-----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, Fq4V+wqq9cjug6Dw7EMVUNEqgCbuUGwitxHM6tyZPi74fVNuAQpkAYIqKgLgK7Gi Lalc0BIzI/QlCZv1IzYcqA== 0000316709-03-000009.txt : 20030321 0000316709-03-000009.hdr.sgml : 20030321 20030321151228 ACCESSION NUMBER: 0000316709-03-000009 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 10 CONFORMED PERIOD OF REPORT: 20021231 FILED AS OF DATE: 20030321 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-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-09700 FILM NUMBER: 03612269 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-K 1 body.txt BODY, FORM 10-K, DECEMBER 31, 2002 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 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 Number) 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 Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered ------------------- ----------------------------------------- Common Stock - $.01 par value New York Stock Exchange Pacific Exchange Securities registered pursuant to Section 12(g) of the Act: None 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 by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. --- Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes X No --- --- As of June 28, 2002, the aggregate market value of the voting stock held by nonaffiliates of the registrant was $12,227,271,269. For purposes of this information, the outstanding shares of Common Stock owned by directors and executive officers of the registrant, and certain investment companies managed by Charles Schwab Investment Management, Inc. were deemed to be shares of the voting stock held by affiliates. The number of shares of Common Stock outstanding as of March 10, 2003 was 1,352,529,053. DOCUMENTS INCORPORATED BY REFERENCE Parts I, II and III of this Form 10-K incorporate certain information contained in the registrant's 2002 Annual Report to Stockholders by reference to portions of that document. Part III of this Form 10-K incorporates certain information contained in the registrant's definitive proxy statement for its annual meeting of stockholders to be held May 9, 2003 by reference to portions of that document. THE CHARLES SCHWAB CORPORATION Annual Report On Form 10-K For Fiscal Year Ended December 31, 2002 --------------------------------------- TABLE OF CONTENTS Part I Item 1. Business ------------------------------------------------------------ 1 Item 2. Properties --------------------------------------------------------- 14 Item 3. Legal Proceedings -------------------------------------------------- 14 Item 4. Submission of Matters to a Vote of Security Holders ---------------- 14 Item 4A. Executive Officers of the Registrant ------------------------------- 14 Part II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters ----------------------------------------------------------- 15 Item 6. Selected Financial Data -------------------------------------------- 15 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations --------------------------------------------- 15 Item 7A. Quantitative and Qualitative Disclosures About Market Risk --------- 16 Item 8. Financial Statements and Supplementary Data ------------------------ 16 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ---------------------------------------------- 16 Part III Item 10. Directors and Executive Officers of the Registrant ------------------16 Item 11. Executive Compensation --------------------------------------------- 19 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters ------------------------------------ 19 Item 13. Certain Relationships and Related Transactions --------------------- 19 Item 14. Controls and Procedures -------------------------------------------- 20 Part IV Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K ---- 20 Exhibit Index ----------------------------------------------------- 21 Signatures -------------------------------------------------------- 26 Certifications ------------------------------------------------- 27-29 Index to Financial Statement Schedules --------------------------- F-1 FORWARD-LOOKING STATEMENTS - This Annual Report on Form 10-K, including the information incorporated by reference, 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," "anticipate," "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 our senior management. These statements relate to, among other things, the impact of the sales of its European operations on the Company's results of operations, the impact of its expense reduction measures on the Company's results of operations, the Company's ability to pursue its strategy of attracting and retaining client assets as well as achieve its strategic priorities, and the availability of the Company's information systems. Achievement of the expressed beliefs, objectives and expectations is subject to certain risks and uncertainties that could cause actual results to differ materially from those beliefs, objectives and expectations. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this Annual Report on Form 10-K or, in the case of documents incorporated by reference, as of the date of those documents. THE CHARLES SCHWAB CORPORATION PART I Item 1. Business (a) General Development of Business The Charles Schwab Corporation (CSC, and with its subsidiaries collectively referred to as the Company) was incorporated in 1986 and engages, through its subsidiaries, in securities brokerage and related financial services. Charles Schwab & Co., Inc. (Schwab) was incorporated in 1971 and is a securities broker-dealer that entered the discount brokerage business in 1974. U.S. Trust Corporation (USTC, and with its subsidiaries collectively referred to as U.S. Trust), which merged with CSC in May 2000, is a wealth management firm that through its subsidiaries also provides fiduciary services and private banking services. Other subsidiaries of CSC include Charles Schwab Investment Management, Inc. (CSIM), Schwab Capital Markets L.P. (SCM), CyberTrader, Inc. (CyberTrader), and The Charles Schwab Trust Company (CSTC). CSIM acts as the investment advisor for Schwab's proprietary mutual funds. The Company refers to certain funds for which CSIM is the investment advisor as the SchwabFunds(R). SCM is a market maker in Nasdaq and other securities providing trade execution services primarily to broker-dealers and institutional clients. CyberTrader, a subsidiary acquired in March 2000, is an electronic trading technology and brokerage firm providing services to highly active, online traders. CSTC serves as trustee for employee benefit plans, primarily 401(k) plans. Available Information On the Company's Internet Web site, www.schwab.com, the Company posts the following filings as soon as reasonably practicable after they are electronically filed with or furnished to the Securities and Exchange Commission (SEC): the Company's annual report on Form 10-K, the Company's quarterly reports on Form 10-Q, the Company's current reports on Form 8-K, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. All such filings on the Company's Web site are available free of charge. Subsequent Events On January 31, 2003, the Company sold Charles Schwab Europe (CSE), a subsidiary located in the United Kingdom, to Barclays PLC (Barclays) in a transaction approved by the Board of Directors (Board) on January 30, 2003. The impact of this sale on the Company's results of operations is not expected to be material. See note "27 - Subsequent Event" in the Notes to Consolidated Financial Statements in the Company's 2002 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report. On March 13, 2003, the Company announced that due to geopolitical uncertainties and a further decline in its clients' trading activity, it plans to implement a series of expense reduction measures until such time as the business environment improves sufficiently. These measures include a postponement of some of the Company's planned marketing investments, reductions in discretionary expenses, further restrictions on hiring, and adjustments to certain employee benefits. These measures are targeted to reduce quarterly expenses by about $40 million, largely beginning in the second quarter of 2003. On March 14, 2003, the Board authorized the repurchase of up to an additional $250 million of CSC's common stock. Including $100 million remaining under an authorization granted by the Board on September 20, 2001, CSC now has authority to repurchase a total of $350 million of its common stock. The shares may be repurchased through open market or privately negotiated transactions based on prevailing market conditions. On March 19, 2003, the Company announced an agreement to sell its 50% ownership interest in Glasgow, Scotland-based Aitken Campbell to its joint venture partner, TD Waterhouse Group, Inc. The sale is expected to close in the next few months, subject to regulatory and other approvals. While financial terms are undisclosed, the Company expects to recognize a tax benefit associated with this transaction; the effect of this benefit will be to increase net income by approximately $10 million in the first quarter of 2003. Except for the effect of the tax benefit, the impact of this sale on the Company's results of operations is not expected to be material. - 1- (b) Financial Information About Segments 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 investment advisors (IAs), serves company 401(k) plan sponsors and third-party administrators, and supports company stock option plans. 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, wealth management, custody, fiduciary, and private banking services to individual and institutional clients. For financial information by segment and geographic area, and for revenues by major client for the three years ended December 31, 2002, see note "25 - Segment Information" in the Notes to Consolidated Financial Statements in the Company's 2002 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report. (c) Narrative Description of Business Business Strategy The Company's primary strategy is to serve the needs of individual investors either directly or indirectly through intermediaries, IAs, or corporate retirement plan sponsors. Meeting these investment needs entails offering a variety of financial services including retail brokerage, investment and wealth management, custody and fiduciary services, support services for IAs, investment services to companies and their employees (including 401(k) defined contribution plans), equity securities market-making, and banking and other financial services. Additionally, the Company provides institutional clients with equity trade execution services, mutual fund clearing services, investment management, and fiduciary services. The Company, through its subsidiaries, serves 8.0 million active client accounts(a). Client assets in these accounts totaled $764.8 billion at December 31, 2002. To pursue its strategy and its objective of long-term profitable growth, the Company plans to leverage its competitive advantages, which include: - - a broad range of products, services, and advice offerings, - - multi-channel delivery systems, - - an ongoing investment in technology, and - - nationally recognized brands. Management continues to believe that the key to sustaining the Company's competitive advantages will be its ability to combine people and technology in ways that provide investors with the access, information, guidance, advice and control they expect - as well as high-quality service - all at a lower cost than traditional providers of financial services. 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 emerging affluent clients - those with less than $250,000 in assets; - - 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 on 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 2002 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report. The table below shows the Company's sources of revenues on a comparative basis for the three years ended December 31, 2002. - -------- (a) Accounts with balances or activity within the preceding eight months. - 2 -
Sources of Revenues (In millions) Year Ended December 31, - ------------------------------------------------------------------------------------------------------------------------------------ 2002 2001 2000 ---------------------------------------------------------------- Amount Percent Amount Percent Amount Percent ---------------------------------------------------------------- Revenues Asset management and administration fees Mutual fund service fees: Proprietary funds (SchwabFunds(R) and Excelsior(R)) $ 874 21% $ 818 19% $ 673 12% Mutual Fund OneSource(R) 264 7% 282 6% 331 6% Other 42 1% 41 1% 35 Asset management and related services 581 14% 534 12% 544 9% - ------------------------------------------------------------------------------------------------------------------------------------ Asset management and administration fees 1,761 43% 1,675 38% 1,583 27% - ------------------------------------------------------------------------------------------------------------------------------------ Commissions Exchange-listed securities 552 13% 540 12% 832 14% Nasdaq and other equity securities 444 11% 606 14% 1,126 19% Mutual funds 111 3% 95 2% 132 2% Options 99 2% 114 3% 204 4% - ------------------------------------------------------------------------------------------------------------------------------------ Commissions 1,206 29% 1,355 31% 2,294 39% - ------------------------------------------------------------------------------------------------------------------------------------ Net interest revenue Margin loans to clients 459 11% 832 19% 1,772 30% Investments, client-related 337 8% 555 13% 338 6% Private banking loans 236 6% 240 5% 219 4% Securities available for sale 76 2% 79 2% 69 1% Other 78 2% 151 3% 191 4% - ------------------------------------------------------------------------------------------------------------------------------------ Interest revenue 1,186 29% 1,857 42% 2,589 45% Interest expense (345) (9%) (928) (21%) (1,352) (24%) - ------------------------------------------------------------------------------------------------------------------------------------ Net interest revenue 841 20% 929 21% 1,237 21% - ------------------------------------------------------------------------------------------------------------------------------------ Principal transactions Fixed income securities 92 3% 65 2% 53 1% Nasdaq and other equity securities 80 2% 173 4% 470 8% Other 12 17 47 1% - ------------------------------------------------------------------------------------------------------------------------------------ Principal transactions 184 5% 255 6% 570 10% - ------------------------------------------------------------------------------------------------------------------------------------ Other 143 3% 139 4% 104 3% - ------------------------------------------------------------------------------------------------------------------------------------ Total revenues $ 4,135 100% $ 4,353 100% $ 5,788 100% ==================================================================================================================================== This table should be read in connection with the Company's consolidated financial statements and notes in the Company's 2002 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report. Certain prior years' revenues and expenses have been reclassified to conform to the 2002 presentation.
Products, Services, and Advice Offerings The Company offers a broad range of products, services, and advice offerings to address its clients' varying investment and financial needs. Such offerings are made through the Company's four segments - Individual Investor, Institutional Investor, Capital Markets, and U.S. Trust. Individual Investors Investors at Schwab, through the Individual Investor segment or indirectly through the Institutional Investor segment, have access to the accounts, features, tools, services, and products described below. Accounts and Features. Through various types of brokerage accounts, Schwab offers the purchase and sale of securities which include Nasdaq, exchange-listed and other equity securities, options, mutual funds, unit investment trusts, variable annuities and fixed income investments, including U.S. Treasuries, zero-coupon bonds, exchange-listed and over-the-counter corporate bonds, municipal bonds, Government National Mortgage Association securities and certificates of deposit. Schwab also offers certain of its clients - 3 - initial and secondary public stock offerings, debt underwritings, and access to futures and commodities trading. Additionally, Schwab provides clients access to a variety of life insurance and annuity products through third-party insurance companies. Clients approved for margin transactions may borrow a portion of the price of certain securities purchased through Schwab, or may sell securities short. Clients must have specific approval to trade options; as of December 31, 2002, 401,000 accounts had such approval. To write uncovered options, clients must go through an additional approval process and must maintain a significantly higher level of equity in their brokerage accounts. Schwab Signature Client(TM) is designed to serve self-directed individual investors who want to manage their own portfolios. For these clients, Schwab offers the Schwab One(R) account, which is an asset management account that allows clients to combine investments and cash in one account. A client may access available funds in his or her Schwab One account either with a personal check, a VISA(R) debit card with ATM access, or Schwab BillPay(R), in addition to the Schwab MoneyLink(R) service offered with all brokerage accounts. When a Schwab One client is approved for margin trading, the checks and debit card also provide access to margin cash available. For cash balances awaiting investment, Schwab pays interest to Schwab One clients. Alternatively, qualifying Schwab One clients may choose to invest in several SchwabFunds(R) sweep money market funds, including state-specific municipal tax-exempt funds. For affluent clients who meet certain trading or asset levels, Schwab offers additional benefits such as premium research, priority handling of their service calls, access to IAs, and other services. Additionally, Schwab offers the Schwab Access(R) account to clients with combined assets of $100,000 or more at Schwab. The Schwab Access account is a payment account designed to work alongside the Schwab One account, allowing clients to manage their investments and conduct many of their cash management activities all within one relationship. The Schwab Access account features include online bill payment, unlimited check writing, a VISA Gold debit card with ATM access, returned check copies, and unlimited money transfers within Schwab accounts. Cash balances in a Schwab Access account are swept daily into the Schwab Government Cash Reserves Fund, a sweep money fund. Schwab Private Client is a fee-based service designed for investors with at least $500,000 in assets at Schwab who desire investment guidance and advice, yet want to be actively involved with day-to-day investment decisions. The Schwab Private Client account is structured with an asset-based pricing fee and includes portfolio construction guidance, ongoing monitoring, and a number of commission-free equity trades. Through Schwab Private Client, investors have access to a team of consultants who can provide financial guidance as discussed below under "Help and Advice, Investment Education, Research, and Analysis Tools." Schwab Signature Platinum(R), the successor to the Schwab Signature Services(R) program, is designed to meet the specific needs of self-directed affluent investors with at least $500,000 in assets at Schwab. Schwab Signature Platinum offers a tailored set of complimentary benefits, including priority service, an expanded suite of investing resources, and preferred pricing. For active traders, Schwab offers accounts that include access to special features and services such as advanced trading tools, priority access to a dedicated team of trading specialists, and reduced pricing on equity trades. Additionally, depending on trading levels, active traders may qualify for Schwab Strategic Trading Resources(TM) benefits, which includes access to a team of trading experts, free premium research (including foreign stock research), discounted commissions, and other exclusive benefits. CyberTrader also offers a brokerage account to its clients. Features of this account include access to CyberTrader's proprietary software designed to benefit highly active traders and the choice of manual or automated order routing for placing trades. Schwab acts as custodian, as well as broker, for Individual Retirement Accounts (IRAs) and Keogh accounts. In Schwab IRAs, cash balances are swept daily into one of three SchwabFunds money market funds. Schwab's IRA-related services include the Personal Rollover Specialist, a service designed to help clients process transfers of retirement assets from former employers and/or consolidate their retirement investments. Active IRAs and Keogh accounts at December 31, 2002 totaled 3,500,000, up 5% from December 31, 2001, while client assets in all IRAs and Keogh accounts decreased 9% to $184.5 billion. Help and Advice, Investment Education, Research, and Analysis Tools. The Company seeks to provide clients with customized advice which is objective, uncomplicated, and not driven by sales commissions. The Company's approach to advice is based on long-term investment strategies and guidance on portfolio diversification and asset allocation. This approach is designed to be offered consistently across all of Schwab's delivery channels and provides clients with a wide selection of choices for their investment needs. Schwab's products, services, and advice offerings cross the spectrum of its clients - those who manage their own investments and make independent investment decisions, those who want ongoing access to guidance while retaining control over their investment decisions, and those who desire to have experienced professionals manage their assets. For affluent investors who make independent investment decisions, the Company offers research, analytic tools, and access to fee-based portfolio consultations and financial planning services. Clients looking for more guidance have access to advanced research, trading and planning resources, - 4- combined with professional advice from Schwab's investment specialists designed to assist in developing an investment strategy and carrying out investment and portfolio management decisions. The Company's full-service advice and relationship service offer includes the Schwab Advisor Network(TM) (the Network), Schwab Private Client, and Schwab Equity Ratings(TM). The Network, the successor to the Schwab AdvisorSource(R) referral program, is designed for investors who want the assistance of an independent professional in managing their financial affairs. The IAs in the Network provide investors with personalized portfolio management, financial planning and wealth management solutions. The Network has over 340 participating IAs who have an average of 17 years of experience and $500 million of assets under management at December 31, 2002. The Network strengthens the Schwab/advisor/client relationship through a pricing model that allows for sharing fee income on referred accounts and features IAs more prominently in advertising that targets affluent investors. Through a separate program, Schwab clients and potential clients who desire personalized investment management, wealth management, trust, and private banking services can receive referrals to U.S. Trust. Schwab Private Client features a face-to-face advice relationship with a designated Schwab consultant who offers individualized service, provides ongoing investment strategy and execution, and acts as a liaison between clients and a team of Schwab professionals. Additionally, Schwab Private Client provides access to dedicated support resources, expanded asset management capabilities, and enhanced portfolio tracking and performance reporting. Schwab Private Client includes over 160 designated Schwab consultants and their support teams at December 31, 2002. Schwab Equity Ratings provide clients with an objective stock rating system on more than 3,000 stocks, assigning each equity a single grade: A, B, C, D, or F. On average, A-rated stocks are expected to strongly outperform the overall market over the next 12 months, while F-rated stocks are expected to strongly underperform the market. Rated stocks are ranked and the number of 'buy consideration' ratings - As and Bs - equals the number of 'sell consideration' ratings - Ds and Fs. Schwab Equity Ratings leverages Schwab's November 2000 acquisition of Chicago Investment Analytics, Inc. (CIA) by applying CIA's research and technology strengths to a systematic ratings methodology that complements the variety of perspectives already available to clients from Goldman Sachs, Standard & Poor's, Argus, and First Call. Schwab's MarketPlace is an internal Web site which includes the AdviceSuite, a software platform that enables service representatives to apply a consistent set of principles and practices when providing market viewpoints and investment advice. Schwab enhanced MarketPlace to include an 'Investment Products' home page with lists of investment perspectives across various products, sectors, and styles. MarketPlace also provides tools to support discussions with clients about events such as retirement and college planning and charitable giving. Schwab's Mutual Fund internal Web site provides service representatives with news, research, and analytic tools designed to support their fund-related advice interactions with clients. In addition, to support service representatives' fund-related advice interactions, Schwab's internal Mutual Fund Web site provides representatives with Morningstar analysis on over 1,400 funds. Schwab redesigned its Mutual Fund Select List(R) to include qualitative analyses for each asset class as well as an integrated view that includes asset class summaries, category descriptions, and average expenses for each fund, presented together on a single page. Schwab strives to demystify investing by educating and assisting clients in the development of investment plans. Educational tools include: WebShop(R), a series of workshops designed to help investors increase their skills in using Schwab's online services; the Schwab Learning Center(R), interactive courses designed to help clients learn more about investing principles and use of the online channel; and the Smart Investor(TM), a centralized location on schwab.com(TM) for educational information about investing. The Live Online program is a series of workshops that utilize the Internet to bring Schwab representatives and clients together to discuss investing strategies, retirement planning and wealth management in a highly interactive format. Representatives from the Schwab Center for Investment Research(R), Schwab Equity Research(TM), and Schwab Investment Center routinely host Webcasts designed to help investors navigate the current markets. Along with advice on investment objectives, diversification, and risk management, representatives share their perspectives on current market conditions and possible investment opportunities. Schwab provides various Internet-based research and analysis tools which are designed to help clients achieve better investment outcomes, including: the Positions Monitor, which tracks clients' mutual fund and equity holdings' historical performance; the Schwab Portfolio Checkup(R), an asset allocation tool that also allows clients to include non-Schwab holdings in their analyses; and SchwabAlerts(R), which delivers investment and market activity news to clients via both wireless and e-mail. Additionally, Schwab provides a variety of stock selection tools. For investors seeking ideas, Schwab provides the Stock Screener, which allows clients to search over 9,000 equities using their own criteria, and Schwab Stock Lists(TM), which are compiled using an unbiased and systematic approach. For investors desiring to analyze a specific equity security, Schwab provides the Charles Schwab Stock Analyzer(R), which provides data for the specific equity security and helps clients interpret such data. Schwab's research and analysis tools include OptionStreet(R), which offers improved online trading screens, tools, and educational content to clients who use options in managing their portfolios. On the schwab.com 'My Home' section, clients can view and manage all of their account balances, watch - 5 - lists, quotes, research, and market information on one customizable page. Additionally, quotes on money market yields and Schwab BillPay(R) enrollment are available online. Schwab also has a feature on its Web site that guides prospective clients to selected service offerings, based on their individual investing behavior and needs. Trading Technology and Tools. The Company strives to deliver information, technology, service and pricing which meets the needs of active traders. For highly active traders, CyberTrader offers integrated software-based trading platforms - CyberX2(TM) and CyberTrader Pro(TM), which utilize direct access and intelligent order routing technology. CyberX2 is a user-friendly trading system with point and click order entry, advanced charting capabilities, streaming news, stock watch lists, multiple Electronic Communication Network (ECN) Book quotes, and advanced risk management tools. CyberTrader Pro is a multifaceted trading platform that offers all of the features of CyberX2 plus additional features including analytical tools, stock filtering tools, and live charting capabilities. Additionally, CyberTrader offers CyberTrader.com(TM), a streaming Web trading platform which includes real-time market data, direct access technology, intelligent order routing, options trading, and premium stock research. When clients are away from their trading platforms, CyberTrader keeps them connected with CyberTrader Wireless(TM), a service giving clients access via handheld communication devices to order-routing capabilities, real-time quotes, customizable stock lists, and account information. Through CyberTrader's Web site, clients have access to CyberTrader U(TM), which offers a variety of introductory and intermediate online classes committed to assisting individuals become more educated traders. The Company offers competitive pricing across all of CyberTrader's platforms with prices as low as $9.95 for equity trades depending on trading levels. For active traders, Schwab also offers Velocity(R), a desktop trading software, and StreetSmart Pro(R), which leverages CyberTrader's trading technology and combines Nasdaq Level II quotes, real-time streaming news, unlimited watch lists, and real-time streaming interactive charts with account management features, risk management tools, multi-channel access, and dedicated personal support. StreetSmart Pro allows clients to execute their trades through SmartEx(R) - Schwab's proprietary order-routing technology - without having to access another trading program. Through education initiatives such as the Branch Active Trader program, Schwab clients can receive training from specially qualified representatives on all of these advanced trading platforms. To support representatives' conversations with active traders, the Company offers Active Trader Street, an internal Web site that provides Schwab representatives with a comprehensive suite of investing perspectives, trading strategies, and educational tools. Clients can experience these active trader offerings firsthand by meeting with a specially-trained field consultant in a branch office. Client Financing and Clearing Services. Clients' securities transactions are conducted on either a cash or margin basis. Generally, a client buying securities in a cash-only brokerage account is required to make payment by settlement date, usually three business days after the trade is executed. However, for purchases of certain types of securities, such as certain mutual fund shares, a client must have a cash or money market fund balance in his or her account sufficient to pay for the trade prior to execution. When selling securities, a client is required to deliver the securities, and is entitled to receive the proceeds, on settlement date. In an account authorized for margin trading, Schwab may lend a client a portion of the market value of certain securities up to the limit established by the Board of Governors of the Federal Reserve System (Federal Reserve Board), which for most equity securities is initially 50%. These loans are collateralized by the securities in the client's account. Short sales of securities represent sales of borrowed securities and create an obligation for the client to purchase the securities at a later date. Clients may sell securities short in a margin account subject to minimum equity and applicable margin requirements and the availability of such securities to be borrowed and delivered. Interest on margin loans to clients provides an important source of revenue to Schwab. During 2002, Schwab's outstanding margin loans to clients averaged $8.0 billion and were $6.6 billion at December 31, 2002. In permitting a client to engage in transactions, Schwab faces credit risk if the client fails to meet his or her obligations in the event of adverse changes in the market value of the securities positions in his or her account. Under applicable rules and regulations for margin transactions, Schwab, in the event of such an adverse change, requires the client to deposit additional securities or cash, so that the amount of the client's obligation is not greater than specified percentages of the cash and market values of the securities in the account. As a matter of policy, Schwab generally requires its clients to maintain higher percentages of collateral values than the minimum percentages required under these regulations. Schwab may use cash balances in client accounts to extend margin credit to other clients. Pursuant to the requirements of Rule 15c3-3 under the Securities Exchange Act of 1934 (Rule 15c3-3), the portion of such cash balances not used to extend margin credit (increased or decreased by certain other client-related balances) must be held in segregated investment accounts. The balances in these segregated investment accounts must be invested in cash or qualified securities, as defined by Rule 15c3-3. To the extent Schwab's clients elect to have cash balances in their brokerage accounts swept into certain SchwabFunds(R) money market funds, the cash balances available to Schwab for investments or for financing margin loans are reduced. - 6 - However, Schwab receives asset management and administration fees from such funds based upon average daily invested balances. See also "Management's Discussion and Analysis of Results of Operations and Financial Condition - Risk Management" in the Company's 2002 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report, and "Regulation" in this report. Schwab performs clearing services for all securities transactions in its client accounts. Schwab clears the vast majority of client transactions through the facilities of The Depository Trust & Clearing Corporation or the Options Clearing Corporation. Certain other transactions, such as mutual fund transactions and transactions in securities not eligible for settlement through a clearing corporation, are settled directly with the mutual funds or other financial institutions. Schwab is obligated to settle transactions with clearing corporations, mutual funds and other financial institutions even if Schwab's client fails to meet his or her obligations to Schwab. In addition, for transactions that do not settle through a clearing corporation, Schwab assumes the risk of the other party's failure to settle the trade. See note "23 - Financial Instruments Subject to Off-Balance-Sheet Risk, Credit Risk or Market Risk" in the Notes to Consolidated Financial Statements in the Company's 2002 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report. Mutual Funds. The Company provides mutual fund services primarily through the Individual Investor, Institutional Investor, and U.S. Trust segments. Schwab's Mutual Fund Marketplace(R) provides clients with the ability to invest in over 3,100 mutual funds from a wide variety of fund companies. Within the Mutual Fund Marketplace, Schwab's Mutual Fund OneSource(R) service offers clients access to over 1,700 no-load mutual funds from a variety of fund families without incurring transaction fees. The Mutual Fund Marketplace also includes Schwab's mutual fund clearing service, which provides mutual fund trading and clearing services to banks and broker-dealers. Schwab's Mutual Fund OneSource service allows investors to access multiple mutual fund companies, avoid brokerage transaction fees, and achieve investment diversification among fund families. In addition, investors' recordkeeping and investment monitoring are simplified through one consolidated statement. Fees received by Schwab for providing services, including recordkeeping and shareholder services, from the Mutual Fund OneSource program are based upon the daily balances of client assets invested in the participating funds through Schwab and are paid by the funds and/or fund sponsors. Client assets invested in third-party funds that have been purchased through the Mutual Fund OneSource service were $73.6 billion at December 31, 2002. Schwab charges a transaction fee on trades placed in non-Mutual Fund OneSource funds included in the Mutual Fund Marketplace. These fees are recorded as commission revenues. In addition to the third-party funds available through the Mutual Fund Marketplace, Schwab offers a family of proprietary funds, referred to as the SchwabFunds(R), and U.S. Trust offers the Excelsior(R) family of funds. Fees received by the Company from the SchwabFunds and the Excelsior funds, for providing shareholder services, administration, investment management and other services, are based upon the net asset value of the funds. SchwabFunds include money market funds, equity index funds, bond funds, asset allocation funds, funds that primarily invest in stock, bond and money market funds, and actively-managed equity funds. Schwab's proprietary funds also include the Schwab MarketMasters Funds(TM), Schwab Core Equity Fund(TM), and Schwab Hedged Equity Fund(TM). Schwab MarketMasters Funds is a suite of four funds designed to spread investment risk and reduce volatility by employing third-party investment managers with different styles and strategies. The Schwab Core Equity Fund and the Schwab Hedged Equity Fund combine the equity selection capabilities of Schwab Equity Ratings(TM) with the diversification and convenience of a mutual fund. Client assets invested in the SchwabFunds were $144.8 billion at December 31, 2002. Excelsior funds include actively-managed domestic equity funds, international equity funds, taxable fixed income funds, tax-exempt fixed income funds and money market funds. Client assets invested in the Excelsior funds were $12.6 billion at December 31, 2002. International. The Company's international business serves both foreign investors and non-English-speaking U.S. clients. At December 31, 2002, the Company had a presence in the United Kingdom, Hong Kong and the Cayman Islands. In the U.S., the Company serves Chinese-, Korean-, Vietnamese-, and Spanish-speaking clients through a combination of designated branch offices and Web-based and telephonic services. As of December 31, 2002, client assets in the Company's international business totaled $19.4 billion. See note "27 - Subsequent Event" in the Notes to Consolidated Financial Statements in the Company's 2002 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report. Institutional Investors Services for IAs. Schwab provides custodial, trading, technology, Web, and other support services to IAs, whose services are integral to the Company's advice offerings, through the Institutional Investor segment. To attract the business of these advisors, Schwab has a dedicated business unit which includes experienced registered representatives assigned to individual advisors. - 7 - IAs participating in this program who custody client accounts at Schwab may use the SchwabLink(R) for Windows(R) product, the Schwab Institutional(R) Web site, and the Managed Account Connection(R) service, and their clients can use the Schwab Signature Services Alliance(TM) program. SchwabLink for Windows, a proprietary software, provides IAs with up-to-date client account information, as well as mutual fund trading and management fee capabilities. The Schwab Institutional Web site is the core platform for IAs to conduct daily business activities online with Schwab, including trading, submitting client account information, and retrieving news and market information. The Managed Account Connection service enables IAs to provide their clients with personalized equity portfolio management by a variety of institutional asset managers. The Schwab Signature Services Alliance provides enhanced personalized services to clients of IAs, including access to a dedicated team of representatives and the Schwab Alliance Web site. Schwab's services to help IAs manage and build their practices include the Electronic Account Submission service, which allows IAs to establish new client account numbers immediately upon request, and the Managed Account Select(R) service, which enables IAs to provide clients with access to pre-screened money managers and fixed income managers under a simplified single-fee structure. Schwab's Centerpiece(R), a portfolio management system for IAs, combines portfolio accounting, performance measurement, fixed income analysis and tracking, and report customization capabilities into a single networked application. To further assist IAs in growing their businesses, Schwab conducts advisor education workshops on operational, trading, and technology solutions. At December 31, 2002, Schwab client assets held in accounts managed by approximately 5,900 active IAs totaled $222.4 billion. Corporate Services. The Company also serves individuals through their workplace in a variety of ways. The Company provides 401(k) recordkeeping and other retirement plan services directly through a dedicated sales force, as well as indirectly through alliances with third-party administrators. SchwabPlan(R), the Company's 401(k) retirement plan product, offers plan sponsors a wide array of investment options, participant education and servicing, trustee services, and participant-level recordkeeping. SchwabPlan features include an electronic desktop delivery service that allows plan participants to receive detailed account information via encrypted e-mail, and a Web site that allows individuals who are using Schwab's retirement plan services through third-party administrators to utilize the education, planning, and investment tools that are available to SchwabPlan participants. SchwabPlan Select(TM) is a comprehensive bundled 401(k) plan designed specifically to meet the needs of 401(k) programs with between $2 million and $20 million in participant assets. Under SchwabPlan Select, plan sponsors can build investment menus from hundreds of different mutual funds and participants have full access to Schwab's online planning and education tools, regional client telephone service centers, and Web support. Retirement plan sponsors have access to a monthly online report that allows them to monitor activity and investment performance in their plans against customized criteria and benchmarks. 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. At December 31, 2002, client assets in employer-sponsored retirement plans totaled $88.4 billion, which included $29.3 billion serviced by Schwab's retirement plan services business. The Company offers stock option plan and restricted stock services to companies, as well as trade execution and education services to their employees. These services include online tools such as Schwab OptionCenter(R), which allows access to stock option accounts where employees can research, model and exercise their options and StockPlanManager(TM), which allows companies to search, view and run reports on stock option data. The Company offers a live interactive seminar called 'Stock Option Strategies and Issues' for clients looking for information on what to consider when developing a personalized stock option strategy. Capital Markets The Company provides its clients with quick and efficient access to the securities markets by offering trade execution services in Nasdaq, exchange-listed and other securities through its market maker and specialist operations. Clients also have the ability to access extended-hours trading through the Company's participation in Archipelago, an ECN, and analyze and trade a variety of fixed income securities through Schwab's multi-channel delivery systems. Schwab has specialist operations on the Boston Stock Exchange to make markets in exchange-listed securities. The majority of trades originated by the clients of Schwab in exchange-listed securities for which Schwab makes a market are directed to this operation. At December 31, 2002, Schwab had three specialists on the Boston Stock Exchange that made markets in 156 securities. Additionally, SCM makes markets in Nasdaq stocks, which totaled over 5,000 at December 31, 2002. The Company continues to enhance its trade execution capabilities and financial product offerings. Through selective hirings, SCM expanded its equity trading capabilities to focus on improving execution services for institutional clients. Additionally, most Nasdaq marketable orders up to 2,000 shares received by Schwab for execution are routed using SmartEx(R), its proprietary order routing technology that combines intelligent order routing with market maker liquidity enhancements. SmartEx is available for Schwab - 8 - client orders in securities in which SCM makes a market. Further, through an agreement with Goldman Sachs, clients have access to OptEx (a service mark of Goldman, Sachs & Co.), which uses advanced technology to scan the entire options marketplace and route orders automatically based on the best price available nationwide and other execution quality factors. Clients also have the ability to analyze and trade a variety of fixed income securities through Schwab's multi-channel delivery systems. Through Schwab's alliance with Valubond, individual and IA clients can analyze and trade fixed income securities through the Schwab Web site. Schwab's fixed income offering includes Schwab BondSource(R) - a fully automated, online bond trading system that provides clients with access to a wide variety of bond investments to meet their needs and risk tolerance. Schwab recently expanded its BondSource platform to provide additional information, new analytical tools, and enhanced fixed income securities price quotes to support more efficient client service. Schwab's fixed income offering also includes Schwab CDSource(R), a service that enables clients to research and purchase certificates of deposits from a variety of FDIC-insured depository institutions, including U.S. Trust, entirely online. Additionally, Schwab has dedicated Schwab Bond Specialists(R) to assist clients in their decisions. See also "Management's Discussion and Analysis of Results of Operations and Financial Condition - Risk Management" in the Company's 2002 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report, and "Regulation" in this report. U.S. Trust U.S. Trust provides an array of financial services for affluent clients and their families. These services include investment and wealth management, trust, custody, financial and estate planning, and private banking. U.S. Trust provides both individually managed balanced portfolios (i.e., portfolios that are invested in several different asset classes with the overall goal of preserving and enhancing those assets) and specialized investment management services to clients with $2 million to $50 million in assets at U.S. Trust. U.S. Trust offers Wealth Advisory Accounts, an investment advisory service that utilizes the Excelsior(R) family of mutual funds, to clients that have over $250,000 in assets at U.S. Trust. In addition to investment management services, U.S. Trust provides specialized fiduciary, financial planning, enhanced master custody, and philanthropic consulting services to clients that have over $50 million in assets at U.S. Trust. U.S. Trust also offers private banking services to assist in meeting the credit and liquidity requirements of its clients. These services include mortgage and personal lending vehicles and an array of deposit-taking products. Additionally, affluent investors may receive referrals to U.S. Trust from Schwab. U.S. Trust's Web site provides clients with secure access to consolidated account information as well as updated equity pricing, proprietary research, and financial information from third-party providers. Additionally, clients can download their account information into selected financial software programs, view their portfolio asset allocations in real-time, and make bill payments directly from the Web site. For institutional clients, including corporations, endowments, foundations, and pension plans, U.S. Trust provides investment management, brokerage, and special fiduciary services. Through these investment management services, U.S. Trust offers a wide range of investment options, including balanced and specialized domestic and international equity investments, structured investments, alternative investments, fixed income securities, and short-term cash management. Institutional clients can also utilize the Excelsior funds. Additionally, U.S. Trust offers to its institutional clients investment, consulting and fiduciary services for employee stock ownership plans. Special fiduciary services also include trustee services for non-qualified or supplemental employee benefit plans, also known as rabbi trusts. Multi-Channel Delivery Systems The Company's multi-channel delivery systems allow clients to choose how they prefer to do business with the Company. In addition to its branch office network, Schwab maintains four regional client telephone service centers as well as automated telephonic and online channels, primarily serving retail investors through the Individual Investor and Institutional Investor segments. U.S. Trust maintains offices serving clients through the U.S. Trust segment. Office Network To enable clients to obtain services in person with a Company representative, the Company maintains a network of offices. At December 31, 2002, Schwab operated 388 domestic branch offices in 48 states, as well as a branch in the Commonwealth of Puerto Rico. At December 31, 2002, U.S. Trust operated 34 offices in 12 states. In addition, the Company had offices in the Cayman Islands, Hong Kong and the United Kingdom. The Company's office network plays a key role in building its business. With the client service support of regional client telephone service centers and automated telephonic and online channels, office personnel focus a significant portion of their time on business development and help and advice interactions with clients. Clients can use Schwab's branch offices to open accounts, deliver and receive checks and securities, obtain market information, place orders, and obtain related client services in person, yet most of these activities are conducted by telephone, mail, and online channels. Schwab's branch offices - 9- also provide investors with access to the Internet and to Schwab's registered representatives who can assist investors in developing asset allocation strategies and evaluating their investment choices. U.S. Trust's clients can meet with wealth management professionals at regional offices to obtain access to U.S. Trust's wide array of financial services and products. Regional Client Telephone Service Centers Schwab's four regional client telephone service centers, located in Denver, Indianapolis, Orlando, and Phoenix, handle client trading and service calls. The Company closed its telephone service center in Austin, Texas in 2002 as part of its restructuring initiatives. Schwab's client service approach is to use teams led by registered representatives in the service centers, who work closely with office network personnel. Additionally, certain teams at these centers provide specialized services to affluent clients. Each registered representative has immediate access to the client account and market-related information necessary to respond to client inquiries. For most client orders, registered representatives can enter the order and confirm the transaction immediately. As a result of this approach, the departure of a registered representative generally does not result in a loss of clients for Schwab. Online and Automated Telephonic Channels Clients are able to obtain financial information and execute trades on an automated basis through Schwab's automated telephonic and online channels. These channels are designed to provide added convenience for clients and minimize Schwab's costs of responding to and processing routine client transactions. Schwab's automated telephonic channels include TeleBroker(R) - Schwab's touch-tone telephone quote and trading service, and Schwab by Phone(TM) - Schwab's voice recognition quote and trading service. Schwab's automated telephonic channels handled over 70% of client calls received in 2002. Schwab handled approximately 59 million automated and live calls received in 2002. Online channels include the Charles Schwab Web Site, an information and trading service on the Internet at schwab.com(TM); the Schwab Institutional(R) Web site, a platform for IAs to conduct daily activities; the SchwabPlan(R) Web site, a service on the Internet at schwabplan.com where plan participants and sponsors can manage their 401(k) accounts; and Schwab Wireless(TM), a wireless information and trading service. Additionally, online mediums designed for highly active traders include StreetSmart Pro(R) and Velocity(R), online trading systems which provide enhanced trade information and order execution, and CyberTrader's integrated software-based trading platforms. While most client transactions are completed through the online channel, the Company continues to stress the importance of Clicks and Mortar access - blending the power of the Internet with personal service to create a full-service client experience. The Company's online channels handled 83% of total trades in 2002. Technology The Company's ongoing investment in technology is a key element in expanding its product and service offerings, enhancing its delivery systems, providing fast and consistent client service, reducing processing costs, and facilitating the Company's ability to handle significant increases in client activity without a corresponding rise in staffing levels. The Company uses technology to empower its clients to manage their financial affairs and is a leader in driving technological advancements in the financial services industry. The Company's operations rely heavily on its information processing and communications systems. The Company's system for processing a securities transaction is highly automated. Registered representatives equipped with online computer terminals can access client account information, obtain securities prices and related information, and enter orders online. To support its multi-channel delivery systems, as well as other applications such as clearing functions, account administration, recordkeeping, and direct client access to investment information, the Company maintains a sophisticated computer network connecting all of the offices and regional client telephone service centers. The Company's computers are also linked to the major registered U.S. securities markets and The Depository Trust & Clearing Corporation. Failure of the Company's information processing or communications systems for a significant period of time could limit the Company's ability to process its large volume of transactions accurately and rapidly. This could cause the Company to be unable to satisfy its obligations to clients and other securities firms, and could result in regulatory violations. External events, such as an earthquake, terrorist attack, or power failure, loss of external information feeds such as security price information, as well as internal malfunctions such as those that could occur during the implementation of system modifications, could render part or all of such systems inoperative. To enhance the reliability of the system and integrity of data, the Company maintains backup and recovery functions. These include logging of all critical files intraday, duplication and storage of all critical data every twenty-four hours, and maintenance of facilities for backup and communications. They also include the maintenance and periodic testing of a disaster recovery plan that management believes would permit the Company to recommence essential computer operations if its central computer site were to become inaccessible. To minimize business interruptions, the - 10 - Company has data centers intended, in part, to further improve the recovery of business processing in the event of an emergency. Nationally Recognized Brands The Company's advertising and marketing programs support its strategy by continually reinforcing the strengths and key attributes of Schwab's full-service offering, U.S. Trust's wealth management services, and CyberTrader's trading technology. In 2002, Schwab launched a new advertising campaign designed to differentiate Schwab's service model from those of other full-service firms. Additionally, the Company launched a new print advertising campaign to increase awareness of the U.S. Trust brand and educate investors about wealth management. To build its CyberTrader(R) brand, the Company launched an advertising campaign complemented with promotional offers. By maintaining a consistent level of visibility in the marketplace, the Company seeks to establish Schwab, U.S. Trust, and CyberTrader as leading financial services brands in a focused and cost-effective manner. The Company primarily uses a combination of network, cable and local television, print media, direct mail, athletic event sponsorship, and online channels in its advertising. Employees As of December 31, 2002, the Company had full-time, part-time and temporary employees, and persons employed on a contract basis that represented the equivalent of 16,700 full-time employees. Risk Management The Company's business and activities expose it to different types of risks. Proper identification, assessment, and management of these risks are essential to the success and financial soundness of the Company. For a 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 2002 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report, and "Technology" and "Regulation" in this report. Business Environment The Company's business, like that of other securities brokerage and related financial services firms, is directly affected by the fluctuations in securities trading volumes and price levels that occur in fundamentally cyclical financial markets, by changes in government monetary policies that impact the growth of bank loans and investments and the level of interest charged for loans and paid on deposits and other funding sources, and by changes in the geopolitical environment. The Company may experience significant variations in revenues from period to period depending on changes in these factors and the overall business environment. Given the nature of the Company's revenues, expenses and risk profile, the Company's earnings and CSC's common stock price may be subject to significant volatility from period to period. For a discussion of the business environment faced by the Company in 2001 and 2002, see "Management's Discussion and Analysis of Results of Operations and Financial Condition - Results of Operations - Financial Overview" in the Company's 2002 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report. Competition The Company faces significant competition from companies seeking to attract client financial assets, including traditional, discount and online brokerage firms, mutual fund companies, banks, and asset management and wealth management companies. For a discussion of competition, see "Management's Discussion and Analysis of Results of Operations and Financial Condition - Risk Management - Competition" in the Company's 2002 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report. Regulation 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's depository institution subsidiaries are subject to regulation and supervision and to various requirements and restrictions under federal and state law. For a discussion of bank holding company requirements, see note "21 - Regulatory Requirements" in the Notes to Consolidated Financial Statements in the Company's 2002 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report. The securities industry in the United States is subject to extensive regulation under both federal and state laws. The - 11 - SEC is the federal agency charged with administration of the federal securities laws. Schwab, SCM, and CyberTrader are registered as broker-dealers with the SEC. Schwab and CSIM are registered as investment advisors with the SEC. Additionally, Schwab is regulated by the Commodities Futures Trading Commission (CFTC) with respect to its introduced futures and commodities trading activities. Much of the regulation of broker-dealers has been delegated to self-regulatory organizations, principally the national securities exchanges such as the New York Stock Exchange (NYSE), which has been designated by the SEC as Schwab's primary regulator with respect to its securities activities, and the NASD, which has been designated as Schwab's primary regulator with respect to its options trading activities. The NASD has been designated by the SEC as SCM's and CyberTrader's primary regulator with respect to its securities activities. The National Futures Association (NFA) has been designated by the CFTC as Schwab's primary regulator with respect to its futures and commodities trading activities. These self-regulatory organizations adopt rules (subject to approval by the SEC or CFTC) governing the industry and conduct periodic examinations of broker-dealers. Securities firms are also subject to regulation by state securities authorities in the states in which they do business. In addition to its membership in the NYSE, Schwab is also a member of all other major U.S. securities exchanges and is consequently subject to their rules and regulations. Schwab and SCM were registered as broker-dealers in fifty states, the District of Columbia and Puerto Rico as of December 31, 2002. The principal purpose of regulating and disciplining broker-dealers and investment advisors is the protection of clients and the securities markets, rather than protection of creditors and stockholders of broker-dealers and investment advisors. The regulations to which broker-dealers and investment advisors are subject cover all aspects of the securities business, including sales methods, trading practices among broker-dealers, uses and safekeeping of clients' funds and securities, capital structure of securities firms, recordkeeping and reporting, fee arrangements, disclosure to clients, and the conduct of directors, officers and employees. As registered investment advisors, Schwab and CSIM are subject to the requirements of the Investment Advisers Act of 1940 and the regulations thereunder, which impose, among other things, various recordkeeping, reporting, and disclosure requirements and impose limitations on fees and principal transactions between an advisor and its clients. Additional legislation, changes in rules promulgated by the SEC, other federal and state regulatory authorities, and self-regulatory organizations, or changes in the interpretation or enforcement of existing laws and rules may directly affect the method of operation and profitability of broker-dealers and investment advisors. The profitability of broker-dealers and investment advisors could also be affected by rules and regulations which impact the business and financial communities