-----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, GTyH/ysSHdxg5aSjvi8p3Rj7RgUITJ0/Gu+eIHakNBVo/o9rrQamANtwlu97407M zS2r7/Ui/RD/RegNGIEMMg== 0000316709-05-000006.txt : 20050302 0000316709-05-000006.hdr.sgml : 20050302 20050302160210 ACCESSION NUMBER: 0000316709-05-000006 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 19 CONFORMED PERIOD OF REPORT: 20041231 FILED AS OF DATE: 20050302 DATE AS OF CHANGE: 20050302 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: 05654386 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 FORM 10-K UNITED STATES 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, 2004 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 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. X --- 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 30, 2004, the aggregate market value of the voting stock held by nonaffiliates of the registrant was $10,683,699,987. 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 February 15, 2005 was 1,319,520,384. DOCUMENTS INCORPORATED BY REFERENCE 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 19, 2005 by reference to portions of that document. THE CHARLES SCHWAB CORPORATION Annual Report On Form 10-K For Fiscal Year Ended December 31, 2004 ------------------------------------------- TABLE OF CONTENTS Part I - ------ Item 1. Business ---------------------------------------------------- 1 General Corporate Overview ------------------------------ 1 Business Strategy and Competitive Environment ----------- 1 Products and Services ----------------------------------- 2 Regulation ---------------------------------------------- 4 Sources of Revenues ------------------------------------- 5 Available Information ----------------------------------- 5 Item 2. Properties -------------------------------------------------- 5 Item 3. Legal Proceedings ------------------------------------------- 5 Item 4. Submission of Matters to a Vote of Security Holders --------- 7 Part II - ------- Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities ------- 7 Item 6. Selected Financial Data ------------------------------------- 8 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations ------------------------------- 9 Description of Business --------------------------------- 9 Overview ------------------------------------------- 9 Results of Operations ----------------------------------- 11 Liquidity and Capital Resources ------------------------- 18 Risk Management ----------------------------------------- 22 Critical Accounting Policies ---------------------------- 25 Forward-Looking Statements ------------------------------ 27 Item 7A. Quantitative and Qualitative Disclosures About Market Risk -- 29 Item 8. Financial Statements and Supplementary Data ----------------- 31 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure -------------------------------- 65 Item 9A. Controls and Procedures ------------------------------------- 65 Item 9B. Other Information ------------------------------------------- 65 Part III - -------- Item 10. Directors and Executive Officers of the Registrant ---------- 65 Item 11. Executive Compensation -------------------------------------- 68 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters --------------- 68 Item 13. Certain Relationships and Related Transactions -------------- 68 Item 14. Principal Accountant Fees and Services ---------------------- 68 Part IV - ------- Item 15. Exhibits and Financial Statement Schedule ------------------ 68 Exhibit Index ------------------------------------------- 69 Signatures ---------------------------------------------- 75 Index to Financial Statement Schedule ------------------ F-1 THE CHARLES SCHWAB CORPORATION PART I Item 1. Business General Corporate Overview The Charles Schwab Corporation (CSC), headquartered in San Francisco, California, and its subsidiaries (collectively referred to as the Company, and primarily located in San Francisco except as indicated), was incorporated in 1986 and engages, through its subsidiaries, in securities brokerage, banking, and related financial services. Client assets totaled $1.081 trillion in 7.3 million active client accounts(a) at December 31, 2004. Charles Schwab & Co., Inc. (Schwab), incorporated in 1971 and entered the discount brokerage business in 1974, is a securities broker-dealer with 236 domestic branch offices in 43 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), which was acquired in 2000 and is located in New York City, New York, is a wealth management firm that through its subsidiaries also provides fiduciary services and private banking services with 37 offices in 15 states. Charles Schwab Bank, N.A. (Schwab Bank), is a retail bank located in Reno, Nevada which commenced operations in April 2003. Other subsidiaries of CSC include Charles Schwab Investment Management, Inc. (CSIM), CyberTrader, Inc. (CyberTrader), located in Austin, Texas, and The Charles Schwab Trust Company (CSTC). CSIM is 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). CyberTrader, which was acquired in 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. On October 29, 2004, the Company sold its capital markets business, consisting of the partnership interests of Schwab Capital Markets L.P. and all of the outstanding capital stock of SoundView Technology Group, Inc. (collectively referred to as Schwab Soundview Capital Markets, or SSCM). In 2003, the Company substantially exited from its international operations with the sales of its U.K. brokerage subsidiary, Charles Schwab Europe, and its investment in Aitken Campbell, a market-making joint venture in the U.K. In 2001, USTC sold its Corporate Trust business. For further information on these transactions, see "Item 8 - Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 5. Discontinued Operations, 6. Business Acquisitions and Divestitures, and 4. Sale of Corporate Trust Business." As of December 31, 2004, the Company had full-time, part-time and temporary employees, and persons employed on a contract basis that represented the equivalent of 14,200 full-time employees. The Company provides financial services to individuals and institutional clients through three segments - Individual Investor, Institutional Investor, and U.S. Trust. The Individual Investor segment includes the Company's retail brokerage and banking 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 U.S. Trust segment provides investment, wealth management, custody, fiduciary, and private banking services to individual and institutional clients. For financial information by segment for the three years ended December 31, 2004, as well as a discussion of the previously-reported Capital Markets segment, see "Item 8 - Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 26. Segment Information." Business Strategy and Competitive Environment Consistent with the Company's vision of being the most useful and ethical provider of financial services in the world, its primary strategy is to meet the financial services needs of individual investors and the independent IAs who serve them. In pursuit of this strategy, the Company has refocused on improving service for these clients and building stronger relationships with them, simplified its organizational structure and client offers, reduced its commission rates and fees, and exited the capital markets business. Another important element of the Company's strategy is its ongoing emphasis on combining people and technology in ways that facilitate the delivery of a full range of investment services at great value. People provide the client focus and personal touch that are essential in serving investors, while technology helps create services that are scalable and consistent. This combination helps the Company to deliver useful, relevant, and value-priced offerings to a broad array of clients - independent investors, individuals investing through retirement plans, individuals seeking advice, active traders, and independent IAs - and compete for a large percentage of the trillions of investable wealth in the U.S. To attract and serve these clients, the Company offers a broad and growing array of investment, banking and lending products. The Company's competition in serving independent investors includes a wide range of brokerage and asset management firms. In serving these investors, the Company offers branch, telephonic and online service capabilities and - --------------------------- (a) Accounts with balances or activity within the preceding eight months. - 1 - THE CHARLES SCHWAB CORPORATION an extensive product line. Schwab's network of branches and regional telephone service centers is staffed with trained and experienced financial consultants focused on building and sustaining client relationships. In addition, the Company offers the ability to meet client trading and/or advice needs through a single ongoing relationship, even as those needs change over time, and it also provides access to automated online and telephonic channels to provide quick and efficient access to an extensive array of information, research, tools, trade execution, and administrative services. Individuals investing for retirement through 401(k) plans can take advantage of the Company's bundled offering of multiple investment choices, education and third-party advice. Competition in serving investors looking for an advisory relationship involves a variety of traditional brokerage, asset management, and wealth advisory firms. Management believes that the Company's competitive strengths in this arena revolve around its ability to provide clients with an individually tailored solution - ranging from occasional consultations to an ongoing relationship with a Schwab Consultant, IA, or U.S. Trust advisor - versus the more fragmented offerings of other firms. For active traders, the Company primarily competes with deep-discount, online-focused firms as well as certain larger financial institutions. Management believes the Company can continue to attract these clients because it combines highly competitive pricing and expert tools with extensive service capabilities - including experienced, knowledgeable teams of trading specialists and integrated product offerings. The Company also offers these clients access to all of the other tools, products, and advice available at Schwab to help them manage their diverse and complex portfolios. In the IA arena, the Company competes with institutional custodians, traditional and discount brokers, banks and trust companies. Management believes that its Schwab Institutional(R) unit can maintain its market leadership position through a combination of superior service, scale, dedicated resources, and extensive familiarity with the industry. Schwab Institutional also leverages technology to provide IAs with the tools and support they need to grow and manage their practices efficiently. Overall, management believes that the Company's multi-channel service delivery model of branch, phone and internet access is essential to its ability to compete effectively with the wide variety of financial services firms striving to attract client relationships and assets across the spectrum of investors. Under this model, the Company can offer personalized service at competitive prices while giving clients the choice of where, when and how they do business with the firm. Another important aspect of the Company's ability to compete is its ongoing focus on efficiency and productivity, as lower costs give the Company greater pricing flexibility. Management believes that this focus remains important in light of the recent competitive environment, in which a number of competitors reduced online trading commission rates and account fees. Additionally, the Company's nationwide marketing effort is an important competitive tool because it reinforces the attributes of the Schwab(R), U.S. Trust(R) and CyberTrader(R) brands, thereby leveraging the local marketing endeavors of the 3,700 Company staff in the offices and service centers. In addition to competition from other financial services firms, the Company faces competition for quality professionals and other personnel, and its ability to continue to compete effectively will depend upon its ability to attract new employees and retain existing employees while managing compensation. The Company's business can also be significantly affected by the general environment - - economic, corporate, securities market, regulatory and geopolitical developments all play a role in client asset valuations, trading activity, interest rates and overall investor engagement. For a discussion of the business environment faced by the Company in 2004, see "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Description of Business - Overview." Products and Services The Company offers a broad range of products to address its clients' varying investment and financial needs. Examples of these product offerings include: o Brokerage - various asset management accounts including some with check-writing features, individual retirement accounts, Keogh accounts, 529 college savings accounts, margin loans, and access to fixed income securities, and equity and debt offerings; o Banking - first mortgages, home equity lines of credit, pledged-asset mortgages, certificates of deposit, demand deposit accounts, private banking accounts, and credit cards; and o Mutual funds - third-party mutual funds through Mutual Fund Marketplace(R), including no-load mutual funds through the Mutual Fund OneSource(R) service, proprietary mutual funds from two fund families - SchwabFunds(R) and Excelsior(R) Funds, and mutual fund trading and clearing services to broker-dealers. In addition, the Company offers a wide array of services designed to meet the needs of independent, advised, and actively trading investors. The Company's products and services are made available through its three segments - Individual Investor, Institutional Investor, and U.S. Trust. Individual Investors Clients of the Company, through the Individual Investor segment or indirectly through the Institutional Investor segment, have access to the services described below. - 2 - THE CHARLES SCHWAB CORPORATION Independent Investors. For investors who make their own investment decisions, the Company offers research, analytic tools, performance reports, market analysis, and educational material. Clients looking for more guidance have access to online portfolio planning tools, as well as professional advice from Schwab's investment specialists who can help develop an investment strategy and carry out investment and portfolio management decisions. Schwab strives to demystify investing by educating and assisting clients in the development of investment plans. Educational tools include workshops, interactive courses, and online information about investing. Additionally, Schwab provides various Internet-based research and analysis tools which are designed to help clients achieve better investment outcomes. As an example of such tools, Schwab Equity Ratings(R) is a quantitative model-based stock rating system which provides all clients with ratings on approximately 3,000 stocks, assigning each equity a single grade: A, B, C, D, or F. Stocks are rated based on specific factors relating to fundamentals, valuation, momentum, and risk, and ranked so that the number of 'buy consideration' ratings - As and Bs - equals the number of 'sell consideration' ratings - Ds and Fs. Advised Investors. The Company seeks to provide clients with customized advice that is uncomplicated and not influenced by commissions on transactions. 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. Schwab Private ClientTM 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. The Schwab Advisor Network(R) is designed for investors who want the assistance of an independent professional in managing their financial affairs. The IAs in the Schwab Advisor Network provide investors with personalized portfolio management, financial planning, and wealth management solutions. Through this program, certain Schwab clients and potential clients who desire personalized investment management, wealth management, trust, and private banking services can also receive referrals to U.S. Trust. Actively Trading Investors. The Company strives to deliver information, education, technology, service and pricing which meets the needs of active traders. For highly active traders, CyberTrader offers integrated Web- and software-based trading platforms, which incorporate direct access and intelligent order routing technology, real-time market data, options trading, and premium stock research. For active traders, Schwab also offers Web- and software-based trading platforms with account management features, risk management tools, multi-channel access, and dedicated personal support. Global Dollar Services. The Company's global dollar business serves both foreign investors and non-English-speaking U.S. clients who wish to trade or invest in U.S. dollar-based securities. The Company has a physical presence in the United Kingdom and Hong Kong. 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. Institutional Investors Schwab Institutional.(R) Through the Institutional Investor segment, Schwab provides custodial, trading, technology, Web, and other support services to IAs, whose services are integral to the Company's advice offerings. To attract and serve advisors, Schwab Institutional has a dedicated sales force and experienced registered representatives assigned to individual advisors. IAs who custody client accounts at Schwab may use proprietary software which provides IAs with up-to-date client account information, as well as trading capabilities. Participating IAs may also utilize the Schwab Institutional website, the core platform for IAs to conduct daily business activities online with Schwab, including submitting client account information, and retrieving news and market information; as well as a service which enables IAs to provide their clients with personalized equity portfolio management by a variety of institutional asset managers. Corporate Services. The Company provides 401(k) recordkeeping and other retirement plan services to corporations and professional organizations. A dedicated sales force markets these services directly to such organizations, and the Company also serves plan sponsors indirectly through alliances with third-party administrators. The Company's bundled 401(k) retirement plan product offers plan sponsors a wide array of investment options, participant education and servicing, trustee services, and participant-level recordkeeping. Participants in these plans have access to customized advice provided by a third party. - 3 - THE CHARLES SCHWAB CORPORATION 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. For clients with less than $2 million in assets at U.S. Trust, the firm offers Wealth Advisory Accounts, an investment advisory service that utilizes the Excelsior(R) family of mutual funds. For clients with $2 million to $50 million in assets, 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. 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. 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 investment, consulting, and fiduciary services for employee stock ownership plans. 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, including Schwab Bank and affiliates of U.S. Trust, are subject to regulation under federal and state law, including supervision by federal and state banking authorities. For a discussion of bank holding company requirements, see "Item 8 - Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 22. Regulatory Requirements." The securities industry in the United States is subject to extensive regulation under both federal and state laws. Schwab and CyberTrader are registered as broker-dealers with the SEC, the fifty states, and the District of Columbia and Puerto Rico. Schwab and CSIM are registered as investment advisors with the Securities and Exchange Commission (SEC). Additionally, Schwab is regulated by the Commodities Futures Trading Commission (CFTC) with respect to the futures and commodities trading activities it conducts as an introducing broker. Much of the regulation of broker-dealers has been delegated to self-regulatory organizations (SROs), namely the national securities exchanges and the Municipal Securities Rulemaking Board (MSRB). Schwab is a member of a number of national securities exchanges and is consequently subject to their rules and regulations. The primary regulators of Schwab and CyberTrader are the National Association of Securities Dealers (NASD) and, for municipal securities, the MSRB. The CFTC has designated the National Futures Association (NFA) as Schwab's primary regulator for futures and commodities trading activities. The Company's business is also subject to oversight by regulatory bodies in other countries in which the Company operates. The principal purpose of regulating broker-dealers and investment advisors is the protection of clients and the securities markets. The regulations to which broker-dealers and investment advisors are subject cover all aspects of the securities business, including, among other things, sales and trading practices, publication of research, margin lending, uses and safekeeping of clients' funds and securities, capital adequacy, recordkeeping and reporting, fee arrangements, disclosure to clients, fiduciary duties owed to advisory clients, and the conduct of directors, officers and employees. New legislation, rule changes, or changes in the interpretation or enforcement of existing federal, state and SRO rules and regulations may directly affect the operation and profitability of the Company. The profitability of the Company could also be affected by rules and regulations which impact the business and financial communities generally, including changes to the laws governing taxation, electronic commerce, and security of client data. The Company is subject to claims, lawsuits, regulatory examinations and enforcement proceedings in the ordinary course of business, which can result in settlements, awards, censures, fines, cease and desist orders, or suspension or expulsion of an affiliate, its officers, or employees. As registered broker-dealers, certain subsidiaries of CSC, including Schwab are subject to SEC Rule 15c3-1 (the Net Capital Rule) and related SRO requirements. The CFTC and NFA also impose net capital requirements. The Net Capital Rule specifies minimum capital requirements that are intended to ensure the general financial soundness and liquidity of broker-dealers. Because CSC itself is not a registered broker-dealer, it is not subject to the Net Capital Rule. However, if Schwab failed to maintain specified levels of net capital, such failure would constitute a default by CSC under certain debt covenants. The Net Capital Rule limits broker-dealers' ability to transfer capital to parent companies and other affiliates. Compliance with the Net Capital Rule could limit Schwab's operations and its ability to repay subordinated debt to CSC, which in turn could limit CSC's ability to repay debt, pay cash dividends and purchase shares of its outstanding stock. - 4 - THE CHARLES SCHWAB CORPORATION See also "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operation - Liquidity and Capital Resources - Liquidity" and "Item 8 - Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 22. Regulatory Requirements." Sources of Revenues For revenue information by source for the three years ended December 31, 2004, see "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations - Revenues." Available Information The Company files annual, quarterly, and current reports, proxy statements and other information with the SEC. You may read and copy any document we file with the SEC at the SEC's public reference room at 450 Fifth Street, NW, Washington, DC 20549. Please call the SEC at 1-800-SEC-0330 for information on the public reference room. The SEC maintains an Internet website that contains annual, quarterly and current reports, proxy and information statements and other information that issuers (including the Company) file electronically with the SEC. The SEC's Internet website is www.sec.gov. On the Company's Internet website, www.aboutschwab.com, the Company posts the following filings as soon as reasonably practicable after they are electronically filed with or furnished to the SEC: the Company's annual reports 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 website are available free of charge. Item 2. Properties A summary of the Company's significant locations at December 31, 2004 is presented in the following table. All locations are leased, except as noted below. The square footage amounts (in thousands) are presented net of space that has been subleased to third parties. - -------------------------------------------------------------------------------- Square Footage Location Leased Owned - -------------------------------------------------------------------------------- Corporate office space: San Francisco, CA (1) 1,607 - New York, NY (2) 436 - Service centers: Phoenix, AZ (3,4) 107 1,009 Denver, CO (3) 274 - Orlando, FL (3) 106 - Indianapolis, IN (3) - 113 - -------------------------------------------------------------------------------- (1) Includes Schwab headquarters. (2) Includes U.S. Trust headquarters. (3) Includes a regional telephone service center. (4) Includes two data centers and an administrative support center. Substantially all of the Company's branch offices are located in leased premises. The corporate headquarters, data centers, offices, and service centers generally support all of the Company's segments. From 2001 to 2004, the Company initiated restructuring initiatives that included reductions in facilities. For a discussion of such initiatives, see "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operation - Description of Business" and "Item 8 - Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 3. Restructuring Charges." Properties that are included in the Company's restructuring initiatives are excluded from the table above. Item 3. Legal Proceedings CSC and its subsidiaries have been named as parties in various legal actions, which include the matters described below. It is inherently difficult to predict the ultimate outcome of these matters, particularly in cases in which claimants seek substantial or unspecified damages, and a substantial judgment, settlement or penalty could be material to the Company's operating results for a particular future period, depending on the Company's results for that period. However, based on current information, it is the opinion of management, after consultation with counsel, that the resolution of these matters will not have a material adverse impact on the financial condition, results of operations or cash flows of the Company. - 5 - THE CHARLES SCHWAB CORPORATION Mutual Funds Litigation: Since November 2003, multiple purported class action and derivative lawsuits have been filed against the Company and certain affiliates, officers and directors in connection with alleged improper and illegal mutual fund trading practices. Two stockholders' derivative actions were filed in California Superior Court in San Francisco in March and April 2004 against CSC and sixteen current or former CSC directors. These actions allege that the directors breached their fiduciary duties to Schwab and its stockholders by allegedly failing to maintain adequate controls to prevent improper mutual fund trading practices. The lawsuits seek the recovery of unspecified compensatory damages and attorneys' fees from the named individuals, along with the return of all salaries and other remuneration they received as directors. CSC is named as a nominal defendant, although no damages are sought against CSC. Several lawsuits filed in federal court relating to mutual fund trading practices have been consolidated in U.S. District Court in Maryland for the purpose of consolidated and coordinated pre-trial proceedings. Lead plaintiffs and lead counsel have been appointed, and lead plaintiffs have filed consolidated and amended complaints in such actions as follows: During September 2004, purported Excelsior(R) Fund shareholders filed a consolidated amended class action complaint against USTC, United States Trust Company of New York (U.S. Trust NY), Schwab and the Excelsior Funds. Plaintiffs allege that the defendants breached fiduciary duties and violated various federal securities laws by permitting market timing and late trading in the Excelsior Funds and by failing to disclose such timing in the fund prospectuses. Plaintiffs seek unspecified compensatory and punitive damages, and disgorgement of investment advisory fees. During September 2004, certain Excelsior Fund shareholders also filed a consolidated amended derivative action on behalf of nominal defendants Excelsior Funds Inc., Excelsior Funds Trust, and Excelsior Tax Exempt Funds Inc. (the Fund Companies), against CSC, USTC, U.S. Trust NY, U.S. Trust Company, N.A. (U.S. Trust NA), various current and former officers, directors and trustees of the Excelsior Funds (the U.S. Trust and Excelsior Defendants) and various third-party defendants. Plaintiffs allege that the U.S. Trust and Excelsior Defendants breached fiduciary duties and violated federal securities laws by permitting market timing in the Excelsior Funds and by failing to disclose such timing in the fund prospectuses. Plaintiffs seek, on behalf of the Fund Companies, unspecified monetary damages, as well as removal of the Excelsior Fund directors, removal of U.S. Trust as advisor to the funds, rescission of U.S. Trust's investment advisory contracts with the funds, and disgorgement of management fees and compensation relating to the funds. During October 2004, certain CSC shareholders filed a consolidated amended class action complaint on behalf of purchasers of CSC stock, against CSC, Schwab, U.S. Trust NA, U.S. Trust NY and current and former CSC and U.S. Trust officers and directors Charles Schwab, Alan Weber, David Pottruck, and Jeffrey Maurer. Plaintiffs allege that the defendants violated federal securities laws by failing to disclose alleged improper mutual fund trading practices. Plaintiffs seek unspecified compensatory damages. During October 2004, Schwab was named in three additional class action lawsuits brought on behalf of shareholders in the Invesco, MFS, and Pilgrim-Baxter mutual fund families. The lawsuits, which were filed in U.S. District Court in Maryland, allege that Schwab and more than 38 other broker-dealers, banks, and other financial intermediaries acted as conduits for market-timing and late-trading activity by disregarding excessive trading on their platforms and facilitating such activity. Plaintiffs seek unspecified compensatory and punitive damages. The Company believes it has strong defenses and is vigorously contesting each of the above mentioned claims. Mutual Funds Regulatory Matters: The Company has been responding to inquiries and subpoenas from federal and state authorities relating to circumstances in which a small number of parties were permitted to engage in short-term trading of certain Excelsior Funds through U.S. Trust. Although the Company is unable to predict the ultimate outcome of these matters, any enforcement actions instituted as a result of the investigations may subject the Company to fines, penalties or other administrative remedies. The Company is cooperating with regulators, and has taken steps to enhance its existing policies and procedures to further discourage, detect, and prevent market timing and late trading. SoundView Technology Group, Inc. (SoundView) Litigation: As part of the sale of SoundView to UBS Securities LLC and UBS Americas Inc. (collectively referred to as UBS), the Company agreed to indemnify UBS for any expenses associated with certain litigation, including the following matters: SoundView and certain of its subsidiaries are among the numerous financial institutions named as defendants in multiple purported securities class actions filed in the United District Court for the Southern District of New York (the IPO Allocation Litigation) between June and December 2001. The IPO Allocation Litigation was brought on behalf of persons who either directly or in the aftermarket purchased IPO securities between March 1997 and December 2000. The plaintiffs allege that SoundView and the other underwriters named as defendants required customers receiving allocations of IPO shares to pay excessive and undisclosed commissions on unrelated trades and to purchase shares in the aftermarket at prices higher than the IPO price, in violation of the federal securities laws. SoundView has been named in 31 of the actions - each involving a different company's IPO - which - 6 - THE CHARLES SCHWAB CORPORATION have been consolidated with 280 other actions in which SoundView is not named as a defendant. The parties, with the assent of the Court, have selected 17 of these cases as focus cases for the purpose of case-specific discovery, and the Court has certified the existence of a class in the focus cases. Wit Capital, a SoundView predecessor, is a defendant in one of the focus cases. Additionally, SoundView and/or related entities had underwriting commitments in approximately 11 other focus cases; SoundView entities are not named as defendants in these cases, but may have indemnification obligations to the lead underwriters depending on the outcome of these actions. The Company is vigorously contesting such claims on behalf of SoundView pursuant to the above-mentioned indemnity. 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 2004. PART II Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities The Company's common stock is listed on the New York Stock Exchange and the Nasdaq Stock Market under the ticker symbol SCH. The number of common stockholders of record as of February 15, 2005 was 11,666. The closing market price per share on that date was $10.95. The other information required to be furnished pursuant to this item is included in "Item 8 - Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 29. Quarterly Financial Information (Unaudited)." (c) Issuer Purchases of Equity Securities The following table summarizes purchases made by or on behalf of CSC of its common stock for each calendar month in the fourth quarter of 2004. - -------------------------------------------------------------------------------- (In millions, except Total Number Approximate per share amounts) of Shares Dollar Value of Purchased as Shares that Total Number Average Part of Publicly May Yet be of Shares Price Paid Announced Purchased under Month Purchased (1) per Share Program (1) the Program - -------------------------------------------------------------------------------- October 7 $ 8.95 7 $109 November 11 9.94 11 - December 5 11.94 5 234 - -------------------------------------------------------------------------------- Total 23 $10.13 23 $234 ================================================================================ (1) All shares were repurchased under authorizations by CSC's Board of Directors of $300 million, $250 million, and $500 million of common stock publicly announced by the Company on December 9, 2004, March 17, 2003, and September 20, 2001, respectively. Both the March 17, 2003 and September 20, 2001 authorizations have been exhausted. Unless modified or revoked by the Board of Directors, the remaining authorization does not have an expiration date. The Company may receive shares to pay the exercise price and/or to satisfy tax withholding obligations by employees who exercise stock options (granted under employee stock incentive plans), which are commonly referred to as stock swap exercises. Such exercises represented less than 500,000 per month for each of the months presented in the above table. - 7 -
THE CHARLES SCHWAB CORPORATION Item 6. Selected Financial Data Selected Financial and Operating Data (In Millions, Except Per Share Amounts, Ratios, Number of Domestic Offices, Average Revenue Per Revenue Trade, and as Noted) - ------------------------------------------------------------------------------------------------------------------------------------ Growth Rates ------------------- Compounded Annual 4-Year 1-Year 2000-2004 2003-2004 2004 2003 2002 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------------ Results of Operations Revenues (1) (5%) 8% $ 4,202 $ 3,896 $ 3,944 $ 4,068 $ 5,199 Expenses excluding interest (1) (4%) 12% $ 3,557 $ 3,179 $ 3,695 $ 3,941 $ 4,183 Income from continuing operations before extraordinary gain (1) (8%) (13%) $ 414 $ 476 $ 149 $ 75 $ 583 Net income (21%) (39%) $ 286 $ 472 $ 109 $ 199 $ 718 Income from continuing operations per share - basic (1) (8%) (11%) $ .31 $ .35 $ .11 $ .05 $ .43 Income from continuing operations per share - diluted (1) (8%) (14%) $ .30 $ .35 $ .11 $ .05 $ .41 Basic earnings per share (2) (21%) (40%) $ .21 $ .35 $ .08 $ .14 $ .53 Diluted earnings per share (2) (20%) (40%) $ .21 $ .35 $ .08 $ .14 $ .51 Dividends declared per common share 16% 48% $ .074 $ .050 $ .044 $ .044 $ .041 Weighted-average common shares outstanding - diluted 1,365 1,364 1,375 1,399 1,404 Non-trading revenues as a percentage of revenues (1,3) 76% 69% 69% 66% 55% Trading revenues as a percentage of revenues (1,3) 24% 31% 31% 34% 45% Effective income tax rate on income from continuing operations (1) 35.8% 33.6% 40.2% 41.4% 42.6% Capital expenditures - cash purchases of equipment, office facilities, property, and internal-use software development costs, net (4) (27%) 32% $ 194 $ 147 $ 154 $ 295 $ 689 Capital expenditures as a percentage of revenues (4) 5% 4% 4% 7% 13% ==================================================================================================================================== Performance Measures Pre-tax profit margin (1) 15.3% 18.4% 6.3% 3.1% 19.5% After-tax profit margin (1) 6.8% 12.1% 2.8% 4.9% 13.8% Return on stockholders' equity 6% 11% 3% 5% 21% ==================================================================================================================================== Financial Condition (at year end) Total assets 5% 3% $ 47,133 $ 45,866 $ 39,705 $ 40,464 $ 38,154 Long-term debt (7%) (24%) $ 585 $ 772 $ 642 $ 730 $ 770 Stockholders' equity 1% (2%) $ 4,386 $ 4,461 $ 4,011 $ 4,163 $ 4,230 Assets to stockholders' equity ratio 11 10 10 10 9 Long-term debt to total financial capital (long-term debt plus stockholders' equity) 12% 15% 14% 15% 15% ==================================================================================================================================== Client Information (at year end) Client assets (in billions) 6% 12% $1,081.2 $ 966.7 $ 764.8 $ 845.9 $ 871.7 Active client accounts (5) (1%) (3%) 7.3 7.5 8.0 7.8 7.5 Total mutual fund assets (in billions) 8% 14% $ 441.3 $ 386.8 $ 323.8 $ 342.8 $ 330.3 Independent investment advisor client assets (in billions) (6) 11% 21% $ 348.2 $ 287.1 $ 222.4 $ 235.0 $ 231.3 Independent investment advisor client accounts (in thousands) (6) 7% 6% 1,316.3 1,238.8 $1,182.4 $1,081.7 $ 986.5 Number of domestic offices (10%) (27%) 273 376 422 429 415 ==================================================================================================================================== Employee Information (4) Full-time equivalent employees (at year end, in thousands) (14%) (11%) 14.2 16.0 16.4 19.2 25.9 Revenues per average full-time equivalent employee (in thousands) 5% 10% $ 269 $ 245 $ 214 $ 183 $ 218 Compensation and benefits expense as a percentage of revenues 45% 43% 44% 44% 44% ==================================================================================================================================== (1) Amounts have been adjusted to summarize the impact of The Charles Schwab Corporation's (the Company's) sales of its capital markets business, Schwab Soundview Capital Markets, and its United Kingdom (U.K.) brokerage susidiary, Charles Schwab Europe, in loss from discontinued operations. (2) Both basic and diluted earnings per share include discontinued operations and extraordinary gains. (3) Non-trading revenues include asset management and administration fees, net interest revenue, and other revenues. Trading revenues include commission and principal transaction revenues. (4) Amounts have been adjusted to reflect the sale of Schwab Soundview Capital Markets. (5) Reflects the removal of 192,000 accounts in 2003 related to the Company's withdrawal from the Employee Stock Purchase Plan business and the transfer of those accounts to other providers. Active accounts are defined as accounts with balances or activity within the preceding eight months. (6) Represents amounts related to the Schwab Institutional(R) unit.
- 8 - THE CHARLES SCHWAB CORPORATION Management's Discussion and Analysis of Financial Condition and Results of Operations (Tabular Amounts in Millions, Except Ratios, and as Noted) Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations DESCRIPTION OF BUSINESS Overview Securities market returns were mixed for much of 2004 due to the cumulative effects of ongoing geopolitical, economic and energy market uncertainties, concerns about rising interest rates, and a close presidential election. While this environment weighed on client engagement, the Company actively pursued its strategy of refocusing on its core client base, improving product and service offerings for those clients, lowering pricing, and streamlining its overall infrastructure. In addition, the Company embarked on a firm-wide cost reduction effort designed to mitigate the effects of its price reductions and to improve overall efficiency and productivity. During the fourth quarter of 2004, the election was decided and market returns turned positive. In this improved environment, client asset valuations recovered and daily average revenue trades rose by 39% over third quarter lows. The Dow Jones Industrial Average, the Standard and Poor's 500 Index, and the Nasdaq Composite Index ended 2004 up 3%, 9%, and 9%, respectively. Total client assets housed at the Company rose by 12% during 2004 to $1.08 trillion; net new client assets brought to the Company totaled $50.3 billion for the year, including $16.8 billion in the fourth quarter, the highest in 13 quarters. Overall, the Company's price cuts contributed to a 14% decline in trading revenues for 2004, yet continued success in attracting client assets and building stronger client relationships led to a 17% increase in non-trading revenues and total revenue growth of 8%. Expenses rose by 12% over 2003 levels, reflecting the reinstatement of the Company's 401(k) match and the payment of higher discretionary bonuses, an increased marketing communications investment, and the recognition of $261 million in after-tax charges relating to the Company's exit from the capital markets business and its cost reduction effort. As a result, net income declined by 39% from 2003, and the Company's 2004 profit margin was 6.8%, compared with 12.1% in the prior year. The Company's 2004 cost reduction effort enabled the firm to steadily reduce its operating expense base throughout 2004, and about $300 million in annualized cost savings were identified and implemented by year end. The Company generates cash primarily through the revenues of its brokerage and banking subsidiaries. These revenues are classified into non-trading and trading categories. The Company earns non-trading revenues primarily through: o Asset management and administration fees earned through its proprietary and third-party mutual fund offerings, as well as fee-based investment management and advisory services; and o Interest revenue earned on margin loans, loans to banking clients, and investments. Non-trading revenues are impacted by securities valuations, interest rates, the Company's ability to attract new clients, and client activity levels. The Company earns trading revenues through: o Commissions earned for executing trades for clients; and o Principal transaction revenues for trading activity in fixed income securities. Trading revenues are impacted by trading volumes, the volatility of equity prices in the securities markets and commission rates. Management of the Company focuses on several key financial and non-financial metrics (as shown in the following table) in evaluating the Company's financial position and operating performance: - -------------------------------------------------------------------------------- Growth Rate 1-year 2003-2004 2004 2003 2002 - -------------------------------------------------------------------------------- Client Activity Metrics: Net new client assets (in billions) (1) (10%) $ 50.3 $ 56.2 $ 47.6 Client assets (in billions, at year end) 12% $1,081.2 $ 966.7 $ 764.8 Daily average revenue trades (in thousands) 11% 156.4 140.8 134.1 Company Financial Metrics: Revenue growth (decline) from prior year (2) 8% (1%) (3%) Pre-tax profit margin (2) 15.3% 18.4% 6.3% Return on stockholders' equity 6% 11% 3% Revenue per average full-time equivalent employee (in thousands) (2) 10% $ 269 $ 245 $ 214 Revenue on client assets (9%) 42 46 49 - -------------------------------------------------------------------------------- (1) Includes an individual outflow of $6.0 billion in 2004 related to a mutual fund clearing client. Includes inflows of $12.1 billion in 2003 at U.S. Trust related to the acquisition of State Street Corporation's Private Asset Management group. (2) All amounts have been adjusted to reflect the sale of the Company's capital markets business. o Net new client assets is defined as the total inflows of client cash and securities to the firm less client outflows. Management believes that this metric depicts how well - 9 - THE CHARLES SCHWAB CORPORATION Management's Discussion and Analysis of Financial Condition and Results of Operations (Tabular Amounts in Millions, Except Ratios, and as Noted) the Company's products and services appeal to new and existing clients. o Client assets is the market value of all client assets housed at the Company. Management considers client assets to be indicative of the Company's appeal in the marketplace. Additionally, growth in certain components of client assets (e.g., money market funds) directly impacts asset management and administration fee revenues. o Schwab's daily average revenue trades (DART) is deemed by management to be a key indicator of client engagement with securities markets and the most prominent driver of commission revenues. o Management believes that revenue growth, pre-tax profit margin, and return on stockholders' equity provide broad indicators of the Company's overall financial health, operating efficiency, and ability to generate acceptable returns. o Revenue per average full-time equivalent employee (revenue per FTE) is considered by management to be the Company's broadest measure of productivity. With the Company's restructuring initiatives over the past four years, revenue per FTE has steadily improved to $269,000 in 2004. o Revenue on client assets is defined as annualized basis points of revenue per dollar of average client assets. Management believes that this metric is a key measure of the Company's ability to broaden the number of services utilized by clients. Restructuring The Company recorded pre-tax restructuring charges as follows: - -------------------------------------------------------------------------------- 2004 2003 2002 - -------------------------------------------------------------------------------- 2004 Cost Reduction Effort: Workforce reduction $ 129 - - Facilities reduction 82 - - - -------------------------------------------------------------------------------- Total 211 - - - -------------------------------------------------------------------------------- 2003, 2002, and 2001 Initiatives: Workforce reduction (1) $ 27 $ 140 Facilities reduction 4 49 202 Systems removal - - 1 - -------------------------------------------------------------------------------- Total 3 76 343 - -------------------------------------------------------------------------------- Total $ 214 $ 76 $ 343 ================================================================================ 2004 Cost Reduction Effort In the second quarter of 2004, the Company commenced a firm-wide cost reduction effort designed to mitigate the financial impact of its pricing changes (see Results of Operations - Financial Overview - Revenues - Commissions) and to strengthen its productivity and efficiency. The goals of this effort include eliminating work that is not essential to meeting client service standards or the Company's ongoing operating needs, reengineering work processes to maximize productivity, minimizing organizational complexity through functional streamlining, and addressing business unit performance across the Company. During 2004, the Company reallocated certain client service functions from its Orlando regional telephone service center to other centers. The Company also closed or consolidated 111 branch offices, began opening smaller satellite offices in selected locations, and took steps to streamline its technology organization. Additionally, the Company reduced its operating facilities, primarily by exiting certain administrative office space in California. The Company recorded pre-tax restructuring charges of $211 million in 2004 related to the 2004 cost reduction effort, primarily reflecting severance costs for approximately 1,600 employees and facilities reduction charges. The Company's 2004 cost reduction effort enabled the firm to steadily reduce its operating expense base throughout 2004, and about $300 million in annualized cost savings were identified and implemented by year end. The Company estimates that its 2004 cost reduction effort will result in approximately $16 million, or $10 million after-tax, of restructuring charges in the first quarter of 2005. Estimated additional charges for, or expense savings from, cost reduction efforts to be implemented during 2005 have not yet been determined. 2003, 2002, and 2001 Initiatives The Company's 2003, 2002, and 2001 restructuring initiatives included workforce reductions, reductions in operating facilities, the removal of certain systems hardware, software, and equipment from service, and the withdrawal from certain international operations. These initiatives reduced operating expenses and adjusted the Company's organizational structure to help improve productivity, enhance efficiency, and increase profitability. During 2004, the Company recorded pre-tax restructuring charges of $3 million related to its 2003, 2002, and 2001 restructuring initiatives, primarily due to changes in estimates of sublease income associated with previously announced efforts to sublease excess facilities. For further information on the Company's restructuring initiatives, see "Item 8 - Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 3. Restructuring Charges." The actual costs of these restructuring initiatives could differ from the estimated costs, depending primarily on the Company's ability to sublease properties. For further information on the - 10 - THE CHARLES SCHWAB CORPORATION Management's Discussion and Analysis of Financial Condition and Results of Operations (Tabular Amounts in Millions, Except Ratios, and as Noted) Company's facilities restructuring reserves, see "Critical Accounting Policies." Corporate Development Discontinued Operations: On October 29, 2004, the Company completed the sale of its capital markets business to UBS. Pursuant to the purchase agreement, UBS acquired all of the partnership interests of Schwab Capital Markets L.P. and all of the outstanding capital stock of SoundView Technology Group, Inc. (collectively referred to as Schwab Soundview Capital Markets, or SSCM) for $265 million in cash. At closing, the Company and Schwab entered into eight-year order routing and execution services agreements with UBS for the handling of Schwab's equity and listed options order flow. SSCM comprised substantially all of the previously-reported Capital Markets segment. The results of operations, net of income taxes, and cash flows of SSCM have been presented as discontinued operations on the consolidated statements of income and of cash flows, respectively, and the assets and liabilities of SSCM prior to the sale have each been combined and presented as assets and liabilities of discontinued operations on the consolidated balance sheet. The Company's consolidated prior period revenues, expenses, taxes on income, assets, liabilities, and cash flows have been adjusted to reflect this presentation. In January 2003, the Company sold its U.K. brokerage subsidiary, Charles Schwab Europe (CSE), to Barclays PLC. The results of operations of CSE, net of income taxes, have been summarized as discontinued operations on the Company's consolidated statement of income. The Company's consolidated prior period revenues, expenses, and taxes on income have been adjusted to reflect this presentation. For further information on the Company's discontinued operations, see "Item 8 - Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 5. Discontinued Operations." Divestiture of Investment: In June 2003, the Company sold its investment in Aitken Campbell, a market-making joint venture in the U.K., to the Company's joint venture partner, TD Waterhouse Group, Inc. In 2003, the Company recorded an impairment charge to reduce the carrying value of its investment and an income tax benefit. The Company's share of Aitken Campbell's historical earnings, which was accounted for under the equity method, was not material to the Company's results of operations, EPS, or cash flows. For further information, see "Item 8 - Financial Statements and Supplementary Data Notes to Consolidated Financial Statements 6. Business Acquisitions and Divestitures." Sale of Corporate Trust Business: In June 2001, USTC sold its Corporate Trust business to The Bank of New York Company, Inc. The Company recognized an extraordinary gain in 2002 related to this sale, primarily for amounts recognized upon satisfaction of certain client retention requirements. For further information, see "Item 8 - Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 4. Sale of Corporate Trust Business." RESULTS OF OPERATIONS Financial Overview Total revenues were $4.2 billion in 2004, up $306 million, or 8%, from 2003. The Company's non-trading revenues totaled $3.2 billion in 2004, up $471 million, or 17%, from 2003. This increase was primarily due to an increase in asset management and administration fees resulting primarily from higher levels of client assets and an increase in net interest revenue resulting primarily from higher levels of and changes in the composition of interest-earning assets. Trading revenues totaled $1.0 billion in 2004, down $165 million, or 14%, from 2003. This decrease was primarily due to lower average revenue earned per revenue trade resulting from reductions in the Company's commission pricing, partially offset by higher client trading activity. Total expenses excluding interest for 2004 were $3.6 billion, up $378 million, or 12%, from 2003. This increase was primarily due to a $212 million, or 13%, increase in compensation and benefits expense resulting from higher levels of discretionary bonuses to employees, employee benefits, and incentive compensation, as well as a $138 million, or 182%, increase in restructuring charges. Income from continuing operations before taxes on income and extraordinary gain for 2004 was $645 million, down $72 million, or 10% from 2003, primarily due to the combination of factors discussed above - higher compensation and benefits expense and restructuring charges, partially offset by higher levels of non-trading revenues. Loss from discontinued operations, net of tax, was $128 million for 2004, compared to $4 million for 2003. Net income for 2004 was $286 million, or $.21 per share, down 39% from 2003, primarily due to a higher loss from discontinued operations, net of tax, as well as lower income from continuing operations before taxes on income and extraordinary gain. The Company's after-tax profit margin for 2004 was 6.8%, down from 12.1% for 2003. Return on stockholders' equity was 6% for 2004, down from 11% in 2003. - 11 - THE CHARLES SCHWAB CORPORATION Management's Discussion and Analysis of Financial Condition and Results of Operations (Tabular Amounts in Millions, Except Ratios, and as Noted) Certain reclassifications have been made to prior year amounts to conform to the current presentation. All references to earnings per share (EPS) information in this Management's Discussion and Analysis of Results of Operations and Financial Condition reflect diluted earnings per share unless otherwise noted. Segment Information: In evaluating the Company's financial performance, management uses adjusted operating income, a non-generally accepted accounting principles (non-GAAP) income measure which excludes items described below. Management believes that adjusted operating income is a useful indicator of the ongoing financial performance of the Company's segments, 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 items, non-operating revenues, restructuring charges, impairment charges, acquisition- and merger-related charges, and discontinued operations). In 2004, net income of $286 million included the following items which in total had the effect of decreasing after-tax income by $252 million: $133 million of after-tax restructuring charges, a $128 million after-tax loss from discontinued operations, and a $9 million after-tax gain on an investment. In 2003, net income of $472 million included the following items which in total had the effect of decreasing after-tax income by $19 million: $48 million of after-tax restructuring charges, a $5 million investment write-down related to the Company's U.K. market-making operation, a $4 million after-tax loss from discontinued operations, a $16 million tax benefit associated with the Company's sale of its U.K. market-making operation, an $11 million after-tax gain on the sale of an investment, and an $11 million tax benefit associated with the Company's merger with U.S. Trust. In 2002, net income of $109 million included the following items which in total had the effect of decreasing after-tax income by $304 million: $211 million of after-tax restructuring charges, a $52 million after-tax loss from discontinued operations, a $37 million investment write-down related to the Company's U.K. market-making operation, $16 million of after-tax acquisition-related charges, and a $12 million after-tax extraordinary gain on the sale of U.S. Trust's Corporate Trust business. As detailed in "Item 8 - Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 26. Segment Information," the Company's adjusted operating income before taxes was $845 million for 2004, up $64 million, or 8%, from 2003 due to increases of $58 million, or 13%, in the Individual Investor segment, and $9 million, or 23%, in the U.S. Trust segment, partially offset by a decrease of $21 million, or 7%, in the Institutional Investor segment. The increase in the Individual Investor segment was primarily due to higher revenues resulting from increased client trading activity and levels of client assets. The decrease in the Institutional Investor segment was primarily due to growth in expenses outpacing growth in revenues primarily as a result of higher client acquisition and servicing costs. Revenues The Company categorizes its revenues as either non-trading or trading. As shown in the following table, non-trading and total revenues increased, while trading revenues decreased from 2003. - 12 -
THE CHARLES SCHWAB CORPORATION Management's Discussion and Analysis of Financial Condition and Results of Operations (Tabular Amounts in Millions, Except Ratios, and as Noted) ==================================================================================================================================== Sources of Revenues Year Ended December 31, - ------------------------------------------------------------------------------------------------------------------------------------ Growth Rate 2004 2003 2002 1-year -------------------------------------------------------------- 2003-2004 Amount Percent Amount Percent Amount Percent ---------------------------------------------------------------------------- Non-Trading Revenues Asset management and administration fees Mutual fund service fees: Proprietary funds (SchwabFunds(R), Excelsior(R), and other) (1%) $ 870 21% $ 883 23% $ 874 22% Mutual Fund OneSource(R) 33% 376 9% 283 7% 264 7% Other 18% 59 1% 50 1% 41 1% Asset management and related services 28% 786 19% 616 16% 574 15% - ------------------------------------------------------------------------------------------------------------------------------------ Asset management and administration fees 14% 2,091 50% 1,832 47% 1,753 45% - ------------------------------------------------------------------------------------------------------------------------------------ Net interest revenue Interest revenue: Margin loans to clients 31% 454 11% 347 9% 459 12% Investments, client-related 3% 293 7% 284 7% 337 8% Loans to banking clients 20% 275 7% 230 6% 236 6% Securities available for sale 88% 139 3% 74 2% 76 2% Other 58% 52 1% 33 1% 48 1% - ------------------------------------------------------------------------------------------------------------------------------------ Interest revenue 25% 1,213 29% 968 25% 1,156 29% Interest expense: Brokerage client cash balances 49% 113 3% 76 2% 164 4% Deposits from banking clients 9% 105 3% 96 3% 94 2% Long-term debt (9%) 32 1% 35 1% 46 1% Short-term borrowings 38% 18 - 13 - 20 1% Other (55%) 9 - 20 - 7 - - ------------------------------------------------------------------------------------------------------------------------------------ Interest expense 15% 277 7% 240 6% 331 8% - ------------------------------------------------------------------------------------------------------------------------------------ Net interest revenue 29% 936 22% 728 19% 825 21% - ------------------------------------------------------------------------------------------------------------------------------------ Other 3% 150 4% 146 3% 129 3% - ------------------------------------------------------------------------------------------------------------------------------------ Total non-trading revenues 17% 3,177 76% 2,706 69% 2,707 69% - ------------------------------------------------------------------------------------------------------------------------------------ Trading Revenues Commissions Equity and other securities (18%) 731 17% 892 23% 925 24% Mutual funds 2% 112 3% 110 3% 111 3% Options (2%) 93 2% 95 3% 99 2% - ------------------------------------------------------------------------------------------------------------------------------------ Commissions (15%) 936 22% 1,097 29% 1,135 29% - ------------------------------------------------------------------------------------------------------------------------------------ Principal transactions (4%) 89 2% 93 2% 102 2% - ------------------------------------------------------------------------------------------------------------------------------------ Total trading revenues (14%) 1,025 24% 1,190 31% 1,237 31% - ------------------------------------------------------------------------------------------------------------------------------------ Total revenues 8% $ 4,202 100% $ 3,896 100% $ 3,944 100% ====================================================================================================================================
