreement. To be effective, a written request to revoke must be received by the Company (as defined by applicable law) no later than 5:00 p.m. PST on the seventh calendar day (or other longer period required by law) from the date the Participant signed the Severance Agreement. V. "Schwab" means Charles Schwab & Co., Inc., a California corporation. W. "Severance Agreement " means a written agreement in a form satisfactory to the Company, in its sole discretion, by which a Participant agrees to waive and release the Company from legal claims in exchange for payment of Severance Benefits as provided in ARTICLE 6. To be effective, a Severance Agreement must be signed and returned by the Return Date (and not revoked during any applicable Revocation Period). Severance Agreements are not required to be identical among Participants. X. "Severance Benefits" means all payments and benefits provided for in this Plan, including but not limited to all salary and benefits for periods during which a Participant remains an Employee after being provided a Notice of Eligibility (such as the Notice Period and/or Severance Period), all forms of compensation and/or benefits of any kind for or in connection with such periods, and all other amounts paid or payable to Participants in accordance with the Plan. The Severance Benefits a Participant may receive are net amounts from which applicable taxes, withholding and appropriate deductions have been taken, including but not limited to deduction of any outstanding amount owed to the Company by the Participant regardless of the reason for or source of the amount due. In order to receive Severance Benefits under ARTICLE 6, a Participant must timely sign and return (and not revoke, where a Revocation Period applies) a Severance Agreement as defined in ARTICLE 2W. All Severance Benefits shall be applied toward satisfaction of the Company's WARN obligations, if any, and shall constitute WARN notice and/or WARN benefits where WARN applies. Y. "Severance Period" means the period of time following the Notice Period during which an Officer Participant is eligible to receive salary in installment payments pursuant to Section 6.3 in exchange for entering into a Severance Agreement. Officer Participants must be available to perform services as may be required. Compliance, Human Resources and Information Security policies continue to apply during the Severance Period. Z. "Termination Date" means the last day that the Employee is employed by the Company. For Non-Officer Participants, the Termination Date is the day the Notice Period ends (as it may be accelerated under ARTICLEs 5 and/or 6)). For Officer Participants, the Termination Date is the last day of the Notice Period (as it may be accelerated under ARTICLEs 5 and/or 6), or, if an Officer Participant signs, returns and does not revoke a Severance Agreement in the required time, the Termination Date is the last day of the Severance Period (as it may be accelerated under ARTICLEs 5 and/or 6). AA. "Voluntary Separation Program" means a program of limited time duration under which an eligible employee is permitted to voluntarily separate from employment with the Company, thereby receiving certain associated benefits, including participation in this Plan. In the absolute discretion of the Company, employees in certain job groups, job descriptions or job categories may not be considered eligible to request participation in the Voluntary Separation Program. Even for employees eligible to participate in the Voluntary Separation Program, their actual participation is not guaranteed and the Company may deny an eligible employee's request for participation, in its absolute discretion. BB. "WARN" means the Federal Worker Adjustment Retraining and Notification Act, as amended, and any applicable state plant or facility closing or mass layoff law. In the event WARN applies to a Participant, any Notice Period and/or Severance Period, and all compensation and all benefits of any kind due or paid with respect to either are also deemed to constitute WARN notice and/or WARN benefits, and will be applied toward satisfying the Company's obligations under WARN. CC. "Year of Service" means a continuous complete twelve-month period commencing on a Participant's date of hire with the Company or an Affiliate (and, in the case of an Employee who is rehired after terminating employment with the Company or an Affiliate, including service prior to a break in service for other than a Severance), and anniversaries thereof, during which a Participant is employed by the Company or an Affiliate, and ending on the Participant's Notice Period Date. For purposes of the foregoing, a Participant will receive credit for any time on a paid leave of absence, but not for time on an unpaid leave of absence. Also for purposes of the foregoing, a Participant who was a seasonal employee at the time of receiving Notice of Eligibility will receive credit for any time on furlough, assuming the Participant returned to Schwab or an Affiliate at the end of the furlough period. A Participant will also receive credit for Service with BankAmerica Corporation and its affiliates during the time it was an affiliated company of the Company, if the Participant was employed by the Company before November 24, 1993, and service