in general, including changes to the laws governing taxation, antitrust regulation, and electronic commerce. The SEC, CFTC, self-regulatory organizations, and state securities authorities may conduct civil or administrative proceedings which can result in censure, fine, cease and desist orders, or suspension or expulsion of a broker-dealer or an investment advisor, its officers, or employees. Schwab and SCM have been the subject of such administrative proceedings. As registered broker-dealers and NASD member organizations, Schwab, SCM, and CyberTrader are required by federal law to belong to the Securities Investor Protection Corporation (SIPC), which provides, in the event of the liquidation of a broker-dealer, protection for securities held in client accounts held by the firm of up to $500,000 per client, subject to a limitation of $100,000 for claims of cash balances. SIPC is funded through assessments on registered broker-dealers. In addition, Schwab purchased from a private surety company account protection for clients above the SIPC limit, as defined, of up to the net equity value for client securities and cash in each account. Stocks, bonds, mutual funds, options, unit investment trusts, and money market funds are considered securities for the purposes of SIPC protection and the additional protection (i.e., protected securities may either be replaced or converted into an equivalent market value as of the date a SIPC trustee is appointed). Neither SIPC protection nor the additional protection applies to fluctuations in the market value of securities. Schwab is authorized by the Municipal Securities Rulemaking Board to conduct transactions in municipal securities on behalf of its clients and has obtained certain additional registrations with the SEC and state regulatory agencies necessary to permit it to engage in certain other activities incidental to its brokerage business. Margin lending by Schwab and SCM is subject to the margin rules of the Federal Reserve Board and the NYSE. Under such rules, broker-dealers are limited in the amount they may lend in connection with certain purchases and short sales of securities and are also required to impose certain maintenance requirements on the amount of securities and cash held in margin accounts. In addition, those rules and rules of the Chicago Board Options Exchange govern the amount of margin clients must provide and maintain in writing uncovered options. As a California state-chartered trust company, CSTC is primarily regulated by the State of California Department of Financial Institutions. Since it provides employee benefit plan trust services, CSTC is also required to comply with the Employee Retirement Income Security Act of 1974 (ERISA) and, consequently, is subject to oversight by both the Internal Revenue Service and Department of Labor. CSTC is required under ERISA to maintain a fidelity bond for the protection of employee benefit trusts for which it serves as trustee. - 12 - The Company's business is also subject to regulation by various non-U.S. governments, securities exchanges, and regulatory bodies, particularly in those countries where it has acquired subsidiaries. Such regulation may directly affect the method of operation and profitability of the Company's foreign operations. As registered broker-dealers, certain subsidiaries of CSC, including Schwab and SCM, are subject to the Uniform Net Capital Rule (Rule 15c3-1) under the Securities Exchange Act of 1934 (the Net Capital Rule), which has also been adopted through incorporation by reference in NYSE Rule 325. The CFTC and NFA also impose net capital requirements. The Net Capital Rule specifies minimum net capital requirements that are intended to ensure the general financial soundness and liquidity of broker-dealers. Failure to maintain the required net capital may subject a firm to suspension or expulsion by the NYSE and the NASD, certain punitive actions by the SEC and other regulatory bodies, and ultimately may require a firm's liquidation. Because CSC itself is not a registered broker-dealer, it is not subject to the Net Capital Rule. However, if Schwab or SCM failed to maintain specified levels of net capital, such failure would constitute a default by CSC under certain debt covenants. "Net capital" is essentially defined as net worth (assets minus liabilities), plus qualifying subordinated borrowings, less certain deductions that result from excluding assets that are not readily convertible into cash and from conservatively valuing certain other assets. These deductions include charges that discount the value of firm security positions to reflect the possibility of adverse changes in market value prior to disposition. The Net Capital Rule requires notice of equity capital withdrawals to be provided to the SEC prior to and subsequent to withdrawals exceeding certain sizes. Such rule prohibits withdrawals that would reduce a broker-dealer's net capital to an amount less than 25% of its deductions required by the Net Capital Rule as to its security positions. The Net Capital Rule also allows the SEC, under limited circumstances, to restrict a broker-dealer from withdrawing equity capital for up to twenty business days. Schwab and SCM have elected the alternative method of calculation under paragraph (a)(1)(ii) of the Net Capital Rule, which requires a broker-dealer to maintain minimum net capital equal to the greater of 2% of its "aggregate debit items," computed in accordance with the Formula for Determination of Reserve Requirements for Brokers and Dealers under Rule 15c3-3, or a minimum dollar amount, which is based on the type of business conducted by the broker-dealer. The minimum dollar amount for both Schwab and SCM is $1 million. "Aggregate debit items" are assets that have as their source transactions with clients, primarily margin loans. Under the alternative method of the Net Capital Rule, a broker-dealer may not (a) pay, or permit the payment or withdrawal of, any subordinated borrowings or (b) pay cash dividends or permit equity capital to be removed if, after giving effect to such payment, withdrawal, or removal, its net capital would be less than 5% of its aggregate debit items. Under NYSE Rule 326, Schwab is required to reduce its business if its net capital is less than 4% of aggregate debit items for more than fifteen consecutive business days; NYSE Rule 326 also prohibits the expansion of business if net capital is less than 5% of aggregate debit items for more than fifteen consecutive business days. The provisions of NYSE Rule 326 also become operative if capital withdrawals (including scheduled maturities of subordinated borrowings during the following six months) would result in a reduction of a firm's net capital to the levels indicated. If compliance with applicable net capital rules were to limit Schwab's or SCM's operations and their ability to repay subordinated debt to CSC, this in turn could limit CSC's ability to repay debt, pay cash dividends and purchase shares of its outstanding stock. See also "Management's Discussion and Analysis of Results of Operations and Financial Condition - Liquidity and Capital Resources - Liquidity" and note "21 - Regulatory Requirements" in the Notes to Consolidated Financial Statements in the Company's 2002 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report. - 13 - Item 2. Properties The Company's corporate headquarters and its principal executive offices are located in leased office space, totaling 433,000 square feet, at 120 Kearny Street in San Francisco, California. These leases have expiration dates that range from 2009 to 2011, and include two five-year extension options at the then current market rates. Schwab also leases a 28-story building at 101 Montgomery Street in San Francisco, California. The building contains 296,000 square feet and is leased by Schwab under a term expiring in the year 2010. Schwab has three successive five-year options to renew this lease at the then current market rates. Schwab also has a lease for 412,000 square feet of office space located at 211 Main Street in San Francisco that serves as the corporate technology support center. A portion of this lease expires in 2010 and has one five-year extension option at the then current market rates, while the remaining portion of this lease expires in 2018 and has two seven-year extension options at the then current market rates. In addition to these locations, Schwab leases space in other buildings for its San Francisco and Pleasanton operations aggregating 831,000 additional square feet. U.S. Trust's headquarters are located in leased office space, totaling 487,000 square feet, in New York City, New York. This lease expires in 2014 and includes two ten-year extension options at the then current market rates. SCM's headquarters are located in leased office space, aggregating 122,000 square feet in Jersey City, New Jersey; this lease expires in 2012. In addition, Schwab and SCM lease an additional 335,000 square feet in Jersey City which is presently on the market to be subleased. A subsidiary of Schwab leases a building, totaling approximately 372,000 square feet, located at 215 Fremont Street in San Francisco, California. Upon the expiration of this 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. For additional information, see note "22 - Commitments and Contingent Liabilities" in the Notes to Consolidated Financial Statements in the Company's 2002 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report. Substantially all of the Company's branch offices are located in leased premises, generally with lease expiration dates of less than ten years from inception. In addition, the Company has four regional client telephone service centers. The Company owns the service centers located in Phoenix and Indianapolis, with 330,000 and 164,000 square feet, respectively. The Company also leases an additional 128,000 square feet as part of its Phoenix service center. The Company leases its service centers located in Denver and Orlando, with 352,000 and 329,000 square feet, respectively. In 2002, the Company closed its fifth service center located in Austin and is currently seeking to sublease this space, which totals 456,000 square feet. The Company owns its data center and administration support center located in Phoenix and aggregating 624,000 square feet. The square footage of the above locations are presented net of space that has been subleased to third parties. While the corporate headquarters and data centers support all of the Company's segments, the offices and service centers primarily support the Individual Investor, Institutional Investor, and U.S. Trust segments. U.S. Trust's headquarters support the U.S. Trust segment and SCM's headquarters support the Capital Markets segment. In 2002 and 2001, the Company initiated restructuring initiatives that included a reduction in facilities. For a discussion of such initiatives, see "Management's Discussion and Analysis of Results of Operations and Financial Condition - Results of Operations" and note "3 - Restructuring and Other Charges" in the Notes to Consolidated Financial Statements in the Company's 2002 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit 13.1 of this report. Item 3. Legal Proceedings The information required to be furnished pursuant to this item is included in note "22 - Commitments and Contingent Liabilities" in the Notes to Consolidated Financial Statements in the Company's 2002 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report. Item 4. Submission of Matters to a Vote of Security Holders No matters were submitted to a vote of the Company's security holders during the fourth quarter of 2002. Item 4A. Executive Officers of the Registrant Information relating to the executive officers of the Company is incorporated by reference from Part III, Item 10 of this report. - 14 - PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters The Company's common stock is listed on the NYSE and the Pacific Exchange under the ticker symbol SCH. The number of common stockholders of record as of March 10, 2003 was 12,929. The closing market price per share on that date was $6.85. The other information required to be furnished pursuant to this item is included in "Quarterly Financial Information (Unaudited)" in the Company's 2002 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report. Item 6. Selected Financial Data The information required to be furnished pursuant to this item is included in "Selected Financial and Operating Data" in the Company's 2002 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The information required to be furnished pursuant to this item is included in "Management's Discussion and Analysis of Results of Operations and Financial Condition" in the Company's 2002 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report. Average balances and interest rates for the fourth quarters of 2002 and 2001 are summarized as follows (dollars in millions): - -------------------------------------------------------------------------------- Three Months Ended December 31, 2002 2001 - -------------------------------------------------------------------------------- Interest-Earning Assets (client-related and other): Investments (client-related): Average balance outstanding $20,225 $16,667 Average interest rate 1.61% 2.55% Margin loans to clients: Average balance outstanding $ 6,576 $ 9,145 Average interest rate 5.46% 5.85% Private banking loans: Average balance outstanding $ 4,204 $ 3,886 Average interest rate 5.50% 6.39% Securities available for sale: Average balance outstanding $ 1,508 $ 1,245 Average interest rate 4.27% 5.42% Average yield on interest-earning assets 3.01% 4.12% Funding Sources (client-related and other): Interest-bearing brokerage client cash balances: Average balance outstanding $22,926 $22,550 Average interest rate .54% 1.57% Interest-bearing banking deposits: Average balance outstanding $ 4,046 $ 3,561 Average interest rate 2.58% 2.72% Other interest-bearing sources: Average balance outstanding $ 1,271 $ 903 Average interest rate 1.53% 2.55% Average noninterest-bearing portion $ 4.270 $ 3,929 Average interest rate on funding sources .76% 1.53% Summary: Average yield on interest-earning assets 3.01% 4.12% Average interest rate on funding sources .76% 1.53% - -------------------------------------------------------------------------------- Average net interest spread 2.25% 2.59% ================================================================================ The decrease in interest revenue, net of interest expense, from the fourth quarter of 2001 to the fourth quarter of 2002 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. - 15 - Item 7A. Quantitative and Qualitative Disclosures About Market Risk The information required to be furnished pursuant to this item is included in "Management's Discussion and Analysis of Results of Operations and Financial Condition - Risk Management - Market Risk" in the Company's 2002 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report. Item 8. Financial Statements and Supplementary Data The information required to be furnished pursuant to this item is included in the Consolidated Financial Statements and "Quarterly Financial Information (Unaudited)" in the Company's 2002 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. PART III Item 10. Directors and Executive Officers of the Registrant The information relating to directors of the Company required to be furnished pursuant to this item is incorporated by reference from portions of the Company's definitive proxy statement for its annual meeting of stockholders to be filed with the SEC pursuant to Regulation 14A by April 30, 2003 (the Proxy Statement) under "The Board of Directors" and "Other Information - Section 16(a) Beneficial Ownership Reporting Compliance." Executive Officers of the Registrant The following table provides certain information about each of the Company's current executive officers. Other information relating to executive officers required to be furnished pursuant to this item is incorporated by reference from portions of the Proxy Statement under "Appendix A - Description of Charles R. Schwab's Employment and License Agreements," and "Appendix H - Description of Lon Gorman's Employment Agreement." - 16 - THE CHARLES SCHWAB CORPORATION ================================================================================ Executive Officers of the Registrant Name Age Title ---- --- ----- Charles R. Schwab 65 Chairman, Co-Chief Executive Officer, and Director David S. Pottruck 54 President, Co-Chief Executive Officer, and Director William L. Atwell 52 Executive Vice President - Institutional, International, and Banking Jody L. Bilney 41 Executive Vice President and Chief Marketing Officer John Philip Coghlan 51 Vice Chairman, President - Schwab Individual Investor Christopher V. Dodds 43 Executive Vice President and Chief Financial Officer Lon Gorman 54 Vice Chairman, President - Schwab Capital Markets/ Asset Management Products and Services Daniel O. Leemon 49 Executive Vice President and Chief Strategy Officer Dawn G. Lepore 48 Vice Chairman - Technology, Operations, and Administration Mary S. McLeod 47 Executive Vice President - Human Resources Geoffrey J. Penney 57 Executive Vice President and Chief Information Officer Alan J. Weber 54 Executive Vice President of The Charles Schwab Corporation, Chairman and Chief Executive Officer of U.S. Trust Corporation ================================================================================ Mr. Schwab has been Co-Chief Executive Officer of the Company since 1998, and Chairman and a director of the Company since its incorporation in 1986. Effective May 9, 2003, Mr. Schwab will become Chairman and director and will cease serving as Co-Chief Executive Officer. Mr. Schwab was Chief Executive Officer of the Company from 1986 to 1997. Mr. Schwab was a founder of Schwab in 1971 and has been its Chairman since 1978. Mr. Schwab is currently a director of USTC and its principal subsidiary, U.S. Trust NY; Gap, Inc.; Siebel Systems, Inc., a company that provides support for software systems; and Xign, Inc., a developer of electronic payment systems using digitally signed electronic check technology. Mr. Schwab is also a trustee of The Charles Schwab Family of Funds, Schwab Investments, Schwab Capital Trust and Schwab Annuity Portfolios, all registered investment companies. Mr. Pottruck has been Co-Chief Executive Officer of the Company since 1998, a director of the Company since 1994, and President of the Company since 1992. Mr. Pottruck's appointment as the sole Chief Executive Officer will become effective on May 9, 2003. Mr. Pottruck was Chief Operating Officer of the Company from 1994 to 1998. Mr. Pottruck joined Schwab in 1984. Mr. Pottruck is currently a director of USTC; U.S. Trust NY; the Nasdaq Stock Market; Intel Corporation, a maker of microcomputer components and related products; and DoveBid, Inc., a provider of online business-to-business capital asset auctions and valuation services. - 17 - Mr. Atwell has been Executive Vice President - Institutional, International and Banking of the Company and Schwab since June 2002 and Executive Vice President - International and Banking of Schwab from February 2002 to May 2002. Mr. Atwell was Executive Vice President - International of Schwab from 2000 to January 2002. Prior to joining Schwab, Mr. Atwell was Senior Vice President - National Sales and Delivery Network for CIGNA Healthcare from 1996 to 2000. Ms. Bilney has been Executive Vice President and Chief Marketing Officer of the Company and Schwab since July 2002. Prior to joining Schwab, Ms. Bilney was Senior Vice President - Brand Management and Marketing Communications from 2001 to 2002, President - Consumer Markets Group from 2000 to 2001, Vice President - Consumer Markets Group from 1999 to 2000, Vice President - General Manager, Consumer Sales from 1997 to 1999, and Vice President - Marketing from 1996 to 1997 for Verizon Communications, a provider of telecommunication services. Mr. Coghlan has been Vice Chairman of the Company and Schwab since 1999, President - Individual Investor of Schwab since July 2002 and Executive Vice President of the Company since 1992. Mr. Coghlan was Enterprise President - Schwab Institutional of Schwab from March 2001 to July 2002. Mr. Coghlan was Enterprise President - Services for Investment Managers of Schwab from 1998 to March 2001 and Enterprise President - Retirement Plan Services of Schwab from 1997 to March 2001. Mr. Coghlan was Executive Vice President of Schwab and General Manager of Schwab Institutional from 1992 to 1997. Mr. Coghlan joined Schwab in 1986. Mr. Dodds has been Chief Financial Officer of the Company and Schwab since 1999 and Executive Vice President of the Company and Schwab since 1998. Mr. Dodds was Corporate Controller of Schwab from 1997 to 1999 and Corporate Treasurer of Schwab from 1993 to 1997. Mr. Dodds joined Schwab in 1986. Mr. Gorman has been Vice Chairman of the Company and Schwab since 1999, President - Asset Management Products and Services since February 2002, Enterprise President - Schwab Capital Markets of Schwab and Executive Vice President of the Company since 1997. Mr. Gorman was Executive Vice President - Schwab Capital Markets of the Company and Schwab from 1996 to 1997. Mr. Gorman joined Schwab in 1996. Mr. Leemon has been Executive Vice President and Chief Strategy Officer of the Company and Schwab since 1995. Mr. Leemon joined Schwab in 1995. Mr. Leemon is currently a director of LiveCapital, a provider of online small business financing. Ms. Lepore has been Vice Chairman - Technology, Operations, and Administration of the Company and Schwab since July 2002 and Vice Chairman - Technology and Administration of the Company and Schwab from October 2001 to July 2002. Ms. Lepore was Vice Chairman and Chief Information Officer of the Company and Schwab from 1999 to October 2001 and Executive Vice President and Chief Information Officer of the Company and Schwab from 1993 to 1999. Ms. Lepore joined Schwab in 1983. Ms. Lepore is currently a director of Wal-Mart Stores, Inc. and eBay Inc. Ms. McLeod has been Executive Vice President - Human Resources of the Company and Schwab since 2001. Ms. McLeod was appointed to the Company's Executive Committee effective January 1, 2003. Prior to joining Schwab, Ms. McLeod was Vice President of Human Resources for the Global Sales Organization of Cisco Systems from 2000 to 2001 and Senior Vice President of Human Resources for Hallmark Cards from 1997 to 2000. Mr. Penney has been Executive Vice President and Chief Information Officer of the Company and Schwab since 2001. Mr. Penney was appointed to the Company's Executive Committee effective January 1, 2003. Mr. Penney was Executive Vice President - Schwab Technology of Schwab from 1998 to 2001. Mr. Penney joined Schwab in 1997 as Senior Vice President of Financial Products and International Technology of Schwab. Mr. Penney is currently a director of Keynote Systems, an internet performance management company. Mr. Weber has been Executive Vice President of the Company, Chief Executive Officer of USTC and U.S. Trust NY, and a director of USTC since October 2002. Mr. Weber was appointed Chairman of USTC as of January 31, 2003. Prior to joining USTC, Mr. Weber was Vice Chairman and Chief Financial Officer for Aetna, Inc. from 1998 to 2001 and Chairman of Citibank International from 1994 to 1998. - 18 - Item 11. Executive Compensation The information required to be furnished pursuant to this item is incorporated by reference from portions of the Proxy Statement under "Compensation Committee Interlocks and Insider Participation," "Director Compensation," "Summary Compensation Table," "Option Grants," "Options Exercised," "Pension Plan Table," "Compensation Committee Report," "Other Information - Certain Transactions," "Appendix A - Description of Charles R. Schwab's Employment and License Agreements," "Appendix B - Description of H. Marshall Schwarz's Separation and Employment Agreements," and "Appendix C - Description of Jeffrey S. Maurer's Separation and Employment Agreements," and "Appendix H - Description of Lon Gorman's Employment Agreement." Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters The information relating to security ownership of certain beneficial owners and management required to be furnished pursuant to this item is incorporated by reference from portions of the Proxy Statement under "Principal Stockholders." Securities Authorized for Issuance Under Equity Compensation Plans The following table summarizes information as of December 31, 2002 with respect to equity compensation plans approved and not approved by stockholders (shares in millions): - -------------------------------------------------------------------------------- (C) (A) (B) Shares Available Shares to be Issued Weighted-Average for Future Issuance Upon Exercise of Exercise Price of (Excluding Shares Plan Category Outstanding Options Outstanding Options in Column A) - -------------------------------------------------------------------------------- Equity compensation plans approved by stockholders 109 (1) $14.37 38 Equity compensation plans not approved by stockholders 47 (2) $17.76 3 - -------------------------------------------------------------------------------- Total 156 $15.38 41 (3) ================================================================================ (1) Represents shares of common stock issuable upon exercise of outstanding options under CSC's 1987 Stock Option Plan, 1987 Executive Officer Stock Option Plan, and the 1992 and 2001 Stock Incentive Plans, which are generally used for grants to officers and directors. Although stock and stock-based awards are still outstanding under the 1987 Stock Option Plan and 1987 Executive Officer Stock Option Plan, no new shares are available under these plans for future grants. (2) Represents shares of common stock issuable upon exercise of outstanding options under CSC's Employee Stock Incentive Plan. Grants under this plan are used for employees other than officers and directors and accordingly, did not require stockholders' approval. The material features of this plan are described in note "17 - Employee Incentive and Deferred Compensation Plans" in the Notes to Consolidated Financial Statements in the Company's 2002 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report. This narrative is an abbreviated description of the plan. For a complete description, see the plan document that is Exhibit 10.226 which was filed with the Company's Form 10-Q for the quarter ended September 30, 2001 and incorporated herein by reference. (3) In addition to options, restricted shares may be granted under the 1992 and 2001 Stock Incentive Plans and the Employee Stock Incentive Plan, and performance-based shares may be granted under the 1992 and 2001 Stock Incentive Plans. Item 13. Certain Relationships and Related Transactions The information required to be furnished pursuant to this item is incorporated by reference from a portion of the Proxy Statement under "Other Information - Certain Transactions." - 19 - Item 14. 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 and operation of the Company's disclosure controls and procedures within 90 days before the filing date of this annual 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 IV Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K (a) Documents filed as part of this Report 1. Financial Statements The financial statements and independent auditors' report are included in the Company's 2002 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report and are listed below: Consolidated Statement of Income Consolidated Balance Sheet Consolidated Statement of Cash Flows Consolidated Statement of Stockholders' Equity Notes to Consolidated Financial Statements Independent Auditors' Report 2. Financial Statement Schedules The financial statement schedules required to be furnished pursuant to this item are listed in the accompanying index appearing on page F-1. (b) Reports on Form 8-K On November 12, 2002, the Registrant filed a Current Report on Form 8-K which included certifications 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 18 U.S.C. Section 1350 (as adopted by Section 906 of the Sarbanes-Oxley Act of 2002). - 20 - THE CHARLES SCHWAB CORPORATION (c) Exhibits The exhibits listed below are filed as part of this annual report on Form 10-K. - -------------------------------------------------------------------------------- Exhibit Number Exhibit - -------------------------------------------------------------------------------- 1.3 The Charles Schwab Corporation Medium-Term Notes Distribution Agreement filed as Exhibit 1.3 to the Registrant's Form 10-Q for the quarter ended June 30, 2000 and incorporated herein by reference. 2.1 Agreement and Plan of Merger dated as of January 12, 2000, by and among The Charles Schwab Corporation, Patriot Merger Corporation and U.S. Trust Corporation, filed as Exhibit 2.1 to the Registrant's Form 8-K dated January 12, 2000 and incorporated herein by reference. 3.9 Second Restated Bylaws, as amended on September 22, 1998, of the Registrant (supersedes Exhibit 3.8) filed as Exhibit 3.9 to the Registrant's Form 10-Q for the quarter ended September 30, 1998 and incorporated herein by reference. 3.10 Fourth Restated Certificate of Incorporation, effective July 30, 1999, of the Registrant, which includes amendments through May 20, 1999 (supersedes Exhibit 3.7), filed as Exhibit 3.10 to the Registrant's Form 10-Q for the quarter ended September 30, 1999 and incorporated herein by reference. 3.11 Fifth Restated Certificate of Incorporation, effective May 7, 2001, of the Registrant (supersedes Exhibit 3.10), filed as Exhibit 3.11 to the Registrant's Form 10-Q for the quarter ended September 30, 2001 and incorporated herein by reference. 4.2 Neither the Registrant nor its subsidiaries are parties to any instrument with respect to long-term debt for which securities authorized thereunder exceed 10% of the total assets of the Registrant and its subsidiaries on a consolidated basis. Copies of instruments with respect to long-term debt of lesser amounts will be provided to the SEC upon request. 10.4 Form of Release Agreement dated as of March 31, 1987 among BAC, Registrant, Schwab Holdings, Inc., Charles Schwab & Co., Inc. and former shareholders of Schwab Holdings, Inc. * 10.57 Registration Rights and Stock Restriction Agreement, dated as of March 31, 1987, between the Registrant and the holders of the Common Stock, filed as Exhibit 4.23 to Registrant's Registration Statement No. 33-16192 on Form S-1 and incorporated herein by reference. 10.72 Restatement of Assignment and License, as amended January 25, 1988, among Charles Schwab & Co., Inc., Charles R. Schwab and the Registrant, filed as Exhibit 10.72 to the Registrant's Form 10-K for the year ended December 31, 1999 and incorporated herein by reference. 10.87 Trust Agreement under the Charles Schwab Profit Sharing and Employee Stock Ownership Plan, effective November 1, 1990, dated October 25, 1990, filed as Exhibit 10.87 to the Registrant's Form 10-Q for the quarter ended September 30, 2000 and incorporated herein by reference. + - 21 - 10.101 First Amendment to the Trust Agreement under the Charles Schwab Profit Sharing and Employee Stock Ownership Plan, effective January 1, 1992, dated December 20, 1991, filed as Exhibit 10.101 to the Registrant's Form 10-K for the year ended December 31, 2001 and incorporated herein by reference. + 10.116 Second Amendment to the Trust Agreement for the Charles Schwab Profit Sharing and Employee Stock Ownership Plan effective July 1, 1992, dated June 30, 1992, filed as Exhibit 10.116 to the Registrant's Form 10-Q for the quarter ended June 30, 2002 and incorporated herein by reference. + 10.138 Form of Nonstatutory Stock Option Agreement for Non-Employee Directors, filed as Exhibit 4.4 to the Registrant's Registration Statement No. 33-47842 on Form S-8 and incorporated herein by reference. + 10.140 Form of Restricted Shares Agreement, filed as Exhibit 4.6 to the Registrant's Registration Statement No. 33-54701 on Form S-8 and incorporated herein by reference. + 10.149 Employment Agreement dated as of March 31, 1995 between the Registrant and Charles R. Schwab, filed as Exhibit 10.149 to the Registrant's Form 10-K for the year ended December 31, 1999 and incorporated herein by reference. + 10.169 Third Amendment to the Trust Agreement for the Charles Schwab Profit Sharing and Employee Stock Ownership Plan effective January 1, 1996, dated May 8, 1996 filed as Exhibit 10.169 to the Registrant's Form 10-Q for the quarter ended June 30, 2002 and incorporated herein by reference. + 10.191 Form of Restricted Shares Award Agreement of The Charles Schwab Corporation 1992 Stock Incentive Plan (supersedes Exhibit 10.171). + 10.192 Form of Nonstatutory Stock Option Agreement of The Charles Schwab Corporation 1992 Stock Incentive Plan (supersedes Exhibit 10.172). + 10.200 Form of Indemnification Agreement entered into between Registrant and members of the Board of Directors of Registrant (supersedes Exhibit 10.34), filed as Exhibit 10.200 to the Registrant's Form 10-K for the year ended December 31, 1998 and incorporated herein by reference. 10.202 Fourth Amendment to the Trust Agreement for the Charles Schwab Profit Sharing and Employee Stock Ownership Plan effective January 1, 1998, filed as Exhibit 10.202 to the Registrant's Form 10-K for the year ended December 31, 1998 and incorporated herein by reference. + 10.212 The Charles Schwab Corporation Corporate Executive Bonus Plan, amended and restated as of January 1, 2000 (supersedes Exhibit 10.182), filed as Exhibit 10.212 to the Registrant's Form 10-Q for the quarter ended March 31, 2000 and incorporated herein by reference. + 10.215 The Charles Schwab Corporation Directors' Deferred Compensation Plan, restated to include amendments through December 13, 2000 (supersedes Exhibit 10.209), filed as Exhibit 10.215 to the Registrant's Form 10-K for the year ended December 31, 2000 and incorporated herein by reference. + - 22 - 10.217 Executive Employment Agreement and Covenants Not to Compete for H. Marshall Schwarz, filed as Exhibit 10.217 to the Registrant's Form 10-Q for the quarter ended March 31, 2001 and incorporated herein by reference. + 10.218 Executive Employment Agreement and Covenant Not To Compete for Jeffrey S. Maurer, filed as Exhibit 10.218 to the Registrant's Form 10-Q for the quarter ended March 31, 2001 and incorporated herein by reference. + 10.220 The Charles Schwab Corporation Annual Executive Individual Performance Plan, as amended and restated, approved at the Annual Meeting of Stockholders on May 7, 2001 (supersedes Exhibit 10.211), filed as Exhibit 10.220 to the Registrant's Form 10-Q for the quarter ended June 30, 2001 and incorporated herein by reference. + 10.221 The SchwabPlan Retirement Savings and Investment Plan, restated and amended as of April 1, 2001 (supersedes Exhibit 10.216), filed as Exhibit 10.221 to the Registrant's Form 10-Q for the quarter ended June 30, 2001 and incorporated herein by reference. + 10.222 The Charles Schwab Corporation 1987 Stock Option Plan, restated and amended as of September 20, 2001, with form of Non-Qualified Stock Option Agreement attached (supersedes Exhibit 10.186), filed as Exhibit 10.222 to the Registrant's Form 10-Q for the quarter ended September 30, 2001 and incorporated herein by reference. + 10.223 The Charles Schwab Corporation Executive Officer Stock Option Plan (1987), restated and amended as of September 20, 2001, with form of Non-Qualified Stock Option Agreement attached (supersedes Exhibit 10.188), filed as Exhibit 10.223 to the Registrant's Form 10-Q for the quarter ended September 30, 2001 and incorporated herein by reference. + 10.224 The Charles Schwab Corporation 1992 Stock Incentive Plan, restated and amended as of September 20, 2001 (supersedes Exhibit 10.214), filed as Exhibit 10.224 to the Registrant's Form 10-Q for the quarter ended September 30, 2001 and incorporated herein by reference. + 10.225 The Charles Schwab Corporation 2001 Stock Incentive Plan, restated and amended as of September 20, 2001 (supersedes Exhibit 10.219), filed as Exhibit 10.225 to the Registrant's Form 10-Q for the quarter ended September 30, 2001 and incorporated herein by reference. + 10.226 The Charles Schwab Corporation Employee Stock Incentive Plan, restated and amended as of September 20, 2001 (supersedes Exhibit 10.190), filed as Exhibit 10.226 to the Registrant's Form 10-Q for the quarter ended September 30, 2001 and incorporated herein by reference. + 10.227 Benefit Equalization Plan of U.S. Trust Corporation, filed as Exhibit 10.227 to the Registrant's Form 10-Q for the quarter ended September 30, 2001 and incorporated herein by reference. + - 23 - 10.228 1990 Change in Control and Severance Policy for Top Tier Officers of United States Trust Company of New York and Affiliated Companies, filed as Exhibit 10.228 to the Registrant's Form 10-Q for the quarter ended September 30, 2001 and incorporated herein by reference. + 10.231 1989 Stock Compensation Plan and Predecessor Plans of U.S. Trust Corporation, filed as Exhibit 10.231 to the Registrant's Form 10-Q for the quarter ended September 30, 2001 and incorporated herein by reference. + 10.234 Executive Deferred Compensation Plan of U.S. Trust Corporation, as amended and restated effective as of January 1, 2001 (supersedes Exhibit 10.229), filed as Exhibit 10.234 to the Registrant's Form 10-K for the year ended December 31, 2001 and incorporated herein by reference. + 10.235 Executive Incentive Plan of U.S. Trust Corporation, as amended and restated effective as of January 1, 2001 (supersedes Exhibit 10.230), filed as Exhibit 10.235 to the Registrant's Form 10-K for the year ended December 31, 2001 and incorporated herein by reference. + 10.236 U.S. Trust Corporation 401(k) Plan, as amended and restated effective as of January 1, 2001 (supersedes Exhibit 10.233), filed as Exhibit 10.236 to the Registrant's Form 10-K for the year ended December 31, 2001 and incorporated herein by reference. + 10.237 U.S. Trust Corporation Employees' Retirement Plan, as amended and restated effective as of January 1, 2001 (supersedes Exhibit 10.232), filed as Exhibit 10.237 to the Registrant's Form 10-K for the year ended December 31, 2001 and incorporated herein by reference. + 10.238 Credit Agreement (364-Day Commitment) dated as of June 22, 2001 between the Registrant and the financial institutions listed therein (supersedes Exhibit 10.198 and 10.206), filed as Exhibit 10.238 to the Registrant's Form 10-K for the year ended December 31, 2001 and incorporated herein by reference. 10.239 The Charles Schwab Corporation Annual Executive Individual Performance Plan, restated to include amendments approved at the Annual Meeting of Stockholders on May 13, 2002 (supersedes Exhibit 10.220), filed as Exhibit 10.239 to the Registrant's Form 10-Q for the quarter ended June 30, 2002 and incorporated herein by reference. + 10.240 The Charles Schwab Corporation Corporate Executive Bonus Plan, restated to include amendments approved at the Annual Meeting of Stockholders on May 13, 2002 (supersedes Exhibit 10.212), filed as Exhibit 10.240 to the Registrant's Form 10-Q for the quarter ended June 30, 2002 and incorporated herein by reference. + 10.241 Credit Agreement (364-Day Commitment) dated as of June 21, 2002 between the Registrant and the financial institutions listed therein (supersedes Exhibit 10.238), filed as Exhibit 10.241 to the Registrant's Form 10-Q for the quarter ended June 30, 2002 and incorporated herein by reference. - 24 - 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), filed as Exhibit 10.242 to the Registrant's Form 10-Q for the quarter ended September 30, 2002 and incorporated herein by reference. + 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), filed as Exhibit 10.243 to the Registrant's Form 10-Q for the quarter ended September 30, 2002 and incorporated herein by reference. + 10.244 The Charles Schwab Corporation 1992 Stock Incentive Plan, amended and restated as of September 25, 2002 (supersedes Exhibit 10.224), filed as Exhibit 10.244 to the Registrant's Form 10-Q for the quarter ended September 30, 2002 and incorporated herein by reference. + 10.245 The Charles Schwab Corporation 2001 Stock Incentive Plan, amended and restated as of September 25, 2002 (supersedes Exhibit 10.225), filed as Exhibit 10.245 to the Registrant's Form 10-Q for the quarter ended September 30, 2002 and incorporated herein by reference. + 10.246 Executive Employment Agreement by and among The Charles Schwab Corporation, Schwab Capital Markets L.P., and Lon Gorman, and Supplemental Agreement thereto, filed as Exhibit 10.246 to the Registrant's Form 10-Q for the quarter ended September 30, 2002 and incorporated herein by reference. + 10.247 The Charles Schwab Severence Pay Plan, restated as of August 1, 2002, filed as Exhibit 10.247 to the Registrant's Form 10-Q for the quarter ended September 30, 2002 and incorporated herein by reference. + 10.248 The Charles Schwab Corporation 2001 Stock Incentive Plan, restated to include amendments through October 23, 2002 (supersedes Exhibits 10.225 and 10.245). + 10.249 Separation Agreement by and between H. Marshall Schwarz and The Charles Schwab Corporation. + 10.250 Separation Agreement by and between Jeffrey S. Maurer and The Charles Schwab Corporation. + 12.1 Computation of Ratio of Earnings to Fixed Charges. 13.1 Portions of The Charles Schwab Corporation 2002 Annual Report to Stockholders, which have been incorporated herein by reference. Except for such portions, such annual report is not deemed to be "filed" herewith. 21.1 Subsidiaries of the Registrant. 23.1 Independent Auditors' Consent. * Incorporated by reference to the identically-numbered exhibit to Registrant's Registration Statement No. 33-16192 on Form S-1, as amended and declared effective on September 22, 1987. + Management contract or compensatory plan. - 25 - THE CHARLES SCHWAB CORPORATION SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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, on March 21, 2003. THE CHARLES SCHWAB CORPORATION (Registrant) BY: /s/ Charles R. Schwab ------------------------- Charles R. Schwab Chairman, Co-Chief Executive Officer and Director Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated, on March 21, 2003. Signature / Title Signature / Title ----------------- ----------------- /s/ Charles R. Schwab /s/ David S. Pottruck - ------------------------ ------------------------- Charles R. Schwab, David S. Pottruck, Chairman, Co-Chief Executive Officer President, Co-Chief Executive and Director Officer and Director (principal executive officer) (principal executive officer) /s/ Christopher V. Dodds - ------------------------- Christopher V. Dodds, Executive Vice President and Chief Financial Officer (principal financial and accounting officer) /s/ Nancy H. Bechtle /s/ C. Preston Butcher - ------------------------- ------------------------- Nancy H. Bechtle, Director C. Preston Butcher, Director - ------------------------- ------------------------- Donald G. Fisher, Director Anthony M. Frank, Director /s/ Frank C. Herringer /s/ Stephen T. McLin - ------------------------- ------------------------- Frank C. Herringer, Director Stephen T. McLin, Director /s/ Arun Sarin /s/ George P. Shultz - ------------------------- ------------------------- Arun Sarin, Director George P. Shultz, Director /s/ Paula A. Sneed /s/ Roger O. Walther - ------------------------- ------------------------- Paula A. Sneed, Director Roger O. Walther, Director - 26 - THE CHARLES SCHWAB CORPORATION CERTIFICATION I, Charles R. Schwab, certify that: 1. I have reviewed this annual report on Form 10-K of The Charles Schwab Corporation; 2. Based on my knowledge, this annual 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 annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual 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 annual 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 annual 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 annual report (the Evaluation Date); and c) presented in this annual 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 annual 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: March 21, 2003 /s/ Charles R. Schwab ---------------- ---------------------------------- Charles R. Schwab Chairman of the Board and Co-Chief Executive Officer - 27 - THE CHARLES SCHWAB CORPORATION CERTIFICATION I, David S. Pottruck, certify that: 1. I have reviewed this annual report on Form 10-K of The Charles Schwab Corporation; 2. Based on my knowledge, this annual 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 annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual 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 annual 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 annual 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 annual report (the Evaluation Date); and c) presented in this annual 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 annual 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: March 21, 2003 /s/ David S. Pottruck ---------------- ---------------------------------- David S. Pottruck President and Co-Chief Executive Officer - 28 - THE CHARLES SCHWAB CORPORATION CERTIFICATION I, Christopher V. Dodds, certify that: 1. I have reviewed this annual report on Form 10-K of The Charles Schwab Corporation; 2. Based on my knowledge, this annual 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 annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual 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 annual 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 annual 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 annual report (the Evaluation Date); and c) presented in this annual 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 annual 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: March 21, 2003 /s/ Christopher V. Dodds ---------------- ---------------------------------- Christopher V. Dodds Executive Vice President and Chief Financial Officer - 29 - THE CHARLES SCHWAB CORPORATION Index to Financial Statement Schedules Page ---- Independent Auditors' Report F-2 Schedule I - Condensed Financial Information of Registrant: Condensed Balance Sheet F-3 Condensed Statement of Income F-4 Condensed Statement of Cash Flows F-5 Notes to Condensed Financial Information F-6 - F-8 Schedule II - Valuation and Qualifying Accounts F-9 U.S. Trust Corporation Supplemental Financial Data (Unaudited) F-10 - F-16 Schedules not listed are omitted because of the absence of the conditions under which they are required or because the information is included in the Company's consolidated financial statements and notes in the Company's 2002 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report. F-1 THE CHARLES SCHWAB CORPORATION INDEPENDENT AUDITORS' REPORT To the Stockholders and Board of Directors of The Charles Schwab Corporation: We have audited the consolidated financial statements of The Charles Schwab Corporation and subsidiaries (the Company) as of December 31, 2002 and 2001, and for each of the three years in the period ended December 31, 2002, and have issued our report thereon dated February 24, 2003 (which report expresses an unqualified opinion and includes an explanatory paragraph relating to an accounting change); such consolidated financial statements and report are included in your 2002 Annual Report to Stockholders and are incorporated herein by reference. Our audits also included the financial statement schedules (Schedules I and II) of the Company on pages F-3 through F-9. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein. /s/ Deloitte & Touche LLP - ------------------------- San Francisco, California February 24, 2003 F-2 SCHEDULE I THE CHARLES SCHWAB CORPORATION (PARENT COMPANY ONLY) Condensed Financial Information of Registrant Condensed Balance Sheet (In millions) December 31, 2002 2001 - -------------------------------------------------------------------------------- Assets Cash and cash equivalents $ 1,079 $ 1,197 Securities owned - at market value 11 Advances to subsidiaries 339 324 Investments in subsidiaries, at equity 3,316 3,550 Other assets 105 48 - -------------------------------------------------------------------------------- Total $ 4,839 $ 5,130 ================================================================================ Liabilities and Stockholders' Equity Drafts payable $ 100 Accrued expenses and other liabilities $ 212 188 Intercompany borrowings 24 Long-term debt 592 679 - -------------------------------------------------------------------------------- Total liabilities 828 967 Stockholders' equity 4,011 4,163 - -------------------------------------------------------------------------------- Total $ 4,839 $ 5,130 ================================================================================ See Notes to Condensed Financial Information. F-3 SCHEDULE I THE CHARLES SCHWAB CORPORATION (PARENT COMPANY ONLY) Condensed Financial Information of Registrant Condensed Statement of Income (In millions) Year Ended December 31, 2002 2001 2000 - -------------------------------------------------------------------------------- Interest revenue $ 41 $ 73 $120 Interest expense (41) (53) (51) - -------------------------------------------------------------------------------- Net interest revenue 20 69 Other revenues (losses) (2) 12 (5) Restructuring expense (29) (30) Other gains (expenses) 5 7 (28) - -------------------------------------------------------------------------------- Income (loss) before income tax benefit (expense) and equity in earnings of subsidiaries (26) 9 36 Income tax benefit (expense) 11 (1) (20) - -------------------------------------------------------------------------------- Income (loss) before equity in earnings of subsidiaries (15) 8 16 Equity in earnings of subsidiaries: Equity in undistributed earnings / (distributions in excess of earnings) of subsidiaries (325) (529) 516 Dividends paid by subsidiaries 437 599 186 Equity in extraordinary item of subsidiary 12 121 - -------------------------------------------------------------------------------- Total 124 191 702 Net income $109 $199 $718 ================================================================================ See Notes to Condensed Financial Information. F-4 SCHEDULE I THE CHARLES SCHWAB CORPORATION (PARENT COMPANY ONLY) Condensed Financial Information of Registrant Condensed Statement of Cash Flows (In millions) Year Ended December 31, 2002 2001 2000 - -------------------------------------------------------------------------------- Cash Flows from Operating Activities Net income $ 109 $ 199 $ 718 Adjustments to reconcile net income to net cash provided by operating activities: Distributions in excess of earnings/(equity in undistributed earnings) of subsidiaries 325 529 (516) Equity gain in extraordinary item of subsidiary (12) (121) Net gain on sale of an investment (26) Other 2 10 Net change in: Other assets (32) (6) (3) Drafts payable (100) (100) Accrued expenses and other liabilities 6 9 26 - -------------------------------------------------------------------------------- Net cash provided by operating activities 298 494 225 - -------------------------------------------------------------------------------- Cash Flows from Investing Activities Purchases of securities available for sale (6) (10) Proceeds from sales of securities available for sale 11 Decrease in net advances to subsidiaries 37 384 545 Increase in investments in subsidiaries (51) (111) (436) Cash payments for business combinations and investments, net of cash received 1 (13) (29) Proceeds from sale of an investment 49 - -------------------------------------------------------------------------------- Net cash provided by (used for) investing activities (2) 303 70 - -------------------------------------------------------------------------------- Cash Flows from Financing Activities Proceeds from intercompany borrowings 24 Proceeds from long-term debt 311 Repayment of long-term debt (113) (39) (48) Dividends paid (60) (61) (62) Purchase of treasury stock (299) (368) Proceeds from stock options exercised and other 34 30 85 Proceeds from issuance of stock to ESOP 25 - -------------------------------------------------------------------------------- Net cash provided by (used for) financing activities (414) (438) 311 - -------------------------------------------------------------------------------- Increase (Decrease) in Cash and Cash Equivalents (118) 359 606 Cash and Cash Equivalents at Beginning of Year 1,197 838 232 - -------------------------------------------------------------------------------- Cash and Cash Equivalents at End of Year $1,079 $1,197 $ 838 ================================================================================ See Notes to Condensed Financial Information. F-5 SCHEDULE I The Charles Schwab Corporation (PARENT COMPANY ONLY) Condensed Financial Information of Registrant Notes to Condensed Financial Information 1. Introduction and Basis of Presentation The condensed financial information of The Charles Schwab Corporation (CSC) should be read in conjunction with the consolidated financial statements of The Charles Schwab Corporation and its majority-owned subsidiaries (collectively referred to as the Company) and notes thereto included in the Company's 2002 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report. On May 31, 2000, CSC completed its merger (the Merger) with U.S. Trust Corporation (USTC). The condensed financial statements, included in this Annual Report on Form 10-K, give retroactive effect to the Merger, which was accounted for as a pooling of interests in the consolidated financial statements. The pooling of interests method of accounting requires the restatement of all periods presented as if CSC and USTC had been operating as a combined entity during such periods. 2. Supplemental Cash Flow Information During 2000, CSC recorded a non-cash capital contribution of $19 million to its subsidiary, Charles Schwab & Co., Inc. (Schwab), through the contribution of net assets. Also during 2000, CSC recorded a non-cash return of capital of $82 million from Schwab and a non-cash capital contribution of $82 million to USTC in connection with Schwab's purchase of rights to software from USTC. Certain of CSC's subsidiaries have remitted the tax benefits from stock options exercised and other stock-based compensation of $4 million in 2002, $37 million in 2001 and $178 million in 2000 to CSC. Certain information affecting the cash flows of CSC follows (in millions): --------------------------------------------------------------------------- Year Ended December 31, 2002 2001 2000 --------------------------------------------------------------------------- Income taxes paid (refunded) $(21) $ 12 $ 10 =========================================================================== Interest paid: Long-term debt $ 49 $ 52 $ 41 Other 1 2 1 --------------------------------------------------------------------------- Total interest paid $ 50 $ 54 $ 42 =========================================================================== Non-cash investing and financing activities: Common stock and options issued for purchases of businesses $ 4 $ 71 $529 =========================================================================== 3. Long-term Debt Long-term debt consists of Senior Medium-Term Notes, Series A (Medium-Term Notes). At December 31, 2002, CSC had $566 million aggregate principal amount of Medium-Term Notes outstanding with maturities ranging from 2003 to 2010 and fixed interest rates ranging from 6.04% to 8.05%. At December 31, 2002, the Medium-Term Notes carried a weighted-average interest rate of 7.29%. During 2002, CSC entered into interest rate swap agreements (Swaps) with an aggregate notional principal amount of $293 million that effectively convert the interest rate characteristics of a like amount of its Medium-Term Notes from fixed to variable. These Swaps are structured for CSC to receive a fixed rate of interest and pay a variable rate of interest based on the three-month LIBOR rate. At December 31, 2002, the net effect of the Swaps converted the hedged portion of the Medium-Term Notes from a weighted-average fixed interest rate of 7.57% to a weighted-average variable interest rate of 3.87%. These Swaps have been designated as fair value hedges under Statement of Financial F-6 Accounting Standards No. 133 - Accounting for Derivative Instruments and Hedging Activities, and are recorded on the condensed balance sheet. Changes in fair value of the Swaps are completely offset by changes in fair value of the hedged Medium-Term Notes. At December 31, 2002, CSC recorded a derivative asset of $26 million for these Swaps. Concurrently, the carrying value of the Medium-Term Notes was increased by $26 million. At December 31, 2001, CSC had $679 million aggregate principal amount of Medium-Term Notes outstanding with maturities ranging from 2002 to 2010 and fixed interest rates ranging from 6.04% to 8.05%. At December 31, 2001, the Medium-Term Notes carried a weighted-average interest rate of 7.27%. Annual maturities on long-term debt outstanding at December 31, 2002 are as follows (in millions): --------------------------------------------------------------------------- 2003 $ 100 2004 81 2005 56 2006 68 2007 38 Thereafter 223 --------------------------------------------------------------------------- Total maturities 566 Fair value adjustment 26 --------------------------------------------------------------------------- Total $ 592 =========================================================================== 4. Related Party Transactions At December 31, 2002, receivables from affiliates, which is included in advances to subsidiaries, was $8 million. At December 31, 2002, payables to affiliates, which is included in accrued expenses and other liabilities, was $44 million and is payable on demand and bears interest at variable rates (1.4% at December 31, 2002). CSC provides subordinated revolving credit facilities and other lending arrangements to certain of its subsidiaries, including Schwab, USTC, Schwab Capital Markets L.P. (SCM) and Charles Schwab Europe (CSE). The amount outstanding under these facilities and arrangements totaled $331 million at December 31, 2002. Schwab has a $1.4 billion subordinated revolving credit facility which is scheduled to expire in September 2003. The amount outstanding under this facility was $220 million at both December 31, 2002 and 2001. At year end 2002, Schwab also had outstanding $25 million in fixed-rate subordinated term loans from CSC maturing in 2004. The outstanding balance of these term loans was $25 million at year end 2001. USTC has a $300 million short-term credit facility maturing in December 2003. The amount outstanding under this facility was $35 million and $30 million at December 31, 2002 and 2001, respectively. SCM has a $150 million subordinated lending arrangement with CSC which is scheduled to expire in August 2003. This subordinated lending arrangement was $70 million at the end of 2001. In addition, CSC provides SCM with a $50 million short-term credit facility. The total amount outstanding under these facilities at December 31, 2002 was $50 million. No funds were drawn under either of these facilities at December 31, 2001. F-7 CSE has a (pound sterling)50 million, equivalent to $81 million, subordinated lending arrangement maturing in 2006, which was not used at December 31, 2002. At December 31, 2001, CSE had a (pound sterling)50 million, equivalent to $73 million, subordinated lending arrangement, which was not used as of that date. CSC also provides other lending arrangements to certain of its subsidiaries. At December 31, 2002, the total amount provided under these lending arrangements was $28 million, of which $1 million was outstanding and matures in 2003. These lending arrangements totaled $48 million, of which $22 million was outstanding at December 31, 2001. Interest earned by CSC from these subordinated revolving credit facilities and other lending arrangements totaled $20 million in 2002, $42 million in 2001 and $90 million in 2000. In 2002, two of CSC's subsidiaries established revolving credit facilities for CSC which are scheduled to expire in 2005. The total amount available to CSC under these borrowing arrangements was $28 million, of which $24 million was outstanding at December 31, 2002. 5. Commitments and Guarantees During 2001, a subsidiary of CSC began occupying and making lease payments on a newly renovated office building in San Francisco, California. 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 subsidiary'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 subsidiary 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 subsidiary also has an option to purchase the office building for $245 million at any time after June 18, 2003. CSC has provided the Trust with a residual value guarantee, which means that if the building is sold to a third party, CSC 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. Faced with continued declines in the San Francisco, California commercial real estate market, CSC obtained appraisals in the first and fourth quarters of 2002 in order to estimate its obligations under the residual value guarantee. On the basis of these appraisals, CSC determined that it was probable that the fair value of the property at the end of the lease term would be less than the residual value guaranteed by approximately $98 million. This shortfall is being amortized as additional rent expense on a straight-line basis over the initial lease term which ends in June 2005. Effective in the first quarter of 2003, the subsidiary plans to cease amortizing the shortfall upon adoption of Financial Accounting Standards Board Interpretation (FIN) No. 46 - Consolidation of Variable Interest Entities. See FIN No. 46 in note "2 - Significant Accounting Policies" in the Notes to Consolidated Financial Statements in the Company's 2002 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report. CSC has provided certain indemnification agreements (i.e., protection against damage or loss) to counterparties in connection with the disposition of certain of the Company's assets. Such indemnifications relate to employee terminations, ownership of intellectual property rights (e.g., patents), accuracy of financial statements, compliance with laws and regulations, and misrepresentations. At December 31, 2002, CSC had indemnification agreements with various expiration dates and a maximum potential liability of approximately $70 million. CSC does not believe that any material loss related to such indemnifications is likely and therefore no liability has been recognized. F-8 SCHEDULE II THE CHARLES SCHWAB CORPORATION Valuation and Qualifying Accounts (In millions) Additions Balance at --------------------- Balance at Beginning Charged Written End Description of Year to Expense Other(1) off of Year - ----------- ---------- ---------- -------- ------- ---------- For the year ended December 31, 2002: Allowance for doubtful accounts of brokerage clients (2) $ 5 $ 3 $ 1 $ (5) $ 4 ===================================================== For the year ended December 31, 2001: Allowance for doubtful accounts of brokerage clients (2) $ 11 $ 3 $ (9) $ 5 ===================================================== For the year ended December 31, 2000: Allowance for doubtful accounts of brokerage clients (2) $ 11 $ 16 $ 2 $(18) $ 11 ===================================================== (1) Represents collections of previously written-off accounts. (2) Excludes banking-related valuation and qualifying accounts. See "U.S. Trust Corporation Supplemental Financial Data (Unaudited) - Loans to Banking Clients and Related Allowance for Credit Losses" in this report for such banking-related information. F-9 The Charles Schwab Corporation U.S. Trust Corporation Supplemental Financial Data (Unaudited) The following supplemental financial data is presented in accordance with the Securities Exchange Act of 1934, Industry Guide 3 - Statistical Disclosure by Bank Holding Companies. The accompanying unaudited financial information only includes U.S. Trust Corporation, a subsidiary of The Charles Schwab Corporation, which is a wealth management firm that also provides fiduciary and private banking services.