- 13 - THE CHARLES SCHWAB CORPORATION Management's Discussion and Analysis of Financial Condition and Results of Operations (Tabular Amounts in Millions, Except Ratios, and as Noted) While the Individual Investor and Institutional Investor segments generate both non-trading and trading revenues, the U.S. Trust segment generates primarily non-trading revenues. Revenues by segment are as shown in the following table: - -------------------------------------------------------------------------------- Growth Rate 1-year 2003-2004 2004 2003 2002 - -------------------------------------------------------------------------------- Individual Investor 3% $ 2,444 $ 2,365 $ 2,375 Institutional Investor 9% 897 821 855 U.S. Trust 23% 773 629 651 Unallocated 16% 74 64 63 - -------------------------------------------------------------------------------- Operating revenues 8% 4,188 3,879 3,944 Non-operating revenues (1) (18%) 14 17 - - -------------------------------------------------------------------------------- Total revenues 8% $ 4,202 $ 3,896 $ 3,944 ================================================================================ (1) Primarily consists of pre-tax gains on investments. The increase in revenues in the U.S. Trust segment was primarily due to the acquisition of State Street Corporation's Private Asset Management group in October 2003 and higher levels of client assets. See "Item 8 - Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 26. Segment Information" for financial information by segment for the last three years. 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 transfer agent services, shareholder services, administration, and investment management provided to its proprietary funds, and recordkeeping and shareholder services provided to third-party 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 each of the Company's segments. The Company also earns asset management and administration fees for financial services provided to individual and institutional clients, including investment management and consulting, trust and fiduciary services, custody services, financial and estate planning, and private banking services. These fees are primarily based on the value and composition of assets under management and are earned through each of the Company's segments. The increase in asset management and related service fees from 2003 to 2004 was primarily due to higher levels of client assets and higher asset-based fees from certain client relationships. The increase in mutual fund service fees from 2003 to 2004 was primarily due to higher average assets in and service fees earned on Schwab's Mutual Fund OneSource(R) service. The increase in asset management and related service fees from 2002 to 2003 was primarily due to higher asset-based fees from certain client relationships, partially offset by a decrease in account fees. The increase in mutual fund service fees from 2002 to 2003 was due to higher service fees earned on and average assets in Schwab's Mutual Fund OneSource service, and higher service fees earned on SchwabFunds(R). Commissions The Company earns commission revenues by executing client trades primarily through the Individual Investor and Institutional Investor segments. 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. The decrease in commission revenues from 2003 to 2004 was primarily due to lower average revenue earned per revenue trade as a result of significant reductions in commission pricing for a wide range of clients in 2004, partially offset by higher daily average revenue trades. The increase in commission revenues from 2002 to 2003 was primarily due to higher daily average trades, partially offset by lower revenue per revenue trade. Effective in June 2004, the Company lowered its online equity pricing to $9.95 for clients with more than $1 million in assets at Schwab and also lowered commission pricing for a wide range of other clients. Additionally, effective in November 2004, the Company lowered its base online equity commission pricing to $19.95, expanded access to $9.95 online equity commissions, and lowered commissions on online and broker-assisted trades of options contracts. Primarily as a result of these pricing changes, the Company's average revenue earned per revenue trade declined from $30.97 in May 2004 to $18.82 in December 2004. - 14 - THE CHARLES SCHWAB CORPORATION Management's Discussion and Analysis of Financial Condition and Results of Operations (Tabular Amounts in Millions, Except Ratios, and as Noted) As illustrated in the following table, daily average revenue trades executed by the Company increased 11% in 2004. Average revenue earned per revenue trade decreased 23% from 2003 to 2004, primarily due to the pricing changes discussed above. Average revenue earned per revenue trade decreased 7% from 2002 to 2003, primarily due to decreased pricing of certain equity trades made through online channels as well as decreased pricing of fixed income securities trades. - -------------------------------------------------------------------------------- 2004 2003 2002 - -------------------------------------------------------------------------------- Daily average revenue trades (in thousands) (1) 156.4 140.8 134.1 Accounts that traded (in thousands) 2,749 2,734 2,871 Average revenue trades per account that traded 14.3 12.9 11.8 Trading frequency proxy (2) 3.4 3.8 3.8 Number of trading days (3) 251.5 250.0 252.0 Average revenue earned per revenue trade (4) $ 26.34 $ 34.06 $ 36.46 Online trades as a percentage of total trades 89% 87% 83% - -------------------------------------------------------------------------------- (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. (3) Effective in the third quarter of 2003, the Company considers reduced exchange trading sessions as half days. (4) All amounts have been adjusted to reflect the sale of the Company's capital markets business. The Company continually monitors its pricing in relation to competitors and periodically adjusts prices to enhance its competitive position. The Company continues to actively evaluate commission rates and fee structures for certain clients. Net Interest Revenue Net interest revenue is the difference between interest earned on certain assets (mainly margin loans to clients, investments of segregated client cash balances, loans to banking clients, and securities available for sale) and interest paid on supporting liabilities (mainly deposits from banking clients and brokerage client cash balances). 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. The Company's net interest revenue is earned through each of its 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. Margin loans arise when Schwab lends funds to clients on a secured basis to purchase securities. Pursuant to SEC regulations, client cash balances that are not used for margin lending are generally segregated into investment accounts that are 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, 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 65% of Schwab's investments of segregated client cash balances. The average maturities of Schwab's total investments of segregated client cash balances were 142 days for 2004, 161 days for 2003, and 66 days for 2002. U.S. Trust and Schwab Bank lend funds to banking clients primarily in the form of mortgage loans. These loans are largely funded by interest-bearing deposits from banking clients. - 15 - THE CHARLES SCHWAB CORPORATION Management's Discussion and Analysis of Financial Condition and Results of Operations (Tabular Amounts in Millions, Except Ratios, and as Noted) 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, as well as stockholders' equity. Client-related daily average balances, interest rates, and average net interest spread are summarized as follows: - -------------------------------------------------------------------------------- 2004 2003 2002 - -------------------------------------------------------------------------------- Interest-Earning Assets (client-related and other): Investments (client-related): Average balance outstanding $20,159 $21,826 $17,869 Average interest rate 1.45% 1.30% 1.89% Margin loans to clients: Average balance outstanding $ 9,074 $ 7,025 $ 8,017 Average interest rate 4.99% 4.94% 5.72% Loans to banking clients: Average balance outstanding $ 6,453 $ 5,034 $ 4,204 Average interest rate 4.24% 4.56% 5.62% Securities available for sale: Average balance outstanding $ 4,031 $ 1,904 $ 1,508 Average interest rate 3.45% 3.91% 5.02% Average yield on interest-earning assets 2.94% 2.62% 3.51% Funding Sources (client-related and other): Interest-bearing brokerage client cash balances: Average balance outstanding $23,788 $23,140 $22,432 Average interest rate .47% .33% .73% Interest-bearing banking deposits: Average balance outstanding $ 9,077 $ 5,395 $ 4,046 Average interest rate 1.15% 1.79% 2.33% Other interest-bearing sources: Average balance outstanding $ 2,519 $ 2,843 $ 1,094 Average interest rate 1.07% 1.05% 2.03% Average noninterest-bearing portion $ 4,333 $ 4,411 $ 4,026 Average interest rate on funding sources .61% .57% .89% Summary: Average yield on interest-earning assets 2.94% 2.62% 3.51% Average interest rate on funding sources .61% .57% .89% - -------------------------------------------------------------------------------- Average net interest spread 2.33% 2.05% 2.62% - -------------------------------------------------------------------------------- The increase in net interest revenue from 2003 to 2004 was primarily due to higher levels of and changes in the composition of interest-earning assets, including increases in margin loan balances, loans to banking clients and securities available for sale, partially offset by higher interest rates on brokerage client cash balances due to changes in the interest rate environment. The decrease in net interest revenue from 2002 to 2003 was primarily due to changes in the composition of interest-earning assets, including the decline in margin loan balances and the corresponding increase in client-related investments. Additionally, the decline in yields on interest-earning assets due to changes in the interest rate environment from 2002 to 2003 was only partially offset by lower yields on funding sources. Since the Company establishes the rates paid on brokerage client cash balances and certain banking deposits and the rates charged on margin loans, it manages a substantial portion of its net interest spread. However, the spread is influenced by external factors such as the interest rate environment and competition. The Company's average net interest spread increased from 2003 to 2004 as the average yield on interest-earning assets, primarily client-related investments, increased more than the average interest rate on funding sources. The Company's average net interest spread decreased from 2002 to 2003 as the average yield on interest-earning assets, primarily client-related investments, 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 Individual Investor and Institutional Investor segments. Factors that influence principal transaction revenues include the volume of client trades, market price volatility, and changes in regulations and industry practices. Other Revenues Other revenues include net gains and losses on certain investments, fees for services (such as transfer of assets), account service fees, and software maintenance fees. Other revenues are earned through each of the Company's segments. - 16 - THE CHARLES SCHWAB CORPORATION Management's Discussion and Analysis of Financial Condition and Results of Operations (Tabular Amounts in Millions, Except Ratios, and as Noted) Expenses Excluding Interest As shown in the table below, total expenses excluding interest increased in 2004 primarily due to higher compensation and benefits expense and restructuring charges. Additionally, increases in professional services expense and advertising and market development expense were substantially offset by decreases in depreciation and amortization expense and occupancy and equipment expense. - -------------------------------------------------------------------------------- Growth Rate 1-year 2003-2004 2004 2003 2002 - -------------------------------------------------------------------------------- Compensation and benefits 13% $ 1,877 $ 1,665 $ 1,755 Occupancy and equipment (10%) 389 430 446 Professional services 40% 245 175 168 Depreciation and amortization (18%) 226 277 309 Communications (2%) 223 228 245 Advertising and market development 32% 184 139 207 Commissions, clearance and floor brokerage (3%) 39 40 46 Restructuring charges 182% 214 76 343 Impairment charges (100%) - 5 37 Other 11% 160 144 139 - -------------------------------------------------------------------------------- Total expenses 12% $ 3,557 $ 3,179 $ 3,695 ================================================================================ Expenses as a percentage of total revenues: Total expenses, excluding interest 85% 82% 94% Compensation and benefits 45% 43% 44% Advertising and market development 4% 4% 5% - -------------------------------------------------------------------------------- Compensation and Benefits Compensation and benefits expense includes salaries and wages, incentive and variable compensation, related employee benefits and taxes, and retention program costs arising from certain acquisitions and mergers. Employees receive variable compensation that is tied to the achievement of specified objectives, primarily related to revenue growth and profit margin. Therefore, a significant portion of compensation and benefits expense will fluctuate with these measures. The increase in compensation and benefits expense from 2003 to 2004 was primarily due to higher levels of discretionary bonuses to employees, employee benefits, and incentive compensation. The decrease in compensation and benefits expense from 2002 to 2003 was primarily due to a reduction in full-time equivalent employees through the Company's expense reduction measures and lower levels of employee benefits, partially offset by higher levels of incentive compensation and discretionary bonuses to employees. The following table shows a comparison of certain compensation and benefits components and employee data: - -------------------------------------------------------------------------------- 2004 2003 2002 - -------------------------------------------------------------------------------- Salaries and wages $ 1,199 $ 1,150 $ 1,229 Incentive and variable compensation 376 270 233 Employee benefits and other 302 245 293 - -------------------------------------------------------------------------------- Total $ 1,877 $ 1,665 $ 1,755 ================================================================================ Full-time equivalent employees (1) (in thousands) At year end 14.2 16.0 16.4 Average 15.6 15.9 18.4 - -------------------------------------------------------------------------------- (1) Includes full-time, part-time and temporary employees, and persons employed on a contract basis. All amounts have been adjusted to reflect the sale of the Company's capital markets business. Employee benefits and other expense increased from 2003 to 2004 primarily due to the reinstatement of the Company's 401(k) employee contribution match, which was suspended in 2003 (except for a discretionary award to certain non-officer employees made in the fourth quarter of 2003). Employee benefits and other expense decreased from 2002 to 2003 primarily due to the suspension of the Company's 401(k) employer contribution in 2003 as discussed above. Additionally, employee benefits and other expense includes net pension expense of $7 million in 2004 and $8 million in 2003 related to U.S. Trust's defined benefit pension plan, compared to net pension income of less than $1 million for 2002. The increase in pension expense in 2003 was primarily due to changes in certain assumptions used to calculate pension expense, including the expected rate of return on pension plan assets and the discount rate, both effective in 2003. See "Item 8 - Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 2. Significant Accounting Policies - New Accounting Standards" for a discussion of future compensation expense related to stock option awards. Expenses Excluding Compensation and Benefits The decreases in occupancy and equipment expense from 2002 to 2004 were primarily due to the Company's restructuring initiatives and other expense reduction measures (see Description of Business - Restructuring). The increases in professional services expense from 2002 to 2004 were primarily due to higher levels of consulting fees in several areas, including new and expanded products and services, and information technology projects. The decreases in depreciation and amortization expense from 2002 to 2004 were primarily due to increases in fully- - 17 - THE CHARLES SCHWAB CORPORATION Management's Discussion and Analysis of Financial Condition and Results of Operations (Tabular Amounts in Millions, Except Ratios, and as Noted) amortized assets and the Company's restructuring initiatives and other expense reduction measures. The increase in advertising and market development expense from 2003 to 2004 was primarily due to the Company's increased print and other media spending. The decrease in advertising and market development expense from 2002 to 2003 was primarily due to reductions, as part of the Company's expense reduction measures, in brand-focused television and other media spending. Taxes on Income The Company's effective income tax rate on income from continuing operations was 35.8% in 2004, 33.6% in 2003 and 40.2% in 2002. The increase in the effective income tax rate from 2003 to 2004 was primarily due to tax benefits in 2003 related to the deductibility of certain costs associated with the Company's merger with U.S. Trust and the Company's sale of its U.K. market-making operation. The decrease in the effective income tax rate from 2002 to 2003 was primarily due to the tax benefits in 2003 discussed above, as well as an impairment charge in 2002 related to the Company's U.K. market-making operation which was not deductible for tax purposes. Management expects the Company's effective income tax rate in 2005 to be approximately 38%. 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 Board of Governors of the Federal Reserve System (Federal Reserve Board) under the Bank Holding Company Act of 1956, as amended. CSC conducts virtually all business through its wholly owned subsidiaries. The capital structure among CSC and its subsidiaries is designed to provide each entity with capital and liquidity to meet its operational needs and regulatory requirements. See "Item 8 - Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 22. Regulatory Requirements." 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 and CSC's depository institution subsidiaries 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, providing adequate liquidity to meet CSC's depository institution subsidiaries' capital guidelines, and maintaining Schwab's net capital. Based on their respective regulatory capital ratios at December 31, 2004 and 2003, the Company and its depository institution subsidiaries are considered well capitalized. CSC has liquidity needs that arise from its Senior Medium-Term Notes, Series A (Medium-Term Notes), as well as from the funding of cash dividends, acquisitions, and other investments. The Medium-Term Notes, of which $386 million was issued and outstanding at December 31, 2004, have maturities ranging from 2005 to 2010 and fixed interest rates ranging from 6.21% to 8.05% with interest payable semiannually. CSC has entered into interest rate swap agreements (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 "Item 8 - Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 24. Financial Instruments Subject to Off-Balance Sheet Risk, Credit Risk or Market Risk." 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 $750 million in Senior or Senior Subordinated Medium-Term Notes, Series A. At December 31, 2004, all of these notes remained unissued. In the second quarter of 2004, the SEC declared effective CSC's Registration Statement under the Securities Act of 1933 on Form S-3 relating to a universal shelf registration for the issuance of up to $1.0 billion aggregate amount of various securities, including common stock, preferred stock, debt securities, and warrants. The Company currently intends to use any proceeds from the issuance of these securities for general corporate purposes, including, but not limited to, working capital and possible acquisitions. At December 31, 2004, all of these securities remained unissued. CSC has authorization from its Board of Directors (Board) to issue commercial paper up to the amount of CSC's committed, unsecured credit facility (see below), not to exceed $1.5 billion. At December 31, 2004, 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 an $800 million committed, unsecured credit facility with a group of nineteen banks which is scheduled to expire in June 2005. This facility replaced a facility that expired in June 2004. These facilities were unused in 2004. 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 - 18 - THE CHARLES SCHWAB CORPORATION Management's Discussion and Analysis of Financial Condition and Results of Operations (Tabular Amounts in Millions, Except Ratios, and as Noted) 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 stockholders' equity, Schwab to maintain minimum net capital ratios, as defined, and CSC's depository institution subsidiaries to be well capitalized, 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 $781 million of the $831 million uncommitted, unsecured bank credit lines, provided by eight banks, that are primarily utilized by Schwab to manage short-term liquidity. The amount available to CSC under these lines is lower than the amount available to Schwab because the credit line provided by one of these banks is only available to Schwab. These lines were not used by CSC in 2004. Schwab Most of Schwab's assets are readily convertible to cash, consisting primarily of short-term (i.e., less than 150 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. Liquidity needs relating to client trading and margin borrowing activities are met primarily through cash balances in brokerage client accounts, which were $27.0 billion, $25.6 billion, and $24.9 billion at December 31, 2004, 2003, and 2002, 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. Upon adoption of Financial Accounting Standards Board Interpretation (FIN) No. 46 - Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51 - Consolidated Financial Statements in the first quarter of 2003, the Company consolidated a special purpose trust (Trust) and recorded a note payable of $235 million. This Trust was formed in 2000 to finance the acquisition and renovation of an office building and land. In June 2004, the Company exercised its option to purchase this property from the Trust and repaid $99 million of the note payable. Simultaneously, the Company completed a transaction on this property with American Financial Realty Trust, a publicly-traded real estate investment trust, resulting in proceeds of $136 million, which was used to repay the remainder of the note payable, and a 20-year lease. This transaction was accounted for as a financing. The remaining lease financing liability of $134 million is being reduced by a portion of the lease payments over the 20-year term. To manage short-term liquidity, Schwab maintains uncommitted, unsecured bank credit lines with a group of eight banks totaling $831 million at December 31, 2004 (as noted previously, $781 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 2004, with the daily amounts borrowed averaging $46 million. There were no borrowings outstanding under these lines at December 31, 2004. 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, 2004. Schwab pays a fee to maintain these arrangements. In connection with its securities lending activities, Schwab is required to provide collateral to certain brokerage clients. Schwab satisfies the collateral requirements by arranging letters of credit (LOCs), in favor of these brokerage clients, that are guaranteed by multiple banks. At December 31, 2004, the outstanding value of these LOCs totaled $52 million. No funds were drawn under these LOCs at December 31, 2004. 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, 2004, Schwab's net capital was $1.2 billion (12% of aggregate debit balances), which was $1.0 billion in excess of its minimum required net capital and $723 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 2005. The amount outstanding under this facility at December 31, 2004 was $220 million. Borrowings under this subordinated lending arrangement qualify as regulatory capital for Schwab. - 19 - THE CHARLES SCHWAB CORPORATION Management's Discussion and Analysis of Financial Condition and Results of Operations (Tabular Amounts in Millions, Except Ratios, and as Noted) U.S. Trust U.S. Trust's liquidity needs are generally met through deposits from banking clients, equity capital, and borrowings. Certain Schwab brokerage clients can sweep the excess cash held in their accounts into a money market deposit account at U.S. Trust. At December 31, 2004, these balances totaled $577 million. In addition to traditional funding sources such as deposits, federal funds purchased, and repurchase agreements, USTC's depository institution subsidiaries have established their own external funding sources. At December 31, 2004, U.S. Trust had $52 million in Trust Preferred Capital Securities outstanding with a fixed interest rate of 8.41%. Certain of USTC's depository institution subsidiaries have established credit facilities with the Federal Home Loan Bank System (FHLB) totaling $1.7 billion. At December 31, 2004, $625 million was outstanding under these facilities. Additionally, at December 31, 2004, U.S. Trust had $38 million of federal funds purchased. U.S. Trust also engages in intercompany repurchase agreements with Schwab Bank and Schwab. At December 31, 2004, U.S. Trust had $400 million and $200 million in repurchase agreements outstanding with Schwab Bank and Schwab, respectively. CSC provides U.S. Trust with a $300 million short-term credit facility maturing in December 2006. Borrowings under this facility do not qualify as regulatory capital for U.S. Trust. The amount outstanding under this facility was $30 million at December 31, 2004. U.S. Trust uses Swaps with CSC and third parties to hedge the interest rate risk associated with its variable rate deposits from banking clients. These Swaps are structured for U.S. Trust to receive a variable rate of interest and pay a fixed rate of interest. At December 31, 2004, the Swaps with CSC have a notional value of $650 million and a fair value of $9 million. For a complete discussion of the Swaps with third parties, see "Item 8 - Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 24. Financial Instruments Subject to Off-Balance Sheet Risk, Credit Risk or Market Risk." 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, USTC's depository institution subsidiaries are subject to limitations on the amount of dividends they can pay to USTC. Schwab Bank Schwab Bank's current liquidity needs are generally met through deposits from banking clients and equity capital. Certain Schwab brokerage clients can sweep the excess cash held in their accounts into a money market deposit account at Schwab Bank. At December 31, 2004, these balances totaled $4.0 billion. Schwab Bank has access to traditional funding sources such as deposits, federal funds purchased, and repurchase agreements. Additionally, CSC provides Schwab Bank with a $100 million short-term credit facility maturing in December 2005. Borrowings under this facility do not qualify as regulatory capital for Schwab Bank. No funds were drawn under this facility at December 31, 2004. In May 2004, Schwab Bank established a credit facility with the FHLB. At December 31, 2004, $266 million was available, and no funds were drawn under this facility. Schwab Bank is subject to the same risk-based and leverage capital guidelines as U.S. Trust (see discussion above), except that Schwab Bank is subject to a minimum tier 1 leverage ratio of 8% for its first three years of operations. In addition, Schwab Bank is subject to limitations on the amount of dividends it can pay to CSC. 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 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: o 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; o a reduction in cash held in banking or brokerage client accounts which may affect the amount of the Company's liquid assets; and o 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 - 20 - THE CHARLES SCHWAB CORPORATION Management's Discussion and Analysis of Financial Condition and Results of Operations (Tabular Amounts in Millions, Except Ratios, and as Noted) activity in securities owned, levels of capital expenditures, acquisition activity, 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 2004, cash and cash equivalents decreased $7 million to $2.8 billion primarily due to higher levels of securities available for sale and increases in loans to banking clients, substantially offset by increases in deposits from banking clients, including sweep deposit accounts. Certain Schwab brokerage clients can sweep the excess cash held in their brokerage accounts into these money market deposit accounts at Schwab Bank or U.S. Trust. At December 31, 2004, these sweep deposit balances totaled $4.6 billion, up $3.0 billion from December 31, 2003. This sweep deposit activity is reflected on the Consolidated Statement of Cash Flows as a cash outflow from payables to brokerage clients (classified as an operating activity) and a cash inflow to deposits from banking clients (classified as a financing activity). The Company's capital expenditures were $194 million in 2004 and $147 million in 2003, or 5% and 4% of revenues in 2004 and 2003, respectively. In 2004, 86% of capital expenditures were for information technology and 14% for facilities expansion and improvements. Capital expenditures include capitalized costs for developing internal-use software of $79 million in 2004 and $64 million in 2003. Management currently anticipates that 2005 capital expenditures will be approximately 15% lower than 2004 spending. As has been the case in recent years, the Company may adjust its capital expenditures from period to period as business conditions change. Management believes that funds generated by its operations will continue to be the primary funding source of its capital expenditures. Certain cash flows from financing activities by the Company in 2004 include: o Net repayment of $179 million of long-term debt; o Receipt of cash proceeds of $51 million on the exercise of 11 million of the Company's stock options, with a weighted-average exercise price of $4.88, and a related tax benefit of $18 million; and o Payment of common stock dividends of $101 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, 2004 was $5.0 billion, down $262 million, or 5%, from a year ago, due to lower stockholders' equity, primarily resulting from stock repurchases and a net decrease in long-term debt. At December 31, 2004, the Company had long-term debt of $585 million, or 12% of total financial capital, bearing interest at a weighted-average rate of 7.08%. At December 31, 2004, the Company's stockholders' equity was $4.4 billion, or 88% of total financial capital. Off-Balance-Sheet Arrangements The Company enters into various off-balance-sheet arrangements in the ordinary course of business, primarily to meet the needs of its clients and to reduce its own exposure to interest rate risk. These arrangements include firm commitments to extend credit and letters of credit. Additionally, the Company enters into guarantees and other similar arrangements as part of transactions in the ordinary course of business. For additional information on each of these arrangements, see "Item 8 - Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 23. Commitments and Contingent Liabilities." - 21 - THE CHARLES SCHWAB CORPORATION Management's Discussion and Analysis of Financial Condition and Results of Operations (Tabular Amounts in Millions, Except Ratios, and as Noted) Commitments A summary of the Company's principal contractual obligations and other commitments as of December 31, 2004 is shown in the following table. Excluded from this table are liabilities recorded on the consolidated balance sheet that are generally short-term in nature (e.g., drafts payable and short-term borrowings) or without contractual payment terms (e.g., deposits from banking clients, payables to brokerage clients, and deferred compensation). 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 3-5 After 5 1 Year Years Years Years Total - -------------------------------------------------------------------------------- Operating leases (1) $ 188 $ 323 $ 270 $ 621 $1,402 Long-term debt (2) 56 106 24 252 438 Credit-related financial instruments (3) 775 264 - 1,194 2,233 Purchase obligations (4) 206 125 32 5 368 Workforce restructuring reserves (5) 70 4 - - 74 - -------------------------------------------------------------------------------- Total $1,295 $ 822 $ 326 $2,072 $4,515 ================================================================================ (1) Represents minimum rental commitments, net of sublease commitments, and includes facilities under the Company's restructuring initiatives. See "Item 8 - Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 3. Restructuring Charges and 23. Commitments and Contingent Liabilities." (2) Excludes maturities under a lease financing liability and the effect of interest swaps. See "Item 8 - Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 16. Long-term Debt." (3) Includes U.S. Trust and Schwab Bank firm commitments to extend credit primarily for loans to banking clients and standby letters of credit. See "Item 8 - Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 24. Financial Instruments Subject to Off-Balance Sheet Risk, Credit Risk or Market Risk." (4) Consists of purchase obligations for services such as advertising and marketing, telecommunications, professional services, and hardware- and software-related agreements. Includes purchase obligations of $126 million at December 31, 2004 which can be canceled by the Company without penalty. (5) Includes workforce restructuring reserves of $51 million and $23 million related to the Company's restructuring initiatives and discontinued operations, respectively. See "Item 8 - Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 3. Restructuring Charges and 5. Discontinued Operations." Share Repurchases CSC repurchased 39 million shares of its common stock for $383 million in 2004 and 4 million shares of its common stock for $32 million in 2003. On December 9, 2004, the Board authorized the repurchase of up to an additional $300 million of CSC's common stock. As of December 31, 2004, CSC has authority to repurchase up to $234 million of its common stock. Dividend Policy Since the initial dividend in 1989, CSC has paid 63 consecutive quarterly dividends and has increased the dividend 14 times, including a 43% increase in the second quarter of 2004. Since 1989, dividends have increased by a 27% compounded annual growth rate. CSC paid common stock dividends of $.074, $.050, and $.044 per share in 2004, 2003, and 2002, respectively. While the payment and amount of dividends are at the discretion of the Board, subject to certain regulatory and other restrictions, the Company currently targets its cash dividend at approximately 10% to 20% of net income. RISK MANAGEMENT Overview The Company's business activities expose it to a variety of risks including, but not limited to, those discussed below. Identification, assessment and management of these risks are essential to the success and financial soundness of the Company. Senior management takes an active role in the Company's risk management process and has developed policies and procedures under which specific business and control units are responsible for identifying, measuring, and controlling various risks. Oversight of risk management has been delegated to the Global Risk Steering Committee, which is comprised of managers who lead major business and control functions. 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, and reviewing changes in regulation and other risk-related developments. The Global Risk Steering Committee regularly reports on risk management to the Audit Committee of the Board of Directors, which reviews major risk exposures and the steps management has taken to monitor and control such exposures. The Company also has a number of functional risk sub-committees, which report into the Global Risk Steering Committee on a frequent basis. These sub-committees include: o Technology and Operations Risk Committee, which focuses on the integrity of operational controls and operating capacity of the Company's technology and operations systems; o Financial Risk Oversight Committee, which focuses on the credit exposures resulting from client activity (e.g., margin lending activities and loans to banking clients), the investing activities of certain of the Company's proprietary funds, corporate credit activities (e.g., - 22 - THE CHARLES SCHWAB CORPORATION Management's Discussion and Analysis of Financial Condition and Results of Operations (Tabular Amounts in Millions, Except Ratios, and as Noted) counterparty and corporate investing activities), the Company's liquidity, capital resources, interest rate risk, and the market risk resulting from securities positioning activities; o Fiduciary Risk Committee, which focuses on overseeing the activities of the Company that are deemed to have a fiduciary component; and o Disclosure Committee, which focuses on the oversight of disclosure and internal controls. Additionally, the Company's compliance, finance, internal audit, legal, and risk and credit management departments assist management and the various risk committees in evaluating, testing and monitoring the Company's risk management. Risk is inherent in the Company's business. Consequently, despite the Company's efforts 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 "Item 8 - Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 24. Financial Instruments Subject to Off-Balance Sheet Risk, Credit Risk or Market Risk" 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 evolving client needs. 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. The Company is committed to an ongoing process of upgrading, enhancing, and testing its technology systems. This effort is focused on meeting client needs, meeting market and regulatory changes, and deploying standardized technology platforms. Technology and operating risk also includes the risk of human error, employee misconduct, external fraud, computer viruses, terrorist attack, and natural disaster. Employee misconduct could include fraud and misappropriation of client or Company assets, improper use or disclosure of confidential client or Company information, and unauthorized activities, such as transactions exceeding acceptable risks or authorized limits. External fraud includes misappropriation of client or Company assets by third parties, including through unauthorized access to Company systems and data and client accounts. The frequency and sophistication of such fraud attempts continue to increase. The Company has specific policies and procedures to identify and manage operational risk, and uses periodic risk self-assessments and internal audit reviews to evaluate the effectiveness of these internal controls. The Company maintains backup and recovery functions, including facilities for backup and communications, and conducts periodic testing of disaster recovery plans. The Company also maintains policies and procedures and technology to protect against fraud and unauthorized access to systems and data. Despite the Company's risk mitigation efforts, it is not always possible to deter or prevent technological or operational failure, or fraud or other misconduct, and the precautions taken by the Company may not be effective in all cases. The Company may be subject to litigation, losses, and regulatory actions in such cases, and may be required to expend significant additional resources to remediate vulnerabilities or other exposures. The Company also faces technology and operating risk when it employs the services of various external vendors, including domestic and international outsourcing of certain technology, processing and support functions. The Company manages its exposure to such outsourcing risks through contractual agreements and ongoing monitoring of vendor performance. The Company is actively 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, the Company may be subject to litigation claims from third parties alleging infringement of their intellectual property rights (e.g., patents). 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 - 23 - THE CHARLES SCHWAB CORPORATION Management's Discussion and Analysis of Financial Condition and Results of Operations (Tabular Amounts in Millions, Except Ratios, and as Noted) 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 margin lending activities, securities lending activities, its 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 adjusting 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 banking loan portfolios held at U.S. Trust and Schwab Bank. This client 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 credit review department which is separate from the loan origination and monitoring department. Management regularly reviews asset quality including concentrations, delinquencies, non-performing loans to banking clients, losses and recoveries. All are factors in the determination of an appropriate allowance for credit losses, which is reviewed quarterly by senior management. See "Item 8 - Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 9. Loans to Banking Clients and Related Allowance for Credit Losses and 24. Financial Instruments Subject to Off-Balance Sheet Risk, Credit Risk or Market Risk" for an analysis of the Company's loan portfolios and allowance for credit losses, and for an additional discussion on credit risk, respectively. Schwab performs clearing services for all securities transactions in its client accounts. Schwab has exposure to credit risk due to its obligation to settle transactions with clearing corporations, mutual funds and other financial institutions even if Schwab's client or a counterparty fails to meet its obligations to Schwab. See "Item 8 - Financial Statements and Supplementary Data - - Notes to Consolidated Financial Statements - 24. Financial Instruments Subject to Off-Balance Sheet Risk, Credit Risk or Market Risk." There were no troubled debt restructurings at December 31, 2004 or 2003. As of December 31, 2004, management is not aware of any significant potential problem loans other than the amounts disclosed in "Item 8 - Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 9. Loans to Banking Clients and Related Allowance for Credit Losses." 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 institutional 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 are provided through the creation, approval, and ongoing review of applicable policies by business units and various fiduciary risk committees. Market Risk See discussion of market risk at "Item 7A - Quantitative and Qualitative Disclosures About Market Risk." Legal and Regulatory Risk The Company faces significant legal and compliance risk in its business, and the volume of litigation and regulatory proceedings against financial services firms and the amount of damages claimed have been increasing. Among other things, these risks relate to the suitability of client investments, disclosure obligations and performance expectations for Company products and services, supervision of employees, and the adequacy of the Company's controls. Claims against the Company may increase due to a variety of factors, such as if clients suffer losses during a period of deteriorating equity market conditions, as the Company increases the level of advice it provides to clients, and as the Company enhances the services it provides to IAs. In addition, the Company and its affiliates are subject to extensive regulation by federal, state and foreign regulatory authorities, and self-regulatory organizations, and such regulation is becoming increasingly extensive and complex. The Company attempts to mitigate legal and compliance risk through policies and procedures reasonably designed to avoid litigation claims and prevent or detect violations of applicable legal and regulatory requirements. These procedures address issues such as business conduct and - 24 - THE CHARLES SCHWAB CORPORATION Management's Discussion and Analysis of Financial Condition and Results of Operations (Tabular Amounts in Millions, Except Ratios, and as Noted) ethics, sales and trading practices, marketing and communications, extension of credit, client funds and securities, books and records, anti-money laundering, client privacy, employment policies, and contracts management. Despite the Company's efforts to maintain an effective compliance program and internal controls, legal breaches and rule violations, even if unintentional, could result in reputational harm, significant losses and disciplinary sanctions, including limitations on the Company's business activities. Potential Strategic Transactions The Company from time to time engages in the evaluation, consideration and negotiation of a wide array of potential strategic transactions, including business combinations, acquisitions and dispositions. Any such transaction could have a material impact on the Company's financial position, results of operations, EPS, or cash flows. The process of integrating any acquisition may create unforeseen challenges for the Company's operational, financial and management information systems, as well as unforeseen expenditures and other risks, including diversion of management's attention from other business concerns, the potential loss of key clients, employees and business partners, and difficulties in managing facilities and employees in different geographic areas. In addition, an acquisition may cause the Company to assume liabilities or become subject to litigation. Further, there can be no assurance that the Company will realize a positive return on any acquisition or that future acquisitions will not be dilutive to the Company's current stockholders' percentage ownership or to EPS. CRITICAL ACCOUNTING POLICIES The consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the U.S. While the majority of the Company's revenues, expenses, assets and liabilities are not based on estimates, there are certain critical accounting policies that require management to make estimates regarding matters that are uncertain and susceptible to change where such change may result in a material adverse impact on the Company's financial position and reported financial results. These critical accounting policies are described below. Management regularly reviews the estimates and assumptions used in the preparation of the Company's financial statements for reasonableness and adequacy. Valuation of Goodwill: Under the provisions of Statement of Financial Accounting Standards (SFAS) No. 142 - Goodwill and Other Intangible Assets, goodwill is required to be tested for impairment at least annually, or whenever indications of impairment exist. An impairment exists when the carrying amount of goodwill exceeds its implied fair value, resulting in an impairment charge for this excess. The Company's goodwill balances, net of accumulated amortization, were $811 million and $810 million at December 31, 2004 and 2003, respectively. The Company has elected April 1 as its annual goodwill impairment testing date. In testing for a potential impairment of goodwill on April 1, 2004, management estimated 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 compared this value to the carrying value of the reporting unit. The estimated fair value of each reporting unit was greater than its carrying value, and therefore management concluded that no amount of goodwill was impaired. The estimated fair value of the reporting units was established using a discounted cash flow model that includes significant assumptions about the future operating results and cash flows of each reporting unit. Adverse changes in the Company's planned business operations such as unanticipated competition, a loss of key personnel, the sale of a reporting unit or a significant portion of a reporting unit, or other unforeseen developments could result in an impairment of the Company's recorded goodwill. Valuation and Estimated Useful Lives of Intangible Assets Other than Goodwill: The Company's intangible assets represent purchased assets that lack physical substance but can be distinguished from goodwill, principally the value of client relationships. Management generally obtains independent valuations to estimate the initial valuation and expected amortization period for client-related intangible assets. These valuations are primarily based on the present value of the estimated net cash flows expected to be derived from the client relationships, and assumptions about future client attrition. At each balance sheet date, management compares the actual and estimated attrition for client-related intangible assets to evaluate whether revisions to the amortization period are necessary. Also, management evaluates the client-related intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Therefore, higher than expected client attrition may result in higher future amortization charges or an impairment charge for client-related intangible assets. The Company's intangible asset balances, net of accumulated amortization, were $153 million and $141 million at December 31, 2004 and 2003, respectively. - 25 - THE CHARLES SCHWAB CORPORATION Management's Discussion and Analysis of Financial Condition and Results of Operations (Tabular Amounts in Millions, Except Ratios, and as Noted) 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. The initial restructuring reserves and any subsequent changes in estimates of such reserves are recorded in restructuring charges on the Company's consolidated statement of income. Factors and uncertainties which may adversely affect the estimates of sublease income include 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 $248 million and $213 million at December 31, 2004 and 2003, respectively. As of December 31, 2004, the remaining facilities restructuring reserve is net of estimated future sublease income of approximately $310 million. This estimated future sublease income amount is 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. At year end, approximately 80% of the total square footage targeted for sublease under the restructuring initiatives has been subleased, up from approximately 65% at December 31, 2003. The increase in subleased square footage is primarily due to the subleasing of certain property in New Jersey to a real estate investment trust in the second quarter of 2004, partially offset by the addition of properties as part of the 2004 cost reduction effort. For a further discussion on the Company's restructuring reserves, see "Description of Business - Restructuring." 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, 2004 and 2003 was $312 million and $283 million, respectively. The related pension expense (credit) is included in compensation and benefits on the Company's consolidated statement of income and was $7 million, $8 million, and less than $(1) million for 2004, 2003, and 2002, respectively. Derivative Instruments and Hedging Activities: As part of its asset and liability management process, the Company uses Swaps to manage interest rate risk. U.S. Trust uses LIBOR-based Swaps to hedge the interest rate risk associated with U.S. Trust'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 a net $6 million and $33 million liability at December 31, 2004 and 2003, respectively, 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 2004, 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. 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 fair value of these Swaps, totaling an aggregate $13 million and $19 million asset at December 31, 2004 and 2003, respectively, 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. 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. For Schwab Bank and U.S. Trust portfolios, which primarily consist of mortgage loans, a risk-based methodology is used to determine the allowance for credit losses. Mortgage loans are categorized into portfolios by loan type and risk characteristics. A probable loss rate, based on company and - 26 - THE CHARLES SCHWAB CORPORATION Management's Discussion and Analysis of Financial Condition and Results of Operations (Tabular Amounts in Millions, Except Ratios, and as Noted) industry experience, is used to determine the credit allowance for each portfolio of loans. At both December 31, 2004 and 2003, the Company's allowance for credit losses was $27 million on loan portfolios of $6.8 billion and $5.8 billion, respectively. Legal Reserve: The Company is subject to legal, regulatory and other proceedings and claims arising from the conduct of its business. The Company establishes a reserve for potential losses that may arise out of these proceedings to the extent that such losses are probable and can be estimated. The amount of the reserve, which is determined on a case-by-case basis, represents the Company's best estimate of probable losses after considering, among other factors, the progress of each case, experience in similar cases, available defenses, insurance coverage, and the opinions and views of legal counsel. However, significant judgment is required in making this estimate and the actual cost of resolving a claim may be higher or lower than the amount of the recorded reserve. The Company's management has discussed the development and selection of these critical accounting estimates with the 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 "Item 8 - Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 2. Significant Accounting Policies." FORWARD-LOOKING STATEMENTS In addition to historical information, this Annual Report on Form 10-K 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 the Company's senior management. These statements relate to, among other things, the Company's ability to pursue its business strategy (see "Item 1 - Business - Business Strategy and Competitive Environment"); the impact of legal proceedings and regulatory matters (see "Item 3 - Legal Proceedings" and "Item 8 - Financial Statements and Supplementary Data - - Notes to Consolidated Financial Statements - 23. Commitments and Contingent Liabilities - Legal Contingencies"); the impact of the firm-wide cost reduction effort on the Company's results of operations and the Company's ability to realize the estimated cost savings (see Description of Business - Overview and - Restructuring); management's expected effective income tax rate (see Results of Operations - Expenses Excluding Interest); capital expenditures (see Liquidity and Capital Resources - Cash and Capital Resources); sources of liquidity and capital (see Liquidity and Capital Resources - Liquidity and - Commitments); the potential impact of future strategic transactions (see Risk Management - Potential Strategic Transactions); the impact of changes in management's estimates on the Company's results of operations (see Critical Accounting Policies); the impact on the Company's results of operations of recording stock option expense (see "Item 8 - Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 2. Significant Accounting Policies"); and net interest expense under interest rate swaps (see "Item 8 - Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 24. Financial Instruments Subject to Off-Balance Sheet Risk, Credit Risk or Market Risk"). 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. 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. 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 effects of the Company's or its competitors' pricing, product and service decisions; the Company's ability to recognize the expected benefits of acquisitions or dispositions; the effects of changes in taxation laws and regulations (including tax rate changes, new tax laws and revised tax law interpretations), as well as the effect of strategic transactions (including business combinations, - 27 - THE CHARLES SCHWAB CORPORATION Management's Discussion and Analysis of Financial Condition and Results of Operations (Tabular Amounts in Millions, Except Ratios, and as Noted) acquisitions, and dispositions) on the Company's effective income tax rate; the size and number of the Company's insurance claims; a significant decline in the real estate market, including the Company's ability to sublease certain properties; and the scope of severance payments related to workforce reductions. 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 or regulatory matters; the inability to obtain external financing at acceptable rates; and intensified industry competition and consolidation. Certain of these factors are discussed in greater detail in this Annual Report on Form 10-K. - 28 - THE CHARLES SCHWAB CORPORATION Item 7A. Quantitative and Qualitative Disclosures About 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, loans to banking clients, mortgage-backed securities, and other fixed-rate investments) and its funding sources (including brokerage client cash balances, banking deposits, proceeds from stock-lending activities, and long-term debt) 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. The Company's exposure to equity price and currency exchange risks is not material. Additional qualitative and quantitative disclosures about market risk are summarized in the following paragraphs. See "Item 8 - Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 24. Financial Instruments Subject to Off-Balance Sheet Risk, Credit Risk or Market Risk" for an additional discussion on market risk. Financial Instruments Held For Trading Purposes The Company holds fixed income securities, which include municipal and government securities, and corporate bonds, in inventory to meet clients' trading needs. The fair value of such inventory was approximately $54 million and $74 million at December 31, 2004 and 2003, respectively. These securities, and the associated interest rate risk, are not material to the Company's financial position, results of operations, or cash flows. Financial Instruments Held For Purposes Other Than Trading Debt Issuances At December 31, 2004, CSC had $386 million aggregate principal amount of Medium-Term Notes outstanding, with fixed interest rates ranging from 6.21% to 8.05%. At December 31, 2003, CSC had $466 million aggregate principal amount of Medium-Term Notes outstanding, with fixed interest rates ranging from 6.04% to 8.05%. At December 31, 2004 and 2003, U.S. Trust had $52 million Trust Preferred Capital Securities outstanding, with a fixed interest rate of 8.41%. 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, 2004 and 2003, based on estimates of market rates for debt with similar terms and remaining maturities, was $485 million and $584 million, respectively, which approximated their carrying amounts of $451 million and $537 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 "Item 8 - Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 24. Financial Instruments Subject to Off-Balance Sheet Risk, Credit Risk or Market Risk." Loans Held for Sale Schwab Bank's loans held for sale portfolio consists of fixed- and adjustable-rate mortgages, which are subject to a loss in value when market interest rates rise. Schwab Bank uses forward sale commitments to manage this risk. At December 31, 2004, the forward sale commitments were designated as cash flow hedging instruments of the loans held for sale. Accordingly, the fair values of the forward sale commitments are recorded on the Company's consolidated balance sheet, with gains or losses recorded in other comprehensive income (loss). At December 31, 2004 and 2003, the derivative liability recorded by Schwab Bank for these forward sale commitments was immaterial. 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 balance growth or decline for client loans, deposits, and brokerage client cash, changes in the level and term structure of interest rates, the repricing of financial instruments, prepayment and reinvestment assumptions, and product pricing assumptions. The simulations involve assumptions that are inherently uncertain and, as a result, cannot precisely estimate net - 29 - THE CHARLES SCHWAB CORPORATION 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 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, 2004 and 2003. The following table also shows the results of a gradual 200 basis point increase or decrease in interest rates relative to the Company's current forecast of net interest revenue over the twelve months ending December 31, 2005. Historically, the Company had used a gradual 200 basis point change when evaluating its sensitivity; however, the Company changed to a 100 basis point simulation in December 2001 due to low levels of interest rates. Given the recent increase in interest rates, the Company will again report its interest rate sensitivity using a gradual 200 basis point change. - -------------------------------------------------------------------------------- December 31, 2004 2003 - -------------------------------------------------------------------------------- Increase of 100 basis points 2.9% 1.7% Decrease of 100 basis points (2.8%) (6.4%) Increase of 200 basis points 5.7% n/a Decrease of 200 basis points (5.9%) n/a - -------------------------------------------------------------------------------- n/a - Not applicable. The down 100 basis point simulation shows reduced exposure to falling interest rates at December 31, 2004 compared to December 31, 2003. This reduced sensitivity results from higher interest rates and an expectation of interest rates continuing to increase, both of which lessen the impact of spread compression between interest-earning assets and brokerage client cash balances and banking deposits. - 30 - THE CHARLES SCHWAB CORPORATION Item 8. Financial Statements and Supplementary Data TABLE OF CONTENTS Consolidated Statement of Income ------------------------------------- 32 Consolidated Balance Sheet ------------------------------------------- 33 Consolidated Statement of Cash Flows --------------------------------- 34 Consolidated Statement of Stockholders' Equity ----------------------- 35 Notes to Consolidated Financial Statements --------------------------- 36 Note 1. Introduction and Basis of Presentation -------------- 36 Note 2. Significant Accounting Policies --------------------- 36 Note 3. Restructuring Charges ------------------------------- 39 Note 4. Sale of Corporate Trust Business -------------------- 41 Note 5. Discontinued Operations ----------------------------- 41 Note 6. Business Acquisitions and Divestitures --------------- 43 Note 7. Securities Owned ------------------------------------ 43 Note 8. Receivables from Brokerage Clients ------------------ 44 Note 9. Loans to Banking Clients and Related Allowance for Credit Losses ------------------------- 44 Note 10. Loan Securitizations -------------------------------- 45 Note 11. Equipment, Office Facilities and Property ----------- 46 Note 12. Deposits from Banking Clients ----------------------- 46 Note 13. Payables to Brokers, Dealers and Clearing Organizations --------------------------------------- 46 Note 14. Payables to Brokerage Clients ----------------------- 46 Note 15. Short-term Borrowings ------------------------------- 46 Note 16. Long-term Debt -------------------------------------- 47 Note 17. Taxes on Income ------------------------------------- 47 Note 18. Employee Incentive and Deferred Compensation Plans ---------------------------------- 48 Note 19. Retirement and Other Employee Benefit Plans --------- 49 Note 20. Accumulated Other Comprehensive Income (Loss) ------- 52 Note 21. Earnings Per Share ---------------------------------- 52 Note 22. Regulatory Requirements ----------------------------- 52 Note 23. Commitments and Contingent Liabilities -------------- 54 Note 24. Financial Instruments Subject to Off-Balance Sheet Risk, Credit Risk or Market Risk -------------- 55 Note 25. Fair Value of Financial Instruments ----------------- 58 Note 26. Segment Information --------------------------------- 58 Note 27. Supplemental Cash Flow Information ------------------ 60 Note 28. The Charles Schwab Corporation - Parent Company Only Financial Statements ------------------- 60 Note 29. Quarterly Financial Information (Unaudited) --------- 62 Management's Report on Internal Control Over Financial Reporting ----- 63 Report of Independent Registered Public Accounting Firm -------------- 64 - 31 -
THE CHARLES SCHWAB CORPORATION Consolidated Statement of Income (In Millions, Except Per Share Amounts) Year Ended December 31, 2004 2003 2002 - ------------------------------------------------------------------------------------------------------------------------------------ Revenues Asset management and administration fees $ 2,091 $ 1,832 $ 1,753 Commissions 936 1,097 1,135 Interest revenue 1,213 968 1,156 Interest expense (277) (240) (331) --------- --------- --------- Net interest revenue 936 728 825 Principal transactions 89 93 102 Other 150 146 129 - ------------------------------------------------------------------------------------------------------------------------------------ Total 4,202 3,896 3,944 - ------------------------------------------------------------------------------------------------------------------------------------ Expenses Excluding Interest Compensation and benefits 1,877 1,665 1,755 Occupancy and equipment 389 430 446 Professional services 245 175 168 Depreciation and amortization 226 277 309 Communications 223 228 245 Advertising and market development 184 139 207 Commissions, clearance and floor brokerage 39 40 46 Restructuring charges 214 76 343 Impairment charges - 5 37 Other 160 144 139 - ------------------------------------------------------------------------------------------------------------------------------------ Total 3,557 3,179 3,695 - ------------------------------------------------------------------------------------------------------------------------------------ Income from continuing operations before taxes on income and extraordinary gain 645 717 249 Taxes on income 231 241 100 - ------------------------------------------------------------------------------------------------------------------------------------ Income from continuing operations before extraordinary gain 414 476 149 Loss from discontinued operations, net of tax (128) (4) (52) Extraordinary gain on sale of corporate trust business, net of tax - - 12 - ------------------------------------------------------------------------------------------------------------------------------------ Net Income $ 286 $ 472 $ 109 ==================================================================================================================================== Weighted-Average Common Shares Outstanding - Diluted 1,365 1,364 1,375 - ------------------------------------------------------------------------------------------------------------------------------------ Earnings Per Share - Basic Income from continuing operations before extraordinary gain $ .31 $ .35 $ .11 Loss from discontinued operations, net of tax $ (.10) - $ (.04) Extraordinary gain, net of tax - - $ .01 Net income $ .21 $ .35 $ .08 Earnings Per Share - Diluted Income from continuing operations before extraordinary gain $ .30 $ .35 $ .11 Loss from discontinued operations, net of tax $ (.09) - $ (.04) Extraordinary gain, net of tax - - $ .01 Net income $ .21 $ .35 $ .08 - ------------------------------------------------------------------------------------------------------------------------------------ Dividends Declared Per Common Share $ .074 $ .050 $ .044 - ------------------------------------------------------------------------------------------------------------------------------------ See Notes to Consolidated Financial Statements. - 32 -