with BankAmerica Corporation and its affiliates prior to the date it became an affiliated company of the Company, if the Participant was employed by the Company prior to April 1, 1987. A Participant will also receive credit for service with any Affiliate prior to the time it became an Affiliate if the Participant was employed by such Affiliate on the date it became an Affiliate. ARTICLE 3 - ELIGIBILITY 3.1. Eligible Employees will become eligible to participate in the Plan as of the date the Eligible Employee is provided with a Notice of Eligibility. ARTICLE 4 - EFFECT ON OTHER BENEFITS 4.1. Eligibility for other employee benefits (such as medical, dental, vision insurance) will cease in accordance with the terms of any respective plan no later than the last day of the month that includes the Termination Date. 4.2 A Participant will continue accruing paid time off benefits until the Termination Date, but in any event no later than the end of the Notice Period. The rate of accrual during the Notice Period will be the same as the rate of accrual prior to Notice of Eligibility. ARTICLE 5 - NOTICE AND SEVERANCE PERIODS 5.1 Notice Period. Following an Eligible Employee's Notice of Eligibility, the Participant will enter a Notice Period for a period of sixty (60) calendar days. During the Notice Period, Participants are not required to report to work unless notified otherwise and Participants remain subject to Company policies and procedures. If WARN is applicable to a Participant, the Notice Period and all compensation (including but not limited to salary/wages, benefits and benefit plan participation) attributable to the Notice Period shall constitute WARN notice and the payment of WARN benefits, respectively, and will be applied against any notice period or other payments that would otherwise be due to satisfy the Company's obligations under WARN. The Termination Date, which is originally established as the end of the 60 day Notice Period, will be accelerated or otherwise changed if any of the following events occur: a. If, prior to the end of the Notice Period, a Participant resigns or otherwise obtains an external position or acts as an employee, consultant or independent contractor or as a sole proprietor of a business or acts as an officer, director, or partner in another public or privately held company. In that case, the Participant is required to notify the Company immediately, the end of the Notice Period and the Termination Date will be accelerated to coincide with the next day after the Participant resigned or otherwise obtained that position. The Participant will receive a payment reflecting the balance of the Base Salary attributable to the unused portion of the original Notice Period, provided however that no payment will be made for the value of bonuses, or other incentive compensation or the value of other employee benefits that might otherwise have been received if the Termination Date had not been accelerated. The Participant remains eligible to sign and return the applicable Severance Agreement by the Return Date in order to obtain additional Severance Benefits under ARTICLE 6, provided however that: (i) Officer Participants who resign or otherwise obtain an external position or act as an employee, consultant or independent contractor or as a sole proprietor of a business or act as an officer, director, or partner in another public or privately held company prior to the end of the Notice Period, who so notify the Company, and who sign, return (and do not revoke) a Severance Agreement within the required time, shall not enter the Severance Period. Such Officer Participants shall receive a lump sum payment for Base Salary that otherwise would have been payable during a Severance Period in accordance with section 6.3. Also, Officer Participants will receive a lump sum payment for COBRA premiums in accordance with section 6.3. Other than as provided here, no lump sum payment shall be made for the value of any bonuses, incentives or other employee benefits the Officer Participant would have received during the Notice Period or Severance Period. b. If a Participant is permitted by the Company to obtain, and does obtain, another regular full time or part time position or seasonal position within the Company before the end of the Notice Period, his/her Termination Date under the Plan will be cancelled and the Participant is no longer eligible to receive any Severance Benefits or any payment of any kind for compensation (including benefits) otherwise attributable to the unused portion of the Notice Period. If a Participant already received payment of lump sum Severance Pay under sections 6.1 and/or 6.2, the Participant is required to repay the lump sum Severance Pay, including the COBRA premium, in full as a condition of the employment. 