- ------------------------------------------------------------------------------------------------------------------------------------ 1. Analysis of Change in Net Interest Revenue An analysis of the year-to-year changes in the categories of interest revenue and interest expense resulting from changes in volume and rate, on a taxable equivalent basis, is as follows (in millions): - ------------------------------------------------------------------------------------------------------------------------------------ 2002 Compared to 2001 2001 Compared to 2000 Increase (Decrease) Due to Increase (Decrease) Due to Change in: Change in: -------------------------------- -------------------------------- Average Average Total Average Average Total Balance Rate Balance Rate - ------------------------------------------------------------------------------------------------------------------------------------ Interest-earning assets: Cash equivalents $ (5) $ (4) $ (9) $ 6 $ (9) $ (3) Loans to banking clients (1) 51 (54) (3) 46 (26) 20 Securities available for sale (2): U.S. Treasury securities 6 (5) 1 (1) (1) (2) U.S. Government agencies and collateralized mortgage obligations (3) 4 (9) (5) 11 11 State and municipal obligations 1 (1) 2 2 - ------------------------------------------------------------------------------------------------------------------------------------ Total securities available for sale 11 (15) (4) 12 (1) 11 Other interest-earning assets 1 (1) 1 1 - ------------------------------------------------------------------------------------------------------------------------------------ Total interest-earning assets 58 (74) (16) 65 (36) 29 - ------------------------------------------------------------------------------------------------------------------------------------ Interest-bearing sources of funds: Interest-bearing deposits from banking clients 25 (58) (33) 15 (42) (27) Short-term borrowings 8 (13) (5) 22 (16) 6 Long-term debt 4 (2) 2 (1) (1) - ------------------------------------------------------------------------------------------------------------------------------------ Total sources on which interest is paid 37 (73) (36) 36 (58) (22) - ------------------------------------------------------------------------------------------------------------------------------------ Change in net interest revenue-taxable equivalent basis $ 21 $ (1) $ 20 $ 29 $ 22 $ 51 ================================================================================== =============================== ========= Tax equivalent adjustment 1 (1) Provision for credit loss (3) - ------------------------------------------------------------------------------------------------------------------------------------ Change in net interest revenue $ 18 $ 50 ==================================================================================================================================== Changes that are not due solely to volume or rate have been allocated ratably to their respective categories. (1) Includes average principal balances of non-accrual and reduced rate loans. (2) The average balance and average rate for securities available for sale have been calculated using their amortized cost. (3) Includes collateralized mortgage obligations securities issued by agencies including GNMA, FNMA and FHLMC.
F-10
2. Three-year Net Interest Revenue (Tax Equivalent Basis) and Average Balances - ------------------------------------------------------------------------------------------------------------------------------------ For the Year Ended December 31, 2002 2001 2000 --------------------------- --------------------------- --------------------------- Average Average Average Average Average Average (Dollars in Millions) Balance Interest Rate Balance Interest Rate Balance Interest Rate - ------------------------------------------------------------------------------------------------------------------------------------ Assets: Cash equivalents $ 193 $ 3 1.55% $ 338 $ 12 3.48% $ 241 $ 15 6.12% Securities available for sale (1)(2) 1,508 80 5.31% 1,317 83 6.33% 1,133 72 6.37% Loans to banking clients (3) 4,204 236 5.62% 3,469 240 6.91% 2,868 219 7.65% Other interest-earning assets 45 2 4.49% 38 3 7.14% 28 2 7.02% - ------------------------------------------------------------------------------------------------------------------------------------ Total interest-earning assets 5,950 321 5.40% 5,162 338 6.54% 4,270 308 7.22% - ------------------------------------------------------------------------------------------------------------------------------------ Non-interest-earning assets 771 776 687 - ------------------------------------------------------------------------------------------------------------------------------------ Total Assets $ 6,721 $ 5,938 $ 4,957 ==================================================================================================================================== Liabilities and Stockholder's Equity: Interest-bearing deposits from banking clients 4,045 95 2.36% 3,365 128 3.80% 3,071 155 5.05% Short-term borrowings 813 19 2.30% 619 24 3.90% 288 18 6.44% Long-term debt 97 6 6.28% 52 4 8.42% 59 5 8.19% - ------------------------------------------------------------------------------------------------------------------------------------ Total sources on which interest is paid 4,955 120 2.43% 4,036 156 3.87% 3,418 178 5.22% ==================================================================================================================================== Non-interest-bearing deposits 632 797 779 Non-interest-bearing liabilities 446 469 349 Stockholder's equity 688 636 411 - ------------------------------------------------------------------------------------------------------------------------------------ Total Liabilities and Stockholder's Equity $ 6,721 $ 5,938 $ 4,957 ==================================================================================================================================== Net interest revenue - taxable equivalent basis 201 182 130 Net free funds $ 994 $ 1,126 $ 852 - ------------------------------------------------------------------------------------------------------------------------------------ Tax equivalent adjustment (2) (4) (5) (4) Provision for credit loss (3) - ------------------------------------------------------------------------------------------------------------------------------------ $ 194 $ 177 $ 126 ==================================================================================================================================== Net yield on interest earning assets (tax equivalent basis) 3.38% 3.51% 3.04% - ------------------------------------------------------------------------------------------------------------------------------------ (1) The average balance and average rate for securities available for sale have been calculated using their amortized cost. (2) Yields on state and municipal obligations are stated on a taxable equivalent basis, employing the federal statutory income tax rate adjusted for the effect of state and local taxes, resulting in a marginal tax rate of approximately 45% for 2002, 42% for 2001, and 40% for 2000. (3) Includes average principal balances of non-accrual and reduced rate loans.
F-11
3. Securities Available for Sale The amortized cost, estimated fair value and gross unrealized gains and losses on securities available for sale are as follows (in millions): - ------------------------------------------------------------------------------------------------------------------------------------ December 31, 2002 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------------ U.S. treasury securities: Amortized cost $ 290 $ 159 $ 157 Aggregate fair value $ 296 $ 160 $ 157 Gross unrealized gains $ 6 $ 1 Gross unrealized losses U.S. government sponsored agencies and corporations: Amortized cost 701 748 774 Aggregate fair value 727 754 776 Gross unrealized gains 26 7 6 Gross unrealized losses 1 4 State and municipal obligations: Amortized cost 169 154 134 Aggregate fair value 178 158 135 Gross unrealized gains 9 4 1 Gross unrealized losses Collateralized mortgage obligations (1): Amortized cost 88 84 129 Aggregate fair value 87 84 129 Gross unrealized gains Gross unrealized losses 1 Other securities: Amortized cost 33 32 23 Aggregate fair value 34 33 23 Gross unrealized gains 1 1 Gross unrealized losses - ------------------------------------------------------------------------------------------------------------------------------------ Total securities available for sale: Amortized cost $ 1,281 $ 1,177 $ 1,217 Aggregate fair value $ 1,322 $ 1,189 $ 1,220 Gross unrealized gains $ 42 $ 13 $ 7 Gross unrealized losses $ 1 $ 1 $ 4 ==================================================================================================================================== (1) Collateralized by either GNMA, FNMA or FHLMC obligations.
F-12
4. Loans to Banking Clients and Related Allowance for Credit Losses An analysis of the composition of the loan portfolio is as follows (in millions): - ------------------------------------------------------------------------------------------------------------------------------------ December 31, 2002 2001 2000 1999 1998 - ------------------------------------------------------------------------------------------------------------------------------------ Private banking: Residential real estate mortgages $ 3,594 $ 3,085 $ 2,249 $ 1,985 $ 1,630 Other 976 943 849 664 526 - ------------------------------------------------------------------------------------------------------------------------------------ Total private banking loans 4,570 4,028 3,098 2,649 2,156 - ------------------------------------------------------------------------------------------------------------------------------------ Loans to financial institutions for purchasing and carrying securities 32 61 57 32 All other 9 7 8 3 3 - ------------------------------------------------------------------------------------------------------------------------------------ Total $ 4,579 $ 4,067 $ 3,167 $ 2,709 $ 2,191 ==================================================================================================================================== An analysis of nonperforming assets is as follows (in millions): - ------------------------------------------------------------------------------------------------------------------------------------ December 31, 2002 2001 2000 1999 1998 - ------------------------------------------------------------------------------------------------------------------------------------ Non-accrual loans $ 1 $ 5 $ 1 $ 2 $ 6 Other real estate owned, net 1 - ------------------------------------------------------------------------------------------------------------------------------------ Total $ 1 $ 5 $ 1 $ 2 $ 7 ==================================================================================================================================== Average non-accrual loans $ 3 $ 4 $ 1 $ 1 $ 8 ==================================================================================================================================== An analysis of the allowance for credit losses on the loan portfolio is as follows (in millions): - ------------------------------------------------------------------------------------------------------------------------------------ 2002 2001 2000 1999 1998 - ------------------------------------------------------------------------------------------------------------------------------------ Balance at beginning of year $ 21 $ 20 $ 20 $ 19 $ 18 Net recoveries: Private banking 1 1 1 Other - ------------------------------------------------------------------------------------------------------------------------------------ Net total recoveries 1 1 1 - ------------------------------------------------------------------------------------------------------------------------------------ Provision charged to income 3 - ------------------------------------------------------------------------------------------------------------------------------------ Balance at end of year $ 24 $ 21 $ 20 $ 20 $ 19 ====================================================================================================================================
F-13
The maturities of the loan portfolio at December 31, 2002 is as follows (in millions): - ------------------------------------------------------------------------------------------------------------------------------------ Within 1-5 Over 1 Year Years 5 Years Total - ------------------------------------------------------------------------------------------------------------------------------------ Private banking: Residential real estate mortgages (1) $ 852 $ 829 $ 1,913 $ 3,594 Other 917 40 19 976 - ------------------------------------------------------------------------------------------------------------------------------------ Total private banking loans 1,769 869 1,932 4,570 - ------------------------------------------------------------------------------------------------------------------------------------ Loans to financial institutions for purchasing and carrying securities All other 4 1 4 9 - ------------------------------------------------------------------------------------------------------------------------------------ Total $ 1,773 $ 870 $ 1,936 $ 4,579 ==================================================================================================================================== Interest sensitivity of loans at December 31, 2002: Loans with predetermined interest rates $ 223 $ 771 $ 994 Loans with floating or adjustable interest rates 647 1,165 1,812 - ------------------------------------------------------------------------------------------------------------------------------------ Total $ 870 $ 1,936 $ 2,806 ==================================================================================================================================== (1) Maturities are based upon the contractual terms of the loans.
5. Summary of Credit Loss on Banking Loans Experience - ------------------------------------------------------------------------------------------------------------------------------------ (Dollars in Millions) 2002 2001 2000 1999 1998 - ------------------------------------------------------------------------------------------------------------------------------------ Average loans $ 4,204 $ 3,469 $ 2,867 $ 2,404 $ 1,969 Allowance to year end loans .52% .53% .64% .74% .89% Allowance to nonperforming loans n/m n/m n/m n/m n/m Net recoveries to average loans .01% .02% .03% Nonperforming assets to average loans and real estate owned .03% .14% .05% .07% .34% - ------------------------------------------------------------------------------------------------------------------------------------ n/m - Not meaningful, greater than two hundred percent. At December 31, 2002, the loan portfolio included loans to individuals involved in the financial services industry of approximately $1.1 billion. Recoveries exceeded charge-offs from loans to individuals involved in the financial services industry in 1998 through 2001. Recoveries approximated charge-offs from loans to individuals involved in the financial services industry in 2002.
6. Deposits from Banking Clients - ------------------------------------------------------------------------------------------------------------------------------------ 2002 2001 2000 -------------------- -------------------- -------------------- (Dollars in Millions) Amount Rate Amount Rate Amount Rate - ------------------------------------------------------------------------------------------------------------------------------------ Analysis of average daily deposits: Noninterest-bearing deposits $ 632 $ 797 $ 779 Certificates of deposits of $100 or more 63 2.30% 80 4.21% 54 5.61% Money market and other savings deposits 3,983 2.98% 3,285 3.79% 3,017 5.15% - ------------------------------------------------------------------------------------------------------------------------------------ Total deposits $ 4,678 $ 4,162 $ 3,850 ====================================================================================================================================
F-14
- ------------------------------------------------------------------------------------------------------------------------------------ Certificates Other (In Millions) of Deposit Deposits - ------------------------------------------------------------------------------------------------------------------------------------ Maturity distribution of interest bearing deposits in Amounts of $100 or more at December 31, 2002: Three months or less $ 32 $ 2,773 Three through six months 33 Six through twelve months 4 Over twelve months 4 - ------------------------------------------------------------------------------------------------------------------------------------ Total $ 73 $ 2,773 ====================================================================================================================================
7. Short-term Borrowings An analysis of outstanding short-term borrowings is as follows (dollars in millions): - ------------------------------------------------------------------------------------------------------------------------------------ December 31, 2002 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------------ Federal funds purchased: Year-end balance $ 16 $ 26 $ 12 Daily average balance $ 133 $ 66 $ 115 Maximum month-end balance $ 449 $ 63 $ 311 Weighted-average interest rate during the year 1.74% 3.89% 6.50% Weighted-average interest rate at year end 1.13% 1.71% 5.81% - ------------------------------------------------------------------------------------------------------------------------------------ Securities sold under agreements to repurchase: Year-end balance $ 326 $ 183 $ 100 Daily average balance $ 296 $ 136 $ 72 Maximum month-end balance $ 388 $ 225 $ 102 Weighted-average interest rate during the year 2.20% 3.66% 5.98% Weighted-average interest rate at year end 2.00% 2.26% 6.39% - ------------------------------------------------------------------------------------------------------------------------------------ Other borrowed funds: Year-end balance $ 166 $ 354 $ 227 Daily average balance $ 350 $ 415 $ 101 Maximum month-end balance $ 408 $ 867 $ 227 Weighted-average interest rate during the year 2.60% 3.99% 6.73% Weighted-average interest rate at year end 1.43% 3.80% 6.76% - ------------------------------------------------------------------------------------------------------------------------------------
F-15
8. Ratios - ------------------------------------------------------------------------------------------------------------------------------------ Year ended December 31, 2002 2001 2000 1999 1998 - ------------------------------------------------------------------------------------------------------------------------------------ Return on average stockholder's equity (1) 4.53% 22.50% 10.54% 29.22% 26.20% Return on average total assets (1) .46% 2.41% .87% 1.85% 1.68% Average stockholder's equity as a percentage of Average total assets 10.24% 10.70% 8.29% 6.35% 6.42% - ------------------------------------------------------------------------------------------------------------------------------------ (1) Includes after-tax extraordinary gain related to the sale of corporate trust business of $12 million, merger retention program costs of $13 million, and restructuring and other charges of $24 million in 2002. Excluding these costs, return on average stockholder's equity would have been 8.17% and return on average total assets would have been .84%. In 2001, includes an after-tax extraordinary gain on the sale of corporate trust business of $121 million, merger retention program costs of $31 million, and restructuring and other charges of $28 million. Excluding these costs, return on average stockholder's equity would have been 12.67% and return on average total assets would have been 1.36%.
F-16 EX-10 3 exh10_191.txt EXHIBIT 10_191 Exhibit 10.191 THE CHARLES SCHWAB CORPORATION 1992 STOCK INCENTIVE PLAN RESTRICTED SHARES AWARD AGREEMENT THIS AGREEMENT is entered into between The Charles Schwab Corporation, a Delaware corporation (the "Company") and xxxxxxxxxxxxx (the "Employee"). WITNESSETH: WHEREAS, the Company has adopted The Charles Schwab Corporation 1992 Stock Incentive Plan (the "Plan"), which provides for the granting of restricted shares of Common Stock of the Company ("Restricted Shares") to key employees of the Company and its Subsidiaries; and WHEREAS, the Compensation Committee of the Board of Directors of the Company (the "Committee"), which is responsible for the administration of the Plan, has authorized the granting of an award of Restricted Shares to the Employee, effective as of GRANT DATE; and WHEREAS, this Agreement is prepared in conjunction with and pursuant to the terms of the Plan and, although all of the terms of the Plan and the definitions used in this Plan have not been set forth herein, such terms and definitions are incorporated herein and made a part hereof by reference, and, except as otherwise expressly stated herein, the provisions of the Plan shall govern any interpretation of this Agreement; and WHEREAS, the Employee has accepted the grant of Restricted Shares and agreed to the terms and conditions hereinafter stated; NOW, THEREFORE, the Employee and the Company agree to the provisions set forth in the Agreement. The Employee signifies agreement with all of the terms and conditions of this Agreement by failing to provide written objection to the Company to any of the terms hereunder within 30 days of receipt of this Agreement, and in any event by accepting any dividends paid with respect to the Restricted Shares granted hereunder. 1. Grant of Restricted Shares. The Company hereby grants to the Employee, as a separate incentive in connection with his or her employment and not in lieu of any salary or other cash compensation for his or her services, an award of xxxxxx Restricted Shares, effective GRANT DATE, subject to all the terms and conditions in this Agreement and the Plan. 2. Restriction on Transfer. The Restricted Shares awarded pursuant to this Agreement shall be issued in the name of The Employee and held by the Secretary of the Company as escrow agent (the "Escrow Agent"), and, except to the extent specifically provided herein, shall not be sold, transferred, otherwise disposed of, pledged or otherwise hypothecated until the date such Restricted Shares become vested pursuant to paragraph 3 hereof (the "Restriction on Transfer"). The Company may instruct the transfer agent for its Common Stock to place a legend on the certificates representing the Restricted Shares or otherwise note its records as to the restrictions on transfer set forth in this Agreement and the Plan. The certificate or certificates representing such shares shall be delivered by the Escrow Agent to The Employee only after the shares become vested on the date specified in paragraph 3 and after all other terms and conditions in this Agreement have been satisfied. Notwithstanding the foregoing, to the extent specifically permitted by the Plan, the Restricted Shares may be transferred by gift, subject to the Restriction on Transfer and the vesting conditions set forth herein. 3. Vesting of Shares. The Restricted Shares awarded by this Agreement shall become vested as follows: Effective as of the date hereof (the "Grant Date"), the Restricted Shares shall be 0% vested. If the Employee is employed for a continuous period beginning on the date hereof and ending on the third anniversary of the Grant Date, 50% of the Restricted Shares shall become vested. If the Employee shall continue to be employed for a continuous period ending on the fourth anniversary of the Grant Date, an additional 50% of the Restricted Shares shall become vested, so that at such time all of the Restricted Shares subject to this Agreement shall be then vested. Notwithstanding the foregoing, in the event of the Employee's death or Disability, 100% of the Restricted Shares shall be then vested, and in the event of the Employee's Retirement after the second anniversary of the Grant Date, 100% of the Restricted Shares shall be then vested. For purposes of this Agreement, Retirement shall mean a termination of employment of the Employee at any time after the Employee (i) has attained fifty (50) years of age, and (ii) has completed seven (7) years of service, as determined pursuant to the terms of the Charles Schwab Profit Sharing and Employee Stock Ownership Plan. Notwithstanding the foregoing, however, the accrual of vesting pursuant to this paragraph is contingent upon the Employee's satisfactory job performance, and the Company may, in its sole discretion, upon notice to the Employee, suspend or delay the vesting of the Restricted Shares hereunder for any period of time in the event that the Company determines, within its sole discretion, that the Employee's performance is unsatisfactory. Moreover, the continued accrual of vesting pursuant to this paragraph shall be suspended during the period of time in which the Optionee is on a leave of absence of more than six months for any reason other than (i) medical reasons, (ii) pregnancy disability, (iii) a leave qualifying under the Family and Medical Leave Act, or (iv) workers' compensation. Moreover, if at the time of the Grant, the Employee is working a part-time work schedule of less than 30 hours per week, and such part-time work schedule is expected to continue for a period of at least one year from the date such part-time work schedule commenced, all vesting dates will be delayed by one year. In addition, if subsequent to the time of Grant, the Employee changes to a part-time work schedule of less than 30 hours per week, and such part-time work schedule is expected to continue for at least one year, all future vesting dates not yet reached at the time of the change will be delayed by one year. Upon the vesting of Restricted Shares hereunder, the certificate or certificates representing such Restricted Shares shall be delivered to the Employee. 4. Change in Control. Upon the determination of the Committee that a Change in Control of the Company has occurred, or in the event of the liquidation or dissolution of the Company, the Restricted Shares shall become fully vested and the Restriction on Transfer shall be lifted, notwithstanding any other provision of this Agreement, and the certificate or certificates representing such Restricted Shares shall be delivered to the Employee. 5. Discretion of Committee. The Committee may decide, in its absolute discretion, to lift at any time the Restriction on Transfer or to accelerate the vesting of the Restricted Shares, and the certificate or certificates representing such Restricted Shares shall be delivered to the Employee. 6. Delivery of Shares to Estate of Deceased Employee. Any distribution or delivery to be made to the Employee under this Agreement shall, if the Employee is then deceased, be made to the Employee's estate in accordance with the terms of Section 7.5 of the Plan. 7. Conditions to Issuance of Shares. The Restricted Shares deliverable to the Employee may be either previously authorized but unissued shares or issued shares which have been reacquired by the Company. The Company shall not be required to issue any certificate or certificates for Restricted Shares hereunder prior to fulfillment of all of the following conditions: (a) The admission of such shares to listing on all stock exchanges on which such class of stock is then listed; (b) The completion of any registration or other qualification of such shares under any State or federal law or under the rulings or regulations of the Securities and Exchange Commission or any other governmental regulatory body, which the Committee shall, in its absolute discretion, deem necessary or advisable; (c) The obtaining of any approval or other clearance from any State or federal governmental agency, which the Committee shall, in its absolute discretion, determine to be necessary or advisable; and (d) The lapse of such reasonable period of time following the date of the grant of the Restricted Shares as the Committee may establish from time to time for reasons of administrative convenience. Neither the Employee nor any person claiming under or through the Employee shall be, or have any of the rights or privileges of, a stockholder of the Company in respect of any Restricted Shares deliverable hereunder unless and until certificates representing such shares shall have been issued, recorded on the records of the Company or its transfer agents or registrars, and delivered to the Employee or the Escrow Agent. Except as provided in paragraph 8, after such issuance, recordation and delivery, the Employee shall have all rights of a stockholder of the Company with respect to voting such Restricted Shares and receipt of dividends and distributions on such Restricted Shares. 8. Certain Adjustments to Shares. In the event that as a result of a stock dividend, stock split, reclassification, recapitalization, combination of shares or the adjustment in capital stock of the Company or otherwise, or as a result of a merger, consolidation, spin-off or other reorganization, the Company's Common Stock shall be increased, reduced or otherwise changed, and by virtue of any such change the Employee shall in his or her capacity as owner of Restricted Shares which have been awarded to him or her (the "Prior Shares") be entitled to new or additional or different shares or securities (other than rights or warrants to purchase securities), such new or additional or different shares or securities shall thereupon be considered to be Restricted Shares and shall be subject to all of the conditions and restrictions which were applicable to the Prior Shares pursuant to the Plan. If the Employee receives rights or warrants with respect to any Prior Shares, such rights or warrants may be held or exercised by the Employee, provided that until such exercise any such rights or warrants and after such exercise any shares or other securities acquired by the exercise of such rights or warrants shall be considered to be Restricted Shares and shall be subject to all of the conditions and restrictions which were applicable to the Prior Shares pursuant to the Plan. The Committee in its absolute discretion at any time may lift the Restriction on Transfer of all or any portion of such new or additional shares of stock or securities, rights or warrants to purchase securities or shares or other securities acquired by the exercise of such rights or warrants. 9. Contribution of Par Value to Capital of the Company. Notwithstanding the provisions of Section 7.2 of the Plan, the Company will contribute to the capital of the Company on behalf of the Employee, as an Award recipient, an amount equal to the par value of the Restricted Shares issued to the Employee hereunder. 10. Tax Withholding. To the extent required by applicable federal, state, local or foreign law, the Employee shall make arrangements satisfactory to the Company for the satisfaction of any withholding tax obligations that arise by reason of the awarding or vesting of the Restricted Shares hereunder, or by reason of any election made by the Employee pursuant to Section 83(b) of the Internal Revenue Code, and no Share certificates shall be issued to the Employee unless such obligation is satisfied. 11. Plan Shall Control. This Agreement is subject to all the terms and provisions of the Plan. In the event of a conflict between any provisions of this Agreement and any provisions of the Plan, the provisions of the Plan shall govern. Terms used in this Agreement that are not defined in this Agreement shall have the meaning set forth in the Plan. 12. Powers of the Committee. The Committee shall have the power to interpret and construe the Plan and this Agreement and to adopt such rules for the administration, interpretation and application of the Plan as are consistent therewith and to interpret or revoke any such rules. All actions taken and all interpretations and determinations made by the Committee in good faith shall be final and binding upon the Employee, the Employee's estate, the Company and all other interested persons. No member of the Committee shall be personally liable for any action, determination or interpretation made in good faith with respect to the Plan or this Agreement. 13. No Effect on Other Benefit Plans. Nothing herein contained shall affect the Employee's right to participate in and receive benefits under and in accordance with the then current provisions of any pension, insurance or other Employee welfare plan or program of the Company or any Subsidiary. 14. Nonassignability. So long as the Restriction on Transfer is in effect, except to the extent specifically permitted by this Agreement, the Restricted Shares herein granted and the rights and privileges conferred hereby shall not be transferred, assigned, pledged or hypothecated in any way (whether by operation or law or otherwise) and shall not be subject to sale under execution, attachment or similar process. Upon any attempt to transfer, assign, pledge, hypothecate or otherwise dispose of such award or any right or privilege conferred hereby, contrary to the provisions hereof, or upon any attempted sale under any execution, attachment or similar process upon the rights and privileges conferred hereby, such award and the rights and privileges conferred hereby shall immediately become null and void. 15. Successors and Assigns. Subject to the limitation on the transferability of the Restricted Shares contained herein, this Agreement shall be binding upon and inure to the benefit of the heirs, legatees, legal representatives, successor and assigns of the Employee and the Company. 16. Notices. Any notice to be given to the Company under the terms of this Agreement shall be addressed to the Company, in care of its Secretary, at 101 Montgomery Street, San Francisco, California 94104, or at such other address as the Company may hereafter designate in writing. Any notice to be given to the Employee shall be addressed to the Employee at the address set forth beneath the Employee's signature hereto, or at such other address as the Employee may hereafter designate in writing. Any such notice shall be deemed to have been duly given if and when enclosed in a properly sealed envelope, addressed as aforesaid, registered or certified and deposited, postage and registry fee prepaid, in a United States post office. 17. Severability. In the event that any provision of this Agreement shall be held invalid or unenforceable, such provision shall be severable from, and such invalidity or unenforceability shall not be construed to have any effect on, the remaining provisions of this Agreement. 18. Governing Law. This Agreement shall be construed in accordance with the laws of the State of California. EX-10 4 exh10_192.txt EXHIBIT 10_192 Exhibit 10.192 THE CHARLES SCHWAB CORPORATION 1992 STOCK INCENTIVE PLAN NONSTATUTORY STOCK OPTION AGREEMENT THIS AGREEMENT is entered into as of GRANT DATE between THE CHARLES SCHWAB CORPORATION, a Delaware corporation (the "Company"), and NAME (the "Optionee"). W I T N E S S E T H: WHEREAS, the Board has adopted and the stockholders of the Company have approved The Charles Schwab Corporation 1992 Stock Incentive Plan, as amended (the "Plan") in order to provide selected Key Employees and Non-Employee Directors with an opportunity to acquire Common Shares; and WHEREAS, the Committee has determined that the Optionee is a Key Employee and that it would be in the best interests of the Company and its stockholders to grant the stock option described in this Agreement (the "Option") to the Optionee as an inducement to enter into or remain in the service of the Company or its subsidiaries and as an incentive for extraordinary efforts during such service: NOW, THEREFORE, the Optionee and the Company agree to the provisions set forth in this Agreement. The Optionee signifies agreement with all of the terms and conditions of this Agreement by failing to provide written objection to the Company to any of the terms hereunder within 30 days of receipt of this Agreement, and in any event by exercising an Option granted hereunder. SECTION 1. GRANT OF OPTION. (a) Option. On the terms and conditions stated below, the Company hereby grants to the Optionee the option to purchase NQ Common Shares for the amount of $XX.XX per Common Share (the "Exercise Price"), which is agreed to be 100% of the Fair Market Value thereof on the Date of Grant. The number of Common Shares subject to this Option and the Exercise Price shall be subject to adjustment under certain limited circumstances as provided in Article 10 of the Plan. (b) 1992 Stock Incentive Plan. This Option is granted pursuant to the Plan, the provisions of which are incorporated into this Agreement by reference, and a copy of which is available upon request at no charge to the Optionee from the Company. In the event of any inconsistency between the provisions of the Plan and the provisions of this Agreement, the provisions of the Plan shall prevail. (c) Tax Treatment. This Option is not intended to qualify as an incentive stock option described in Section 422(b) of the Code. (d) Expiration Date. Notwithstanding any other provision contained herein, this Option shall expire not later than the date immediately preceding the tenth anniversary of the Date of Grant. SECTION 2. NO TRANSFER OR ASSIGNMENT OF OPTION. Except as otherwise provided in this Agreement or as permitted by the Plan, this Option, and any interest therein, shall not be transferred, assigned, pledged or hypothecated in any way (whether by operation of law or otherwise) and shall not be subject to sale under execution, attachment or similar process. SECTION 3. RIGHT TO EXERCISE OPTION. (a) Vesting. So long as the Optionee remains employed by the Company or its subsidiaries, and subject to the remaining provisions of this Section 3, the Optionee will acquire the right to exercise this Option (become "Vested" in the Option) on the following dates and in the following amounts: Percentage of Cumulative Percentage of Vesting Date Award That Will Award Vested Vest - -------------------------------------------------------------------------------- 1st Anniversary of Grant Date 25% 25% 2nd Anniversary of Grant Date 25% 50% 3rd Anniversary of Grant Date 25% 75% 4th Anniversary of Grant Date 25% 100% The number of Options that are vested at any time will be the number of Shares in this Option, multiplied by the Cumulative Percentage of Award Vested, determined under this table. (b) Minimum Number of Shares. This Option shall be exercisable for at least 100 Common Shares (without regard to adjustments to the number of Common Shares subject to this Option pursuant to Article 10 of the Plan) or, if less, (i) the number of shares with respect to which this Option has become vested under Section 3(a) above, or (ii) all of the remaining Common Shares subject to this Option. (c) Full Vesting on Change in Control. Notwithstanding subparagraph (a) hereof, this Option shall become fully exercisable as to the Total Award Common Shares immediately preceding any Change in Control with respect to the Company. In the event that the Committee determines that a Change in Control is likely to occur, the Company shall so advise the Optionee, and the provisions of this subparagraph (c) shall take effect as of the date ten (10) days prior to the anticipated date of such Change in Control. (d) Accelerated Vesting in Certain Cases. Notwithstanding subparagraph (a) hereof, if the Optionee terminates employment with the Company and its subsidiaries on account of death or Disability, all options granted hereunder shall become fully exerciseable, and if the Optionee terminates employment with the Company and its subsidiaries on account of Retirement, all options granted hereunder shall become fully exerciseable, but only if such Retirement occurs at least two (2) years after the date of grant. (e) Vesting Contingent on Satisfactory Performance. Notwithstanding subparagraph (a) hereof, the continued accrual of vesting pursuant to subparagraph (a) is contingent upon the Optionee's satisfactory job performance, and the Company may, in its sole discretion, upon notice to the Optionee suspend or delay the vesting of Options hereunder for any period of time in the event that the Company determines, within its sole discretion, that the Optionee's performance is unsatisfactory. (f) Suspension of Vesting During Certain Leaves of Absence. Notwithstanding subparagraph (a) hereof, the continued accrual of vesting pursuant to subparagraph (a) shall be suspended during the period of time in which the Optionee is on a leave of absence of more than six months for any reason other than (i) medical reasons, (ii) pregnancy disability, (iii) a leave qualifying under the Family and Medical Leave Act, or (iv) workers' compensation. (g) Delayed Vesting for Part Time Work Schedule. Notwithstanding subparagraph (a) hereof, if at the time of the Grant, the Optionee is working a part-time work schedule of less than 30 hours per week, and such part-time work schedule is expected to continue for a period of at least one year from the date such part-time work schedule commenced, all vesting dates set forth in subparagraph (a) will be delayed by one year. In addition, if subsequent to the time of Grant, the Optionee changes to a part-time work schedule of less than 30 hours per week, and such part-time work schedule is expected to continue for at least one year, all future vesting dates not yet reached at the time of the change will be delayed by one year. SECTION 4. EXERCISE OF OPTION. (a) Notice of Exercise. The Optionee or the Optionee's representative may exercise this Option by giving written notice to the Company (or its designee) pursuant to Section 9(d). The notice shall specify the election to exercise this Option, the date of exercise, the number of Common Shares for which it is being exercised and the form of payment. The notice shall be signed by the person or persons exercising this Option. In the event that this Option is being exercised by the representative of the Optionee, the notice shall be accompanied by proof satisfactory to the Company of the representative's right to exercise this Option. The Purchase Price for Common Shares shall be paid in a form that conforms to Sections 6.1 through 6.3 of the Plan at the time such notice is given. (b) Issuance of Shares. After receiving a proper notice of exercise, the Company shall cause to be issued the Common Shares so purchased, registered in the name of the person exercising this Option. SECTION 5. TERM. (a) Basic Term. This Option shall in any event expire on the date specified in Section 1(d). (b) Termination of Employment. Subject only to the provisions of Section 3(d), upon the Optionee's termination of employment with the Company and its subsidiaries for any reason, whether as a result of a voluntary or involuntary event of termination of employment (including a termination of employment as may be provided for or determined under an employment contract, if any, entered into between the Company or its subsidiary and the Optionee) (each, a "Termination Event"), no unvested portion of the Total Award Common Shares thereafter shall vest or become exercisable. With respect to the vested or exercisable portion of the Total Award Common Shares as of the date of such a Termination Event, this Option shall expire on the earlier of (i) the expiration date specified in Section 1(d) or (ii) whichever of the following is applicable: (A) in the case of a Termination Event resulting from death or Disability, the date one year following such Termination Event; (B) in the case of a Termination Event resulting from Retirement, the date two years following such Termination Event; or (C) in all other cases, the date three (3) months following such Termination Event. (c) Divestment of Options. Notwithstanding anything to the contrary contained herein, this Option shall immediately become forfeited and expire in the event that the Company terminates the Optionee's employment on account of conduct inimical to the best interests of the Company, including, without limitation, conduct constituting a violation of law or Company policy, fraud, theft, conflict of interest, dishonesty or harassment. The determination whether the Optionee's employment has been terminated on account of conduct inimical to the best interests of the Company shall be made by the Company in its sole discretion. SECTION 6. LEGALITY OF INITIAL ISSUANCE. No Common Shares shall be issued upon the exercise of this Option unless and until the Company has determined that: (a) A registration statement for the Common Shares is effective under the Securities Act or an exemption from the registration requirements thereof has been perfected; (b) Any applicable listing requirement of any stock exchange on which Common Shares are listed has been satisfied; and (c) Any other applicable provisions of state or federal law have been satisfied. SECTION 7. NO REGISTRATION RIGHTS. The Company may, but shall not be obligated to, register or qualify the Common Shares for resale or other disposition by the Optionee under the Securities Act or any other applicable law. SECTION 8. RESTRICTIONS ON TRANSFER OF SHARES. (a) Restrictions. Regardless of whether the offering and sale of Common Shares under the Plan have been registered under the Securities Act or have been registered or qualified under the securities laws of any state, the Company may impose restrictions upon the sale, pledge or other transfer of such Common Shares (including the placement of appropriate legends on stock certificates) if, in the judgment of the Company and its counsel, such restrictions are necessary or desirable in order to achieve compliance with the provisions of the Securities Act, the securities laws of any state or any other law. (b) Investment Intent at Exercise. If the Common Shares under the Plan are not registered under the Securities Act but an exemption is available which requires an investment representation or other representation, the Optionee shall represent and agree at the time of exercise that the Common Shares being acquired upon exercising this Option are being acquired for investment, and not with a view to the sale or distribution thereof, and shall make such other representations as are deemed necessary or appropriate by the Company and its counsel. (c) Administration. Any determination by the Company and its counsel in connection with any of the matters set forth in this Section 8 shall be conclusive and binding on the Optionee and all other persons. SECTION 9. MISCELLANEOUS PROVISIONS. (a) Withholding Taxes. To the extent required by applicable federal, state, local or foreign law, the Optionee shall make arrangements satisfactory to the Company for the satisfaction of any withholding tax obligations that arise by reason of the exercise of an Option hereunder, and no Option may be exercised unless such obligation is satisfied. (b) Rights as a Stockholder. Neither the Optionee nor the Optionee's representative shall have any rights as a stockholder with respect to any Common Shares subject to this Option until such Common Shares have been issued in the name of the Optionee or the Optionee's representative. (c) No Employment Rights. Nothing in this Agreement shall be construed as giving the Optionee the right to be retained as an employee of the Company or its subsidiaries. The Company reserves the right to terminate the Optionee's employment at any time for any reason, subject only to the terms of any written employment contract entered into between the Company and the Optionee. (d) Notice. Any notice required by the terms of this Agreement shall be given in writing and shall be deemed effective upon personal delivery or upon deposit with the appropriate postal service, by registered or certified mail with postage and fees prepaid and addressed to the party entitled to such notice at the address shown below such party's signature on this Agreement, or at such other address as such party may designate by ten (10) days advance written notice to the other party to this Agreement. Notwithstanding the foregoing, no notice of exercise, as required by Section 4(a), shall be effective until actual receipt thereof by the Company or its designee. (e) Entire Agreement. This Agreement and the Plan constitute the entire agreement between the parties hereto with regard to the subject matter hereof; provided, however, that in the event of any inconsistency or conflict between any provision hereof and the terms of the Plan, the terms of the Plan shall control. (f) Choice of Law. This Agreement shall be governed by, and construed in accordance with, the laws of the State of California, as such laws are applied to contracts entered into and performed in such State. SECTION 10. DEFINITIONS. (a) Capitalized terms defined in the Plan shall have the same meaning when used in this Agreement. (b) "Change in Control" shall mean the occurrence of any of the following events after the effective date of the Plan as set out in Section 15.1 of the Plan: (1) A change in control required to be reported pursuant to Item 6(e) of Schedule 14A of Regulation 14A under the Securities Exchange Act of 1934, as amended (the "Exchange Act"); (2) A change in the composition of the Company's Board of Directors (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; (3) 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. (c) "Common Share" shall mean one share of the common stock of the Company. (d) "Date of Grant" shall mean the date of this Agreement, which is the date first written above. (e) "Fair Market Value" shall mean the market price of a Common Share, determined by the Committee as follows: (1) 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; (2) 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; (3) 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 (4) 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. (f) "Purchase Price" shall mean the Exercise Price multiplied by the number of Common Shares with respect to which this Option is being exercised. (g) "Retirement" shall mean a termination of employment of the Optionee occurring at any time after the Optionee (i) has attained fifty (50) years of age, and (ii) completed seven (7) years of service, as determined pursuant to the terms of the SchwabPlan Retirement Savings and Investment Plan. (h) "Securities Act" shall mean the Securities Act of 1933, as amended. EX-10 5 exh10_248.txt EXHIBIT 10_248 Exhibit 10.248 THE CHARLES SCHWAB CORPORATION 2001 STOCK INCENTIVE PLAN as Amended October 23, 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 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 of the 2001 Plan, 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 on the date of grant(or such earlier date as may be agreed with the Board of the Inland Revenue) and 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. Articles 5.9, 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. No Options shall be granted under this Scheme pursuant to Articles 4.6 or 4.7 of the 2001 Plan. 