THE CHARLES SCHWAB CORPORATION Consolidated Balance Sheet (In Millions, Except Share and Per Share Amounts) December 31, 2004 2003 - ------------------------------------------------------------------------------------------------------------------------------------ Assets Cash and cash equivalents $ 2,778 $ 2,785 Cash and investments segregated and on deposit for federal or other regulatory purposes (1) (including resale agreements of $12,901 in 2004 and $16,824 in 2003) 19,019 21,341 Securities owned - at market value (including securities pledged of $8 in 2004 and $131 in 2003) 5,335 3,934 Receivables from brokers, dealers and clearing organizations 482 476 Receivables from brokerage clients - net 9,841 8,581 Loans to banking clients - net 6,822 5,736 Loans held for sale 20 29 Equipment, office facilities and property - net 903 943 Goodwill - net 811 810 Intangible assets - net 153 141 Other assets 969 829 Assets of discontinued operations - 261 - ------------------------------------------------------------------------------------------------------------------------------------ Total $47,133 $45,866 ==================================================================================================================================== Liabilities and Stockholders' Equity Deposits from banking clients $11,118 $ 8,308 Drafts payable 363 152 Payables to brokers, dealers and clearing organizations 1,468 2,633 Payables to brokerage clients 27,154 27,184 Accrued expenses and other liabilities 1,396 1,216 Short-term borrowings 663 996 Long-term debt 585 772 Liabilities of discontinued operations - 144 - ------------------------------------------------------------------------------------------------------------------------------------ Total liabilities 42,747 41,405 - ------------------------------------------------------------------------------------------------------------------------------------ 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; 1,392,091,544 shares issued 14 14 Additional paid-in capital 1,769 1,749 Retained earnings 3,258 3,125 Treasury stock - 61,434,850 and 34,452,710 shares in 2004 and 2003, respectively, at cost (591) (319) Unamortized stock-based compensation (59) (95) Accumulated other comprehensive loss (5) (13) - ------------------------------------------------------------------------------------------------------------------------------------ Total stockholders' equity 4,386 4,461 - ------------------------------------------------------------------------------------------------------------------------------------ Total $47,133 $45,866 ==================================================================================================================================== (1) Amounts included represent actual balances on deposit, whereas cash and investments required to be segregated for federal or other regulatory purposes were $19,004 million at December 31, 2004, excluding $200 million of intercompany repurchase agreements, and $21,004 million at December 31, 2003. On January 4, 2005 and January 5, 2004, the Company deposited $426 million and $221 million, respectively, into its segregated reserve bank accounts. See Notes to Consolidated Financial Statements. - 33 -
THE CHARLES SCHWAB CORPORATION Consolidated Statement of Cash Flows (In Millions) Year Ended December 31, 2004 2003 2002 - ------------------------------------------------------------------------------------------------------------------------------------ Cash Flows from Operating Activities Net income $ 286 $ 472 $ 109 Adjustments to reconcile net income to net cash provided by operating activities: Loss from discontinued operations, net of tax 128 4 52 Depreciation and amortization 226 277 309 Impairment charges - 5 37 Tax benefits from, and amortization of, stock-based awards 64 29 31 Deferred income taxes (4) 5 19 Non-cash restructuring charges 16 12 37 Extraordinary gain on sale of corporate trust business, net of tax - - (12) Other 2 (26) 27 Originations of loans held for sale (856) (1,606) - Proceeds from sales of loans held for sale 870 1,585 - Net change in: Cash and investments segregated and on deposit for federal or other regulatory purposes 2,321 (1,065) (3,302) Securities owned (excluding securities available for sale) 32 (117) 87 Receivables from brokers, dealers and clearing organizations (7) (278) 218 Receivables from brokerage clients (1,261) (1,741) 2,745 Other assets (51) (72) (5) Drafts payable 210 19 (259) Payables to brokers, dealers and clearing organizations (1,165) 1,184 646 Payables to brokerage clients (31) 1,479 (527) Accrued expenses and other liabilities 111 (110) (18) - ------------------------------------------------------------------------------------------------------------------------------------ Net cash provided by operating activities 891 56 194 - ------------------------------------------------------------------------------------------------------------------------------------ Cash Flows from Investing Activities Purchases of securities available for sale (3,387) (3,264) (1,147) Proceeds from sales of securities available for sale 686 397 636 Proceeds from maturities, calls and mandatory redemptions of securities available for sale 1,154 819 415 Net increase in loans to banking clients (2,112) (1,538) (705) Proceeds from sales of banking client loans 1,026 355 196 Purchase of equipment, office facilities and property - net (194) (147) (154) Cash payments for business combinations and investments, net of cash received (2) (374) - Proceeds from sales of subsidiaries and investments 271 70 26 - ------------------------------------------------------------------------------------------------------------------------------------ Net cash used for investing activities (2,558) (3,682) (733) - ------------------------------------------------------------------------------------------------------------------------------------ Cash Flows from Financing Activities Net change in deposits from banking clients 2,810 3,077 (217) Net change in short-term borrowings (333) 488 (55) Proceeds from long-term debt 136 - 100 Repayment of long-term debt (315) (100) (214) Dividends paid (101) (68) (60) Purchase of treasury stock (383) (32) (299) Proceeds from stock options exercised and other 51 34 34 - ------------------------------------------------------------------------------------------------------------------------------------ Net cash provided by (used for) financing activities 1,865 3,399 (711) - ------------------------------------------------------------------------------------------------------------------------------------ Net cash (used for) provided by discontinued operations (205) 33 (142) - ------------------------------------------------------------------------------------------------------------------------------------ Decrease in Cash and Cash Equivalents (7) (194) (1,392) Cash and Cash Equivalents at Beginning of Year 2,785 2,979 4,371 - ------------------------------------------------------------------------------------------------------------------------------------ Cash and Cash Equivalents at End of Year $ 2,778 $ 2,785 $ 2,979 ==================================================================================================================================== See Notes to Consolidated Financial Statements. - 34 -
THE CHARLES SCHWAB CORPORATION Consolidated Statement of Stockholders' Equity (In Millions) Accumulated Additional Unamortized Other Common Paid-In Retained Treasury Stock-based Comprehensive Stock Capital Earnings Stock Compensation Income(Loss) Total - ------------------------------------------------------------------------------------------------------------------------------------ Balance at December 31, 2001 $ 14 $ 1,726 $ 2,794 $ (295) $ (39) $ (37) $ 4,163 ==================================================================================================================================== Comprehensive income: Net income - - 109 - - - 109 Net loss on cash flow hedging instruments, net of tax of $3 - - - - - (6) (6) Net unrealized gain on securities available for sale, net of reclassification adjustment, and tax of $11 - - - - - 17 17 Foreign currency translation adjustment - - - - - 8 8 -------- 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 (465) (33) (18) 4,011 ==================================================================================================================================== Comprehensive income: Net income - - 472 - - - 472 Net gain on cash flow hedging instruments, net of tax of $13 - - - - - 19 19 Net unrealized loss on securities available for sale, net of reclassification adjustment, and tax of $13 - - - - - (19) (19) Foreign currency translation adjustment - - - - - 5 5 -------- Total comprehensive income 477 Dividends declared on common stock - - (68) - - - (68) Purchase of treasury stock - - - (32) - - (32) Stock options exercised, and shares and stock options issued under stock-based compensation plans - (4) (47) 174 (97) - 26 Non-cash stock-based compensation expense related to restructuring - 8 - - 1 - 9 Issuance of shares for acquisitions - 1 (1) 4 - - 4 Amortization of stock-based compensation awards - - - - 34 - 34 - ------------------------------------------------------------------------------------------------------------------------------------ Balance at December 31, 2003 14 1,749 3,125 (319) (95) (13) 4,461 ==================================================================================================================================== Comprehensive income: Net income - - 286 - - - 286 Net gain on cash flow hedging instruments, net of tax of $10 - - - - - 15 15 Net unrealized loss on securities available for sale, net of reclassification adjustment, and tax of $5 - - - - - (8) (8) Foreign currency translation adjustment - - - - - 1 1 -------- Total comprehensive income 294 Dividends declared on common stock - - (101) - - - (101) Purchase of treasury stock - - - (383) - - (383) Stock options exercised, and shares and stock options issued under stock-based compensation plans - 17 (52) 111 (47) - 29 Non-cash stock-based compensation expense related to restructuring - 3 - - 3 - 6 Amortization of stock-based compensation awards - - - - 80 - 80 - ------------------------------------------------------------------------------------------------------------------------------------ Balance at December 31, 2004 $ 14 $ 1,769 $ 3,258 $ (591) $ (59) $ (5) $ 4,386 ==================================================================================================================================== See Notes to Consolidated Financial Statements. - 35 -
THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, and as Noted) 1. Introduction and Basis of Presentation The Charles Schwab Corporation (CSC) is a financial holding company engaged, through its subsidiaries, in securities brokerage, banking, and related financial services. Charles Schwab & Co., Inc. (Schwab) is a securities broker-dealer with 236 domestic branch offices in 43 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 37 offices in 15 states. Other subsidiaries include Charles Schwab Investment Management, Inc., the investment advisor for Schwab's proprietary mutual funds, CyberTrader, Inc. (CyberTrader), an electronic trading technology and brokerage firm providing services to highly active, online traders, and Charles Schwab Bank, N.A. (Schwab Bank), a retail bank. The consolidated financial statements include CSC and its majority-owned subsidiaries (collectively referred to as the Company). These consolidated financial statements have been 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 intangible assets, equipment, office facilities, and property; valuation of goodwill, intangible assets, and equity investments; valuation of employee stock options; 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 reserves; and legal reserves. Actual results could differ from such estimates. Certain prior-year amounts have been reclassified to conform to the 2004 presentation. All material intercompany balances and transactions have been eliminated. The Company completed the sale of its capital markets business in 2004 and the sale of its U.K. brokerage business in 2003. These financial statements have been adjusted to reflect these businesses as discontinued operations. See note "5 - Discontinued Operations" for further discussion of these sales. 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 recorded at market value. Securities borrowed, securities loaned, and securities sold under agreements to repurchase (repurchase agreements): 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 using quoted market prices, where available, or third-party pricing services. Unrealized gains and losses are reported, net of taxes, in accumulated other comprehensive income (loss) included in stockholders' equity. Realized gains and losses from sales of securities - 36 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, and as Noted) 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(R) money market funds, and equity and bond mutual funds and are recorded at estimated fair value. Unrealized gains and losses are included in principal transaction revenues. Receivables from brokerage clients are stated net of allowance for doubtful accounts of $1 million and $2 million at December 31, 2004 and 2003, respectively. Cash receivables from brokerage clients that remain unsecured or partially secured for more than 30 days are fully reserved. 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. 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. Loans to banking clients are stated net of allowance for credit losses of $27 million at both December 31, 2004 and 2003. The allowance 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. Loans held for sale consist of fixed-rate and adjustable-rate mortgage loans intended for sale. Loans held for sale are stated at lower of cost or market value. Market value is determined using quoted market prices. 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 three to ten 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 or five 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. Derivative financial instruments are recorded on the balance sheet at fair value based upon dealer quotes and third-party pricing services. As part of its consolidated asset and liability management process, the Company utilizes interest rate swap agreements (Swaps) to manage interest rate risk of both fixed-rate and variable-rate financial instruments. The Company applies hedge accounting to these swaps and therefore gains and losses are generally deferred and recognized in interest expense to offset the impact of changing interest rates on the hedged financial instruments. For further discussion on these derivative financial instruments, see note "24 - Financial Instruments Subject to Off-Balance Sheet Risk, Credit Risk or Market Risk." 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 when the awards are granted. Expense is recognized if the original terms of an award are subsequently modified, which has occurred in connection with restructuring and severance activities. 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. The Company changed its option pricing model from the Black-Scholes model to a binomial model for all options granted on or after January 1, 2004. The fair values of stock options granted prior to January 1, 2004 were determined using the Black-Scholes model. The Company believes that the binomial model offers greater flexibility in reflecting the characteristics of employee stock options. The binomial model takes into account similar inputs to a Black-Scholes model such as volatility, dividend yield rate, and risk-free - 37 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, and as Noted) interest rate. In addition to these assumptions, the binomial model considers the contractual term of the option, the probability that the option will be exercised prior to the end of its contractual life, and the probability of termination or retirement of the option holder in computing the value of the option. The Company determines these probabilities generally based on analysis of historical trends of such events. The weighted-average of the assumptions used in the respective option pricing models were as follows: - -------------------------------------------------------------------------------- 2004 2003 2002 - -------------------------------------------------------------------------------- Expected dividend yield .48% .30% .30% Expected volatility 35% 49% 51% Risk-free interest rate 3.9% 2.7% 3.5% Expected life (in years) (1) 3.4 5.0 5.0 - -------------------------------------------------------------------------------- (1) Reflects a decrease in the contractual term and vesting period for 2004 stock option grants. Had compensation expense for the Company's stock option awards been determined based on the Black-Scholes or binomial fair value, as described above, at the grant dates for awards under those plans consistent with the fair value method of Statement of Financial Accounting Standards (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: - -------------------------------------------------------------------------------- 2004 2003 2002 - -------------------------------------------------------------------------------- Expense for stock-based compensation (after tax) (1): As reported $ 39 $ 23 $ 20 Pro forma (2) $ 127 $ 124 $ 162 - -------------------------------------------------------------------------------- Net income (loss): As reported $ 286 $ 472 $ 109 Pro forma $ 198 $ 371 $ (33) - -------------------------------------------------------------------------------- Basic EPS: As reported $ .21 $ .35 $ .08 Pro forma $ .15 $ .28 $ (.02) Diluted EPS: As reported $ .21 $ .35 $ .08 Pro forma $ .15 $ .27 $ (.02) - -------------------------------------------------------------------------------- (1) Includes compensation expense related to restricted stock awards of $37 million, $18 million, and $14 million in 2004, 2003, and 2002, respectively. (2) Includes pro forma compensation expense related to stock options granted in both current and prior years. Pro forma stock option compensation is amortized on a basis consistent with the vesting terms over the vesting period beginning with the month in which the option was granted. Goodwill represents the cost of acquired businesses in excess of the fair value of the related net assets acquired. Goodwill is tested for impairment at least annually or whenever indications of impairment exist. In testing for a potential impairment of goodwill, management estimates 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 compares 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. The carrying amount of goodwill attributable to each of the Company's reportable segments is presented in the following table: - -------------------------------------------------------------------------------- December 31, 2004 2003 - -------------------------------------------------------------------------------- Individual Investor $ 416 $ 416 Institutional Investor 3 3 U.S. Trust 392 391 - -------------------------------------------------------------------------------- Total $ 811 $ 810 ================================================================================ Changes in the carrying amount of goodwill associated with the capital markets business, which was sold in 2004, are discussed in note "5 - Discontinued Operations" and note "6 - Business Acquisitions and Divestitures." Intangible assets consist primarily of purchased client accounts. These intangible assets have finite lives and are amortized over their estimated useful lives and subject to impairment testing whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. In testing for a potential impairment of intangible assets, management assesses whether the future cash flows related to the asset will be greater than its carrying value at the time of the test. Accordingly, the process of evaluating a potential impairment is based on estimates and is subjective. The Company's gross amortizing intangible asset balances were $145 million and $138 million at December 31, 2004 and 2003, respectively. Accumulated amortization relating to these intangible assets was $11 million and $2 million at December 31, 2004 and 2003, respectively. These intangible assets have a weighted-average estimated useful life of 20 years. The Company recorded amortization expense of $9 million, $2 million, and $4 million in 2004, 2003, and 2002, respectively, related to these intangible assets. Estimated future amortization expense for these intangible assets is approximately $10 million in each of 2005 - 38 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, and as Noted) and 2006, and approximately $7 million in each of 2007, 2008, and 2009. Additionally, the Company has certain intangible assets which are non-amortizing but are subject to impairment testing as described above. The Company's non-amortizing intangible asset balances were $19 million and $5 million at December 31, 2004 and 2003, respectively, and are primarily comprised of the value of contracts acquired in 2004 to manage investments of mutual funds. Variable interest entities: Upon adoption of Financial Accounting Standards Board Interpretation (FIN) No. 46 - Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51 - Consolidated Financial Statements, in the first quarter of 2003, the Company consolidated a special purpose trust (Trust) and recorded a note payable of $235 million. This Trust was formed in 2000 to finance the acquisition and renovation of an office building and land. In June 2004, the Company exercised its option to purchase this property from the Trust and repaid $99 million of the note payable. Simultaneously, the Company completed a transaction on this property with American Financial Realty Trust, a publicly-traded real estate investment trust, resulting in proceeds of $136 million, which was used to repay the remainder of the note payable, and a 20-year lease. This transaction was accounted for as a financing. The remaining lease financing liability of $134 million at December 31, 2004 is being reduced by a portion of the lease payments over the 20-year term. New accounting standards: SEC Staff Accounting Bulletin (SAB) No. 105 "Application of Accounting Principles to Loan Commitments" was released in March 2004. This release summarizes the SEC staff position regarding the application of GAAP to loan commitments accounted for as derivative instruments. The Company accounts for interest rate lock commitments issued on mortgage loans that will be held for sale as derivative instruments. Consistent with SAB No. 105, the Company considers the fair value of these commitments to be zero at the commitment date, with subsequent changes in fair value determined solely on changes in market interest rates. As of December 31, 2004, the Company had interest rate lock commitments on mortgage loans to be held for sale with principal balances totaling approximately $110 million, the fair value of which was immaterial. Emerging Issues Task Force Issue (EITF) No. 03-01 "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments" was ratified by the Financial Accounting Standards Board (FASB) in March 2004. This EITF addresses how to determine the meaning of other-than-temporary impairment and its application to investments classified as either available-for-sale or held-to-maturity under Statement of Financial Accounting Standards (SFAS) No. 115 - Accounting for Certain Investments in Debt and Equity Securities (including individual securities and investments in mutual funds), and investments accounted for under the cost method or the equity method. In September 2004, the FASB delayed the effective date of the portion of this EITF that relates to measuring and recognizing other-than-temporary impairment until implementation guidance is finalized. This delay does not suspend the requirement to recognize other-than-temporary impairment required by existing accounting literature. A revision to SFAS No. 123, Share-Based Payment, which supersedes APB No. 25 (SFAS No. 123R) and was issued in December 2004, requires that the cost resulting from all share-based payments be recognized as an expense in the consolidated financial statements, and also changes the classification of certain tax benefits in the consolidated statement of cash flows. The Company is required to adopt SFAS No. 123R on July 1, 2005. The Company has historically recorded compensation expense for all restricted stock awards. Beginning in the third quarter of 2005, the Company will record compensation expense for unvested stock option awards over the future periods in which the awards vest. Based upon stock options outstanding at December 31, 2004, pre-tax compensation expense related to stock option awards would be approximately $22 million, $23 million, and $10 million in the second half of 2005 and full-year 2006 and 2007, respectively, which equates to a decrease in EPS of $.01 in the second half of 2005 and full-year 2006. The amount and timing of total future compensation expense related to stock option grants will vary based upon additional awards, if any, cancellations, forfeitures, or modifications of existing awards, and employee severance terms. 3. Restructuring Charges The Company recorded pre-tax restructuring charges as follows: - -------------------------------------------------------------------------------- 2004 2003 2002 - -------------------------------------------------------------------------------- 2004 Cost Reduction Effort $ 211 - - 2003, 2002, and 2001 Initiatives 3 $ 76 $ 343 - -------------------------------------------------------------------------------- Total restructuring charges $ 214 $ 76 $ 343 ================================================================================ - 39 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, and as Noted) A summary of restructuring reserve liabilities is as follows: - -------------------------------------------------------------------------------- December 31, 2004 2003 - -------------------------------------------------------------------------------- 2004 Cost Reduction Effort $ 118 - 2003, 2002, and 2001 Initiatives 143 $ 220 - -------------------------------------------------------------------------------- Total restructuring reserves $ 261 $ 220 ================================================================================ In addition to these restructuring reserves, see note "5 - Discontinued Operations" for a discussion of the Company's restructuring reserves related to discontinued operations. All restructuring reserve liabilities are included in accrued expenses and other liabilities on the Company's consolidated balance sheet. 2004 Cost Reduction Effort In the second quarter of 2004, the Company commenced a firm-wide cost reduction effort designed to mitigate the financial impact of its pricing changes and to strengthen its productivity and efficiency. The goals of this effort include eliminating work that is not essential to meeting client service standards or the Company's ongoing operating needs, reengineering work processes to maximize productivity, minimizing organizational complexity through functional streamlining, and addressing business unit performance across the Company. During 2004, the Company reallocated certain client service functions from its Orlando regional telephone service center to other centers. The Company also closed or consolidated 111 branch offices, began opening smaller satellite offices in selected locations, and took steps to streamline its technology organization. Additionally, the Company reduced its operating facilities, primarily by exiting certain administrative office space in California. The Company recorded pre-tax restructuring charges of $211 million in 2004 related to the 2004 cost reduction effort, primarily reflecting severance costs for approximately 1,600 employees and facilities reduction charges. A summary of pre-tax restructuring charges related to the Company's 2004 cost reduction effort is as follows: - -------------------------------------------------------------------------------- 2004 - -------------------------------------------------------------------------------- Workforce reduction: Severance pay and benefits $ 122 Charges for officers' stock-based compensation 7 - -------------------------------------------------------------------------------- Total workforce reduction 129 - -------------------------------------------------------------------------------- Facilities reduction: Non-cancelable lease costs, net of estimated sublease income 75 Write-downs of fixed assets 7 - -------------------------------------------------------------------------------- Total facilities reduction 82 - -------------------------------------------------------------------------------- Total restructuring charges $ 211 ================================================================================ A summary of the activity in the restructuring reserve related to the Company's 2004 cost reduction effort is as follows: - -------------------------------------------------------------------------------- Workforce Facilities Reduction Reduction Total - -------------------------------------------------------------------------------- Restructuring charges $ 129 $ 82 $ 211 Cash payments (72) (8) (80) Non-cash charges (1) (7) (7) (14) Other (2) - 1 1 - -------------------------------------------------------------------------------- Balance at December 31, 2004 $ 50 (3) $ 68 (4) $ 118 ================================================================================ (1) Primarily includes charges for officers' stock-based compensation and write-downs of fixed assets. (2) Primarily includes the accretion of facilities restructuring reserves, which are initially recorded at net present value. Accretion expense is recorded in occupancy and equipment expense on the Company's consolidated statement of income. (3) The Company expects to substantially utilize the remaining workforce reduction reserve through cash payments for severance pay and benefits over the respective severance periods through 2006. (4) The Company expects to substantially utilize the remaining facilities reduction reserve through cash payments for the net lease expense over the respective lease terms through 2014. 2003, 2002, and 2001 Initiatives The Company's 2003, 2002, and 2001 restructuring initiatives included workforce reductions, reductions in operating facilities, the removal of certain systems hardware, software and equipment from service, and the withdrawal from certain international operations. These initiatives reduced operating expenses and adjusted the Company's organizational structure to help improve productivity, enhance efficiency, and increase profitability. In 2004, the Company recorded pre-tax restructuring charges of $3 million related to its 2003, 2002, and 2001 restructuring initiatives, primarily due to changes in estimates of sublease income associated with previously announced efforts to sublease excess facilities. In 2003, the Company recorded pre-tax restructuring charges of $76 million related to these - 40 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, and as Noted) restructuring initiatives, primarily due to adjustments to the Company's workforce and facilities levels in response to the market environment, as well as changes in estimates of sublease income associated with previously announced efforts to sublease excess facilities. A summary of the activity in the restructuring reserve related to the Company's 2003, 2002, and 2001 restructuring initiatives for the years ended December 31, 2004, 2003, and 2002 is as follows: - -------------------------------------------------------------------------------- Workforce Facilities Systems Reduction Reduction Removal Total - -------------------------------------------------------------------------------- Balance at December 31, 2001 $ 71 $ 97 $ 4 $ 172 Restructuring charges 140 202 1 343 Cash payments (144) (49) (3) (196) Non-cash charges (1) (9) (26) (2) (37) - -------------------------------------------------------------------------------- Balance at December 31, 2002 $ 58 $ 224 $ - $ 282 Restructuring charges 27 49 - 76 Cash payments (58) (75) - (133) Non-cash charges (1) (8) (4) - (12) Other (2) - 7 - 7 - -------------------------------------------------------------------------------- Balance at December 31, 2003 $ 19 $ 201 $ - $ 220 Restructuring charges (1) 4 - 3 Cash payments (15) (71) - (86) Non-cash charges (1) (2) - - (2) Other (2) - 8 - 8 - -------------------------------------------------------------------------------- Balance at December 31, 2004 $ 1 (3) $ 142 (4) $ - $ 143 ================================================================================ (1) Primarily includes charges for officers' stock-based compensation and write-downs of fixed assets. (2) Primarily includes the accretion of facilities restructuring reserves, which are initially recorded at net present value. Accretion expense is recorded in occupancy and equipment expense on the Company's consolidated statement of income. (3) Relates to the Company's 2003 restructuring initiative. The Company expects to substantially utilize the remaining workforce reduction reserve through cash payments for severance pay and benefits over the respective severance periods through 2005. (4) Includes $5 million, $62 million, and $75 million related to the Company's 2003, 2002, and 2001 restructuring initiatives, respectively. The Company expects to substantially utilize the remaining facilities reduction reserve through cash payments for the net lease expense over the respective lease terms through 2017. The actual costs of these restructuring initiatives could differ from the estimated costs, depending primarily on the Company's ability to sublease properties. 4. Sale of Corporate Trust Business In 2001, U.S. Trust sold its Corporate Trust business to The Bank of New York Company, Inc. In 2002, the Company recorded a pre-tax 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. 5. Discontinued Operations On October 29, 2004, the Company completed the sale of its capital markets business to UBS Securities LLC and UBS Americas Inc. (collectively referred to as UBS). Pursuant to the purchase agreement, UBS acquired all of the partnership interests of Schwab Capital Markets L.P. and all of the outstanding capital stock of SoundView Technology Group, Inc. (collectively referred to as Schwab Soundview Capital Markets, or SSCM) for $265 million in cash. At closing, the Company and Schwab entered into eight-year order routing and execution services agreements with UBS for the handling of Schwab's equity and listed options order flow. The Company has deferred $28 million of the purchase price, representing the fair value of these services agreements, to be recognized as revenue over the eight-year term on a straight-line basis. SSCM comprised substantially all of the previously-reported Capital Markets segment. The results of operations, net of income taxes, and cash flows of SSCM have been presented as discontinued operations on the consolidated statements of income and of cash flows, respectively, and the assets and liabilities of SSCM prior to the sale have each been combined and presented as assets and liabilities of discontinued operations on the consolidated balance sheet. The Company's consolidated prior period revenues, expenses, taxes on income, assets, liabilities, and cash flows have been adjusted to reflect this presentation. The carrying amounts of SSCM assets and liabilities included as part of the sale are as follows: - -------------------------------------------------------------------------------- October 29, 2004 - -------------------------------------------------------------------------------- Assets Cash $ 43 Securities owned 87 Goodwill 123 Other assets 53 - -------------------------------------------------------------------------------- Total assets $ 306 - -------------------------------------------------------------------------------- Liabilities Accrued expenses and other liabilities $ 88 - -------------------------------------------------------------------------------- Total liabilities $ 88 - -------------------------------------------------------------------------------- - 41 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, and as Noted) On January 31, 2003, the Company sold its U.K. brokerage subsidiary, Charles Schwab Europe (CSE), to Barclays PLC. The results of the operations of CSE, net of income taxes, have been presented as discontinued operations on the Company's consolidated statement of income. A summary of revenues and losses for discontinued operations is as follows: - -------------------------------------------------------------------------------- 2004 2003 2002 - -------------------------------------------------------------------------------- Revenues (1) $ 226 $ 202 $ 195 Loss on sale (2) $ 88 $ 3 $ 24 Total pre-tax loss (3) $ 199 $ 6 $ 80 After-tax losses $ 128 $ 4 $ 52 - -------------------------------------------------------------------------------- (1) Includes revenues of $4 million and $44 million in 2003 and 2002, respectively, related to CSE. (2) Includes goodwill impairment charges of $95 million in 2004 for SSCM, based upon the negotiated terms of the sale, and $24 million in 2002 for CSE. (3) Includes restructuring charges of $113 million, $17 million, and $30 million in 2004, 2003, and 2002, respectively. In addition to the restructuring reserves discussed in note "3 - Restructuring Charges," the Company retained certain restructuring-related obligations following the sales of SSCM and CSE, and recorded reserves for severance, facilities leases and systems. A summary of the activity in these reserves for the years ended December 31, 2004, 2003, and 2002 is as follows: - -------------------------------------------------------------------------------- Workforce Facilities Systems Reduction Reduction Removal Total - -------------------------------------------------------------------------------- Balance at December 31, 2001 $ 3 $ - $ - $ 3 Restructuring charges (1) 20 6 4 30 Cash payments (12) (1) (2) (15) Non-cash charges (2) (1) (2) (2) (5) - -------------------------------------------------------------------------------- Balance at December 31, 2002 $ 10 $ 3 $ - $ 13 Restructuring charges (1) 5 12 - 17 Cash payments (10) - - (10) Non-cash charges (2) (1) (3) - (4) - -------------------------------------------------------------------------------- Balance at December 31, 2003 $ 4 $ 12 $ - $ 16 Restructuring charges (1) 75 38 - 113 Cash payments (55) (5) - (60) Non-cash charges (2) (1) (7) - (8) - -------------------------------------------------------------------------------- Balance at December 31, 2004 $ 23(3) $ 38(4) $ - $ 61 ================================================================================ (1) Included in loss from discontinued operations. (2) Primarily includes charges for officers' stock-based compensation and write-downs of fixed assets. (3) The Company expects to substantially utilize the remaining workforce reduction reserve through cash payments for severance pay and benefits over the respective severance periods through 2006. (4) The Company expects to substantially utilize the remaining facilities reduction reserve through cash payments for the net lease expense over the respective lease terms through 2015. In January 2004, as part of the Company's purchase accounting for the acquisition of SoundView Technology Group, Inc. (SoundView), the Company recorded a $29 million liability for above-market lease rates for certain facilities leases expiring through 2011. At December 31, 2004, the remaining liability was $23 million. - 42 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, and as Noted) 6. Business Acquisitions and Divestitures In January 2004, the Company completed its acquisition of SoundView Technology Group, Inc. (SoundView) for approximately $340 million, or $289 million net of SoundView's cash and cash equivalents acquired. Additionally, the Company recorded securities owned of $93 million related to this acquisition. As a result of a purchase price allocation, the Company recorded goodwill of $194 million and intangible assets of $21 million related to this acquisition. On October 29, 2004, the Company completed the sale of SSCM, including all outstanding capital stock of SoundView. See note "5 - Discontinued Operations" for further discussion. In October 2003, U.S. Trust acquired State Street Corporation's Private Asset Management group, a provider of wealth management services to clients in the New England area, for $365 million. In June 2003, the Company sold its investment in Aitken Campbell, a market-making joint venture in the U.K., to the Company's joint venture partner, TD Waterhouse Group, Inc. In 2003 and 2002, the Company recorded pre-tax impairment charges of $5 million and $37 million, respectively, to reduce the carrying value of its investment. In 2003, the Company also recorded an income tax benefit of $16 million. The Company's share of Aitken Campbell's historical earnings, which was accounted for under the equity method, has not been material to the Company's results of operations, EPS, or cash flows. 7. Securities Owned A summary of securities owned is as follows: - -------------------------------------------------------------------------------- December 31, 2004 2003 - -------------------------------------------------------------------------------- Securities available for sale $4,870 $3,437 SchwabFunds(R) money market funds 285 306 Equity, fixed income, and other securities 161 167 Equity and bond mutual funds 19 24 - -------------------------------------------------------------------------------- Total $5,335 $3,934 ================================================================================ The amortized cost, estimated fair value, and gross unrealized gains and losses on securities available for sale are as follows: - -------------------------------------------------------------------------------- December 31, 2004 2003 - -------------------------------------------------------------------------------- U.S. treasury securities: Amortized cost $ 263 $ 301 Aggregate fair value $ 262 $ 302 Gross unrealized gains - $ 1 Gross unrealized losses $ 1 - U.S. government sponsored agencies and corporations: Amortized cost 1,534 1,421 Aggregate fair value 1,534 1,421 Gross unrealized gains 5 5 Gross unrealized losses 5 5 State and municipal obligations: Amortized cost 1 148 Aggregate fair value 1 155 Gross unrealized gains - 7 Gross unrealized losses - - Collateralized mortgage obligations: Amortized cost 3,062 1,508 Aggregate fair value 3,051 1,508 Gross unrealized gains 5 4 Gross unrealized losses 16 4 Other securities: Amortized cost 22 51 Aggregate fair value 22 51 Gross unrealized gains - - Gross unrealized losses - - - -------------------------------------------------------------------------------- Total securities available for sale: Amortized cost $ 4,882 $ 3,429 Aggregate fair value $ 4,870 $ 3,437 Gross unrealized gains $ 10 $ 17 Gross unrealized losses $ 22 $ 9 ================================================================================ A summary of investments with unrealized losses, aggregated by category and period of continuous unrealized loss, at December 31, 2004, is as follows: - -------------------------------------------------------------------------------- Less than 12 months 12 months or longer Total ---------------- ---------------- ---------------- Fair Unrealized Fair Unrealized Fair Unrealized Value Losses Value Losses Value Losses - -------------------------------------------------------------------------------- U.S. treasury securities $ 236 $ 1 - - $ 236 $ 1 U.S. government sponsored agencies and corporations 601 4 $ 53 $ 1 654 5 Collateralized mortgage obligations 1,557 15 58 1 1,615 16 Other securities 13 - 1 - 14 - - -------------------------------------------------------------------------------- Total temporarily impaired securities $2,407 $ 20 $ 112 $ 2 $2,519 $ 22 ================================================================================ Management views the unrealized losses noted above as temporary as the decline in market value is attributable to changes in interest rates and not credit quality. The determination of whether or not other-than-temporary - 43 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, and as Noted) impairment exists is a matter of judgment. Factors considered in evaluating whether a decline in value is other than temporary include: the financial conditions and near-term prospects of the issuer; the Company's intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery; and the length of time and the extent to which the fair value has been less than cost. The maturities and related weighted-average yields of debt securities available for sale at December 31, 2004 are as follows: - -------------------------------------------------------------------------------- Within 1 - 5 5 - 10 Over 10 1 Year Years Years Years Total - -------------------------------------------------------------------------------- U.S. treasury securities $ 259 $ 4 - - $ 263 U.S. government sponsored agencies and corporations - 16 - $1,518 1,534 State and municipal obligations - 1 - - 1 Collateralized mortgage obligations (1) - - - 3,062 3,062 Other debt securities 13 9 - - 22 - -------------------------------------------------------------------------------- Total at amortized cost 272 30 - 4,580 4,882 Estimated fair value 271 29 - 4,570 4,870 - -------------------------------------------------------------------------------- Net unrealized losses $ 1 $ 1 - $ 10 $ 12 ================================================================================ Weighted-average yield (2) 1.77% 3.31% - 4.08% 3.94% - -------------------------------------------------------------------------------- (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, 2004. Gross proceeds and gross realized gains and losses related to sales of securities available for sale are as follows. Realized gains and losses of securities available for sale are included in other income on the Company's consolidated income statement. - -------------------------------------------------------------------------------- 2004 2003 2002 - -------------------------------------------------------------------------------- Gross proceeds $ 686 $ 397 $ 636 Gross realized gains $ 9 $ 12 $ 12 Gross realized losses $ (2) - - - -------------------------------------------------------------------------------- The Company's positions in SchwabFunds(R) money market funds arise from certain overnight funding of clients' redemption, check-writing, and debit card activities. Fixed income securities are 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 $16 million and $20 million at December 31, 2004 and 2003, respectively, consist primarily of mutual fund shares that are distributed to clients to satisfy their dividend reinvestment requests. These securities are recorded at market value in accrued expenses and other liabilities. 8. Receivables from Brokerage Clients Receivables from brokerage clients consist primarily of margin loans to brokerage clients of $9.8 billion and $8.5 billion at December 31, 2004 and 2003, respectively. Securities owned by brokerage clients are held as collateral for margin loans. Such collateral is not reflected in the consolidated financial statements. 9. Loans to Banking Clients and Related Allowance for Credit Losses An analysis of the composition of the loan portfolio is as follows: - -------------------------------------------------------------------------------- December 31, 2004 2003 - -------------------------------------------------------------------------------- Residential real estate mortgages $ 5,342 $ 4,624 Consumer loans 971 735 Other 536 404 - -------------------------------------------------------------------------------- Total loans 6,849 5,763 Less: allowance for credit losses (27) (27) - -------------------------------------------------------------------------------- Loans to banking clients - net $ 6,822 $ 5,736 ================================================================================ Included in the loan portfolio are non-accrual loans totaling $1 million at both December 31, 2004 and 2003, respectively. Non-accrual loans are considered impaired by the Company, and represent all the Company's nonperforming assets at both December 31, 2004 and 2003. For 2004 and 2003, 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 $4 million and $1 million at December 31, 2004 and 2003, respectively. - 44 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, and as Noted) A summary of activity in the allowance for credit losses related to loans to banking clients is as follows. Recoveries and charge-offs were immaterial for each of 2004, 2003, and 2002. - -------------------------------------------------------------------------------- 2004 2003 2002 - -------------------------------------------------------------------------------- Balance at beginning of year $ 27 $ 24 $ 21 Provision 2 4 3 Release of allowance on loans sold (2) (1) - - -------------------------------------------------------------------------------- Balance at end of year $ 27 $ 27 $ 24 ================================================================================ 10. Loan Securitizations In the fourth quarters of 2004 and 2003, U.S. Trust sold $1.0 billion and $354 million, respectively, of residential mortgage loans originated through its private banking business in securitization transactions. In these securitizations, U.S. Trust retained a portion of the senior mortgage pass-through certificates and all subordinated pass-through certificates that were created by the securitization process (the retained securities), and the servicing rights. U.S. Trust received proceeds of $1.0 billion and $355 million from these securitizations in 2004 and 2003, respectively, reacquired the retained securities of $820 million and $7 million, respectively, and recognized immaterial net gains after payment of transaction expenses. These securitization transactions are accounted for as sales under the requirements of SFAS No. 140 - Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. The fair values of the retained securities at the date of securitization were primarily determined based on the following key economic assumptions: - -------------------------------------------------------------------------------- 2004 2003 - -------------------------------------------------------------------------------- Average discount rate 4.5% 6.4% Constant prepayment rate (1) 25% n/a Prepayment speed assumption (2) n/a 300% Expected weighted average life (in years) 2.4 6.0 Expected credit losses 0% 0% - -------------------------------------------------------------------------------- (1) Constant prepayment rate and constant prepayment rate to balloon methodologies were used. (2) Based upon the Public Securities Association convention, a 300% prepayment speed assumption equates to an increasing constant prepayment rate from 0% to 18% over the initial 30 month loan term and 18% thereafter. n/a Not applicable. The estimated fair values of the retained securities were $805 million and $12 million at December 31, 2004 and 2003, respectively, and were included in securities owned on the Company's consolidated balance sheet. The fair values of the servicing rights were immaterial. Key economic assumptions, and the sensitivities of the current fair value of retained securities related to these securitizations to immediate adverse changes in those assumptions, are presented in the table below. - -------------------------------------------------------------------------------- December 31, 2004 - -------------------------------------------------------------------------------- Fair value of retained securities $ 805 Expected weighted-average life (in years) 1.3 - 6.0 Prepayment speed assumption (1) 9.4 - 25.0% Impact on fair value of: 50 basis point adverse change $ - 100 basis point adverse change $ - Discount rate assumption 4.9 - 11.3% Impact on fair value of: 50 basis point adverse change $ (9) 100 basis point adverse change $ (18) - -------------------------------------------------------------------------------- (1) Constant prepayment rate and constant prepayment rate to balloon methodologies were used. The sensitivity analysis above is hypothetical and should be used with caution. Changes in fair value based on a variation in assumptions generally cannot be extrapolated because the relationship of the change in the assumption to the change in fair value may not be linear. Also, in the table above, the effect of a variation in a particular assumption on the fair value of the retained interest is calculated independently without changing any other assumption. In practice, changes in one factor may result in changes in another, which might magnify or counteract the sensitivities. Cash flows received from the retained securities were $28 million and $1 million in 2004 and 2003, respectively. Cash flows received from servicing fees were immaterial in both 2004 and 2003. Any credit losses on the securitized loans are assigned to U.S. Trust, as holder of the subordinated securities, up to the par value. There were no delinquencies in the securitized mortgage loans at December 31, 2004 and 2003, and there were no losses for either 2004 or 2003. U.S. Trust has not guaranteed the mortgage loans as these transactions are structured without recourse to U.S. Trust or the Company. - 45 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, and as Noted) The following table presents information about the principal balances of managed and securitized loans. - -------------------------------------------------------------------------------- December 31, 2004 2003 - -------------------------------------------------------------------------------- Residential real estate mortgages $ 6,628 $ 5,012 Consumer loans 971 735 Other 536 404 - -------------------------------------------------------------------------------- Total loans managed and securitized 8,135 6,151 Less: Sold or securitized loans 1,266 359 Loans held for sale 20 29 Allowance for credit losses 27 27 - -------------------------------------------------------------------------------- Total loans to banking clients - net $ 6,822 $ 5,736 ================================================================================ 11. Equipment, Office Facilities and Property Equipment, office facilities and property are detailed below: - -------------------------------------------------------------------------------- December 31, 2004 2003 - -------------------------------------------------------------------------------- Land (1) $ 55 $ 55 Buildings (1) 472 479 Leasehold improvements 358 348 Furniture and equipment 218 217 Telecommunications equipment 145 156 Information technology equipment 426 413 Software 667 552 Software development and construction in progress 61 83 - -------------------------------------------------------------------------------- Subtotal 2,402 2,303 Accumulated depreciation and amortization (1,499) (1,360) - -------------------------------------------------------------------------------- Total $ 903 $ 943 ================================================================================ (1) See note "2 - Significant Accounting Policies" for discussion on the consolidation of a Trust. 12. Deposits from Banking Clients Deposits from banking clients consist of money market and other savings deposits, certificates of deposit, and noninterest-bearing deposits. Deposits from banking clients are as follows: - -------------------------------------------------------------------------------- December 31, 2004 2003 - -------------------------------------------------------------------------------- Interest-bearing deposits (1) $10,280 $ 7,585 Noninterest-bearing deposits 838 723 - -------------------------------------------------------------------------------- Total $11,118 $ 8,308 ================================================================================ (1) Includes certificates of deposit of $100,000 or more totaling $340 million and $886 million at December 31, 2004 and 2003, respectively. During the years ended December 31, 2004 and 2003, the Company paid an average rate of 1.15% and 1.79%, respectively, on its interest-bearing deposits from banking clients. 13. Payables to Brokers, Dealers and Clearing Organizations Payables to brokers, dealers and clearing organizations consist primarily of securities loaned of $1.4 billion and $2.6 billion at December 31, 2004 and 2003, respectively. The cash collateral received from counterparties under securities lending transactions was equal to or greater than the market value of the securities loaned. 14. Payables to Brokerage Clients The principal source of funding for Schwab's margin lending is cash balances in brokerage client accounts. At December 31, 2004, Schwab was paying interest at 1.2% on $23.9 billion of cash balances in brokerage client accounts, which were included in payables to brokerage clients. At December 31, 2003, Schwab was paying interest at .2% on $23.8 billion of such cash balances. 15. Short-term Borrowings CSC may borrow up to $800 million under a committed, unsecured credit facility with a group of nineteen banks which is scheduled to expire in June 2005. CSC plans to establish a similar facility to replace this one when it expires. This facility replaced a facility that expired in June 2004. 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 stockholders' equity, Schwab to maintain minimum net capital ratios, as defined, and CSC's depository institution subsidiaries to be well capitalized, as defined. These facilities were unused at December 31, 2004 and 2003. To manage short-term liquidity, Schwab maintains uncommitted, unsecured bank credit lines with a group of eight banks totaling $831 million at December 31, 2004. CSC has access to $781 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, 2004 and 2003. - 46 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, and as Noted) 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, 2004. Schwab pays a fee to maintain these arrangements. In connection with its securities lending activities, Schwab is required to provide collateral to certain brokerage clients. Schwab satisfies the collateral requirements by arranging letters of credit (LOCs), in favor of these brokerage clients, that are guaranteed by multiple banks. At December 31, 2004, the outstanding value of these LOCs totaled $52 million. No funds were drawn under these LOCs at December 31, 2004 and 2003. Other short-term borrowings include Federal Home Loan Bank System borrowings, federal funds purchased, repurchase agreements, and other borrowed funds. At December 31, 2004 and 2003, these other short-term borrowings totaled $663 million and $996 million, respectively, with weighted-average interest rates ranging from 2.13% to 2.50% and .87% to 1.22%, respectively. 16. Long-term Debt Long-term debt consists of the following: - -------------------------------------------------------------------------------- December 31, 2004 2003 - -------------------------------------------------------------------------------- Senior Medium-Term Notes, Series A $ 386 $ 466 Lease financing liability 134 - Note payable - 235 8.41% Trust Preferred Capital Securities 52 52 Fair value adjustment (1) 13 19 - -------------------------------------------------------------------------------- Total $ 585 $ 772 ================================================================================ (1) Represents the fair value adjustment related to hedged Medium-Term Notes. See note "24 - 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, 2004 had maturities ranging from 2005 to 2010. The aggregate principal amount of Medium-Term Notes outstanding at December 31, 2004 and 2003 had fixed interest rates ranging from 6.21% to 8.05%, and 6.04% to 8.05%, respectively. At December 31, 2004 and 2003, the Medium-Term Notes carried a weighted-average interest rate of 7.46% and 7.31%, respectively. Upon adoption of FIN No. 46 in the first quarter of 2003, the Company consolidated a Trust and recorded a note payable of $235 million. This Trust was formed in 2000 to finance the acquisition and renovation of an office building and land. In June 2004, the Company exercised its option to purchase this property from the Trust and repaid $99 million of the note payable. Simultaneously, the Company completed a transaction on this property with American Financial Realty Trust, a publicly-traded real estate investment trust, resulting in proceeds of $136 million, which was used to repay the remainder of the note payable, and a 20-year lease. This transaction was accounted for as a financing. The remaining lease financing liability of $134 million at December 31, 2004 is being reduced by a portion of the lease payments over the 20-year term. 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, 2004 are as follows: - -------------------------------------------------------------------------------- 2005 $ 60 2006 72 2007 43 2008 20 2009 14 Thereafter 363 - -------------------------------------------------------------------------------- Total maturities 572 Fair value adjustment 13 - -------------------------------------------------------------------------------- Total $ 585 ================================================================================ 17. Taxes on Income Income tax expense on income from continuing operations is as follows: - -------------------------------------------------------------------------------- 2004 2003 2002 - -------------------------------------------------------------------------------- Current: Federal $ 196 $ 215 $ 92 State 39 21 (1) - -------------------------------------------------------------------------------- Total current 235 236 91 - -------------------------------------------------------------------------------- Deferred: Federal 15 8 4 State (19) (3) 15 - -------------------------------------------------------------------------------- Total deferred (4) 5 19 - -------------------------------------------------------------------------------- Taxes on income 231 241 110 Current tax expense on extraordinary gain - - (10) - -------------------------------------------------------------------------------- Taxes on income before extraordinary gain $ 231 $ 241 $ 100 ================================================================================ - 47 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, and as Noted) The above amounts do not include tax benefits or expense from the exercise of stock options and the vesting of restricted stock awards, which for accounting purposes are recorded in additional paid-in capital. Such tax amounts totaled a net tax benefit of $16 million in 2004, compared to net tax expense of $3 million in 2003 and a net tax benefit of $4 million in 2002. The income tax benefit related to loss from discontinued operations was $71 million, $2 million, and $28 million in 2004, 2003, and 2002, respectively. The temporary differences that created deferred tax assets and liabilities, included in other assets, are detailed below: - -------------------------------------------------------------------------------- December 31, 2004 2003 - -------------------------------------------------------------------------------- Deferred tax assets: Reserves and allowances $ 164 $ 125 Deferred compensation and employee benefits 99 103 Property and equipment leasing 28 26 State loss carryforwards (1) 25 16 Net loss on cash flow hedging instruments 3 12 Other 7 14 - -------------------------------------------------------------------------------- Total deferred assets 326 296 - -------------------------------------------------------------------------------- Deferred tax liabilities: Capitalized internal-use software development costs (65) (55) Depreciation and amortization (38) (14) Net unrealized gains (losses) on securities available for sale 5 (3) - -------------------------------------------------------------------------------- Total deferred liabilities (98) (72) - -------------------------------------------------------------------------------- Net deferred tax asset $ 228 $ 224 ================================================================================ (1) Consists primarily of net operating losses in New York State that will expire in 2022 through 2024. Realization is dependent on generating sufficient taxable income in New York State prior to the expiration of such losses. The Company determined that no valuation allowance against deferred tax assets at December 31, 2004 and 2003 was necessary. The effective income tax rate on income from continuing operations differs from the amount computed by applying the federal statutory income tax rate as follows: - -------------------------------------------------------------------------------- 2004 2003 2002 - -------------------------------------------------------------------------------- Federal statutory income tax rate 35.0% 35.0% 35.0% State income taxes, net of federal tax benefit 2.4 1.6 1.1 (Gain) write-down on investment in Aitken Campbell - (1.9) 5.2 Merger-related costs - (1.5) - Other charges (1.6) .4 (1.1) - -------------------------------------------------------------------------------- Effective income tax rate 35.8% 33.6% 40.2% ================================================================================ The effective income tax rate including loss from discontinued operations and extraordinary gain was 35.9% in 2004, 33.6% in 2003, and 42.9% in 2002. 18. 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 seven or ten years from the date of grant. Options generally vest over a three- to four-year period from the date of grant. A summary of option activity follows:
- ------------------------------------------------------------------------------------------------------------------------------------ 2004 2003 2002 -------------------------- ---------------------------- --------------------------- 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 136 $ 15.25 156 $ 15.38 153 $ 16.20 Granted 22 $ 9.39 2 $ 9.39 26 $ 11.32 Exercised (11) $ 4.88 (6) $ 6.21 (6) $ 6.59 Canceled (1) (14) $ 17.77 (16) $ 18.84 (17) $ 19.39 - ------------------------------------------------------------------------------------------------------------------------------------ Outstanding at end of year 133 $ 14.88 136 $ 15.25 156 $ 15.38 ==================================================================================================================================== Exercisable at end of year 101 $ 15.97 90 $ 15.03 77 $ 12.93 - ------------------------------------------------------------------------------------------------------------------------------------ Available for future grant at end of year 37 44 41 - ------------------------------------------------------------------------------------------------------------------------------------ Weighted-average fair value of options granted during the year (2) $ 2.75 $ 4.20 $ 5.35 - ------------------------------------------------------------------------------------------------------------------------------------ (1) In 2002, 5 million options were voluntarily rescinded by the then Chief Executive Officer and the Chairman of the Board. The weighted-average exercise price of these options is $17.04 and the weighted-average fair value is $8.03. (2) The fair value of options granted is estimated as of the grant date using the Black-Scholes option pricing model for grants made prior to January 1, 2004, and a binomial option pricing model for grants made on or after January 1, 2004. See discussion in note "2 - Significant Accounting Policies - Stock-based Compensation."