5.2 Severance Period. For Officer Participants who sign and return (and do not revoke, if a Revocation Period applies) the Severance Agreement as required, the Notice Period is followed by a Severance Period. Officer Participants receive installment payments in the form of Base Salary during the Severance Period and continue to be eligible for certain employee benefits (as determined by the Company in accordance with the terms of the respective plans) in exchange for agreeing to remain available to perform services for the Company during the Severance Period. The length of the Severance Period is determined by the officer level and Years of Service, in accordance with section 6.3. During the Severance Period, Compliance, Human Resources and Information Security policies and procedures continue in full force and effect and Officer Participants remain subject to those policies and procedures. If WARN is applicable to an Officer Participant, the Severance Period and all compensation (including but not limited to salary/wages, benefits and benefit plan participation) attributable to the Severance Period shall constitute WARN notice and the payment of WARN benefits, respectively, and will be applied against any notice period or other payments that would otherwise be due to satisfy the Company's obligations under WARN. In addition: a. During the Severance Period, Officer Participants are not eligible for bonuses or any other incentive compensation. b. The Termination Date for Officer Participants who sign and return (and do not revoke, where applicable) the Severance Agreement in the required time is reset to the end of the Severance Period under section 6.3. The Termination Date will be accelerated or otherwise changed: (i) if, prior to the end of the Severance Period, an Officer Participant resigns or otherwise obtains an external position or acts as an employee, consultant or independent contractor or as a sole proprietor of a business or acts as an officer, director, or partner in another public or privately held company. In that case, an Officer Participant must notify the Company immediately and the end of the Severance Period and the Termination Date will be accelerated to coincide with the next day after the Officer Participant resigned or otherwise obtained that position. The Officer Participant will receive a lump sum payment for the balance of Base Salary for the unused portion of the original Severance Period, provided however that no payment will be made for the value of bonuses, incentive compensation or other employee benefits. In addition, Officer Participants will receive a lump sum payment for COBRA premiums as provided in section 6.3. (ii) if an Officer Participant is permitted by the Company to obtain, and does obtain, another regular full time or part time or seasonal position within the Company after the Severance Period begins and before the date it is scheduled to end. In that case, the Termination Date under the Plan will be cancelled and the Officer Participant is no longer eligible to receive any Severance Benefits or any payment of any kind for compensation (including but not limited to benefits or the value of any benefits) otherwise attributable to the unused portion of the Severance Period. ARTICLE 6 - BENEFITS Upon being provided with a Notice of Eligibility, a Participant becomes entitled to receive the Severance Benefits described in sections 6.1, 6.2, and 6.3 (as applicable) only if the Participant returns to the Company a signed Severance Agreement no later than the Return Date. If a Revocation Period applies, a Participant's entitlement to these Severance Benefits also is conditioned upon the Participant not revoking (or attempting to revoke) the Severance Agreement during the Revocation Period. Subject to those conditions, the Participant will be entitled to receive the amounts set forth in Sections 6.1 and 6.2, or 6.3 (as applicable). 6.1 Non-Officer Severance Pay. Non-Officer Participants who experience an involuntary termination will receive a lump sum severance pay benefit hereunder equal to the greater of the amount determined under (a) or (b) below: a. The amount of Base Salary that would have been payable for one-half month of active employment (i.e., 11 business days) multiplied by the Non-Officer Participant's full Years of Service (but in no event to exceed the maximum amount equivalent to 176 business days). The Non-Officer Participant also will receive credit for a partial Year of Service (after aggregation of partial years), based on the following table: Length of Partial Year No. of Days ---------------------- ----------- Not more than 3 months 3 Business Days More than 3 but not more than 6 months 6 Business Days More than 6 but not more than 9 months 9 Business Days More than 9 but less than 12 months 11 Business Days OR b. The amount of Base Salary that would have been payable for the number of business days determined under the following table: Base Salary No. of Days ----------- ----------- $29,999 or less 22 Business Days $30,000 to $39,999 44 Business Days $40,000 to $54,999 66 Business Days $55,000 to $74,999 88 Business Days $75,000 and over 110 Business Days The length of service under Formula A will be used in the event application of A and B result in the same amount. c. Non-Officer Participants who experience a voluntary separation will receive a lump sum severance pay benefit equaIl to the greater of the amount determined under (a) or (b) plus an amount equal to three months of Base Salary. The three months of Base Salary will be calculated by multiplying the amount of the Non-Officer Participant's semimonthly paycheck by six (6). 