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 amounts payable on the exercise of options over 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 and laid down at the time of grant. Any such terms or conditions shall not be amended or waived after the time of grant unless they relate to performance targets and 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 more difficult to satisfy than the original condition. 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 when issued on grant the date when all or any instalment of the Option is to become exercisable including whether there shall be any acceleration of vesting on certain events (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 or injury (in the latter case on the production of such evidence as the Committee shall reasonably require to show the Option-holder has ceased to exercise by reason of injury and is incapable of exercising that employment and is likely to remain so incapable for the foreseeable future) or redundancy as defined in the Employment Rights Act 1996 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 or 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) 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 for any reason other than those set out above, including redundancy, three months following such cessation; and (v) 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 it is a condition of exercise that 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 certificate or agreement 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 7.1 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. 7.2 Article 10.2 of the 2001 Plan shall apply for the purposes of this Scheme with the exclusion of the words "for accelerated vesting or for settlement in cash". Withholding Taxes 7.3 Article 13.1 of the 2001 Plan shall apply for the purposes of this scheme with the exclusion of the last sentence. 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 6 exh10_249.txt EXHIBIT 10_249 Exhibit 10.249 January 23, 2002 Mr. H. Marshall Schwarz Apartment 6-A 1220 Park Avenue New York, New York 10128 Dear Marshall: As a result of your discussions with Jeff Maurer and me, this letter details the terms of our agreement ("Agreement") relative to your employment status with U.S. Trust Corporation and The Charles Schwab Corporation (together with any affiliated entity, collectively the "Company"). References in this letter agreement to "U.S. Trust" that do not designate a particular U.S. Trust entity, mean the appropriate U.S. Trust Corporation subsidiary as the context requires. 1. As of close of business on February 28, 2002, you will voluntarily step down from and are relieved of your current responsibilities as Chairman and any other employment positions you hold (hereafter, "Separation from Employment"). Also on that same date, you are deemed to have resigned as an Officer and, except as set forth in 1(a) and 1(b) below, all board positions, committee positions and other positions you may hold. The date your employment ends is the "Separation Date." (a) Notwithstanding your Separation from Employment or the provisions of paragraph 12(h) of that certain Executive Employment Agreement and Covenant Not to Compete entered into by and among U.S. Trust Corporation, The Charles Schwab Corporation and you ("Employment Agreement") you will remain a member of the U.S. Trust Corporation and United States Trust Company of New York Boards of Directors until the earlier of (i) your resignation; (ii) your 72nd birthday; (iii) your death, incapacity or other inability to perform your duties as a board member; or (iv) you are removed from the board as result of appropriate board action due to unsatisfactory performance or breach of duty. (b) Notwithstanding the above, you will remain a member of The Charles Schwab Corporation Board of Directors, subject to the same terms and conditions that currently apply to you, until the expiration of the current board term. After the expiration of the current board term you will not seek election for any subsequent term without the prior express written consent of the Co-Chief Executive Officers of The Charles Schwab Corporation. 2. In consideration for the promises and other consideration provided by you, U.S. Trust will provide you with a one-time lump-sum payment in the amount of two million five hundred thirty three thousand three hundred thirty-three dollars ($2,533,333) less usual and customary taxes, withholding and authorized deductions. Said payment will be made on or before June 30, 2002. You will also receive options to purchase 51,233 shares of stock of The Charles Schwab Corporation ("Options"). The Options shall possess the same exercise price, vesting schedule, expiration date and such other particulars as set forth in the U.S. Trust Retention Bonus Program. 3. For purposes of the Employment Agreement your Separation from Employment shall be treated as a separation by mutual consent pursuant to paragraph 12(e) of said Employment Agreement. 4. You acknowledge that the amounts referred to in paragraph 2 above are, with the exception of any accrued and vested benefits, including without limitation, those under any plan or agreement described in this Agreement below or in Schedule A attached hereto, in lieu of and in full satisfaction of any amounts that might otherwise be payable under any contract, agreement, plan, policy, program, practice or otherwise, past or present, of the Company, including, but not limited to, the Employment Agreement, the 1990 Change in Control and Severance Policy for Top Tier Officers of United States Trust Company of New York and Affiliated Companies, as amended and restated effective as of October 22, 1996, 1990 Change in Control and Severance Policy for Officers and Employees of United States Trust Company of New York and Affiliated Companies, as amended and restated effective as of October 22, 1996, the U.S. Trust Retention Bonus Program, the Executive Incentive Plan of U.S. Trust Corporation and any incentive compensation plans. You expressly agree that you are not entitled to receive any other payments or benefits under any contract, plan, policy, agreement, program, practice or otherwise, including but not limited to those listed in this paragraph, in exchange for receipt of benefits under this Agreement. Specifically excepted from this agreement is a normal and customary director's fee for any directorship you may hold. 5. 1992 Stock Incentive Plan: You will continue to vest in any stock options previously granted to you until your Separation Date, in accordance with the terms and conditions of the applicable Plan documents. Under the provisions of The Charles Schwab Corporation 1992 Stock Incentive Plan, you retain the right to exercise vested options plan for a specific period of time after your Separation Date. Any stock options that are not vested as of your Separation Date are immediately cancelled. Please refer to your Stock Option Agreement(s) and Plan documents to determine how your rights apply to exercising your options. Restricted Shares: You will continue to vest in any restricted shares granted to you until your Separation Date in accordance with the terms and conditions of the applicable Plan documents. Restricted shares not vested as of your Separation Date will be forfeited as provided by the applicable Plan documents. Please refer to your Restricted Share Agreement(s) and Plan documents for further information. 6. In the event of your death prior to your Separation Date, your Separation Date will be changed to the date of your death and the Company will pay to your estate any amounts due to you under paragraph 2 of this Agreement. 7. Through your Separation Date, you will continue to be eligible for all regular employee insured benefits (excluding Short and Long Term Disability, except as otherwise required by law) on the same terms and conditions as the other plan participants in accordance with the terms of each plan. Commencing with your Separation Date you will be entitled to the health and life insurance benefits provided all qualified retirees of U.S. Trust. 8. A payment representing the amount of unused vacation and floating holiday time you accrued through February 28, 2002 will be included in your last salary payment. 9. Should there be any outstanding advances, loans or other obligations which you owe the Company, or any of its parent(s), and/or its/their affiliates or subsidiaries, such amounts must be repaid by your Separation Date (except as provided above regarding 401(k) loans). If you have not repaid such amount, you expressly agree that any outstanding amount due at your Separation Date may be deducted from any payment(s) otherwise due you under this Agreement. You agree that you nonetheless remain responsible for repayment if an amount is outstanding after the offset. 10. In the event you incur travel or other business expenses after your Separation Date related to Company business or your duties as a director, reimbursement for such expenses will be approved or disapproved in accordance with the travel and entertainment expense policies then in effect. 11. You acknowledge that by reason of your employment, you had access to and did receive knowledge of the Company's trade secrets and proprietary and confidential information ("Confidential Information"). You acknowledge and affirm your obligations to maintain the confidentiality of Confidential Information and not to use it or to disclose it to any third party in the future. You understand and agree that the term "Confidential Information" includes, but is not limited to, customer identity, customer account, personal or business information, customer lists, lead information, employee information (employment, personal, financial or account information), employee lists, know-how, computer hardware or software configuration or design, research and development, product designs, plans and/or methods (whether currently in use or in development), source codes, future developments, costs, profits, account valuation, pricing and pricing structure, technical, marketing, business, financial, or other information which constitute trade secret information, or information not available to competitors of the Company, the use or disclosure of which might reasonably be construed to be contrary to the interests of the Company. You agree that this paragraph is not intended to limit any definition of "Confidential Information" in any prior written confidentiality agreement you signed as a condition of your employment. You also agree that Confidential Information is a valuable and unique asset which is actively protected and that unauthorized use and/or disclosure of Confidential Information would cause immediate and irreparable harm. 12. You expressly agree that any attempt on your part to induce any employee, consultant or contractor to leave his/her assignment or employment with the Company, or any other effort by you to interfere in those relationships will be harmful and damaging to the Company. Therefore you agree that for a period of twelve (12) months after your Separation Date, you will not in any way (directly or indirectly), on your own behalf of any other person or entity: (1) solicit, induce or attempt to solicit or induce, any employee, consultant or contractor of the Company to leave his or her employment or assignment; (2) otherwise interfere with or disrupt the employment or contract relationship with the Company; (3) recruit, solicit, entice or hire away any employee, consultant or contractor of the Company; or (4) hire or engage any employee, consultant or contractor of the Company, or any former employee of the Company whose employment ceased less than one (1) year before the date of such hire or engagement. 13. You further acknowledge your continuing obligations pursuant to paragraph 8 (Covenant Not to Compete), paragraph 10 (Intellectual Property Rights) and paragraph 11 (Media Communication and Non-Disparagement) of the Employment Agreement. 14. You also agree that you will return to Therese Kelly, Senior Vice President, or her designee any and all originals and copies of documents (including hard copy and electronic documents, disks, and files) that you received, obtained and/or created as part of your employment (excluding information you received about your insured benefits or other benefit programs)(collectively "Files"), and that you will return all Company property, including but not limited to Company sponsored credit cards and/or calling cards, telephones, pagers, Palm Pilots, laptops and other computer software and/or hardware, keys and identity badges, by no later than March 15, 2002. Notwithstanding the foregoing, you may maintain Files on U.S. Trust premises, sharing access thereto with U.S. Trust personnel, as long as you are a director of U.S. Trust or maintain an office at U.S. Trust. 15. U.S. Trust will provide you with office space, on a space available basis, and administrative support, on an as needed basis, until such time as you notify U.S. Trust that you no longer require such resources. 16. You understand that the benefits you receive under this Agreement are in lieu of and a substitute for any severance benefits you may have been eligible to receive under U.S. Trust Severance Program. 17. RELEASE: In exchange for the promises contained in this Agreement, you, your heirs, executors, representatives, successors and assigns (referred to collectively as "You"), fully release and discharge The Charles Schwab Corporation, U.S. Trust Corporation, their parent(s), subsidiaries and affiliates and/or their directors, officers, shareholders, agents, servants, employees, successors, and assigns (referred to collectively as "Schwab") from any and all claims for monetary or other damages or any other form of recovery or relief, whether or not known, suspected or claimed, which You have or hereafter may have against Schwab, including but not limited to claims for attorneys' fees and costs, and causes of action with respect to, or arising out of, your employment or separation from employment with Schwab. This release includes, but is not limited to, claims arising under: (1) any federal, state or local fair employment practice law, (2) any unemployment insurance law, (3) any disability benefits law, (4) any workers' compensation law, (5) any wage law, (6) the Age Discrimination in Employment Act, (7) any local, state or federal civil rights laws that prohibit discrimination on the basis of age, color, race, gender, sex, marital status, national origin, mental or physical disability, religion, ancestry, or veteran status or any other form of discrimination (and, for employees in New Jersey, the Conscientious Employee Protection Act), (8) the Employment Retirement Income Security Act, or (9) any other statute, law, rule, regulation, ordinance, executive order, contract or tort. You waive and release the right to institute a lawsuit, arbitration, or other judicial or quasi-judicial action in accordance with the law. With respect to any charges, complaints, petitions or claims that have been or may be filed by you concerning events or actions relating to your employment or separation from employment, and which events or actions occurred on or before the date You sign this Agreement, You expressly waive and release any right You may have to recover monetary or other damages (including equitable relief) or any other form of recovery or relief in any lawsuit, investigation, hearing, or proceeding of any kind brought by You, an administrative agency, or any other person on Your behalf or which includes You in any class. If you breach this paragraph, You understand that You will be liable for all expenses, including costs and attorneys' fees, incurred by Schwab (if Schwab prevails) in defending any lawsuit, arbitration, charge, complaint, petition or claim. This paragraph 17 is not intended to limit you from pursuing an action for the sole purpose of enforcing this Agreement. You understand that this Agreement constitutes a release by You of any and all claims and causes of action of any nature or description which You have or may have arising up to and including the date You execute this Agreement, whether or not You have asserted any or all such claims or causes of action. However, nothing in this agreement is intended to alter the agreement between you and US Trust dated August 15, 2001 ("August Agreement") to provide the payment of legal fees in the event of pending or threatened litigation addressed in the August Agreement. Nor is anything in this paragraph 17 intended to limit your right to reimbursement for legal fees or other costs with respect to any actual or threatened proceeding to the extent provided in the By-laws, certificate of incorporation or any resolution of U.S. Trust or The Charles Schwab Corporation. 18. Except as specifically set forth herein, you expressly agree that You intend this Agreement to extend to all claims, unknown and/or unsuspected, and to all unanticipated injuries and/or damages, as well as to those claims, injuries or damages which are now known to or suspected by You, that arose before the date You signed this Agreement. This Agreement shall remain in effect as a full and complete release notwithstanding the discovery or existence of any additional or different facts. 19. You understand and agree that the terms and conditions of this Agreement, the existence of this Agreement and the circumstances giving rise to it are confidential and that you will not discuss, orally or in writing, the fact of this Agreement, any aspect of this Agreement or the circumstances giving rise to it with anyone other than your immediate family, attorney, CPA, or financial advisor (with instructions to them that they are bound to maintain the confidentiality of the terms and conditions of the Agreement), unless you are subpoenaed or otherwise required by law to disclose the terms or conditions. If You or your above referenced representatives receive legal notice that disclosure is being sought, you will immediately provide Schwab with notice of the potential disclosure (which notice must be prior to the disclosure). Nothing in this provision is intended to undermine obligations you or Schwab may have to comply with applicable banking or securities laws, rules and/or regulations. 20. You further agree that you will refrain from taking actions or making written or oral statements regarding Schwab, which could or would: - - Disparage or defame the goodwill or reputation, - - Adversely affect the morale of other employees, - - Impact the ability to attract qualified candidates, or - - Affect the relationship with its analysts, investors, rating agencies, media representatives, external consultants or any other entity which could have influence over its reputation, shareholder value or market share. You also agree that you will refrain from acting as a source (attributable or otherwise) or engaging in any dialogue with the media, regarding your experiences with or at Schwab that in any way would or could be injurious or detrimental to any Schwab entity or affiliated person, or regarding any information you may have acquired (first hand or otherwise) concerning Schwab operations, marketing or advertising strategies or plans, financial performance, recruitment or retention strategies and/or internal policies and procedures.) Nothing in this paragraph is intended to undermine obligations you or Schwab may have to comply with applicable banking and/or securities laws, rules and/or regulations. 21. You agree that you will continue to cooperate (before and after your Separation Date) with the Company in all inquiries and/or investigations (internal, regulatory or otherwise) and on all claims, litigation or arbitration pertaining to the Company's business or relationships, regardless of whether the Company is or becomes a named party. In that event, the Company will reimburse you for reasonable travel expenses in accordance with the travel policies then in effect and will reimburse you for reasonable legal fees incurred by you to the extent you determine, with the approval of the Company (such approval not to be unreasonably withheld), that it is appropriate for you to have independent legal advice or representation in connection therewith. This reimbursement is for your convenience. The Company confirms its expectation that you will provide truthful information in accordance with this paragraph. 22. In the event that any amounts payable under paragraph 2 of this Agreement, any amounts referred to in paragraph 4 of this Agreement, any amount payable under the Employment Agreement, or any other payments or benefits to which you are entitled from the Company are subject to the excise tax imposed under Section 4999 of the Internal Revenue Code (the "Excise Tax"), the Company shall pay you an additional amount (the "Gross-Up Payment") such that the net amount retained by you, after deduction of any Excise Tax and any Federal, state and local income and employment tax and Excise Tax upon the payment provided by this paragraph, shall be equal to the amount you would have received had the Excise Tax not been imposed. 23 All rights and obligations under the Split Dollar Insurance Agreement dated December 21, 1998 between U.S. Trust Corporation and you (the "Split Dollar Agreement") shall survive this Agreement and your separation from the Company. The Company agrees that it will report consistently with any election permitted by IRS Notice 2002-8, or the regulations to be issued announced in such Notice, made by the trustee under your trust indenture dated March 3, 1998 with respect to the income taxation of the insurance provided under the Split Dollar Agreement. The Company further agrees that it will provide such information with respect to the financial performance of the insurance policy acquired under the Split Dollar Agreement as such trustee shall from time to time reasonably request. 24. By entering into this Agreement, the Company does not admit any liability to you or any other person arising out of or attributable to your employment at the Company or the ending of that employment. The Company expressly denies any and all such liability and denies it has engaged in any wrongful act. 25. You confirm that you have been supplied with and have read a copy of this Agreement and understand its terms, that you have been advised to consult with an attorney before signing this Agreement, that you fully understand the content and effect of this Agreement, and that you enter into this Agreement voluntarily. You also confirm that you have been given at least twenty-one (21) days in which to consider the terms of this Agreement (which 21 day period begins on the date you were first provided with a copy of the original Agreement for review and signature), and that you approve and accept the terms and knowingly and voluntarily agree to be bound by them. This notice is provided in accordance with the Age Discrimination in Employment Act. 26. For a period of seven (7) calendar days after you sign this Agreement, you are entitled to revoke it, and this Agreement will not become effective or enforceable until that seven-day period has expired without a revocation by you. To revoke this Agreement, please deliver to me a writing requesting revocation. The writing must be physically received by me within 7 calendar days of the date of your signature on this Agreement in order to be effective. 27. This Agreement is severable. If a provision or a portion of a provision is found legally unenforceable or invalid, the remaining portions and provisions of this Agreement remain enforceable and shall be enforced to the full extent of the law. 28. This Agreement shall be governed by and interpreted in accordance with the laws of the State of New York. 29. This Agreement, the August Agreement, and the surviving provisions of the Employment Agreement constitute the complete understanding between you and Schwab as to the subject matter contained herein and supercedes any other agreements or understandings, whether written or verbal. No other subsequent promises or agreements shall be binding unless they are reduced to writing and are signed by you and an authorized Schwab Officer, except as otherwise provided above. Marshall, if the terms of this Agreement are satisfactory, please date, sign and initial this document in the space provided below and on the following page. Please do not make any other marks on the Agreement. The signed original should be returned to Charles Fergusson, Senior Vice President, United States Trust Company of New York, 114 West 47th Street, New York, New York 10036 in the enclosed envelope on or before March 1, 2002. I have included a copy for your files. Once you return the signed and initialed original, I will initial it as well and provide you with a copy of the fully executed document. Please feel free to contact me should you have any questions. Very truly yours, /s/ David S. Pottruck - ------------------------ David Pottruck President and Co-Chief Executive Officer The Charles Schwab Corporation AGREED: /s/ H. Marshall Schwarz DATE: 2/28/02 ------------------------ -------------------- H. Marshall Schwarz Schedule A ---------- H. Marshall Schwarz A/O January 10, 2002 Account Balance as of 1/10/02* Benefit Equalization Plan of U.S. Trust Corp. $ 2,689,528.73 - -------------------------------------------------------------------------------- Executive Deferred Compensation Plan of U.S. Trust Corp. 5,846,263.12 - -------------------------------------------------------------------------------- Long Term Performance Plan of U.S. Trust Corp 1,628,943.83 - -------------------------------------------------------------------------------- U.S. Trust Corporation 401(k) Plan - 401(k) 2,335,761.09 - -------------------------------------------------------------------------------- U.S. Trust Corporation 401(k) Plan - ESOP 267,303.94 - -------------------------------------------------------------------------------- U.S. Trust Corporation 401(k) Plan - ESOP Diversification 267,492.46 - ------------------------------------------------------------==================== Total $ 13,035,293.17 - -------------------------------------------------------------------------------- *Amounts will change with changes in market values, additions and withdrawals. In addition: 1) Rights under the Split Dollar Insurance Agreement dated December 21, 1998, between U.S. Trust Corporation and H.M. Schwarz 2) Rights to a pension pursuant to the terms of the U.S. Trust Retirement Plan EX-10 7 exh10_250.txt EXHIBIT 10_250 Exhibit 10.250 November 4, 2002 Mr. Jeffrey S. Maurer 241 Kings Point Road Kings Point, New York 11024 Dear Jeff: The purpose of this letter is to confirm our understanding of, and agreement to, the following terms regarding your recent change in position. We recognize that you have been terminated as Chairman and Chief Executive Officer of U.S. Trust and have the right to leave at any time hereafter prior to May 31, 2003 with or without Good Reason and have it treated as a termination of your employment without Cause by us. Any termination by you or us (whether with or without Cause) hereafter and on or prior to May 31, 2003, including termination as a result of your death or Disability, shall be treated as a "Protected Termination" entitling you to the compensation, benefits, and perquisites set forth in your Employment Agreement and as expanded herein. (Any terms not defined in this letter shall have the meanings given to them in your Employment Agreement.) Position - -------- As announced, you will chair the Affluent Client Strategy and Policy Committee and continue to serve on Schwab's Executive Committee. Salary - ------ Your annual salary will continue to be paid at the rate of $565,000, until the end of calendar year 2002. Beginning January 1, 2003, you will be paid in accordance with the Schwab Executive Committee members who lead a similar function to the Affluent Client Strategy and Policy Committee (e.g., Corporate Strategy). However, all of your non-pay-related benefits and perquisites will continue at the same amounts and levels currently in effect. Your pay-related benefits will reflect your 2003 base salary. David Pottruck, in good faith, in accordance with the above principles and after consultation with you, will establish your base salary, bonus and long-term incentive targets for 2003 by December 1, 2002. In addition, assuming your employment terminates as a result of a Protected Termination, you will receive two (2) times your annual base salary of $565,000, totaling $1,130,000, which shall be payable within two weeks of your Protected Termination date in a lump sum cash payment (less customary withholding). Bonus - ----- You will receive a cash payment equal to your 2001 bonus (170% of your 2001 base salary) payable on the first business day of January 2003. You will also receive any bonus due for Schwab's fiscal year 2002 in accordance with the pay-out received by other Executive Committee members; provided that this bonus shall be calculated and paid as if you had worked for all of fiscal year 2002 even if you have a Protected Termination prior to the end of the 2002 fiscal year. You will also receive a full or pro-rated 2003 bonus upon termination of your employment during or after 2003. The EIP waiver under the Split Dollar Agreement will not apply. Assuming you have a Protected Termination, you will receive a payment equal to two (2) times your current targeted bonus. Although this target is now 125%, for purposes of this termination payment only, the target will be 170%, or an amount of $960,500 per year. The total payment will be two (2) times that amount or $1,921,000, less applicable taxes and withholding. You will receive these amounts within two (2) weeks of your Protected Termination date in a lump sum cash payment (less applicable withholding). Stock Grants - ------------ Upon a Protected Termination, you will receive full and immediate vesting of any outstanding stock options and other equity based awards effective as of such termination date. The exercise period for all vested and exercisable Incentive Stock Options ("ISOs") will be no later than three (3) months after the termination date (or expiration date, whichever is earlier) and for all vested and exercisable Non-Qualified Stock Options ("NQSOs") will be no later than two (2) years after the termination date (or expiration date, whichever is earlier). Non Compete/Non-Solicitation - ----------------------------- In the event of a Protected Termination, the non-compete and non-solicitation clauses described in Section 8 of your Employment Agreement will begin to run on the earlier of your Protected Termination date or October 4, 2002 and will cease one (1) year thereafter, provided that Sections 8(b)(i) and (iii) of your Employment Agreement will continue to apply until one (1) year after the earlier of January 1, 2003 or your Protected Termination date. We also agree that the non-compete in your Employment Agreement will not apply to financial services departments of corporate conglomerates. Other - ----- The remaining provisions in the Employment Agreement will remain in full force and effect, including, but not limited to, the provisions addressing Media Communication and Non-Disparagement. Furthermore, no member of the Schwab or U.S. Trust Control Group (as defined below) will make any public statements to any third parties intended to disparage or damage your reputation, nor will any member of the Control Group or anyone acting on the Control Group's behalf as an entity, issue any press releases or media communications intended to disparage or damage your reputation, provided that the foregoing is not intended to prevent truthful testimony by any members of the Control Group in connection with any statutory or contractual reporting obligations, in any judicial proceeding, or as a defense to any claim, action or allegation raised by you. For purposes of this agreement, Control Group shall mean Charles Schwab, Alan J. Weber, David Pottruck, and Mary S. McLeod. In addition, we further agree that the non-disparagement provisions in section 11 of your Employment Agreement shall not affect your ability to respond truthfully and professionally to any disparaging statements made by any executive employee of Schwab or U.S. Trust. Nothing in this paragraph is intended to prevent you from engaging in "competitive puffery" regarding the Company's products or services providing no disparaging comments are made regarding Schwab or U.S. Trust in connection with the same. Other Terms, Benefits & Perquisites - ----------------------------------- In addition, listed below are the benefits you would be eligible to receive upon a Protected Termination. Please note, we have assumed a December 31, 2002 termination date for purposes of these calculations; however, we assume this will not be the actual date and therefore, the calculations may change consistent with the actual date. Retirement Plan Benefit - You can retire on January 1, 2003 and begin receiving a monthly pension benefit of $6,237.47 assuming a 50% Joint & Survivor form of pension. If you defer receipt of your pension benefits until August 1, 2007 (age 60), this amount will increase to $8,060.55. Under the 50% Joint & Survivor form of pension you would receive the stated monthly amount for your lifetime and, at your death, your surviving spouse would begin to receive half of this monthly benefit for her lifetime. Forms of payment other than the 50% Joint & Survivor are available with spousal consent. In addition, we agree that, in the event of your Protected Termination, you will be entitled to receive from the Company, on your termination date, a single sum payment in an amount equal to the excess of: (x) the present value of your accrued benefit, expressed in the form of a single life annuity, under the U.S. Trust Corporation Employees' Retirement Plan ("UST Pension Plan"), with such accrued benefit to be calculated at the time of your Protected Termination by adding two (2) additional years of age and Credited Service and (y) the present value of your accrued benefit, expressed in the form of a single life annuity, under the UST Pension Plan calculated at the time of your Protected Termination. 401K/ESPOP - Beginning in January 2003, you can elect to receive a full distribution of your account balance during any month; however, you must request a distribution by the end of the year in which you attain age 65. Non-Qualified Plans - Your account balances in the EDCP and BEP will fully vest and be paid in 10 annual installments. The first installment will be in March 2003. The September 30, 2002 balances for the BEP and EDCP are $539,871.00 and $701,425.00, respectively. The EDCP amount includes the 2000 EIP Mandatory Deferred portion which was scheduled to vest in 2006, but will now vest immediately. Within the next few days these balances will be updated on SchwabPlan.com to reflect the September 30, 2002 values. Upon a Protected Termination, your account balance under the BEP will be credited with amounts as if you had remained employed by U.S. Trust for two (2) years beyond the Protected Termination date. In addition, the value of two additional years of Credited Service under the U.S. Trust Corporation Employees' Retirement Plan will be credited to your account under the EDCP. Retirement Medical Plan - You are eligible to participate under the Retirement Medical Plan when your active employee coverage ends. You are also entitled, upon a Protected Termination, to two (2) additional years of coverage under the medical plan(s) in which you currently participate and, following the expiration of this period, you may elect to commence coverage under the Retirement Medical Plan, to the extent this is more beneficial to you. Retirement Life Insurance - After your active coverage ends you are eligible for retirement life insurance equal to an initial amount of your active life amount or $100,000, whichever is less. This initial amount is reduced by 10% during the first 5 years of your coverage. You are currently enrolled for $10,000 of active life insurance; therefore, you may want to consider increasing this amount during the next open enrollment period to maximize this benefit. Any increase in life insurance coverage is subject to evidence of good health acceptable to Metropolitan Life. Upon a Protected Termination, you will continue to be covered under all insurance arrangements as if you had remained actively employed for two (2) additional years, except under the Split Dollar Insurance Agreement, currently in effect. With respect to said Split Dollar Insurance Agreement, the following terms will apply: (1) U.S. Trust will not be under any obligation to make the additional premium payments otherwise required under said Agreement; (2) U.S. Trust will assign all of its rights and benefits in the insurance policy subject to such Agreement to you; and (3) U.S. Trust will waive its right to receive the "Corporation's Recovery Amount" as defined in said Agreement. Dental - You can elect COBRA continuation for 18 months after your active employee coverage ends. In the event of a Protected Termination, you will receive two (2) additional years of active employee coverage and then may elect COBRA coverage. Vacation - You will be paid for any unused vacation days through the date of your Protected Termination; such payment will be made in a lump sum cash payment (less applicable withholding) promptly after your Protected Termination date. 280G Gross-Up - Your rights under Section 12(j) of the Employment Agreement shall in all events, whether your termination is a Protected Termination or otherwise, continue in full force and effect. Legal Fees - We will pay the reasonable legal fees incurred by you in connection with the negotiation and finalization of this letter and the new arrangement. Jeff, we very much look forward to working with you in your new position at Schwab. Please review the terms set forth above. If any of the terms are contrary to your understanding of our agreement, please let me know as soon as possible. If the terms are consistent with your understanding of our agreement, please sign below. This letter will serve as a modification to the Employment Agreement entered into as of January 12, 2000. Sincerely, /s/ David Pottruck /s/ Mary S. McLeod - ------------------------------- ------------------------------ David Pottruck Mary S. McLeod President and Co-CEO Executive Vice President The Charles Schwab Corporation; Human Resources Member, Board of Directors U. S. Trust /s/ Jeffrey S. Maurer 11/7/02 - ------------------------------ ------------------------------ Jeffrey S. Maurer Date EX-12 8 exh12_1.txt EXHIBIT 12_1
EXHIBIT 12.1 THE CHARLES SCHWAB CORPORATION Computation of Ratio of Earnings to Fixed Charges (Dollar amounts in millions, unaudited) - ------------------------------------------------------------------------------------------------------------------------------------ Year Ended December 31, 2002 2001 2000 1999 1998 ---- ---- ---- ---- ---- Earnings before taxes on earnings and extraordinary gain $ 168 $ 135 $1,231 $1,099 $ 678 - ------------------------------------------------------------------------------------------------------------------------------------ Fixed charges Interest expense: Brokerage client cash balances 173 696 1,076 701 580 Deposits from banking clients 98 128 155 117 108 Long-term debt 46 55 55 33 30 Short-term borrowings 23 27 20 8 9 Other 5 22 46 39 47 - ------------------------------------------------------------------------------------------------------------------------------------ Total 345 928 1,352 898 774 Interest portion of rental expense 86 93 75 54 41 - ------------------------------------------------------------------------------------------------------------------------------------ Total fixed charges (A) 431 1,021 1,427 952 815 - ------------------------------------------------------------------------------------------------------------------------------------ Earnings before taxes on earnings and extraordinary gain and fixed charges (B) $ 599 $1,156 $2,658 $2,051 $1,493 ==================================================================================================================================== Ratio of earnings to fixed charges (B) divided by (A)(1) 1.4 1.1 1.9 2.2 1.8 ==================================================================================================================================== Ratio of earnings to fixed charges excluding brokerage client interest expense(2) 1.7 1.4 4.5 5.4 3.9 ==================================================================================================================================== (1) The ratio of earnings to fixed charges is calculated in accordance with SEC requirements. For such purposes, "earnings" consist of earnings before taxes on earnings 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) 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.
EX-13 9 exh13_1.txt EXHIBIT 13_1, 2002 ANNUAL REPORT EXHIBIT 13.1 The Charles Schwab Corporation 2002 Annual Report to Stockholders (Only those portions specifically incorporated by reference into The Charles Schwab Corporation 2002 Annual Report on Form 10-K)
Selected Financial and Operating Data The Charles Schwab Corporation (In Millions, Except Per Share Amounts, Ratios, Number of Offices, Average Revenue Per Revenue Trade, and as Noted) - ------------------------------------------------------------------------------------------------------------------------------------ Growth Rates ------------------- Compounded Annual 5-Year 1-Year 1997-2002 2001-2002 2002 2001 2000 1999 1998 - ------------------------------------------------------------------------------------------------------------------------------------ Operating Results Revenues 9% (5%) $ 4,135 $ 4,353 $ 5,788 $ 4,486 $ 3,178 Expenses excluding interest 13% (6%) $ 3,967 $ 4,218 $ 4,557 $ 3,387 $ 2,500 Net income (19%) (45%) $ 109 $ 199 $ 718 $ 666 $ 410 Basic earnings per share (1) (20%) (43%) $ .08 $ .14 $ .53 $ .51 $ .32 Diluted earnings per share (1) (20%) (43%) $ .08 $ .14 $ .51 $ .49 $ .31 Adjusted operating income (2) 3% (3%) $ 396 $ 407 $ 849 $ 666 $ 410 Dividends declared per common share (3) 7% $ .0440 $ .0440 $ .0407 $ .0373 $ .0360 Weighted-average common shares outstanding - diluted 1,375 1,399 1,404 1,373 1,343 Non-trading revenues as a percentage of revenues (4) 66% 63% 51% 47% 49% Trading revenues as a percentage of revenues (4) 34% 37% 49% 53% 51% Effective income tax rate 42.6% 44.1% 41.7% 39.4% 39.5% Capital expenditures - cash purchases of equipment, office facilities, property, and internal-use software development costs, net 1% (47%) $ 160 $ 301 $ 705 $ 370 $ 199 Capital expenditures as a percentage of revenues 3.9% 6.9% 12.2% 8.3% 6.3% ==================================================================================================================================== Performance Measures Revenue growth (decline) (5%) (25%) 29% 41% 19% Pre-tax profit margin - reported 4.6% 8.2% 21.3% 24.5% 21.3% After-tax profit margin - reported 2.6% 4.6% 12.4% 14.9% 12.9% After-tax profit margin - operating (2) 9.6% 9.4% 14.7% 14.9% 12.9% Return on stockholders' equity 3% 5% 21% 31% 27% ==================================================================================================================================== Financial Condition (at year end) Total assets 14% (2%) $39,705 $40,464 $38,154 $34,322 $26,407 Long-term debt 8% (12%) $ 642 $ 730 $ 770 $ 518 $ 419 Stockholders' equity 24% (4%) $ 4,011 $ 4,163 $ 4,230 $ 2,576 $ 1,673 Assets to stockholders' equity ratio 10 10 9 13 16 Long-term debt to total financial capital (long-term debt plus stockholders' equity) 14% 15% 15% 17% 20% ==================================================================================================================================== Client Information (at year end) Active client accounts (5) 11% 3% 8.0 7.8 7.5 6.6 5.6 Client assets (in billions) 12% (10%) $ 764.8 $ 845.9 $ 871.7 $ 846.0 $ 594.3 Total mutual fund assets (in billions) 14% (6%) $ 323.8 $ 342.8 $ 330.3 $ 294.0 $ 218.1 Active independent investment advisors (in thousands) 2% 2% 5.9 5.8 5.7 5.8 5.4 Independent investment advisor client accounts (in thousands) 17% 9% 1,182.4 1,081.7 986.5 848.3 689.9 Independent investment advisor client assets (in billions) 16% (5%) $ 222.4 $ 235.0 $ 231.3 $ 213.1 $ 146.4 Number of Schwab domestic branch offices 7% (2%) 388 395 384 340 291 Number of U.S. Trust offices 12% 34 34 31 28 24 ==================================================================================================================================== Employee Information Full-time equivalent employees (at year end, in thousands) 3% (15%) 16.7 19.6 26.3 20.1 15.1 Revenues per average full-time equivalent employee (in thousands) 2% 15% $ 220 $ 192 $ 239 $ 249 $ 214 Compensation and benefits expense as a percentage of revenues 44.8% 43.1% 41.7% 42.1% 43.3% ==================================================================================================================================== Clients' Daily Average Trading Volume (in thousands) Daily average revenue trades 13% (16%) 134.1 159.7 242.0 163.1 97.2 Mutual Fund OneSource and other asset-based trades 10% 4% 56.1 54.0 58.1 45.6 40.3 - ------------------------------------------------------------------------------------------------------------------------------------ Daily average trades 12% (11%) 190.2 213.7 300.1 208.7 137.5 ==================================================================================================================================== Average Revenue Per Revenue Trade (10%) 8% $ 37.78 $ 35.02 $ 37.38 $ 45.55 $ 53.44 ==================================================================================================================================== (1) Both basic and diluted earnings per share include an extraordinary gain of $.01 per share in 2002 and $.08 per share in 2001. (2) Represents a non-GAAP income measure, which in 2002 excludes an extraordinary gain, restructuring charges, goodwill and other impairment charges, and merger- and acquisition-related costs totaling $287 million after-tax. In 2001, excludes an extraordinary gain, non-operating revenue (which primarily consists of a gain on the sale of an investment), restructuring and other charges, and merger- and acquisition-related costs totaling $208 million after-tax. In 2000, excludes merger- and acquisition-related costs totaling $131 million after-tax. (3) Dividends declared per common share do not include dividends declared by USTC prior to the completion of the merger in 2000. (4) Non-trading revenues include asset management and administration fees, net interest revenue, and other revenues. Trading revenues include commission and principal transaction revenues. (5) Effective in 1998, active accounts are defined as accounts with balances or activity within the preceding eight months instead of twelve months as previously defined. This change in definition had the effect of decreasing the number of active accounts in 1998 by approximately 200,000.