- 48 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, and as Noted) Options outstanding and exercisable are as follows: - ------------------------------------------------------------------------------------------------------------------------------------ December 31, 2004 - ------------------------------------------------------------------------------------------------------------------------------------ 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 - ------------------------------------------------------------------------------------------------------------------------------------ $ .11 to $ 7.00 8 1.5 $ 4.76 8 $ 4.76 $ 7.01 to $ 10.00 40 5.5 $ 8.88 23 $ 8.62 $ 10.01 to $ 15.00 29 6.5 $ 11.99 19 $ 12.03 $ 15.01 to $ 19.00 22 5.8 $ 15.44 19 $ 15.45 $ 19.01 to $ 26.00 15 4.5 $ 22.02 13 $ 22.15 $ 26.01 to $ 38.29 19 4.7 $ 29.63 19 $ 29.64 - ------------------------------------------------------------------------------------------------------------------------------------ $ .11 to $ 38.29 133 5.3 $ 14.88 101 $ 15.97 ====================================================================================================================================
Restricted Stock and Long-term Incentive Plans The Company's stock incentive plans provide for granting restricted stock awards to employees and officers. Restricted stock awards are restricted from transfer or sale and generally vest over a four-year period, but some vest based upon the Company achieving certain financial or other measures. The Company also awards eligible officers long-term incentive plan (LTIP) units and restricted stock under a long-term incentive program. These awards are restricted from transfer or sale and generally vest over a three- to four-year period. The cash payout of the LTIP units at the end of the vesting period is based upon the Company achieving certain cumulative EPS levels. The LTIP liability was $24 million and $9 million at December 31, 2004 and 2003, respectively. Restricted stock and LTIP unit information is as follows: - -------------------------------------------------------------------------------- 2004 2003 2002 - -------------------------------------------------------------------------------- Restricted stock awards (shares) 4 11 2 Average market price of awarded shares $ 11.93 $ 8.75 $ 10.44 Restricted shares outstanding (at year end) 9 13 4 Restricted stock amortization $ 27 $ 28 $ 23 LTIP unit compensation expense $ 15 $ 9 - - -------------------------------------------------------------------------------- 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 $221 million and $207 million at December 31, 2004 and 2003, 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. 19. 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 in 2000. 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(R) 401(k) Retirement Savings and Investment Plan (SchwabPlan). The Company may match certain employee contributions or make additional contributions to this plan at its discretion. Total company contribution expense was $48 million in 2004, $3 million in 2003, and $47 million in 2002. In 2004, the Company reinstated its 401(k) employee contribution match, which was suspended in 2003 (except for a discretionary award to certain non-officer employees made in the fourth quarter of 2003). U.S. Trust previously sponsored a 401(k) Plan and ESOP covering all eligible U.S. Trust employees. U.S. Trust terminated this plan, effective December 2003, and merged the plan assets into the SchwabPlan. Total contribution expense under this plan was $9 million in 2002. There was no contribution expense in 2003 as U.S. Trust suspended contributions beginning in the first quarter of 2003. Pension and Other Postretirement Benefits U.S. Trust maintains a trustee managed, noncontributory, qualified defined benefit pension plan for the benefit of eligible U.S. Trust employees, the U.S. Trust Corporation Employees' Retirement Plan (the Pension Plan). U.S. Trust provides certain health care and life insurance benefits for active employees and 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. - 49 -
THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, and as Noted) 2004 2003 2002 ----------------------------- ----------------------------- ----------------------------- Pension Health Pension Health Pension Health Plan & Life Total Plan & Life Total Plan & Life Total - ------------------------------------------------------------------------------------------------------------------------------------ Change in benefit obligation: Benefit obligation at beginning of year $ 283 $ 21 $ 304 $ 281 $ 21 $ 302 $ 248 $ 20 $ 268 Service cost, including expenses 11 - 11 13 - 13 13 - 13 Interest cost 17 1 18 19 1 20 18 2 20 Amendments (1) - - - (49) - (49) (1) - (1) Actuarial loss 15 2 17 31 - 31 13 1 14 Benefits and expenses paid (14) (2) (16) (12) (1) (13) (10) (2) (12) - ------------------------------------------------------------------------------------------------------------------------------------ Pension benefit obligation at end of year $ 312 $ 22 $ 334 $ 283 $ 21 $ 304 $ 281 $ 21 $ 302 ==================================================================================================================================== Change in plan assets: Fair value of plan assets at beginning of year $ 284 - $ 284 $ 252 - $ 252 $ 281 - $ 281 Actual gain (loss) on plan assets 35 - 35 44 - 44 (19) - (19) Employer contribution 40 2 42 - $ 1 1 - $ 1 1 Benefits and expenses paid (13) (2) (15) (12) (1) (13) (10) (1) (11) - ------------------------------------------------------------------------------------------------------------------------------------ Fair value of plan assets at end of year $ 346 - $ 346 $ 284 - $ 284 $ 252 - $ 252 ==================================================================================================================================== Funded Status $ 34 $ (22) $ 12 $ 1 $ (21) $ (20) $ (29) $ (21) $ (50) Unrecognized net actuarial loss (gain) 81 1 82 85 (1) 84 74 - 74 Unrecognized prior service cost (benefit) (41) - (41) (45) - (45) 4 (1) 3 - ------------------------------------------------------------------------------------------------------------------------------------ Net amount recognized $ 74 $ (21) $ 53 $ 41 $ (22) $ 19 $ 49 $ (22) $ 27 ==================================================================================================================================== Amount recognized in the balance sheet consists of: Prepaid benefit cost $ 74 - $ 74 $ 41 - $ 41 $ 49 - $ 49 Accrued benefit costs - $ (21) (21) - $ (22) (22) - $ (22) (22) - ------------------------------------------------------------------------------------------------------------------------------------ Net amount recognized $ 74 $ (21) $ 53 $ 41 $ (22) $ 19 $ 49 $ (22) $ 27 ==================================================================================================================================== Components of net periodic benefit cost: Service cost and expenses $ 11 - $ 11 $ 13 - $ 13 $ 13 - $ 13 Interest cost 17 $ 1 18 19 $ 1 20 18 $ 1 19 Expected return on plan assets (22) - (22) (24) - (24) (30) - (30) Amortization of prior service cost (4) - (4) - - - - - - Amortization of net loss (gain) 5 - 5 - - - (1) - (1) - ------------------------------------------------------------------------------------------------------------------------------------ Net periodic benefit expense (2) $ 7 $ 1 $ 8 $ 8 $ 1 $ 9 $ - $ 1 $ 1 ==================================================================================================================================== Additional information Increase in additional minimum liability included in other comprehensive income - n/a - n/a - n/a - ------------------------------------------------------------------------------------------------------------------------------------ Weighted-average assumptions used to determine benefit obligations Discount rate 5.88% 5.88% 6.00% 6.00% 6.75% 6.75% Rate of increase in compensation (3) 5.10% 5.10% 5.25% 5.25% 5.30% 5.30% Measurement date Sept. 30, Sept. 30, Sept. 30, Sept. 30, Sept. 30, Sept. 30, 2004 2004 2003 2003 2002 2002 Weighted-average assumptions used to determine net periodic benefit cost Discount rate 6.00% 6.00% 6.75% 6.75% 7.50% 7.50% Rate of increase in compensation (3) 5.25% 5.25% 5.30% 5.30% 6.18% 6.18% Expected rate of return on plan assets 8.25% n/a 8.25% n/a 9.00% n/a - ------------------------------------------------------------------------------------------------------------------------------------ (1) In 2003, U.S. Trust amended the Pension Plan with respect to the computation of retirement benefits earned by qualifying employees hired on or before December 31, 2001. (2) The pension expense 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 end of the year. The measurement date of the Pension Plan is September 30. (3) The assumed rate of increase in compensation is based on the age-related table with assumed rates of increase in compensation ranging from 8.0% to 3.0%. n/a Not applicable. - 50 -
THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, and as Noted) The accumulated benefit obligation for the Pension Plan was $311 million and $283 million at September 30, 2004 and 2003, respectively. To develop the expected long-term rate of return on assets assumption, U.S. Trust considered the current level of expected returns on risk free investments (primarily government bonds), the historical level of risk premium associated with other classes in which the portfolio is invested and the expectations for future returns of each asset class. The expected return for each asset class was then weighted based on the target asset allocation to develop the expected long-term rate of return on assets assumption for the portfolio. This resulted in the selection of the 8.25% expected long-term rate of return on assets assumption for 2004 and 2003. The assumed rate of future increases in per capita cost of health care benefits (the health care cost trend rate) is 13.0% at December 31, 2004, decreasing gradually to 5.0% by the year 2013. A one-percentage-point change in the assumed health care cost trend rates would have an immaterial effect on the postretirement benefit obligation, as well as on service and interest costs. The Pension Plan's weighted average asset allocations at September 30, 2004 and 2003, by asset category are as follows: - -------------------------------------------------------------------------------- September 30, 2004 2003 - -------------------------------------------------------------------------------- Equity securities 62% 60% Debt securities 37% 34% Other 1% 6% - -------------------------------------------------------------------------------- Total 100% 100% ================================================================================ The goals of the asset strategy are to ensure that the principal of the Pension Plan is preserved and enhanced over the long term, both in real and nominal terms, manage risk exposure, and exceed the funding requirement over a market cycle (3 to 5 years). Risk is managed by investing in a broad range of asset classes, and within those classes, a broad range of individual securities. The Pension Plan's Investment Committee, which oversees the investment of Pension Plan assets, utilizes the following target asset allocation and ranges: - -------------------------------------------------------------------------------- Low Target High - -------------------------------------------------------------------------------- Domestic equity securities 28% 30% 32% Foreign equity securities 18% 20% 22% Domestic fixed income 30% 35% 40% Other equity investments (1) 14% 15% 16% - -------------------------------------------------------------------------------- (1) Includes real estate equity trusts, private equity funds, and hedge funds with a 5% target allocation for each. Equity securities include shares of common stock of CSC in the amount of $3 million (1% of total plan assets) at both September 30, 2004 and 2003. In addition, due to external investment management of the funds, the Pension Plan may indirectly hold additional shares of CSC stock. The aggregate amount of these shares would not be considered material relative to the total fund assets. U.S. Trust's funding policy is to make contributions consistent with Federal laws and regulations. In September 2004, U.S. Trust contributed $40 million to the Pension Plan. No contributions are expected to be made to the Pension Plan during 2005, while $2 million is expected to be paid with respect to postretirement benefits plans in 2005. The following benefit payments, which reflect future service, as appropriate, are expected to be paid: - -------------------------------------------------------------------------------- Pension Health & Plan Life Total - -------------------------------------------------------------------------------- 2005 $ 14 $ 2 $ 16 2006 16 2 18 2007 17 2 19 2008 18 2 20 2009 19 2 21 2010-2014 114 7 121 - -------------------------------------------------------------------------------- Total $ 198 $ 17 $ 215 ================================================================================ - 51 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, and as Noted) 20. 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: - -------------------------------------------------------------------------------- 2004 2003 2002 - -------------------------------------------------------------------------------- Net loss on cash flow hedging instruments, net of tax: Beginning balance $ (18) $ (37) $ (31) Change during the year 15 19 (6) - -------------------------------------------------------------------------------- Ending balance $ (3) $ (18) $ (37) ================================================================================ Net unrealized gain (loss) on securities available for sale, net of tax: Beginning balance $ 5 $ 24 $ 7 Net unrealized (loss) gain arising during the year (9) (19) 15 Reclassification adjustment for realized loss included in net income 1 - 2 - -------------------------------------------------------------------------------- Ending balance $ (3) $ 5 $ 24 ================================================================================ Foreign currency translation adjustment: Beginning balance $ - $ (5) $ (13) Change during the year 1 5 8 - -------------------------------------------------------------------------------- Ending balance $ 1 $ - $ (5) ================================================================================ Total accumulated other comprehensive income (loss), net of tax: Beginning balance $ (13) $ (18) $ (37) Change during the year 8 5 19 - -------------------------------------------------------------------------------- Ending balance $ (5) $ (13) $ (18) ================================================================================ 21. Earnings Per Share Basic EPS excludes dilution and is computed by dividing net income by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential reduction in EPS that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. EPS under the basic and diluted computations are as follows: - -------------------------------------------------------------------------------- 2004 2003 2002 - -------------------------------------------------------------------------------- Net income $ 286 $ 472 $ 109 - -------------------------------------------------------------------------------- Weighted-average common shares outstanding - basic 1,343 1,342 1,358 Common stock equivalent shares related to stock incentive plans 22 22 17 - -------------------------------------------------------------------------------- Weighted-average common shares outstanding - diluted 1,365 1,364 1,375 ================================================================================ Basic EPS: Income from continuing operations before extraordinary gain $ .31 $ .35 $ .11 Loss from discontinued operations, net of tax $ (.10) $ - $ (.04) Extraordinary gain, net of tax $ - $ - $ .01 Net income $ .21 $ .35 $ .08 - -------------------------------------------------------------------------------- Diluted EPS: Income from continuing operations before extraordinary gain $ .30 $ .35 $ .11 Loss from discontinued operations, net of tax $ (.09) $ - $ (.04) Extraordinary gain, net of tax $ - $ - $ .01 Net income $ .21 $ .35 $ .08 - -------------------------------------------------------------------------------- The computation of diluted EPS for the years ended December 31, 2004, 2003, and 2002, respectively, excludes outstanding stock options to purchase 91 million, 107 million, and 111 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. 22. 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 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 - 52 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, and as Noted) 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 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 subsidiaries are United States Trust Company of New York (U.S. Trust NY), U.S. Trust Company, National Association (U.S. Trust NA), and Schwab Bank. 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. Among other things, these requirements govern transactions with CSC and its non-depository institution subsidiaries, including loans and other extensions of credit, investments or asset purchases, dividends and investments. 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, USTC, 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 and USTC are subject to those guidelines. The 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. To maintain its status as a financial holding company, each of CSC's depository institution subsidiaries must be kept "well capitalized" and "well managed." In addition, each of CSC's insured depository institution subsidiaries must be rated "satisfactory" or better in meeting the Community Reinvestment Act of 1977 in order for CSC to engage in new financial activities or enter into certain acquisitions of companies engaged in financial activities. At December 31, 2004, CSC and its depository institution subsidiaries met all the above requirements. The regulatory capital and ratios of the Company, U.S. Trust, U.S. Trust NY, U.S. Trust NA, and Schwab Bank are as follows: - -------------------------------------------------------------------------------- 2004 2003 ----------------- ----------------- December 31, Amount Ratio(1) Amount Ratio(1) - -------------------------------------------------------------------------------- Tier 1 Capital: Company $ 3,485 17.5% $ 3,569 20.3% U.S. Trust $ 695 13.8% $ 653 15.4% U.S. Trust NY $ 390 10.1% $ 357 10.4% U.S. Trust NA $ 269 24.5% $ 252 33.7% Schwab Bank $ 370 22.7% $ 277 35.1% Total Capital: Company $ 3,513 17.7% $ 3,598 20.4% U.S. Trust $ 720 14.3% $ 679 16.0% U.S. Trust NY $ 412 10.7% $ 380 11.1% U.S. Trust NA $ 273 24.8% $ 255 34.1% Schwab Bank $ 371 22.8% $ 278 35.2% Leverage: Company $ 3,485 7.8% $ 3,569 8.2% U.S. Trust $ 695 7.6% $ 653 8.5% U.S. Trust NY $ 390 5.8% $ 357 5.5% U.S. Trust NA $ 269 9.6% $ 252 18.5% Schwab Bank $ 370 8.8% $ 277 13.4% - -------------------------------------------------------------------------------- (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. Additionally, Schwab Bank is subject to a minimum tier 1 leverage ratio of 8% for its first three years of operations. Well-capitalized tier 1 capital, total capital, and tier 1 leverage ratios are 6%, 10%, and 5%, respectively. Based on their respective regulatory capital ratios at December 31, 2004 and 2003, the Company, U.S. Trust, U.S. Trust NY, U.S. Trust NA, and Schwab Bank are considered well capitalized (the highest category) pursuant to banking regulatory guidelines. There are no conditions or events that management believes have changed the Company's, U.S. Trust's, U.S. Trust NY's, U.S. Trust NA's, or Schwab Bank's well-capitalized status. 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 $94 million in 2004 and $57 million in 2003. Schwab is subject to the Uniform Net Capital Rule under the Securities Exchange Act of 1934 (the Rule). Schwab computes net capital under the alternative method permitted by this Rule. This method requires the maintenance of - 53 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, and as Noted) 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. At December 31, 2004, 2% of aggregate debits was $205 million, which exceeded the minimum dollar requirement for Schwab of $1 million. At December 31, 2004, Schwab's net capital was $1.2 billion (12% of aggregate debit balances), which was $1.0 billion in excess of its minimum required net capital and $723 million in excess of 5% of aggregate debit balances. 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. Schwab had portions of its cash and investments segregated for the exclusive benefit of clients at December 31, 2004, in accordance with applicable regulations. 23. Commitments and Contingent Liabilities Operating leases and other commitments: The Company has noncancelable operating leases for office space and equipment. Future minimum rental commitments under these leases, net of committed subleases, at December 31, 2004 are as follows: - -------------------------------------------------------------------------------- Operating Leases (1) Subleases (1) Net - -------------------------------------------------------------------------------- 2005 $ 232 $ (44) $ 188 2006 205 (41) 164 2007 200 (41) 159 2008 173 (38) 135 2009 170 (35) 135 Thereafter 804 (183) 621 - -------------------------------------------------------------------------------- Total $1,784 $ (382) $1,402 ================================================================================ (1) Amounts include facilities under the Company's restructuring initiatives. For further discussion, see note "3 - Restructuring Charges." 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 $262 million in 2004, $300 million in 2003, and $306 million in 2002. Purchase Obligations: At December 31, 2004, the Company has purchase obligations as follows, including $126 million which can be canceled by the Company without penalty. - -------------------------------------------------------------------------------- 2005 $ 206 2006 85 2007 40 2008 28 2009 4 Thereafter 5 - -------------------------------------------------------------------------------- Total $ 368 ================================================================================ Guarantees: The Company recognizes, at the inception of a guarantee, a liability for the estimated fair value of the obligation undertaken in issuing the guarantee. The fair values of the obligations relating to standby LOCs are estimated based on fees charged to enter into similar agreements, considering the creditworthiness of the counterparties. The fair values of the obligations relating to other guarantees are estimated based on transactions for similar guarantees or expected present value measures. 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. At December 31, 2004, the Company's maximum potential liability under these indemnification agreements is limited to approximately $115 million. Additionally, the Company has guaranteed certain payments in the event of a termination of certain mutual fund sub-advisor agreements, related to the adoption of AXA Rosenberg LLC's U.S. family of mutual funds, known as the Laudus Funds. The maximum aggregate guarantee is $75 million through 2011, and $50 million thereafter. The Company does not believe that any material loss related to such indemnifications is likely and therefore the liabilities recorded for these guarantees are immaterial. In connection with the sale of SSCM, the Company provided indemnifications to UBS regarding certain litigation and income tax matters. The Company recorded a liability of $19 million reflecting the estimated fair value of these indemnifications. 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 - 54 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, and as Noted) 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, 2004, U.S. Trust had LOCs outstanding totaling $66 million which are short-term in nature and generally expire within one year. At December 31, 2004, the liability recorded for these LOCs is immaterial. 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, 2004, the outstanding value of these LOCs totaled $630 million. In connection with its securities lending activities, Schwab is required to provide collateral to certain brokerage clients. Schwab satisfies the collateral requirements by arranging LOCs, in favor of these brokerage clients, that are guaranteed by multiple banks. At December 31, 2004, the outstanding value of these LOCs totaled $52 million. No funds were drawn under these LOCs at December 31, 2004. 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: The Company and its affiliates have been named in various legal proceedings arising from the conduct of its business. Some of these legal actions include claims for substantial damages or unspecified damages. The Company believes it has strong defenses and is vigorously contesting such actions. The Company is also involved, from time to time, in investigations and proceedings by regulatory and other governmental agencies, which may result in adverse judgments, fines or penalties. It is inherently difficult to predict the ultimate outcome of these legal and regulatory matters, particularly in cases in which claimants seek substantial or unspecified damages, and a substantial judgment, settlement or penalty could be material to the Company's operating results for a particular future period, depending on the Company's results for that period. However, based on current information, it is the opinion of management, after consultation with counsel, that the resolution of these matters will not have a material adverse impact on the financial condition, results of operations, or cash flows of the Company. As part of the sale of SSCM to UBS, the Company agreed to indemnify UBS for expenses associated with certain litigation, including multiple purported securities class actions against SoundView and certain of its subsidiaries filed in the United District Court for the Southern District of New York, brought on behalf of persons who either directly or in the aftermarket purchased IPO securities between March 1997 and December 2000. The Company is vigorously contesting the claims on behalf of SoundView. 24. Financial Instruments Subject to Off-Balance Sheet Risk, Credit Risk or Market Risk Securities lending: Through Schwab, 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 market value of Schwab's client securities pledged in securities lending transactions to other broker-dealers was $1.2 billion and $2.3 billion at December 31, 2004 and 2003, respectively. Additionally, Schwab borrows securities from other broker-dealers to fulfill short sales of its clients. The market value of these borrowed securities was $254 million and $229 million at December 31, 2004 and 2003, respectively. Client trade settlement: 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 - 55 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, and as Noted) 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. Schwab may be liable for the margin requirement of its 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. Clients with margin loans have agreed to allow Schwab to pledge collateralized securities in their brokerage accounts in accordance with federal regulations. Schwab was allowed, under such regulations, to pledge securities with a market value of $13.8 billion and $12.0 billion at December 31, 2004 and 2003, respectively. The market value of Schwab's client securities pledged to fulfill the short sales of its clients was $1.2 billion and $1.1 billion at December 31, 2004 and 2003, respectively. The market value of Schwab's client securities pledged to fulfill Schwab's proprietary short sales was $15 million and $13 million at December 31, 2004 and 2003, 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 $8 million and $2 million at December 31, 2004 and 2003, respectively. The Company may also pledge client securities to fulfill client margin requirements for open option contracts established with the OCC. The market value of these pledged securities to the OCC was $365 million and $424 million at December 31, 2004 and 2003, respectively. Financial instruments held for trading purposes: The Company maintains inventories in securities on a long and short 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. Resale and repurchase agreements: Schwab enters 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, 2004 and 2003, the market value of collateral received in connection with resale agreements that is available to be repledged or sold was $13.4 billion and $17.2 billion, respectively. U.S. Trust may enter into repurchase agreements where it sells its fixed income securities with an agreement to repurchase the securities at a future specified date. At December 31, 2004, U.S. Trust did not have any of these agreements with third parties. At both December 31, 2004 and 2003, financial instruments in the amount of $1.3 billion were pledged to secure public deposits, to qualify for fiduciary powers and for other purposes or as collateral for borrowings. Included in the above amount at December 31, 2003, the fair value of collateral pledged under repurchase agreements that is available to be repledged or sold by the counterparties was $129 million. At December 31, 2004, there was no collateral pledged under repurchase agreements that is available to be repledged or sold by the counterparties. 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 $3.2 billion and $1.6 billion at December 31, 2004 and 2003, respectively. 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, 2004 and 2003 totaled $13.4 billion and $17.2 billion, respectively. Commitments to extend credit and LOCs: In the normal course of business, U.S. Trust and Schwab Bank enter into various transactions involving off-balance sheet financial instruments to meet the needs of their clients and to reduce their 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. - 56 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, and as Noted) 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 and Schwab Bank's firm commitments are related to mortgage lending to banking clients. Firm commitments totaled $2.2 billion and $1.6 billion at December 31, 2004 and 2003, respectively. LOCs outstanding at December 31, 2004 and 2003 amounted to $66 million and $64 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 LIBOR-based 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. Information on these Swaps is summarized in the following table: - -------------------------------------------------------------------------------- December 31, 2004 2003 - -------------------------------------------------------------------------------- Notional principal amount $ 625 $ 705 Weighted-average variable interest rate 2.39% 1.17% Weighted-average fixed interest rate 4.25% 6.41% Weighted-average maturity (in years) 3.3 1.0 - -------------------------------------------------------------------------------- These Swaps have been designated as cash flow hedges under SFAS No. 133 and are recorded on the Company's consolidated balance sheet, with changes in their fair values primarily recorded in other comprehensive income (loss), a component of stockholders' equity. At December 31, 2004, U.S. Trust recorded a derivative asset of $3 million and a derivative liability of $9 million related to these Swaps. At December 31, 2003, U.S. Trust recorded a derivative liability of $33 million 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 $4 million, or $3 million after tax, from other comprehensive loss to interest expense over the next twelve months. CSC uses Swaps to effectively convert the interest rate characteristics of a portion 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. The variable interest rates reset every three months. Information on these Swaps is summarized in the following table: - -------------------------------------------------------------------------------- December 31, 2004 2003 - -------------------------------------------------------------------------------- Notional principal amount $ 293 $ 293 Weighted-average variable interest rate 4.85% 3.62% Weighted-average fixed interest rate 7.57% 7.57% Weighted-average maturity (in years) 4.3 5.3 - -------------------------------------------------------------------------------- These Swaps have been designated as fair value hedges under SFAS No. 133, and are recorded on the Company's 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, 2004 and 2003, CSC recorded a derivative asset of $13 million and $19 million, respectively, for these Swaps. Concurrently, the carrying value of the Medium-Term Notes was increased by $13 million and $19 million at December 31, 2004 and 2003, respectively. - 57 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, and as Noted) 25. 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 Company's consolidated balance sheet) and estimated fair values of the Company's financial instruments are as follows: - -------------------------------------------------------------------------------- 2004 2003 ---------------- ----------------- Carrying Fair Carrying Fair December 31, Amount Value Amount Value - -------------------------------------------------------------------------------- Financial Assets: Cash and cash equivalents $ 2,778 $ 2,778 $ 2,785 $ 2,785 Cash and investments segregated 19,019 19,019 21,341 21,341 Securities owned 5,335 5,335 3,934 3,934 Receivables from brokers, dealers and clearing organizations 482 482 476 476 Receivables from brokerage clients - net 9,841 9,841 8,581 8,581 Loans to banking clients - net 6,822 6,651 5,736 5,640 Loans held for sale 20 20 29 29 Swaps 16 16 19 19 - -------------------------------------------------------------------------------- Total $44,313 $44,142 $42,901 $42,805 ================================================================================ Financial Liabilities: Deposits from banking clients $11,118 $11,118 $ 8,308 $ 8,308 Drafts payable 363 363 152 152 Payables to brokers, dealers and clearing organizations 1,468 1,468 2,633 2,633 Payables to brokerage clients 27,154 27,154 27,184 27,184 Accrued expenses and other liabilities, excluding interest rate swap agreements 1,387 1,387 1,183 1,183 Swaps 9 9 33 33 Short-term borrowings 663 663 996 996 Long-term debt 585 618 772 820 - -------------------------------------------------------------------------------- Total $42,747 $42,780 $41,261 $41,309 ================================================================================ 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. Loans held for sale: The fair value of the Company's loans held for sale are estimated using the quoted market prices for securities backed by similar types of 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 "24 - 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, 2004, 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, 2004 and 2003. 26. 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 three reportable segments - Individual Investor, Institutional Investor, and U.S. Trust. In the third quarter of 2004, the Company exited from the capital markets business, and as a result, the previously-reported Capital Markets segment has been eliminated. The Individual Investor segment includes the Company's retail brokerage and banking 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 U.S. Trust segment provides investment, wealth management, custody, fiduciary, and private banking services to individual and - 58 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, and as Noted) institutional 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. In the first quarter of 2004, the Company changed its methodology for the computation of its segment information. The new methodology utilizes an activity-based costing model to allocate traditional income statement line item expenses (e.g., compensation and benefits, depreciation, and professional services) to the business activities driving segment expenses (e.g., client service, opening new accounts, or business development). Previously-reported segment information has been revised to reflect this new methodology. Previously, technology, corporate, and general administrative expenses were allocated to the segments generally in proportion to either their respective revenues or average full-time equivalent employees, except for the U.S. Trust segment, for which expenses were directly incurred. 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 (a non-GAAP income measure), which excludes items such as non-operating revenues, restructuring charges, impairment charges, acquisition- and merger-related charges, discontinued operations, and extraordinary items. 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. Total revenues, net interest revenue (i.e., interest revenue, net of interest expense), income from continuing operations 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. - -------------------------------------------------------------------------------- 2004 2003 2002 - -------------------------------------------------------------------------------- Revenues Individual Investor $ 2,444 $ 2,365 $ 2,375 Institutional Investor 897 821 855 U.S. Trust 773 629 651 Unallocated 74 64 63 - -------------------------------------------------------------------------------- Operating revenues 4,188 3,879 3,944 Non-operating revenue (1) 14 17 - - -------------------------------------------------------------------------------- Total $ 4,202 $ 3,896 $ 3,944 ================================================================================ Net interest revenue Individual Investor $ 586 $ 437 $ 508 Institutional Investor 95 84 106 U.S. Trust 212 186 196 Unallocated 43 21 15 - -------------------------------------------------------------------------------- Total $ 936 $ 728 $ 825 ================================================================================ Adjusted operating income before taxes Individual Investor $ 492 $ 434 $ 354 Institutional Investor 282 303 254 U.S. Trust (2) 49 40 51 Unallocated 22 4 (3) - -------------------------------------------------------------------------------- Adjusted operating income before taxes 845 781 656 Excluded items (3) (200) (64) (407) - -------------------------------------------------------------------------------- Income from continuing operations before taxes on income and extraordinary gain 645 717 249 Taxes on income (231) (241) (100) Loss from discontinued operations, net of tax (128) (4) (52) Extraordinary gain on sale of corporate trust business, net of tax - - 12 - -------------------------------------------------------------------------------- Net Income $ 286 $ 472 $ 109 ================================================================================ Capital expenditures Individual Investor $ 145 $ 97 $ 101 Institutional Investor 31 28 31 U.S. Trust 20 19 21 Unallocated 2 4 4 - -------------------------------------------------------------------------------- Total $ 198 $ 148 $ 157 ================================================================================ Depreciation and amortization Individual Investor $ 113 $ 140 $ 174 Institutional Investor 25 33 40 U.S. Trust 37 31 30 Unallocated 51 73 65 - -------------------------------------------------------------------------------- Total $ 226 $ 277 $ 309 ================================================================================ (1) Primarily consists of gains on investments. (2) In accordance with the Company's new cost allocation methodology, amounts include costs ($63 million, $55 million, and $38 million in 2004, 2003, and 2002, respectively) allocated to U.S. Trust. - 59 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, and as Noted) (3) In 2004, includes restructuring charges of $214 million (see note "3 - Restructuring Charges") and a pre-tax gain on an investment of $14 million. In 2003, includes restructuring charges of $76 million (see note "3 - Restructuring Charges"), an impairment charge of $5 million (see note "6 - Business Acquisitions and Divestitures"), and a pre-tax gain recorded on the sale of an investment of $17 million. In 2002, includes restructuring charges of $343 million (see note "3 - Restructuring Charges"), impairment charges of $37 million (see note "6 - Business Acquisitions and Divestitures"), and acquisition- and merger-related charges of $27 million. Fees received from Schwab's proprietary mutual funds represented approximately 21% of the Company's consolidated revenues in 2004, 23% in 2003, and 22% in 2002. 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 2004, 2003, or 2002. 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 26% at December 31, 2004 and 27% at each of December 31, 2003 and 2002. 27. Supplemental Cash Flow Information - -------------------------------------------------------------------------------- 2004 2003 2002 - -------------------------------------------------------------------------------- Income taxes paid $ 153 $ 255 $ 91 - -------------------------------------------------------------------------------- Interest paid: Brokerage client cash balances $ 112 $ 77 $ 166 Deposits from banking clients 106 91 86 Long-term debt 30 37 55 Short-term borrowings 15 15 21 Other 9 19 6 - -------------------------------------------------------------------------------- Total interest paid $ 272 $ 239 $ 334 ================================================================================ Non-cash investing and financing activities: Consolidation of a Trust: (1) Building and land $ - $ 229 - Note payable and other liabilities $ - $ 228 - Common stock and options issued for purchases of businesses $ 3 $ 4 $ 4 - -------------------------------------------------------------------------------- (1) Upon adoption of FIN No. 46 in the first quarter 2003, the Company consolidated a Trust. See note "2 - Significant Accounting Policies - Variable Interest Entities." 28. The Charles Schwab Corporation - Parent Company Only Financial Statements Condensed Statement of Income - -------------------------------------------------------------------------------- 2004 2003 2002 - -------------------------------------------------------------------------------- Interest revenue $ 26 $ 28 $ 41 Interest expense (18) (27) (41) - -------------------------------------------------------------------------------- Net interest revenue 8 1 - Other losses (8) (2) (2) Restructuring credit (charges) 2 (25) (29) Other gains (expenses) (16) (26) 5 - -------------------------------------------------------------------------------- Loss before income tax benefit and equity in earnings of subsidiaries (14) (52) (26) Income tax benefit 5 27 11 - -------------------------------------------------------------------------------- Loss from continuing operations before equity in earnings of subsidiaries (9) (25) (15) Equity in earnings of subsidiaries: Equity in undistributed earnings/ (distributions in excess of earnings) of subsidiaries 80 22 (273) Dividends paid by non-banking subsidiaries 333 479 437 Dividends paid by banking subsidiaries 10 - - Equity in extraordinary gain of subsidiary - - 12 Equity in discontinued operations of subsidiaries (128) (4) (52) - -------------------------------------------------------------------------------- Total 295 497 124 Net Income $ 286 $ 472 $ 109 - -------------------------------------------------------------------------------- - 60 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, and as Noted) Condensed Balance Sheet - -------------------------------------------------------------------------------- December 31, 2004 2003 - -------------------------------------------------------------------------------- Assets Cash and cash equivalents $ 693 $ 764 Securities owned - at market value 80 74 Intercompany receivables 11 18 Loans to non-banking subsidiaries 220 270 Loans to banking subsidiaries 30 45 Investments in non-banking subsidiaries, at equity 2,622 2,589 Investments in banking subsidiaries, at equity 1,538 1,397 Other assets 139 95 - -------------------------------------------------------------------------------- Total $5,333 $5,252 ================================================================================ Liabilities and Stockholders' Equity Accrued expenses and other liabilities $ 281 $ 195 Intercompany payables 267 87 Loans from non-banking subsidiaries - 24 Long-term debt 399 485 - -------------------------------------------------------------------------------- Total liabilities 947 791 - -------------------------------------------------------------------------------- Stockholders' equity 4,386 4,461 - -------------------------------------------------------------------------------- Total $5,333 $5,252 ================================================================================ Condensed Statement of Cash Flows - -------------------------------------------------------------------------------- 2004 2003 2002 - -------------------------------------------------------------------------------- Cash Flows from Operating Activities Net income $ 286 $ 472 $ 109 Adjustments to reconcile net income to net cash provided by operating activities: Distributions in excess of earnings/ (equity in undistributed earnings) of subsidiaries (80) (22) 273 Equity in extraordinary gain of subsidiary - - (12) Equity in discontinued operations of subsidiaries 128 4 52 Other (7) (7) 2 Net change in: Other assets 6 9 (29) Drafts payable - - (100) Accrued expenses and other liabilities 44 24 6 - -------------------------------------------------------------------------------- Net cash provided by operating activities 377 480 301 - -------------------------------------------------------------------------------- Cash Flows from Investing Activities Proceeds from sales of securities available for sale - - 11 Advances to subsidiaries (230) (100) (71) Repayments from subsidiaries 245 116 57 Change in net intercompany receivables 7 23 103 Decrease (increase) in investments in subsidiaries (20) (643) 10 Cash payments for business combinations and investments, net of cash received (1) (25) (1) Proceeds from sale of subsidiary 271 - - - -------------------------------------------------------------------------------- Net cash provided by (used for) investing activities 272 (629) 109 - -------------------------------------------------------------------------------- Cash Flows from Financing Activities Proceeds from loans from subsidiaries - - 24 Repayment of loans from subsidiaries (24) - - Repayment of long-term debt (80) (100) (113) Dividends paid (101) (68) (60) Purchase of treasury stock (383) (32) (299) Proceeds from stock options exercised and other 51 34 34 - -------------------------------------------------------------------------------- Net cash used for financing activities (537) (166) (414) - -------------------------------------------------------------------------------- Net cash used for discontinued operations (183) - (114) - -------------------------------------------------------------------------------- Decrease in Cash and Cash Equivalents (71) (315) (118) Cash and Cash Equivalents at Beginning of Year 764 1,079 1,197 - -------------------------------------------------------------------------------- Cash and Cash Equivalents at End of Year $ 693 $ 764 $1,079 ================================================================================ - 61 - THE CHARLES SCHWAB CORPORATION Notes to Consolidated Financial Statements (Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, and as Noted) 29. Quarterly Financial Information (Unaudited) - -------------------------------------------------------------------------------- Fourth Third Second First Quarter Quarter Quarter Quarter - -------------------------------------------------------------------------------- Year Ended December 31, 2004: Revenues (1) $1,060 $1,000 $1,034 $1,108 Expenses, Excluding Interest (1) $ 900 $ 928 $ 865 $ 864 Net Income (Loss) $ 53 $ (41) $ 113 $ 161 Weighted Average Common Shares - Diluted 1,348 1,364 1,373 1,375 Basic Earnings (Loss) Per Share (2) $ .04 $ (.03) $ .08 $ .12 Diluted Earnings (Loss) Per Share (2) $ .04 $ (.03) $ .08 $ .12 Dividends Declared Per Common Share $ .020 $ .020 $ .020 $ .014 Range of Common Stock Price Per Share: High $12.03 $10.03 $11.93 $13.76 Low $ 8.47 $ 8.30 $ 9.05 $10.74 Range of Price/Earnings Ratio (3): High 57 36 30 34 Low 40 30 23 26 - -------------------------------------------------------------------------------- Year Ended December 31, 2003: Revenues (1) $1,062 $ 997 $ 971 $ 866 Expenses, Excluding Interest (1) $ 829 $ 801 $ 788 $ 761 Net Income $ 148 $ 127 $ 126 $ 71 Weighted Average Common Shares - Diluted 1,371 1,366 1,360 1,357 Basic Earnings Per Share (2) $ .11 $ .09 $ .10 $ .05 Diluted Earnings Per Share (2) $ .11 $ .09 $ .09 $ .05 Dividends Declared Per Common Share $ .014 $ .014 $ .011 $ .011 Range of Common Stock Price Per Share: High $13.98 $12.73 $11.64 $12.46 Low $10.90 $10.01 $ 7.20 $ 6.25 Range of Price/Earnings Ratio (3): High 40 75 146 208 Low 31 59 90 104 - -------------------------------------------------------------------------------- (1) Amounts have been adjusted to summarize the impact of the Company's sales of SSCM and CSE in loss from discontinued operations. For further discussion, see note "5 - Discontinued Operations." (2) Both basic and diluted earnings per share include loss from discontinued operations. (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. - 62 - THE CHARLES SCHWAB CORPORATION Management's Report on Internal Control Over Financial Reporting Management of The Charles Schwab Corporation, together with its subsidiaries (the Company), is responsible for establishing and maintaining adequate internal control over financial reporting. The Company's internal control over financial reporting is a process designed under the supervision of the Company's chief executive officer and chief financial officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of published financial statements in accordance with accounting principles generally accepted in the United States of America. As of December 31, 2004, management conducted an evaluation of the effectiveness of the Company's internal control over financial reporting based on the framework established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management has determined that the Company's internal control over financial reporting was effective as of December 31, 2004. The Company's internal control over financial reporting includes policies and procedures that pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and dispositions of assets; provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures are being made only in accordance with authorizations of management and the directors of the Company; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on the Company's financial statements. Management's assessment of the effectiveness of internal control over financial reporting as of December 31, 2004 has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their report appearing on the following page, which expresses unqualified opinions on management's assessment and on the effectiveness of the Company's internal control over financial reporting as of December 31, 2004. /s/ Charles R. Schwab - -------------------------- Charles R. Schwab Chairman and Chief Executive Officer February 28, 2005 /s/ Christopher V. Dodds - -------------------------- Christopher V. Dodds Executive Vice President and Chief Financial Officer February 28, 2005 - 63 - THE CHARLES SCHWAB CORPORATION Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders 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, 2004 and 2003, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2004. Our audits also included the financial statement schedule of the Company on page F-2. We also have audited management's assessment, included in the accompanying Management's Report on Internal Control Over Financial Reporting, that the Company maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on these financial statements and financial statement schedule, an opinion on management's assessment, and an opinion on the effectiveness of the Company's internal control over financial reporting based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audit of financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2004 and 2003, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2004, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. Also, in our opinion, management's assessment that the Company maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. /s/ Deloitte & Touche LLP San Francisco, California February 28, 2005 - 64 - THE CHARLES SCHWAB CORPORATION Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. Item 9A. Controls and Procedures Disclosure Controls and Procedures The Company's management, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company's disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of December 31, 2004. Based on this evaluation, the Company's Chief Executive Officer and Chief Financial Officer have concluded that the Company's disclosure controls and procedures were effective as of December 31, 2004. Additionally in connection with this evaluation, no change in the Company's internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) was identified during the quarter ended December 31, 2004 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. Management's Report on Internal Control Over Financial Reporting and the Report of Independent Registered Public Accounting Firm are included in "Item 8 - - Financial Statements and Supplementary Data." Item 9B. Other Information 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 29, 2005 (the Proxy Statement) under "The Board of Directors - Members of the Board of Directors," "The Board of Directors - Board and Committee Meetings," "The Board of Directors - - Director Nominations," and "Section 16(a) Beneficial Ownership Reporting Compliance." The Company's Code of Conduct and Business Ethics, applicable to directors and all employees, including senior financial officers, is available on the Company's website at www.aboutschwab.com/corpgov. If the Company makes any amendments to or grants any waivers from its Code of Conduct and Business Ethics which are required to be disclosed pursuant to the Securities Exchange Act of 1934, the Company will make such disclosures on this website. Executive Officers of the Registrant The following table provides certain information about each of the Company's current executive officers. - 65 - THE CHARLES SCHWAB CORPORATION ================================================================================ Executive Officers of the Registrant Name Age Title ---- --- ----- Charles R. Schwab 67 Chairman, Chief Executive Officer, and Director William L. Atwell 54 Executive Vice President and President - Individual Investor Enterprise Walter W. Bettinger 44 Executive Vice President and Chief Operating Officer - Individual Investor Enterprise Jeremiah H. Chafkin 45 Executive Vice President and President - Advised Investor Christopher V. Dodds 45 Executive Vice President and Chief Financial Officer Carrie E. Dwyer 54 Executive Vice President, General Counsel and Corporate Secretary Charles G. Goldman 43 Executive Vice President - Strategy and Corporate Development Jan Hier-King 50 Executive Vice President - Human Resources Jeffrey M. Lyons 50 Executive Vice President and President - Active Trader Deborah D. McWhinney 49 Executive Vice President and President - Schwab Institutional Randall W. Merk 50 Executive Vice President and President - Asset Management Products and Services Rebecca Saeger 49 Executive Vice President - Brand Management and Marketing Communications Gideon Sasson 49 Executive Vice President and Chief Information Officer Alan J. Weber 56 Executive Vice President of The Charles Schwab Corporation, Chairman and Chief Executive Officer of U.S. Trust Corporation ================================================================================ Mr. Schwab has been Chairman and a director of CSC since its incorporation in 1986. Effective July 20, 2004, CSC's Board of Directors appointed Mr. Schwab as Chief Executive Officer of CSC, replacing David S. Pottruck. Mr. Schwab was Co-Chief Executive Officer of CSC from 1998 to 2003, and Chief Executive Officer of CSC from 1986 to 1997. Mr. Schwab was a founder of Schwab in 1971, its Chairman since 1978, and its Chief Executive Officer since July 20, 2004. Mr. Schwab is currently a director of USTC and its principal subsidiary, U.S. Trust NY. Mr. Schwab is also Chairman of Charles Schwab Bank, N.A., and is a trustee of The Charles Schwab Family of Funds, Schwab Investments, Schwab Capital Trust and Schwab Annuity Portfolios, all registered investment companies. - 66 - THE CHARLES SCHWAB CORPORATION Mr. Atwell has been Executive Vice President and President - Individual Investor Enterprise of CSC and Schwab since December 2004. He served as Executive Vice President and President - Client Sales and Service and Banking of CSC and Schwab from 2003 until December 2004, Executive Vice President - Institutional, International and Banking of CSC and Schwab from 2002 until 2003, and Executive Vice President - International and Banking of Schwab for part of 2002. Mr. Atwell was Executive Vice President - International of Schwab from 2000 to 2002. Prior to joining Schwab, Mr. Atwell was Senior Vice President - National Sales and Delivery Network for CIGNA Healthcare from 1996 to 2000. Mr. Atwell is currently a director of the Securities Industry Association. Mr. Bettinger has been Executive Vice President and Chief Operating Officer - - Individual Investor Enterprise of CSC and Schwab since June 2004. He served as Executive Vice President and President - Corporate Services of Schwab from 2002 until June 2004, and Executive Vice President and President - Retirement Plan Services of Schwab from 2000 to 2002. Mr. Bettinger was appointed to CSC's Executive Committee effective June 28, 2004. Mr. Bettinger joined Schwab in 1995. Mr. Chafkin has been Executive Vice President and President - Advised Investor of CSC and Schwab since December 2004. He was Executive Vice President - - Advice, Products and Tools of Schwab from 2002 to December 2004, Executive Vice President - Investment Advice and Products of Schwab from 2001 to 2002, and Executive Vice President - Asset Management Products and Services of Schwab from 2000 to 2001. Mr. Chafkin was appointed to CSC's Executive Committee effective January 1, 2005. Mr. Chafkin joined Schwab in 1999. Mr. Dodds has been Chief Financial Officer of CSC and Schwab since 1999 and Executive Vice President of CSC 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. Ms. Dwyer has been Executive Vice President, General Counsel and Corporate Secretary of CSC and Executive Vice President - Corporate Oversight of Schwab since 1996. Ms. Dwyer was appointed to CSC's Executive Committee effective June 28, 2004. Ms. Dwyer joined Schwab in 1996. Mr. Goldman has been Executive Vice President - Strategy and Corporate Development of CSC and Schwab since May 2004. He served as Senior Vice President of Corporate Development of Schwab from 2002 until May 2004. Mr. Goldman joined Schwab in 2001 as Senior Vice President of Venture Capital Investing and served in that role until 2002. Prior to joining Schwab, Mr. Goldman was President and Chief Operating Officer of Paramount Farms, Inc. and Paramount Citrus Association from 1996 to 2000. Mr. Goldman was appointed to CSC's Executive Committee effective January 1, 2005. Mr. Goldman is currently a director of Woolf Enterprises, Inc. and Chairman of the Board of Wall Street on Demand. Ms. Hier-King has been Executive Vice President - Human Resources of CSC and Schwab since July 2004. She served as Senior Vice President of Human Resources of Schwab from 2002 until July 2004. Ms. Hier-King joined Schwab in 1994 as Senior Vice President - Technology and served in that role until 2002. Ms. Hier-King was appointed to CSC's Executive Committee effective January 1, 2005. Ms. Hier-King is currently a director of Akamai Technologies, Inc. Mr. Lyons has been Executive Vice President and President - Active Trader of CSC and Schwab since June 2004. He served as Executive Vice President and President - Asset Management Products and Services of Schwab from 2002 until June 2004, and Executive Vice President - Mutual Funds of Schwab from 1999 to 2002. Mr. Lyons was appointed to CSC's Executive Committee effective June 28, 2004. Mr. Lyons joined Schwab in 1984. Mr. Merk has been Executive Vice President and President - Asset Management Products and Services of CSC and Schwab since December 2004. Mr. Merk joined Schwab in 2002 as Executive Vice President and President - Investment Management of Schwab and served in that role until December 2004. Prior to joining Schwab, Mr. Merk was Chief Investment Officer - Fixed Income for American Century from 1998 to 2001, and President and Chief Investment Officer for American Century from 2001 to 2002. Mr. Merk was appointed to CSC's Executive Committee effective January 1, 2005. Ms. McWhinney has been Executive Vice President and President - Schwab Institutional of CSC and Schwab since 2001 when she joined Schwab. Prior to joining Schwab, Ms. McWhinney was Group President for Engage Media Services from 1999 to 2001. Ms. McWhinney was appointed to CSC's Executive Committee effective June 28, 2004. Ms. McWhinney is currently a director of SIPC and serves as Executive Advisor of Hitachi Data Systems. Ms. Saeger has been Executive Vice President - Brand Management and Marketing Communications of CSC and Schwab since December 2004. Ms. Saeger joined Schwab in March 2004 as Executive Vice President - Brand Management and served in that role until December 2004. Prior to joining Schwab, Ms. Saeger was Executive Vice President of Brand Marketing for Visa USA from 1997 to 2004. Ms. Saeger was appointed to CSC's Executive - 67 - THE CHARLES SCHWAB CORPORATION Committee effective January 1, 2005. Ms. Saeger is currently a director of the Association of National Advertisers. Mr. Sasson has been Executive Vice President and Chief Information Officer of CSC and Schwab since June 2004. He served as Executive Vice President and President - Active Trader of Schwab from 2001 until June 2004, and Executive Vice President and President - Electronic Brokerage of Schwab from 1997 to 2001. Mr. Sasson was appointed to CSC's Executive Committee effective June 28, 2004. Mr. Sasson joined Schwab in 1995. Mr. Sasson is currently a director of Quris, Inc., an affiliate of CSC, and CommercialWare. Mr. Weber has been Executive Vice President of CSC, Chief Executive Officer of USTC and U.S. Trust NY, and a director of USTC since 2002 and Chairman of USTC since 2003. Prior to joining USTC, Mr. Weber was Vice Chairman and Chief Financial Officer for Aetna, Inc. from 1998 to 2001. Mr. Weber currently serves as Advisory Committee Chairman of Computer Repair Systems, LLC. 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 "The Board of Directors - Compensation Committee Interlocks and Insider Participation," "- Director Compensation," "Executive Compensation - Summary Compensation Table," "- Options Granted in 2004," "- Fiscal Year-End Option Values," "- Long-Term Incentive Plan - Awards in 2004," "Certain Relationships and Related Transactions," "Appendix B - Description of Charles R. Schwab's Employment and License Agreements," "Appendix C - Description of Lon Gorman's Employment Agreement," and "Appendix D - Description of Dave Pottruck's Severance Agreement." Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters The information required to be furnished pursuant to this item is incorporated by reference from portions of the Proxy Statement under "Principal Stockholders," "Executive Compensation - Securities Authorized for Issuance Under Equity Compensation Plans," and "- Material Features of Employee Stock Incentive Plan." 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 "Certain Relationships and Related Transactions." Item 14. Principal Accountant Fees and Services The information required to be furnished pursuant to this item is incorporated by reference from a portion of the Proxy Statement under "Independent Auditors - Auditor Selection and Fees." PART IV Item 15. Exhibits and Financial Statement Schedule (a) Documents filed as part of this Report 1. Financial Statements The financial statements and independent auditors' report are included in "Item 8 - Financial Statements and Supplementary Data" 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 Report of Independent Registered Public Accounting Firm 2. Financial Statement Schedule The financial statement schedule required to be furnished pursuant to this item is listed in the accompanying index appearing on page F-1. - 68 - THE CHARLES SCHWAB CORPORATION (b) 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. 3.11 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. 3.12 Third Restated Bylaws, as amended on May 9, 2003, of the Registrant (supersedes Exhibit 3.9), filed as Exhibit 3.12 to the Registrant's Form 10-Q for the quarter ended June 30, 2003 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. 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. + 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. + - 69 - THE CHARLES SCHWAB CORPORATION - -------------------------------------------------------------------------------- Exhibit Number Exhibit - -------------------------------------------------------------------------------- 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. + 10.169 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), filed as Exhibit 10.191 to the Registrant's Form 10-K for the year ended December 31, 2002 and incorporated herein by reference. + 10.192 Form of Nonstatutory Stock Option Agreement of The Charles Schwab Corporation 1992 Stock Incentive Plan (supersedes Exhibit 10.172), filed as Exhibit 10.192 to the Registrant's Form 10-K for the year ended December 31, 2002 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, 2003. + 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. + 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. + 10.221 The SchwabPlan(R) 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. + - 70 - THE CHARLES SCHWAB CORPORATION - -------------------------------------------------------------------------------- Exhibit Number Exhibit - -------------------------------------------------------------------------------- 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. + 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. + 10.239 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. + - 71 - THE CHARLES SCHWAB CORPORATION - -------------------------------------------------------------------------------- Exhibit Number Exhibit - -------------------------------------------------------------------------------- 10.242 The Charles Schwab Corporation 1987 Stock Option Plan, amended and restated as of September 25, 2002, with form of Non-Qualified Stock Option Agreement attached (supersedes Exhibit 10.222), 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. + 10.246 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. + 10.250 Separation Agreement by and between Jeffrey S. Maurer and The Charles Schwab Corporation, filed as Exhibit 10.250 to the Registrant's Form 10-K for the year ended December 31, 2002 and incorporated herein by reference. + 10.251 The Charles Schwab Corporation 2001 Stock Incentive Plan, restated to include amendments through May 2003 (supersedes Exhibit 10.248), filed as Exhibit 10.251 to the Registrant's Form 10-Q for the quarter ended June 30, 2003 and incorporated herein by reference. + 10.252 The Charles Schwab Corporation Long-Term Incentive Plan, filed as Exhibit 10.252 to the Registrant's Form 10-Q for the quarter ended June 30, 2003 and incorporated herein by reference. + 10.253 Employment Agreement dated as of March 31, 2003 between the Registrant and Charles R. Schwab (supersedes Exhibit 10.149), filed as Exhibit 10.253 to the Registrant's Form 10-Q for the quarter ended June 30, 2003 and incorporated herein by reference. + 10.254 The Charles Schwab Severance Pay Plan restated as of May 1, 2003 (supersedes Exhibit 10.247), filed as Exhibit 10.254 to the Registrant's Form 10-Q for the quarter ended June 30, 2003 and incorporated herein by reference. + 10.255 Credit Agreement (364-Day Commitment) dated as of June 20, 2003 between the Registrant and the financial institutions listed therein (supersedes Exhibit 10.241), filed as Exhibit 10.255 to the Registrant's Form 10-Q for the quarter ended June 30, 2003 and incorporated herein by reference. - 72 - THE CHARLES SCHWAB CORPORATION - -------------------------------------------------------------------------------- Exhibit Number Exhibit - -------------------------------------------------------------------------------- 10.256 Separation Agreement and General Release by and among The Charles Schwab Corporation, Charles Schwab & Co., Inc., and John Philip Coghlan dated July 25, 2003, filed as Exhibit 10.256 to the Registrant's Form 10-Q for the quarter ended September 30, 2003 and incorporated herein by reference. + 10.257 The Charles Schwab Corporation Deferred Compensation Plan, as amended through January 1, 2004, filed as Exhibit 10.257 to the Registrant's Form 10-Q for the quarter ended March 31, 2004 and incorporated herein by reference. + 10.258 Credit Agreement (364-Day Commitment) dated as of June 18, 2004 between the Registrant and the financial institutions listed therein (supersedes Exhibit 10.255), filed as Exhibit 10.258 to the Registrant's Form 10-Q for the quarter ended June 30, 2004 and incorporated herein by reference. 10.259 The Charles Schwab Corporation 2004 Stock Incentive Plan, approved at the Annual Meeting of Stockholders on May 17, 2004, filed as Exhibit 10.259 to the Registrant's Form 10-Q for the quarter ended June 30, 2004 and incorporated herein by reference. + 10.260 The Charles Schwab Severance Pay Plan, restated as of September 14, 2004 (supersedes Exhibit 10.254), filed as Exhibit 10.260 to the Registrant's Form 10-Q for the quarter ended September 30, 2004 and incorporated herein by reference. + 10.261 Purchase Agreement by and among The Charles Schwab Corporation, CS Capital Markets and Co., Schwab Associates and Co., UBS Securities LLC, and UBS Americas Inc., dated as of August 31, 2004, filed as Exhibit 10.261 to the Registrant's Form 10-Q for the quarter ended September 30, 2004 and incorporated herein by reference. *** 10.262 Equities Order Handling Agreement dated October 29, 2004 by and among UBS Securities LLC, Schwab Capital Markets L.P., Charles Schwab & Co., Inc., and The Charles Schwab Corporation, filed as Exhibit 10.262 to the Registrant's Form 10-Q for the quarter ended September 30, 2004 and incorporated herein by reference. *** 10.263 Separation Agreement, General Release and Waiver of Claims by and among The Charles Schwab Corporation, Charles Schwab & Co., Inc., and David S. Pottruck dated August 2, 2004, filed as Exhibit 10.263 to the Registrant's Form 10-Q for the quarter ended September 30, 2004 and incorporated herein by reference. + 10.264 The Charles Schwab Corporation Deferred Compensation Plan II, effective December 9, 2004. + 10.265 The Charles Schwab Corporation Directors' Deferred Compensation Plan II, effective December 9, 2004. + 10.266 Form of Notice and Restricted Stock Agreement for Non-Employee Directors Under The Charles Schwab Corporation 2004 Stock Incentive Plan. + - 73 - THE CHARLES SCHWAB CORPORATION - -------------------------------------------------------------------------------- Exhibit Number Exhibit - -------------------------------------------------------------------------------- 10.267 Form of Notice and Restricted Stock Unit Agreement for Non-Employee Directors Under The Charles Schwab Corporation 2004 Stock Incentive Plan. + 10.268 Form of Notice and Stock Option Agreement for Non-Employee Directors Under The Charles Schwab Corporation 2004 Stock Incentive Plan. + 10.269 Form of Notice and Non-Qualified Stock Option Agreement Under The Charles Schwab Corporation 2004 Stock Incentive Plan. + 10.270 Form of Notice and Restricted Stock Agreement Under The Charles Schwab Corporation 2004 Stock Incentive Plan. + 10.271 The Charles Schwab Corporation Directors' Deferred Compensation Plan, as amended through December 8, 2004 (supersedes Exhibit 10.215). + 10.272 The Charles Schwab Corporation Deferred Compensation Plan, as amended through December 8, 2004 (supersedes Exhibit 10.257). + 10.273 Executive Deferred Compensation Plan of U.S. Trust Corporation, as amended and restated effective January 1, 2001, and incorporating action taken as of December 31, 2004 (supersedes Exhibit 10.234). + 12.1 Computation of Ratio of Earnings to Fixed Charges. 21.1 Subsidiaries of the Registrant. 23.1 Independent Auditors' Consent. 31.1 Certification Pursuant to Rule 13a-14(a)/15d-14(a), As Adopted Pursuant to Section 302 of The Sarbanes-Oxley Act of 2002. 31.2 Certification Pursuant to Rule 13a-14(a)/15d-14(a), As Adopted Pursuant to Section 302 of The Sarbanes-Oxley Act of 2002. 32.1 Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002. ** 32.2 Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002. ** * 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. ** Furnished as an exhibit to this annual report on Form 10-K. *** Confidential treatment has been requested for certain portions of this exhibit. + Management contract or compensatory plan. - 74 - 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 February 28, 2005. THE CHARLES SCHWAB CORPORATION (Registrant) BY: /s/ Charles R. Schwab --------------------------- Charles R. Schwab Chairman and Chief Executive Officer 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 February 28, 2005. Signature / Title Signature / Title ----------------- ----------------- /s/ Charles R. Schwab /s/ Christopher V. Dodds - ---------------------------- ---------------------------- Charles R. Schwab, Christopher V. Dodds, Chairman and Chief Executive Executive Vice President Officer 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 /s/ Donald G. Fisher /s/ Frank C. Herringer - ---------------------------- ---------------------------- Donald G. Fisher, Director Frank C. Herringer, Director /s/ Stephen T. McLin /s/ Paula A. Sneed - ---------------------------- ---------------------------- Stephen T. McLin, Director Paula A. Sneed, Director /s/ Roger O. Walther /s/ Robert N. Wilson - ---------------------------- ---------------------------- Roger O. Walther, Director Robert N. Wilson, Director /s/ David B. Yoffie - ---------------------------- David B. Yoffie, Director - 75 - THE CHARLES SCHWAB CORPORATION Index to Financial Statement Schedule Page ---- Schedule II - Valuation and Qualifying Accounts F-2 Combined Supplemental Financial Data for U.S. Trust Corporation and Charles Schwab Bank, N.A. (Unaudited) F-3 - F-9 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 "Item 8 - Financial Statements and Supplementary Data." F-1
THE CHARLES SCHWAB CORPORATION SCHEDULE II Valuation and Qualifying Accounts (In millions) Additions Balance at -------------------------- Balance at Beginning Charged End Description of Year to Expense Other (1) Written off of Year - ------------------------------------------------------------------------------------------------------------------------------------ For the year ended December 31, 2004: Allowance for doubtful accounts of brokerage clients (2) $ 2 $ 1 $ - $ (2) $ 1 ========================================================================== For the year ended December 31, 2003: Allowance for doubtful accounts of brokerage clients (2) $ 4 $ 1 $ - $ (3) $ 2 ========================================================================== For the year ended December 31, 2002: Allowance for doubtful accounts of brokerage clients (2) $ 5 $ 3 $ 1 $ (5) $ 4 ========================================================================== (1) Represents collections of previously written-off accounts. (2) Excludes banking-related valuation and qualifying accounts. See "Item 8 - Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 9. Loans to Banking Clients and Related Allowance for Credit Losses." F-2
THE CHARLES SCHWAB CORPORATION Combined Supplemental Financial Data for U.S. Trust Corporation and Charles Schwab Bank, N.A. (Unaudited) (Dollars in Millions) 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 includes U.S. Trust Corporation (U.S. Trust) and Charles Schwab Bank, N.A. (Schwab Bank), which are subsidiaries of The Charles Schwab Corporation. U.S. Trust is a wealth management firm that also provides fiduciary and private banking services. Schwab Bank is a retail bank which commenced operations in April 2003.