6.2 COBRA Payment - Non-Officers A Non-Officer Participant who becomes entitled to receive Severance Benefits under section 6.1 will also receive payment for a portion of the Non-Officer Participant's COBRA health care coverage premium. The Non-Officer Participant shall receive a single lump sum payment in an amount equal to the amount the Non-Officer Participant will be charged for the COBRA premiums for the employee and his/her enrolled dependents for a number of days equal to the number of days for which the Non-Officer Participant is eligible to receive Severance Pay under Section 6.1. The payment for a portion of COBRA premiums is based on group medical, dental, vision, and employee assistance program ("EAP") coverage at the same benefits levels in effect for the Non-Officer Participant and any enrolled dependents at the time the Non-Officer Participant is given Notice of Eligibility. The single lump sum payment representing COBRA premiums is based on COBRA premium levels in effect at the Termination Date and in no event is a Participant entitled to receive payment for a subsequent increase, if any, in COBRA premium levels. If the Non-Officer Participant or his/her dependents were not enrolled for group health coverage at the time the Company gave Notice of Eligibility, the Non-Officer Participant will not receive any payments under this Section 6.2. 6.3 Officer Severance Pay Benefit. Officer Participants shall receive Base Salary (paid in installment payments in accordance with normal payroll practices) for a Severance Period based on the applicable provision below, taking into account officer level, Years of Service and the reason for termination of employment (involuntary termination or voluntary separation): a. Officer (Vice President) - Involuntary Termination: -------------------------------------------------- Base Salary: An Officer (Vice President) Participant who experiences an involuntary termination shall receive Base Salary for a Severance Period as follows: Years of Service Severance Period ---------------- ---------------- Less than 2 years 9 months At least 2 years but no more than 5 years 11 months More than 5 years 12 months Officer (Vice President) - Voluntary Termination: An Officer (Vice President) Participant who experiences a voluntary separation shall receive the benefit determined under (a) above and, in addition, will receive a lump sum payment equal to three months of Base Salary. The three months of Base Salary will be calculated by multiplying the amount of the Officer Participant's semimonthly paycheck by six (6). b. Officer (Senior Vice President and Executive Vice President) - Involuntary Termination: Base Salary: An Officer (Senior Vice President and Executive Vice President) Participant who experiences an involuntary termination shall receive Base Salary for a Severance Period as follows: Years of Service Severance Period ---------------- ---------------- Less than 2 years 12 months At least 2 years but no more than 5 years 14 months More than 5 years 16 months Officer (Senior Vice President and Executive Vice President) - Voluntary Separation: An Officer (Senior Vice President and Executive Vice President) Participant who experiences a voluntary separation shall receive the benefit determined under (b) above and, in addition, will receive a lump sum payment equal to three months of Base Salary. The three months of Base Salary will be calculated by multiplying the amount of the Officer Participant's semimonthly paycheck by six (6). For purposes of determining the Severance Period above under section 6.3a and 6.3b, a "month" is considered 30 calendar days. An Officer Participant whose Termination Date is accelerated and is entitled to receive a lump sum payment for the installment payments contained in section 6.3a or 6.3b, also will receive a lump sum payment calculated in an amount equal to the amount the Officer Participant will be charged for COBRA premiums for him/herself and his/her enrolled dependents for the number of months for which the Officer Participant would otherwise have been eligible to receive installment payments during a Severance Period. The payment for a portion of COBRA premiums is based on group medical, dental, vision and EAP coverage at the same benefits level that is in effect for the Officer Participant and any enrolled dependents at the time the Officer Participant enters the Severance Period or the Termination Date, whichever is earlier. The single lump sum payment representing COBRA premiums is based on COBRA premium levels in effect at the Termination Date and in no event is a Participant entitled to receive payment for a subsequent increase, if any, in COBRA premium levels. If the Officer Participant or his/her dependents were not enrolled for group health coverage at the time the Company gave Notice of Eligibility, the Officer Participant will not receive any payments representing COBRA premiums. 