- 1 - The Charles Schwab Corporation Management's Discussion and Analysis of Results of Operations and Financial Condition (Tabular Amounts in Millions, Except Trades, Average Revenue Per Revenue Trade, and as noted) 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 $764.8 billion at December 31, 2002. Charles Schwab & Co., Inc. (Schwab) is a securities broker-dealer with 388 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 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 traders. 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 investment advisors (IAs), serves company 401(k) plan sponsors and third-party administrators, and supports company stock option plans. 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, wealth management, custody, fiduciary, and private banking services to individual and institutional clients. Business Strategy The Company's primary strategy is to serve the needs of individual investors either directly or indirectly through intermediaries, IAs, or corporate retirement plan sponsors. Meeting these investment needs entails offering a variety of financial services including retail brokerage, investment and wealth management, custody and fiduciary services, support services for IAs, investment services to companies and their employees (including 401(k) defined contribution plans), equity securities market-making, and banking and other financial services. Additionally, the Company provides institutional clients with equity trade execution services, mutual fund clearing services, investment management, and fiduciary services. To pursue its strategy and its objective of long-term profitable growth, the Company plans to leverage its competitive advantages, which include: - - a broad range of products, services, and advice offerings, - - multi-channel delivery systems, - - an ongoing investment in technology, and - - nationally recognized brands. Management continues to believe that the key to sustaining the Company's competitive advantages will be its ability to combine people and technology in ways that provide investors with the access, information, guidance, advice and control they expect - as well as high-quality service - all at a lower cost than traditional providers of financial services. The Company's products and services are designed to meet clients' varying investment and financial needs, including help and advice and access to extensive investment research, news and information. 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 emerging affluent clients - those with less than $250,000 in assets; - - 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. Services for Affluent Investors: For affluent investors who make independent investment decisions, the Company offers research, analytic tools, and access to fee-based portfolio consultations and financial planning services. Clients looking - -------- (a) Accounts with balances or activity within the preceding eight months. - 2 - for more guidance have access to advanced research, trading and planning resources, combined with professional advice from Schwab's investment specialists designed to assist in developing an investment strategy and carrying out investment and portfolio management decisions. In 2002, the Company launched nationwide its full-service advice and relationship service offering, including the Schwab Advisor Network (the successor to the Schwab AdvisorSource(R) referral program), Schwab Private Client, and Schwab Equity Ratings. The IAs in the Schwab Advisor Network provide customized and personalized portfolio management and financial planning services to investors who want the assistance of an independent professional in managing their financial affairs. The Schwab Advisor Network strengthens the Schwab/advisor/client relationship through a pricing model that allows for sharing fee income on referred accounts and features IAs more prominently in advertising that targets affluent investors. Including the over 340 participating IAs in the Schwab Advisor Network, there are 5,900 IAs who use Schwab for custody, trading, technology, and other support services. Schwab is focused on enhancing the support services it offers to IAs, including improvements to their business management and client service technology, as well as expanding the wealth management services and investment alternatives available to them and their clients. In 2002, Schwab established several new services to help IAs manage and build their practices, including improving the Managed Account Select offering (which enables IAs to provide their clients with access to pre-screened money managers under a single-fee structure), by adding fixed income managers. Schwab also upgraded its Centerpiece portfolio management software to help IAs with fixed income tracking, analytics, and enhanced reporting capabilities. Also in 2002, Schwab conducted advisor education workshops on operational, trading, and technology solutions to help IAs grow their businesses efficiently. Schwab Private Client is a fee-based service designed to help clients who want access to an ongoing, face-to-face advice relationship with a designated Schwab consultant while retaining day-to-day responsibility for their investment decisions. Schwab Private Client provides access to dedicated support resources, expanded asset management capabilities, and enhanced portfolio tracking and performance reporting. Schwab Equity Ratings provide clients with an objective stock rating system on more than 3,000 stocks, assigning each equity a single grade: A, B, C, D, or F. On average, A-rated stocks are expected to strongly outperform the overall market over the next 12 months, while F-rated stocks are expected to strongly underperform the market. Rated stocks are ranked and the number of 'buy consideration' ratings - As and Bs - equals the number of 'sell consideration' ratings - Ds and Fs. Schwab Equity Ratings leverages Schwab's November 2000 acquisition of Chicago Investment Analytics, Inc. (CIA) by applying CIA's research and technology strengths to a systematic ratings methodology that complements the variety of perspectives already available to clients from Goldman Sachs, Standard & Poor's, Argus, and First Call. In 2002, the Company introduced the Schwab Signature Platinum program, the successor to the Schwab Signature Services(R) program, for self-directed affluent investors. Schwab Signature Platinum enables Schwab to provide a select group of its affluent clients with enhanced benefits such as priority service, expanded resources, and preferred pricing. The Company's most affluent clients and their families may utilize U.S. Trust's broad array of wealth management services, including investment management, trust, custody, financial and estate planning, and private banking, which includes a full array of personal lending and deposit products. Affluent investors may receive referrals to U.S. Trust from Schwab. The Company intends to continue leveraging U.S. Trust's highly personalized service model, research capabilities, trust and estate services, investment track record, and reputation in wealth management to serve affluent investors, as well as IAs and their clients. Services for Active Traders: The Company strives to deliver information, technology, service and pricing which meets the needs of active traders. For highly active traders, a CyberTrader Pro(TM) account offers an integrated software-based trading platform which provides enhanced trade information and order execution. Schwab's StreetSmart Pro desktop trading software for active trader clients also leverages CyberTrader Pro technology. During 2002, the Company made several technological, pricing, and service enhancements to its offerings for active traders. The Company enhanced its CyberTrader 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, including reduced prices of $9.95 per trade available on all CyberTrader platforms depending on trading levels. Additionally, CyberTrader's enhanced pricing and technology are available to clients who trade as few as ten times per month. To support representatives' conversations with active traders, 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. The Company expects to continue expanding its services for active traders and providing them with access to advanced technology. - 3 - Services for Emerging Affluent Clients: The Company strives to provide high-quality service to committed investors with portfolios of all sizes. As part of its strategic priorities, the Company is focused on developing more value-added products and services for emerging affluent clients, including advice that clients can access when the need arises. Other efforts underway include making it easier for clients to develop as investors with Schwab and find the appropriate service model for them over the long term, as well as creating incentives for clients to consolidate their financial relationships at Schwab. The Company also expects to continue serving a full spectrum of investors by pricing services appropriately based on resources utilized, and by its ongoing work to combine people and technology in ways that help clients manage and administer their investments independently. Corporate Services: The Company also serves individuals through their workplace in a variety of ways. The Company provides 401(k) recordkeeping and other retirement plan services directly through a dedicated sales force, as well as indirectly through alliances with third-party administrators. In the direct channel, SchwabPlan(R), the Company's 401(k) retirement plan product, offers plan sponsors a wide array of investment options, participant education and servicing, trustee services, and participant-level recordkeeping. Additionally, the Company offers stock option plan and restricted stock services to companies, as well as trade execution and education services to their employees. The Company made several improvements to its retirement and stock option plan offerings during 2002. In 2002, the Company created a Corporate Services division, integrating the Company's investment and brokerage services for corporations under a single division. The Company introduced Schwab Retirement Solutions to address the diverse investing styles of 401(k) plan participants. The program includes four new Schwab Managed Retirement Trust Funds(TM), which are professionally managed target retirement fund portfolios. These new funds complement a traditional menu of plan sponsor-selected investment choices and self-directed brokerage accounts to meet the needs of a variety of types of plan participants. The Company also introduced SchwabPlan Select, a comprehensive bundled 401(k) plan for retirement plans with assets between $2 million to $20 million. Further, a variety of tools designed to assist plan sponsors in monitoring activity and investment performance and to assist clients in evaluating their retirement plan holdings were launched during 2002. The Company intends to continue to enhance its investing and advice services offered to individuals through employers, including employee retirement and option plan capabilities. Banking and Other Financial Products: In addition to the banking services which U.S. Trust offers its clients, the Company is working to provide all of its clients with access to selected banking products that complement its existing asset and wealth management capabilities and facilitate the consolidation of household financial assets at Schwab. During 2002, the Company filed applications with the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation (FDIC) to establish a national bank and to obtain deposit insurance for the bank. The Company received preliminary approval from the Office of the Comptroller of the Currency and the FDIC in early February 2003 and has filed related 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 2003. Upon commencement of banking operations, the Company expects to begin offering a broader array of cash management and credit products. The Company intends for the first phase of its product expansion to be focused on building and launching residential mortgage loans and checking and savings account products. As the Company makes progress in its development of banking and other financial products, it expects to provide a fully integrated client experience which combines cash, credit, and asset management capabilities, helping clients to gain greater control over, and more effectively manage, their personal finances. Capital Markets: The Company provides its clients with: quick and efficient access to the securities markets by offering trade execution services in Nasdaq, exchange-listed and other securities through its market maker and specialist operations; access to extended-hours trading through its participation in Archipelago, an electronic communication network (ECN); and the ability to analyze and trade a variety of fixed income securities through Schwab's multi-channel delivery systems. The Capital Markets segment earns commission revenues when it executes trades as agent and principal transaction revenues when it executes trades as principal. The Company expanded its trade execution capabilities and financial product offerings during 2002. Most Nasdaq orders up to 2,000 shares received by Schwab for execution are routed using SmartEx(R), its proprietary order routing technology that combines intelligent order routing with market maker liquidity enhancements. SmartEx, which was formally launched by the Company in 2002, automatically seeks the best available price to complete orders, whether it is from an ECN or a market maker. SmartEx is available for Schwab client orders in securities in which SCM makes a market. Through an agreement with Goldman Sachs, clients have access to OptEx (a service mark of Goldman, Sachs & Co.), which uses advanced technology to scan the entire options marketplace and route orders automatically based on - 4 - the best price available nationwide and other execution quality factors. In 2002, the Company expanded its equity trading capabilities by assembling a team of 40 professionals to focus on improving execution services for institutional clients. Revenues from institutional equities trading were $80 million in 2002, up 42% from 2001. To meet growing client demand for fixed income information and products, the Company enhanced its fixed income services, including its Web site and Schwab BondSource platform. The BondSource service links Schwab with 50 other broker-dealers, allowing clients to choose fixed income securities from a network that supports trading in all U.S. Treasury securities, over 450 U.S. agency securities, 1,200 corporate bonds, and 3,500 municipal bond issues. Additionally, the Schwab CDSource service allows clients to invest in time deposits from over 110 participating banks. In 2002, Schwab's fixed income division achieved a record $159 million in revenues, up 28% from 2001. Client assets held in fixed income securities equaled $121.8 billion at December 31, 2002, up 20% from a year ago. The Company intends to continue strengthening its capital markets capabilities in the future through further automation, increased scale in its market-making business, and expanded product offerings for both individuals and institutions. FORWARD-LOOKING STATEMENTS In addition to historical information, this Annual Report contains forward-looking statements that reflect management's beliefs, objectives and expectations as of the date hereof. These statements relate to, among other things, growth of non-trading revenues as a percentage of total revenues (see CFO Financial Overview); the impact of the restructuring initiatives on the Company's results of operations (see CFO Financial Overview and Results of Operations - Financial Overview); long-term debt to total capital ratio (see CFO Financial Overview); capital expenditures and capital structure (see CFO Financial Overview and Liquidity and Capital Resources - Cash and Capital Resources); revenue growth, after-tax operating profit margin, and return on stockholders' equity (see CFO Financial Overview); the Company's ability to pursue its strategy of attracting and retaining client assets as well as achieve its six strategic priorities (see Description of Business - Business Strategy); the impact of changes in management's estimates on the Company's results of operations (see Description of Business - Critical Accounting Policies); sources of liquidity and capital (see Liquidity and Capital Resources - Liquidity and - Commitments); the impact of the consolidation of the special purpose trust on the Company's financial position, results of operations, and earnings per share (see note "2 - Significant Accounting Policies" in the Notes to Consolidated Financial Statements); and contingent liabilities (see note "22 - Commitments and Contingent Liabilities" in the Notes to Consolidated Financial Statements). Achievement of the expressed beliefs, objectives and expectations described in these statements is subject to certain risks and uncertainties that could cause actual results to differ materially from the expressed beliefs, objectives and expectations described in these statements. Important factors that may cause such differences include, but are not limited to: the Company's success in building fee-based relationships with its clients; 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; geopolitical developments affecting the securities markets, the economy, and investor sentiment; 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 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. Certain of these factors are discussed in greater detail in this Annual Report and in the Company's Annual Report on Form 10-K. CRITICAL ACCOUNTING POLICIES The consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the U.S. The Company records trading revenues (i.e., commissions and principal transactions) and related expenses on a trade date basis. The Company records non-trading revenues (e.g., proprietary mutual fund and asset-based financial services fees, and interest on client-related balances) and related expenses when the revenues are earned, generally on an accrual basis or upon completion of the Company's required performance. The majority of the Company's revenues, expenses, assets and liabilities are not based on estimates. Management regularly reviews the estimates and assumptions used in preparation of the Company's financial statements for reasonableness and adequacy. Certain of the Company's accounting policies that involve a higher degree of judgment and complexity are discussed below. - 5 - Valuation of Goodwill: 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. The Company adopted SFAS No. 142 and accordingly discontinued the amortization of goodwill as of January 1, 2002. SFAS No. 142 also requires that goodwill and certain intangible assets be tested for impairment at least annually, or whenever indications of impairment exist. In testing for a potential impairment of goodwill, SFAS No. 142 requires management to estimate the fair value of each of the Company's reporting units (generally defined as the Company's businesses for which financial information is available and reviewed regularly by management) and compare it to their carrying value. If the estimated fair value of a reporting unit is less than its carrying value, management is required to estimate the fair value of all assets and liabilities of the reporting unit, including goodwill. If the carrying value of the reporting unit's goodwill is greater than the estimated fair value, an impairment charge is recognized for the excess. Accordingly, the process of evaluating a potential impairment of goodwill is subjective and is based on estimates. The Company's goodwill balances, net of accumulated amortization, were $603 million and $628 million at December 31, 2002 and 2001, respectively. The decline in 2002 was primarily due to an impairment charge of $24 million related to Charles Schwab Europe (CSE), a subsidiary located in the United Kingdom, which is included in goodwill and other impairment charges on the Company's consolidated statement of income. This policy is implemented in each of the Company's four segments. The Company has elected April 1 as its annual impairment testing date. Pension and Other Postretirement Benefits: Under U.S. Trust's trusteed, noncontributory, qualified defined benefit pension plan, the benefit obligation and related plan assets are based on certain estimates - years of employee service, rate of increase in salary, discount rate and expected rate of return on plan assets - which are made by management with recommendations by actuaries. In addition to the years of employee service, rate of increase in salary, and discount rate, U.S. Trust's postretirement medical and life insurance benefit obligation is based on the health care cost trend rate which is an actuarial estimated rate of future increases in per capita cost of health care benefits. The Company's benefit obligation at December 31, 2002 and 2001 was $281 million and $248 million, respectively. The related pension expense (credit) is included in compensation and benefits on the Company's consolidated statement of income and was immaterial for both 2002 and 2001. This policy is implemented in the U.S. Trust segment. Software Development Costs: The Company capitalizes software and certain costs incurred for developing software for internal use under Statement of Position 98-1 - Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. Costs directly related to the development of the software incurred in the application development stage are capitalized based on an estimate of the portion of a project's total costs that relate to the application development stage. This estimated percentage is based on the Company's historical computer software project spending and is reviewed periodically by management for reasonableness. The Company's capitalized internal-use software development costs, net of accumulated amortization, were $175 million and $181 million at December 31, 2002 and 2001, respectively, and are included in equipment, office facilities and property on the Company's consolidated balance sheet. Internal-use software development costs capitalized were $71 million in 2002 and $79 million in 2001. These costs are amortized over three years and are included in depreciation and amortization on the Company's consolidated statement of income. This policy is implemented in each of the Company's four segments. Derivative Instruments and Hedging Activities: As part of its asset and liability management process, the Company has entered into interest rate swap agreements (Swaps) to hedge the interest rate risk associated with the Company's variable rate deposits from banking clients. The Company has designated these Swaps as cash flow hedges, as allowed by SFAS No. 133 - Accounting for Derivative Instruments and Hedging Activities. Therefore, principally all of the cumulative change in the fair value of these Swaps from inception, totaling an aggregate $64 million liability at December 31, 2002, has been recorded in accumulated other comprehensive loss, which is a component of stockholders' equity that is not recognized in current earnings. Any actual hedge ineffectiveness, which was immaterial for 2002, is recorded in interest expense on the Company's consolidated statement of income. In order to maintain hedge accounting treatment, management performs a quarterly assessment of its expectation that these Swaps are effective in achieving the desired hedging results. This policy is implemented in the U.S. Trust segment. Additionally, the Company has entered into Swaps that effectively convert the interest rate characteristics of a portion of the Company's Senior Medium-Term Notes, Series A (Medium-Term Notes) from fixed to variable. The Company has designated such Swaps as fair value hedges, as allowed by SFAS No. 133. Since the notional amount, fixed interest rate, and maturity of these Swaps exactly match the terms of the corresponding Medium-Term Notes, the Company has concluded that these Swaps are completely effective in achieving the desired hedging results, as permitted under SFAS No. 133. Consequently, changes in the - 6 - fair value of these Swaps, totaling an aggregate $26 million asset at December 31, 2002, are completely offset by changes in the fair value of the hedged Medium-Term Notes. Accordingly, there has not been any impact on earnings as a result of this hedging program except for the conversion from a fixed to a floating rate of interest on a portion of the Medium-Term Notes. This policy is implemented in each of the Company's four segments. Restructuring Reserves: A portion of the reserves under the Company's restructuring initiatives are based on assumptions, including the Company's ability to successfully sublease certain real estate properties. These estimates are included in restructuring and other charges on the Company's consolidated statement of income. Factors and uncertainties which may adversely affect the estimates of sublease income include further deterioration in the respective properties' real estate markets, including Northern California, Texas, and New Jersey, and prolonged vacancy periods prior to execution of tenant subleases. The Company's total facilities reserves related to its restructuring initiatives were $227 million and $97 million at December 31, 2002 and 2001, respectively. For a further discussion on the Company's restructuring reserves, see "Results of Operations - Financial Overview." Allowance for Credit Losses: The Company regularly evaluates its portfolio of loans to banking clients and provides allowances for the portion management believes may be uncollectible. Several factors are taken into consideration in this evaluation including current economic conditions, the composition of the loan portfolio, past loss experience, and risks inherent in the loan portfolio. At December 31, 2002 and 2001, the Company's allowance for credit losses was $24 million and $21 million, respectively, on loan portfolios of $4.6 billion and $4.0 billion, respectively. Total charge-offs and total recoveries were immaterial for 2002 and 2001. This policy is implemented in the U.S. Trust Segment. The Company's management has discussed the development and selection of these critical accounting estimates with the Audit Committee of the Board of Directors (Audit Committee). Additionally, the Audit Committee has reviewed the Company's disclosures relating to the estimates discussed in this Management's Discussion and Analysis of Results of Operations and Financial Condition. For further information on the Company's accounting policies, see note "2 - Significant Accounting Policies" in the Notes to Consolidated Financial Statements. RESULTS OF OPERATIONS Financial Overview The Company's 2002 financial performance was significantly affected by persistent declines in securities market valuations, as investor confidence continued to be weighed down by concerns about corporate governance and geopolitical developments. The Nasdaq Composite and Standard & Poor's 500 indices declined 31% and 23%, respectively, in 2002. Assets in client accounts at the Company totaled $764.8 billion at December 31, 2002, down $81.1 billion, or 10%, from a year ago, as net new assets of $47.6 billion were more than offset by net market losses of $128.7 billion. In the difficult market environment that prevailed during 2002, daily average revenue trades decreased 16% from 2001 and the Company's trading revenues declined 14%, as clients scaled back their trading activity. Despite pressure on securities market valuations, the Company's non-trading revenues in 2002 were comparable to 2001 as a result of the Company's ongoing efforts to build client relationships. Total revenues for 2002 were $4.1 billion, down $218 million, or 5%, from 2001. Total expenses excluding interest for 2002 were $4.0 billion, down $251 million, or 6%, from 2001. Since 2001, the Company has implemented a number of expense reduction measures, including its restructuring initiatives, to reduce operating expenses in light of prevailing market conditions. Primarily as a result of these expense reduction measures, most expense categories in 2002 decreased when compared to 2001. In June 2001, USTC sold its Corporate Trust business to The Bank of New York Company, Inc. (Bank of NY). In 2001, the Company recognized a pre-tax extraordinary gain of $221 million, or $121 million after tax, on this sale. Total proceeds received were $273 million and the Company incurred pre-tax closing and exit costs of $30 million for severance, professional fees, and other related disposal costs. During 2002, the Company recorded an extraordinary gain of $22 million, or $12 million after tax, which represented the remaining gain from this sale that was recognized upon satisfaction of certain client retention requirements. Income before taxes on income and extraordinary gain for 2002 was $168 million, up $33 million, or 24%, from 2001. This increase was primarily due to the combination of factors discussed separately above - declines in almost all expense categories, partially offset by lower trading revenues and goodwill and other impairment charges recorded in 2002. Net income for 2002 was $109 million, or $.08 per share, down 45% from $199 million, or $.14 per share, for 2001. This decline was primarily due to a lower extraordinary gain in 2002 and the changes in income before taxes on income and extraordinary gain as previously discussed. The Company's after-tax profit margin for 2002 was 2.6%, down from 4.6% - 7 - for 2001. Return on stockholders' equity was 3% for 2002, compared to 5% in 2001. In evaluating the Company's financial performance, management uses adjusted operating income, a non-GAAP income measure which excludes items as detailed in the following table. Management believes that adjusted 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, goodwill and other impairment charges, and merger- and acquisition-related charges). The Company's after-tax adjusted operating income for 2002 was $396 million, down 3% from 2001, and its after-tax operating profit margin for 2002 was 9.6%, up from 9.4% for 2001. A reconciliation of the Company's adjusted operating income to net income is shown in the following table: - -------------------------------------------------------------------------------- 2002 2001 2000 - -------------------------------------------------------------------------------- Adjusted operating income, after tax $396 $407 $ 849 Excluded items: Extraordinary gain (1) 22 221 Other income (2) 26 Restructuring charges (3) (373) (391) Other charges (4) (28) Goodwill and other impairment charges (5) (61) Merger- and acquisition-related charges (6) (27) (119) (157) - -------------------------------------------------------------------------------- Total excluded items (439) (291) (157) Tax effect 152 83 26 - -------------------------------------------------------------------------------- Total excluded items, after tax (287) (208) (131) - -------------------------------------------------------------------------------- Net income $109 $199 $ 718 ================================================================================ (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 NY in June 2001. In March 2002, the Company recorded an extraordinary pre-tax gain upon satisfaction of certain client retention requirements related to this sale. (2) Primarily consists of a gain recorded on the sale of an investment. (3) Restructuring charges primarily 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 charges associated with the Company's European operations for the impairment of goodwill and an investment write-down. (6) 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 2002. For 2001 and 2000, amount also includes goodwill amortization, which ceased on January 1, 2002 upon the adoption of SFAS No. 142. As detailed in note "25 - Segment Information" in the Notes to Consolidated Financial Statements, the Company's adjusted operating income before taxes for 2002 was $629 million, down $18 million, or 3%, from 2001 due to increases of $31 million, or 14%, in the Individual Investor segment, and $5 million, or 4%, in the U.S. Trust segment, partially offset by decreases of $34 million, or 12%, in the Institutional Investor segment, and $20 million, or 56%, in the Capital Markets segment. The increase in the Individual Investor segment was primarily due to lower expenses resulting from the Company's workforce reduction under its restructuring initiatives. 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, which, along with an increase in certain direct costs, resulted in the adjusted operating income decline in that segment. The decrease in the Capital Markets segment was due to lower average revenue per equity share traded and lower levels of trading activity in 2002. Certain reclassifications have been made to prior year amounts to conform to the current presentation. All references to earnings per share information in this Annual Report reflect diluted earnings per share unless otherwise noted. Restructuring: The Company recorded pre-tax restructuring charges for 2002 and 2001 as follows: - -------------------------------------------------------------------------------- Restructuring Charges 2002 2001 - -------------------------------------------------------------------------------- 2002 Initiatives: Workforce reduction $ 141 Facilities reduction 132 Systems removal 4 - -------------------------------------------------------------------------------- Total 2002 Initiatives 277 - -------------------------------------------------------------------------------- 2001 Initiatives: Workforce reduction 19 $ 87 Facilities reduction 76 141 Systems removal 1 63 - -------------------------------------------------------------------------------- Total 2001 Initiatives 96 391 - -------------------------------------------------------------------------------- Total $ 373 $ 391 ================================================================================ 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 primarily included further reductions in the Company's workforce and facilities. The Company recorded pre-tax restructuring charges of $277 million in 2002 related to these restructuring initiatives. The Company estimates that its 2002 restructuring initiatives will reduce pre-tax operating expenses for 2003 by approximately $250 million compared to annualized second quarter 2002 operating expenses. Expected reductions include approximately $170 million in compensation and benefits for staff reductions which occurred in 2002, and approximately $80 million in spending for development - 8 - projects, advertising, occupancy, and professional services. A portion of these reductions in operating expenses, however, will likely be used to enhance employee discretionary incentives. 2001 Initiatives The Company's 2001 restructuring initiatives included a workforce reduction, a reduction in operating facilities, the removal of certain systems hardware, software and equipment from service, and the withdrawal from certain international operations. In 2002, the Company recorded pre-tax restructuring charges related to its 2001 restructuring initiatives of $96 million, primarily resulting from facilities charges for changes in estimates of sublease income due to a continued deterioration of the commercial real estate market. In 2001, the Company recorded pre-tax charges for restructuring costs of $391 million. Facilities Restructuring Reserves As of December 31, 2002, the remaining facilities restructuring reserve of $124 million related to the Company's 2001 initiatives is net of estimated future sublease income of approximately $270 million. Additionally, as of December 31, 2002, the remaining facilities restructuring reserve of $103 million related to the Company's 2002 initiatives is net of estimated future sublease income of approximately $110 million. These estimated future sublease income amounts are determined based upon a number of factors, including current and expected commercial real estate lease rates in the respective properties' real estate markets, and estimated vacancy periods prior to execution of tenant subleases. In 2002, following a continued deterioration of the commercial real estate market, the Company recorded additional facilities restructuring charges related to its 2001 initiatives primarily due to decreases in estimated sublease rates and increases in the estimated vacancy periods prior to sublease. At December 31, 2002, approximately 30% of the total square footage covered under the 2001 restructuring initiatives has been subleased. At December 31, 2002, less than 5% of the total square footage covered under the 2002 restructuring initiatives has been subleased. The actual costs of these initiatives could differ from the Company's estimates, depending primarily on the Company's ability to successfully sublease certain properties. Factors and uncertainties which may adversely affect the estimates of sublease income include further deterioration in the respective properties' real estate markets, including Northern California, Texas, and New Jersey, and prolonged vacancy periods prior to execution of tenant subleases. For further information on the Company's restructuring initiatives, see note "3 - Restructuring and Other Charges" in the Notes to Consolidated Financial Statements. REVENUES Revenues declined $218 million, or 5%, to $4.1 billion in 2002, mainly due to an 11% decrease in commission revenues, a 9% decrease in interest revenue, net of interest expense (referred to as net interest revenue), and a 28% decrease in principal transaction revenues. These declines were partially offset by a 5% increase in asset management and administration fees, and a 3% increase in other revenues. [Chart Omitted] As trading volumes decreased during 2002, non-trading revenues represented 66% of total revenues, up from 63% of total revenues for 2001 and 51% for 2000 as shown in the following table. - -------------------------------------------------------------------------------- Composition of Revenues 2002 2001 2000 - -------------------------------------------------------------------------------- Asset management and administration fees 43% 38% 27% Net interest revenue 20 21 21 Other 3 4 3 - -------------------------------------------------------------------------------- Total non-trading revenues 66 63 51 - -------------------------------------------------------------------------------- Commissions 29 31 39 Principal transactions 5 6 10 - -------------------------------------------------------------------------------- Total trading revenues 34 37 49 - -------------------------------------------------------------------------------- Total 100% 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 $218 million decline in revenues from 2001 was due to decreases of $118 million, or 5%, in the Individual Investor segment, $83 million, or 24%, in the Capital Markets segment, and $3 million in the U.S. Trust segment, slightly offset by an increase of $12 million, or 1%, in the Institutional Investor segment. Additionally, the Company recognized $26 million in non-operating revenues in 2001, consisting primarily of a gain on the sale of an investment. 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 "25 - Segment Information" in the Notes to Consolidated Financial Statements for financial information by segment for the last three years. [Chart Omitted] - 9 - 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, custody 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 $1.8 billion in 2002, compared to $1.7 billion in 2001 and $1.6 billion in 2000, as shown in the following table: - -------------------------------------------------------------------------------- Asset Management and Administration Fees 2002 2001 2000 - -------------------------------------------------------------------------------- Mutual fund service fees: Proprietary funds (SchwabFunds and Excelsior) $ 874 $ 818 $ 673 Mutual Fund OneSource 264 282 331 Other 42 41 35 Asset management and related services 581 534 544 - -------------------------------------------------------------------------------- Total $1,761 $1,675 $1,583 ================================================================================ The increase from 2001 to 2002 was primarily due to higher account fees, increases in average assets in and service fees earned on Schwab's proprietary funds (collectively referred to as the SchwabFunds), and higher service fees earned on assets in Schwab's Mutual Fund OneSource service. These increases were partially offset by decreases in average assets in Schwab's Mutual Fund OneSource service and average U.S. Trust client assets primarily due to declines in market valuations. The increase from 2000 to 2001 was primarily due to a significant increase in client assets in the Company's proprietary funds, partially offset by a decrease in client assets in Schwab's Mutual Fund OneSource service. Commissions The Company earns revenues by executing client trades primarily through the Individual Investor and Institutional Investor segments, as well as the Capital Markets segment. These revenues are affected by the number of client accounts that trade, the average number of revenue-generating trades per account, and the average revenue earned per revenue trade. Commission revenues were $1.2 billion in 2002, compared to $1.4 billion in 2001 and $2.3 billion in 2000, as shown in the following table: - -------------------------------------------------------------------------------- Commissions 2002 2001 2000 - -------------------------------------------------------------------------------- Exchange-listed securities $ 552 $ 540 $ 832 Nasdaq and other equity securities 444 606 1,126 Mutual funds 111 95 132 Options 99 114 204 - -------------------------------------------------------------------------------- Total $1,206 $1,355 $2,294 ================================================================================ Total commission revenues include $67 million in 2002, $59 million in 2001, and $54 million in 2000 related to certain securities serviced by Schwab's fixed income division, including exchange-traded unit investment trusts, real estate investment trusts, preferred debt, and preferred equities. Schwab's fixed income division also generates principal transaction revenues. Additionally, commission revenues include $52 million in 2002, $29 million in 2001, and $25 million in 2000, related to Schwab's institutional trading business. Schwab's institutional trading business also generates principal transaction revenues, as well as other revenues. - 10 - The Company's client trading activity is shown in the following table (in thousands): - -------------------------------------------------------------------------------- Daily Average Trades 2002 2001 2000 - -------------------------------------------------------------------------------- Revenue Trades (1) Online 111.9 133.5 204.1 TeleBroker(R) and Schwab by Phone(TM) 5.7 7.5 8.2 Regional client telephone service centers, branch offices, and other 16.5 18.7 29.7 - -------------------------------------------------------------------------------- Total 134.1 159.7 242.0 ================================================================================ Mutual Fund OneSource(R) and Other Asset-Based Trades Online 46.7 37.0 36.8 TeleBroker and Schwab by Phone .4 .5 1.0 Regional client telephone service centers, branch offices, and other 9.0 16.5 20.3 - -------------------------------------------------------------------------------- Total 56.1 54.0 58.1 ================================================================================ Total Daily Average Trades Online 158.6 170.5 240.9 TeleBroker and Schwab by Phone 6.1 8.0 9.2 Regional client telephone service centers, branch offices, and other 25.5 35.2 50.0 - -------------------------------------------------------------------------------- Total 190.2 213.7 300.1 ================================================================================ (1) Includes all client trades (both individuals and institutions) that generate either commission revenue or revenue from principal markups (i.e., fixed income). As illustrated in the following table, the total number of client revenue trades executed by the Company decreased 15% in 2002 as both the number of client accounts that traded and the average number of trades per account have declined. Average revenue earned per revenue trade increased 8% from 2001 to 2002, mainly due to higher client fixed income securities trades and increased pricing of equity trades made through automated telephone channels and broker-assisted trades. Average revenue earned per revenue trade decreased 6% from 2000 to 2001, mainly due to reduced pricing for online equity trades placed by more active traders, as well as reduced pricing of equity trades made through automated telephone channels. In 2002, the decrease in trading activity more than offset the effect of higher average revenue earned per revenue trade. However, in 2001 both trading activity and average revenue earned per revenue trade declined from 2000. - -------------------------------------------------------------------------------- Trading Activity 2002 2001 2000 - -------------------------------------------------------------------------------- Total revenue trades (in thousands) (1) 33,791 39,625 60,972 Accounts that traded during the year (in thousands) 2,871 3,028 3,787 Average revenue trades per account that traded 11.8 13.1 16.1 Trading frequency proxy (2) 3.8 4.2 6.2 Number of trading days 252 248 252 Average revenue earned per revenue trade $ 37.78 $ 35.02 $ 37.38 - -------------------------------------------------------------------------------- (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 revenue trades per $100,000 in total client assets. Net Interest Revenue Net interest revenue is the difference between interest earned on assets (mainly margin loans to clients, investments of segregated client cash balances, private banking loans, and securities available for sale) and interest paid on liabilities (mainly brokerage client cash balances and deposits from banking clients). 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. In clearing its clients' trades, Schwab holds cash balances payable to clients. In most cases, Schwab pays its clients interest on cash balances awaiting investment, and may invest these funds and earn interest revenue. Schwab also may lend funds to clients on a secured basis to purchase qualified securities - a practice commonly known as "margin lending." Pursuant to Securities and Exchange Commission (SEC) regulations, client cash balances that are not used for margin lending are generally segregated into an investment account that is maintained for the exclusive benefit of clients. When investing segregated client cash balances, Schwab must adhere to SEC regulations that restrict investments to U.S. government securities, participation certificates and mortgage-backed securities guaranteed by the Government National Mortgage Association, certificates of deposit issued by U.S. banks and thrifts, and resale agreements collateralized by qualified securities. Schwab's policies for credit quality and maximum maturity requirements are more restrictive than these SEC regulations. In each of the last three years, resale agreements accounted for over 75% of Schwab's investments of segregated client cash balances. The average maturities of Schwab's total investments of segregated client cash balances were 66 days for both 2002 and 2001, and 59 days for 2000. U.S. Trust lends funds to its private banking clients primarily in the form of mortgage loans. These loans are largely funded by interest-bearing deposits from banking clients. - 11 - Net interest revenue was $841 million in 2002, compared to $929 million in 2001, and $1.2 billion in 2000, as shown in the following table: - -------------------------------------------------------------------------------- 2002 2001 2000 - -------------------------------------------------------------------------------- Interest Revenue: Margin loans to clients $ 459 $ 832 $1,772 Investments, client-related 337 555 338 Private banking loans 236 240 219 Securities available for sale 76 79 69 Other 78 151 191 - -------------------------------------------------------------------------------- Total 1,186 1,857 2,589 - -------------------------------------------------------------------------------- Interest Expense: Brokerage client cash balances 173 696 1,076 Deposits from banking clients 98 128 155 Long-term debt 46 55 55 Short-term borrowings 23 27 20 Other 5 22 46 - -------------------------------------------------------------------------------- Total 345 928 1,352 - -------------------------------------------------------------------------------- Net interest revenue $ 841 $ 929 $1,237 ================================================================================ The Company's interest-earning assets are financed primarily by interest-bearing brokerage client cash balances and deposits from banking clients. Other funding sources include noninterest-bearing brokerage client cash balances, proceeds from stock-lending activities, short-term borrowings and long-term debt, and stockholders' equity. Client-related daily average balances, interest rates, and average net interest spread are summarized as follows: - -------------------------------------------------------------------------------- 2002 2001 2000 - -------------------------------------------------------------------------------- Interest-Earning Assets (client-related and other): Investments (client-related): Average balance outstanding $18,645 $14,198 $ 6,170 Average interest rate 1.81% 3.91% 5.48% Margin loans to clients: Average balance outstanding $ 8,020 $11,432 $19,764 Average interest rate 5.72% 7.28% 8.96% Private banking loans: Average balance outstanding $ 4,125 $ 3,469 $ 2,867 Average interest rate 5.73% 6.91% 7.65% Securities available for sale: Average balance outstanding $ 1,520 $ 1,317 $ 1,133 Average interest rate 4.98% 5.98% 6.08% Average yield on interest-earning assets 3.43% 5.61% 8.01% Funding Sources (client-related and other): Interest-bearing brokerage client cash balances: Average balance outstanding $23,087 $22,295 $20,961 Average interest rate .75% 3.12% 5.14% Interest-bearing banking deposits: Average balance outstanding $ 3,905 $ 3,365 $ 3,071 Average interest rate 2.51% 3.80% 5.05% Other interest-bearing sources: Average balance outstanding $ 1,094 $ 1,117 $ 1,831 Average interest rate 2.03% 3.99% 4.53% Average noninterest-bearing portion $ 4,224 $ 3,639 $ 4,071 Average interest rate on funding sources .91% 2.85% 4.39% Summary: Average yield on interest-earning assets 3.43% 5.61% 8.01% Average interest rate on funding sources .91% 2.85% 4.39% - -------------------------------------------------------------------------------- Average net interest spread 2.52% 2.76% 3.62% ================================================================================ The decrease in net interest revenue from 2001 to 2002 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. The decrease in net interest revenue from 2000 to 2001 was primarily due to lower levels of, and lower rates received on, margin loans to clients, partially offset by higher average balances of client-related investments and lower rates paid on brokerage client cash balances. Since the Company establishes the rates paid on brokerage client cash balances and certain banking deposits and the - 12 - rates charged on margin and private banking loans, a substantial portion of its net interest spread is managed by the Company. However, the spread is influenced by external factors such as the interest rate environment and competition. The Company's average net interest spread decreased from 2001 to 2002 as the average yield on interest-earning assets, primarily client-related investments, declined more than the average interest rate on funding sources. The Company's average net interest spread decreased from 2000 to 2001 as the average yield on interest-earning assets, primarily margin loans to clients, declined more than the average interest rate on funding sources. Principal Transactions Principal transaction revenues are primarily comprised of revenues from client fixed income securities trading activity, which are included in the Capital Markets, 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 revenue per equity share traded, and changes in regulations and industry practices. While substantially all Nasdaq security trades originated by the clients of Schwab are directed to SCM, a substantial portion of SCM's trading volume comes from parties other than Schwab. Orders handled by SCM represented approximately 4% of the total shares traded on Nasdaq in both 2002 and 2001(b). Principal transaction revenues were $184 million in 2002, compared to $255 million in 2001 and $570 million in 2000, as shown in the following table: - -------------------------------------------------------------------------------- Principal Transactions 2002 2001 2000 - -------------------------------------------------------------------------------- Fixed income securities $ 92 $ 65 $ 53 Nasdaq and other equity securities 80 173 470 Other 12 17 47 - -------------------------------------------------------------------------------- Total (1) $ 184 $ 255 $ 570 ================================================================================ (1) Includes $23 million in each of 2002 and 2001, and $33 million in 2000, related to Schwab's institutional trading business. The decreases in principal transaction revenues from 2000 to 2002 were 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. SCM's average revenue per equity share traded decreased from 1.8(cents) in 2000 to .8(cents) in 2001, and to .4(cents) in 2002, primarily due to market conditions as well as the change to decimal pricing, which was fully implemented by April 2001. Other Revenues Other revenues include fees for services, such as order handling fees, account service fees, net gains and losses on certain investments, and software maintenance fees. Other revenues are earned primarily through the Individual Investor, Institutional Investor and U.S. Trust segments. These revenues were $143 million in 2002, compared to $139 million in 2001 and $104 million in 2000. The increase from 2001 to 2002 was primarily due to higher fees for services, substantially offset by lower gains recorded on sales of investments. The increase from 2000 to 2001 was primarily due to gains recorded on sales of investments. EXPENSES EXCLUDING INTEREST Total expenses excluding interest declined $251 million, or 6%, in 2002. The Company's restructuring initiatives and other expense reduction measures resulted in decreases in most expense categories during 2002 when compared to 2001. The Company monitors each of its expense categories as a percentage of revenues, as detailed in the table below. - -------------------------------------------------------------------------------- Expenses Excluding Interest as a Percentage of Revenues 2002 2001 2000 - -------------------------------------------------------------------------------- Compensation and benefits 45% 43% 42% Other compensation - merger retention programs 1 1 1 Occupancy and equipment 11 11 7 Depreciation and amortization 8 8 4 Communications 6 8 6 Advertising and market development 5 6 6 Professional services 4 4 4 Commissions, clearance and floor brokerage 2 2 2 Restructuring and other charges 9 10 Goodwill and other impairment charges 2 Goodwill amortization 2 1 Merger-related 1 Other 3 2 5 - -------------------------------------------------------------------------------- Total 96% 97% 79% ================================================================================ Compensation and Benefits Compensation and benefits expense includes salaries and wages, related employee benefits and taxes, and variable compensation. Employees receive variable compensation that is tied to the achievement of specified objectives relating primarily to revenue growth, profit margin, and growth in client assets. Additionally, at management's discretion, employees may receive incentive compensation relating to progress on the Company's strategic priorities. Therefore, a significant portion of compensation and benefits expense will fluctuate with these measures. Compensation and benefits expense was $1.9 billion in 2002, down 1% from 2001 and 23% from 2000. The decrease from 2001 to 2002 was primarily due to a reduction in full-time equivalent employees, partially offset by the - -------- (b) Source: The Nasdaq Stock Market, Inc. - 13 - accrual of higher discretionary and incentive compensation, and higher employee benefits. The decrease from 2000 to 2001 was primarily due to a substantial decline in variable compensation expense resulting from the Company's financial performance, as well as a reduction in full-time equivalent employees. The following table shows a comparison of certain compensation and benefits components and employee data: - -------------------------------------------------------------------------------- Compensation and Benefits 2002 2001 2000 - -------------------------------------------------------------------------------- Salaries and wages $1,267 $1,380 $1,409 Employee benefits and other 306 285 340 Incentive and variable compensation 281 210 665 - -------------------------------------------------------------------------------- Total $1,854 $1,875 $2,414 ================================================================================ Incentive and variable compensation as a % of compensation and benefits expense 15% 11% 28% Compensation for temporary employees, contractors and overtime hours as a % of compensation and benefits expense 6% 6% 9% Full-time equivalent employees (1) (at year end, in thousands) 16.7 19.6 26.3 Revenues per average full-time equivalent employee (in thousands) $ 220 $ 192 $ 239 - -------------------------------------------------------------------------------- (1) Includes full-time, part-time and temporary employees, and persons employed on a contract basis. Employee benefits and other expense increased by $21 million, or 7%, from 2001 primarily due to higher health insurance costs and employee claims. Additionally, employee benefits and other expense includes net pension income (which is a reduction to this expense line item) related to U.S. Trust's defined benefit pension plan. Net pension income totaled less than $1 million for 2002, $12 million for 2001, and $10 million for 2000. The decrease in net pension income in 2002 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. Following market declines in 2001 and 2002, U.S. Trust changed certain assumptions used to calculate its pension expense. The impact of these changes will be effective in 2003. U.S. Trust decreased its expected rate of return on pension plan assets from 9.00% to 8.25% and its discount rate from 7.50% to 6.75%. The Company expects that the impact of these changes will increase pension expense by approximately $8 million in 2003. The Company encourages and provides for employee ownership of the Company's common stock through its qualified retirement plan, its stock incentive plans, and its automatic investment plan. The Company's overall compensation structure is intended to attract, retain and reward highly qualified employees, and to align the interests of employees with those of stockholders. To further this alignment, the Company granted to all non-officer employees 11 million, 26 million and 11 million stock options in 2002, 2001 and 2000, respectively. In 2003, management expects to reduce the level of stock option grants to employees and to provide officers a new long-term incentive program, which includes both cash and restricted stock. At December 31, 2002, directors, management and employees, and their respective families, trusts and foundations, owned, including stock held for employees' benefit in the Company's retirement plan, approximately 28% of the Company's outstanding common stock. In addition, directors, management and employees held options to purchase common stock in an amount equal to approximately 12% of the Company's outstanding common stock at December 31, 2002. Other Compensation - Merger Retention Programs Other compensation - merger retention programs consists of retention programs established for U.S. Trust and CyberTrader employees, under which the employees received cash compensation, contingent upon continued employment for the two-year periods ended May 31, 2002 and March 1, 2002, respectively. The aggregate cost of the U.S. Trust and CyberTrader retention programs was $117 million and was amortized over the programs' respective two-year periods. The combined expense for the programs was $22 million in 2002, $56 million in 2001, and $39 million in 2000. The decrease from 2001 to 2002 and the increase from 2000 to 2001 were due to the fact that the retention programs were in place for a full year in 2001 compared to partial years in 2002 and 2000. Occupancy and Equipment Occupancy and equipment expense includes the costs of leasing and maintaining the Company's office space, four regional client telephone service centers, two primary data centers, 388 Schwab domestic branch offices, and 34 U.S. Trust offices. It also includes lease and rental expenses for computer and other equipment. Occupancy and equipment expense was $471 million in 2002, compared to $490 million in 2001 and $415 million in 2000. The decrease in occupancy and equipment expense from 2001 to 2002 was primarily due to the Company's restructuring initiatives and other expense reduction measures. The increase in occupancy and equipment expense from 2000 to 2001 reflects the Company's growth and expansion in 1999 and 2000, as well as higher lease and maintenance expenses for information technology equipment. Schwab opened 1 new domestic branch office in 2002, 22 in 2001, and 44 in 2000. The Company's 2002 restructuring initiatives included charges for the consolidation of 18 Schwab branch offices and 2 U.S. Trust offices planned for 2003. - 14 - Depreciation and Amortization Depreciation and amortization includes expenses relating to equipment and office facilities, capitalized software, leasehold improvements, property and other intangibles. This expense was $321 million in 2002, compared to $338 million in 2001 and $255 million in 2000. The decrease from 2001 to 2002 was primarily due to the Company's restructuring initiatives and other expense reduction measures. The increase from 2000 to 2001 was primarily due to increased amortization of internally-developed software, information technology equipment acquired in 2000 and 1999, and leasehold improvements for new branches and expanded office space. Amortization expense related to intangible assets was $11 million in both 2002 and 2001, and $10 million in 2000. Communications Communications expense includes telephone, postage and printing, and news and quotation costs. This expense was $262 million in 2002, compared to $339 million in 2001 and $353 million in 2000. The decreases from 2000 to 2002 were primarily due to lower client trading volumes and the Company's expense reduction measures. In 2001, this decrease was partially offset by increased client use of automated telephonic and online channel news, quotation and information services. Advertising and Market Development Advertising and market development expense includes media, print and direct mail advertising expenses, and related production, printing and postage costs. This expense was $211 million in 2002, compared to $246 million in 2001 and $332 million in 2000. The decreases from 2000 to 2002 were primarily due to reductions, as part of the Company's expense reduction measures, in brand-focused television and other media spending. In 2002, this decrease was partially offset by an increase in print media spending to promote the launch of the Company's full-service advice and relationship service offering. Professional Services Professional services expense includes fees paid to consultants engaged to support product, service and information technology projects, as well as legal and accounting fees, but excludes all merger-related professional fees related to the merger with USTC. This expense was $177 million in 2002, compared to $193 million in 2001 and $255 million in 2000. The decreases from 2000 to 2002 were primarily due to the Company's expense reduction measures. Commissions, Clearance and Floor Brokerage Commissions, clearance and floor brokerage expense includes fees paid to stock and option exchanges for trade executions, fees paid by SCM to broker-dealers for orders received for execution, and fees paid to clearing entities for trade processing. This expense was $71 million in 2002, compared to $92 million in 2001 and $138 million in 2000. The decreases from 2000 to 2002 were primarily due to decreases in trading volume processed by SCM and Schwab. Goodwill and Other Impairment Charges Goodwill represents the cost of acquired businesses in excess of fair value of the related net assets at acquisition. On January 1, 2002, the Company adopted SFAS No. 142 - Goodwill and Other Intangible Assets. The Company did not record any goodwill impairment charges upon completion of the initial transitional impairment test under SFAS No. 142 in the second quarter of 2002. During the fourth quarter of 2002, the Company developed plans for the possible sale of CSE. Accordingly, the Company performed a goodwill impairment test relating to CSE at that time pursuant to SFAS No. 142. In December 2002, the Company recorded goodwill and other impairment charges of $61 million associated with the Company's European operations, including $24 million for goodwill impairment related to CSE and $37 million for an investment write-down of Aitken Campbell, the Company's market-making joint venture in the United Kingdom. For further information, see note "4 - Goodwill and Other Impairment Charges" in the Notes to Consolidated Financial Statements. Goodwill Amortization Upon adoption of SFAS No. 142, amortization of the existing goodwill ceased and therefore there was no such expense in 2002. Goodwill amortization expense was $66 million in 2001, compared to $53 million in 2000. The increase from 2000 to 2001 was primarily due to goodwill related to the acquisition of CyberTrader. Merger-related Merger-related expense includes professional fees, change-in-control related compensation expense and other expenses related to the merger with USTC. This expense was $69 million in 2000. There were no such expenses in 2002 or 2001. Other Expenses Other expenses include trading volume-related regulatory expenses, travel and entertainment, trade-related errors, and other miscellaneous expenses. These other expenses were $144 million in 2002, compared to $104 million in 2001 and $234 million in 2000. The increase from 2001 to 2002 was partially due to minority interest losses of certain subsidiaries which were closed during 2001. These minority interest losses represent the proportionate amount of operating losses related to third-party shareholders and are netted against other expenses. Accordingly, the absence of these minority interest losses has the effect of increasing expense in 2002. - 15 - Additionally, the increase from 2001 to 2002 was due to an increase in error and bad debt expense, and higher travel and related costs associated with new product offerings, partially offset by lower trading volume-related regulatory expenses. The decrease from 2000 to 2001 was primarily due to significantly lower levels of trade-related errors, travel and related costs, and trading volume-related regulatory expenses. Taxes on Income The Company's effective income tax rate was 42.6% in 2002, 44.1% in 2001, and 41.7% in 2000. The decrease from 2001 to 2002 was primarily due to the cessation of goodwill amortization, which was primarily non-deductible for tax purposes. The increase from 2000 to 2001 was primarily due to the greater impact of goodwill amortization as a percentage of income before taxes on income. 