- ------------------------------------------------------------------------------------------------------------------------------------ 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: - ------------------------------------------------------------------------------------------------------------------------------------ 2004 Compared to 2003 2003 Compared to 2002 Increase (Decrease) Due to Increase (Decrease) Due to Change in: Change in: -------------------------------- -------------------------------- Average Average Total Average Average Total Volume Rate Volume Rate - ------------------------------------------------------------------------------------------------------------------------------------ Interest-Earning assets: Cash equivalents $ 2 $ 1 $ 3 $ 1 $ (2) $ (1) Securities available for sale (1) U.S. Treasury securities (2) (3) (5) 1 (1) - U.S. Government agencies and collateralized mortgage obligations (2) 70 3 73 8 (9) (1) State and municipal obligations (5) - (5) (1) - (1) - ------------------------------------------------------------------------------------------------------------------------------------ Total securities available for sale 63 - 63 8 (10) (2) Loans to banking clients (3) 58 (13) 45 45 (51) (6) Other interest-earning assets 8 2 10 7 - 7 - ------------------------------------------------------------------------------------------------------------------------------------ Total interest-earning assets 131 (10) 121 61 (63) (2) - ------------------------------------------------------------------------------------------------------------------------------------ Interest-bearing sources of funds: Interest-bearing banking deposits 34 (23) 11 21 (19) 2 Short-term borrowings (2) 6 4 5 (11) (6) Long-term debt 41 (27) 14 (3) 1 (2) - ------------------------------------------------------------------------------------------------------------------------------------ Total sources on which interest is paid 73 (44) 29 23 (29) (6) - ------------------------------------------------------------------------------------------------------------------------------------ Change in net interest revenue-taxable equivalent basis $ 58 $ 34 92 38 (34) 4 ==================================================================================================================================== Tax equivalent adjustment 2 (1) Provision for credit loss 2 - - ------------------------------------------------------------------------------------------------------------------------------------ Change in net interest revenue $ 96 $ 3 ==================================================================================================================================== Changes that are not due solely to volume or rate have been allocated to rate. (1) The average balance and average rate for securities available for sale have been calculated using their amortized cost. (2) Includes collateralized mortgage obligations securities issued by agencies including GNMA, FNMA and FHLMC. (3) Includes average principal balances of non-accrual and reduced rate loans.
F-3
2. Three-year Net Interest Revenue (Tax Equivalent Basis) and Average Balances - ------------------------------------------------------------------------------------------------------------------------------------ For the Year Ended December 31, 2004 2003 2002 --------------------------- --------------------------- --------------------------- (Dollars in Millions) Average Average Average Average Average Average Balance Interest Rate Balance Interest Rate Balance Interest Rate - ------------------------------------------------------------------------------------------------------------------------------------ Assets: Cash equivalents $ 396 $ 5 1.30% $ 229 $ 2 1.00% $ 193 $ 3 1.55% Securities available for sale (1), (2) 4,031 141 3.50% 1,904 78 4.12% 1,508 80 5.31% Loans to banking clients (3) 6,453 275 4.24% 5,034 230 4.56% 4,204 236 5.62% Other interest-earning assets 896 19 2.20% 447 9 1.89% 45 2 4.49% - ------------------------------------------------------------------------------------------------------------------------------------ Total interest-earning assets 11,776 440 3.74% 7,614 319 4.19% 5,950 321 5.40% - ------------------------------------------------------------------------------------------------------------------------------------ Non-interest-earning assets 1,179 810 771 - ------------------------------------------------------------------------------------------------------------------------------------ Total Assets $12,955 $ 8,424 $ 6,721 ==================================================================================================================================== Liabilities and Stockholder's Equity: Interest-bearing banking deposits 9,077 108 1.19% 5,395 97 1.80% 4,046 95 2.36% Short-term borrowings 848 17 2.01% 1,013 13 1.24% 813 19 2.30% Long-term debt 582 18 3.14% 58 4 7.76% 96 6 6.28% - ------------------------------------------------------------------------------------------------------------------------------------ Total sources on which interest is paid 10,507 143 1.37% 6,466 114 1.77% 4,955 120 2.43% ==================================================================================================================================== Non-interest-bearing deposits 615 589 632 Non-interest-bearing liabilities 369 392 446 Stockholder's equity 1,464 977 688 - ------------------------------------------------------------------------------------------------------------------------------------ Total Liabilities and Stockholder's Equity $12,955 $ 8,424 $ 6,721 ==================================================================================================================================== Net interest revenue - taxable equivalent basis 297 205 201 Net free funds $ 1,269 $ 1,149 $ 994 - ------------------------------------------------------------------------------------------------------------------------------------ Tax equivalent adjustment (2) (2) (4) (4) Provision for credit loss (2) (4) (3) $ 293 $ 197 $ 194 ==================================================================================================================================== Net yield on interest earning assets (tax equivalent basis) 2.52% 2.69% 3.38% - ------------------------------------------------------------------------------------------------------------------------------------ (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 40% for 2004, 40% for 2003, and 41% for 2002. (3) Includes average principal balances of non-accrual and reduced rate loans.
F-4
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: - ------------------------------------------------------------------------------------------------------------------------------------ December 31, 2004 2003 2002 - ------------------------------------------------------------------------------------------------------------------------------------ U.S. treasury securities: Amortized cost $ 263 $ 301 $ 290 Aggregate fair value $ 262 $ 302 $ 296 Gross unrealized gains - $ 1 $ 6 Gross unrealized losses $ 1 - - U.S. government sponsored agencies and corporations: Amortized cost 1,534 1,421 701 Aggregate fair value 1,534 1,421 727 Gross unrealized gains 5 5 26 Gross unrealized losses 5 5 - State and municipal obligations: Amortized cost 1 148 169 Aggregate fair value 1 155 178 Gross unrealized gains - 7 9 Gross unrealized losses - - - Collateralized mortgage obligations: Amortized cost 3,062 1,508 88 Aggregate fair value 3,051 1,508 87 Gross unrealized gains 5 4 - Gross unrealized losses 16 4 1 Other securities: Amortized cost 22 51 33 Aggregate fair value 22 51 34 Gross unrealized gains - - 1 Gross unrealized losses - - - - ------------------------------------------------------------------------------------------------------------------------------------ Total securities available for sale: Amortized cost $ 4,882 $ 3,429 $ 1,281 Aggregate fair value $ 4,870 $ 3,437 $ 1,322 Gross unrealized gains $ 10 $ 17 $ 42 Gross unrealized losses $ 22 $ 9 $ 1 ====================================================================================================================================
F-5 4. Loans to Banking Clients and Related Allowance for Credit Losses An analysis of the composition of the loan portfolio is as follows:
- ------------------------------------------------------------------------------------------------------------------------------------ December 31, 2004 2003 2002 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------------ Residential real estate mortgages $ 5,342 $ 4,624 $ 3,580 $ 3,076 $ 2,239 Consumer loans 971 735 630 584 554 Other 536 404 369 407 374 - ------------------------------------------------------------------------------------------------------------------------------------ Total $ 6,849 $ 5,763 $ 4,579 $ 4,067 $ 3,167 ==================================================================================================================================== An analysis of nonperforming assets is as follows: - ------------------------------------------------------------------------------------------------------------------------------------ December 31, 2004 2003 2002 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------------ Non-accrual loans $ 1 $ 1 $ 1 $ 5 $ 1 Average non-accrual loans $ 1 $ 1 $ 3 $ 4 $ 1 - ------------------------------------------------------------------------------------------------------------------------------------ An analysis of the allowance for credit losses on the loan portfolio is as follows: - ------------------------------------------------------------------------------------------------------------------------------------ 2004 2003 2002 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------------ Balance at beginning of year $ 27 $ 24 $ 21 $ 20 $ 20 Provision charged to income 2 4 3 - - Net recoveries - - - 1 - Release of reserves on loans sold (2) (1) - - - - ------------------------------------------------------------------------------------------------------------------------------------ Balance at end of year $ 27 $ 27 $ 24 $ 21 $ 20 ====================================================================================================================================
The maturities of the loan portfolio at December 31, 2004 is as follows: - ------------------------------------------------------------------------------------------------------------------------------------ Within 1-5 Over 1 Year Years 5 Years Total - ------------------------------------------------------------------------------------------------------------------------------------ Residential real estate mortgages (1) $ 96 $ 771 $ 4,475 $ 5,342 Consumer loans 938 21 12 971 Other 380 104 52 536 - ------------------------------------------------------------------------------------------------------------------------------------ Total $ 1,414 $ 896 $ 4,539 $ 6,849 ==================================================================================================================================== - ------------------------------------------------------------------------------------------------------------------------------------ (1) Maturities are based upon the contractual terms of the loans.
F-6
The interest sensitivity of loans with maturities in excess of one year at December 31, 2004 is as follows: - ------------------------------------------------------------------------------------------------------------------------------------ 1-5 Over Years 5 Years Total - ------------------------------------------------------------------------------------------------------------------------------------ Loans with predetermined interest rates $ 197 $ 1,055 $ 1,252 Loans with floating or adjustable interest rates 699 3,484 4,183 - ------------------------------------------------------------------------------------------------------------------------------------ Total $ 896 $ 4,539 $ 5,435 ==================================================================================================================================== - ------------------------------------------------------------------------------------------------------------------------------------
5. Summary of Credit Loss on Banking Loans Experience - ------------------------------------------------------------------------------------------------------------------------------------ 2004 2003 2002 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------------ Average loans $ 6,453 $ 5,034 $ 4,204 $ 3,469 $ 2,867 Allowance to year end loans .39% .46% .52% .53% .64% Allowance to nonperforming loans n/m n/m n/m n/m n/m Net recoveries to average loans - - - .01% - Nonperforming assets to average loans and real estate owned .01% .03% .03% .14% .05% - ------------------------------------------------------------------------------------------------------------------------------------ n/m - Not meaningful, greater than two hundred percent. At December 31, 2004, U.S. Trust's loan portfolio included loans to individuals involved in the financial services industry of approximately $1.4 billion. Recoveries exceeded charge-offs from loans to individuals involved in the financial services industry in 2000 to 2001. Recoveries approximated charge-offs from loans to individuals involved in the financial services industry in 2002 to 2004.
6. Deposits from Banking Clients - ------------------------------------------------------------------------------------------------------------------------------------ 2004 2003 2002 ------------------- -------------------- ------------------- Amount Rate Amount Rate Amount Rate - ------------------------------------------------------------------------------------------------------------------------------------ Analysis of average daily deposits: Noninterest-bearing deposits $ 615 - $ 589 - $ 632 - Certificates of deposits of $100,000 or more 397 1.35% 372 1.23% 63 2.30% Money market and other savings deposits 8,680 1.19% 5,023 1.85% 3,983 2.36% - ------------------------------------------------------------------------------------------------------------------------------------ Total deposits $ 9,692 $ 5,984 $ 4,678 ====================================================================================================================================
F-7 - ------------------------------------------------------------------------------------------------------------------------------------ Certificates Other of Deposit Deposits - ------------------------------------------------------------------------------------------------------------------------------------ Maturity distribution of interest bearing deposits in Amounts of $100,000 or more at December 31, 2004: Three months or less $ 281 $ 7,730 Three through six months 37 - Six through twelve months 17 - Over twelve months 5 - - ------------------------------------------------------------------------------------------------------------------------------------ Total $ 340 $ 7,730 ==================================================================================================================================== - ------------------------------------------------------------------------------------------------------------------------------------
7. Short-term Borrowings An analysis of outstanding short-term borrowings is as follows: - ------------------------------------------------------------------------------------------------------------------------------------ December 31, 2004 2003 2002 - ------------------------------------------------------------------------------------------------------------------------------------ Federal funds purchased: Year-end balance $ 7 $ 58 $ 16 Daily average balance $ 78 $ 82 $ 133 Maximum month-end balance $ 611 $ 232 $ 449 Weighted-average interest rate during the year 1.09% 1.13% 1.74% Weighted-average interest rate at year end 2.13% .93% 1.13% - ------------------------------------------------------------------------------------------------------------------------------------ Securities sold under agreements to repurchase: Year-end balance $ - $ 128 $ 326 Daily average balance $ 14 $ 304 $ 296 Maximum month-end balance $ 51 $ 354 $ 388 Weighted-average interest rate during the year 1.18% 1.29% 2.20% Weighted-average interest rate at year end -% 1.17% 2.00% - ------------------------------------------------------------------------------------------------------------------------------------ Other borrowed funds: Year-end balance $ 685 $ 905 $ 200 Daily average balance $ 756 $ 627 $ 384 Maximum month-end balance $ 1,138 $ 983 $ 449 Weighted-average interest rate during the year 1.58% 1.23% 2.60% Weighted-average interest rate at year end 2.48% 1.19% 1.43% - ------------------------------------------------------------------------------------------------------------------------------------
F-8 8. Ratios
- ------------------------------------------------------------------------------------------------------------------------------------ Year ended December 31, 2004 2003 2002 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------------ Return on average stockholder's equity (1) 5.01% 5.90% 4.53% 22.50% 10.54% Return on average total assets (1) .57% .69% .46% 2.41% .87% Average stockholder's equity as a percentage of Average total assets 11.30% 11.61% 10.24% 10.70% 8.29% - ------------------------------------------------------------------------------------------------------------------------------------ (1) Includes after-tax restructuring charges of $17 million in 2004. Excluding these charges, return on average stockholder's equity would have been 6.17% and return on average total assets would have been .70%. Includes a tax benefit related to retention programs of $11 million in 2003. Excluding this tax benefit, return on average stockholder's equity would have been 4.81% and return on average total assets would have been .56%. Includes after-tax extraordinary gain related to the sale of corporate trust business of $12 million, 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%.
F-9 EX-10 2 exh10_72.txt EXHIBIT 10.72 EXHIBIT 10.72 RESTATEMENT OF ASSIGNMENT AND LICENSE Preamble. This is a restatement of the Assignment and License made the 31st day of March, 1987, and the Amendment thereof made as of July 30, 1987, by and between CL Acquisition Corporation, a Delaware corporation, The Charles Schwab Corporation, a Delaware corporation, Charles Schwab & Co., Inc., a California corporation, and Charles R. Schwab, an individual. For purposes of this restatement, the parties are referred to herein by their present names: The Charles Schwab Corporation, formerly CL Acquisition ("CS Corp."); Schwab Holdings, Inc., formerly The Charles Schwab Corporation ("Holdings, Inc."); Charles Schwab & Co., Inc. ("Schwab, Inc."); and Charles R. Schwab ("Schwab"). The parties hereby agree as follows: 1. Definitions. In this Agreement: a. "Name" means "Schwab" and each name and mark based thereon or derived therefrom including, without limitation, Schwab, C. Schwab, C.R. Schwab, Charles Schwab, Charles R. Schwab, Chuck Schwab, Schwab One, Schwab Tech, CRS, and the corporate names The Charles Schwab Corporation and Charles Schwab & Co., Inc. b. "Likeness" means any photograph, portrait, drawing or other image or likeness of Schwab, however reproduced, and whether still, single, multiple or moving. c. "Financial Services Business" means the business in which Schwab, Inc. is currently engaged and any additional and related business in which CS Corp., Holdings, Inc. and/or Schwab, Inc. are permitted to engage from time to time during the term of this Agreement under applicable statutes or by the rules, regulations or orders of those regulatory agencies to which such entities are from time to time subject. d. "Permitted Assignees and Licensees" means persons and entitles who have been assigned or licensed the right to use the Name and/or Likeness as permitted in Section 9 hereof. e. "Employment Agreement" means that certain Employment Agreement of even date with the Assignment and License under the terms of which Schwab agrees to perform certain services on behalf of CS Corp. f. "Involuntary Termination," "Cause" and "Voluntary Termination" will have the same meaning as "involuntary termination," "cause," and "voluntary termination," respectively, in the Employment Agreement. g. "Loan Agreement" means that certain "Loan Agreement dated as of March 31, 1987 between CS Corp. as Borrower, The Banks herein named as the Banks, and Security Pacific National Bank, as the Agent." h. "Obligations," "Bank," "Agents," "Loan Documents" will all have the same meaning as in the Loan Agreement. i. "Restricted Period" means that period beginning with the date of the Assignment and License and ending on the earlier of (i) eight years from the date of the Assignment and License and (ii) the first date when all Obligations are fully paid. 2. Assignment and License Back. Schwab hereby assigns to CS Corp. all service mark, trademark and trade name rights in and to the Name and Likeness as defined below as well as all good will associated therewith. CS Corp. hereby grants back to Schwab the perpetual, unrestricted, ongoing, exclusive, irrevocable license to use the Name and Likeness throughout the world for activities other than the Financial Services Business. 3. Reversion. In the event CS Corp. and all Permitted Assignees and Licensees shall all cease using the Name while Schwab still lives, all rights granted to CS Corp. with respect thereto shall revert to Schwab without further act or deed. In the event CS Corp. and all Permitted Assignees and Licensees shall all cease using the Likeness while Schwab still lives, all rights granted to CS Corp. with respect thereto shall revert to Schwab without further act or deed. 4. Representations by Schwab. Schwab represents that, except as provided in this Agreement, no person or organization is authorized, permitted or licensed by Schwab to use the Name and/or the Likeness in conjunction with any Financial Services Business, and Schwab agrees that he will not directly, nor indirectly through any other person or organization, use the Name and/or Likeness in conjunction with any such business or authorize, permit, or license any other party to use the Name or the Likeness in conjunction with any such business, other than as permitted by Section 5 hereof. 5. Employment; Payment; Expansion of License. 5.1 As used in this Section 5: a. "Purchase Payment" means three-tenths of one percent (0.3%) of the Purchase Payment Base. b. "Purchase Payment Base" means the sum of the Net Revenues of all of the Included Users. c. "Net Revenues" of an Included User means the Gross Revenues of that Included User minus the Operating Interest Expense of that Included User, in each case during the Payment Period. d. "Gross Revenues" of an Included User means the gross revenues of that Included User during the Payment Period, determined in accordance with generally accepted accounting principles, and, to the extent permitted by such principles in consolidated financial statements of that Included User, shall include the gross revenues of all subsidiaries and affiliates of that Included User during the Payment Period, but excluding nonetheless from the gross revenues of that Included User and its subsidiaries and affiliates all gross revenues (i) that would otherwise be included more than once in the Purchase Payment Base, (ii) received from other Included Users, or (iii) received from subsidiaries and affiliates of other Included Users. e. "Operating Interest Expense" of an Included User means the operating interest expense of that Included User during the Payment Period, determined in accordance with generally accepted accounting principles and, to the extent permitted by such principles in consolidated financial statements of that Included User, shall include the operating interest expense of all subsidiaries and affiliates of the Included User during the Payment Period, but excluding nonetheless from the operating interest expense of that Included User and its subsidiaries and affiliates all operating interest expense that would otherwise be deducted more than once in calculating the Purchase Payment Base. f. "Included Users" means CS Corp. and all Permitted Assignees and Licensees except Banks and Agent. g. The "Payment Period" begins on the first day of the month following the termination of Schwab's employment by CS Corp., whether during or after the Restricted Period and regardless of the reason for such termination, unless (x) immediately prior to such termination Schwab and CS Corp. are parties to an employment agreement whose term extends beyond the date of termination, (y) that employment agreement requires CS Corp. to make a payment or payments in lieu of salary or other payments that would have been payable under the employment agreement had Schwab continued to be employed beyond the date of termination, and (z) CS Corp. makes such payment or payments or pays a mutually acceptable settlement in lieu thereof. If (x), (y) and (z) are all true, then the "Payment Period" shall begin on the first day of the month following the end of the full term of the employment agreement, provided that if a written agreement between CS Corp. and Schwab expressly provides that the payment(s) made or settlement paid as contemplated by (z) is (are) in lieu of salary or other payments otherwise payable under the employment agreement for a term shorter than the entire term of the employment agreement, then the "Payment Period" shall begin on the first day of the month following the end of such shorter term. The "Payment Period" shall end on the earliest of (i) such time as CS Corp. and all Permitted Assignees and Licensees shall no longer use the Name and/or Likeness, (ii) the day before the fifteenth (15th) anniversary of the beginning of the Payment Period, or (iii) a Disqualifying Event. h. A "Disqualifying Event" would occur if at any time during the Restricted Period, whether or not Schwab is still employed by CS Corp. and whether or not any license granted by Section 5.4 has come into effect, Schwab should serve as a director of, render services to, invest in or otherwise engage in any business competitive with any existing or contemplated business of CS Corp., Holdings, Inc. or Schwab, Inc., and fail to terminate such activity or investment within sixty (60) days after demand by CS Corp. Despite the foregoing, a purely passive investment will not constitute a basis for a Disqualifying Event if it is in (i) publicly traded securities, provided that Schwab does not own beneficially or of record more than five percent (5%) of any class of security or (ii) a professionally managed venture capital fund, provided that Schwab does not provide more than five percent (5%) of the capital invested in any such fund. The determination of the Board of Directors of CS Corp. that an action or activity is or is not competitive shall be controlling on Schwab unless Schwab objects to such determination within thirty (30) days after the demand, in which case the determination shall be made by arbitration in accordance with California Code of Civil Procedure, Sections 1280 et seq., and that determination shall be binding upon the parties. Each party shall be entitled to discovery. The sixty-day opportunity to cure will not be extended by any actual or requested arbitration, so that if Schwab does not terminate the specified activity or investment within the sixty-day period and the arbitration subsequently determines that it was in fact competitive, Schwab will have no further opportunity to cure. Both CS Corp. and Schwab will use their best efforts to complete the arbitration before the end of the sixty-day period. 5.2 Subject to the provisions of Sections 5.6 and 5.7 below, and in consideration for the assignments made herein, CS Corp. agrees to pay the Purchase Payment to Schwab, his executor, successor or assigns. The amount payable shall be computed and paid on a calendar quarterly basis, commencing with the end of the first complete calendar quarter in the Payment Period. CS Corp. agrees to keep (and to require each Included User to keep) accurate books of account and records relating to its Net Revenues, and Schwab and his duly authorized representatives shall have the right at all reasonable hours of the day to an examination and audit of such books of account and records and of all documents and materials in the possession or under the control of Included Users with respect to Gross Revenues and Operating Interest Expense. Each book of account and record shall be kept available for at least two (2) years after all payments are made with respect to the revenues and expenses reflected therein. 5.3. Despite anything in Section 5.2, payments to Schwab shall be limited as follows: a. As used in this Section 5.3: (i) The first day of the first calendar quarter during the Payment Period is the "Base Date." (ii) Each twelve month period which (x) begins on the Base Date or an anniversary of the Base Date and (y) falls entirely within the Payment Period will be a "Payment Year." (iii) If the Payment Period begins on any date other than the first day of a calendar quarter, then the period beginning on the first day of the Payment Period and ending the day before Base Date will be the "Initial Payment Period." (iv) If the Payment Period ends after the Base Date and on any date other than the day before an anniversary of the Base Date, then the period beginning on the last anniversary of the Base Date during the Payment Period and ending at the end of the Payment Period will be the "Final Payment Period." (v) "Consumer Price Index" means the Consumer Price Index for All Urban Consumers for the San Francisco-Oakland-San Jose Metropolitan Area published by the Bureau of Labor Statistics, as it was constituted for the month of May 1987. If the Bureau of Labor Statistics should cease publication of the Consumer Price Index for all Urban Consumers for the San Francisco-Oakland-San Jose Metropolitan Area or changes the basis on which it is constituted, then the parties shall use the index then being published by the Bureau of Labor Statistics or its successor agency which most closely approximates the original "Consumer Price Index." b. Despite anything to the contrary in this Agreement, the amount payable to Schwab pursuant to Section 5.2 of this Agreement with respect to any Initial Payment Period shall not exceed two million dollars ($2,000,000) multiplied by two fractions. The first fraction is the number of days in the Initial Payment Period divided by three hundred sixty-five (365). The second fraction is the Consumer Price Index for the calendar month preceding the Base Date divided by the Consumer Price Index for the same calendar month in 1987. c. Despite anything to the contrary in this Agreement, the amount payable to Schwab pursuant to Section 5.2 of the Agreement with respect to any Payment Year shall not exceed two million dollars ($2,000,000) multiplied by a fraction, the numerator of which is the Consumer Price Index for the calendar month immediately preceding the first month in the Payment Year and the denominator of which is the Consumer Price Index for the same calendar month in 1987. d. Despite anything to the contrary in the Agreement, the amount payable to Schwab pursuant to Section 5.2 of the Agreement with respect to any Final Payment Period shall not exceed two million dollars ($2,000,000) multiplied by two fractions. The first fraction is the number of days in the Final Payment Period divided by three hundred sixty-five (365). The second fraction is the Consumer Price Index for the calendar month preceding the beginning of the Final Payment Period divided by the Consumer Price Index for the same calendar month in 1987. e. If b, c or d above requires the use of the Consumer Price Index for a month for which it is not published, then the Consumer Price Index for the next preceding month which is published shall be used. 5.4 Subject to the provisions of Section 5.6 below: a. Effective immediately upon the termination of Schwab's employment by CS Corp., Schwab shall have, without further action on his part, a perpetual, unrestricted, ongoing, non-exclusive, irrevocable license to use the Likeness throughout the world in the following part of the Financial Services Business: the sale, distribution, broadcast and promotion of books, videotapes, lectures, radio programs and television programs. b. At any time after termination of Schwab's employment by CS Corp., Schwab may notify CS Corp. that Schwab proposes to engage in all or part of that portion of the Financial Services Business commonly known as financial planning. The notice shall describe in summary form the financial planning products and services that Schwab expects will be offered by the business in which he proposes to engage. CS Corp. promptly shall grant to Schwab an immediately effective, perpetual, unrestricted, ongoing, non-exclusive, irrevocable license to use the Likeness to engage in the financial planning business described except that CS Corp. need not grant such a license to the extent that the business described would be in direct competition with any Financial Services Business in which CS Corp. or any Permitted Assignee or Licensee is then engaged or which CS Corp. or any Permitted Assignee or Licensee plans as of the date of receipt of Schwab's notice to commence within three (3) months after receipt of Schwab's notice. c. Commencing on the date that is two (2) years from the beginning of the Payment Period, Schwab shall have a perpetual, unrestricted, ongoing, non-exclusive, irrevocable license to use the Likeness throughout the world in the Financial Services Business. This license will supersede any license previously granted pursuant to Section 5.4.b of this Agreement. d. The licenses pursuant to this Section 5.4 may not be assigned or sublicensed except that Schwab may grant sublicenses to use the Likeness in connection with the sale, distribution, broadcast and promotion, of goods, services and programs that Schwab personally plays a substantial role in creating. 5.5 It is the understanding and intent of the parties that when and if any license granted in Section 5.4 of this Agreement comes into effect, Schwab then may engage in the business covered by the license and use his personal name, personal initials and personal nicknames in connection therewith without any restriction imposed by this Agreement except (i) the restrictions set forth in Sections 6.1, 6.2 and 7 of this Agreement and (ii) the possibility that the Payment Period might prematurely terminate because engaging in such a business might constitute a Disqualifying Event. Further, the restriction described in (ii) would terminate at the end of the Restricted Period. 5.6 Despite anything in Sections 5.2 and 5.4, if the termination of Schwab's employment by CS Corp. is an Involuntary Termination for Cause during the Restricted Period, or alternatively if such termination is a Voluntary Termination during the Restricted Period, then Sections 5.2 and 5.4 shall be of no further force or effect. 5.7 Despite anything in Section 5.2, if Banks or Agent should acquire legal and beneficial ownership of the Name by virtue of foreclosing a security interest granted to them in the Loan Documents, then thereafter Section 5.2 shall be of no further force or effect. Further, if a third party other than Banks or Agent should acquire legal and beneficial ownership of the Name by virtue of the foreclosure of the security interest granted to Banks and Agent in the Loan Documents and such foreclosure does not result in an immediate and complete satisfaction of the Obligations, then the Payment Period shall exclude all time elapsed between the date when that third party so acquires title and the first date when the Obligations are satisfied in full. 6. Schwab's Use of the Name. 6.1 Schwab may use all or part of his personal name, personal initials or personal nicknames in any manner not prohibited by this Agreement. Despite anything to the contrary in this Agreement, however, but subject nevertheless to the provisions of Section 3 of this Agreement, in exercising that right and the rights granted to Schwab in Sections 2 and 5.4 of this Agreement, Schwab may not (i) use or authorize another to use the Name (including without limitation his personal name, personal initials or personal nicknames) as a service mark, trademark or trade name in the Financial Services Business or (ii) use or authorize another to use the Name or Likeness or both in a manner that causes confusion as to whether CS Corp. or any of the Permitted Assignees and Licensees has created, manufactured, endorsed, sold or otherwise been involved with any product or service. 6.2 Further, Schwab may not refer or authorize another to refer to CS Corp. or any of the Permitted Assignees and Licensees by name in any advertisement, press release, interview or other written, spoken or visual material which is intended to promote any product or service, without first obtaining the written consent of CS Corp. Cs Corp. shall not withhold any consent required by the previous sentence unless CS Corp. reasonably believes that the proposed reference would be a breach of Section 6.1 of this Agreement or another term of the Agreement. Should Schwab request any such consent, Schwab shall provide CS Corp. with all information that CS Corp. reasonably requests regarding the proposed reference in order to determine whether or not such reference would be a breach of Section 6.1 of this Agreement or another term of the Agreement. 7. Quality of Goods and Services. CS Corp. acknowledges that Schwab has, and Schwab acknowledges that CS Corp. intends to develop, the highest quality reputation for the delivery of goods and services in the Financial Services Business, and each agrees that the goods and services offered by it or him using the Name or Likeness shall be of such quality as to be appropriate and suited to the protection and enhancement of the Name and Likeness and the good will appurtenant thereto, that such goods and services will be manufactured, sold, distributed and performed in accordance with all Federal, state and local laws that are applicable and material, and that the sale, distribution, provision of services, and/or exploration by it or him shall be of the highest standard and that the same shall in no manner reflect adversely upon the good name of the other or the Name and/or Likeness. Further, CS Corp. agrees not to use any Likeness in advertising or as a mark while Schwab is alive without first obtaining Schwab's approval of his appearance in the Likeness, but such approval shall not be unreasonably withheld. 8. Remedies. CS Corp. and Schwab each acknowledge that the manufacture, sale or distribution of goods or the provision of services in breach of Section 7 of this Agreement would result in immediate and irreparable damage to the other. Each acknowledges and admits that there is no adequate remedy at law for such manufacture, sale, distribution or provision and agrees that the other shall be entitled to equitable relief by way of temporary and permanent injunctions, without bond, and such other further relief as any court having jurisdiction shall deem just and proper. However, such relief may not include an injunction or other prohibition against use of the Name and Likeness that is permitted by this agreement, a rescission of this Agreement or reversion of the rights granted to either party herein. 9. Assignment. 9.1 Subject to compliance with Section 9.2 below, CS Corp. may assign or license any or all rights granted to it herein: (i) as security under the Loan Documents; (ii) to Holdings, Inc., to Schwab, Inc. and to subsidiaries and affiliates of CS Corp., Holdings, Inc. and Schwab, Inc.; (iii) if Schwab gives his prior written consent or votes in favor of the assignment in his capacity as a director of CS Corp, Holdings, Inc. or Schwab, Inc., and (iv) after the death of Schwab. In exercise of their rights under the Loan Documents, the Banks and Agent may assign or license any and all rights assigned to them pursuant to the preceding sentence. 9.2 All assignments to Banks or Agent must be made expressly subject to all the terms and conditions of this Agreement. In any other assignment or license pursuant to the other provisions of Section 9.1, all assignees and licensees must join in all covenants of CS Corp. hereunder and assume joint and several liability for all obligations of CS Corp. hereunder, with such joinder and assumption being made for the express and direct benefit of Schwab. No assignment or license by CS Corp. shall relieve it of any of its obligations hereunder. 9.3 Except for assignments and licenses that both (i) are permitted by Section 9.1 and (ii) conform to the requirements of Section 9.2, neither CS Corp. nor Permitted Assignees and Licensees may assign or license any rights granted to CS Corp. herein, and any purported assignment or license of such rights that is not permitted shall be null and void. 9.4 For purposes hereof "assignment" and "license" shall be construed in their broadest sense and shall include any purported direct or indirect transfer or other disposition, voluntary or involuntary, of any of such rights, including without limitation, any distribution upon dissolution, any merger or other reorganization to which CS Corp. or a Permitted Assignee or Licensee is a party unless the shareholders of such entity immediately before the merger or other reorganization retain the ability to elect a majority of the board of directors immediately after such merger or reorganization, any pledge or hypothecation of any of such rights, or the imposition of any lien upon such rights which is not fully and finally removed within 30 days following the date of such imposition, but does not include the sale of securities for cash or property. 10. Notices. Any notice, demand or other communication to be given hereunder by any party to another shall be in writing and delivered personally or sent by certified mail, postage prepaid, as follows: CS CORP: The Charles Schwab Corporation 101 Montgomery Street San Francisco, CA 94104 Attention: Lawrence J. Stupski, President SCHWAB: Charles R. Schwab c/o Charles Schwab & Co., Inc. 101 Montgomery Street San Francisco, CA 94104 or to such other persons as may be designated in writing by the parties, by a notice given as aforesaid. 11. Joint and Several Liability. Holdings, Inc. and Schwab, Inc. join in all covenants of CS Corp. hereunder; and CS Corp., Holdings, Inc. and Schwab, Inc. each agree to be jointly and severally liable for all obligations of each of the others hereunder. Holdings, Inc. and Schwab, Inc. each acknowledge that its inclusion in the class of Permitted Assignees and Licensees is full and fair consideration for the liability that it is undertaking hereunder. 12. Miscellaneous. This Agreement shall be construed in accordance with the laws of California applicable to agreements made and to be performed entirely in that state. Section headings used herein are inserted for convenience only and are not part of this Agreement. None of the terms of this Agreement may be waived or modified except by an express agreement in writing signed by both parties. Nothing contained herein shall be construed to place the parties in the relationship of partners or joint venturers, and CS Corp. shall have no power to obligate or bind Schwab in any manner whatsoever. In any controversy hereunder the prevailing party shall be entitled to recover its reasonable attorneys' fee and expenses from the opposing party or parties. This Agreement constitutes the entire agreement between the parties with respect to the subject matter hereof, and shall inure to the benefit of and shall be binding upon the parties, their respective heirs, executors, administrators, successors and permitted assigns. 13. Survival of Previous Actions; Effective Date. 13.1 This Agreement supersedes the original Assignment and License and the Amendment thereof; but all assignments, licenses, notices, waivers and consents previously effected by or given pursuant to either the original Assignment and License or the Amendment thereof or both shall survive and remain in full force and effect. 13.2 The Preamble to this Agreement and this Section 13 will become effective on the date of execution hereof as set forth in the paragraph next following. Sections 5.3, 5.5, 6.1 and 6.2 of this Agreement originated in the Amendment of the original Assignment and License and hence became effective as of July 30, 1987. Sections 5.1(a), and 5.1 (g) and 5.4 of this Agreement were revised in the Amendment of the original Assignment and License and hence became effective in their present form as of July 30, 1987, but the previous versions of those sections were effective from March 31, 1987 until July 30, 1987. All other portions of this Agreement became effective on March 31, 1987. IN WITNESS WHEREOF, the parties hereto have affixed their signatures on the _________ day of _________, 1988. The Charles Schwab Corporation /S/ Charles R. Schwab by /S/ Lawrence J. Stupski - --------------------------- -------------------------- Charles R. Schwab Lawrence J. Stupski, President Charles Schwab & Co., Inc. Schwab Holdings, Inc. by /S/ Lawrence J. Stupski by /S/ Charles R. Schwab ----------------------- -------------------------- Lawrence J. Stupski, Charles R. Schwab, President and Chief Chairman and Chief Operating Officer Executive Officer STATE OF CALIFORNIA ) ) ss. CITY AND COUNTY OF SAN FRANCISCO ) On this 25th day of January, 1988, before me, Sheila S. Providenza, the undersigned Notary Public, personally appeared Charles R. Schwab. personally known to me or proved to me on the basis of satisfactory evidence to be the person who executed the within instrument as Chairman for and on behalf of Charles Schwab & Co., Inc. and acknowledged to me that corporation executed it. WITNESS my hand and official seal. /S/ Sheila S. Providenza ------------------------ Notary Public ********************************************* * SHEILA S. PROVIDENZA * * NOTARY PUBLIC-CALIFORNIA * * CITY & COUNTY OF * * SAN FRANCISCO * * My Commission Expires October 13, 1990. * ********************************************* OFFICIAL SEAL STATE OF CALIFORNIA ) ) ss. CITY AND COUNTY OF SAN FRANCISCO ) On this 25th day of January, 1988, before me, Sheila S. Providenza, the undersigned Notary Public, personally appeared Charles R. Schwab. personally known to me or proved to me on the basis of satisfactory evidence to be the person whose name is subscribed to the within instruments, and acknowledged to me that he executed the same. WITNESS my hand and official seal. /S/ Sheila S. Providenza ------------------------ Notary Public ********************************************* * SHEILA S. PROVIDENZA * * NOTARY PUBLIC-CALIFORNIA * * CITY & COUNTY OF * * SAN FRANCISCO * * My Commission Expires October 13, 1990. * ********************************************* OFFICIAL SEAL STATE OF CALIFORNIA ) ) ss. CITY AND COUNTY OF SAN FRANCISCO ) On this 25th day of January, 1988, before me, Sheila S. Providenza, the undersigned Notary Public, personally appeared Lawrence J. Stupski. personally known to me or proved to me on the basis of satisfactory evidence to be the person who executed the within instrument as President for and on behalf of The Charles Schwab Corporation, Inc. and acknowledged to me that corporation executed it. WITNESS my hand and official seal. /S/ Sheila S. Providenza ------------------------ Notary Public ********************************************* * SHEILA S. PROVIDENZA * * NOTARY PUBLIC-CALIFORNIA * * CITY & COUNTY OF * * SAN FRANCISCO * * My Commission Expires October 13, 1990. * ********************************************* OFFICIAL SEAL STATE OF CALIFORNIA ) ) ss. CITY AND COUNTY OF SAN FRANCISCO ) On this 25th day of January, 1988, before me, Sheila S. Providenza, the undersigned Notary Public, personally appeared Lawrence J. Stupski. personally known to me or proved to me on the basis of satisfactory evidence to be the person who executed the within instrument as President and C.O.O. for and on behalf of the Schwab Holdings, Inc. and acknowledged to me that corporation executed it. WITNESS my hand and official seal. /S/ Sheila S. Providenza ------------------------ Notary Public ********************************************* * SHEILA S. PROVIDENZA * * NOTARY PUBLIC-CALIFORNIA * * CITY & COUNTY OF * * SAN FRANCISCO * * My Commission Expires October 13, 1990. * ********************************************* OFFICIAL SEAL EX-10 3 exh10_264.txt EXHIBIT 10.264 Exhibit 10.264 ________________________________________________ THE CHARLES SCHWAB CORPORATION DEFERRED COMPENSATION PLAN II (Effective December 9, 2004) ________________________________________________ Table of Contents ----------------- ARTICLE 1: PURPOSE.........................................................1 1.1 Establishment of the Plan..........................................1 1.2 Purpose of the Plan................................................1 ARTICLE 2: DEFINITIONS.....................................................1 2.1 Definitions........................................................1 2.2 Gender and Number..................................................3 ARTICLE 3: ADMINISTRATION........... ......................................3 3.1 Committee and Administrator........................................3 ARTICLE 4: PARTICIPANTS....................................................3 4.1 Participants.......................................................3 ARTICLE 5: DEFERRALS.......................................................4 5.1 Salary Deferrals...................................................4 5.2 Deferrals of Bonuses, Commissions and Other Cash Incentive Compensation..................................4 5.3 Timing of Elections................................................4 5.4 Deferral Procedures................................................5 5.5 Election of Time and Manner of Payment.............................5 5.6 Accounts and Earnings..............................................7 5.7 Maintenance of Accounts............................................7 5.8 Change in Control..................................................8 5.9 Payment of Deferred Amounts........................................9 5.10 Payment on Certain Events.........................................10 ARTICLE 6: GENERAL PROVISIONS.............................................10 6.1 Unfunded Obligation...............................................10 6.2 Informal Funding Vehicles.........................................10 6.3 Beneficiary.......................................................11 6.4 Incapacity of Participant or Beneficiary..........................11 6.5 Nonassignment.....................................................11 6.6 No Right to Continued Employment..................................12 6.7 Tax Withholding...................................................12 6.8 Claims Procedure and Arbitration..................................12 6.9 Termination and Amendment.........................................13 6.10 Applicable Law....................................................13 ARTICLE 7: EXECUTION......................................................13 THE CHARLES SCHWAB CORPORATION DEFERRED COMPENSATION PLAN II ARTICLE 1: PURPOSE 1.1 Establishment of the Plan. Effective as of December 9, 2004, The Charles Schwab Corporation (hereinafter, the "Company") hereby establishes The Charles Schwab Corporation Deferred Compensation Plan II (the "Plan"), as set forth in this document. This Plan shall apply to cash compensation that is earned and deferred by eligible Participants after December 31, 2004. 1.2 Purpose of the Plan. The Plan permits participating employees to defer the payment of certain cash compensation that they may earn. The opportunity to elect such deferrals is provided in order to help the Company attract and retain key employees. This Plan is unfunded and is maintained primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees. It is accordingly intended to be exempt from the participation, vesting, funding, and fiduciary requirements set forth in Title I of the Employee Retirement Income Security Act of 1974. The Plan also is intended to meet the requirements of section 409A of the Internal Revenue Code of 1986 and is to be construed in accordance with that section and any regulatory guidance issued thereunder. ARTICLE 2: DEFINITIONS 2.1 Definitions. The following definitions are in addition to any other definitions set forth elsewhere in the Plan. Whenever used in the Plan, the capitalized terms in this Section 2.1 shall have the meanings set forth below unless otherwise required by the context in which they are used: (a) "Administrator" the administrator described in Section 3.1 that is selected by the Committee to assist in the administration of the Plan. (b) "Beneficiary" means a person entitled to receive any payments that remain to be paid after a Participant's death, as determined under Section 6.3. (c) "Board" means the Board of Directors of the Company. (d) "Company" means The Charles Schwab Corporation, a Delaware corporation. (e) "Category 1 Participant" and "Category 2 Participant" each refer to a specific Participant group and have the meaning set forth in Section 4.1. (f) "Committee" means the Compensation Committee of the Board. - 1 - (g) "Deferral Account" means the account representing deferrals of cash compensation, plus investment adjustments, as described in Sections 5.6 and 5.7. (h) "Disability" means a condition such that an individual (a) is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or can be expected to last for a continuous period of not less than 12 months; or (b) is, by reason of any medically determinable physical or mental impairment which can be expected to result in death or can be expected to last for a continuous period of not less than 12 months, receiving income replacement benefits for a period of not less than 3 months under an accident and health plan covering employees of the Company or its Subsidiaries. (i) "Participant" means any employee who meets the eligibility requirements of the Plan, as set forth in Article 4, and includes, where appropriate to the context, any former employee who is entitled to payments under this Plan. (j) "Plan" means The Charles Schwab Corporation Deferred Compensation Plan II, as in effect from time to time. (k) "Plan Year" means the calendar year. (l) "Retirement" shall mean: (i) separation from service with respect to the Company and its Subsidiaries with the exception of U.S. Trust Corporation for any reason other than death at any time after the Participant has attained 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; and (ii) separation from service with respect to U.S. Trust Corporation for any reason other than death at any time after (A) the Participant has attained age sixty-five (65); (B) the sum of the Participant's age and credited Years of Service, at the time of such separation, is equal to or greater than eighty (80); or (C) the Participant has attained age sixty (60), but only if, at the time of such termination, the Participant has been credited with at least ten (10) Years of Service. For purpose of this subparagraph (l), the term "Years of Service" shall have the same meaning given to it under the SchwabPlan Retirement Savings and Investment Plan (or any successor plan). (m) "Specified Employee" means a "specified employee" within the meaning of section 409A of the Code. (n) "Subsidiary" means a corporation or other business entity in which the Company owns, directly or indirectly, securities with more than 80 percent of the total voting power. - 2 - (o) "Unforeseeable Emergency" means a severe financial hardship to the Participant resulting from (i) an illness or accident of the Participant, the Participan's spouse, or the Participant's dependent (as defined in section 152(a) of the Code); (ii) loss of the Participant's property due to casualty; or (iii) other similar extraordinary and unforeseeable circumstances arising as a result of events beyond the control of the Participant, as determined in the sole discretion of the Administrator in accordance with section 409A of the Code. (p) "Valuation Date" means each December 31 and any other date designated from time to time by the Committee for the purpose of determining the value of a Participant's Deferral Account balance pursuant to Section 5.6. 2.2 Gender and Number. Except when otherwise indicated by the context, any masculine or feminine terminology shall also include the neuter and other gender, and the use of any term in the singular or plural shall also include the opposite number. ARTICLE 3: ADMINISTRATION 3.1 Committee and Administrator. The Committee shall administer the Plan and may select one or more persons to serve as the Administrator. The Administrator shall perform such administrative functions as the Committee may delegate to it from time to time. Any person selected to serve as the Administrator may, but need not, be a Committee member or an officer or employee of the Company. However, if a person serving as Administrator or a member of the Committee is a Participant, such person may not vote on a matter affecting his or her interest as a Participant. The Committee shall have discretionary authority to construe and interpret the Plan provisions and resolve any ambiguities thereunder; to prescribe, amend, and rescind administrative rules relating to the Plan; to select the employees who may participate and to terminate the future participation of any such employees; to determine eligibility for benefits under the Plan; and to take all other actions that are necessary or appropriate for the administration of the Plan. Such interpretations, rules, and actions of the Committee shall be final and binding upon all concerned and, in the event of judicial review, shall be entitled to the maximum deference allowable by law. Where the Committee has delegated its responsibility for matters of interpretation and Plan administration to the Administrator, the actions of the Administrator shall constitute actions of the Committee. ARTICLE 4: PARTICIPANTS 4.1 Participants. Officers and other key employees of the Company and each of its Subsidiaries shall be eligible to participate in this Plan upon selection by the Administrator. To be nominated for participation, an employee must be a member of a select group of management or highly compensated employees. Directors of the Company who are full-time employees of the - 3 - Company shall be eligible to participate in the Plan. Participating employees of the Company in the position of Executive Vice President or above shall be "Category 1 Participants." All other participating employees shall be "Category 2 Participants." ARTICLE 5: DEFERRALS 5.1 Salary Deferrals. Each Category 2 Participant selected under Section 4.1 may elect to defer up to 50 percent of his or her regular base salary (subject to the provisions of this Article V). Any such election must be made by entering into a deferred compensation agreement with the employer in accordance with procedures established by the Administrator on or before the applicable deadline under Section 5.3 for the election period during which the services for which the deferred salary is to be earned are performed. For this purpose, the election period shall be the Plan Year; provided, however, that during periods in which the Plan is not in effect for a full Plan Year or an employee is not a Participant for a full Plan Year, the election period shall be the portion of the Plan Year during which the Plan is in effect and the employee is an eligible Participant. Notwithstanding the foregoing, a person who is not a Participant at the beginning of a Plan Year shall not be allowed to elect a deferral of compensation that takes effect during that year unless the requirements under Section 5.3(b) are met. Salary deferrals that have been elected shall occur throughout the election period in equal increments for each payroll period. 5.2 Deferrals of Bonuses, Commissions and Other Cash Incentive Compensation. Each Category 1 Participant and each Category 2 Participant may elect to defer all or any portion (subject to the provisions of this Article 5) of (a) his or her commissions; and (b) any amount that he or she subsequently earns under an annual cash bonus program and/or a long-term cash incentive compensation program of the Company or a participating Subsidiary. Any such election must be made by entering into a deferred compensation agreement with the employer in accordance with procedures established by the Administrator on or before the applicable deadline under Section 5.3. Rules similar to those in Section 5.1 shall apply in cases where the Plan is not in existence or an employee is not a Participant for the full period in which an annual cash bonus, commission or long-term incentive compensation award is earned. 5.3 Timing of Elections. (a) Except as otherwise provided under subparagraph (b) or (c) below, compensation for services performed during a Plan Year may be deferred at the Participant's election only if the election to defer such compensation is made not later than the close of the preceding Plan Year or, if permitted by the Administrator in its sole discretion, at such other time permitted under the Code. (b) In the case of the first Plan Year in which a Participant becomes eligible to participate in the Plan, the Administrator may, in its sole discretion, provide that the Participant may make an election to defer compensation for services to be performed subsequent to the - 4 - election provided that such election is made not later than 30 days after the date the Participant becomes eligible to participate in the Plan. (c) In the case of "performance-based compensation" within the meaning section 409A of the Code that is based on services performed over a period of at least 12 months, the Administrator may, in its sole discretion, provide that the Participant may make an election to defer such performance-based compensation provided that such election is made not later than 6 months before the end of such period. 5.4 Deferral Procedures. Subject to Section 5.3, Participants eligible to elect salary deferrals under Section 5.1 shall have an opportunity to do so each year. Participants eligible to elect deferrals under Section 5.2 shall have a separate opportunity to do so for each (a) cash bonus under an annual bonus program; (b) cash bonus or incentive payment under a long-term incentive plan; and (c) commission that they may earn. The Administrator shall specify the rules for the deferrals that may be elected. If a deferral is elected, the election shall be irrevocable with respect to the particular compensation that is subject to the election. Deferral elections shall be made on a form prescribed by the Committee or the Administrator. As provided in Section 6.7, any deferral is subject to appropriate tax withholding measures and may be reduced to satisfy tax withholding requirements. 