6.4 Additional Provisions Related to Severance Benefits a) If a Participant who either has incurred a Job Elimination or has voluntarily separated under the Voluntary Separation Program, and then has terminated employment is subsequently rehired by the Company (or an Affiliate), any subsequent Severance Benefit that may become payable to the Participant under this Plan following the date of rehire on account of a Job Elimination or voluntary separation under the Voluntary Separation Program shall be calculated based solely on the Participant's Years of Service following his date of rehire after Severance. b) Notwithstanding anything to the contrary contained herein, (i) an Employee or Participant whose employment with the Company (or an Affiliate) is terminated before or after receipt of Notice of Eligibility for any reason other than Job Elimination within the meaning of ARTICLE 2H or voluntary separation under the Voluntary Separation Program shall not be entitled to receive any Severance Benefits hereunder, (ii) a Participant may lose eligibility to receive Severance Benefits if the Company becomes aware of circumstances which could or would have caused a Participant's termination from employment, such as engaging in violations of the law or of Company polic(ies), including without limitation, fraud, theft, inappropriate use of confidential information, or misconduct (including, but not limited to, dishonesty or harassment), and (iii) in the case of an Employee who has entered into an employment agreement with the Company or an Affiliate which contains a provision for the payment (or nonpayment) of severance benefits (or payments upon termination of employment), the calculation of any payment of such Eligible Employee upon a Severance shall be governed by the terms of such employment agreement, and not by this ARTICLE 6. c) Except for any lump sum payment equal to three months of Base Salary, any lump sum benefit payable pursuant to Sections 6.1 or 6.2 shall be paid during the next Payroll processing cycle, assuming the Severance Agreement is signed and returned to the Company in the required time and is not revoked in accordance with any applicable Revocation Period. Generally, the close date for a payroll cycle is the 2nd business day of that cycle. The lump sum payment equal to three months of Base Salary shall be payable as soon as practicable following the end of the Notice Period provided that, by that date, the Severance Agreement is signed and returned to the Company in the required time and was not revoked in accordance with any applicable Revocation Period. d) Except for any lump sum payment equal to three months of Base Salary, any lump sum benefit payable pursuant to section 6.3 shall be paid during the Payroll processing cycle that follows the later of (i) the date the signed Severance Agreement is received, assuming it is signed and returned to the Company in the required time and is not revoked in accordance with any applicable Revocation Period; or (ii) the Termination Date, as it may be accelerated under ARTICLE 5 or 6. The lump sum payment equal to three months of Base Salary shall be payable as soon as practicable following the end of the Notice Period provided that, by that date, the Severance Agreement is signed and returned to the Company in the required time and was not revoked in accordance with any applicable Revocation Period. e) (i) If a Non-Officer Participant receives payment of any or all of his/her Severance Benefit under sections 6.1 and 6.2 and after his Termination Date subsequently accepts re-employment by the Company or with an Affiliate, the Participant will be required, except as the Company otherwise determines in its sole discretion, as a condition of reemployment, to repay the amount (if any) by which the lump sum payment (including COBRA payments) exceeds the amount the Participant would have received if such payment had been calculated based on the number of business days that have actually elapsed between Termination Date and the date of the subsequent employment. The repayment obligation is applicable regardless of whether the Participant's severance pay was paid under 6.1 and/or 6.2 above. Repayment of a pro rata share of Severance Benefits does not affect the validity of the Severance Agreement. (ii) If an Officer Participant receives a lump sum payment for any or all of his/her Severance Benefits under section 6.3 due to acceleration of the Termination Date, and the Participant subsequently accepts re-employment by the Company or with an Affiliate, the Participant will be required, except as the Company otherwise determines in its sole discretion, as a condition of reemployment, to repay the amount (if any) by which the lump sum payment (including COBRA payments) exceeds the amount the Participant would have received if such payment had been calculated based on the number of business days that have actually elapsed between Termination Date and the date of the subsequent employment. Repayment of a pro rata share of Severance Benefits does not affect the validity of the Severance Agreement. f) Notwithstanding anything to the contrary contained in this Plan, in the event WARN is applicable to a Participant: (1) any Notice Period and/or Severance Benefits paid or payable to the Participant will be deemed to constitute and shall be attributed to WARN notice and/or WARN benefits; (2) all Severance Benefits under this Plan will be reduced and/or offset by any notice, payments or benefits to which the Participant may be entitled under WARN; and (3) all Severance Benefits under this Plan will be reduced and/or offset by any amount of paid days and/or paid benefits in lieu of notice the Participant is given or is required to be given by the Company to satisfy its