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 (the Act). 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 "21 - Regulatory Requirements" in the Notes to 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 December 31, 2002 and 2001, the Company and its depository institution subsidiaries are considered well capitalized. CSC has liquidity needs that arise from its issued and outstanding $566 million Medium-Term Notes, as well as from the funding of cash dividends, acquisitions, and other investments. The Medium-Term Notes have maturities ranging from 2003 to 2010 and fixed interest rates ranging from 6.04% to 8.05% with interest payable semiannually. During 2002, CSC entered into Swaps that effectively convert the interest rate characteristics of a portion of the Medium-Term Notes from fixed to variable. For a complete discussion of the Swaps, see note "23 - Financial Instruments Subject to Off-Balance-Sheet Risk, Credit Risk or Market Risk" in the Notes to Consolidated Financial Statements. 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 SEC enabling CSC to issue up to an additional $750 million in Medium-Term Notes. At December 31, 2002, all of these notes remained unissued. CSC has authorization from its Board of Directors (Board) to issue up to $1.0 billion in commercial paper. At December 31, 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 scheduled to expire in June 2003. CSC plans to establish a similar facility to replace this one when it expires. This facility was unused in 2002. Any issuances under CSC's commercial paper program (see above) 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 a total of $770 million uncommitted, unsecured bank credit lines, provided by 8 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 in 2002. Schwab Most of Schwab's assets are liquid, consisting primarily of short-term (i.e., less than 90 days) investment-grade, interest-earning investments (the majority of which are segregated for the exclusive benefit of clients pursuant to regulatory requirements), receivables from brokerage clients, and receivables from brokers, dealers and clearing organizations. Client margin loans are demand loan obligations secured by readily marketable securities. Receivables from and payables to brokers, dealers and clearing organizations primarily represent current open transactions, which usually settle, or can be closed out, within a few business days. - 16 - Liquidity needs relating to client trading and margin borrowing activities are met primarily through cash balances in brokerage client accounts, which were $24.9 billion, $25.0 billion and $25.2 billion at December 31, 2002, 2001 and 2000, 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 December 31, 2002, Schwab's net capital was $1.2 billion (18% of aggregate debit balances), which was $1.1 billion in excess of its minimum required net capital and $869 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 requirement, 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 December 31, 2002 was $220 million. At year 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 maintains uncommitted, unsecured bank credit lines with a group of eight banks totaling $770 million at December 31, 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 15 days in 2002, with the daily amounts borrowed averaging $47 million. There were no borrowings outstanding under these lines at December 31, 2002. To satisfy the margin requirement of client option transactions with the Options Clearing Corporation (OCC), Schwab has unsecured letter of credit agreements with nine banks in favor of the OCC aggregating $630 million at December 31, 2002. Schwab pays a fee to maintain these letters of credit. No funds were drawn under these letters of credit at December 31, 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 December 31, 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 $701 million. At December 31, 2002, there were no borrowings outstanding under these facilities. Additionally, at December 31, 2002, U.S. Trust had $181 million of federal funds purchased and $326 million of repurchase agreements outstanding. CSC provides U.S. Trust with a $300 million short-term credit facility maturing in December 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 December 31, 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 equivalents, marketable securities, and receivables from brokers, dealers and clearing organizations. SCM's liquidity is affected by the same net capital regulatory requirements as Schwab (see previous discussion). At December 31, 2002, SCM's net capital was $99 million, which was $98 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 December 31, 2002 was $50 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 December 31, 2002. - 17 - Liquidity Risk Factors The Company manages risk by maintaining sufficient liquid financial resources to fund its balance sheet and meet its obligations. The Company's liquidity needs are met primarily through cash generated by its subsidiaries' operations, as well as cash provided by external financing. Risks in meeting these needs may arise with fluctuations in client cash or deposit balances, as well as changes in market conditions. Specific risk factors which may affect the Company's liquidity position include: - - a dramatic increase in the Company's client lending activities (including margin, mortgage, and personal lending) which may reduce the Company's liquid resources and capital position; - - a significant increase in client order flow in SCM's market-making activities, creating an imbalance of long or short securities positions which may reduce the Company's liquid resources and excess capital position; - - a reduction in cash held in banking or brokerage client accounts which may affect the amount of the Company's liquid assets; and - - a significant downgrade in the Company's credit ratings which could increase its borrowing costs and limit its access to the capital markets. Cash and Capital Resources The Company's cash position (reported as cash and cash equivalents on the Company's 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, payments of dividends, and repurchases of CSC's common stock. In 2002, cash and cash equivalents decreased $1.3 billion, or 29%, to $3.1 billion primarily due to movements of brokerage client-related funds to meet segregation requirements, increases in loans to banking clients, and decreases in brokerage client cash balances. Management does not believe that this decline in cash and cash equivalents is an indication of a trend. The Company's capital expenditures were $160 million in 2002 and $301 million in 2001, or 4% and 7% of revenues, respectively. In 2002, 82% of capital expenditures were for information technology and 18% for facilities expansion and improvements. The $141 million, or 47%, decrease in capital expenditures in 2002 was primarily due to the Company's response to continued declines in client trading volumes and difficult market conditions which characterized most of the year. Capital expenditures as described above include the capitalized costs for developing internal-use software of $71 million in 2002 and $79 million in 2001. Schwab opened 1 new domestic branch office during 2002, compared to 22 in 2001. The Company continues to view its office network as important to pursuing its strategy of attracting client assets. Management currently anticipates that 2003 capital expenditures will be approximately equal to 2002 spending. As has been the case in recent years, the Company may adjust its capital expenditures from period to period as business conditions change. During 2002, the Company: - - Issued $100 million and repaid $214 million of long-term debt; - - Received cash proceeds of $34 million on the exercise of 6 million of the Company's stock options, with a weighted-average exercise price of $6.59, and a related tax benefit of $7 million; and - - Paid common stock dividends of $60 million. 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 December 31, 2002 was $4.7 billion, down $240 million, or 5%, from a year ago, due to an increase in common stock repurchases and a net decline in long-term debt. At December 31, 2002, the Company had long-term debt of $642 million, or 14% of total financial capital, bearing interest at a weighted-average rate of 7.4%. At December 31, 2002, the Company's stockholders' equity was $4.0 billion, or 86% of total financial capital. Management currently anticipates that long-term debt will remain below 30% of total financial capital. - 18 - Commitments A summary of the Company's principal contractual obligations and other commitments as of December 31, 2002 is shown in the following table. 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) $ 257 $ 798 $ 306 $ 649 $2,010 Long-term debt (2) 100 205 53 258 616 Credit-related financial instruments (3) 565 128 693 Other commitments (4) 6 6 - -------------------------------------------------------------------------------- Total $ 928 $1,131 $ 359 $ 907 $3,325 ================================================================================ (1) Includes minimum rental commitments, net of sublease commitments, and maximum guaranteed residual values under noncancelable leases for office space and equipment. See Note 22 to the Consolidated Financial Statements. (2) See Note 15 to the Consolidated Financial Statements. (3) Includes U.S. Trust firm commitments to extend credit primarily for mortgage loans to private banking clients and standby letters of credit. See Note 23 to the Consolidated Financial Statements. (4) Includes committed capital contributions to venture capital funds. See Note 22 to the Consolidated Financial Statements. 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 according to the terms specified in the agreements. Share Repurchases On September 20, 2001, the Board authorized repurchases of the Company's common stock totaling up to $500 million. The shares may be repurchased through open market or privately negotiated transactions based on prevailing market conditions. This authorization superseded the Board's repurchase authorization on March 21, 2001 for up to 20 million shares of CSC's common stock. CSC repurchased 32 million shares of its common stock for $299 million in 2002 and 27 million shares of its common stock for $368 million in 2001. At December 31, 2002, the authorization granted by the Board allows for future repurchases of CSC's common stock totaling up to $100 million. Dividend Policy Since the initial dividend in 1989, CSC has paid 55 consecutive quarterly dividends and has increased the dividend 12 times. Since 1989, dividends have increased by a 27% compounded annual growth rate. CSC paid common stock dividends of $.0440 per share in each of 2002 and 2001, and $.0407 per share in 2000. Dividends declared per common share do not include dividends declared by USTC prior to the completion of the merger. While the payment and amount of dividends are at the discretion of the Board, subject to certain regulatory and other restrictions, the Company targets its cash dividend at approximately 5% to 10% of net income plus depreciation and amortization. OFF-BALANCE SHEET ARRANGEMENTS During 2001, the Company began occupying and making lease payments on a newly renovated office building in San Francisco, California. The lease for the building was arranged by working with a bank to create an unconsolidated special purpose trust (Trust). For a discussion of the Trust and other contingent liabilities, see note "22 - Commitments and Contingent Liabilities" in the Notes to Consolidated Financial Statements. The Company plans to adopt Financial Accounting Standards Board Interpretation No. 46 - Consolidation of Variable Interest Entities in the first quarter of 2003. Under this interpretation, the Company will be required to consolidate the Trust by recording the Trust's assets and liabilities on the Company's consolidated balance sheet. For a discussion on the expected impact of this interpretation, see note "2 - Significant Accounting Policies" in the Notes to Consolidated Financial Statements. RISK MANAGEMENT Overview The Company's business and activities expose it to different types of risks including, but not limited to, those discussed below. Proper identification, assessment and management of these risks are essential to the success and financial soundness of the Company. Risk management and oversight at the Company begins with the Board. The Audit Committee reviews major risk exposures and the steps management has taken to monitor and control such exposures, and reports on these issues to the full Board. The Audit Committee delegates the formulation of policies and day-to-day risk oversight and management to the Executive Committee of the Company. The Executive Committee provides guidance regarding strategies and risk tolerance and is responsible for an integrated approach to risk exposures. The Executive Committee both delegates to and has several members who actively participate in risk management at the Company through the Global Risk Steering Committee. The Global Risk Steering Committee is responsible for reviewing and monitoring the Company's risk exposures, leading in the continued development of the Company's risk management policies and practices, reviewing changes in regulations and other risk-related developments, and reporting to the Audit Committee. Various other functional risk committees consisting of - 19 - members of senior management report into the Global Risk Steering Committee on a frequent basis. These committees include: - - Technology and Operations Risk Committee, which focuses on the integrity of operational controls and operating capacity of the Company's technology and operations systems; - - Credit, Finance, and Market Risk Oversight Committee, which focuses on the credit exposures resulting from client activity (i.e., margin lending activities and private banking loans), the investing activities of certain of the Company's proprietary funds, corporate credit activities (i.e., counterparty and corporate investing activities), the Company's liquidity, capital resources, interest rate risk, and the market risk resulting from securities positioning activities; - - Fiduciary Risk Committee, which focuses on overseeing the activities of the Company that are deemed to have a fiduciary component; - - Disclosure Committee, which focuses on the implementation and oversight of disclosure and internal controls as recommended pursuant to the Sarbanes-Oxley Act of 2002; and - - U.S. Trust Risk Policy Committee, which has broad responsibilities for the oversight of risk management at U.S. Trust; also reports to the Board of Directors of U.S. Trust. Additionally, the Finance, Risk Management, Compliance, and Internal Audit Departments and the Office of Corporate Counsel assist management and the various risk committees in evaluating and monitoring the Company's risk profile. 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. The following discussion highlights the Company's principal risks and some of the policies and procedures for risk identification, assessment, and mitigation. See Liquidity and Capital Resources for a discussion on liquidity risk and note "23 - Financial Instruments Subject to Off-Balance-Sheet Risk, Credit Risk or Market Risk" in the Notes to Consolidated Financial Statements for additional discussion on credit risk and market risk. Technology and Operating Risk Technology and operating risk is the potential for loss due to deficiencies in control processes or technology systems that constrain the Company's ability to gather, process and communicate information efficiently and securely, without interruptions. The Company's operations are highly dependent on the integrity of its technology systems and the Company's success depends, in part, on its ability to make timely enhancements and additions to its technology in anticipation of client demands. To the extent the Company experiences system interruptions, errors or downtime (which could result from a variety of causes, including changes in client use patterns, technological failure, changes to its systems, linkages with third-party systems, and power failures), the Company's business and operations could be significantly negatively impacted. Additionally, rapid increases in client demand may strain the Company's ability to enhance its technology and expand its operating capacity. To minimize business interruptions, Schwab has two data centers intended, in part, to further improve the recovery of business processing in the event of an emergency. Technology and operating risk also includes human error, fraud, a terrorist attack, and natural disaster. The Company attempts to mitigate technology and operating risk by maintaining a comprehensive internal control system and by employing experienced personnel. In 2002, as part of its restructuring initiatives, the Company centralized certain of its operations, mitigating the risks associated with decentralization of functions. Also, the Company maintains backup and recovery functions, including facilities for backup and communications, and conducts periodic testing of a disaster recovery plan. Each functional area deemed to be potentially of medium to high risk by management performs a risk self assessment on an annual basis to evaluate the appropriateness of these internal controls and recovery plans. During 2002, the Company enhanced its procedures related to its risk self assessments. The Company's risk committees and various policies and procedures, combined with these risk self assessments, are used in part to provide a vehicle for the Co-Chief Executive Officers and Chief Financial Officer to attest to the adequacy of the Company's controls. The Company is committed to an ongoing process of upgrading, enhancing, and testing its technology systems. This effort is focused on meeting client demands, meeting market and regulatory changes, and deploying standardized technology platforms. See note "21 - Regulatory Requirements" in the Notes to Consolidated Financial Statements for a discussion on the improvements to U.S. Trust's risk management processes and systems as a result of the USTC and U.S. Trust NY cease and desist order with the Federal Reserve Board and the Superintendent of Banks of the State of New York. The Company is engaged in the research and development of new technologies, services, and products. The Company endeavors to protect its research and development efforts, and its brands, through the use of copyrights, patents, trade secrets, and contracts. From time to time, third parties indicate that they believe the Company may be infringing on their intellectual property (e.g., patents) rights. The Company's efforts to assess the merits of third-party claims of infringement of intellectual property, and its efforts to protect its own intellectual property, require an investment of - 20 - time and resources. In certain circumstances, the Company attempts to obtain licenses under third-party intellectual property rights. In some circumstances, a license may not be available from a third party under acceptable terms. Similarly, the Company from time to time licenses its intellectual property to third parties. Under some circumstances, litigation may result from questions regarding infringement, ownership, validity, and scope of intellectual property. Such litigation can require the expenditure of significant Company resources. If the Company were found to have infringed a third-party patent, or other intellectual property rights, it could incur substantial liability, and in some circumstances could be enjoined from using certain technology, or providing certain products or services. Credit Risk Credit risk is the potential for loss due to a client or counterparty failing to perform its contractual obligations, or the value of collateral held to secure obligations proving to be inadequate. The Company's direct exposure to credit risk mainly results from its margin lending activities, securities lending activities, role as a counterparty in financial contracts, and investing activities, and indirectly from the investing activities of certain of the Company's proprietary funds. To mitigate the risks of such losses, the Company has established policies and procedures which include: establishing and reviewing credit limits, monitoring of credit limits and quality of counterparties, and increasing margin requirements for certain securities. In addition, most of the Company's credit extensions, such as margin loans to clients, securities lending agreements, and resale agreements, are supported by collateral arrangements. These arrangements are subject to requirements to provide additional collateral in the event that market fluctuations result in declines in the value of collateral received. Additionally, the Company has exposure to credit risk associated with the Company's private banking loan portfolio held at U.S. Trust. This counterparty credit exposure is actively managed through individual and portfolio reviews performed by account officers and senior line management. Periodic assessment of the validity of credit ratings, credit quality and the credit management process is conducted by a risk review department which is separate from the loan origination and monitoring department. Management regularly reviews asset quality including concentrations, delinquencies, non-performing private banking loans, losses and recoveries. All are factors in the determination of an appropriate allowance for credit losses, which is reviewed quarterly by senior management. See notes "8 - Loans to Banking Clients and Related Allowance for Credit Losses" and "23 - Financial Instruments Subject to Off-Balance-Sheet Risk, Credit Risk or Market Risk" in the Notes to Consolidated Financial Statements for an analysis of the Company's loan portfolio and allowance for credit losses, and for an additional discussion on credit risk, respectively. There were no troubled debt restructurings at December 31, 2002 or 2001. As of December 31, 2002, management is not aware of any significant potential problem loans other than the amounts disclosed in note "8 - Loans to Banking Clients and Related Allowance for Credit Losses" in the Notes to Consolidated Financial Statements. Fiduciary Risk Fiduciary risk is the potential for financial or reputational loss through the breaching of fiduciary duties to a client. Fiduciary activities include, but are not limited to, individual and corporate trust, investment management, custody, and cash and securities processing. The Company attempts to mitigate this risk by establishing procedures to ensure that obligations to clients are discharged faithfully and in compliance with applicable legal and regulatory requirements. Business units have the primary responsibility for adherence to the procedures applicable to their business. Guidance and control is provided through the creation, approval, and ongoing review of applicable policies by business units and various fiduciary risk committees. Market Risk Market risk is the potential for loss due to a change in the value of a financial instrument held by the Company as a result of fluctuations in interest rates, equity prices or currency exchange rates. The Company is exposed to interest rate risk primarily from changes in the interest rates on its interest-earning assets (mainly margin loans to clients, investments, private banking loans, mortgage-backed securities, and other fixed-rate investments) and its funding sources (including brokerage client cash balances, banking deposits, proceeds from stock-lending activities, long-term debt, and stockholders' equity) which finance these assets. To mitigate the risk of loss, the Company has established policies and procedures which include setting guidelines on the amount of net interest revenue at risk, and by monitoring the net interest margin and average maturity of its interest-earning assets and funding sources. The Company also has the ability to adjust the rates paid on certain brokerage client cash balances and certain banking deposits and the rates charged on margin loans. Additionally, the Company uses Swaps to mitigate interest rate exposure associated with short-term floating interest-rate deposits. As the Company looks ahead to 2003, the interest rate environment remains at cyclical lows and the Federal Reserve Board has adopted a neutral stance toward monetary policy. Additional interest rate declines could adversely affect the Company's ability to maintain its net interest spread as well as the revenue yields on its money funds. The Company is exposed to equity price risk through its role as a financial intermediary in client-related transactions, - 21 - and by holding financial instruments mainly in its capacity as a market maker and relating to its specialists' and proprietary equity trading operations. To mitigate the risk of losses, these financial instruments are monitored by management to assure compliance with limits established by the Company. In addition, these financial instruments are marked to market on a daily basis. Also, the Company purchases and sells from time to time exchange-traded futures and options to mitigate market risk on these inventories. During 2002, the Company expanded its institutional equity capabilities to focus on improving execution capabilities for institutional clients. To accommodate the growth, certain trading limits were expanded. The Company mitigates the risk associated with the increased limits by using those limits primarily on an intra-day basis. While not material, the Company is also exposed to currency exchange risks through its international operations. Additional qualitative and quantitative disclosures about market risk are summarized in the following paragraphs. See note "23 - Financial Instruments Subject to Off-Balance-Sheet Risk, Credit Risk or Market Risk" in the Notes to Consolidated Financial Statements for an additional discussion on 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 needs. The fair value of such inventory was approximately $34 million and $36 million at December 31, 2002 and 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 is shown in the following table: - -------------------------------------------------------------------------------- December 31, 2002 2001 - -------------------------------------------------------------------------------- Equity Securities: Long positions $ 79 $ 167 Short positions (7) (27) - -------------------------------------------------------------------------------- Net long positions $ 72 $ 140 ================================================================================ Using a hypothetical 10% increase or decrease in prices, the potential loss or gain in fair value is estimated to be approximately $7 million and $14 million at December 31, 2002 and 2001, respectively. 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: - -------------------------------------------------------------------------------- December 31, 2002 2001 - -------------------------------------------------------------------------------- Exchange-traded Contracts: Net Short Futures (1): Notional Amount $ 61 $ 125 Fair Value $ 63 $ 125 Long Put Options: Notional Amount $ 4 $ 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 December 31, 2002 and 2001. 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 December 31, 2002 and December 31, 2001, respectively, which would substantially offset the potential loss or gain on the equity securities previously discussed. In view of the continued expansion of the Company's businesses, the Company plans to transition its market risk disclosures to incorporate a value-at-risk (VAR) methodology in 2003. VAR is an increasingly utilized industry tool that provides a process for assessing and aggregating market risk across the Company's trading activities. The methodology will draw on market data to estimate the potential price volatility of financial instruments held for trading purposes and then measure the potential decline in their value, under a variety of market conditions over a discrete period of time. By assessing disparate risks on a consistent basis, VAR will further the integration of risk management across the Company's different businesses. Financial Instruments Held For Purposes Other Than Trading The Company maintains investments in mutual funds related to its deferred compensation plan, which is available to certain employees. These investments were approximately $49 million and $61 million at December 31, 2002 and 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 December 31, 2002 and 2001, CSC had $566 million and $679 million aggregate principal amount of Medium-Term Notes outstanding, respectively, with fixed interest rates ranging from 6.04% to 8.05%. At December 31, 2002 and 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 - 22 - 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 December 31, 2002 and 2001, based on estimates of market rates for debt with similar terms and remaining maturities, was $674 million and $765 million, respectively, which approximated their carrying amounts of $642 million and $730 million, respectively. Interest Rate Swaps As part of its consolidated asset and liability management process, the Company utilizes Swaps to manage interest rate risk. For a discussion of such Swaps, see note "23 - Financial Instruments Subject to Off-Balance-Sheet Risk, Credit Risk or Market Risk" in the Notes to Consolidated Financial Statements. 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 loan and brokerage client cash balance growth or decline, changes in 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 interest rates fall (i.e., interest-earning assets are repricing more quickly than interest-bearing liabilities). The Swaps entered into during 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 results 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 December 31, 2002 and 2001. The simulations demonstrate a greater sensitivity to changes in interest rates as of December 31, 2002 than in the prior year. This is primarily due to the continued decline in interest rates from year to year and its impact on the Company's ability to earn net interest revenue on client cash balances. - -------------------------------------------------------------------------------- Impact on Net Interest Revenue Percentage Increase (Decrease) December 31, 2002 2001 - -------------------------------------------------------------------------------- Increase of 100 basis points 5.3% 3.8% Decrease of 100 basis points (12.1%) (7.0%) ================================================================================ Legal and Compliance Risk Legal and compliance risk refers to the possibility that the Company will be found, by a court, arbitration panel or regulatory authority, not to have complied with an applicable legal or regulatory requirement. The Company may be subject to lawsuits or arbitration claims by clients, employees or other third parties in the different jurisdictions in which it conducts business. Claims against the Company may increase as clients suffer losses due to deteriorating equity market conditions, as the Company increases the level of advice it provides to clients, and as the Company strengthens its relationship with IAs. In addition, the Company is subject to extensive regulation by the SEC, the National Association of Securities Dealers, Inc., the New York Stock Exchange (NYSE), the Commodity Futures Trading Commission, the Federal Reserve Board, the FDIC, the Superintendent of Banks of the State of New York, and other federal, state and market regulators, as well as certain foreign regulatory authorities. New rules and changes in application of current rules could affect the Company's manner of operations and profitability. The Company attempts to mitigate legal and compliance risk through policies and procedures that it believes are reasonably designed to prevent or detect violations of applicable statutory and regulatory requirements (see note "22 - Commitments and Contingent Liabilities" in the Notes to Consolidated Financial Statements). However, violations of applicable statutory and regulatory requirements could subject the Company and/or its directors, officers or employees to disciplinary proceedings or civil or criminal liability. Any such proceeding could cause a significant negative impact on the Company's business and operations. Competition The Company faces significant competition from companies seeking to attract client financial assets, including traditional, discount and online brokerage firms, mutual fund - 23 - companies, banks, and asset management and wealth management companies. Certain of these competitors have greater financial resources than the Company. As the Company makes progress in its development of banking and other financial products as well as advice offerings to clients, it may face competition from different companies. The expansion and client acceptance of conducting financial transactions online, as well as through wireless applications, have also attracted competition from providers of online services, software development companies and other providers of financial services. Finally, online trading has led to the creation of ECNs and new exchanges which may intensify competition. Increased competition may have a negative impact on the Company's business and operations. CORPORATE GOVERNANCE On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002 (S.O. Act) in response to corporate and accounting scandals that were adversely affecting public confidence in the securities markets. Among other things, the S.O. Act imposes stringent requirements to ensure independence of public accounting firms, independence of audit committees, full and fair disclosure of financial and other information in public reports, and accountability of chief executive officers and chief financial officers for such reports. The SEC has issued final and proposed rules for implementing certain requirements of the S.O. Act. In addition, on August 16, 2002, the NYSE submitted to the SEC proposed new corporate governance rules for companies listed on the NYSE. These rules are intended, among other things, to enhance director independence standards, empower non-management directors to play a more active role on companies' boards, increase the authority and responsibilities of audit committees, and otherwise augment corporate governance processes and enhance disclosures of those processes. The proposed NYSE rules are under consideration by the SEC. The Company supports the goals of these new requirements, and has undertaken a comprehensive review of its corporate governance processes to help achieve compliance with the S.O. Act and promote a strong culture of corporate governance and ethical decision-making. The Company has also taken action to comply with the new SEC rules issued under the S.O. Act and to be in position to comply with proposed rules under the S.O. Act and the NYSE listing standards if and when adopted. The Company has announced that effective May 9, 2003, the date of the annual meeting of shareholders, David S. Pottruck will become President and Chief Executive Officer (CEO), and Charles R. Schwab will remain as Chairman of the Board. The Company believes that separating the roles of Chairman and CEO is an important corporate governance measure. Additionally, the Company has, among other things: - - Created a Nominating and Corporate Governance Committee of the Board responsible for identifying candidates for the Board and recommending corporate governance guidelines, policies and procedures for the Company. - - Revised the charters for the Audit Committee and Compensation Committee. - - Adopted a Code of Business Conduct and Ethics applicable to directors and all employees. - - Adopted Corporate Governance Guidelines for the Company. - - Created a Corporate Governance Office, headed by the General Counsel, to assist the Board in fulfilling its oversight responsibilities. - - Revised the charters for the Audit Committee and Compensation Committee to clarify the responsibilities of these committees in light of the new and proposed rules. - - Adopted procedures for reporting to the Audit Committee complaints regarding accounting, internal accounting controls and auditing matters, as well as any significant deficiencies or material weaknesses in internal controls or fraud involving management or employees who have significant roles in internal controls. - - Adopted an interim policy regarding the approval of non-audit services to be performed by the Company's independent auditors. - - Created a Disclosure Committee to carry out the development, implementation and oversight of disclosure controls and procedures to ensure that the Company's public disclosures are accurate, timely, and complete in accordance with applicable legal and regulatory requirements. The Disclosure Committee provides written attestation to the Co-Chief Executive Officers, Chief Financial Officer, and the Audit Committee as to the adequacy of disclosure controls and procedures. As of December 31, 2002, with the exception of Charles R. Schwab and David S. Pottruck, all of the directors on the Board are independent. All of the directors on the Board's Audit, Compensation, and Nominating and Corporate Governance Committees are independent. - 24 -
Consolidated Statement of Income The Charles Schwab Corporation (In Millions, Except Per Share Amounts) Year Ended December 31, 2002 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------------ Revenues Asset management and administration fees $ 1,761 $ 1,675 $ 1,583 Commissions 1,206 1,355 2,294 Interest revenue 1,186 1,857 2,589 Interest expense (345) (928) (1,352) -------- -------- -------- Net interest revenue 841 929 1,237 Principal transactions 184 255 570 Other 143 139 104 - ------------------------------------------------------------------------------------------------------------------------------------ Total 4,135 4,353 5,788 - ------------------------------------------------------------------------------------------------------------------------------------ Expenses Excluding Interest Compensation and benefits 1,854 1,875 2,414 Other compensation - merger retention programs 22 56 39 Occupancy and equipment 471 490 415 Depreciation and amortization 321 338 255 Communications 262 339 353 Advertising and market development 211 246 332 Professional services 177 193 255 Commissions, clearance and floor brokerage 71 92 138 Restructuring and other charges 373 419 Goodwill and other impairment charges 61 Goodwill amortization 66 53 Merger-related 69 Other 144 104 234 - ------------------------------------------------------------------------------------------------------------------------------------ Total 3,967 4,218 4,557 - ------------------------------------------------------------------------------------------------------------------------------------ Income before taxes on income and extraordinary gain 168 135 1,231 Taxes on income 71 57 513 - ------------------------------------------------------------------------------------------------------------------------------------ Income before extraordinary gain 97 78 718 Extraordinary gain on sale of corporate trust business, net of tax 12 121 - ------------------------------------------------------------------------------------------------------------------------------------ Net Income $ 109 $ 199 $ 718 ==================================================================================================================================== Weighted-Average Common Shares Outstanding - Diluted 1,375 1,399 1,404 ==================================================================================================================================== Earnings Per Share - Basic Income before extraordinary gain $ .07 $ .06 $ .53 Extraordinary gain, net of tax $ .01 $ .08 Net income $ .08 $ .14 $ .53 Earnings Per Share - Diluted Income before extraordinary gain $ .07 $ .06 $ .51 Extraordinary gain, net of tax $ .01 $ .08 Net income $ .08 $ .14 $ .51 ==================================================================================================================================== Dividends Declared Per Common Share $ .0440 $ .0440 $ .0407 ==================================================================================================================================== See Notes to Consolidated Financial Statements.
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Consolidated Balance Sheet The Charles Schwab Corporation (In Millions, Except Share and Per Share Amounts) December 31, 2002 2001 - ------------------------------------------------------------------------------------------------------------------------------------ Assets Cash and cash equivalents $ 3,114 $ 4,407 Cash and investments segregated and on deposit for federal or other regulatory purposes (1) (including resale agreements of $16,111 in 2002 and $14,811 in 2001) 21,005 17,741 Securities owned - at market value (including securities pledged of $337 in 2002 and $185 in 2001) 1,716 1,700 Receivables from brokers, dealers and clearing organizations 222 446 Receivables from brokerage clients - net 6,845 9,620 Loans to banking clients - net 4,555 4,046 Equipment, office facilities and property - net 868 1,058 Goodwill - net 603 628 Other assets 777 818 - ------------------------------------------------------------------------------------------------------------------------------------ Total $39,705 $40,464 ==================================================================================================================================== Liabilities and Stockholders' Equity Deposits from banking clients $ 5,231 $ 5,448 Drafts payable 134 396 Payables to brokers, dealers and clearing organizations 1,476 833 Payables to brokerage clients 26,401 26,989 Accrued expenses and other liabilities 1,302 1,327 Short-term borrowings 508 578 Long-term debt 642 730 - ------------------------------------------------------------------------------------------------------------------------------------ Total liabilities 35,694 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; 1,391,991,180 and 1,391,673,494 shares issued in 2002 and 2001, respectively 14 14 Additional paid-in capital 1,744 1,726 Retained earnings 2,769 2,794 Treasury stock - 47,195,631 and 23,110,972 shares in 2002 and 2001, respectively, at cost (465) (295) Unamortized stock-based compensation (33) (39) Accumulated other comprehensive loss (18) (37) - ------------------------------------------------------------------------------------------------------------------------------------ Total stockholders' equity 4,011 4,163 - ------------------------------------------------------------------------------------------------------------------------------------ Total $39,705 $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 $21,252 million and $18,261 million at December 31, 2002 and 2001, respectively. On January 2, 2003, the Company deposited $655 million into its segregated reserve bank accounts. As of January 3, 2002, the Company had deposited $710 million into its segregated reserve bank accounts. See Notes to Consolidated Financial Statements.
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Consolidated Statement of Cash Flows The Charles Schwab Corporation (In Millions) Year Ended December 31, 2002 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------------ Cash Flows from Operating Activities Net income $ 109 $ 199 $ 718 Adjustments to reconcile net income to net cash provided by (used for) operating activities: Depreciation and amortization 321 338 255 Goodwill and other impairment charges 61 Goodwill amortization 66 53 Compensation payable in common stock 27 32 82 Deferred income taxes 4 (79) (27) Tax benefits from stock options exercised and other stock-based compensation 4 37 330 Non-cash restructuring and other charges 42 80 Net gain on sale of an investment (26) Extraordinary gain on sale of corporate trust business, net of tax (12) (121) Other (1) 22 8 Net change in: Cash and investments segregated and on deposit for federal or other regulatory purposes (3,302) (8,334) (942) Securities owned (excluding securities available for sale) 105 14 (54) Receivables from brokers, dealers and clearing organizations 220 (89) 131 Receivables from brokerage clients 2,745 6,709 727 Other assets 7 (35) (94) Drafts payable (261) (150) 75 Payables to brokers, dealers and clearing organizations 643 (335) (662) Payables to brokerage clients (527) 1,291 2,329 Accrued expenses and other liabilities (16) (203) (13) - ------------------------------------------------------------------------------------------------------------------------------------ Net cash provided by (used for) operating activities 169 (584) 2,916 - ------------------------------------------------------------------------------------------------------------------------------------ Cash Flows from Investing Activities Purchases of securities available for sale (1,147) (1,025) (545) Proceeds from sales of securities available for sale 636 473 93 Proceeds from maturities, calls and mandatory redemptions of securities available for sale 415 611 227 Net increase in loans to banking clients (705) (835) (458) Proceeds from sale of banking client loans 196 Purchase of equipment, office facilities and property - net (160) (301) (705) Cash payments for business combinations and investments, net of cash received (52) (35) Proceeds from sale of an investment 49 Proceeds from sale of Canadian operations 26 Proceeds from sale of corporate trust business 273 - ------------------------------------------------------------------------------------------------------------------------------------ Net cash used for investing activities (739) (807) (1,423) - ------------------------------------------------------------------------------------------------------------------------------------ Cash Flows from Financing Activities Net change in deposits from banking clients (217) 1,139 4 Net change in short-term borrowings (70) 224 198 Proceeds from long-term debt 100 311 Repayment of long-term debt (214) (40) (59) Dividends paid (60) (61) (62) Purchase of treasury stock (299) (368) Proceeds from stock options exercised and other 34 30 85 - ------------------------------------------------------------------------------------------------------------------------------------ Net cash provided by (used for) financing activities (726) 924 477 - ------------------------------------------------------------------------------------------------------------------------------------ Effect of exchange rate changes on cash and cash equivalents 3 (2) (4) - ------------------------------------------------------------------------------------------------------------------------------------ Increase (Decrease) in Cash and Cash Equivalents (1,293) (469) 1,966 Cash and Cash Equivalents at Beginning of Year 4,407 4,876 2,910 - ------------------------------------------------------------------------------------------------------------------------------------ Cash and Cash Equivalents at End of Year $ 3,114 $ 4,407 $ 4,876 ==================================================================================================================================== See Notes to Consolidated Financial Statements.
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Consolidated Statement of Stockholders' Equity The Charles Schwab Corporation (In Millions) Common Stock Accumu- Issued lated Deferred to Other Addi- Compen- Employee Unamortized Deferred Compre- tional sation Stock Stock-based Compen- hensive Common Paid-In Retained Stock Treasury Ownership Compen- sation Income Stock Capital Earnings Trust (1) Stock Plans sation Trust (1) (Loss) Total - ------------------------------------------------------------------------------------------------------------------------------------ Balance at December 31, 1999 $ 13 $ 595 $ 2,145 $ 2 $ (97) $ (1) $ (71) $ (2) $ (8) $2,576 - ------------------------------------------------------------------------------------------------------------------------------------ Comprehensive income: Net income 718 718 Foreign currency translation adjustment (16) (16) Net unrealized gain (loss) on securities available for sale, net of reclassification adjustment and tax 10 10 ------ Total comprehensive income 712 Dividends declared on common stock (58) (58) Stock options exercised, and shares and stock options issued under stock-based compensation plans 1 440 (37) 404 Issuance of shares for acquisitions 529 529 Retirement of treasury stock (5) (92) 97 Amortization of stock-based compensation awards 37 37 ESOP shares released for allocation 29 1 30 - ------------------------------------------------------------------------------------------------------------------------------------ Balance at December 31, 2000 14 1,588 2,713 2 (71) (2) (14) 4,230 - ------------------------------------------------------------------------------------------------------------------------------------ Comprehensive income: Net income 199 199 Cumulative effect of accounting change, net of tax (12) (12) Net loss on cash flow hedging instruments, net of tax (19) (19) Foreign currency translation adjustment (2) (2) Net unrealized gain (loss) on securities available for sale, net of reclassification adjustment and tax 10 10 ------ Total comprehensive income 176 Dividends declared on common stock (61) (61) Purchase of treasury stock (368) (368) Deferred compensation payable in common stock 1 (1) Stock options exercised, and shares and stock options issued under stock-based compensation plans 48 (57) 77 (3) 65 Non-cash stock-based compensation expense related to restructuring 19 1 20 Issuance of shares for acquisitions 71 71 Receipt of shares in settlement of accounts receivable (4) (4) Amortization of stock-based compensation awards 34 34 - ------------------------------------------------------------------------------------------------------------------------------------ Balance at December 31, 2001 14 1,726 2,794 3 (295) (39) (3) (37) 4,163 - ------------------------------------------------------------------------------------------------------------------------------------ Comprehensive income: Net income 109 109 Net loss on cash flow hedging instruments, net of tax (6) (6) Foreign currency translation adjustment 8 8 Net unrealized gain (loss) on securities available for sale, net of reclassification adjustment and tax 17 17 ------ Total comprehensive income 128 Dividends declared on common stock (60) (60) Purchase of treasury stock (299) (299) Stock options exercised, and shares and stock options issued under stock-based compensation plans 5 (74) 129 (22) 38 Non-cash stock-based compensation expense related to restructuring 9 1 10 Issuance of shares for acquisitions 4 4 Amortization of stock-based compensation awards 27 27 - ------------------------------------------------------------------------------------------------------------------------------------ Balance at December 31, 2002 $ 14 $1,744 $ 2,769 $ 3 $ (465) $ (33) $ (3) $ (18) $4,011 ==================================================================================================================================== (1) Deferred compensation stock trust amounts are presented net on the Consolidated Balance Sheet. See Notes to Consolidated Financial Statements.