5.5 Election of Time and Manner of Payment. (a) At the time a Participant makes a deferral election under Section 5.1 or 5.2, the Participant shall also designate the manner of payment and the date on which payments from his or her Deferral Account shall begin. Subject to Section 5.5(b), a Participant may elect from among the following options: (i) a lump sum payable by the end of the month of February of any year that the Participant specifies; (ii) a lump sum payable by the end of the month of February in the year immediately following the Participant's Retirement; (iii) a series of annual installments, commencing in any year selected by the Participant and payable each year on orbefore the end of February, over a period of four years; or (iv) a series of annual installments, commencing in the year following the Participant's Retirement and payable each year on or before the end of February, over a period of five, ten, or fifteen years, as designated by the Participant. Notwithstanding the terms of a Participant's election, if a Participant incurs a separation from service for any reason other than Retirement, the payment of the Participant's entire Deferral Account, including any unpaid installments pursuant to subparagraph (iii) above, shall - 5 - be made in a single lump sum by the end of February next following the year of the Participant's separation from service; provided, however, in the case of a Specified Employee who incurs a separation from service on or after August 1 of a Plan Year, such payment shall be made no earlier than the end of the month of August next following such Plan Year. Any election of a specified payment date pursuant to subparagraphs (i) or (ii), above, shall be subject to any restrictions that the Committee may, in its sole discretion, choose to establish in order to limit the number of different payment dates that a Participant may have in effect at one time. (b) Notwithstanding anything to the contrary in this Plan, except as otherwise permitted under section 409A of the Code, a Participant's Deferral Account shall not be distributed earlier than (i) separation from service or, in the case of a Specified Employee, the date that is six (6) months after separation from service; (ii) Disability; (iii) death; (iv) the specified time or schedule under Section 5.5(a); (v) to the extent permitted under section 409A of the Code and any regulatory guidance promulgated thereunder, a change in the ownership or effective control of the Company, or in the ownership of a substantial portion of the assets of the Company; or (vi) the occurrence of an Unforeseeable Emergency. (c) The acceleration of the time or schedule of any payment under the Plan shall not be permitted unless permitted by the Administrator in accordance with the requirements of section 409A of the Code and any regulatory guidance promulgated thereunder. In accordance with the procedures established by the Administrator, a Participant may elect to delay the timing or change the form of payment provided that (i) the election shall not take effect until at least 12 months after the date on which the election is made; (ii) the first payment with respect to which such election is made is deferred for a period of not less than five years from the date such payment would otherwise have been made, except in the case of elections relating to distributions on death, Disability, or Unforeseeable Emergency; and (iii) if related to a payment at a specified time or pursuant to a fixed schedule under Section 5.5(a), the election shall be made at least 12 months prior to the date of the first scheduled payment. (d) If payment is due in the form of a lump sum, the payment shall equal the balance of the Deferral Account being paid, determined as of the Valuation Date coincident with or immediately preceding the payment date. If payment is due in the form of installments, the amount of each installment payment shall be equal to the quotient determined by dividing (i) the value of the portion of the Deferral Account to which the installment payment election applies (determined as of the Valuation Date coincident with or immediately preceding the date the payment is to be made), by (ii) the number of years over which the installment payments are to be made, less the number of years in which prior payments attributable to such installment payment election have been made. (e) Notwithstanding the foregoing, however, if earnings or any other amounts credited to a Participant's Deferral Account are not considered performance-based compensation, within the meaning of section 162(m) of the Code, and do not otherwise meet the conditions under the Code allowing the Company and its Subsidiaries to receive a federal income tax deduction for such amounts upon paying them at the time provided under the Participant's - 6 - election, the payment of such amounts, to the extent in excess of the amount that would be currently tax deductible, shall automatically be deferred until the earliest year that the payment can be deducted, to the extent such deferral is permitted under section 409A of the Code. 5.6 Accounts and Earnings. The Company shall establish a Deferral Account for each Participant who has elected a deferral under Section 5.1 or 5.2 above, and its accounting records for the Plan with respect to each such Participant shall include a separate Deferral Account or subaccount for each deferral election of the Participant that could cause a payment made at a different time or in a different form from other payments of deferrals elected by the same Participant. Each Deferral Account balance shall reflect the Company's obligation to pay a deferred amount to a Participant or Beneficiary as provided in this Article 5. Under procedures approved by the Committee and communicated to Participants, a Participant's Deferral Account balance shall be increased periodically (not less frequently than annually) to reflect an assumed earnings increment, based on an interest rate or other benchmark selected by the Committee and in effect at the time. Until the time for determining the amount to be paid to the Participant or Beneficiary, such assumed earnings shall accrue from each Valuation Date on the Deferral Account balance as of that date and shall be credited to the account as of the next Valuation Date. The rate of earnings may, but need not, be determined with reference to the actual rate of earnings on assets held under any existing grantor trust or other informal funding vehicle that is in effect pursuant to Section 6.2. Any method of crediting earnings that is followed from time to time may, with reasonable advance notice to affected Participants, be revoked or revised prospectively as of the beginning of any new Plan Year. Earnings that have been credited for any Plan Year, like deferred amounts that have been previously credited to a Participant, shall not be reduced or eliminated retroactively unless they were credited in error. The crediting of assumed earnings shall not mean that any deferred compensation promise to a Participant is secured by particular investment assets or that the Participant is actually earning interest or any other form of investment income under the Plan. Consistent with the foregoing authority to exercise flexibility in establishing a method for crediting assumed earnings on account balances, the Committee may, but need not, consult with Participants about their investment preferences and may, but need not, institute a program of assumed earnings that tracks the investment performance in a Participant's qualified defined contribution plan account or in an assumed participant-directed investment arrangement. 5.7 Maintenance of Accounts. The Accounts of each Participant shall be entered on the books of the Company and shall represent a liability, payable when due under this Plan, out of the general assets of the Company. Prior to benefits becoming due hereunder, the Company shall expense the liability for such accounts in accordance with policies determined appropriate by the Company's auditors. Except to the extent provided pursuant to the second paragraph of this Section 5.7, the Accounts created for a Participant by the Company shall not be funded by a trust or an insurance contract; nor shall any assets of the Company be segregated or identified to such account; nor shall any property or assets of the Company be pledged, encumbered, or otherwise subjected to a lien or security interest for payment of benefits hereunder. - 7 - Notwithstanding that the amounts to be paid hereunder to Participants constitute an unfunded obligation of the Company, the Company may direct that an amount equal to any portion of the Accounts shall be invested by the Company as the Company, in its sole discretion, shall determine. The Committee may in its sole discretion determine that all or any portion of an amount equal to the Accounts shall be paid into one or more grantor trusts that may be established by the Company for the purpose of providing a potential source of funds to pay Plan benefits. The Company may designate an investment advisor to direct the investment of funds that may be used to pay benefits, including the investment of the assets of any grantor trusts hereunder. 5.8 Change in Control. In the event of a Change in Control (as defined below), the following rules shall apply: (a) All Participants shall continue to have a fully vested, non-forfeitable interest in their Deferral Accounts. (b) To the extent permitted under section 409A of the Code and any regulatory guidance issued thereunder, deferrals of amounts for the year that includes the Change in Control shall cease beginning with the first payroll period that follows the Change in Control. (c) A special allocation of earnings on all Deferral Accounts shall be made under Section 5.6 as of the date of the Change in Control on a basis no less favorable to Participants than the method being followed prior to the Change in Control. (d) To the extent permitted under section 409A of the Code and any regulatory guidance issued thereunder, all payments of deferred amounts following a Change in Control, whether or not they have previously begun, shall be made in a cash lump sum no later than 30 days following the Change in Control and, except as provided in Section 5.5 with respect to installment payments in progress, shall be in an amount equal to the full Deferral Account balance, as adjusted pursuant to paragraph (c) above, as of the date of the Change in Control. (e) Subject to section 409A and any regulatory guidance promulgated thereunder, nothing in this Plan shall prevent a Participant from enforcing any rules in a contract or another plan of the Company or any Subsidiary concerning the method of determining the amount of a bonus, incentive compensation, or other form of compensation to which a Participant may become entitled following a change in control, or the time at which that compensation is to be paid in the event of a change in control. For purposes of this Plan, a "Change in Control" means any of the following: (1) Any "person" who, alone or together with all "affiliates" and "associates" of such person, is or becomes (A) an "acquiring person" or (B) the "beneficial owner" of 35% of the outstanding voting securities of the Company (the terms "person", "affiliates", "associates" and "beneficial owner" are used as such terms are used in the Securities Exchange Act of 1934 and the General Rules and Regulations thereunder); provided, however, that a "Change in - 8 - Control" shall not be deemed to have occurred if such "person" is Charles R. Schwab, the Company, any subsidiary or any employee benefit plan or employee stock plan of the Company or of any Subsidiary, or any trust or other entity organized, established or holding shares of such voting securities by, for or pursuant to, the terms of any such plan; or (2) Individuals who at the beginning of any period of two consecutive calendar years constitute the Board cease for any reason, during such period, to constitute at least a majority thereof, unless the election, or the nomination for election by the Company's Shareholders, of each new Board Member was approved by a vote of at least three-quarters (3/4) of the Board members then still in office who were Board members at the beginning of such period; or (3) Approval by the shareholders of the Company of: (A) the dissolution or liquidation of the Company; (B) the sale or transfer of substantially all of the Company's business and/or assets to a person or entity which is not a "subsidiary" (any corporation or other entity a majority or more of whose outstanding voting stock or voting power is beneficially owned directly or indirectly by the Company); or (C) an agreement to merge or consolidate, or otherwise reorganize, with one or more entities which are not subsidiaries (as defined in (B) above), as a result of which less than 50% of the outstanding voting securities of the surviving or resulting entity are, or are to be, owned by former shareholders of the Company; or (4) The Board agrees by a majority vote that an event has or is about to occur that, in fairness to the Participants, is tantamount to a Change in Control. A Change of Control shall occur on the first day on which any of the preceding conditions has been satisfied. However, notwithstanding the foregoing, this Section 5.8 shall not apply to any Participant who alone or together with one or more other persons acting as a partnership, limited partnership, syndicate, or other group for the purpose of acquiring, holding or disposing of securities of the Company, triggers a "Change in Control" within the meaning of paragraphs (1) and (2) above. 5.9 Payment of Deferred Amounts. A Participant shall have a fully vested, non-forfeitable interest in his or her Deferral Account balance at all times. However, vesting does not confer a right to payment other than in the manner elected by the Participant pursuant to Section 5.5 (subject to any modification that may occur pursuant to Section 5.6 or 5.8). Upon the expiration of a deferral period selected by the Participant in one or more deferral elections, the Company shall pay to such Participant (or to the Participant's Beneficiary, in the case of the Participant's death) an amount equal to the balance of the Participant's Account attributable to such expiring deferral elections, plus assumed earnings (determined by the Company pursuant to Section 5.6) thereon. - 9 - 5.10 Payment on Certain Events. Notwithstanding any elections that have been made under Section 5.5, the unpaid balance of a Participant's Deferral Account, including any unpaid installments, shall be paid in a lump sum in the event of the Participant's death, Disability, or upon receipt of a written request from a Participant and the Administrator's determination that the Participant (or his or her Beneficiary in the case of the Participant's death) has incurred an Unforeseeable Emergency; provided, that the amounts distributed because of an Unforeseeable Emergency shall not exceed the amounts necessary to satisfy such Unforeseeable Emergency plus amounts necessary to pay taxes reasonably anticipated as a result of the distribution, after taking into account the extent to which such hardship is or may be relieved through reimbursement or compensation by insurance or otherwise or by liquidation of the individual's assets (to the extent the liquidation of such assets would not itself cause severe financial hardship). ARTICLE 6: GENERAL PROVISIONS 6.1 Unfunded Obligation. The deferred amounts to be paid to Participants pursuant to this Plan constitute unfunded obligations of the Company. Except to the extent specifically provided hereunder, the Company is not required to segregate any monies from its general funds, to create any trusts, or to make any special deposits with respect to this obligation. Title to and beneficial ownership of any investments, including any grantor trust investments which the Company has determined and directed the Administrator to make to fulfill obligations under this Plan shall at all times remain in the Company. Any investments and the creation or maintenance of any trust or Accounts shall not create or constitute a trust or a fiduciary relationship between the Administrator or the Company and a Participant, or otherwise create any vested or beneficial interest in any Participant or his or her Beneficiary or his or her creditors in any assets of the Company whatsoever. The Participants shall have no claim for any changes in the value of any assets which may be invested or reinvested by the Company in an effort to match its liabilities under this Plan. 6.2 Informal Funding Vehicles. Notwithstanding Section 6.1, the Company may, but need not, arrange for the establishment and use of a grantor trust or other informal funding vehicle to facilitate the payment of benefits and to discharge the liability of the Company and participating Affiliates under this Plan to the extent of payments actually made from such trust or other informal funding vehicle. Any investments and any creation or maintenance of memorandum accounts or a trust or other informal funding vehicle shall not create or constitute a trust or a fiduciary relationship between the Committee or the Company or an affiliate and a Participant, or otherwise confer on any Participant or Beneficiary or his or her creditors a vested or beneficial interest in any assets of the Company or any Affiliate whatsoever. Participants and Beneficiaries shall have no claim against the Company or any Affiliate for any changes in the value of any assets which may be invested or reinvested by the Company or any Affiliate with respect to this Plan. - 10 - 6.3 Beneficiary. The term "Beneficiary" shall mean the person or persons to whom payments are to be paid pursuant to the terms of the Plan in the event of the Participant's death. A Participant may designate a Beneficiary on a form provided by the Administrator, executed by the Participant, and delivered to the Administrator. The Administrator may require the consent of the Participant's spouse to a designation if the designation specifies a Beneficiary other than the spouse. Subject to the foregoing, a Participant may change a Beneficiary designation at any time. Subject to the property rights of any prior spouse, if no Beneficiary is designated, if the designation is ineffective, or if the Beneficiary dies before the balance of the Account is paid, the balance shall be paid to the Participant's surviving spouse, or if there is no surviving spouse, to the Participant's estate. 6.4 Incapacity of Participant or Beneficiary. Every person receiving or claiming benefits under the Plan shall be conclusively presumed to be mentally competent and of age until the date on which the Administrator receives a written notice, in a form and manner acceptable to the Administrator, that such person is incompetent or a minor, for whom a guardian or other person legally vested with the care of his or her person or estate has been appointed; provided, however, that if the Administrator finds that any person to whom a benefit is payable under the Plan is unable to care for his or her affairs because of incompetency, or because he or she is a minor, any payment due (unless a prior claim therefor shall have been made by a duly appointed legal representative) may be paid to the spouse, a child, a parent, a brother or sister, or to any person or institution considered by the Administrator to have incurred expense for such person otherwise entitled to payment. To the extent permitted by law, any such payment so made shall be a complete discharge of liability therefor under the Plan. If a guardian of the estate of any person receiving or claiming benefits under the Plan is appointed by a court of competent jurisdiction, benefit payments may be made to such guardian provided that proper proof of appointment and continuing qualification is furnished in a form and manner acceptable to the Administrator. In the event a person claiming or receiving benefits under the Plan is a minor, payment may be made to the custodian of an account for such person under the Uniform Gifts to Minors Act. To the extent permitted by law, any such payment so made shall be a complete discharge of any liability therefor under the Plan. 6.5 Nonassignment. The right of a Participant or Beneficiary to the payment of any amounts under the Plan may not be assigned, transferred, pledged or encumbered nor shall such right or other interests be subject to attachment, garnishment, execution, or other legal process. - 11 - 6.6 No Right to Continued Employment. Nothing in the Plan shall be construed to confer upon any Participant any right to continued employment with the Company, nor shall the Plan interfere in any way with the right of the Company to terminate the employment of such Participant at any time without assigning any reason therefor. 6.7 Tax Withholding. Appropriate taxes shall be withheld from cash payments made to Participants pursuant to the Plan. To the extent tax withholding is payable in connection with the Participant's deferral of income rather than in connection with the payment of deferred amounts, such withholding may be made from other wages and salary currently payable to the Participant, or, as determined by the Administrator, the amount of the deferral elected by the Participant may be reduced in order to satisfy required tax withholding for employment taxes and any other taxes. 6.8 Claims Procedure and Arbitration. The Administrator shall establish a reasonable claims procedure consistent with the requirements of the Employee Retirement Income Security Act of 1974, as amended. Following a Change in Control of the Company (as determined under Section 5.8) the claims procedure shall include the following arbitration procedure. Following a Change in Control of the Company (as determined under Section 5.8) the claims procedure shall include the following arbitration procedure. Since time will be of the essence in determining whether any payments are due to the Participant under this Plan following a Change in Control, a Participant may submit any claim for payment to arbitration as follows: On or after the second day following the termination of the Participant's employment or other event triggering a right to payment, the claim may be filed with an arbitrator of the Participant's choice by submitting the claim in writing and providing a copy to the Company. The arbitrator must be (a) a member of the National Academy of Arbitrators or one who currently appears on arbitration panels issued by the Federal Mediation and Conciliation Service or the American Arbitration Association; or (b) a retired judge of the State in which the claimant is a resident who served at the appellate level or higher. The arbitration hearing shall be held within 72 hours (or as soon thereafter as possible) after filing of the claim unless the Participant and the Company agree to a later date. No continuance of said hearing shall be allowed without the mutual consent of the Participant and the Company. Absence from or nonparticipation at the hearing by either party shall not prevent the issuance of an award. Hearing procedures which will expedite the hearing may be ordered at the arbitrator's discretion, and the arbitrator may close the hearing in his or her sole discretion upon deciding he or she has heard sufficient evidence to satisfy issuance of an award. In reaching a decision, the arbitrator shall have no authority to ignore, change, modify, add to or delete from any provision of this Plan, but instead is limited to interpreting this Plan. The arbitrator's award shall be rendered as expeditiously as possible, and unless the arbitrator rules within seven days after the close of the hearing, he will be deemed to have ruled in favor of the Participant. If the arbitrator finds that any payment is due to the Participant from the Company, the arbitrator shall order the Company to pay that amount to the Participant within 48 hours after the decision is rendered. The award of the arbitrator shall be final and binding upon the Participant and the Company. - 12 - Judgment upon the award rendered by the arbitrator may be entered in any court in any State of the United States. In the case of any arbitration regarding this Agreement, the Participant shall be awarded the Participant's costs, including attorney's fees. Such fee award may not be offset against the deferred compensation due hereunder. The Company shall pay the arbitrator's fee and all necessary expenses of the hearing, including stenographic reporter if employed. 6.9 Termination and Amendment. The Committee may from time to time amend, suspend or terminate the Plan, in whole or in part, and if the Plan is suspended or terminated, the Committee may reinstate any or all of its provisions. The Executive Vice President - Human Resources has the authority to amend the Plan to comply with the requirements of the Code, to avoid a plan failure under section 409A of the Code and to facilitate administration of the Plan to the extent that any such amendments will not materially increase the cost of the Plan. Except as otherwise required by law, the Committee may delegate to the Administrator all or any of its foregoing powers to amend, suspend, or terminate the Plan. Any such amendment, suspension, or termination may affect future deferrals without the consent of any Participant or Beneficiary. However, with respect to deferrals that have already occurred, no amendment, suspension or termination may impair the right of a Participant or a designated Beneficiary to receive payment of the related deferred compensation in accordance with the terms of the Plan prior to the effective date of such amendment, suspension or termination, unless the affected Participant or Beneficiary gives his or her express written consent to the change; provided that such consent shall not be required if an amendment is required to avoid a plan failure under section 409A of the Code. 6.10 Applicable Law. The Plan shall be construed and governed in accordance with applicable federal law and, to the extent not preempted by such federal law, the laws of the State of California to the extent the application of such state laws would not result in the taxation of amounts deferred under the Plan until such amounts are distributed to participants under the Plan. ARTICLE 7: EXECUTION To record the adoption of the Plan to read as set forth herein effective as of December 9, 2004, The Charles Schwab Corporation has caused its authorized officer to execute the same this 21st day of December, 2004. THE CHARLES SCHWAB CORPORATION By: /s/ Christopher v. Dodds --------------------------- Its: Chief Financial Officer - 13 - EX-10 4 exh10_265.txt EXHIBIT 10.265 Exhibit 10.265 ______________________________________________________________________________ THE CHARLES SCHWAB CORPORATION DIRECTORS' DEFERRED COMPENSATION PLAN II (Effective December 9, 2004) ______________________________________________________________________________ THE CHARLES SCHWAB CORPORATION DIRECTORS' DEFERRED COMPENSATION PLAN TABLE OF CONTENTS Section Page Article I. Purpose..........................................................1 1.1 Establishment of the Plan..........................................1 1.2 Purpose of the Plan................................................1 Article II. Definitions......................................................1 2.1 Definitions........................................................1 2.2 Gender and Number..................................................3 Article III. Administration...................................................3 3.1 Committee and Administrator........................................3 Article IV. Participants.....................................................3 4.1 Participants.......................................................3 Article V. Deferrals........................................................3 5.1 Deferrals..........................................................3 5.2 Timing of Elections................................................3 5.3 Deferral Procedures................................................4 5.4 Election of Manner of Payment......................................4 5.5 Accounts and Earnings..............................................4 5.6 Maintenance of Accounts............................................5 5.7 Change in Control..................................................6 5.8 Payment of Deferred Amounts........................................8 Article VI. General Provisions...............................................8 6.1 Unfunded Obligation................................................8 6.2 Informal Funding Vehicles..........................................8 6.3 Beneficiary........................................................9 6.4 Incapacity of Participant or Beneficiary...........................9 6.5 Nonassignment......................................................9 6.6 No Right to Continued Service......................................9 6.7 Tax Withholding....................................................9 6.8 Claims Procedure and Arbitration..................................10 6.9 Termination and Amendment.........................................10 6.10 Applicable Law....................................................11 Article VII. General Provisions..............................................11 - i - THE CHARLES SCHWAB CORPORATION DIRECTORS' DEFERRED COMPENSATION PLAN II Article I. Purpose 1.1 Establishment of the Plan. Effective as of December 9, 2004, The Charles Schwab Corporation(hereinafter, the "Company") hereby establishes The Charles Schwab Corporation Directors' Deferred Compensation Plan II (the "Plan"), as set forth in this document. This Plan shall apply to cash compensation that is earned and deferred by eligible Participants after December 31, 2004. This Plan is adopted by the Committee pursuant to its authority under the Company's 2004 Stock Incentive Plan to prescribe procedures for Directors to elect to receive annual retainer payments and/or meeting fees from the Company in the form of Nonqualified Stock Options and Restricted Stock Units, among other awards, to be issued under the 2004 Stock Incentive Plan. 1.2 Purpose of the Plan. The Plan permits Directors to defer the payment of directors' fees that they may earn. The opportunity to elect such deferrals is provided in order to help the Company attract and retain outside directors. This Plan is unfunded and is maintained primarily for the purpose of providing deferred compensation for its outside directors. It is intended to be exempt from the requirements of the Employee Retirement Income Security Act of 1974, as amended. The Plan also is intended to meet the requirements of section 409A of the Internal Revenue Code of 1986 and is to be construed in accordance with that section and any regulatory guidance issued thereunder. Article II. Definitions 2.1 Definitions. The following definitions are in addition to any other definitions set forth elsewhere in the Plan. Whenever used in the Plan, the capitalized terms in this Section shall have the meanings set forth below unless otherwise required by the context in which they are used: (a) "Administrator" the administrator described in Section 3.1 that is selected by the Committee to assist in the administration of the Plan. (b) "Beneficiary" means a person entitled to receive any benefit payments that remain to be paid after a Participant's death, as determined under Section 6.3. (c) "Board" means the Board of Directors of the Company. (d) "Code" means the Internal Revenue Code of 1986, as amended. (e) "Company" means The Charles Schwab Corporation, a Delaware corporation. (f) "Committee" means the Compensation Committee of the Board. - 1 - (g) "Deferral Account" means the account representing deferrals of cash compensation, plus investment adjustments, as described in Sections 5.5 and 5.6. (h) "Director" means each member of the Board of Directors who is not an employee of the Company or any of its subsidiaries. The term "Director" shall also include each member of the Board of Directors of any subsidiary of the Company who is not an employee of the Company or any of its subsidiaries, but only if the Committee has approved participation in the Plan for such subsidiary's non-employee directors. (i) "Disability" means a condition such that an individual (a) is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or can be expected to last for a continuous period of not less than 12 months; or (b) is, by reason of any medically determinable physical or mental impairment which can be expected to result in death or can be expected to last for a continuous period of not less than 12 months, receiving income replacement benefits for a period of not less than 3 months under an accident and health plan covering employees of the Company or its subsidiaries. (j) "Nonqualified Stock Options" means nonqualified stock options as defined in and issued under the Company's 2004 Stock Incentive Plan. (k) "Plan" means The Charles Schwab Corporation Directors' Deferred Compensation Plan II, as in effect from time to time. (l) "Plan Year" means the calendar year. (m) "Restricted Stock Units" means restricted stock units as defined in and issued under the Company's 2004 Stock Incentive Plan. (n) "Specified Employee" means a "specified employee" within the meaning of section 409A of the Code. (o) "Termination" means the date a Participant ceases to be a Director and otherwise incurs a "separation of service" within the meaning of section 409A of the Code. (p) "Unforeseeable Emergency" means a severe financial hardship to the Participant resulting from (i) an illness or accident of the Participant, the Participant's spouse, or the Participant's dependent (as defined in section 152(a) of the Code); (ii) loss of the Participant's property due to casualty; or (iii) other similar extraordinary and unforeseeable circumstances arising as a result of events beyond the control of the Participant, as determined in the sole discretion of the Administrator in accordance with section 409A of the Code. - 2 - (q) "Valuation Date" means each December 31 and any other date designated from time to time by the Committee for the purpose of determining the value of a Participant's Deferral Account balance pursuant to Section 5.5. 2.2 Gender and Number. Except when otherwise indicated by the context, any masculine or feminine terminology shall also include the neuter and other gender, and the use of any term in the singular or plural shall also include the opposite number. Article III. Administration 3.1 Committee and Administrator. The Committee shall administer the Plan and may select one or more persons to serve as the Administrator. The Administrator shall perform such administrative functions as the Committee may delegate to it from time to time. Any person selected to serve as the Administrator may, but need not, be a Committee member or an officer or employee of the Company. However, if a person serving as Administrator or a member of the Committee is a Participant, such person may not vote on a matter affecting his or her interest as a Participant. The Committee shall have discretionary authority to construe and interpret the Plan provisions and resolve any ambiguities thereunder; to prescribe, amend, and rescind administrative rules relating to the Plan; to determine eligibility for benefits under the Plan; and to take all other actions that are necessary or appropriate for the administration of the Plan. Such interpretations, rules, and actions of the Committee shall be final and binding upon all concerned and, in the event of judicial review, shall be entitled to the maximum deference allowable by law. Where the Committee has delegated its responsibility for matters of interpretation and Plan administration to the Administrator, the actions of the Administrator shall constitute actions of the Committee. Article IV. Participants 4.1 Participants. Each Director shall be eligible to participate in this Plan. Article V. Deferrals 5.1 Deferrals. Each Director may elect to defer up to 100 percent of the fees otherwise receivable from the Company for service as a Director. Any such election must be made by entering a deferred compensation agreement with the Company in accordance with the procedures established by the Administrator on or before the applicable deadline under Section 5.2. 5.2 Timing of Elections. (a) Except as otherwise provided under subparagraph (b) below, compensation for services performed during a Plan Year may be deferred at the Participant's election only if the election to defer such compensation is made not later than the close of the preceding Plan Year - 3 - or, if permitted by the Administrator in its sole discretion, at such other time permitted under the Code. (b) In the case of the first Plan Year in which a Participant becomes eligible to participate in the Plan, the Administrator may, in its sole discretion, provide that the Participant may make an election to defer compensation for services to be performed subsequent to the election provided that such election is made not later than 30 days after the date the Participant becomes eligible to participate in the Plan. 5.3 Deferral Procedures. Subject to Section 5.2, Participants shall have an opportunity to elect deferrals each year. Unless the Committee specifies other rules for the deferrals that may be elected, deferrals may be made in increments of 10 percent or in a fixed dollar amount. If a deferral is elected, the election shall be irrevocable. Deferral elections shall be made by following the procedures adopted by the Committee or the Administrator. As provided in Section 6.7, any deferral is subject to any applicable tax withholding measures and may be reduced to satisfy any applicable tax withholding requirements. 5.4 Election of Manner of Payment. (a) Notwithstanding anything to the contrary in this Plan, except as otherwise permitted under section 409A of the Code, a Participant's Deferral Account shall not be distributed earlier than (i) separation from service or, in the case of a Specified Employee, the date that is six (6) months after separation from service; (ii) Disability; (iii) death; (iv) a specified time or schedule; (v) to the extent permitted under section 409A of the Code and any regulatory guidance promulgated thereunder, a change in the ownership or effective control of the Company, or in the ownership of a substantial portion of the assets of the Company; or (vi) the occurrence of an Unforeseeable Emergency. (b) The acceleration of the time or schedule of any payment under the Plan shall not be permitted unless permitted by the Administrator in accordance with the requirements of section 409A of the Code and any regulatory guidance promulgated thereunder. 5.5 Accounts and Earnings. The Company shall establish a Deferral Account for each Participant who has elected a deferral under Section 5.1 above, and its accounting records for the Plan with respect to each such Participant shall include a separate Deferral Account or subaccount for each deferral election of the Participant that could cause a payment made at a different time or in a different form from other payments of deferrals elected by the same Participant. Each Deferral Account balance shall reflect the Company's obligation to pay a deferred amount to a Participant or Beneficiary as provided in this Article V. Under procedures approved by the Committee and communicated to Participants, a Participant shall elect between the following two alternatives with respect to the deferred amounts at the same time that the Participant elects to defer the fees payable for a calendar year. Once made, a Participant's election for the method of payment may not be changed; however, a - 4 - Participant may make a different election with respect to amounts that the Participant elects to defer in subsequent periods. (1) Payment in Shares. Under this alternative, a Participant automatically shall be granted fully vested Restricted Stock Units pursuant to section 8 of the Company's 2004 Stock Incentive Plan in a number equal to (i) the amounts deferred hereunder, divided by (ii) the closing price of the Common Stock of the Company on the date the fees deferred pursuant to Section 5.1 hereof would otherwise have been payable. The Company shall issue a number of shares of Common Stock equal to the number of such Restricted Stock Units to one or more grantor trusts formed by the Company ("rabbi trusts") pursuant to Section 6.2 hereof. Any dividends paid on shares of the Common Stock of the Company issued to a rabbi trust shall be reinvested in Common Stock of the Company, which shall be credited to the Participant as additional Restricted Stock Units pursuant to sections 7(f) and 8 of the Company's 2004 Stock Incentive Plan. Notwithstanding the foregoing, the issuance of shares of Common Stock to a rabbi trust and the crediting of assumed earnings shall not mean that any deferred compensation promise to a Participant is secured by particular investment assets or that the Participant is actually earning any form of investment income under the Plan. The Restricted Stock Units shall be settled in shares of Common Stock of the Company and shall be paid in a lump sum by the end of February in the year immediately following the Participant's Termination. (2) Issuance of Stock Options Under Company's Stock Incentive Plan. Under this alternative, a Participant automatically shall be granted fully vested Nonqualified Stock Options pursuant to section 8 of the Company's 2004 Stock Incentive Plan. A Participant who elects this alternative shall, on the date the fees deferred pursuant to Section 5.1 hereof would otherwise have been payable, automatically be granted a number of Nonqualified Stock Options with a fair market value equal to the amounts deferred, as determined under the valuation method used by the Company to value stock options at the time of the deferral. The award of Restricted Stock Units and Nonqualified Stock Options shall be subject to all of the requirements of the Company's 2004 Stock Incentive Plan, including without limitation the limits on authorized shares and individual awards, and the terms and conditions of an individual Restricted Stock Unit or Nonqualified Stock Option award agreement in a form approved by the Committee pursuant to its authority under the 2004 Stock Incentive Plan. 5.6 Maintenance of Accounts. The Accounts of each Participant shall be entered on the books of the Company and shall represent a liability, payable when due under this Plan, from the general assets of the Company. Prior to benefits becoming due hereunder, the Company shall expense the liability for such accounts in accordance with policies determined appropriate by the Company's auditors. Except to the extent provided under Section 5.5(1), the Accounts created for a Participant by the Company shall not be funded by a trust or an insurance contract; nor shall any assets of the Company be segregated or identified to such account; nor shall any property or assets of the Company be pledged, encumbered, or otherwise subjected to a lien or security interest for payment of benefits hereunder. - 5 - 5.7 Change in Control. In the event of a Change in Control (as defined below), the following rules shall apply: (a) All Participants shall continue to have a fully vested, nonforfeitable interest in their Deferral Accounts. (b) To the extent permitted under section 409A of the Code and any regulatory guidance issued thereunder, deferrals of amounts for the year that includes the Change in Control shall cease beginning with the first payment otherwise due that follows the Change in Control. (c) To the extent permitted under section 409A of the Code and any regulatory guidance issued thereunder, Restricted Stock Units shall be settled no later than 30 days following the Change in Control. (d) Subject to section 409A and any regulatory guidance promulgated thereunder, nothing in this Plan shall prevent a Participant from enforcing any rules in a contract or another plan of the Company or any subsidiary concerning the method of determining the amount of fees or other form of compensation to which a Participant may become entitled following a Change in Control, or the time at which that compensation is to be paid in the event of a Change in Control. For purposes of this Plan, a "Change in Control" means any of the following: (1) The acquisition by any individual, entity or group (within the meaning of Section 13(d) (3) or 14(d) (2) of the Securities Exchange Act of 1934, as amended (the "Exchange Act")) (a "Person") of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of 20% or more of either (i) the then outstanding shares of common stock of the Corporation (the "Outstanding Corporation Common Stock") or (ii) the combined voting power of the then outstanding voting securities of the Corporation entitled to vote generally in the election of directors (the "Outstanding Corporation Voting Securities"); provided, however, that for purposes of this paragraph (1), the following acquisitions shall not constitute a Change of Control: (i) any acquisition directly from the Company, (ii) any acquisition by the Company, (iii) any acquisition by any employee benefit plan (or related trust) sponsored or maintained by the Company or any corporation controlled by the Company, or (iv) any acquisition by any corporation pursuant to a transaction which complies with clauses (i), (ii) and (iii) of paragraph (3) hereof; or (2) Individuals who, as of December 9, 2004, constitute the Board (the "Incumbent Board") cease for any reason to constitute at least a majority of the Board; provided, however, that any individual becoming a director subsequent to such date whose election, or nomination for election by the Company's shareholders, was approved by a vote of at least a majority of - 6 - the directors then comprising the Incumbent Board shall be considered as though such individual were a member of the Incumbent Board, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of a Person other than the Board; or (3) Consummation of a reorganization, merger or consolidation, or sale or other disposition of all or substantially all of the assets of the Company (a "Business Combination"), in each case, unless, following such Business Combination, (i) all or substantially all of the individuals and entities who were the beneficial owners, respectively, of the Outstanding Corporation Common Stock and Outstanding Corporation Voting Securities immediately prior to such Business Combination beneficially own, directly or indirectly, more than 50% of, respectively, the then outstanding shares of common stock and the combined voting power of the then outstanding voting securities entitled to vote generally in the election of directors, as the case may be, of the corporation resulting from such Business Combination (including, without limitation, a corporation which as a result of such transaction owns the Company or all or substantially all of the Company's assets either directly or through one or more subsidiaries) in substantially the same proportions as their ownership, immediately prior to such Business Combination, of the Outstanding Corporation Common Stock and Outstanding Corporation Voting Securities, as the case may be, (ii) no Person (excluding any corporation resulting from such Business Combination or any employee benefit plan (or related trust) of the Company or such corporation resulting from such Business Combination) beneficially owns, directly or indirectly, 20% or more of, respectively, the then outstanding shares of common stock of the corporation resulting from such Business Combination or the combined voting power of the then outstanding voting securities of such corporation except to the extent that such ownership existed prior to the Business Combination and (iii) at least a majority of the members of the board of directors of the corporation resulting from such Business Combination were members of the Incumbent Board at the time of the execution of the initial agreement, or of the action of the Board, providing for such Business Combination; or (4) Approval by the shareholders of the Company of a complete liquidation or dissolution of the Company. A Change of Control shall occur on the first day on which any of the preceding conditions has been satisfied. However, notwithstanding the foregoing, this Section 5.7 shall not apply to any Participant who alone or together with one or - 7 - more other persons acting as a partnership, limited partnership, syndicate, or other group for the purpose of acquiring, holding or disposing of securities of the Company, triggers a "Change in Control" within the meaning of paragraphs (1) and (2) above. Moreover, no acquisition by (i) Charles Schwab and/or his spouse or any of his or her lineal descendants or (ii) any trust created by or for the benefit of Charles Schwab and/or his spouse or any of his lineal descendants or (iii) the Schwab Family Foundation shall constitute a Change of Control. 5.8 Payment of Deferred Amounts. A Participant shall have a fully vested, nonforfeitable interest in his or her Deferral Account balance at all times. However, vesting does not confer a right to payment other than as provided in the applicable Restricted Stock Unit or Nonqualified Stock Option Agreement. Article VI. General Provisions 6.1 Unfunded Obligation. The deferred amounts to be paid to Participants pursuant to this Plan constitute unfunded obligations of the Company. Except to the extent specifically provided hereunder, the Company is not required to segregate any monies from its general funds, to create any trusts, or to make any special deposits with respect to this obligation. Title to and beneficial ownership of any investments, including any grantor trust investments which the Company has determined and directed the Administrator to make to fulfill obligations under this Plan shall at all times remain in the Company. Any investments and the creation or maintenance of any trust or Accounts shall not create or constitute a trust or a fiduciary relationship between the Administrator or the Company and a Participant, or otherwise create any vested or beneficial interest in any Participant or his or her Beneficiary or his or her creditors in any assets of the Company whatsoever. The Participants shall have no claim for any changes in the value of any assets which may be invested or reinvested by the Company in an effort to match its liabilities under this Plan. 6.2 Informal Funding Vehicles. To the extent required pursuant to Section 5.5(1), the Company shall arrange for the establishment and use of a grantor trust or other informal funding vehicle to facilitate the payment of benefits and to discharge the liability of the Company and participating Affiliates under this Plan to the extent of payments actually made from such trust or other informal funding vehicle. In addition, the Company may, but need not, arrange for the establishment and use of such a grantor trust or other informal funding vehicle to the extent otherwise permitted pursuant to the Plan. Any investments and any creation or maintenance of memorandum accounts or a trust or other informal funding vehicle shall not create or constitute a trust or a fiduciary relationship between the Committee or the Company or an affiliate and a Participant, or otherwise confer on any Participant or Beneficiary or his or her creditors a vested or beneficial interest in any assets of the Company or any Affiliate whatsoever. Participants and Beneficiaries shall have no claim against the Company or any Affiliate for any changes in the value of any assets which may be invested or reinvested by the Company or any Affiliate with respect to this Plan. - 8 - 6.3 Beneficiary. The term "Beneficiary" shall mean the person or persons to whom payments are to be paid pursuant to the terms of the Plan in the event of the Participant's death. A Participant may designate a Beneficiary by following the procedures established by the Administrator, executed by the Participant, and delivered to the Administrator. The Administrator may require the consent of the Participant's spouse to a designation if the designation specifies a Beneficiary other than the spouse. Subject to the foregoing, a Participant may change a Beneficiary designation at any time. Subject to the property rights of any prior spouse, if no Beneficiary is designated, if the designation is ineffective, or if the Beneficiary dies before the balance of the Account is paid, the balance shall be paid to the Participant's surviving spouse, or if there is no surviving spouse, to the Participant's estate. 6.4 Incapacity of Participant or Beneficiary. Every person receiving or claiming benefits under the Plan shall be conclusively presumed to be mentally competent and of age until the date on which the Administrator receives a written notice, in a form and manner acceptable to the Administrator, that such person is incompetent or a minor, for whom a guardian or other person legally vested with the care of his or her person or estate has been appointed; provided, however, that if the Administrator finds that any person to whom a benefit is payable under the Plan is unable to care for his or her affairs because of incompetency, or because he or she is a minor, any payment due (unless a prior claim therefor shall have been made by a duly appointed legal representative) may be paid to the spouse, a child, a parent, a brother or sister, or to any person or institution considered by the Administrator to have incurred expense for such person otherwise entitled to payment. To the extent permitted by law, any such payment so made shall be a complete discharge of liability therefor under the Plan. If a guardian of the estate of any person receiving or claiming benefits under the Plan is appointed by a court of competent jurisdiction, benefit payments may be made to such guardian provided that proper proof of appointment and continuing qualification is furnished in a form and manner acceptable to the Administrator. In the event a person claiming or receiving benefits under the Plan is a minor, payment may be made to the custodian of an account for such person under the Uniform Gifts to Minors Act. To the extent permitted by law, any such payment so made shall be a complete discharge of any liability therefor under the Plan. 6.5 Nonassignment. The right of a Participant or Beneficiary to the payment of any amounts under the Plan may not be assigned, transferred, pledged or encumbered nor shall such right or other interests be subject to attachment, garnishment, execution, or other legal process. 6.6 No Right to Continued Service. Nothing in the Plan shall be construed to confer upon any Participant any right to continue as a Director of the Company. 6.7 Tax Withholding. Any appropriate taxes shall be withheld from payments made to Participants pursuant to the Plan. To the extent tax withholding is payable in connection with the Participant's deferral of income rather than in connection with the payment of deferred amounts, such withholding may be made from amounts currently payable to the Participant, or, as determined by the Administrator, the amount of the deferral elected by the Participant may be reduced in order to satisfy required tax withholding for any applicable taxes. - 9 - 6.8 Claims Procedure and Arbitration. The Administrator shall establish a reasonable claims procedure. Following a Change in Control of the Company (as determined under Section 5.7) the claims procedure shall include the following arbitration procedure. Since time will be of the essence in determining whether any payments are due to the Participant under this Plan following a Change in Control, a Participant may submit any claim for payment to arbitration as follows: On or after the second day following the Termination or other event triggering a right to payment, the claim may be filed with an arbitrator of the Participant's choice by submitting the claim in writing and providing a copy to the Company. The arbitrator must be: (a) a member of the National Academy of Arbitrators or one who currently appears on arbitration panels issued by the Federal Mediation and Conciliation Service or the American Arbitration Association; or (b) a retired judge of the State in which the claimant is a resident who served at the appellate level or higher. The arbitration hearing shall be held within 72 hours (or as soon thereafter as possible) after filing of the claim unless the Participant and the Company agree to a later date. No continuance of said hearing shall be allowed without the mutual consent of the Participant and the Company. Absence from or nonparticipation at the hearing by either party shall not prevent the issuance of an award. Hearing procedures which will expedite the hearing may be ordered at the arbitrator's discretion, and the arbitrator may close the hearing in his or her sole discretion upon deciding he or she has heard sufficient evidence to satisfy issuance of an award. In reaching a decision, the arbitrator shall have no authority to ignore, change, modify, add to or delete from any provision of this Plan, but instead is limited to interpreting this Plan. The arbitrator's award shall be rendered as expeditiously as possible, and unless the arbitrator rules within seven days after the close of the hearing, he will be deemed to have ruled in favor of the Participant. If the arbitrator finds that any payment is due to the Participant from the Company, the arbitrator shall order the Company to pay that amount to the Participant within 48 hours after the decision is rendered. The award of the arbitrator shall be final and binding upon the Participant and the Company. Judgment upon the award rendered by the arbitrator may be entered in any court in any State of the United States. In the case of any arbitration regarding this Agreement, the Participant shall be awarded the Participant's costs, including attorney's fees. Such fee award may not be offset against the deferred compensation due hereunder. The Company shall pay the arbitrator's fee and all necessary expenses of the hearing, including stenographic reporter if employed. 