obligations under WARN. A Severance Agreement is not required for receipt of WARN benefits. g) Notwithstanding anything to the contrary contained herein, the Company may revoke a Participant's Severance Agreement during any applicable Revocation Period. ARTICLE 7 - FUNDING The amount required to be paid as Severance Benefit under this Plan shall be paid from the general assets of the Company at the time such Severance Benefits are to be paid. ARTICLE 8 - ADMINISTRATION The administration of the Plan shall be under the supervision of the Administrator. It shall be the responsibility of the Administrator to assure that the Plan is carried out in accordance with its terms, for the exclusive benefit of Participants without discrimination among them. The Administrator shall have full power and discretionary authority to administer, interpret and construe the Plan, and to determine all claims for benefits, subject to the requirements of ERISA. For this purpose, the Administrator's powers shall include, but shall not be limited to, the following authority, in addition to all other powers provided by this Plan. (a) To make and enforce such rules and regulations as it deems necessary or proper for the efficient administration of the Plan; (b) To interpret and construe the plan, its interpretation and construction thereof in good faith to be final and conclusive on all persons claiming benefits under the Plan; (c) To decide all questions concerning the Plan and the eligibility of any person to participate in the Plan; (d) To compute the amount of benefits which will be payable to any Participant accordance with the provisions of the Plan, and to determine the person or persons to whom such benefits will be paid; (e) To authorize the payment of benefits; (f) To appoint such agents, counsel, accountants, consultants and actuaries as may be required to assist in administering the Plan; and (g) To allocate and delegate its responsibilities under the Plan and to designate other persons to carry out any of its responsibilities under the Plan, and such allocation, delegation or designation to be by written instrument and in accordance with Section 405 of ERISA. The interpretations and determinations of the Administrator shall be final and binding unless lawfully determined to be arbitrary and capricious. The Administrator also reserves the right to provide additional benefits, in the Administrator's sole discretion. Determinations to be made in the discretion of the Company are made by the Company in its non-fiduciary capacity, with regard to the best interests of the Company, and are not required to be uniform among similarly situated individuals. In administering the Plan, the Administrator shall be entitled, to the extent permitted by law, to rely conclusively on all tables, valuations, certificates, opinions and reports which are furnished by any accountant, counsel or other expert who is employed or engaged by the Administrator. Schwab shall be the "named fiduciary" for purposes of Section 402(a)(1) of ERISA with authority to control and manage the operation and administration of the Plan, and shall be responsible for complying with all of the reporting and disclosure requirements of Part 1 of Subtitle B of Title I of ERISA. 8.1 Claims Procedure If any person believes he or she is being denied any rights or benefits under the Plan or disagrees with the calculation of Severance Benefits as set forth in the Notice of Eligibility, such person must file a claim in writing with the Administrator. If any such claim is wholly or partially denied, the Administrator shall notify such person of its decision in writing. Such notification shall be written in a manner calculated to be understood by such person and shall contain (i) specific reasons for the denial, (ii) specific reference to pertinent Plan provisions, (iii) a description of any additional material or information necessary for such person to perfect such claim and an explanation of why such material or information is necessary, and (iv) information as to the steps to be taken if the person wishes to submit a request for review. Such notification shall be given within ninety (90) calendar days after the claim is received by the Administrator (or within one hundred eighty (180) calendar days, if special circumstances require an extension of time for processing the claim, and if written notice of such extension and circumstances is given to such person within the initial ninety (90) day period). If such notification is not given within such period, the claim shall be considered denied as of the last day of such period and such person may request a review of his or her claim. 