- 28 - The Charles Schwab Corporation Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share and Option Price Amounts) 1. Introduction and 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 388 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 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 traders. The consolidated financial statements include CSC and its majority-owned subsidiaries (collectively referred to as the Company). Investments in equity securities of other firms where the Company has significant influence, but owns less than a majority of the voting securities, are generally accounted for by the equity method. Under the equity method, the investment is initially recorded at cost with the carrying amount subsequently adjusted to recognize the Company's proportionate share of the earnings or losses of the investee. The consolidated financial statements are prepared in conformity with accounting principles generally accepted in the U.S., which require management to make certain estimates and assumptions that affect the reported amounts in the accompanying financial statements. Such estimates relate to capitalized development costs for internal-use software, useful lives of equipment, office facilities, and property, valuation of goodwill and other intangible assets and equity investments, fair value of financial instruments and investments, allowance for credit losses on banking loans, allowance for doubtful accounts of brokerage clients, retirement and postretirement benefits, future tax benefits, restructuring liabilities, and legal reserves. Actual results could differ from such estimates. Certain prior-year amounts have been reclassified to conform to the 2002 presentation. All material intercompany balances and transactions have been eliminated. On May 31, 2000, CSC completed its merger (the Merger) with USTC. Under the terms of the merger agreement, USTC became a wholly owned subsidiary of CSC and USTC shareholders received 5.1405 shares of CSC's common stock for each common share of USTC. During 2000, merger-related costs totaled $69 million pre-tax, or $63 million after-tax, for change-in-control related compensation payable to U.S. Trust employees and professional fees. The consolidated financial statements, included in this Annual Report, give retroactive effect to the Merger, which was accounted for as a pooling of interests. On March 1, 2000, the Company acquired CyberTrader for $517 million in a non-taxable stock-for-stock exchange. Because the acquisition is accounted for using the purchase method, the operating results of CyberTrader are included in the consolidated results of the Company since the acquisition date. The historical results of CyberTrader are not included in periods prior to the acquisition. The net assets acquired are recorded at fair value and the excess of the purchase price over the fair value of net assets acquired is recorded as goodwill. The Company recorded intangible assets acquired of $512 million, including $482 million of goodwill. 2. Significant Accounting Policies Securities transactions: Clients' securities transactions are recorded on the date that they settle, while the related commission revenues and expenses are recorded on the date that the trade occurs. Principal transactions are recorded on a trade date basis. Cash and cash equivalents: The Company considers all highly liquid investments, including money market funds, interest-bearing deposits with banks, federal funds sold, commercial paper and treasury securities, with original maturities of three months or less that are not segregated and on deposit for federal or other regulatory purposes to be cash equivalents. Cash and investments segregated and on deposit for federal or other regulatory purposes consist primarily of securities purchased under agreements to resell (resale agreements), which are collateralized by U.S. government securities, and certificates of deposit. Resale agreements are collateralized investing transactions that are recorded at their contractual amounts plus accrued interest. The Company obtains possession of collateral (U.S. government securities) with a market value equal to or in excess of the principal amount loaned and accrued interest under resale agreements. Collateral is valued daily by the Company, with additional collateral obtained when necessary. Certificates of deposit are stated at cost, which approximates market. - 29 - Securities borrowed, securities loaned, and securities sold under agreements to repurchase (repurchase agreements) are collateralized investing and financing transactions. Securities borrowed require the Company to deliver cash to the lender in exchange for securities and are included in receivables from brokers, dealers and clearing organizations. For securities loaned, the Company receives collateral in the form of cash in an amount generally equal to the market value of securities loaned. Securities loaned are included in payables to brokers, dealers and clearing organizations. The Company monitors the market value of securities borrowed and loaned, with additional collateral obtained or refunded when necessary. Repurchase agreements are recorded at their contractual amounts plus accrued interest and are included in short-term borrowings. Securities owned include securities available for sale that are recorded at estimated fair value with unrealized gains and losses reported, net of taxes, in accumulated other comprehensive income (loss) included in stockholders' equity. Realized gains and losses from sales of securities available for sale are determined on a specific identification basis and are included in other revenues. Securities owned also include equity, fixed income and other securities, SchwabFunds money market funds, and equity and bond mutual funds. These securities are recorded at estimated fair value with unrealized gains and losses included in principal transaction revenues. Receivables from brokerage clients that remain unsecured for more than 30 days or partially secured for more than 90 days are generally fully reserved for, and are stated net of allowance for doubtful accounts. Nonperforming assets included in the loan portfolio consist of financial instruments where the Company has stopped accruing interest (non-accrual financial instruments). Interest accruals are discontinued when principal or interest is contractually past due 90 days or more unless collectibility of the loan is reasonably assured. In addition, interest accruals may be discontinued when principal or interest is contractually past due less than 90 days if, in the opinion of management, the amount due is not likely to be received in accordance with the terms of the contractual agreement, even though the financial instruments are currently performing. Any accrued but unpaid interest previously recorded on a non-accrual financial instrument is reversed and recorded as a reduction of interest income. Interest received on non-accrual financial instruments is applied either to the outstanding principal balance or recorded as interest income, depending on management's assessment of the ultimate collectibility of principal. Non-accrual financial instruments are generally returned to accrual status only when all delinquent principal and interest payments become current and the collectibility of future principal and interest on a timely basis is reasonably assured. Allowance for credit losses on banking loans is established through charges to income based on management's evaluation of the adequacy of the allowance for credit losses in the existing portfolio. The adequacy of the allowance is reviewed regularly by management, taking into consideration current economic conditions, the existing loan portfolio composition, past loss experience and risks inherent in the portfolio, including the value of impaired loans. Equipment, office facilities and property: Equipment and office facilities are depreciated on a straight-line basis over the estimated useful life of the asset of two to fifteen years. Buildings are depreciated on a straight-line basis over twenty years. Leasehold improvements are amortized on a straight-line basis over the lesser of the estimated useful life of the asset or the term of the lease. Software and certain costs incurred for purchasing or developing software for internal use are amortized on a straight-line basis over an estimated useful life of three years. Equipment, office facilities and property are stated at cost net of accumulated depreciation and amortization, except for land, which is stated at cost. Equipment, office facilities and property are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. For a discussion of the Company's restructuring initiatives, which included the removal of assets from service, see note "3 - Restructuring and Other Charges." Derivative financial instruments are accounted for under Statement of Financial Accounting Standards (SFAS) No. 133 - Accounting for Derivative Instruments and Hedging Activities. This statement requires that all derivatives be recorded on the balance sheet at fair value. As part of its consolidated asset and liability management process, the Company utilizes interest rate swap agreements (Swaps) to manage interest rate risk. Other derivative activities primarily consist of exchange-traded futures and options to hedge potential losses in equity inventory positions. These futures and options are recorded at fair value in securities owned on the consolidated balance sheet, and gains and losses are included in principal transaction revenues. For further discussion on these derivative financial instruments, see note "23 - Financial Instruments Subject to Off-Balance-Sheet Risk, Credit Risk or Market Risk." Foreign currency translation: Assets and liabilities denominated in foreign currencies where the local currency is the functional currency are translated at the exchange rate on the balance sheet date, while revenues and expenses are translated at average rates of exchange prevailing during the - 30 - year. Translation adjustments are included in other comprehensive income (loss). Income taxes: The Company files a consolidated U.S. federal income tax return and uses the asset and liability method in recording income tax expense. Under this method, deferred tax assets and liabilities are recorded for temporary differences between the tax basis of assets and liabilities and their recorded amounts for financial reporting purposes, using currently enacted tax law. Stock-based compensation: The Company applies Accounting Principles Board Opinion (APB) No. 25 - Accounting for Stock Issued to Employees, and related interpretations, for its stock-based employee compensation plans. Because the Company grants stock option awards at market value, there is no compensation expense recorded, except for restructuring-related expense for modifications of officers' stock options. Compensation expense for restricted stock awards is based on the market value of the shares awarded at the date of grant and is amortized on a straight-line basis over the vesting period. The unamortized portion of the award is recorded as unamortized stock-based compensation in stockholders' equity. Had compensation expense for the Company's stock option awards been determined based on the Black-Scholes fair value at the grant dates for awards under those plans consistent with the fair value method of SFAS No. 123 - Accounting for Stock-Based Compensation, the Company would have recorded additional compensation expense and its net income and earnings per share (EPS) would have been reduced to the pro forma amounts presented in the following table: - -------------------------------------------------------------------------------- Year Ended December 31, 2002 2001 2000 - -------------------------------------------------------------------------------- Compensation expense for stock options (after tax): As reported $ 6 $ 13 Pro forma $ 154 $ 181 $ 81 - -------------------------------------------------------------------------------- Net Income (Loss): As reported $ 109 $ 199 $ 718 Pro forma $ (39) $ 31 $ 637 - -------------------------------------------------------------------------------- Basic EPS: As reported $ .08 $ .14 $ .53 Pro forma $(.03) $ .02 $ .47 Diluted EPS: As reported $ .08 $ .14 $ .51 Pro forma $(.03) $ .02 $ .45 - -------------------------------------------------------------------------------- The fair value of each option granted is estimated as of the grant date using the Black-Scholes option pricing model with the following assumptions: - -------------------------------------------------------------------------------- 2002 2001 2000 - -------------------------------------------------------------------------------- Expected dividend yield .30% .30% .40% Expected volatility 51% 50% 48% Risk-free interest rate 3.5% 4.3% 6.0% Expected life (in years) 5 5 5 - -------------------------------------------------------------------------------- During 2002, the Company changed its methodology for amortizing pro forma stock option compensation. Pro forma stock option compensation is amortized monthly on a straight-line basis over the vesting period beginning with the month when the option was granted. In prior periods, a full year of amortization was recognized regardless of when an option was granted during the year. Pro forma amounts have been revised to reflect this change in methodology on a retroactive basis. Goodwill represents the cost of acquired businesses in excess of the fair value of the related net assets acquired. Goodwill is accounted for under SFAS No. 142 - - Goodwill and Other Intangible Assets. This statement requires that goodwill be tested for impairment at least annually or whenever indications of impairment exist. In testing for a potential impairment of goodwill, SFAS No. 142 requires management to estimate the fair value of each of the Company's reporting units (generally defined as the Company's businesses for which financial information is available and reviewed regularly by management), and compare it to their carrying value. If the estimated fair value of a reporting unit is less than its carrying value, management is required to estimate the fair value of all assets and liabilities of the reporting unit, including goodwill. If the carrying value of the reporting unit's goodwill is greater than the estimated fair value, an impairment charge is recognized for the excess. The Company has elected April 1 as its annual impairment testing date. See "Accounting Change" below and note "4 - - Goodwill and Other Impairment Charges." Accounting change: The Company adopted SFAS No. 142 on January 1, 2002. Under 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 for impairment as discussed above. The Company completed its transitional testing for goodwill impairment during the second quarter of 2002 as required, and did not record any impairment charges at that time. The following table compares net income and EPS for 2002, which excludes goodwill amortization, with net income and EPS for 2001 and 2000, which has been adjusted to exclude goodwill amortization. - 31 - - -------------------------------------------------------------------------------- 2002 2001 2000 (Reported) (Adjusted) (Adjusted) - -------------------------------------------------------------------------------- Net income: Reported income before extraordinary gain $ 97 $ 78 $ 718 Add: Goodwill amortization, net of tax 62 51 - -------------------------------------------------------------------------------- Reported/adjusted income before extraordinary gain 97 140 769 Extraordinary gain, net of tax 12 121 - -------------------------------------------------------------------------------- Reported/adjusted net income $ 109 $ 261 $ 769 ================================================================================ Basic EPS: Reported EPS before extraordinary gain $ .07 $ .06 $ .53 Add: Goodwill amortization .05 .04 - -------------------------------------------------------------------------------- Reported/adjusted EPS before extraordinary gain .07 .11 .57 Extraordinary gain, net of tax .01 .08 - -------------------------------------------------------------------------------- Reported/adjusted EPS $ .08 $ .19 $ .57 ================================================================================ Diluted EPS: Reported EPS before extraordinary gain $ .07 $ .06 $ .51 Add: Goodwill amortization .04 .04 - -------------------------------------------------------------------------------- Reported/adjusted EPS before extraordinary gain .07 .10 .55 Extraordinary gain, net of tax .01 .08 - -------------------------------------------------------------------------------- Reported/adjusted EPS $ .08 $ .18 $ .55 ================================================================================ The Company's goodwill balance declined during 2002 primarily due to the write-off of goodwill associated with Charles Schwab Europe (CSE), a subsidiary located in the United Kingdom. The decline in goodwill during 2002 was also 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: - -------------------------------------------------------------------------------- 2002 2001 - -------------------------------------------------------------------------------- Individual Investor $ 415 $ 440 Institutional Investor 3 3 Capital Markets 27 27 U.S. Trust 158 158 - -------------------------------------------------------------------------------- Total $ 603 $ 628 ================================================================================ New accounting standards: 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 APB 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. Financial Accounting Standards Board Interpretation (FIN) No. 45 - Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, was issued in November 2002. This interpretation addresses the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. FIN No. 45 also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. In accordance with FIN No. 45, the Company adopted the disclosure requirements on December 31, 2002 and is required to adopt the recognition requirements effective on January 1, 2003. The Company is evaluating the impact of the recognition requirements of this interpretation and does not expect it to have a material impact on its financial position, results of operations, EPS, or cash flows. SFAS No. 148 - Accounting for Stock-Based Compensation - Transition and Disclosure was issued in December 2002. This statement amends SFAS No. 123 - Accounting for Stock-Based Compensation to provide companies with alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation. Additionally, SFAS No. 148 amends certain disclosure requirements of SFAS No. 123. The Company adopted the disclosure requirements of SFAS No. 148 as of December 31, 2002. The transitional provisions of SFAS No. 148 did not have an impact on the Company's financial position, results of operations, EPS, or cash flows, as the fair value method has not been adopted. FIN No. 46 - Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51 - Consolidated Financial Statements, was issued in January 2003. FIN No. 46 is effective for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to - 32 - February 1, 2003, the provisions of FIN No. 46 must be adopted by the third quarter of 2003. The Company plans to adopt FIN No. 46 in the first quarter of 2003. This interpretation provides new criteria for determining whether a company is required to consolidate (i.e., record the assets and liabilities on the balance sheet) a variable interest entity such as the Company's participation in the unconsolidated special purpose trust (Trust) formed in 2000 to finance an office building. Because the Trust meets the definition of a variable interest entity and the criteria to consolidate, upon adoption of this interpretation in the first quarter of 2003, the Company will record the building at cost, net of depreciation, on the consolidated balance sheet. Specifically, the impact is expected to increase equipment, office facilities and property by approximately $230 million, increase long-term debt by approximately $235 million, and reduce accrued expenses and other liabilities by approximately $5 million. Further, the expected annual impact on the Company's consolidated statement of income will be to cease both amortizing the shortfall of the residual value guarantee and recording rent expense on the lease and to begin recording both the depreciation on the building and the interest expense associated with the debt. Upon adoption and in future periods, the Company expects the impact on its consolidated statement of income will be immaterial. See note "22 - Commitments and Contingent Liabilities" for a further discussion of the Trust. 3. Restructuring and Other Charges Restructuring The Company recorded pre-tax restructuring charges in 2002 and 2001 as follows: - -------------------------------------------------------------------------------- 2002 2001 - -------------------------------------------------------------------------------- 2002 Initiatives $ 277 2001 Initiatives 96 $ 391 - -------------------------------------------------------------------------------- Total restructuring charges $ 373 $ 391 ================================================================================ 2002 Initiatives In 2002, the Company commenced and substantially completed 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 primarily included further reductions in the Company's workforce and facilities. The Company recorded pre-tax restructuring charges of $277 million in 2002 related to 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 2002, the Company reduced full-time equivalent employees by 2,900, or 15%, including 2,040 through mandatory staff reductions, 130 related to a reduction in contractors, and 730 mainly related to voluntary attrition. The workforce reductions encompassed employees from each of the Company's segments. Facilities: The restructuring charges recognized in 2002 included facility exit costs which are net of estimated sublease income. Facilities restructuring charges related to reductions of administrative office space primarily in Northern California, Texas, New York, and the United Kingdom, as well as the consolidation of 18 Schwab branch offices and 2 U.S. Trust offices in 2003. The restructuring charges also included write-downs of leasehold improvements, telecommunications infrastructure, and fixed assets removed from service at these facilities. Systems: The restructuring charges recognized in 2002 included the removal of certain computer systems software and equipment from service at certain of the Company's facilities. A summary of pre-tax restructuring charges related to the Company's 2002 restructuring initiatives is as follows: - -------------------------------------------------------------------------------- 2002 - -------------------------------------------------------------------------------- Workforce reduction: Severance pay and benefits $ 134 Non-cash compensation expense for officers' stock options 7 - -------------------------------------------------------------------------------- Total workforce reduction 141 - -------------------------------------------------------------------------------- Facilities reduction: Non-cancelable lease costs, net of estimated sublease income 104 Write-downs of leasehold improvements, telecommunications infrastructure, and fixed assets removed from service 28 - -------------------------------------------------------------------------------- Total facilities reduction 132 - -------------------------------------------------------------------------------- Systems removal 4 - -------------------------------------------------------------------------------- Total restructuring charges $ 277 ================================================================================ - 33 - A summary of the activity in the restructuring reserve related to the Company's 2002 restructuring initiatives for the year ended December 31, 2002 is as follows: - -------------------------------------------------------------------------------- Workforce Facilities Systems Reduction Reduction Removal Total - -------------------------------------------------------------------------------- Restructuring charges $ 141 $ 132 $ 4 $ 277 Utilization: Cash payments (79) (1) (80) Non-cash charges (1) (7) (28) (4) (39) - -------------------------------------------------------------------------------- Balance at December 31, 2002 $ 55 (2) $ 103 (3) $ 158 ================================================================================ (1) Primarily includes charges for write-downs of leasehold improvements, telecommunications infrastructure, fixed assets, and systems equipment removed from service, as well as officers' stock-based compensation. (2) The Company expects to substantially utilize the remaining workforce restructuring reserve through cash payments for severance pay and benefits over the respective severance periods through 2004. (3) The Company expects to substantially utilize the remaining facilities restructuring reserve through cash payments for the net lease expense over the respective lease terms through 2013. 2001 Initiatives In 2001, the Company initiated a restructuring plan to reduce operating expenses due to continued economic uncertainties and difficult market conditions. The restructuring plan was completed in 2002 and 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. During 2002, the Company recorded pre-tax restructuring charges related to its 2001 restructuring initiatives of $96 million, primarily resulting from facilities charges for changes in estimates of sublease income due to a continued deterioration of the commercial real estate market. The Company recorded pre-tax charges for restructuring costs of $391 million in 2001. The actual costs of these restructuring 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 reserve related to the Company's 2001 restructuring initiatives for the years ended December 31, 2002 and 2001 is as follows: - -------------------------------------------------------------------------------- Workforce Facilities Systems Reduction Reduction Removal Total - -------------------------------------------------------------------------------- Initial restructuring charges in 2001 $ 187 $ 141 $ 63 $ 391 Utilization: Cash payments (93) (8) (43) (144) Non-cash charges (1) (20) (36) (16) (72) - -------------------------------------------------------------------------------- Balance at December 31, 2001 $ 74 $ 97 $ 4 $ 175 Restructuring charges 19 76 (2) 1 96 Utilization: Cash payments (77) (49) (5) (131) Non-cash charges (1) (3) (3) - -------------------------------------------------------------------------------- Balance at December 31, 2002 $ 13 (3) $ 124 (4) $ 137 ================================================================================ (1) In 2002, primarily includes charges for officers' stock-based compensation. In 2001, includes charges for officers' stock-based compensation, write-downs, and accelerated depreciation. (2) Includes $65 million primarily due to changes in estimates of sublease income resulting from a continued deterioration of the commercial real estate market. (3) The Company expects to substantially utilize the remaining workforce restructuring reserve through cash payments for severance pay and benefits over the respective severance periods through 2003. (4) The Company expects to substantially utilize the remaining facilities restructuring reserve through cash payments for the net lease expense over the respective lease terms through 2017. Other Charges The Company recorded other pre-tax charges of $28 million in 2001. These charges include a regulatory fine assessed to USTC and United States Trust Company of New York (U.S. Trust NY), professional service fees for operational and risk management remediation at USTC and U.S. Trust NY, and the write-off of certain software development costs at CSE. There were no such charges for 2002 or 2000. 4. Goodwill and Other Impairment Charges During the fourth quarter of 2002, the Company developed plans for the possible sale of CSE. Accordingly, the Company performed a goodwill impairment test at that time pursuant to SFAS No. 142 - Goodwill and Other Intangible Assets. The fair value of CSE, a reporting unit within the Individual Investor segment, was estimated when performing the impairment test using a combination of the expected present value of future cash flows and an indicative sales price. As a result of this test, the Company recorded an impairment charge of $24 million pre tax during the fourth quarter of 2002. See note "27 - Subsequent Event" for a discussion of CSE. During the fourth quarter of 2002, the Company also evaluated whether its investment in Aitken Campbell, a market-making joint venture in the United Kingdom accounted for under the equity method, had incurred a loss in value, and - 34 - whether such loss was other than a temporary decline. Taking into consideration the possible sale of CSE and the potential reduction of its client order flow, the Company determined that its ability to retain its investment in Aitken Campbell for a period of time sufficient to allow for recovery in fair value was no longer reasonably assured. The fair value of the investment was estimated principally using the expected present value of future cash flows and was compared to the carrying value of the investment. As a result of this analysis, an impairment charge of $37 million pre tax was recorded in the fourth quarter of 2002. 5. Sale of Corporate Trust Business In 2001, USTC sold its Corporate Trust business to The Bank of New York Company, Inc. (Bank of NY). During 2001, the Company recognized a pre-tax extraordinary gain of $221 million on this sale, or $121 million after tax. Total proceeds received were $273 million and the Company incurred pre-tax closing and exit costs of $30 million for severance, professional fees, and other related disposal costs. During 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. Securities Owned A summary of securities owned is as follows: - -------------------------------------------------------------------------------- December 31, 2002 2001 - -------------------------------------------------------------------------------- Securities available for sale $1,322 $1,200 SchwabFunds money market funds 197 171 Equity, fixed income and other securities 126 223 Equity and bond mutual funds 71 106 - -------------------------------------------------------------------------------- Total $1,716 $1,700 ================================================================================ The amortized cost, estimated fair value, and gross unrealized gains and losses on securities available for sale are as follows: - -------------------------------------------------------------------------------- December 31, 2002 2001 - -------------------------------------------------------------------------------- U.S. treasury securities: Amortized cost $ 290 $ 159 Aggregate fair value $ 296 $ 160 Gross unrealized gains $ 6 $ 1 Gross unrealized losses U.S. government sponsored agencies and corporations: Amortized cost 701 748 Aggregate fair value 727 754 Gross unrealized gains 26 7 Gross unrealized losses 1 State and municipal obligations: Amortized cost 169 154 Aggregate fair value 178 158 Gross unrealized gains 9 4 Gross unrealized losses Collateralized mortgage obligations (1): Amortized cost 88 84 Aggregate fair value 87 84 Gross unrealized gains Gross unrealized losses 1 Other securities: Amortized cost 33 43 Aggregate fair value 34 44 Gross unrealized gains 1 1 Gross unrealized losses - -------------------------------------------------------------------------------- Total securities available for sale: Amortized cost $ 1,281 $ 1,188 Aggregate fair value $ 1,322 $ 1,200 Gross unrealized gains $ 42 $ 13 Gross unrealized losses $ 1 $ 1 ================================================================================ (1) Collateralized by either GNMA, FNMA or FHLC obligations. - 35 - The maturities of debt securities available for sale at December 31, 2002, and the related weighted-average yield on such debt securities are as follows: - -------------------------------------------------------------------------------- Within 1 - 5 5 - 10 1 Year Years Years Total - -------------------------------------------------------------------------------- U.S. treasury securities $145 $ 145 $ 290 U.S. government sponsored agencies and corporations 8 690 $ 3 701 State and municipal obligations 20 149 169 Collateralized mortgage obligations (1) 12 76 88 Other debt securities 21 12 33 - -------------------------------------------------------------------------------- Total at amortized cost 206 1,072 3 1,281 Estimated fair value 208 1,111 3 1,322 - -------------------------------------------------------------------------------- Net unrealized gains $ 2 $ 39 $ 41 ================================================================================ Weighted-average yield (2) 3.62% 5.08% 7.13% 4.85% ================================================================================ (1) Collateralized mortgage obligations have been allocated over maturity groupings based on contractual maturities. Expected maturities may differ from contractual maturities because borrowers have the right to prepay obligations with or without prepayment penalties. (2) Yields have been computed by dividing annualized interest revenue, on a taxable equivalent basis, by the amortized cost of the respective securities at December 31, 2002. The Company's positions in SchwabFunds money market funds arise from certain overnight funding of clients' redemption, check-writing, and debit card activities. Equity and other securities include the Company's inventories resulting from proprietary equity trading, market making, and its specialist operations. Fixed income securities consist primarily of municipal bonds and U.S. government and corporate obligations held to meet clients' trading activities. Equity and bond mutual funds include investments made by the Company relating to its deferred compensation plan and inventory maintained to facilitate certain SchwabFunds and third-party mutual fund clients' transactions. Securities sold, but not yet purchased, of $26 million and $27 million at December 31, 2002 and 2001, respectively, consist primarily of mutual fund shares that are distributed to clients to satisfy their dividend reinvestment requests and subsequently purchased by the Company from the mutual funds, as well as equity and other securities. These securities are recorded at market value in accrued expenses and other liabilities. 7. Receivables from Brokerage Clients Receivables from brokerage clients consist primarily of margin loans to brokerage clients of $6.6 billion and $9.2 billion at December 31, 2002 and 2001, respectively. Securities owned by brokerage clients are held as collateral for margin loans. Such collateral is not reflected in the consolidated financial statements. Receivables from brokerage clients are stated net of allowance for doubtful accounts of $4 million and $5 million at December 31, 2002 and 2001, respectively. 8. Loans to Banking Clients and Related Allowance for Credit Losses An analysis of the composition of the loan portfolio is as follows: - -------------------------------------------------------------------------------- December 31, 2002 2001 - -------------------------------------------------------------------------------- Private banking: Residential real estate mortgages $ 3,594 $ 3,085 Other 976 943 - -------------------------------------------------------------------------------- Total private banking loans 4,570 4,028 - -------------------------------------------------------------------------------- Loans to financial institutions for purchasing and carrying securities 32 All other 9 7 - -------------------------------------------------------------------------------- Total $ 4,579 $ 4,067 ================================================================================ Nonperforming assets consist of non-accrual loans of $1 million and $5 million at December 31, 2002 and 2001, respectively. The Company considers all non-accrual loans impaired. For 2002 and 2001, the impact of interest revenue which would have been earned on non-accrual loans versus interest revenue recognized on these loans was not material to the Company's results of operations. The amount of loans accruing interest that were contractually 90 days or more past due was immaterial at both December 31, 2002 and 2001. The allowance for credit losses on the loan portfolio was $24 million at December 31, 2002, $21 million at December 31, 2001 and $20 million at December 31, 2000. Total charge-offs and total recoveries were immaterial for each of 2002, 2001 and 2000. 9. Loan Securitization During the second quarter of 2002, U.S. Trust securitized and sold $193 million of 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, after payment of $2 million of transaction expenses, recognized a net 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, and servicing rights. The gain on securitization of $1 million was determined based upon the previous carrying amount of the - 36 - securitized loans, allocated between the loans sold and the retained securities based on their relative fair values at the date of sale. The fair values of retained securities were primarily determined based on quoted market prices, incorporating key economic assumptions as follows: - -------------------------------------------------------------------------------- At December 31, Securitization 2002 - -------------------------------------------------------------------------------- Average discount rate 8.33% 10.84% Average annual constant prepayment rate 16.00% 57.50% Expected weighted-average life (in years) 8.0 4.3 Expected credit losses 0% 0% - -------------------------------------------------------------------------------- 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. There were no delinquencies in the securitized mortgage loans at December 31, 2002, and there were no losses for 2002. U.S. Trust has not guaranteed the mortgage loans as this transaction was structured without recourse to U.S. Trust or the Company. The estimated fair value of the retained securities was $5 million at December 31, 2002 and was included in securities owned on the Company's consolidated balance sheet. A hypothetical change of 50 or 100 basis points in any of the above key assumptions would not have a material impact on the Company's financial condition at December 31, 2002. Cash flows received from the retained securities, including servicing fees, were immaterial in 2002. 10. Equipment, Office Facilities and Property Equipment, office facilities and property are detailed below: - -------------------------------------------------------------------------------- December 31, 2002 2001 - -------------------------------------------------------------------------------- Land $ 24 $ 22 Buildings 265 264 Leasehold improvements 400 410 Furniture and equipment 233 247 Telecommunications equipment 172 184 Information technology equipment and software 938 875 Construction and software development in progress 82 72 - -------------------------------------------------------------------------------- Subtotal 2,114 2,074 Accumulated depreciation and amortization (1,246) (1,016) - -------------------------------------------------------------------------------- Total $ 868 $ 1,058 ================================================================================ 11. Deposits from Banking Clients Deposits from banking clients consist of money market and other savings deposits, noninterest-bearing deposits and certificates of deposit. Deposits from banking clients are as follows: - -------------------------------------------------------------------------------- December 31, 2002 2001 - -------------------------------------------------------------------------------- Interest-bearing deposits $ 4,471 $ 4,046 Noninterest-bearing deposits 760 1,402 - -------------------------------------------------------------------------------- Total $ 5,231 $ 5,448 ================================================================================ During the years ended December 31, 2002 and 2001, the Company paid an average rate of 2.4% and 3.8%, respectively, on its interest-bearing deposits from banking clients. 12. Payables to Brokers, Dealers and Clearing Organizations Payables to brokers, dealers and clearing organizations consist primarily of securities loaned of $1.4 billion and $628 million at December 31, 2002 and 2001, respectively. The cash collateral received from counterparties under securities lending transactions was equal to or greater than the market value of the securities loaned. 13. Payables to Brokerage Clients The principal source of funding for Schwab's margin lending is cash balances in brokerage client accounts. At December 31, 2002, Schwab was paying interest at .4% on $23.0 billion of cash balances in brokerage client accounts, which were included in payables to brokerage clients. At December 31, 2001, Schwab was paying interest at 1.1% on $23.1 billion of such cash balances. 14. Short-term Borrowings CSC may borrow under its $1.0 billion committed, unsecured credit facility with a group of twenty-two banks which is scheduled to expire in June 2003. CSC plans to establish a similar facility to replace this one when it expires. 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. This facility was unused at December 31, 2002 and 2001. To manage short-term liquidity, Schwab maintains uncommitted, unsecured bank credit lines with a group of - 37 - eight banks totaling $770 million at December 31, 2002. CSC has access to $670 million of these credit lines. 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. There were no borrowings outstanding under these lines at December 31, 2002 and 2001. To satisfy the margin requirement of client option transactions with the Options Clearing Corporation (OCC), Schwab has unsecured letter of credit agreements with nine banks in favor of the OCC aggregating $630 million at December 31, 2002. Schwab pays a fee to maintain these letters of credit. No funds were drawn under these letters of credit at December 31, 2002 and 2001. Other short-term borrowings include Federal Home Loan Bank System borrowings, federal funds purchased, repurchase agreements, and other borrowed funds. At December 31, 2002 and 2001, these other short-term borrowings totaled $508 million and $578 million, respectively, with weighted-average interest rates ranging from 1.13% to 2.00% and 1.71% to 3.69%, respectively. 15. Long-term Debt Long-term debt consists of the following: - -------------------------------------------------------------------------------- December 31, 2002 2001 - -------------------------------------------------------------------------------- Senior Medium-Term Notes, Series A $ 566 $ 679 8.414% Trust Preferred Capital Securities 50 50 Fair value adjustment (1) 26 Other 1 - -------------------------------------------------------------------------------- Total $ 642 $ 730 ================================================================================ (1) Represents the fair value adjustment related to hedged Medium-Term Notes. See note "23 - Financial Instruments Subject to Off-Balance-Sheet Risk, Credit Risk or Market Risk." The aggregate principal amount of Senior Medium-Term Notes, Series A (Medium-Term Notes) outstanding at December 31, 2002 had maturities ranging from 2003 to 2010. The aggregate principal amount of Medium-Term Notes outstanding at both December 31, 2002 and 2001 had fixed interest rates ranging from 6.04% to 8.05%. At December 31, 2002 and 2001, the Medium-Term Notes carried a weighted-average interest rate of 7.29% and 7.27%, respectively. The Trust Preferred Capital Securities qualify as tier 1 capital under guidelines of the Board of Governors of the Federal Reserve System (Federal Reserve Board) and have no voting rights. Holders of the Trust Preferred Capital Securities are entitled to receive cumulative cash distributions semi-annually. The Company has the right to redeem the Trust Preferred Capital Securities prior to their stated maturity of February 1, 2027, on or after February 1, 2007, upon approval (if then required) of the Federal Reserve Board. Annual maturities on long-term debt outstanding at December 31, 2002 are as follows: - -------------------------------------------------------------------------------- 2003 $ 100 2004 81 2005 56 2006 68 2007 38 Thereafter 273 - -------------------------------------------------------------------------------- Total maturities 616 Fair value adjustment 26 - -------------------------------------------------------------------------------- Total $ 642 ================================================================================ 16. Taxes on Income Income tax expense is as follows: - -------------------------------------------------------------------------------- Year Ended December 31, 2002 2001 2000 - -------------------------------------------------------------------------------- Current: Federal $ 78 $ 201 $ 475 State (1) 35 65 - -------------------------------------------------------------------------------- Total current 77 236 540 - -------------------------------------------------------------------------------- Deferred: Federal (11) (70) (24) State 15 (9) (3) - -------------------------------------------------------------------------------- Total deferred 4 (79) (27) - -------------------------------------------------------------------------------- Taxes on income 81 157 513 Current tax expense on extraordinary gain (10) (100) - -------------------------------------------------------------------------------- Taxes on income before extraordinary gain $ 71 $ 57 $ 513 ================================================================================ The above amounts do not include tax benefits from the exercise of stock options and the vesting of restricted stock awards, which for accounting purposes are credited directly to additional paid-in capital. Such tax benefits reduced income taxes paid by $4 million in 2002, $37 million in 2001, and $190 million in 2000. The above amounts also do not include a tax benefit of $140 million in 2000 from the conversion of unexercised USTC stock options into shares of CSC's common stock. Additionally, the above deferred amounts do not include tax expenses or benefits related to intangible assets recorded in connection with the acquisition of CyberTrader, and other comprehensive income (loss). - 38 - The temporary differences that created deferred tax assets and liabilities, included in other assets, and accrued expenses and other liabilities, are detailed below: - -------------------------------------------------------------------------------- December 31, 2002 2001 - -------------------------------------------------------------------------------- Deferred tax assets: Reserves and allowances $ 143 $ 128 Deferred compensation and employee benefits 95 152 Property and equipment leasing 28 14 Net loss on cash flow hedging instruments 25 23 Foreign investments 19 4 Trust and fiduciary activities 9 10 Other 6 (3) - -------------------------------------------------------------------------------- Total deferred assets 325 328 - -------------------------------------------------------------------------------- Deferred tax liabilities: Capitalized internal-use software development costs (65) (70) Net unrealized gains on securities available for sale (16) (5) Depreciation and amortization (7) (5) State and local taxes (4) (3) - -------------------------------------------------------------------------------- Total deferred liabilities (92) (83) - -------------------------------------------------------------------------------- Net deferred tax asset $ 233 $ 245 ================================================================================ The Company determined that no valuation allowance against deferred tax assets at December 31, 2002 and 2001 was necessary. The effective income tax rate on income before extraordinary gain differs from the amount computed by applying the federal statutory income tax rate as follows: - -------------------------------------------------------------------------------- Year Ended December 31, 2002 2001 2000 - -------------------------------------------------------------------------------- Federal statutory income tax rate 35.0% 35.0% 35.0% State income taxes, net of federal tax benefit 1.5 1.6 3.4 Goodwill amortization 14.8 1.3 Variable life insurance 1.3 (6.5) Restructuring of international operations (4.9) Merger-related costs 1.3 Non-deductible penalties 2.6 Write-down of investment in Aitken Campbell 7.6 Other charges (3.1) (.4) .7 - -------------------------------------------------------------------------------- Effective income tax rate 42.3% 42.2% 41.7% ================================================================================ The effective income tax rate including the extraordinary gain was 42.6% in 2002 and 44.1% in 2001. 17. Employee Incentive and Deferred Compensation Plans Stock Option Plans The Company's stock incentive plans provide for granting options to employees, officers and directors. Options are granted for the purchase of shares of common stock at an exercise price not less than market value on the date of grant, and expire within ten years from the date of grant. Options generally vest over a four-year period from the date of grant. The Company granted to all non-officer employees 11 million, 26 million and 11 million options in 2002, 2001 and 2000, respectively. A summary of option activity follows:
- ------------------------------------------------------------------------------------------------------------------------------------ 2002 2001 2000 ------------------------- --------------------------- ---------------------------- Weighted- Weighted- Weighted- Number Average Number Average Number Average of Exercise of Exercise of Exercise Options Price Options Price Options Price - ------------------------------------------------------------------------------------------------------------------------------------ Outstanding at beginning of year 153 $ 16.20 97 $ 16.46 90 $ 10.31 Granted (1) 26 $ 11.32 68 $ 15.43 29 $ 26.27 Exercised (6) $ 6.59 (6) $ 4.73 (20) $ 2.74 Canceled (2) (17) $ 19.39 (6) $ 24.10 (2) $ 20.15 - ------------------------------------------------------------------------------------------------------------------------------------ Outstanding at end of year 156 $ 15.38 153 $ 16.20 97 $ 16.46 ==================================================================================================================================== Exercisable at end of year 77 $ 12.93 54 $ 11.31 38 $ 7.02 ==================================================================================================================================== Available for future grant at end of year 41 50 22 ==================================================================================================================================== Weighted-average fair value of options granted during the year (1,3) $ 5.35 $ 7.26 $ 15.44 ==================================================================================================================================== (1) In 2000, 3 million options were granted and exchanged for outstanding options of CyberTrader. The exercise prices for individual options granted retained the excess of the market value over the exercise price on each CyberTrader option canceled. The weighted-average exercise price of these options is $1.04 and the weighted-average fair value is $28.27. The remaining 26 million options were granted with an exercise price equal to the fair market value of the Company's common stock on the date of grant. The weighted-average exercise price of these options is $29.23 and the weighted-average fair value is $13.93. (2) In 2002, 5 million options were voluntarily rescinded by the Co-Chief Executive Officers of the Company. The weighted-average exercise price of these options is $17.04 and the weighted-average fair value is $8.03. (3) The fair value of options granted is estimated as of the grant date using the Black-Scholes option pricing model. See discussion in note "2 - Significant Accounting Policies."