6.9 Termination and Amendment. The Committee may from time to time amend, suspend or terminate the Plan, in whole or in part, and if the Plan is suspended or terminated, the Committee may reinstate any or all of its provisions. The Executive Vice President - Human - 10 - Resources has the authority to amend the Plan to comply with the requirements of the Code, to avoid a plan failure under section 409A of the Code and to facilitate administration of the Plan to the extent that any such amendments will not materially increase the cost of the Plan. Except as otherwise required by law, the Committee may delegate to the Administrator all or any of its foregoing powers to amend, suspend, or terminate the Plan. Any such amendment, suspension, or termination may affect future deferrals without the consent of any Participant or Beneficiary. However, with respect to deferrals that have already occurred, no amendment, suspension or termination may impair the right of a Participant or a designated Beneficiary to receive payment of the related deferred compensation in accordance with the terms of the Plan prior to the effective date of such amendment, suspension or termination, unless the affected Participant or Beneficiary gives his or her express written consent to the change; provided that such consent shall not be required if an amendment is required to avoid a plan failure under section 409A of the Code. 6.10 Applicable Law. The Plan shall be construed and governed in accordance with applicable federal law and, to the extent not preempted by such federal law, the laws of the State of California to the extent the application of such state laws would not result in the taxation of amounts deferred under the Plan until such amounts are distributed to participants under the Plan. Article VII. General Provisions To record the adoption of the Plan to read as set forth herein effective as of December 9, 2004, The Charles Schwab Corporation has caused its authorized officer to execute the same this 21st day of December, 2004. THE CHARLES SCHWAB CORPORATION By: /s/ Christopher V. Dodds -------------------------- Its: Chief Financial Officer - 11 - EX-10 5 exh10_266.txt EXHIBIT 10.266 Exhibit 10.266 THE CHARLES SCHWAB CORPORATION 2004 STOCK INCENTIVE PLAN NOTICE OF RESTRICTED STOCK AWARD You have been granted restricted shares of Common Stock of The Charles Schwab Corporation ("Schwab") under the Charles Schwab Corporation 2004 Stock Incentive Plan (the "Plan") on the following terms: Name of Recipient: ______________________________ Total Number of Shares Granted: ______________________________ Fair Market Value per Share $____________ Total Fair Market Value of Award: $____________ Date of Grant: __________ ___, _________ Vesting Schedule: So long as you continue as a non-employee director or an employee of Schwab or its subsidiaries and subject to the terms of the Restricted Stock Agreement, the restricted shares subject to this award will become vested on the following dates and in the following amounts. Percentage of the Total Number of Shares Vesting Date Granted under this Award That Will Vest ------------------------------------------------------------------------- 1st Anniversary of Grant Date 25% 2nd Anniversary of Grant Date 25% 3rd Anniversary of Grant Date 50% You and Schwab agree that this award is granted under and governed by the terms and conditions of the Plan and the Restricted Stock Agreement, both of which are made a part of this notice. Please review the Restricted Stock Agreement carefully, as it explains the terms and conditions of this award. You agree that Schwab may deliver electronically all documents relating to the Plan or this award (including, without limitation, prospectuses required by the Securities and Exchange Commission) and all other documents that Schwab is required to deliver to its stockholders. Unless you provide written objection to Schwab within 30 days of your receipt of this notice, you agree to all of the terms and conditions of this notice, the restricted stock agreement and the Plan. THE CHARLES SCHWAB CORPORATION 2004 STOCK INCENTIVE PLAN RESTRICTED STOCK AGREEMENT Payment for No payment is required for the shares that you are receiving. Shares Vesting The shares become vested in installments as described in the Notice of Restricted Stock Award. If you become a common-law employee of Schwab or its subsidiaries, then the shares will continue to vest as described in the Notice of Restricted Stock Award so long as you continue as either a non-employee director or an employee of Schwab or its subsidiaries. Accelerated The shares will become fully vested if your service as a Vesting non-employee director terminates on account of your death, disability or retirement. If, prior to the date your service terminates, Schwab is subject to a "change in control" (as defined in the Plan document), the shares will become fully vested. Section 83(b) You may make an election pursuant to Section 83(b) of the Election Internal Revenue Code. Definition of For all purposes of this Agreement, "disability" means that Disability you are unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which has lasted, or can be expected to last, for a continuous period of not less than 12 months or which can be expected to result in death. Definition of For all purposes of this Agreement, "retirement" means your Retirement resignation or removal from the Board at any time after you have attained age 70 or completed 5 years of service as a non-employee director. Shares Restricted Unvested shares will be considered "Restricted Shares." You may not sell, transfer, pledge or otherwise dispose of any Restricted Shares without Schwab's written consent until they are vested. Restricted Shares will be issued in your name but held by the Schwab Corporate Secretary as escrow agent. Schwab may instruct the transfer agent for its stock to place a legend on the certificates representing the Restricted Shares or may note in its records the applicable restrictions. The escrow agent will deliver Restricted Shares to you only after they become vested and after all other terms and conditions in this Agreement have been satisfied. You may gift Restricted Shares to your spouse, children or grandchildren or to a trust established by you for the benefit of yourself or your spouse, children or grandchildren. However, a transferee of Restricted Shares must agree in writing on a form prescribed by Schwab to be bound by all provisions of this Agreement. Forfeiture If your service terminates for any reason, then your shares will be forfeited to the extent that they have not vested before the termination date and do not vest as a result of the termination. This means that the Restricted Shares will immediately revert to Schwab. You receive no payment for Restricted Shares that are forfeited. Schwab determines when your service terminates for this purpose. Committee In its sole discretion the Compensation Committee of the Discretion Schwab Board of Directors may lift the transfer restrictions or accelerate the vesting of Restricted Shares at any time. Delivery of In the event of your death prior to the date your service Shares After terminates, your shares will be delivered to your beneficiary Death or beneficiaries. You may designate one or more beneficiaries by filing a beneficiary designation form. You may change your beneficiary designation by filing a new form with Schwab at any time prior to your death. If you do not designate a beneficiary or if your designated beneficiary predeceases you, then any shares will be delivered after your death to your estate. The Compensation Committee, in its sole discretion, will determine the form and time of the distribution of shares to your beneficiary or estate. Restrictions on You agree not to sell any shares at a time when applicable Resale laws, Schwab's policies or an agreement between Schwab and its underwriters prohibit a sale. This restriction will apply as long as your service continues and for such period of time after the termination of your service as Schwab may specify. Stockholder As a holder of Restricted Shares, you have the same voting, Rights dividend and other rights as Schwab's stockholders. Contribution of On your behalf Schwab will contribute to its capital an Par Value amount equal to the par value of the Restricted Shares issued to you. No Right to Nothing in this Agreement will be construed as giving you the Remain Director right to be retained as a non-employee director or an or Employee employee of Schwab and its subsidiaries. Limitation on If a payment from the Plan would constitute an excess Payments parachute payment or if there have been certain securities law violations, then your award may be reduced or forfeited and you may be required to disgorge any profit that you have realized from your award. If a disqualified individual receives a payment or transfer under the Plan that would constitute an excess parachute payment under the Internal Revenue Code of 1986, as amended (the "Code"), such payment will be reduced, as described below. Generally, someone is a "disqualified individual" if he or she is (a) an officer of Schwab, (b) a member of the group consisting of the highest paid 1% of the employees of Schwab or, if less, the highest paid 250 employees of Schwab, or (c) a 1% stockholder of Schwab. For purposes of the section on "Limitation on Payments," the term "Schwab" will include affiliated corporations to the extent determined by the Auditors in accordance with section 280G(d)(5) of the Code. In the event that the independent auditors most recently selected by the Schwab Board of Directors (the "Auditors") determine that any payment or transfer in the nature of compensation to or for your benefit, whether paid or payable (or transferred or transferable) pursuant to the terms of the 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 will be reduced (but not below zero) to the Reduced Amount; provided, however, that the Compensation Committee may specify in writing that the award will not be so reduced and will not be subject to reduction under this section. For this purpose, the "Reduced Amount" will 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 Schwab because of section 280G of the Code. If the Auditors determine that any Payment would be nondeductible because of section 280G of the Code, then Schwab will promptly give you notice to that effect and a copy of the detailed calculation and of the Reduced Amount. You may then elect, in your discretion, which and how much of the Payments will be eliminated or reduced (as long as after such election, the aggregate present value of the Payments equals the Reduced Amount). You will advise Schwab in writing of your election within 10 days of receipt of the notice. If you do not make such an election within the 10-day period, then Schwab may elect which and how much of the Payments will be eliminated or reduced (as long as after such election the aggregate present value of the Payments equals the Reduced Amount). Schwab will notify you promptly of its election. Present value will be determined in accordance with section 280G(d)(4) of the Code. The Auditors' determinations will be binding upon you and Schwab and will be made within 60 days of the date when a Payment becomes payable or transferable. As promptly as practicable following these determination and elections, Schwab will pay or transfer to or for your benefit such amounts as are then due to you under the Plan, and will promptly pay or transfer to or for your benefit in the future such amounts as become due to you under the Plan. As a result of uncertainty in the application of section 280G of the Code at the time of an initial determination by the Auditors, it is possible that Payments will have been made by Schwab which should not have been made (an "Overpayment") or that additional Payments which will not have been made by Schwab could have been made (an "Underpayment"), consistent in each case with the calculation of the Reduced Amount. In the event that the Auditors, based upon the assertion of a deficiency by the Internal Revenue Service against you or Schwab which the Auditors believe has a high probability of success, determine that an Overpayment has been made, such Overpayment will be treated for all purposes as a loan to you which you will repay to Schwab on demand, together with interest at the applicable federal rate provided in section 7872(f)(2) of the Code. However, no amount will be payable by you to Schwab 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 will promptly be paid or transferred by Schwab to or for your benefit, together with interest at the applicable federal rate provided in section 7872(f)(2) of the Code. Claims Procedure You may file a claim for benefits under the Plan by following the procedures prescribed by Schwab. If your claim is denied, generally you will receive written or electronic notification of the denial within 90 days of the date on which you filed the claim. If special circumstances require more time to make a decision about your claim, you will receive notification of when you may expect a decision. You may appeal the denial by submitting to the Plan Administrator a written request for review within 30 days of receiving notification of the denial. Your request should include all facts upon which your appeal is based. Generally, the Plan Administrator will provide you with written or electronic notification of its decision within 90 days after receiving the review request. If special circumstances require more time to make a decision about your request, you will receive notification of when you may expect a decision. The Plan Administrator has discretionary authority to construe the terms of the Plan and this Agreement and its determinations are conclusive and binding on all persons. Adjustments In the event of a stock split, a stock dividend or a similar change in Schwab stock, the number of Restricted Shares that remain subject to forfeiture may be adjusted accordingly. Severability In the event that any provision of this Agreement is held invalid or unenforceable, the provision will be severable from, and such invalidity or unenforceability will not be construed to have any effect on, the remaining provisions of this Agreement. Applicable Law This Agreement will be interpreted and enforced under the laws of the State of California (without regard to their choice-of-law provisions), as such laws are applied to contracts entered into and performed in California. The Plan and The text of the Plan is incorporated in this Agreement by Other Agreements reference. This Agreement and the Plan constitute the entire understanding between you and Schwab regarding this award. Any prior agreements, commitments or negotiations concerning this award are superseded. This Agreement may be amended only by another written agreement, signed by both parties. If there is any inconsistency or conflict between any provision of this Agreement and the Plan, the terms of the Plan will control. BY ACCEPTING THIS AWARD, YOU AGREE TO ALL OF THE TERMS AND CONDITIONS DESCRIBED ABOVE AND IN THE PLAN. EX-10 6 exh10_267.txt EXHIBIT 10.267 Exhibit 10.267 THE CHARLES SCHWAB CORPORATION 2004 STOCK INCENTIVE PLAN NOTICE OF RESTRICTED STOCK UNIT AWARD You have been granted the following restricted stock units representing shares of Common Stock of The Charles Schwab Corporation ("Schwab") under the Charles Schwab Corporation 2004 Stock Incentive Plan (the "Plan"): Name of Grantee: _________________________________ Total Number of Units Granted: _________________________________ Grant Date: __________ ___, _________ You and Schwab agree that these units are granted under and governed by the terms and conditions of the Plan, The Charles Schwab Corporation Directors' Deferred Compensation Plan and the Restricted Stock Unit Agreement, which are made a part of this notice. Please review the Restricted Stock Unit Agreement carefully, as it explains the terms and conditions of these units. You agree that Schwab may deliver electronically all documents relating to the Plan or these units (including, without limitation, prospectuses required by the Securities and Exchange Commission) and all other documents that Schwab is required to deliver to its stockholders. Unless you provide written objection to Schwab within 30 days of your receipt of this notice, you agree to all of the terms and conditions of this notice, the restricted stock unit agreement and the Plan. THE CHARLES SCHWAB CORPORATION 2004 STOCK INCENTIVE PLAN RESTRICTED STOCK UNIT AGREEMENT Vesting These restricted stock units have been issued under the Plan pursuant to your deferral election under The Charles Schwab Corporation Directors' Deferred Compensation Plan (the "Deferred Compensation Plan") and are fully vested and non-forfeitable at all times. Nature of Units Your units are mere bookkeeping entries. They represent only Schwab's unfunded and unsecured promise to issue shares of Schwab Common Stock on a future date. As a holder of units, you have no rights other than the rights of a general creditor of Schwab. Voting Rights and Your units carry no voting rights. Any dividends paid on Dividend Rights shares of Schwab Common Stock shall be credited to you as additional Restricted Stock Units. Otherwise, you have no rights as a Schwab stockholder until your units are settled by issuing shares of Schwab Common Stock. Settlement of Your units will be settled in accordance with the terms of Units the Deferred Compensation Plan. At the time of settlement, you will receive one share of Schwab's Common Stock for each unit. Other Terms and Your units will be governed by all of the applicable terms Conditions and conditions of the Deferred Compensation Plan, which are made part of this Agreement. Restrictions on You agree not to sell any shares at a time when applicable Resale laws, Schwab policies or an agreement between Schwab and its underwriters prohibit a sale. This restriction will apply as long as your service continues and for such period of time after the termination of your service as Schwab may specify. Adjustments In the event of a stock split, a stock dividend or a similar change in Schwab stock, the number of your units will be adjusted accordingly, as Schwab may determine pursuant to the Plan. The Plan and The text of the Plan and the Deferred Compensation Plan (the Other Agreements "Plans") are incorporated in this Agreement by reference. This Agreement and the Plans constitute the entire understanding between you and Schwab regarding these units. Any prior agreements, commitments or negotiations concerning these units are superseded. This Agreement may be amended only by another written agreement, signed by both parties. If there is any inconsistency or conflict between any provision of this Agreement and the Plans, the terms of the Plans will control. BY ACCEPTING THIS AWARD, YOU AGREE TO ALL OF THE TERMS AND CONDITIONS DESCRIBED ABOVE AND IN THE PLAN. - 1 - EX-10 7 exh10_268.txt EXHIBIT 10.268 Exhibit 10.268 THE CHARLES SCHWAB CORPORATION 2004 STOCK INCENTIVE PLAN NOTICE OF STOCK OPTION GRANT You have been granted the following option to purchase Common Stock of The Charles Schwab Corporation ("Schwab") under the Charles Schwab Corporation 2004 Stock Incentive Plan (the "Plan"): Name of Grantee: ________________________________ Total Number of Shares Granted: ________________________________ Exercise Price Per Share: $_____________ Grant Date: __________ ___, _________ Expiration Date: __________ ___, _________ Vesting Schedule: So long as you continue as a non-employee director or an employee of Schwab or its subsidiaries and subject to the terms of the Stock Option Agreement, you will acquire the right to exercise this option (become "vested" in this option) on the following dates and in the following amounts. Percentage of the Total Number of Shares Vesting Date Granted under this Option That Will Vest ----------------------------------------------------------------------- 1st Anniversary of Grant Date 25% 2nd Anniversary of Grant Date 25% 3rd Anniversary of Grant Date 50% You and Schwab agree that this option is granted under and governed by the terms and conditions of the Plan and the Stock Option Agreement, both of which are made a part of this notice. Please review the Stock Option Agreement carefully, as it explains the terms and conditions of this option. You agree that Schwab may deliver electronically all documents relating to the Plan or this option (including, without limitation, prospectuses required by the Securities and Exchange Commission) and all other documents that Schwab is required to deliver to its stockholders. Unless you provide written objection to Schwab within 30 days of your receipt of this notice, you agree to all of the terms and conditions of this notice, the stock option agreement and the Plan. THE CHARLES SCHWAB CORPORATION 2004 STOCK INCENTIVE PLAN STOCK OPTION AGREEMENT Tax Treatment This option is a non-qualified stock option and is not intended to qualify as an incentive stock option under federal tax laws. Vesting This option becomes vested in installments as described in the Notice of Stock Option Grant. If you become a common-law employee of Schwab or its subsidiaries, then this option will continue to vest as described in the Notice of Stock Option Grant so long as you continue as either a non-employee director or an employee of Schwab or its subsidiaries. Accelerated This option will become fully exercisable if your service as Vesting a non-employee director terminates on account of your death, disability or retirement. If, prior to the date your service terminates, Schwab is subject to a "change in control" (as defined in the Plan document), this option will become fully exercisable immediately preceding the change in control. If the Committee determines that a change in control is likely to occur, Schwab will advise you and this option will become fully exercisable as of the date 10 days prior to the anticipated date of the change in control. Definition of For all purposes of this Agreement, "disability" means that Disability you are unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which has lasted, or can be expected to last, for a continuous period of not less than 12 months or which can be expected to result in death. Definition of For all purposes of this Agreement, "retirement" means your Retirement resignation or removal from the Board at any time after you have attained age 70 or completed 5 years of service as a non-employee director. Exercise You or your representative may exercise this option by Procedures following the procedures prescribed by Schwab. If this option is being exercised by your representative, your representative must furnish proof satisfactory to Schwab of your representative's right to exercise this option. After completing the prescribed procedures, Schwab will cause to be issued the shares purchased, which will be registered in the name of the person exercising this option. Forms of Payment When you submit your notice of exercise, you must include payment of the option exercise price for the shares you are purchasing. Payment may be made in one of the following forms: o Cash, your personal check, a cashier's check or a money order. o Shares of Schwab stock that are surrendered to Schwab. These shares will be valued at their fair market value on the date when the new shares are purchased. o By delivery (in a manner prescribed by Schwab) of an irrevocable direction to Charles Schwab & Co., Inc. to sell shares of Schwab stock (including shares to be issued upon exercise of this option) and to deliver all or part of the sale proceeds to Schwab in payment of all or part of the exercise price. Term This option expires no later than the 10th anniversary of the Grant Date but may expire earlier upon your termination of service, as described below. Termination of This option will expire on the date three months following Service as a the date of your termination of service as a non-employee Non-Employee director if such service terminates for any reason other Director than on account of becoming a common-law employee of Schwab or its subsidiaries, death, disability or retirement. The terms "disability" and "retirement" are defined above. If you become an employee of Schwab or its subsidiaries, this option will expire on the date three months following the date you cease to be an employee of Schwab and its subsidiaries (other than by reason of disability, death or retirement). If you cease to be a non-employee director or an employee of Schwab and its subsidiaries by reason of your disability or death, then this option will expire on the first anniversary of the date of your death or disability. If you cease to be a non-employee director by reason of your retirement, then this option will expire on the second anniversary of the date of your retirement. Restrictions on You cannot exercise this option and no shares of Schwab Exercise and stock may be issued under this option if the issuance of Issuance or shares at that time would violate any applicable law, Transfer of regulation or rule. Schwab may impose restrictions upon the Shares sale, pledge or other transfer of shares (including the placement of appropriate legends on stock certificates) if, in the judgment of Schwab and its counsel, such restrictions are necessary or desirable to comply with applicable law, regulations or rules. Stockholder You, or your estate or heirs, have no rights as a Rights stockholder of Schwab until you have exercised this option by giving the required notice to the Company and paying the exercise price. No adjustments are made for dividends or other rights if the applicable record date occurs before you exercise this option, except as described in the Plan. No Right to Nothing in this Agreement will be construed as giving you Remain Director the right to be retained as a director or an employee of or Employee Schwab and its subsidiaries. Transfer of In general, only you may exercise this option prior to your Option death. You may not transfer or assign this option, except as provided below. For instance, you may not sell this option or use it as security for a loan. If you attempt to do any of these things, this option will immediately become invalid. You may, however, dispose of this option in your will or in a beneficiary designation. You may transfer this option as a gift to one or more family members. For this purpose, "family member" means a child, stepchild, grandchild, parent, stepparent, grandparent, spouse, former spouse, sibling, niece, nephew, mother-in-law, father-in-law, son-in-law, daughter-in-law, brother-in-law or sister-in-law (including adoptive relationships), any individual sharing your household (other than a tenant or employee), a trust in which one or more of these individuals have more than 50% of the beneficial interest, a foundation in which you or one or more of these persons control the management of assets, and any entity in which you or one or more of these persons own more than 50% of the voting interest. Schwab may, in its sole discretion, allow you to transfer this option under a domestic relations order in settlement of marital or domestic property rights. In order to transfer this option, you and the transferee(s) must execute the forms prescribed by Schwab, which include the consent of the transferee(s) to be bound by this Agreement. Limitation on If a payment from the Plan would constitute an excess Payments parachute payment or if there have been certain securities law violations, then your award may be reduced or forfeited and you may be required to disgorge any profit that you have realized from your award. If a disqualified individual receives a payment or transfer under the Plan that would constitute an excess parachute payment under the Internal Revenue Code of 1986, as amended (the "Code"), such payment will be reduced, as described below. Generally, someone is a "disqualified individual" if he or she is (a) an officer of Schwab, (b) a member of the group consisting of the highest paid 1% of the employees of Schwab or, if less, the highest paid 250 employees of Schwab, or (c) a 1% stockholder of Schwab. For purposes of the section on "Limitation on Payments," the term "Schwab" will include affiliated corporations to the extent determined by the Auditors in accordance with section 280G(d)(5) of the Code. In the event that the independent auditors most recently selected by the Schwab Board of Directors (the "Auditors") determine that any payment or transfer in the nature of compensation to or for your benefit, whether paid or payable (or transferred or transferable) pursuant to the terms of the 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 will be reduced (but not below zero) to the Reduced Amount; provided, however, that the Compensation Committee may specify in writing that the award will not be so reduced and will not be subject to reduction under this section. For this purpose, the "Reduced Amount" will 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 Schwab because of section 280G of the Code. If the Auditors determine that any Payment would be nondeductible because of section 280G of the Code, then Schwab will promptly give you notice to that effect and a copy of the detailed calculation and of the Reduced Amount. You may then elect, in your discretion, which and how much of the Payments will be eliminated or reduced (as long as after such election, the aggregate present value of the Payments equals the Reduced Amount). You will advise Schwab in writing of your election within 10 days of receipt of the notice. If you do not make such an election within the 10-day period, then Schwab may elect which and how much of the Payments will be eliminated or reduced (as long as after such election the aggregate present value of the Payments equals the Reduced Amount). Schwab will notify you promptly of its election. Present value will be determined in accordance with section 280G(d)(4) of the Code. The Auditors' determinations will be binding upon you and Schwab and will be made within 60 days of the date when a Payment becomes payable or transferable. As promptly as practicable following these determination and elections, Schwab will pay or transfer to or for your benefit such amounts as are then due to you under the Plan, and will promptly pay or transfer to or for your benefit in the future such amounts as become due to you under the Plan. As a result of uncertainty in the application of section 280G of the Code at the time of an initial determination by the Auditors, it is possible that Payments will have been made by Schwab which should not have been made (an "Overpayment") or that additional Payments which will not have been made by Schwab could have been made (an "Underpayment"), consistent in each case with the calculation of the Reduced Amount. In the event that the Auditors, based upon the assertion of a deficiency by the Internal Revenue Service against you or Schwab which the Auditors believe has a high probability of success, determine that an Overpayment has been made, such Overpayment will be treated for all purposes as a loan to you which you will repay to Schwab on demand, together with interest at the applicable federal rate provided in section 7872(f)(2) of the Code. However, no amount will be payable by you to Schwab 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 will promptly be paid or transferred by Schwab to or for your benefit, together with interest at the applicable federal rate provided in section 7872(f)(2) of the Code. Claims You may file a claim for benefits under the Plan by Procedure following the procedures prescribed by Schwab. If your claim is denied, generally you will receive written or electronic notification of the denial within 90 days of the date on which you filed the claim. If special circumstances require more time to make a decision about your claim, you will receive notification of when you may expect a decision. You may appeal the denial by submitting to the Plan Administrator a written request for review within 30 days of receiving notification of the denial. Your request should include all facts upon which your appeal is based. Generally, the Plan Administrator will provide you with written or electronic notification of its decision within 90 days after receiving the review request. If special circumstances require more time to make a decision about your request, you will receive notification of when you may expect a decision. The Plan Administrator has discretionary authority to construe the terms of the Plan and this Agreement and its determinations are conclusive and binding on all persons. Adjustments In the event of a stock split, a stock dividend or a similar change in Schwab stock, the Compensation Committee, in its discretion, may adjust the number of shares covered by this option and the exercise price per share. Severability In the event that any provision of this Agreement is held invalid or unenforceable, the provision will be severable from, and such invalidity or unenforceability will not be construed to have any effect on, the remaining provisions of this Agreement. Applicable Law This Agreement will be interpreted and enforced under the laws of the State of California (without regard to their choice-of-law provisions), as such laws are applied to contracts entered into and performed in California. The Plan and The text of the Plan is incorporated in this Agreement by Other Agreements reference. This Agreement and the Plan constitute the entire understanding between you and Schwab regarding this option. Any prior agreements, commitments or negotiations concerning this option are superseded. This Agreement may be amended only by another written agreement, signed by both parties. If there is any inconsistency or conflict between any provision of this Agreement and the Plan, the terms of the Plan will control. BY ACCEPTING THIS OPTION GRANT, YOU AGREE TO ALL OF THE TERMS AND CONDITIONS DESCRIBED ABOVE AND IN THE PLAN. EX-10 8 exh10_269.txt EXHIBIT 10.269 Exhibit 10.269 THE CHARLES SCHWAB CORPORATION 2004 STOCK INCENTIVE PLAN NOTICE OF STOCK OPTION GRANT You have been granted the following option to purchase Common Stock of The Charles Schwab Corporation ("Schwab") under the Charles Schwab Corporation 2004 Stock Incentive Plan (the "Plan"): Name of Grantee: _______________________________ Total Number of Shares Granted: _______________________________ Exercise Price Per Share: $______________________________ Grant Date: __________ ___, _________ Expiration Date: __________ ___, _________ Accelerated Vesting on Retirement: [Yes/No] Vesting Schedule: So long as you remain employed in good standing by Schwab or its subsidiaries and subject to the terms of the Nonqualified Stock Option Agreement, you will acquire the right to exercise this option (become "vested" in this option) on the following dates and in the following amounts: Percentage of the Total Number of Shares Vesting Date Granted under this Option That Will Vest ----------------------------------------------------------------------- 1st Anniversary of Grant Date 25% 2nd Anniversary of Grant Date 25% 3rd Anniversary of Grant Date 25% 4th Anniversary of Grant Date 25% You and Schwab agree that this option is granted under and governed by the terms and conditions of the Plan and the Nonqualified Stock Option Agreement, both of which are made a part of this notice. Please review the Nonqualified Stock Option Agreement and the Plan carefully, as they explain the terms and conditions of this option. You agree that Schwab may deliver electronically all documents relating to the Plan or this option (including, without limitation, prospectuses required by the Securities and Exchange Commission) and all other documents that Schwab is required to deliver to its stockholders. Unless you provide written objection to Schwab within 30 days of your receipt of this notice, you agree to all of the terms and conditions of this notice, the Nonqualified Stock Option Agreement and the Plan. THE CHARLES SCHWAB CORPORATION 2004 STOCK INCENTIVE PLAN NONQUALIFIED STOCK OPTION AGREEMENT Tax Treatment This option is a nonqualified stock option and is not intended to qualify as an incentive stock option under federal tax laws. Vesting This option becomes vested in installments as described in the Notice of Stock Option Grant. Accelerated This option will become fully exercisable if your service Vesting with Schwab and its subsidiaries terminates on account of your death or disability. If "Yes" appears next to "Accelerated Vesting on Retirement" in the Notice of Stock Option Grant, this option will become fully exercisable if your service with Schwab and its subsidiaries terminates on account of your retirement provided that your retirement occurs at least two years after the Grant Date indicated in the Notice of Stock Option Grant. If, prior to the date your service terminates, Schwab is subject to a "change in control" (as defined in the Plan document), this option will become fully exercisable immediately preceding the change in control. If the Committee determines that a change in control is likely to occur, Schwab will advise you and this option will become fully exercisable as of the date 10 days prior to the anticipated date of the change in control. Definition of For all purposes of this Agreement, "disability" means that Disability you have a disability such that you have been determined to be eligible for benefits under Schwab's long-term disability plan. Definition of For all purposes of this Agreement, "retirement" will mean: Retirement o any termination of employment with Schwab and its subsidiaries with the exception of U.S. Trust Corporation or its subsidiaries for any reason other than death at any time after you attain age 50, but only if, at the time of your termination, you have been credited with at least 7 years of service; and o any termination of employment from U.S. Trust Corporation or its subsidiaries for any reason other than death at any time after (1) you attain age 65, (2) the sum of your age and credited years of service, at the time of your termination, is equal to or greater than 80, or (3) you attain age 60, but only if, at the time of your termination, you have been credited with at least 10 years of service. The phrase "years of service" above has the same meaning given to it under the SchwabPlan Retirement Savings and Investment Plan (or any successor plan). Exercise You or your representative may exercise this option by Procedures following the procedures prescribed by Schwab. If this option is being exercised by your representative, your representative must furnish proof satisfactory to Schwab of your representative's right to exercise this option. After completing the prescribed procedures, Schwab will cause to be issued the shares purchased, which will be registered in the name of the person exercising this option. - 1 - Forms of When you submit your notice of exercise, you must include Payment payment of the option exercise price for the shares you are purchasing. Payment may be made in one of the following forms: o Cash, your personal check, a cashier's check or a money order. o Shares of Schwab stock that are surrendered to Schwab. These shares will be valued at their fair market value on the date when the new shares are purchased. o By delivery (in a manner prescribed by Schwab) of an irrevocable direction to Charles Schwab & Co., Inc. to sell shares of Schwab stock (including shares to be issued upon exercise of this option) and to deliver all or part of the sale proceeds to Schwab in payment of all or part of the exercise price. Term This option expires no later than the Expiration Date specified in the Notice of Stock Option Grant but may expire earlier upon your termination of service, as described below. Termination of This option will expire on the date three months following Service the date of your termination of employment with Schwab and its subsidiaries for any reason other than on account of death, disability or retirement. The terms "disability" and "retirement" are defined above. If you cease to be an employee of Schwab and its subsidiaries by reason of your disability or death, then this option will expire on the first anniversary of the date of your death or disability. If you cease to be an employee of Schwab and its subsidiaries by reason of your retirement, then this option will expire on the second anniversary of the date of your retirement. Effect of If you are entitled to severance benefits under Schwab's Entitlement to severance plan, then your "termination date" for purposes of Severance continued vesting and exercisability of this option with regard to any post-termination period will be determined under the terms of that plan. Cancellation of To the fullest extent permitted by applicable laws, this Options option will immediately be cancelled and expire in the event that Schwab terminates your employment on account of conduct contrary to the best interests of Schwab, including, without limitation, conduct constituting a violation of law or Schwab policy, fraud, theft, conflict of interest, dishonesty or harassment. The determination whether your employment has been terminated on account of conduct inimical to the best interests of Schwab shall be made by Schwab in its sole discretion. Restrictions on You cannot exercise this option and no shares of Schwab Exercise and stock may be issued under this option if the issuance of Issuance or shares at that time would violate any applicable law, Transfer of regulation or rule. Schwab may impose restrictions upon the Shares sale, pledge or other transfer of shares (including the placement of appropriate legends on stock certificates) if, in the judgment of Schwab and its counsel, such restrictions are necessary or desirable to comply with applicable law, regulations or rules. - 2 - Stockholder You, or your estate or heirs, have no rights as a Rights stockholder of Schwab until you have exercised this option by giving the required notice to Schwab and paying the exercise price. No adjustments are made for dividends or other rights if the applicable record date occurs before you exercise this option, except as described in the Plan. No Right to Nothing in this Agreement will be construed as giving you Employment the right to be retained as an employee, consultant or director of Schwab and its subsidiaries for any specific duration or at all. Transfer of In general, only you may exercise this option prior to your Option death. You may not transfer or assign this option, except as provided below. For instance, you may not sell this option or use it as security for a loan. If you attempt to do any of these things, this option will immediately become invalid. You may, however, dispose of this option in your will or in a beneficiary designation. You may transfer this option as a gift to one or more family members. For this purpose, "family member" means a child, stepchild, grandchild, parent, stepparent, grandparent, spouse, former spouse, sibling, niece, nephew, mother-in-law, father-in-law, son-in-law, daughter-in-law, brother-in-law or sister-in-law (including adoptive relationships), any individual sharing your household, e.g., a domestic partner, other than a tenant or employee, a trust in which one or more of these individuals have more than 50% of the beneficial interest, a foundation in which you or one or more of these persons control the management of assets, and any entity in which you or one or more of these persons own more than 50% of the voting interest. Schwab may, in its sole discretion, allow you to transfer this option under a domestic relations order in settlement of marital or domestic property rights. In order to transfer this option, you and the transferee(s) must execute the forms prescribed by Schwab, which include the consent of the transferee(s) to be bound by this Agreement. Limitation on If a payment from the Plan would constitute an excess Payments parachute payment or if there have been certain securities law violations, then your award may be reduced or cancelled and you may be required to disgorge any profit that you have realized from your award. If a disqualified individual receives a payment or transfer under the Plan that would constitute an excess parachute payment under the Internal Revenue Code of 1986, as amended (the "Code"), such payment will be reduced, as described below. Generally, someone is a "disqualified individual" if he or she is (a) an officer of Schwab, (b) a member of the group consisting of the highest paid 1% of the employees of Schwab or, if less, the highest paid 250 employees of Schwab, or (c) a 1% stockholder of Schwab. For purposes of the section on "Limitation on Payments," the term "Schwab" will include affiliated corporations to the extent determined by the Auditors in accordance with section 280G(d)(5) of the Code. - 3 - In the event that the independent auditors most recently selected by the Schwab Board of Directors (the "Auditors") determine that any payment or transfer in the nature of compensation to or for your benefit, whether paid or payable (or transferred or transferable) pursuant to the terms of the 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 will be reduced (but not below zero) to the Reduced Amount; provided, however, that the Compensation Committee may specify in writing that the award will not be so reduced and will not be subject to reduction under this section. For this purpose, the "Reduced Amount" will 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 Schwab because of section 280G of the Code. If the Auditors determine that any Payment would be nondeductible because of section 280G of the Code, then Schwab will promptly give you notice to that effect and a copy of the detailed calculation and of the Reduced Amount. You may then elect, in your discretion, which and how much of the Payments will be eliminated or reduced (as long as after such election, the aggregate present value of the Payments equals the Reduced Amount). You will advise Schwab in writing of your election within 10 days of receipt of the notice. If you do not make such an election within the 10-day period, then Schwab may elect which and how much of the Payments will be eliminated or reduced (as long as after such election the aggregate present value of the Payments equals the Reduced Amount). Schwab will notify you promptly of its election. Present value will be determined in accordance with section 280G(d)(4) of the Code. The Auditors' determinations will be binding upon you and Schwab and will be made within 60 days of the date when a Payment becomes payable or transferable. As promptly as practicable following these determination and elections, Schwab will pay or transfer to or for your benefit such amounts as are then due to you under the Plan, and will promptly pay or transfer to or for your benefit in the future such amounts as become due to you under the Plan. As a result of uncertainty in the application of section 280G of the Code at the time of an initial determination by the Auditors, it is possible that Payments will have been made by Schwab which should not have been made (an "Overpayment") or that additional Payments which will not have been made by Schwab could have been made (an "Underpayment"), consistent in each case with the calculation of the Reduced Amount. In the event that the Auditors, based upon the assertion of a deficiency by the Internal Revenue Service against you or Schwab which the Auditors believe has a high probability of success, determine that an Overpayment has been made, such Overpayment will be treated for all purposes as a loan to you which you will repay to Schwab on demand, together with interest at the applicable federal rate provided in section 7872(f)(2) of the Code. However, no amount will be payable by you to Schwab 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 will promptly be paid or transferred by Schwab to or for your benefit, together with interest at the applicable federal rate provided in section 7872(f)(2) of the Code. - 4 - Claims You may file a claim for benefits under the Plan by Procedure following the procedures prescribed by Schwab. If your claim is denied, generally you will receive written or electronic notification of the denial within 90 days of the date on which you filed the claim. If special circumstances require more time to make a decision about your claim, you will receive notification of when you may expect a decision. You may appeal the denial by submitting to the Plan Administrator a written request for review within 30 days of receiving notification of the denial. Your request should include all facts upon which your appeal is based. Generally, the Plan Administrator will provide you with written or electronic notification of its decision within 90 days after receiving the review request. If special circumstances require more time to make a decision about your request, you will receive notification of when you may expect a decision. Plan The Plan Administrator has discretionary authority to make Administration all determinations related to this option and to construe the terms of the Plan, the Notice of Stock Option Grant and this Agreement. The Plan Administrator's determinations are conclusive and binding on all persons. Right to If Schwab adopts the fair-value-based method of accounting Replace Option under FASB Statement No. 123, the Committee shall have the with SARs right to replace this option (or any portion of this option) to the extent outstanding with a Stock Appreciation Right subject to substantially the same terms and conditions contained in this Agreement to be settled in shares of Schwab stock on a one-to-one basis; provided, that this provision shall not become effective if it would cause Schwab to recognize compensation expense. Adjustments In the event of a stock split, a stock dividend or a similar change in Schwab stock, the Compensation Committee, in its discretion, may adjust the number of shares covered by this option and the exercise price per share. Severability In the event that any provision of this Agreement is held invalid or unenforceable, the provision will be severable from, and such invalidity or unenforceability will not be construed to have any effect on, the remaining provisions of this Agreement. Applicable Law This Agreement will be interpreted and enforced under the laws of the State of California (without regard to their choice-of-law provisions), as such laws are applied to contracts entered into and performed in California. The Plan and The text of the Plan is incorporated in this Agreement by Other Agreements reference. This Agreement and the Plan constitute the entire understanding between you and Schwab regarding this option. Any prior agreements, commitments or negotiations concerning this option are superseded. This Agreement may be amended only by another written agreement, signed by both parties. If there is any inconsistency or conflict between any provision of this Agreement and the Plan, the terms of the Plan will control. BY ACCEPTING THIS OPTION GRANT, YOU AGREE TO ALL OF THE TERMS AND CONDITIONS DESCRIBED ABOVE, IN THE NOTICE OF STOCK OPTION GRANT AND IN THE PLAN. - 5 - EX-10 9 exh10_270.txt EXHIBIT 10.270 Exhibit 10.270 THE CHARLES SCHWAB CORPORATION 2004 STOCK INCENTIVE PLAN NOTICE OF RESTRICTED STOCK AWARD You have been granted restricted shares of Common Stock of The Charles Schwab Corporation ("Schwab") under the Charles Schwab Corporation 2004 Stock Incentive Plan (the "Plan") on the following terms: Name of Recipient: ________________________________ Total Number of Shares Granted: ________________________________ Fair Market Value per Share: $____________ Total Fair Market Value of Award: $____________ Grant Date: ______ ___, _________ Accelerated Vesting on Retirement: [Yes/No] Vesting Schedule: So long as you remain employed in good standing by Schwab or its subsidiaries and subject to the terms of the Restricted Stock Agreement, the restricted shares subject to this award will become vested on the following dates and in the following amounts: Percentage of the Total Number of Shares Vesting Date Granted under this Award That Will Vest ----------------------------------------------------------------------- 1st Anniversary of Grant Date 25% 2nd Anniversary of Grant Date 25% 3rd Anniversary of Grant Date 25% 4th Anniversary of Grant Date 25% You and Schwab agree that this award is granted under and governed by the terms and conditions of the Plan and the Restricted Stock Agreement, both of which are made a part of this notice. Please review the Restricted Stock Agreement and the Plan carefully, as they explain the terms and conditions of this award. You agree that Schwab may deliver electronically all documents relating to the Plan or this award (including, without limitation, prospectuses required by the Securities and Exchange Commission) and all other documents that Schwab is required to deliver to its stockholders. Unless you provide written objection to Schwab within 30 days of your receipt of this notice, you agree to all of the terms and conditions of this notice, the Restricted Stock Agreement and the Plan. THE CHARLES SCHWAB CORPORATION 2004 STOCK INCENTIVE PLAN RESTRICTED STOCK AGREEMENT Payment for No payment is required for the shares that you are Shares receiving. Vesting This award becomes vested in installments as described in the Notice of Restricted Stock Award. Accelerated This award will become fully vested if your service with Vesting Schwab and its subsidiaries terminates on account of your death or disability. If "Yes" appears next to "Accelerated Vesting on Retirement" in the Notice of Restricted Stock Award, this award will become fully vested if your service with Schwab and its subsidiaries terminates on account of your retirement provided that your retirement occurs at least two years after the Grant Date indicated in the Notice of Restricted Stock Award. If, prior to the date your service terminates, Schwab is subject to a "change in control" (as defined in the Plan document), this award will become fully vested. Definition of For all purposes of this Agreement, "disability" means that Disability you have a disability such that you have been determined to be eligible for benefits under Schwab's long-term disability plan. Definition of For all purposes of this Agreement, "retirement" will mean: Retirement o any termination of employment with Schwab and its subsidiaries with the exception of U.S. Trust Corporation or its subsidiaries for any reason other than death at any time after you attain age 50, but only if, at the time of your termination, you have been credited with at least 7 years of service, and o any termination of employment from U.S. Trust Corporation or its subsidiaries for any reason other than death at any time after (1) you attain age 65, (2) the sum of your age and credited years of service, at the time of your termination, is equal to or greater than 80, or (3) you attain age 60, but only if, at the time of your termination, you have been credited with at least 10 years of service. The phrase "years of service" above has the same meaning given to it under the SchwabPlan Retirement Savings and Investment Plan (or any successor plan). Section 83(b) You may make an election pursuant to Section 83(b) of the Election Internal Revenue Code. - 1 - Shares Unvested shares will be considered "Restricted Shares." You Restricted may not sell, transfer, pledge or otherwise dispose of any Restricted Shares without Schwab's written consent until they are vested. Restricted Shares will be issued in your name but held by the Schwab Corporate Secretary as escrow agent. Schwab may instruct the transfer agent for its stock to place a legend on the certificates representing the Restricted Shares or may note in its records the applicable restrictions. The escrow agent will deliver Restricted Shares to you only after they become vested and after all other terms and conditions in this Agreement have been satisfied. You may gift Restricted Shares to your spouse, children or grandchildren or to a trust established by you for the benefit of yourself or your spouse, children or grandchildren. However, a transferee of Restricted Shares must agree in writing on a form prescribed by Schwab to be bound by all provisions of this Agreement. Forfeiture If your service terminates for any reason, then your shares will be forfeited to the extent that they have not vested before the termination date and do not vest as a result of the termination. This means that the Restricted Shares will immediately revert to Schwab. You receive no payment for Restricted Shares that are forfeited. Schwab determines when your service terminates for this purpose. Effect of If you are entitled to severance benefits under Schwab's Entitlement to severance plan, then your termination date for purposes of Severance continued vesting of this award with regard to any post-termination period will be determined under the terms of that plan. Committee In its sole discretion the Compensation Committee of the Discretion Schwab Board of Directors may lift the transfer restrictions or accelerate the vesting of Restricted Shares at any time. Delivery of In the event of your death prior to the date your service Shares After terminates, your shares will be delivered to your Death beneficiary or beneficiaries. You may designate one or more beneficiaries by filing a beneficiary designation form. You may change your beneficiary designation by filing a new form with Schwab at any time prior to your death. If you do not designate a beneficiary or if your designated beneficiary predeceases you, then any shares will be delivered after your death to your estate. The Compensation Committee, in its sole discretion, will determine the form and time of the distribution of shares to your beneficiary or estate. Restrictions on You agree not to sell any shares at a time when applicable Resale laws, Schwab's policies or an agreement between Schwab and its underwriters prohibit a sale. This restriction will apply as long as your service continues and for such period of time after the termination of your service as Schwab may specify. Stockholder As a holder of Restricted Shares, you have the same voting, Rights dividend and other rights as Schwab's stockholders. Contribution of On your behalf Schwab will contribute to its capital an Par Value amount equal to the par value of the Restricted Shares issued to you. No Right to Nothing in this Agreement will be construed as giving you Remain Employee the right to be retained as an employee, consultant or director of Schwab and its subsidiaries for any specific duration or at all. - 2 - Limitation on If a payment from the Plan would constitute an excess Payments parachute payment or if there have been certain securities law violations, then your award may be reduced or forfeited and you may be required to disgorge any profit that you have realized from your award. If a disqualified individual receives a payment or transfer under the Plan that would constitute an excess parachute payment under the Internal Revenue Code of 1986, as amended (the "Code"), such payment will be reduced, as described below. Generally, someone is a "disqualified individual" if he or she is (a) an officer of Schwab, (b) a member of the group consisting of the highest paid 1% of the employees of Schwab or, if less, the highest paid 250 employees of Schwab, or (c) a 1% stockholder of Schwab. For purposes of the section on "Limitation on Payments," the term "Schwab" will include affiliated corporations to the extent determined by the Auditors in accordance with section 280G(d)(5) of the Code. In the event that the independent auditors most recently selected by the Schwab Board of Directors (the "Auditors") determine that any payment or transfer in the nature of compensation to or for your benefit, whether paid or payable (or transferred or transferable) pursuant to the terms of the 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 will be reduced (but not below zero) to the Reduced Amount; provided, however, that the Compensation Committee may specify in writing that the award will not be so reduced and will not be subject to reduction under this section. For this purpose, the "Reduced Amount" will 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 Schwab because of section 280G of the Code. If the Auditors determine that any Payment would be nondeductible because of section 280G of the Code, then Schwab will promptly give you notice to that effect and a copy of the detailed calculation and of the Reduced Amount. You may then elect, in your discretion, which and how much of the Payments will be eliminated or reduced (as long as after such election, the aggregate present value of the Payments equals the Reduced Amount). You will advise Schwab in writing of your election within 10 days of receipt of the notice. If you do not make such an election within the 10-day period, then Schwab may elect which and how much of the Payments will be eliminated or reduced (as long as after such election the aggregate present value of the Payments equals the Reduced Amount). Schwab will notify you promptly of its election. Present value will be determined in accordance with section 280G(d)(4) of the Code. The Auditors' determinations will be binding upon you and Schwab and will be made within 60 days of the date when a Payment becomes payable or transferable. As promptly as practicable following these determination and elections, Schwab will pay or transfer to or for your benefit such amounts as are then due to you under the Plan, and will promptly pay or transfer to or for your benefit in the future such amounts as become due to you under the Plan. - 3 - As a result of uncertainty in the application of section 280G of the Code at the time of an initial determination by the Auditors, it is possible that Payments will have been made by Schwab which should not have been made (an "Overpayment") or that additional Payments which will not have been made by Schwab could have been made (an "Underpayment"), consistent in each case with the calculation of the Reduced Amount. In the event that the Auditors, based upon the assertion of a deficiency by the Internal Revenue Service against you or Schwab which the Auditors believe has a high probability of success, determine that an Overpayment has been made, such Overpayment will be treated for all purposes as a loan to you which you will repay to Schwab on demand, together with interest at the applicable federal rate provided in section 7872(f)(2) of the Code. However, no amount will be payable by you to Schwab 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 will promptly be paid or transferred by Schwab to or for your benefit, together with interest at the applicable federal rate provided in section 7872(f)(2) of the Code. Claims You may file a claim for benefits under the Plan by Procedure following the procedures prescribed by Schwab. If your claim is denied, generally you will receive written or electronic notification of the denial within 90 days of the date on which you filed the claim. If special circumstances require more time to make a decision about your claim, you will receive notification of when you may expect a decision. You may appeal the denial by submitting to the Plan Administrator a written request for review within 30 days of receiving notification of the denial. Your request should include all facts upon which your appeal is based. Generally, the Plan Administrator will provide you with written or electronic notification of its decision within 90 days after receiving the review request. If special circumstances require more time to make a decision about your request, you will receive notification of when you may expect a decision. Plan The Plan Administrator has discretionary authority to make Administration all determinations related to this award and to construe the terms of the Plan, the Notice of Restricted Stock Award and this Agreement. The Plan Administrator's determinations are conclusive and binding on all persons. Adjustments In the event of a stock split, a stock dividend or a similar change in Schwab stock, the number of Restricted Shares that remain subject to forfeiture may be adjusted accordingly. Severability In the event that any provision of this Agreement is held invalid or unenforceable, the provision will be severable from, and such invalidity or unenforceability will not be construed to have any effect on, the remaining provisions of this Agreement. Applicable Law This Agreement will be interpreted and enforced under the laws of the State of California (without regard to their choice-of-law provisions), as such laws are applied to contracts entered into and performed in California. - 4 - The Plan and The text of the Plan is incorporated in this Agreement by Other Agreements reference. This Agreement and the Plan constitute the entire understanding between you and Schwab regarding this award. Any prior agreements, commitments or negotiations concerning this award are superseded. This Agreement may be amended only by another written agreement, signed by both parties. If there is any inconsistency or conflict between any provision of this Agreement and the Plan, the terms of the Plan will control. BY ACCEPTING THIS RESTRICTED STOCK AWARD, YOU AGREE TO ALL OF THE TERMS AND CONDITIONS DESCRIBED ABOVE, IN THE NOTICE OF RESTRICTED STOCK AWARD AND IN THE PLAN. - 5 - EX-10 10 exh10_271.txt EXHIBIT 10.271 Exhibit 10.271 THE CHARLES SCHWAB CORPORATION DIRECTORS' DEFERRED COMPENSATION PLAN (As Amended through December 8, 2004) THE CHARLES SCHWAB CORPORATION DIRECTORS' DEFERRED COMPENSATION PLAN Article I. Purpose 1.1 Establishment of the Plan. Effective as of January 1, 1996, The Charles Schwab Corporation (hereinafter, the "Company") hereby establishes The Charles Schwab Corporation Directors' Deferred Compensation Plan (the "Plan"), as set forth in this document. Effective December 8, 2004, no further deferrals shall be permitted under the Plan except deferrals relating to payments earned prior to January 1, 2005. 1.2 Purpose of the Plan. The Plan permits Directors to defer the payment of directors' fees that they may earn. The opportunity to elect such deferrals is provided in order to help the Company attract and retain outside directors. This Plan is unfunded and is maintained primarily for the purpose of providing deferred compensation for its outside directors. It is intended to be exempt from the participation, vesting, funding, and fiduciary requirements set forth in Title I of the Employee Retirement Income Security Act of 1974, as amended. Article II. Definitions 2.1 Definitions. The following definitions are in addition to any other definitions set forth elsewhere in the Plan. Whenever used in the Plan, the capitalized terms in this section shall have the meanings set forth below unless otherwise required by the context in which they are used: (a) "Administrator" the administrator described in section 3.1 that is selected by the Committee to assist in the administration of the Plan. (b) "Beneficiary" means a person entitled to receive any benefit payments that remain to be paid after a Participant's death, as determined under section 6.3. (c) "Board" means the Board of Directors of the Company. (d) "Company" means The Charles Schwab Corporation, a Delaware corporation. (e) "Committee" means the Compensation Committee of the Board. - 1 - (f) "Deferral Account" means the account representing deferrals of cash compensation, plus investment adjustments, as described in sections 5.4 and 5.5. (g) "Director" means each member of the Board of the Directors who is not an employee of the Company or any of its subsidiaries. The term "Director" shall also include each member of the Board of Directors of any subsidiary of the Company who is not an employee of the Company or any of its subsidiaries, but only if the Committee has approved participation in the Plan for such subsidiary's non-employee directors. (h) "Plan" means The Charles Schwab Corporation Directors' Deferred Compensation Plan, as in effect from time to time. (i) "Plan Year" means the calendar year. (j) "Termination" means the date a Participant ceases to be a Director. (k) "Valuation Date" means each December 31 and any other date designated from time to time by the Committee for the purpose of determining the value of a Participant's Deferral Account balance pursuant to section 5.4. 