8.2 Review Procedure Within sixty (60) calendar days after the date on which a person receives a written notice of a denied claim (or, if applicable, within sixty (60) calendar days after the date on which such denial is considered to have occurred) such person (or his duly authorized representative) may (i) file a written request with the Administrator for a review of his denied claim and of pertinent documents and (ii) submit written issues and comments to the Administrator. The Administrator shall notify such person of its decision in writing. Such notification shall be written in a manner calculated to be understood by such person and shall contain specific reasons for the decision as well as specific references to pertinent Plan provisions. The decision on review shall be made within sixty (60) calendar days after the request for review is received by the Administrator (or within one hundred twenty (120) calendar days, if special circumstances require an extension of time for processing the request, such as an election by the Administrator to hold a hearing, and if written notice of such extension and circumstances is given to such person within the initial sixty (60) day period). If the decision on review is not made within such period, the claim shall be considered denied. The Company agrees to indemnify, defend and hold harmless to the fullest extent permitted by law any Employee serving as or on behalf of the Administrator or as a member of a committee designated as Administrator (including any Employee or former Employee who formerly served as Administrator or as a member of such committee) against all liabilities, damages, costs and expenses (including attorneys' fees and amounts paid in settlement of any claims approved by the Company) occasioned by any act or omission to act in connection with the Plan, if such act or omission is in good faith. ARTICLE 9 - AMENDMENT AND TERMINATION The Plan and/or any of its terms may be amended at any time with or without prior notice by action of the Board of Directors of Schwab or its delegee. The Plan and/or any of its terms may be terminated at any time with or without prior notice by the Board of Directors of the Company or its delegee. ARTICLE 10 - MISCELLANEOUS Except where otherwise indicated by the context, any masculine terminology used herein shall also include the feminine and vice versa, and the definition of any term herein in the singular shall also include the plural, and vice versa. This Plan shall not be deemed to constitute a contract between the Company and any Eligible Employee or to be a consideration or an inducement for the employment of any Eligible Employee. Nothing contained in this Plan shall be deemed to give any Eligible Employee the right to be retained in the service of the Company or to interfere with the right of the Company to discharge any Eligible Employee at any time, irrespective of the effect which such discharge shall have upon such individual as a Eligible Employee of this Plan. This Plan shall be construed and enforced according to federal law, except where not preempted, by the laws of the State of California other than its laws respecting choice of law. EX-12 9 exh12_1.txt EXHIBIT 12_1, SEPTEMEBER 30, 2002
Exhibit 12.1 THE CHARLES SCHWAB CORPORATION Computation of Ratio of Earnings to Fixed Charges (Dollar amounts in millions) (Unaudited) Three Months Ended Nine Months Ended September 30, September 30, 2002 2001 2002 2001 --------- --------- --------- --------- Earnings (loss) before taxes on earnings (loss) and extraordinary gain $ (5) $ 26 $ 281 $ 164 Fixed charges Interest expense: Brokerage client cash balances 43 147 141 606 Deposits from banking clients 26 29 72 104 Long-term debt 10 13 37 42 Short-term borrowings 6 8 19 18 Stock-lending activities 1 3 3 17 Other 1 3 ------------------------------------------------------------------------------------------------------------------------------ Total 86 201 272 790 Interest portion of rental expense 21 25 65 71 ------------------------------------------------------------------------------------------------------------------------------ Total fixed charges (A) 107 226 337 861 ------------------------------------------------------------------------------------------------------------------------------ Earnings before taxes on earnings and extraordinary gain and fixed charges (B) $ 102 $ 252 $ 618 $1,025 ============================================================================================================================== Ratio of earnings to fixed charges (B) / (A) (1) 1.0 (2) 1.1 1.8 1.2 ============================================================================================================================== Ratio of earnings to fixed charges excluding brokerage client interest expense (3) .9 1.3 2.4 1.6 ============================================================================================================================== (1) The ratio of earnings to fixed charges is calculated in accordance with SEC requirements. For such purposes, "earnings" consist of earnings (loss) before taxes on earnings (loss) and extraordinary gain and fixed charges. "Fixed charges" consist of interest expense as listed above, including one-third of rental expense, which is estimated to be representative of the interest factor. (2) The amount of the deficiency in the ratio of earnings to fixed charges was $5 million for the three months ended September 30, 2002. (3) Because interest expense incurred in connection with payables to brokerage clients is completely offset by interest revenue on related investments and margin loans, the Company considers such interest to be an operating expense. Accordingly, the ratio of earnings to fixed charges excluding brokerage client interest expense reflects the elimination of such interest expense as a fixed charge.
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