- 39 - Options outstanding and exercisable are as follows:
- ------------------------------------------------------------------------------------------------------------------------------------ December 31, 2002 - ------------------------------------------------------------------------------------------------------------------------------------ Options Outstanding Options Exercisable --------------------------------------------- ------------------------------------- Weighted- Average Weighted- Weighted- Remaining Average Average Range of Number Contractual Exercise Number Exercise Exercise Prices of Options Life (in years) Price of Options Price - ------------------------------------------------------------------------------------------------------------------------------------ $ 1.00 to $ 7.00 19 2.9 $ 3.91 19 $ 3.91 $ 7.01 to $ 10.00 26 6.2 $ 8.74 19 $ 8.38 $ 10.01 to $ 15.00 36 8.5 $ 11.97 11 $ 12.00 $ 15.01 to $ 19.00 29 8.3 $ 15.41 10 $ 15.30 $ 19.01 to $ 26.00 20 7.0 $ 22.06 10 $ 22.27 $ 26.01 to $ 40.00 26 7.2 $ 29.64 8 $ 29.82 ----------------------------------------------------------------------------------------------------------------------------------- $ 1.00 to $ 40.00 156 7.0 $ 15.38 77 $ 12.93 ====================================================================================================================================
Restricted Stock Plans The Company's stock incentive plans provide for granting restricted stock awards to employees and officers. Restricted stock awards are restricted from sale and generally vest over a four-year period, but some vest based upon the Company achieving certain financial or other measures. Restricted stock information is as follows: - -------------------------------------------------------------------------------- 2002 2001 2000 - -------------------------------------------------------------------------------- Restricted stock awards 2 1 Average market price of awarded shares $ 10.44 $ 18.15 $ 27.73 Restricted shares outstanding (at year end) 4 5 8 Restricted stock expense and amortization $ 22 $ 27 $ 32 - -------------------------------------------------------------------------------- Other Deferred Compensation Plans The Company sponsors deferred compensation plans for both officers and non-employee directors. The Company's deferred compensation plan for officers permits participants to defer the payment of certain cash compensation. The deferred compensation liability was $184 million and $199 million at December 31, 2002 and 2001, respectively. The Company's deferred compensation plan for non-employee directors permits participants to defer receipt of all or a portion of their directors' fees and to receive either a grant of stock options, or upon ceasing to serve as a director, the number of shares of CSC's common stock that would have resulted from investing the deferred fee amount into CSC's common stock. 18. Retirement and Other Employee Benefit Plans The Company's retirement and other employee benefit plans consist of CSC's and U.S. Trust's plans that were in effect prior to the merger with USTC. The following summarizes such plans. Retirement Plans Eligible employees of the Company who have met certain service requirements may participate in the Company's qualified retirement plan, the SchwabPlan 401(k) Retirement Savings and Investment Plan (SchwabPlan). The Company matches certain employee contributions; additional contributions to this plan are at the discretion of the Company. Total company contribution expense was $47 million in 2002, $49 million in 2001 and $78 million in 2000. In 2000, the final payment on the Company's note receivable from the employee stock ownership plan (ESOP) was received and all remaining shares were allocated to eligible participants. The fair value of shares released for allocation to employees through the ESOP was recognized by the Company as compensation and benefits expense - $31 million in 2000. At December 31, 2000, the ESOP held a total of 42 million shares of common stock. In 2001, substantially all shares held in the Company's ESOP were converted into units and transferred to the Schwab Equity Unit Fund in the SchwabPlan. U.S. Trust sponsors a 401(k) Plan and ESOP covering all U.S. Trust employees who have met the specified service requirement. U.S. Trust matches certain employees' U.S. Trust 401(k) plan contributions in the form of common stock. Total contribution expense under the U.S. Trust 401(k) Plan was $9 million in 2002, $7 million in 2001 and $4 million in 2000. At December 31, 2002 and 2001, the U.S. Trust ESOP held a total of 6 million and 7 million shares of common stock, respectively. Pension and Other Postretirement Benefits U.S. Trust provides a trusteed, noncontributory, qualified defined benefit pension plan to substantially all U.S. Trust employees. Benefits are based upon years of service, average compensation over the final years of service, and the social security covered compensation. U.S. Trust uses the projected unit credit cost method to compute the vested benefit obligation, where the vested benefit obligation is the actuarial present value of the vested benefits to which the employee is entitled based on the employee's expected date of separation or retirement. In addition, U.S. Trust provides certain health care and life insurance benefits which are unfunded for all employees, certain qualifying retired employees and their dependents. Postretirement medical and life insurance benefits are accrued during the years that the employee renders service to reflect the expected cost of providing health care and life insurance and other benefits to an employee upon retirement. The following table summarizes the components of retirement and postretirement benefit expenses (credits), the funded status of U.S. Trust's qualified retirement plan, changes in the benefit obligations related to these plans and the major assumptions used to determine these amounts. The assumed rate of future increases in per capita cost of - 40 - health care benefits (the health care cost trend rate) is 12.0% in 2002, decreasing gradually to 5.5% in the year 2010. A one percentage point change in the assumed health care cost trend rates would not have a material effect on the postretirement benefit obligation. - 41 -
2002 2001 2000 ---------------------------------- -------------------------------- ----------------------------------- Pension Health & Pension Health & Pension Health & Plan Life Total Plan Life Total Plan Life Total - ------------------------------------------------------------------------------------------------------------------------------------ Components of expense (credit): Service cost and expenses $ 13 $ 13 $ 9 $ 9 $ 8 $ 8 Interest cost 18 $ 1 19 17 $ 1 18 16 $ 1 17 Actual (gain) loss on plan assets 19 19 78 78 (9) (9) Other net amortizations and deferrals (50) (50) (116) (116) (25) (25) - ------------------------------------------------------------------------------------------------------------------------------------ Net expense (credit)(1) $ $ 1 $ 1 $ (12) $ 1 $ (11) $ (10) $ 1 $ (9) - ------------------------------------------------------------------------------------------------------------------------------------ Change in plan assets: Fair value of plan assets at beginning of year $ 281 $ 369 $ 367 Actual gain (loss) on plan assets (19) (78) 9 Employer contribution $ 1 $ 1 $ 1 Benefits and expenses paid (10) (1) (10) (1) (7) (1) - ------------------------------------------------------------------------------------------------------------------------------------ Fair value of plan assets at end of year $ 252 $ 281 $ 369 - ------------------------------------------------------------------------------------------------------------------------------------ Change in benefit obligation: Benefit obligation at beginning of year $ 248 $ 20 $ 211 $ 20 $ 200 $ 19 Service cost 13 9 8 Interest cost 18 2 17 1 16 2 Actuarial (gain) loss 13 1 16 (6) Benefits paid (10) (2) (9) (1) (7) (1) Amendments (1) 4 - ------------------------------------------------------------------------------------------------------------------------------------ Pension benefit obligation at end of year (PBO) $ 281 $ 21 $ 248 $ 20 $ 211 $ 20 - ------------------------------------------------------------------------------------------------------------------------------------ Prepaid (accrued) cost: Excess of plan assets over benefit obligation $ (29) $ (21) $ 34 $ (20) $ 158 $ (20) Unrecognized cumulative net (gains) losses 74 10 (1) (120) (1) Unrecognized prior service cost 4 (1) 5 (1) 1 (1) Unrecognized net asset at date of initial application (2) - ------------------------------------------------------------------------------------------------------------------------------------ Prepaid (accrued) cost $ 49 $ (22) $ 49 $ (22) $ 37 $ (22) - ------------------------------------------------------------------------------------------------------------------------------------ Discount rate used for PBO 6.75% 6.75% 7.50% 7.50% 8.00% 8.00% Rate of increase in salary (2) 5.30% 5.30% 6.10% 6.10% 6.10% 6.10% Health care cost trend rate N/A 12.00% N/A 13.00% N/A 8.00% Expected rate of return on plan assets 9.00% N/A 9.00% N/A 9.00% N/A - ------------------------------------------------------------------------------------------------------------------------------------ (1) The pension credit and postretirement benefit expense are determined using the assumptions as of the beginning of the year. The benefit obligations and the funded status are determined using the assumptions as of the measurement date. (2) In 2002, the rate of increase in compensation is based on an age-related table with assumed rates of increase in compensation ranging from 8.0% to 3.0%. The amount shown is the average assumed rate of increase for the given plan year. N/A Not applicable. - 42 -
19. Accumulated Other Comprehensive Income (Loss) Accumulated other comprehensive income (loss) represents cumulative gains and losses that are not reflected in earnings. The components of accumulated other comprehensive income (loss) are as follows: - -------------------------------------------------------------------------------- 2002 2001 2000 - -------------------------------------------------------------------------------- Net loss on cash flow hedging instruments, net of tax: Beginning balance $ (31) Cumulative effect of accounting change for adoption of SFAS No. 133 $ (12) Change during the year (6) (19) - -------------------------------------------------------------------------------- Ending balance $ (37) $ (31) ================================================================================ Foreign currency translation adjustment: Beginning balance $ (13) $ (11) $ 5 Change during the year 8 (2) (16) - -------------------------------------------------------------------------------- Ending balance $ (5) $ (13) $ (11) ================================================================================ Net unrealized gain (loss) on securities available for sale, net of tax: Beginning balance $ 7 $ (3) $ (13) Net unrealized gain arising during the year 18 5 10 Reclassification adjustment for realized (gain) loss included in net income (1) 5 - -------------------------------------------------------------------------------- Ending balance $ 24 $ 7 $ (3) ================================================================================ Total accumulated other comprehensive income (loss), net of tax: Beginning balance $ (37) $ (14) $ (8) Change during the year 19 (23) (6) - -------------------------------------------------------------------------------- Ending balance $ (18) $ (37) $ (14) ================================================================================ 20. Earnings Per Share 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 as follows: - -------------------------------------------------------------------------------- Year Ended December 31, 2002 2001 2000 - -------------------------------------------------------------------------------- Net income $ 109 $ 199 $ 718 ================================================================================ Weighted-average common shares outstanding - basic 1,358 1,373 1,360 Common stock equivalent shares related to stock incentive plans 17 26 44 - -------------------------------------------------------------------------------- Weighted-average common shares outstanding - diluted 1,375 1,399 1,404 ================================================================================ Basic EPS: Income before extraordinary gain $ .07 $ .06 $ .53 Extraordinary gain, net of tax $ .01 $ .08 Net income $ .08 $ .14 $ .53 ================================================================================ Diluted EPS: Income before extraordinary gain $ .07 $ .06 $ .51 Extraordinary gain, net of tax $ .01 $ .08 Net income $ .08 $ .14 $ .51 ================================================================================ The computation of diluted EPS for the years ended December 31, 2002, 2001 and 2000, respectively, excludes outstanding stock options to purchase 111 million, 83 million and 13 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. 21. Regulatory Requirements 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 (the Act). The Gramm-Leach-Bliley Act (the GLB Act), permits financial holding companies to engage in activities that are financial in nature, including banking, securities brokerage, underwriting, dealing in or making a market in securities, investment management services and insurance activities. The Federal Reserve Board may impose limitations, restrictions, or prohibitions on the activities or acquisitions of a financial holding company if the Federal Reserve Board believes that the company does not have the appropriate financial and managerial resources to commence or conduct - 43 - an activity, make an acquisition, or retain ownership of a company. The Federal Reserve Board may also take actions as appropriate to enforce applicable federal law. Federal Reserve Board policy provides that a bank holding company generally should not pay cash dividends unless its net income is sufficient to fully fund the dividends and the company's prospective retained earnings appear to be sufficient to meet the capital needs, asset quality and overall financial condition of the holding company and its depository institution subsidiaries. CSC's primary depository institution subsidiary is U.S. Trust NY. The operations and financial condition of CSC's depository institution subsidiaries are subject to regulation and supervision and to various requirements and restrictions under federal and state law, including requirements governing: transactions with CSC and its non-depository institution subsidiaries, loans and other extensions of credit, investments or asset purchases, or otherwise financing or supplying funds to CSC; dividends; investments; and aspects of CSC's operations. The federal banking agencies have broad powers to enforce these regulations, including the power to terminate deposit insurance, impose substantial fines and other civil and criminal penalties and appoint a conservator or receiver. CSC, U.S. Trust and their U.S.-based insured depository institution subsidiaries must meet regulatory capital guidelines adopted by the federal banking agencies. Under the Federal Deposit Insurance Act, the banking regulatory agencies are permitted or, in certain cases, required to take certain substantial restrictive actions with respect to institutions falling within one of the lowest three of five capital categories. Under the Act, the Federal Reserve Board has established consolidated capital requirements for bank holding companies. CSC is subject to those guidelines. The GLB Act prohibits the Federal Reserve Board from imposing capital requirements on functionally regulated non-depository institution subsidiaries of a financial holding company, such as broker-dealers and investment advisors. The Company's, U.S. Trust's, and U.S. Trust NY's regulatory capital and ratios are as follows: - -------------------------------------------------------------------------------- 2002 2001 ----------------- ----------------- December 31, Amount Ratio (1) Amount Ratio (1) - -------------------------------------------------------------------------------- Tier 1 Capital: Company $ 3,477 22.5% $ 3,606 19.8% U.S. Trust $ 600 16.5% $ 564 16.0% U.S. Trust NY $ 360 12.1% $ 354 12.3% Total Capital: Company $ 3,505 22.7% $ 3,632 19.9% U.S. Trust $ 624 17.1% $ 585 16.6% U.S. Trust NY $ 380 12.8% $ 372 12.9% Leverage: Company $ 3,477 9.2% $ 3,606 9.7% U.S. Trust $ 600 9.2% $ 564 8.9% U.S. Trust NY $ 360 6.8% $ 354 6.8% - -------------------------------------------------------------------------------- (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 December 31, 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. To remain a financial holding company, each of CSC's depository institution subsidiaries must be well capitalized and well managed. In addition, each of CSC's insured depository institution subsidiaries must be rated "satisfactory" or better on the institutions' records of meeting the credit needs of their communities under the Community Reinvestment Act of 1977 in order for CSC to engage in new financial activities or, with certain limited exceptions, acquire a company engaged in financial activities. CSC's depository institution subsidiaries are required, under federal regulations, to maintain reserve balances at the Federal Reserve Bank based on deposit levels. These amounts are included in cash and investments segregated and on deposit for federal or other regulatory purposes. The average balances were $49 million in 2002 and $62 million in 2001. On July 11, 2001 USTC and U.S. Trust NY (collectively, USTC/USTNY) entered into a cease and desist order (the order) with the Federal Reserve Board and the Superintendent of Banks of the State of New York (State). Under the order, USTC/USTNY neither admitted nor denied that it had violated any law, but was required to pay a $5 million penalty to the Federal Reserve Board and a $5 million penalty to the State for alleged violations of various reporting and recordkeeping requirements. There was no allegation that client assets were exposed to any risk of loss, nor that there was any evidence of misappropriation or misuse of client funds on the part of any USTC/USTNY employee. In addition, the order required USTC/USTNY to - 44 - take a number of steps to review and improve its risk management processes and systems with respect to the Bank Secrecy Act and banking and securities laws and to provide regular reports to regulators concerning the progress of such measures. USTC/USTNY reached an agreement with the regulators on a plan to improve risk management processes and systems in response to the order. Although the order remains in effect, the Company believes the measures USTC/USTNY have taken, and have committed to take in the future, will be sufficient to address substantially all of the issues identified in the order in a timely manner. 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 this 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 December 31, 2002, Schwab's net capital was $1.2 billion (18% of aggregate debit balances), which was $1.1 billion in excess of its minimum required net capital and $869 million in excess of 5% of aggregate debit balances. At December 31, 2002, SCM's net capital was $99 million, which was $98 million in excess of its minimum required net capital. Schwab, SCM and CSE had portions of their cash and investments segregated for the exclusive benefit of clients at December 31, 2002, in accordance with applicable regulations. 22. Commitments and Contingent Liabilities Operating leases and other commitments: The Company has noncancelable operating leases for office space and equipment. Future minimum rental commitments, including guaranteed residual values (discussed below under Guarantees) and which are net of sublease commitments, under these leases at December 31, 2002 are as follows: - -------------------------------------------------------------------------------- 2003 $ 257 2004 244 2005 393 2006 161 2007 169 Thereafter 786 - -------------------------------------------------------------------------------- Total $ 2,010 ================================================================================ Certain leases contain provisions for renewal options, purchase options and rent escalations based on increases in certain costs incurred by the lessor. Rent expense was $338 million in 2002, $365 million in 2001 and $298 million in 2000. At December 31, 2002, the Company had other commitments totaling $6 million, which include committed capital contributions to venture capital funds. Guarantees: During 2001, the Company began occupying and making lease payments on a newly renovated office building in San Francisco, California. 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. Faced with continued declines in the San Francisco, California commercial real estate market, the Company obtained appraisals in the first and fourth quarters of 2002 in order to estimate its obligations under the residual value guarantee. On the basis of these appraisals, the Company determined that it was probable that the fair value of the property at the end of the lease term would be less than the residual value - 45 - guarantee by approximately $98 million. This shortfall is being amortized as additional rent expense on a straight-line basis over the initial lease term which ends in June 2005. Effective in the first quarter of 2003, the Company plans to cease amortizing the shortfall upon adoption of FIN No. 46 - Consolidation of Variable Interest Entities. See note "2 - Significant Accounting Policies" regarding FIN No. 46. The Company has also provided residual value guarantees in connection with the operating leases it used to finance two corporate aircraft and a fractional interest in a third airplane. At December 31, 2002, the maximum amounts of residual value guarantees under these leases totaled $14 million expiring in 2004 and $20 million expiring in 2007. The Company believes that proceeds from the sale of these airplanes would be sufficient to cover the residual value guarantees and therefore no liability for these guarantees has been recognized. The Company provides certain indemnifications (i.e., protection against damage or loss) to counterparties in connection with the disposition of certain of its assets. Such indemnifications typically relate to title to the assets transferred, ownership of intellectual property rights (e.g., patents), accuracy of financial statements, compliance with laws and regulations, failure to pay, satisfy or discharge any liability, or to defend claims, as well as errors, omissions, and misrepresentations. These indemnification agreements have various expiration dates and the Company's liability under these agreements is generally limited to certain maximum amounts. The Company, however, remains subject to certain uncapped potential liabilities, for example regarding the transfer of trust assets and related obligations in connection with the sale of its Corporate Trust business to Bank of NY. Other than the possible uncapped obligations, at December 31, 2002, the Company's maximum potential liability under these indemnification agreements is limited to approximately $215 million. The Company does not believe that any material loss related to such indemnifications, including the uncapped indemnification obligations, is likely and therefore no liability for these indemnifications has been recognized. Standby letters of credit (LOCs) are conditional commitments issued by U.S. Trust to guarantee the performance of a client to a third party. For example, LOCs can be used to guarantee performance under lease and other agreements by professional business corporations and for other purposes. The credit risk involved in issuing LOCs is essentially the same as that involved in extending loans. LOCs are generally partially or fully collateralized by cash, marketable equity securities, marketable debt securities (including corporate and U.S. Treasury debt securities), and other assets. At December 31, 2002, U.S. Trust had LOCs outstanding totaling $71 million which are short-term in nature and generally expire within one year. At December 31, 2002, no liability for these LOCs has been recognized. The Company has clients that sell (i.e., write) listed option contracts that are cleared by various clearing houses. The clearing houses establish margin requirements on these transactions. The Company satisfies the margin requirements by arranging LOCs, in favor of the clearing houses, that are guaranteed by multiple banks. At December 31, 2002, the outstanding value of these LOCs totaled $639 million. No funds were drawn under these LOCs at December 31, 2002. The Company also provides guarantees to securities clearing houses and exchanges under their standard membership agreement, which requires members to guarantee the performance of other members. Under the agreement, if another member becomes unable to satisfy its obligations to the clearing houses and exchanges, other members would be required to meet shortfalls. The Company's liability under these arrangements is not quantifiable and may exceed the cash and securities it has posted as collateral. However, the potential requirement for the Company to make payments under these arrangements is remote. Accordingly, no liability has been recognized for these transactions. Legal contingencies: In March 2000, three purported class action complaints were filed against U.S. Trust Company, N.A. (USTC, N.A.) in the 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 UC ESOP, breached its fiduciary duties under the Employee Retirement Income Security Act of 1974 by failing to diversify the assets of UC ESOP. Damages were not specified. In November 2000, the plaintiffs filed a consolidated complaint for all three purported class actions, which USTC, N.A. answered, denying all liability. In December 2001, plaintiffs and USTC, N.A. reached a tentative settlement. Under the terms of this settlement, plaintiffs would release USTC, N.A. of all liability. Other than an insignificant deductible, the settlement payment would be paid from insurance coverage. The settlement was presented to the court for its approval in December 2002. In 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. served as Trustee of the Trusts from approximately December of 1992 to March of 1994, and U.S. Trust NY served as Trustee from approximately September 1998 until its recent resignation. At some time during the period from March of - 46 - 1994 to September of 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, and have been consolidated. The other two individual cases have been filed in Montana. In the complaints now applicable to the 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. U.S. Trust NY and USTC, N.A. have reached a tentative settlement with the plaintiffs. Under the terms of this settlement, plaintiffs would release U.S. Trust NY and USTC, N.A. of all liability. Other than an insignificant deductible, the settlement payment would be paid from insurance coverage. The settlement is expected to be presented to the court for its approval after notice to members of the class. On October 24, 2001, partnership and individual plaintiffs filed a complaint in the United States District Court in California (Betker Action) against U.S. Trust Company of Texas, N.A. (US Trust Texas) and other defendants, including USTC, in which the plaintiffs seek to hold the defendants liable for losses that the plaintiffs sustained in connection with the defaults of certain bond offerings (Heritage Bond Offerings). On November 26, 2001, the receiver for certain bond funds (Heartland Funds), filed a complaint in the U.S. District Court of Illinois (Heartland Action) against US Trust Texas, seeking to hold it liable for losses allegedly sustained by the Heartland Funds in connection with the Heritage Bond Offerings. On November 30, 2001, a plaintiff filed a purported class action complaint in California state court (Kivenson Class Action), against US Trust Texas, and other defendants, including USTC. The Kivenson Class Action seeks to hold defendants liable for losses allegedly sustained by the putative class in connection with the Heritage Bond Offerings. US Trust Texas was indenture trustee under various Indentures executed in connection with the Heritage Bond Offerings. Although USTC sold its corporate trust business in 2001, under the sale agreement, USTC retains responsibility for certain litigation, including these cases. In the complaints, the plaintiffs allege that, as indenture trustee, US Trust Texas breached certain duties owed to the plaintiffs. The plaintiffs in the Betker Action and the Kivenson Class Action seek unspecified compensatory damages, punitive damages and other relief. The representative plaintiff in the Heartland Action seeks compensatory damages in excess of $4.8 million, punitive damages and other relief. US Trust Texas and USTC have not yet answered any of these complaints. They intend to defend all of these cases vigorously. The nature of the Company's business subjects it to claims, lawsuits, regulatory examinations, and other proceedings in the ordinary course of business. The ultimate outcome of the matters described above and the various other lawsuits, arbitration proceedings, and claims pending against the Company cannot be determined at this time, and 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 these existing claims and proceedings will not have a material adverse impact on the financial condition, results of operations, or cash flows of the Company. 23. Financial Instruments Subject to Off-Balance-Sheet Risk, Credit Risk or Market Risk Securities lending: Through Schwab and SCM, the Company loans client securities temporarily to other brokers in connection with its securities lending activities. The Company receives cash as collateral for the securities loaned. Increases in security prices may cause the market value of the securities loaned to exceed the amount of cash received as collateral. In the event the counterparty to these transactions does not return the loaned securities or provide additional cash collateral, the Company may be exposed to the risk of acquiring the securities at prevailing market prices in order to satisfy its client obligations. The Company mitigates this risk by requiring credit approvals for counterparties, by monitoring the market value of securities loaned, and by requiring additional cash as collateral when necessary. The Company is obligated to settle transactions with brokers and other financial institutions even if its clients fail to meet their obligations to the Company. Clients are required to complete their transactions on settlement date, generally three business days after trade date. If clients do not fulfill their contractual obligations, the Company may incur losses. The Company has established procedures to reduce this risk by requiring deposits from clients in excess of amounts prescribed by regulatory requirements for certain types of trades, and therefore the potential for Schwab to make payments under these client transactions is remote. Accordingly, no liability has been recognized for these transactions. Margin lending: Schwab provides margin loans to its clients which are collateralized by securities in their brokerage accounts. These clients have agreed to allow Schwab to pledge those securities in accordance with federal regulations. Schwab was allowed, under such regulations, to - 47 - pledge securities with a market value of $9.4 billion and $13.1 billion at December 31, 2002 and 2001, respectively. The market value of Schwab's client securities pledged to fulfill the short sales of its clients was $824 million and $894 million at December 31, 2002 and 2001, respectively, and the market value of Schwab's client securities pledged in securities lending transactions to other broker-dealers was $1.3 billion and $554 million at December 31, 2002 and 2001, respectively. The market value of Schwab's client securities pledged to fulfill Schwab's and SCM's proprietary short sales was $12 million and $15 million at December 31, 2002 and 2001, respectively. Additionally, Schwab borrows securities from other broker-dealers to fulfill short sales of its clients. The market value of these borrowed securities was $57 million and $247 million at December 31, 2002 and 2001, respectively. Schwab has also pledged a portion of its securities owned in order to fulfill the short sales of clients and in connection with securities lending transactions to other broker-dealers. The market value of these pledged securities was $3 million and $1 million at December 31, 2002 and 2001, respectively. In the normal course of its margin lending activities, Schwab may be liable for the margin requirement of client margin securities transactions. As clients write options or sell securities short, the Company may incur losses if the clients do not fulfill their obligations and the collateral in client accounts is not sufficient to fully cover losses which clients may incur from these strategies. To mitigate this risk, the Company monitors required margin levels and clients are required to deposit additional collateral, or reduce positions, when necessary. Financial instruments held for trading purposes: In its capacity as market maker, SCM maintains inventories in Nasdaq and other securities on both a long and short basis. While long inventory positions represent SCM's ownership of securities, short inventory positions represent SCM's obligations to deliver specified securities at a contracted price, which may differ from market prices prevailing at the time of completion of the transaction. Accordingly, both long and short inventory positions may result in losses or gains to SCM as market values of securities fluctuate. Also, the Company maintains inventories on both a long and short basis in exchange-listed securities relating to its specialist operations and proprietary equity trading operations. The Company also maintains inventories in securities on a long basis relating to its fixed income operations. The Company could incur losses or gains as a result of changes in the market value of these securities. To mitigate the risk of losses, long and short positions are marked to market and are monitored by management to assure compliance with limits established by the Company. Additionally, the Company may enter into exchange-traded futures and options contracts to mitigate market risk on these inventories. The notional amounts and fair values of these futures and options contracts are shown in the following table: - -------------------------------------------------------------------------------- December 31, 2002 2001 - -------------------------------------------------------------------------------- Exchange-traded Contracts: Net Short Futures (1): Notional Amount $ 61 $ 125 Fair Value $ 63 $ 125 Long Put Options: Notional Amount $ 4 $ 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 December 31, 2002 and 2001. Securities financing: Schwab and U.S. Trust enter into collateralized resale agreements principally with other broker-dealers, which could result in losses in the event the counterparty to the transaction does not purchase the securities held as collateral for the cash advanced and the market value of these securities declines. To mitigate this risk, Schwab requires that the counterparty deliver securities to a custodian, to be held as collateral, with a market value in excess of the resale price. Schwab also sets standards for the credit quality of the counterparty, monitors the market value of the underlying securities as compared to the related receivable, including accrued interest, and requires additional collateral where deemed appropriate. At December 31, 2002 and 2001, the market value of collateral received in connection with resale agreements that is available to be repledged or sold was $16.5 billion and $15.3 billion, respectively. At December 31, 2002 and 2001, financial instruments in the amount of $674 million and $809 million, respectively, were pledged to secure public deposits, to qualify for fiduciary powers and for other purposes or as collateral for borrowings. Included in the above amounts at December 31, 2002 and 2001, the fair value of collateral pledged under repurchase agreements that is available to be repledged or sold by the counterparties is $334 million and $184 million, respectively. Concentration risk: The Company's most significant concentration of risk is its exposure to securities issued by the U.S. Government and its agencies (U.S. Government). The Company's direct market risk exposure, primarily from investments in securities available for sale, amounted to $1.2 billion at December 31, 2002. The Company maintains indirect exposure to U.S. Government securities held as collateral to secure its resale agreements. The Company's primary credit exposure on these resale transactions is with its counterparty. The Company would have exposure to the U.S. Government securities only in the event of the counterparty's default on the resale agreements. Securities issued by the U.S. Government held as collateral for resale agreements at December 31, 2002 totaled $16.5 billion. - 48 - Commitments to extend credit and LOCs: In the normal course of business, U.S. Trust enters into various transactions involving off-balance sheet financial instruments to meet the needs of its clients and to reduce its own exposure to interest rate risk. The credit risk associated with these instruments varies depending on the creditworthiness of the client and the value of any collateral held. Collateral requirements vary by type of instrument. The contractual amounts of these instruments represent the amounts at risk should the contract be fully drawn upon, the client default, and the value of any existing collateral become worthless. Credit-related financial instruments include firm commitments to extend credit (firm commitments) and LOCs. Firm commitments are legally binding agreements to lend to a client that generally have fixed expiration dates or other termination clauses, may require payment of a fee and are not secured by collateral until funds are advanced. Collateral held includes marketable securities, real estate mortgages or other assets. The majority of U.S. Trust's firm commitments are related to mortgage lending to private banking clients. Firm commitments totaled $622 million and $586 million at December 31, 2002 and 2001, respectively. LOCs outstanding at December 31, 2002 and 2001 amounted to $71 million and $77 million, respectively. Interest rate swaps: As part of its consolidated asset and liability management process, the Company utilizes Swaps to manage interest rate risk. The market values of Swaps can vary depending on movements in interest rates. The amounts at risk upon default are generally limited to the unrealized market value gains of the Swaps, if any. The risk of default depends on the creditworthiness of the counterparty. The Company evaluates the creditworthiness of its counterparties as part of its normal credit review procedures. U.S. Trust uses Swaps to hedge the interest rate risk associated with its variable rate deposits from banking clients. The Swaps are structured for U.S. Trust to receive a variable rate of interest and pay a fixed rate of interest. At December 31, 2002, these Swaps had a weighted-average variable interest rate of 1.57%, a weighted-average fixed interest rate of 6.38%, a weighted-average maturity of 1.8 years, and an aggregate notional principal amount of $790 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 and are recorded on the consolidated balance sheet, with changes in their fair values primarily recorded in other comprehensive income (loss), a component of stockholders' equity. At December 31, 2002 and 2001, U.S. Trust recorded a derivative liability of $64 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 $35 million, or $21 million after tax, from other comprehensive loss to interest expense over the next twelve months. During 2002, CSC entered into Swaps with an aggregate notional principal amount of $293 million that effectively convert the interest rate characteristics of a like amount of its Medium-Term Notes from fixed to variable. These Swaps are structured for CSC to receive a fixed rate of interest and pay a variable rate of interest based on the three-month LIBOR rate. At December 31, 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 3.87%. The variable interest rates reset every three months. At December 31, 2002, these Swaps had a weighted-average maturity of 6.3 years. These Swaps have been designated as fair value hedges under SFAS No. 133, and are recorded on the consolidated balance sheet. Changes in fair value of the Swaps are completely offset by changes in fair value of the hedged Medium-Term Notes. Therefore, there is no effect on net income. At December 31, 2002, CSC recorded a derivative asset of $26 million for these Swaps. Concurrently, the carrying value of the Medium-Term Notes was increased by $26 million. - 49 - 24. Fair Value of Financial Instruments Substantially all of the Company's financial instruments are recorded at estimated fair value or amounts that approximate fair value. The carrying amounts (as recorded on the consolidated balance sheet) and estimated fair values of the Company's financial instruments are as follows: - -------------------------------------------------------------------------------- 2002 2001 ------------------ ------------------ Carrying Fair Carrying Fair Amount Value Amount Value - -------------------------------------------------------------------------------- Financial Assets: Cash and cash equivalents $ 3,114 $ 3,114 $ 4,407 $ 4,407 Cash and investments segregated 21,005 21,005 17,741 17,741 Securities owned 1,716 1,716 1,700 1,700 Receivables from brokers, dealers and clearing organizations 222 222 446 446 Receivables from brokerage clients - net 6,845 6,845 9,620 9,620 Loans to banking clients - net 4,555 4,651 4,046 4,048 Swaps 26 26 - -------------------------------------------------------------------------------- Total $37,483 $37,579 $37,960 $37,962 ================================================================================ Financial Liabilities: Deposits from banking clients $ 5,231 $ 5,231 $ 5,448 $ 5,448 Drafts payable 134 134 396 396 Payables to brokers, dealers and clearing organizations 1,476 1,476 833 833 Payables to brokerage clients 26,401 26,401 26,989 26,989 Accrued expenses and other liabilities, excluding interest rate swap agreements 1,238 1,238 1,273 1,273 Swaps 64 64 54 54 Short-term borrowings 508 508 578 578 Long-term debt 642 674 730 765 - -------------------------------------------------------------------------------- Total $35,694 $35,726 $36,301 $36,336 ================================================================================ Cash and cash equivalents, cash and investments segregated, receivables, deposits from banking clients, payables, accrued expenses and other liabilities, and short-term borrowings are short-term in nature and accordingly are recorded at fair value or amounts that approximate fair value. Securities owned are recorded at estimated fair value. Such fair values are estimated using quoted market prices, where available, or third-party pricing services. Loans to banking clients: The fair value of the Company's loans are estimated using discounted contractual cash flows adjusted for current prepayment estimates. The discount rates used are based on the interest rates charged to current clients for comparable loans. Swaps: The fair value of the Company's Swaps are estimated by obtaining quotes from dealers and third-party pricing services. Long-term debt: A portion of the Company's long-term debt has been adjusted for changes in the fair value of Swaps. See note "23 - Financial Instruments Subject to Off-Balance-Sheet Risk, Credit Risk or Market Risk." The fair value of the Company's long-term debt is estimated using third-party pricing services and discounted cash flow analyses utilizing discount rates currently available for similar instruments. Off-balance sheet financial instruments: In the normal course of business, the Company is a party to certain off-balance-sheet financial instruments, primarily consisting of firm commitments and LOCs, which represent obligations of the Company. As of December 31, 2002, the majority of these commitments mature within one year. The fair value of firm commitments and LOCs are estimated based on fees charged to enter into similar agreements, considering the creditworthiness of the counterparties. The Company has reviewed the unfunded portion of its firm commitments as well as its LOCs and determined that the fair values of these instruments were immaterial at December 31, 2002 and 2001. 25. Segment Information Segments are defined as components of a company in which separate financial information is evaluated regularly by the chief operating decision maker, or decision-making group, in deciding how to allocate resources and in assessing performance. 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. The Individual Investor segment includes Schwab's domestic and international retail operations. The Institutional Investor segment provides custodial, trading, and support services to independent investment advisors, serves company 401(k) plan sponsors and third-party administrators, and supports company stock option plans. (The Company's mutual fund services are considered a product and not a segment. Mutual fund service fees are included in the Individual Investor, Institutional Investor, and U.S. Trust segments.) 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, wealth management, custody, fiduciary, and private banking services to individual and institutional - 50 - clients. The accounting policies of the segments are the same as those described in note "2 - Significant Accounting Policies." 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 non-operating revenues, restructuring and other charges, goodwill and other impairment charges, merger- and acquisition-related charges, and extraordinary gains. Segment assets are not disclosed because they are not used for evaluating segment performance and deciding how to allocate resources to segments. However, capital expenditures are used in evaluating segment performance and are therefore disclosed. Intersegment revenues, defined as revenues from transactions with other segments within the Company, are not material and are therefore not disclosed. Except for the U.S. Trust segment, for which expenses are directly incurred, technology, corporate, and general administrative expenses are allocated to the remaining segments generally in proportion to either their respective revenues or average full-time equivalent employees. Total revenues, net interest revenue (i.e., interest revenue, net of interest expense), income before taxes on income and extraordinary gain, and net income are equal to the Company's consolidated amounts as reported in the consolidated financial statements. Capital expenditures are reported gross, as opposed to net of proceeds from the sale of fixed assets. - -------------------------------------------------------------------------------- Year Ended December 31, 2002 2001 2000 - -------------------------------------------------------------------------------- Total Revenues Individual Investor $ 2,392 $ 2,510 $ 3,617 Institutional Investor 833 821 841 Capital Markets 259 342 687 U.S. Trust 651 654 643 - -------------------------------------------------------------------------------- Operating revenues 4,135 4,327 5,788 Non-operating revenues (1) 26 - -------------------------------------------------------------------------------- Total $ 4,135 $ 4,353 $ 5,788 ================================================================================ Net Interest Revenue Individual Investor $ 524 $ 591 $ 894 Institutional Investor 107 134 165 Capital Markets 14 27 52 U.S. Trust 196 177 126 - -------------------------------------------------------------------------------- Total $ 841 $ 929 $ 1,237 ================================================================================ Adjusted Operating Income Before Taxes Individual Investor $ 256 $ 225 $ 779 Institutional Investor 240 274 311 Capital Markets 16 36 140 U.S. Trust (2) 117 112 158 - -------------------------------------------------------------------------------- Adjusted Operating Income Before Taxes 629 647 1,388 Excluded items (3) (461) (512) (157) - -------------------------------------------------------------------------------- Income before taxes on income and extraordinary gain 168 135 1,231 Tax expense on income (71) (57) (513) Extraordinary gain on sale of corporate trust business, net of tax 12 121 - -------------------------------------------------------------------------------- Net Income $ 109 $ 199 $ 718 ================================================================================ Capital Expenditures Individual Investor $ 104 $ 203 $ 483 Institutional Investor 30 51 95 Capital Markets 12 25 83 U.S. Trust 17 36 44 - -------------------------------------------------------------------------------- Total $ 163 $ 315 $ 705 ================================================================================ Depreciation and Amortization (4) Individual Investor $ 222 $ 295 $ 228 Institutional Investor 55 49 32 Capital Markets 21 27 23 U.S. Trust 23 33 25 - -------------------------------------------------------------------------------- Total $ 321 $ 404 $ 308 ================================================================================ (1) Primarily consists of a gain on the sale of an investment. (2) Excludes an extraordinary pre-tax gain of $22 million in 2002 and $221 million in 2001 relating to the sale of USTC's Corporate Trust business. (3) In 2002, includes restructuring and other charges of $373 million (see note "3 - Restructuring and Other Charges") and goodwill and other impairment charges of $61 million (see note "4 - Goodwill and Other Impairment Charges"). In 2001, includes restructuring and other charges of $419 million (see note "3 - Restructuring and Other Charges") and a gain on the sale of an investment. In 2002, 2001 and 2000, also include merger- and acquisition-related charges of $27 million, $119 million and $157 million, respectively. (4) For 2001 and 2000, include goodwill amortization, which ceased on January 1, 2002 upon the adoption of SFAS No. 142. - 51 - Fees received from Schwab's proprietary mutual funds represented approximately 20% of the Company's consolidated revenues in 2002, 18% in 2001, and 11% in 2000. Except for Schwab's proprietary mutual funds, which are considered a single client for purposes of this computation, no single client accounted for more than 10% of the Company's consolidated revenues in 2002, 2001 and 2000. Substantially all of the Company's revenues and assets are attributed to or located in the U.S. The percentage of Schwab's total client accounts located in California was approximately 27% at December 31, 2002, 2001 and 2000. 26. Supplemental Cash Flow Information - -------------------------------------------------------------------------------- Year Ended December 31, 2002 2001 2000 - -------------------------------------------------------------------------------- Income taxes paid $ 91 $ 218 $ 240 ================================================================================ Interest paid: Brokerage client cash balances $ 176 $ 706 $1,068 Deposits from banking clients 88 128 155 Long-term debt 55 56 47 Short-term borrowings 24 25 19 Other 5 25 45 - -------------------------------------------------------------------------------- Total interest paid $ 348 $ 940 $1,334 ================================================================================ Non-cash investing and financing activities: Common stock and options issued for purchases of businesses $ 4 $ 71 $ 529 ================================================================================ 27. Subsequent Event On January 31, 2003, the Company sold CSE to Barclays PLC (Barclays) in a transaction approved by the Board of Directors on January 30, 2003. Pursuant to the sale agreement, Barclays acquired CSE's British pound sterling product offering and its client base. As part of the sale, assets of approximately $760 million (consisting primarily of cash and cash equivalents and receivables from brokers, dealers and clearing organizations) and liabilities of approximately $735 million (consisting primarily of payables to brokerage clients) were transferred by the Company to Barclays. The impact of this sale on the Company's results of operations is not expected to be material. The Company will continue to maintain its U.S. dollar-based business in the United Kingdom, which provides trading on U.S. exchanges and access to U.S. investment products. - 52 - Management's Report To Our Stockholders: Management of the Company is responsible for the preparation, integrity and objectivity of the consolidated financial statements, and the other financial information presented in this annual report. To meet these responsibilities we maintain a system of internal control that is designed to provide reasonable assurance as to the integrity and reliability of the financial statements, the protection of Company and client assets from unauthorized use, and the execution and recording of transactions in accordance with management's authorization. The system is augmented by careful selection of our managers, by organizational arrangements that provide an appropriate division of responsibility, and by communications programs aimed at assuring that employees adhere to the highest standards of personal and professional integrity. The Company's internal audit function monitors and reports on the adequacy of and compliance with our internal controls, policies, and procedures. Although no cost-effective internal control system will preclude all errors and irregularities, we believe the Company's system of internal control is adequate to accomplish the objectives set forth above. Management of the Company is also responsible for establishing and maintaining disclosure controls and procedures for the Company. Disclosure controls and procedures are designed to help ensure that information we disclose to the public is recorded, processed, summarized and reported within required time specifications and to enable management to make timely decisions regarding required disclosures. To meet these responsibilities, management of the Company has designed such disclosure controls and procedures to help ensure that material information relating to the Company is evaluated and, where appropriate, communicated to management, particularly during the period in which a public report is being prepared. Additionally, management of the Company has evaluated, on a quarterly basis, the effectiveness of the Company's disclosure controls and procedures. Although no cost-effective disclosure controls and procedures system will preclude all errors and irregularities, we believe the Company's system of disclosure controls and procedures is adequate to accomplish the objectives set forth above. The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America and necessarily include some amounts that are based on estimates and our best judgments. The financial statements have been audited by the independent accounting firm of Deloitte & Touche LLP, who were given unrestricted access to all the Company's financial records and related data. We believe that all representations made to Deloitte & Touche LLP during their audit were valid and appropriate. The Board of Directors through its Audit Committee, which is comprised entirely of nonmanagement directors, has an oversight role in the area of financial reporting and internal control. The Audit Committee periodically meets with Deloitte & Touche LLP, our internal auditors, and Company management to discuss accounting, auditing, internal controls over financial reporting, and other matters. /s/ Charles R. Schwab - ------------------------- Chairman of the Board and Co-Chief Executive Officer February 24, 2003 /s/ David S. Pottruck - ------------------------- President and Co-Chief Executive Officer February 24, 2003 /s/ Christopher V. Dodds - ------------------------- Executive Vice President and Chief Financial Officer February 24, 2003 - 53 - Independent Auditors' Report To the Stockholders and Board of Directors of The Charles Schwab Corporation: We have audited the accompanying consolidated balance sheets of The Charles Schwab Corporation and subsidiaries (the Company) as of December 31, 2002 and 2001, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2002. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of The Charles Schwab Corporation and subsidiaries at December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2002 in conformity with accounting principles generally accepted in the United States of America. As discussed in Note 2 to the consolidated financial statements, the Company adopted Statement of Financial Accounting Standards No. 142 - Goodwill and Other Intangible Assets effective January 1, 2002. /s/ Deloitte & Touche LLP - ------------------------- San Francisco, California February 24, 2003 - 54 -
Quarterly Financial Information (Unaudited) The Charles Schwab Corporation (In Millions, Except Per Share Data and Ratios) - ------------------------------------------------------------------------------------------------------------------------------------ Weighted- Basic Diluted Dividends Average Earnings Earnings Declared Range Expenses Net Common (Loss) (Loss) Per of Common Range of Excluding Income Shares- Per Per Common Stock Price Price/Earnings Revenues Interest (Loss) Diluted Share(1) Share(1) Share(2) Per Share Ratio(3) - ------------------------------------------------------------------------------------------------------------------------------------ 2002 by Quarter (4) Fourth $ 996 $1,109 $ (79) 1,340 $(.06) $(.06) $.0110 $12.00 - 7.22 150 - 90 Third 1,031 1,036 (4) 1,358 .00 .00 .0110 11.89 - 7.51 91 - 58 Second 1,049 893 98 1,385 .07 .07 .0110 13.19 - 9.60 94 - 69 First 1,059 929 94 1,389 .07 .07 .0110 19.00 - 12.25 136 - 88 - ------------------------------------------------------------------------------------------------------------------------------------ 2001 by Quarter (5) Fourth $1,059 $1,088 $ (13) 1,362 $(.01) $(.01) $.0110 $16.30 - 10.38 116 - 74 Third 1,023 997 13 1,395 .01 .01 .0110 16.18 - 8.13 65 - 33 Second 1,071 1,097 102 1,405 .07 .07 .0110 23.18 - 13.14 68 - 39 First 1,200 1,036 97 1,410 .07 .07 .0110 33.00 - 14.50 92 - 40 - ------------------------------------------------------------------------------------------------------------------------------------ 2000 by Quarter (6) Fourth $1,335 $1,109 $ 139 1,414 $ .10 $ .10 $.0110 $35.88 - 25.69 70 - 50 Third dividend increase 1,323 1,083 142 1,415 .10 .10 .0110 40.50 - 30.00 74 - 55 Second stock split 1,404 1,151 137 1,407 .10 .09 .0094 40.58 - 24.00 72 - 43 First 1,726 1,214 300 1,390 .23 .22 .0093 44.75 - 22.46 76 - 38 - ------------------------------------------------------------------------------------------------------------------------------------ 1999 by Quarter Fourth $1,274 $ 959 $ 190 1,374 $ .15 $ .14 $.0094 $31.17 - 17.96 64 - 37 Third stock split 1,015 779 144 1,376 .11 .11 .0093 37.67 - 21.33 84 - 47 Second 1,117 835 171 1,377 .13 .12 .0093 51.67 - 26.67 123 - 64 First 1,080 814 161 1,366 .12 .12 .0093 32.67 - 16.96 88 - 46 - ------------------------------------------------------------------------------------------------------------------------------------ 1998 by Quarter Fourth dividend increase/ stock split $ 905 $ 703 $ 122 1,349 $ .10 $ .10 $.0093 $22.83 - 7.03 74 - 23 Third 819 630 114 1,339 .08 .08 .0089 10.22 - 6.17 38 - 23 Second 746 595 91 1,338 .08 .07 .0089 8.89 - 6.58 36 - 26 First 708 572 83 1,345 .06 .06 .0089 9.32 - 7.58 39 - 32 - ------------------------------------------------------------------------------------------------------------------------------------ (1) Both basic and diluted earnings per share include an extraordinary gain of $.01 per share in 2002 and $.08 per share in 2001. (2) Dividends declared per common share do not include dividends declared by U.S. Trust Corporation prior to the completion of the merger in 2000. (3) Price/earnings ratio is computed by dividing the high and low market prices by diluted earnings per share for the 12-month period ended on the last day of the quarter presented. (4) 2002 includes an extraordinary gain, restructuring charges, goodwill and other impairment charges, and merger- and acquisition-related costs totaling $287 million after-tax. Excluding this amount, net income would have been $396 million and the after-tax profit margin would have been 9.6%. (5) 2001 includes an extraordinary gain, non-operating revenue (which primarily consists of a gain on the sale of an investment), restructuring and other charges, and merger- and acquisition-related costs totaling $208 million after-tax. Excluding this amount, net income would have been $407 million and the after-tax profit margin would have been 9.4%. (6) 2000 includes merger- and acquisition-related costs totaling $131 million after-tax. Excluding this amount, net income would have been $849 million and the after-tax profit margin would have been 14.7%.
- 55 - THE CHARLES SCHWAB CORPORATION Chart Appendix List In this appendix, the following descriptions of certain charts in portions of the Company's 2002 Annual Report to Stockholders that are omitted from the EDGAR Version are more specific with respect to the actual numbers, amounts and percentages than is determinable from the charts themselves. The Company submits such more specific descriptions only for the purpose of complying with the requirements for transmitting portions of this Annual Report on Form 10-K electronically via EDGAR; such more specific descriptions are not intended in any way to provide information that is additional to the information otherwise provided in portions of the Company's 2002 Annual Report to Stockholders. EDGAR Version Page Number Chart Description - ----------- ----------------- 9 Stacked bar chart titled "Revenues" representing the composition of revenues by category for the years ended December 31, 2002, 2001, and 2000 (years shown on the bottom axis) as follows (billions of dollars): Asset management & administration fees $1.8, $1.7 and $1.6, respectively; Net interest revenue $.8, $.9 and $1.2, respectively; Other $.1, $.1 and $.1, respectively; Commissions $1.2, $1.4 and $2.3, respectively; Principal transactions $.2, $.3 and $.6, respectively; Revenues (bar labeled) $4.1, $4.4 and $5.8, respectively. 9 Stacked bar chart titled "Revenues by Segment" representing the composition of revenues by segment for the years ended December 31, 2002, 2001, and 2000 (years shown on the bottom axis) as follows (billions of dollars): Individual Investor $2.4, $2.6 and $3.6, respectively; Institutional Investor $.8, $.8 and $.8, respectively; Capital Markets $.2, $.3 and $.7, respectively; U.S. Trust $.7, $.7 and $.7, respectively; Revenues by Segment (bar labeled) $4.1, $4.4 and $5.8, respectively. - 56 - EX-21 10 exh21_1.txt EXHIBIT 21_1 EXHIBIT 21.1 THE CHARLES SCHWAB CORPORATION Subsidiaries of the Registrant Pursuant to Item 601 (b)(21)(ii) of Regulation S-K, certain subsidiaries of the Registrant have been omitted which, considered in the aggregate as a single subsidiary, would not constitute a significant subsidiary (as defined in Rule 1-02(w) of Regulation S-X) as of December 31, 2002. The following is a listing of the significant subsidiaries of the Registrant: Schwab Holdings, Inc. (holding company for Charles Schwab & Co., Inc.), a Delaware corporation Charles Schwab & Co., Inc., a California corporation Charles Schwab Investment Management, Inc., a Delaware corporation U.S. Trust Corporation (holding company for United States Trust Company of New York), a New York corporation United States Trust Company of New York, a New York corporation Other subsidiaries of the Registrant include: The Charles Schwab Trust Company, a California corporation Mayer & Schweitzer, Inc. (holding company for Schwab Associates & Co.), a New Jersey corporation Schwab Associates & Co. (99% limited partner of Schwab Capital Markets L.P.), a Delaware corporation Schwab Capital Markets L.P., a New Jersey limited partnership U.S. Trust Mortgage Service Company (holding company for Co-op Holdings), a Florida corporation Co-op Holdings, a Nevada corporation U.S. Trust Company, a Connecticut corporation EX-23 11 exh23_1.txt EXHIBIT 23_1 EXHIBIT 23.1 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in the following Registration Statements of The Charles Schwab Corporation of our reports dated February 24, 2003 (which reports express an unqualified opinion and include an explanatory paragraph relating to an accounting change), appearing in and incorporated by reference in this Annual Report on Form 10-K of The Charles Schwab Corporation for the year ended December 31, 2002. Filed on Form S-3: Registration Statement No. 333-47107 (The Charles Schwab Corporation Employee Stock Incentive Plan) Registration Statement No. 333-32084 (Common stock registered pursuant to the acquisition of CyBerCorp Holdings, Inc.) Registration Statement No. 333-36410 (Debt Securities) Registration Statement No. 333-50812 (Common stock registered pursuant to the acquisition of Chicago Investment Analytics, Inc.) Filed on Form S-4: Registration Statement No. 333-30886 (Common stock registered pursuant to the acquisition of U.S. Trust Corporation) Registration Statement No. 333-48764 (Registration of common stock) Filed on Form S-8: Registration Statement No. 333-101992 (The Charles Schwab Corporation Employee Stock Incentive Plan) Registration Statement No. 333-44793 (Charles Schwab Profit Sharing and Employee Stock Ownership Plan) Registration Statement No. 333-48335 (The Charles Schwab Corporation Employee Stock Incentive Plan) Registration Statement No. 333-93125 (The Charles Schwab Corporation Employee Stock Incentive Plan) Registration Statement No. 333-32058 (CyBerCorp Holdings, Inc. 1996 Incentive Plan) Registration Statement No. 333-38150 (401(k) Plan and ESOP of United States Trust Company of New York and Affiliated Companies) Registration Statement No. 333-59280 (The Charles Schwab Corporation Employee Stock Incentive Plan) Registration Statement No. 333-63452 (The Charles Schwab Corporation Employee Stock Incentive Plan) Registration Statement No. 333-63448 (The Charles Schwab Corporation 2001 Stock Incentive Plan) Registration Statement No. 333-71322 (The SchwabPlan Retirement Savings and Investment Plan) Registration Statement No. 333-81840 (The Charles Schwab Corporation Employee Stock Incentive Plan) /s/ Deloitte & Touche LLP - ------------------------- San Francisco, California March 21, 2003 -----END PRIVACY-ENHANCED MESSAGE-----