2.2 Gender and Number. Except when otherwise indicated by the context, any masculine or feminine terminology shall also include the neuter and other gender, and the use of any term in the singular or plural shall also include the opposite number. Article III. Administration 3.1 Committee and Administrator. The Committee shall administer the Plan and may select one or more persons to serve as the Administrator. The Administrator shall perform such administrative functions as the Committee may delegate to it from time to time. Any person selected to serve as the Administrator may, but need not, be a Committee member or an officer or employee of the Company. However, if a person serving as Administrator or a member of the Committee is a Participant, such person may not vote on a matter affecting his interest as a Participant. - 2 - The Committee shall have discretionary authority to construe and interpret the Plan provisions and resolve any ambiguities thereunder; to prescribe, amend, and rescind administrative rules relating to the Plan; to determine eligibility for benefits under the Plan; and to take all other actions that are necessary or appropriate for the administration of the Plan. Such interpretations, rules, and actions of the Committee shall be final and binding upon all concerned and, in the event of judicial review, shall be entitled to the maximum deference allowable by law. Where the Committee has delegated its responsibility for matters of interpretation and Plan administration to the Administrator, the actions of the Administrator shall constitute actions of the Committee. Article IV. Participants 4.1 Participants. Each Director shall be eligible to participate in this Plan. Article V. Deferrals 5.1 Deferrals. Each Director may elect to defer up to 100 percent of the fees otherwise receivable from the Company for service as a Director. Any such election must be made by entering a deferred compensation agreement with the Company, as evidenced by a form approved by and filed with the Administrator on or before the deadline specified by the Committee (which shall be no earlier than one month prior to the beginning of the election period for which the deferred fees are to be earned; provided that for the first year in which the Plan is in effect, the deferral election shall be made within the first thirty days of the election period). For this purpose, the election period shall be the calendar year; provided, however, that during periods in which the Plan is not in effect for a full calendar year or a Director is not a Participant for a full calendar year, the election period shall be the portion of the calendar year during which the Plan is in effect and the Director is an eligible Participant. Deferrals that have been elected shall occur throughout the election period in pro rata increments. 5.2 Deferral Procedures. Participants shall have an opportunity to elect deferrals each year. Unless the Committee specifies other rules for the deferrals that may be elected, deferrals may be made in increments of 10 percent or in a fixed dollar amount. If a deferral is elected, the - 3 - election shall be irrevocable. Deferral elections shall be made on a form prescribed by the Committee or the Administrator. As provided in section 6.7, any deferral is subject to any applicable tax withholding measures and may be reduced to satisfy any applicable tax withholding requirements. 5.3 Election of Time and Manner of Payment. At the time a Participant makes a deferral election under section 5.1, the Participant shall also designate the manner of payment and the date on which payments from his or her Deferral Account shall begin, from among the following options: (i) a lump sum payable by the end of February in the year immediately following the Participant's Termination; or (ii) a series of annual installments, commencing in the year following the Participant's Termination and payable each year on or before the end of February, over a period of five, ten, or fifteen years, as designated by the Participant. A Participant may modify an election of the time for payment under circumstances determined by the Committee, provided that (i) a payment election may not be modified in a manner that would cause payments to commence earlier than the date payments would have commenced absent such modification, and (ii) all payment elections shall become irrevocable one year prior to the date on which payment will commence under the election. If payment is due in the form of a lump sum, the payment shall equal the balance of the Deferral Account being paid, determined as of the Valuation Date coincident with or immediately preceding the payment date. If payment is due in the form of installments, the amount of each installment payment shall be equal to the quotient determined by dividing (A) the value of the portion of the Deferral Account to which the installment payment election applies (determined as of the Valuation Date coincident with or immediately preceding the date the payment is to be made), by (B) the number of years over which the installment payments are to be made, less the number of years in which prior payments attributable to such installment payment election have been made. - 4 - Notwithstanding the foregoing, however, if earnings or any other amounts credited to a Participant's Deferral Account do not otherwise meet any applicable requirements of the Internal Revenue Code allowing the Company and its Subsidiaries to receive a federal income tax deduction for such amounts upon paying them at the time provided under the Participant's election, the payment of such amounts, to the extent in excess of the amount that would be currently tax deductible, shall automatically be deferred until the earliest year that the payment can be deducted. 5.4 Accounts and Earnings. The Company shall establish a Deferral Account for each Participant who has elected a deferral under section 5.1 above, and its accounting records for the Plan with respect to each such Participant shall include a separate Deferral Account or subaccount for each deferral election of the Participant that could cause a payment made at a different time or in a different form from other payments of deferrals elected by the same Participant. Each Deferral Account balance shall reflect the Company's obligation to pay a deferred amount to a Participant or Beneficiary as provided in this Article V. Under procedures approved by the Committee and communicated to Participants, a Participant shall elect between the following two alternatives with respect to the deferred amounts at the same time that the Participant elects to defer the fees payable for a calendar year (provided that elections made for the 1999 calendar year shall be made within 30 days of the date the Participant receives notice of the election, or such shorter time as may be specified by the Committee). Once made, a Participant's election for the method of payment may not be changed; however, a Participant may make a different election with respect to amounts that the Participant elects to defer in subsequent periods. (1) Payment in Shares. Under this alternative, a Participant shall be credited with an award of Performance Shares pursuant to Section 4.7 of the 1992 Stock Incentive Plan, in a number of Performance Shares equal to (i) the amounts deferred hereunder, divided by (ii) the closing price of the Common Stock of the Company on the date the Deferral occurred. Performance Shares credited hereunder shall be issued to one or more grantor trusts formed by - 5 - the Company ("rabbi trusts") pursuant to Section 6.2 hereof. Any dividends paid on shares of the Common Stock of the Company issued to a rabbi trust shall be reinvested in Common Stock of the Company, which shall be treated as having been issued to the Participant as additional Performance Shares under the 1992 Stock Incentive Plan. Notwithstanding the foregoing, the crediting of assumed earnings shall not mean that any deferred compensation promise to a Participant is secured by particular investment assets or that the Participant is actually earning any form of investment income under the Plan. (2) Issuance of Stock Options Under the 1992 Stock Incentive Plan. Under this alternative, a Participant may elect, in lieu of receiving any payments from the Plan, to be issued nonqualified stock options pursuant to Section 4.6 of The Charles Schwab Corporation 1992 Stock Incentive Plan. A Participant who elects this alternative shall, on the date the fees deferred pursuant to Section 5.1 hereof would otherwise have been payable, be issued a number of nonqualified stock options with a fair market value equal to the amounts deferred, as determined under the valuation methods set forth in Exhibit A hereto. 5.5 Maintenance of Accounts. The Accounts of each Participant shall be entered on the books of the Company and shall represent a liability, payable when due under this Plan, from the general assets of the Company. Prior to benefits becoming due hereunder, the Company shall expense the liability for such accounts in accordance with policies determined appropriate by the Company's auditors. Except to the extent provided pursuant to the second paragraph of this section 5.5, the Accounts created for a Participant by the Company shall not be funded by a trust or an insurance contract; nor shall any assets of the Company be segregated or identified to such account; nor shall any property or assets of the Company be pledged, encumbered, or otherwise subjected to a lien or security interest for payment of benefits hereunder. 5.6 Change in Control. In the event of a Change in Control (as defined below), the following rules shall apply: (a) All Participants shall continue to have a fully vested, nonforfeitable interest in their Deferral Accounts. - 6 - (b) Deferrals of amounts for the year that includes the Change in Control shall cease beginning with the first payment otherwise due that follows the Change in Control. (c) A special allocation of earnings on all Deferral Accounts shall be made under section 5.4 as of the date of the Change in Control on a basis no less favorable to Participants than the method being followed prior to the Change in Control. (d) All payments of deferred amounts following a Change in Control, whether or not they have previously begun, shall be made in a lump sum no later than 30 days following the Change in Control and, except as provided in section 5.3 with respect to installment payments in progress, shall be in an amount equal to the full Deferral Account balance, as adjusted pursuant to paragraph (c) above, as of the date of the Change in Control. (e) Nothing in this Plan shall prevent a Participant from enforcing any rules in a contract or another plan of the Company or any Subsidiary concerning the method of determining the amount of fees or other form of compensation to which a Participant may become entitled following a change in control, or the time at which that compensation is to be paid in the event of a change in control. For purposes of this Plan, a "Change in Control" means any of the following: (1) The acquisition by any individual, entity or group (within the meaning of Section 13(d) (3) or 14(d) (2) of the Securities Exchange Act of 1934, as amended (the "Exchange Act")) (a "Person") of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of 20% or more of either (i) the then outstanding shares of common stock of the Corporation (the "Outstanding Corporation Common Stock") or (ii) the combined voting power of the then outstanding voting securities of the Corporation entitled to vote generally in the election of directors (the "Outstanding Corporation Voting Securities"); provided, however, - 7 - that for purposes of this paragraph (1), the following acquisitions shall not constitute a Change of Control: (i) any acquisition directly from the Company, (ii) any acquisition by the Company, (iii) any acquisition by any employee benefit plan (or related trust) sponsored or maintained by the Company or any corporation controlled by the Company, or (iv) any acquisition by any corporation pursuant to a transaction which complies with clauses (i), (ii) and (iii) of paragraph (3) hereof; or (2) Individuals who, as of January 1, 1996, constitute the Board (the "Incumbent Board") cease for any reason to constitute at least a majority of the Board; provided, however, that any individual becoming a director subsequent to January 1, 1996 whose election, or nomination for election by the Company's shareholders, was approved by a vote of at least a majority of the directors then comprising the Incumbent Board shall be considered as though such individual were a member of the Incumbent Board, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of a Person other than the Board; or (3) Consummation of a reorganization, merger or consolidation, or sale or other disposition of all or substantially all of the assets of the Company (a "Business Combination"), in each case, unless, following such Business Combination, (i) all or substantially all of the individuals and entities who were the beneficial owners, respectively, of the Outstanding Corporation Common Stock and Outstanding Corporation Voting Securities immediately prior to such Business Combination beneficially own, directly or indirectly, more than 50% of, respectively, the then - 8 - outstanding shares of common stock and the combined voting power of the then outstanding voting securities entitled to vote generally in the election of directors, as the case may be, of the corporation resulting from such Business Combination (including, without limitation, a corporation which as a result of such transaction owns the Company or all or substantially all of the Company's assets either directly or through one or more subsidiaries) in substantially the same proportions as their ownership, immediately prior to such Business Combination, of the Outstanding Corporation Common Stock and Outstanding Corporation Voting Securities, as the case may be, (ii) no Person (excluding any corporation resulting from such Business Combination or any employee benefit plan (or related trust) of the Company or such corporation resulting from such Business Combination) beneficially owns, directly or indirectly, 20% or more of, respectively, the then outstanding shares of common stock of the corporation resulting from such Business Combination or the combined voting power of the then outstanding voting securities of such corporation except to the extent that such ownership existed prior to the Business Combination and (iii) at least a majority of the members of the board of directors of the corporation resulting from such Business Combination were members of the Incumbent Board at the time of the execution of the initial agreement, or of the action of the Board, providing for such Business Combination; or (4) Approval by the shareholders of the Company of a complete liquidation or dissolution of the Company. A Change of Control shall occur on the first day on which any of the preceding conditions has been satisfied. However, notwithstanding the foregoing, this section 5.6 shall not apply to any Participant who alone or together with one or - 9 - more other persons acting as a partnership, limited partnership, syndicate, or other group for the purpose of acquiring, holding or disposing of securities of the Company, triggers a "Change in Control" within the meaning of paragraphs (1) and (2) above. Moreover, no acquisition by (i) Charles Schwab and/or his spouse or any of his lineal descendants or (ii) any trust created by or for the benefit of Charles Schwab and/or his spouse or any of his lineal descendants or (iii) the Schwab Family Foundation shall constitute a Change of Control. 5.7 Payment of Deferred Amounts. A Participant shall have a fully vested, nonforfeitable interest in his or her Deferral Account balance at all times. However, vesting does not confer a right to payment other than in the manner elected by the Participant pursuant to section 5.3 (subject to any modification that may occur pursuant to section 5.4, 5.6 or 5.8). Upon the expiration of a deferral period selected by the Participant in one or more deferral elections, the Company shall pay to such Participant (or to the Participant's Beneficiary, in the case of the Participant's death), an amount equal to the balance of the Participant's Account attributable to such expiring deferral elections, plus any assumed earnings (determined by the Company pursuant to section 5.4) thereon. 5.8 Acceleration of Payment. The Committee, in its discretion, upon receipt of a written request from a Participant, may accelerate the payment of all or any portion of the unpaid balance of a Participant's Deferral Account in the event of the Participant's death, permanent disability, or upon its determination that the Participant (or his Beneficiary in the case of his death) has incurred a severe, unforeseeable financial hardship creating an immediate and heavy need for cash that cannot reasonably be satisfied from sources other than an accelerated payment from this Plan. The Committee in making its determination may consider such factors and require such information as it deems appropriate. Article VI. General Provisions 6.1 Unfunded Obligation. The deferred amounts to be paid to Participants pursuant to this Plan constitute unfunded obligations of the Company. Except to the extent specifically - 10 - provided hereunder, the Company is not required to segregate any monies from its general funds, to create any trusts, or to make any special deposits with respect to this obligation. Title to and beneficial ownership of any investments, including any grantor trust investments which the Company has determined and directed the Administrator to make to fulfill obligations under this Plan shall at all times remain in the Company. Any investments and the creation or maintenance of any trust or Accounts shall not create or constitute a trust or a fiduciary relationship between the Administrator or the Company and a Participant, or otherwise create any vested or beneficial interest in any Participant or his or her Beneficiary or his or her creditors in any assets of the Company whatsoever. The Participants shall have no claim for any changes in the value of any assets which may be invested or reinvested by the Company in an effort to match its liabilities under this Plan. 6.2 Informal Funding Vehicles. To the extent required pursuant to Section 5.4(1), the Company shall arrange for the establishment and use of a grantor trust or other informal funding vehicle to facilitate the payment of benefits and to discharge the liability of the Company and participating Affiliates under this Plan to the extent of payments actually made from such trust or other informal funding vehicle. In addition, the Company may, but need not, arrange for the establishment and use of such a grantor trust or other informal funding vehicle to the extent otherwise permitted pursuant to the Plan. Any investments and any creation or maintenance of memorandum accounts or a trust or other informal funding vehicle shall not create or constitute a trust or a fiduciary relationship between the Committee or the Company or an affiliate and a Participant, or otherwise confer on any Participant or Beneficiary or his or her creditors a vested or beneficial interest in any assets of the Company or any Affiliate whatsoever. Participants and Beneficiaries shall have no claim against the Company or any Affiliate for any changes in the value of any assets which may be invested or reinvested by the Company or any Affiliate with respect to this Plan. 6.3 Beneficiary. The term "Beneficiary" shall mean the person or persons to whom payments are to be paid pursuant to the terms of the Plan in the event of the Participant's death. - 11 - A Participant may designate a Beneficiary on a form provided by the Administrator, executed by the Participant, and delivered to the Administrator. The Administrator may require the consent of the Participant's spouse to a designation if the designation specifies a Beneficiary other than the spouse. Subject to the foregoing, a Participant may change a Beneficiary designation at any time. Subject to the property rights of any prior spouse, if no Beneficiary is designated, if the designation is ineffective, or if the Beneficiary dies before the balance of the Account is paid, the balance shall be paid to the Participant's surviving spouse, or if there is no surviving spouse, to the Participant's estate. 6.4 Incapacity of Participant or Beneficiary. Every person receiving or claiming benefits under the Plan shall be conclusively presumed to be mentally competent and of age until the date on which the Administrator receives a written notice, in a form and manner acceptable to the Administrator, that such person is incompetent or a minor, for whom a guardian or other person legally vested with the care of his person or estate has been appointed; provided, however, that if the Administrator finds that any person to whom a benefit is payable under the Plan is unable to care for his or her affairs because of incompetency, or because he or she is a minor, any payment due (unless a prior claim therefor shall have been made by a duly appointed legal representative) may be paid to the spouse, a child, a parent, a brother or sister, or to any person or institution considered by the Administrator to have incurred expense for such person otherwise entitled to payment. To the extent permitted by law, any such payment so made shall be a complete discharge of liability therefor under the Plan. If a guardian of the estate of any person receiving or claiming benefits under the Plan is appointed by a court of competent jurisdiction, benefit payments may be made to such guardian provided that proper proof of appointment and continuing qualification is furnished in a form and manner acceptable to the Administrator. In the event a person claiming or receiving benefits under the Plan is a minor, payment may be made to the custodian of an account for such person under the Uniform Gifts to Minors Act. To the extent permitted by law, any such payment so made shall be a complete discharge of any liability therefor under the Plan. - 12 - 6.5 Nonassignment. The right of a Participant or Beneficiary to the payment of any amounts under the Plan may not be assigned, transferred, pledged or encumbered nor shall such right or other interests be subject to attachment, garnishment, execution, or other legal process. 6.6 No Right to Continued Service. Nothing in the Plan shall be construed to confer upon any Participant any right to continue as a Director of the Company. 6.7 Tax Withholding. Any appropriate taxes shall be withheld from payments made to Participants pursuant to the Plan. To the extent tax withholding is payable in connection with the Participant's deferral of income rather than in connection with the payment of deferred amounts, such withholding may be made from amounts currently payable to the Participant, or, as determined by the Administrator, the amount of the deferral elected by the Participant may be reduced in order to satisfy required tax withholding for any applicable taxes. 6.8 Claims Procedure and Arbitration. The Company shall establish a reasonable claims procedure consistent with the requirements of the Employee Retirement Income Security Act of 1974, as amended. Following a Change in Control of the Company (as determined under section 5.6) the claims procedure shall include the following arbitration procedure. Since time will be of the essence in determining whether any payments are due to the Participant under this Plan following a Change in Control, a Participant may submit any claim for payment to arbitration as follows: On or after the second day following the Termination or other event triggering a right to payment, the claim may be filed with an arbitrator of the Participant's choice by submitting the claim in writing and providing a copy to the Company. The arbitrator must be: (a) a member of the National Academy of Arbitrators or one who currently appears on arbitration panels issued by the Federal Mediation and Conciliation Service or the American Arbitration Association; or (b) a retired judge of the State in which the claimant is a resident who served at the appellate level or higher. The arbitration hearing shall be held within 72 hours (or as soon thereafter as possible) after filing of the claim unless the Participant - 13 - and the Company agree to a later date. No continuance of said hearing shall be allowed without the mutual consent of the Participant and the Company. Absence from or nonparticipation at the hearing by either party shall not prevent the issuance of an award. Hearing procedures which will expedite the hearing may be ordered at the arbitrator's discretion, and the arbitrator may close the hearing in his or her sole discretion upon deciding he or she has heard sufficient evidence to satisfy issuance of an award. In reaching a decision, the arbitrator shall have no authority to ignore, change, modify, add to or delete from any provision of this Plan, but instead is limited to interpreting this Plan. The arbitrator's award shall be rendered as expeditiously as possible, and unless the arbitrator rules within seven days after the close of the hearing, he will be deemed to have ruled in favor of the Participant. If the arbitrator finds that any payment is due to the Participant from the Company, the arbitrator shall order the Company to pay that amount to the Participant within 48 hours after the decision is rendered. The award of the arbitrator shall be final and binding upon the Participant and the Company. Judgment upon the award rendered by the arbitrator may be entered in any court in any State of the United States. In the case of any arbitration regarding this Agreement, the Participant shall be awarded the Participant's costs, including attorney's fees. Such fee award may not be offset against the deferred compensation due hereunder. The Company shall pay the arbitrator's fee and all necessary expenses of the hearing, including stenographic reporter if employed. 6.9 Termination and Amendment. The Committee may from time to time amend, suspend or terminate the Plan, in whole or in part, and if the Plan is suspended or terminated, the Committee may reinstate any or all of its provisions. Except as otherwise required by law, the Committee may delegate to the Administrator all or any of its foregoing powers to amend, suspend, or terminate the Plan. Any such amendment, suspension, or termination may affect - 14 - future deferrals without the consent of any Participant or Beneficiary. However, with respect to deferrals that have already occurred, no amendment, suspension or termination may impair the right of a Participant or a designated Beneficiary to receive payment of the related deferred compensation in accordance with the terms of the Plan prior to the effective date of such amendment, suspension or termination, unless the affected Participant or Beneficiary gives his express written consent to the change. 6.10 Applicable Law. The Plan shall be construed and governed in accordance with applicable federal law and, to the extent not preempted by such federal law, the laws of the State of California. - 15 - Exhibit A For purposes of determining the number of Options to be granted Under the Stock Option Investment Election, Options will be valued under the Black-Scholes method, based on the following assumptions: o Assumed Option Term = 5 years o Volatility = Actual volatility over the 3 year period immediately preceding the grant o Risk Free Interest Rate = 5 year Treasury Note Rate o Dividend Yield = Current Annual Dividend Yield On Option Grant Date (Quarterly Dividend x 4) / Market Price on Option Grant Date = Dividend Yield Sample Calculation: ($.028 x 4)/ $55 = .2% o Fair Market Value = Closing Price Of Schwab Common Stock on Date of Grant (Same as Date of Retainer and Meeting Fee Payment) o Exercise Price = Same as above Sample Stock Option Calculation o Fees Deferred / Black Scholes Valuation = Number of Stock Option grants from Deferral Election Sample Calculation: $14,250 / $23.82 = 598.2368 Stock Options, rounded up to nearest full option, = grant of 599 Stock Options. - 1 - EX-10 11 exh10_272.txt EXHIBIT 10.272 Exhibit 10.272 ________________________________________________________________________________ THE CHARLES SCHWAB CORPORATION DEFERRED COMPENSATION PLAN (As Amended Through December 8, 2004) ________________________________________________________________________________ Table of Contents Article I . Purpose...........................................................1 1.1 Establishment of the Plan..............................................1 1.2 Purpose of the Plan....................................................1 Article II . Definitions......................................................1 2.1 Definitions............................................................1 2.2 Gender and Number......................................................3 Article III . Administration..................................................3 3.1 Committee and Administrator............................................3 Article IV Participants........................................................3 4.1 Participants...........................................................3 Article V Deferrals............................................................3 5.1 Salary Deferrals.......................................................3 5.2 Deferrals of Bonuses, Commissions and Other Cash Incentive Compensation...........................................................4 5.3 Deferral Procedures....................................................4 5.4 Election of Time and Manner of Payment.................................4 5.5 Accounts and Earnings..................................................6 5.6 Maintenance of Accounts................................................6 5.7 Change in Control......................................................7 5.8 Payment of Deferred Amounts............................................8 5.9 Acceleration of Payment................................................8 Article VI General Provisions..................................................9 6.1 Unfunded Obligation....................................................9 6.2 Informal Funding Vehicles..............................................9 6.3 Beneficiary............................................................9 6.4 Incapacity of Participant or Beneficiary..............................10 6.5 Nonassignment.........................................................10 6.6 No Right to Continued Employment......................................10 6.7 Tax Withholding.......................................................10 6.8 Claims Procedure and Arbitration......................................11 6.9 Termination and Amendment.............................................11 6.10 Applicable Law........................................................12 THE CHARLES SCHWAB CORPORATION DEFERRED COMPENSATION PLAN Article I. Purpose 1.1 Establishment of the Plan. Effective as of July 1, 1994, The Charles Schwab Corporation (hereinafter, the "Company") hereby establishes The Charles Schwab Corporation Deferred Compensation Plan (the "Plan"), as set forth in this document. Effective December 8, 2004, no further deferrals shall be permitted under the Plan except deferrals relating to payments earned prior to January 1, 2005. 1.2 Purpose of the Plan. The Plan permits participating employees to defer the payment of certain cash compensation that they may earn. The opportunity to elect such deferrals is provided in order to help the Company attract and retain key employees. This Plan is unfunded and is maintained primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees. It is accordingly intended to be exempt from the participation, vesting, funding, and fiduciary requirements set forth in Title I of the Employee Retirement Income Security Act of 1974. Article II . Definitions 2.1 Definitions. The following definitions are in addition to any other definitions set forth elsewhere in the Plan. Whenever used in the Plan, the capitalized terms in this section shall have the meanings set forth below unless otherwise required by the context in which they are used: (a) "Administrator" the administrator described in section 3.1 that is selected by the Committee to assist in the administration of the Plan. (b) "Beneficiary" means a person entitled to receive any benefit payments that remain to be paid after a Participant's death, as determined under section 6.3. (c) "Board" means the Board of Directors of the Company. (d) "Company" means The Charles Schwab Corporation, a Delaware corporation. (e) "Category 1 Participant" and "Category 2 Participant" each refer to a specific Participant group and have the meaning set forth in section 4.1. (f) "Committee" means the Compensation Committee of the Board. - 1 - (g) "Deferral Account" means the account representing deferrals of cash compensation, plus investment adjustments, as described in sections 5.5 and 5.6. (h) "Participant" means any employee who meets the eligibility requirements of the Plan, as set forth in Article 4, and includes, where appropriate to the context, any former employee who is entitled to benefits under this Plan. (i) "Plan" means The Charles Schwab Corporation Deferred Compensation Plan, as in effect from time to time. (j) "Plan Year" means the calendar year. (k) "Retirement" shall mean: (l) any termination of employment with the Company and its Subsidiaries with the exception of U.S. Trust Corporation for any reason other than death at any time after the Participant has attained 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; provided, however, that with respect to any payments made on account of a deferral election made prior to November 1, 1994, Retirement shall also mean any termination of employment with the Company and its Subsidiaries for any reason other than death after the Participant has attained age 55; and (m) any termination of employment from U.S. Trust Corporation for any reason other than death at any time after (i) the Participant has attained age sixty-five (65); (ii) the sum of the Participant's age and credited Years of Service, at the time of such termination, is equal to or greater than eighty (80); or (iii) the Participant has attained age sixty (60), but only if, at the time of such termination, the Participant has been credited with at least ten (10) Years of Service. For purposes of this subparagraph (k), the term "Years of Service" shall have the same meaning given to it under the SchwabPlan Retirement Savings and Investment Plan (or any successor plan). (n) "Subsidiary" means a corporation or other business entity in which the Company owns, directly or indirectly, securities with more than 80 percent of the total voting power. (o) "Valuation Date" means each December 31 and any other date designated from time to time by the Committee for the purpose of determining the value of a Participant's Deferral Account balance pursuant to section 5.5. - 2 - 2.2 Gender and Number. Except when otherwise indicated by the context, any masculine or feminine terminology shall also include the neuter and other gender, and the use of any term in the singular or plural shall also include the opposite number. Article III. Administration 3.1 Committee and Administrator. The Committee shall administer the Plan and may select one or more persons to serve as the Administrator. The Administrator shall perform such administrative functions as the Committee may delegate to it from time to time. Any person selected to serve as the Administrator may, but need not, be a Committee member or an officer or employee of the Company. However, if a person serving as Administrator or a member of the Committee is a Participant, such person may not vote on a matter affecting his interest as a Participant. The Committee shall have discretionary authority to construe and interpret the Plan provisions and resolve any ambiguities thereunder; to prescribe, amend, and rescind administrative rules relating to the Plan; to select the employees who may participate and to terminate the future participation of any such employees; to determine eligibility for benefits under the Plan; and to take all other actions that are necessary or appropriate for the administration of the Plan. Such interpretations, rules, and actions of the Committee shall be final and binding upon all concerned and, in the event of judicial review, shall be entitled to the maximum deference allowable by law. Where the Committee has delegated its responsibility for matters of interpretation and Plan administration to the Administrator, the actions of the Administrator shall constitute actions of the Committee. Article IV Participants 4.1 Participants. Officers and other key employees of the Company and each of its Subsidiaries shall be eligible to participate in this Plan upon selection by the Committee. To be nominated for participation, an employee must be highly compensated or have significant responsibility for the management, direction and/or success of the Company as a whole or a particular business unit thereof. Directors of the Company who are full-time employees of the Company shall be eligible to participate in the Plan. Participating employees of the Company in the position of executive vice president or above shall be "Category 1 Participants." All other participating employees shall be "Category 2 Participants." Article V Deferrals 5.1 Salary Deferrals. Each Category 2 Participant selected under Section 4.1 may elect to defer up to 50 percent of his regular base salary (subject to the provisions of this Article V). Any such election must be made by entering a deferred compensation agreement with the employer, as evidenced by a form approved by and filed with the Administrator on or before the deadline specified by the Administrator (which shall be no earlier than one month prior to the beginning of the election - 3 - period for which the deferred salary is to be earned). For this purpose, the election period shall be the calendar year; provided, however, that during periods in which the Plan is not in effect for a full calendar year or an employee is not a Participant for a full calendar year, the election period shall be the portion of the calendar year during which the Plan is in effect and the employee is an eligible Participant. Notwithstanding the foregoing, a person who is not a Participant at the beginning of a calendar year shall not be allowed to elect a deferral of compensation that takes effect during that year without the consent of the Committee. Salary deferrals that have been elected shall occur throughout the election period in equal increments for each payroll period. 5.2 Deferrals of Bonuses, Commissions and Other Cash Incentive Compensation. Each Category 1 Participant and each Category 2 Participant may elect to defer all or any portion (subject to the provisions of this Article V) of (a) his or her commissions; and (b) any amount that he or she subsequently earns under an annual cash bonus program and/or a long-term cash incentive compensation program of the Company or a participating Subsidiary. Any such election must be made by entering a deferred compensation agreement with the employer, as evidenced by a form approved by the Committee that is filed with the Administrator on or before the deadline specified by the Administrator. For annual cash bonuses, this deadline shall be no earlier than one month prior to the beginning of year (or portion thereof) for which the bonus will be earned. For commissions and other cash incentive compensation, this deadline shall be a date no later than six months before the end of the year or other period for which the commissions or incentive compensation will be earned. Rules similar to those in Section 5.1 shall apply in cases where the Plan is not in existence or an employee is not a Participant for the full period in which an annual cash bonus, commission or long-term incentive compensation award is earned. 5.3 Deferral Procedures. Participants eligible to elect salary deferrals under section 5.1 shall have an opportunity to do so each year. Participants eligible to elect deferrals under section 5.2 shall have a separate opportunity to do so for each (a) cash bonus under an annual bonus program; (b) cash bonus or incentive payment under a long-term incentive plan; and (c) commission that they may earn. Unless the Committee specifies other rules for the deferrals that may be elected, the minimum deferral shall be 20 percent of the compensation to which a deferral election applies; and, subject to the maximum percentage allowed under section 5.1 or 5.2, as applicable, deferrals in excess of the minimum allowable percentage may be made only in increments of 10 percent. If a deferral is elected, the election shall be irrevocable with respect to the particular compensation that is subject to the election. Deferral elections shall be made on a form prescribed by the Committee or the Administrator. As provided in section 6.7, any deferral is subject to appropriate tax withholding measures and may be reduced to satisfy tax withholding requirements. 5.4 Election of Time and Manner of Payment. At the time a Participant makes a deferral election under section 5.1 or 5.2, the Participant shall also designate the manner of payment and the date on which payments from his or her Deferral Account shall begin, from among the following options: (a) A lump sum payable by the end of February of any year that the Participant specifies; - 4 - (b) a lump sum payable by the end of February in the year immediately following the Participant's Retirement; (c) a series of annual installments, commencing in any year selected by the Participant and payable each year on or before the end of February, over a period of four years; or (d) a series of annual installments, commencing in the year following the Participant's Retirement and payable each year on or before the end of February, over a period of five, ten, or fifteen years, as designated by the Participant. However, if a Participant terminates employment for any reason other than Retirement, the payment of the Participant's entire Deferral Account, including any unpaid installments pursuant to clause (c) above, shall be made in a single lump sum by the end of February in the year next following the year in which the Participant terminates employment, notwithstanding the terms of the Participant's election. Any election of a specified payment date pursuant to clauses (a) or (b), above, shall be subject to any restrictions that the Committee may, in its sole discretion, choose to establish in order to limit the number of different payment dates that a Participant may have in effect at one time. A Participant may modify an election of the time for payment under circumstances determined by the Committee, provided that (a) a payment election may not be modified in a manner that would cause payments to commence earlier than the date payments would have commenced absent such modification, and (b) all payment elections shall become irrevocable one year prior to the date on which payment will commence under the election. If payment is due in the form of a lump sum, the payment shall equal the balance of the Deferral Account being paid, determined as of the Valuation Date coincident with or immediately preceding the payment date. If payment is due in the form of installments, the amount of each installment payment shall be equal to the quotient determined by dividing (A) the value of the portion of the Deferral Account to which the installment payment election applies (determined as of the Valuation Date coincident with or immediately preceding the date the payment is to be made), by (B) the number of years over which the installment payments are to be made, less the number of years in which prior payments attributable to such installment payment election have been made. Notwithstanding the foregoing, however, if earnings or any other amounts credited to a Participant's Deferral Account are not considered performance-based compensation, within the meaning of Section 162(m) of the Internal Revenue Code, and do not otherwise meet Internal Revenue Code conditions allowing the Company and its Subsidiaries to receive a federal income tax deduction for such amounts upon paying them at the time provided under the Participant's election, the payment of such amounts, to the extent in excess of the amount that would be currently tax deductible, shall automatically be deferred until the earliest year that the payment can be deducted. - 5 - 5.5 Accounts and Earnings. The Company shall establish a Deferral Account for each Participant who has elected a deferral under section 5.1 or 5.2 above, and its accounting records for the Plan with respect to each such Participant shall include a separate Deferral Account or subaccount for each deferral election of the Participant that could cause a payment made at a different time or in a different form from other payments of deferrals elected by the same Participant. Each Deferral Account balance shall reflect the Company's obligation to pay a deferred amount to a Participant or Beneficiary as provided in this Article V. Under procedures approved by the Committee and communicated to Participants, a Participant's Deferral Account balance shall be increased periodically (not less frequently than annually) to reflect an assumed earnings increment, based on an interest rate or other benchmark selected by the Committee and in effect at the time. Until the time for determining the amount to be paid to the Participant or Beneficiary, such assumed earnings shall accrue from each Valuation Date on the Deferral Account balance as of that date and shall be credited to the account as of the next Valuation Date.The rate of earnings may, but need not, be determined with reference to the actual rate of earnings on assets held under any existing grantor trust or other informal funding vehicle that is in effect pursuant to section 6.2. Any method of crediting earnings that is followed from time to time may, with reasonable advance notice to affected Participants, be revoked or revised prospectively as of the beginning of any new Plan Year. Earnings that have been credited for any Plan Year, like deferred amounts that have been previously credited to a Participant, shall not be reduced or eliminated retroactively unless they were credited in error. The crediting of assumed earnings shall not mean that any deferred compensation promise to a Participant is secured by particular investment assets or that the Participant is actually earning interest or any other form of investment income under the Plan. Consistent with the foregoing authority to exercise flexibility in establishing a method for crediting assumed earnings on account balances, the Committee may, but need not, consult with Participants about their investment preferences and may, but need not, institute a program of assumed earnings that tracks the investment performance in a Participant's qualified defined contribution plan account or in an assumed participant-directed investment arrangement. 5.6 Maintenance of Accounts. The Accounts of each Participant shall be entered on the books of the Company and shall represent a liability, payable when due under this Plan, out of the general assets of the Company. Prior to benefits becoming due hereunder, the Company shall expense the liability for such accounts in accordance with policies determined appropriate by the Company's auditors. Except to the extent provided pursuant to the second paragraph of this section 5.6, the Accounts created for a Participant by the Company shall not be funded by a trust or an insurance contract; nor shall any assets of the Company be segregated or identified to such account; nor shall any property or assets of the Company be pledged, encumbered, or otherwise subjected to a lien or security interest for payment of benefits hereunder. Notwithstanding that the amounts to be paid hereunder to Participants constitute an unfunded obligation of the Company, the Company may direct that an amount equal to any portion of the Accounts shall be invested by the Company as the Company, in its sole discretion, shall determine. The Committee may in its sole discretion determine that all or any portion of an amount equal to the Accounts shall be paid into one or more grantor trusts that may be established by the Company for the purpose of providing a potential source of funds to pay Plan benefits. The Company may designate an investment - 6 - advisor to direct the investment of funds that may be used to pay benefits, including the investment of the assets of any grantor trusts hereunder. 5.7 Change in Control. In the event of a Change in Control (as defined below), the following rules shall apply: (a) All Participants shall continue to have a fully vested, nonforfeitable interest in their Deferral Accounts. (b) Deferrals of amounts for the year that includes the Change in Control shall cease beginning with the first payroll period that follows the Change in Control. (c) A special allocation of earnings on all Deferral Accounts shall be made under section 5.5 as of the date of the Change in Control on a basis no less favorable to Participants than the method being followed prior to the Change in Control. (d) All payments of deferred amounts following a Change in Control, whether or not they have previously begun, shall be made in a cash lump sum no later than 30 days following the Change in Control and, except as provided in section 5.4 with respect to installment payments in progress, shall be in an amount equal to the full Deferral Account balance, as adjusted pursuant to paragraph (c) above, as of the date of the Change in Control. (e) Nothing in this Plan shall prevent a Participant from enforcing any rules in a contract or another plan of the Company or any Subsidiary concerning the method of determining the amount of a bonus, incentive compensation, or other form of compensation to which a Participant may become entitled following a change in control, or the time at which that compensation is to be paid in the event of a change in control. For purposes of this Plan, a "Change in Control" means any of the following: (1) Any "person" who, alone or together with all "affiliates" and "associates" of such person, is or becomes (A) an "acquiring person" or (B) the "beneficial owner" of 35% of the outstanding voting securities of the Company (the terms "person", "affiliates", "associates" and "beneficial owner" are used as such terms are used in the Securities Exchange Act of 1934 and the General Rules and Regulations thereunder); provided, however, that a "Change in Control" shall not be deemed to have occurred if such "person" is Charles R. Schwab, the Company, any subsidiary or any employee benefit plan or employee stock plan of the Company or of any Subsidiary, or any trust or other entity organized, established or holding shares of such voting securities by, for or pursuant to, the terms of any such plan; or (2) Individuals who at the beginning of any period of two consecutive calendar years constitute the Board cease for any reason, during such period, to constitute at least a majority thereof, unless the election, or the - 7 - nomination for election by the Company's Shareholders, of each new Board Member was approved by a vote of at least three-quarters (3/4) of the Board members then still in office who were Board members at the beginning of such period; or (3) Approval by the shareholders of the Company of: (A) the dissolution or liquidation of the Company; (B) the sale or transfer of substantially all of the Company's business and/or assets to a person or entity which is not a "subsidiary" (any corporation or other entity a majority or more of whose outstanding voting stock or voting power is beneficially owned directly or indirectly by the Company); or (C) an agreement to merge or consolidate, or otherwise reorganize, with one or more entities which are not subsidiaries (as defined in (B) above), as a result of which less than 50% of the outstanding voting securities of the surviving or resulting entity are, or are to be, owned by former shareholders of the Company; or (4) The Board agrees by a majority vote that an event has or is about to occur that, in fairness to the Participants, is tantamount to a Change in Control. A Change of Control shall occur on the first day on which any of the preceding conditions has been satisfied. However, notwithstanding the foregoing, this section 5.7 shall not apply to any Participant who alone or together with one or more other persons acting as a partnership, limited partnership, syndicate, or other group for the purpose of acquiring, holding or disposing of securities of the Company, triggers a "Change in Control" within the meaning of paragraphs (1) and (2) above. 5.8 Payment of Deferred Amounts. A Participant shall have a fully vested, nonforfeitable interest in his or her Deferral Account balance at all times. However, vesting does not confer a right to payment other than in the manner elected by the Participant pursuant to section 5.4 (subject to any modification that may occur pursuant to section 5.5, 5.7 or 5.9). Upon the expiration of a deferral period selected by the Participant in one or more deferral elections, the Company shall pay to such Participant (or to the Participant's Beneficiary, in the case of the Participant's death) an amount equal to the balance of the Participant's Account attributable to such expiring deferral elections, plus assumed earnings (determined by the Company pursuant to section 5.5) thereon. 5.9 Acceleration of Payment. The Committee, in its discretion, upon receipt of a written request from a Participant, may accelerate the payment of all or any portion of the unpaid balance of a Participant's Deferral - 8 - Account in the event of the Participant's Retirement, death, permanent disability, resignation or termination of employment, or upon its determination that the Participant (or his Beneficiary in the case of his death) has incurred a severe, unforeseeable financial hardship creating an immediate and heavy need for cash that cannot reasonably be satisfied from sources other than an accelerated payment from this Plan. The Committee in making its determination may consider such factors and require such information as it deems appropriate. Article VI General Provisions 6.1 Unfunded Obligation. The deferred amounts to be paid to Participants pursuant to this Plan constitute unfunded obligations of the Company. Except to the extent specifically provided hereunder, the Company is not required to segregate any monies from its general funds, to create any trusts, or to make any special deposits with respect to this obligation. Title to and beneficial ownership of any investments, including any grantor trust investments which the Company has determined and directed the Administrator to make to fulfill obligations under this Plan shall at all times remain in the Company. Any investments and the creation or maintenance of any trust or Accounts shall not create or constitute a trust or a fiduciary relationship between the Administrator or the Company and a Participant, or otherwise create any vested or beneficial interest in any Participant or his or her Beneficiary or his or her creditors in any assets of the Company whatsoever. The Participants shall have no claim for any changes in the value of any assets which may be invested or reinvested by the Company in an effort to match its liabilities under this Plan. 6.2 Informal Funding Vehicles. Notwithstanding section 6.1, the Company may, but need not, arrange for the establishment and use of a grantor trust or other informal funding vehicle to facilitate the payment of benefits and to discharge the liability of the Company and participating Affiliates under this Plan to the extent of payments actually made from such trust or other informal funding vehicle. Any investments and any creation or maintenance of memorandum accounts or a trust or other informal funding vehicle shall not create or constitute a trust or a fiduciary relationship between the Committee or the Company or an affiliate and a Participant, or otherwise confer on any Participant or Beneficiary or his or her creditors a vested or beneficial interest in any assets of the Company or any Affiliate whatsoever. Participants and Beneficiaries shall have no claim against the Company or any Affiliate for any changes in the value of any assets which may be invested or reinvested by the Company or any Affiliate with respect to this Plan. 6.3 Beneficiary. The term "Beneficiary" shall mean the person or persons to whom payments are to be paid pursuant to the terms of the Plan in the event of the Participant's death. A Participant may designate a Beneficiary on a form provided by the Administrator, executed by the Participant, and delivered to the Administrator. The Administrator may require the consent of the Participant's spouse to a designation if the designation specifies a Beneficiary other than the spouse. Subject to the foregoing, a Participant may change a Beneficiary designation at any time. Subject to the property rights of any prior spouse, if no Beneficiary is designated, if the - 9 - designation is ineffective, or if the Beneficiary dies before the balance of the Account is paid, the balance shall be paid to the Participant's surviving spouse, or if there is no surviving spouse, to the Participant's estate. 6.4 Incapacity of Participant or Beneficiary. Every person receiving or claiming benefits under the Plan shall be conclusively presumed to be mentally competent and of age until the date on which the Administrator receives a written notice, in a form and manner acceptable to the Administrator, that such person is incompetent or a minor, for whom a guardian or other person legally vested with the care of his person or estate has been appointed; provided, however, that if the Administrator finds that any person to whom a benefit is payable under the Plan is unable to care for his or her affairs because of incompetency, or because he or she is a minor, any payment due (unless a prior claim therefor shall have been made by a duly appointed legal representative) may be paid to the spouse, a child, a parent, a brother or sister, or to any person or institution considered by the Administrator to have incurred expense for such person otherwise entitled to payment. To the extent permitted by law, any such payment so made shall be a complete discharge of liability therefor under the Plan. If a guardian of the estate of any person receiving or claiming benefits under the Plan is appointed by a court of competent jurisdiction, benefit payments may be made to such guardian provided that proper proof of appointment and continuing qualification is furnished in a form and manner acceptable to the Administrator. In the event a person claiming or receiving benefits under the Plan is a minor, payment may be made to the custodian of an account for such person under the Uniform Gifts to Minors Act. To the extent permitted by law, any such payment so made shall be a complete discharge of any liability therefor under the Plan. 6.5 Nonassignment. The right of a Participant or Beneficiary to the payment of any amounts under the Plan may not be assigned, transferred, pledged or encumbered nor shall such right or other interests be subject to attachment, garnishment, execution, or other legal process. 6.6 No Right to Continued Employment. Nothing in the Plan shall be construed to confer upon any Participant any right to continued employment with the Company, nor shall the Plan interfere in any way with the right of the Company to terminate the employment of such Participant at any time without assigning any reason therefor. 6.7 Tax Withholding. Appropriate taxes shall be withheld from cash payments made to Participants pursuant to the Plan. To the extent tax withholding is payable in connection with the Participant's deferral of income rather than in connection with the payment of deferred amounts, such withholding may be made from other wages and salary currently payable to the Participant, or, as determined by the Administrator, the amount of the deferral elected by the Participant may be reduced in order to satisfy required tax withholding for employment taxes and any other taxes. - 10 - 6.8 Claims Procedure and Arbitration. The Senior Vice President, Specialty Services of Charles Schwab & Co., Inc. shall establish a reasonable claims procedure consistent with the requirements of the Employee Retirement Income Security Act of 1974, as amended. Following a Change in Control of the Company (as determined under section 5.8) the claims procedure shall include the following arbitration procedure. Following a Change in Control of the Company (as determined under section 5.8) the claims procedure shall include the following arbitration procedure. Since time will be of the essence in determining whether any payments are due to the Participant under this Plan following a Change in Control, a Participant may submit any claim for payment to arbitration as follows: On or after the second day following the termination of the Participant's employment or other event triggering a right to payment, the claim may be filed with an arbitrator of the Participant's choice by submitting the claim in writing and providing a copy to the Company. The arbitrator must be (a) a member of the National Academy of Arbitrators or one who currently appears on arbitration panels issued by the Federal Mediation and Conciliation Service or the American Arbitration Association; or (b) a retired judge of the State in which the claimant is a resident who served at the appellate level or higher. The arbitration hearing shall be held within 72 hours (or as soon thereafter as possible) after filing of the claim unless the Participant and the Company agree to a later date. No continuance of said hearing shall be allowed without the mutual consent of the Participant and the Company. Absence from or nonparticipation at the hearing by either party shall not prevent the issuance of an award. Hearing procedures which will expedite the hearing may be ordered at the arbitrator's discretion, and the arbitrator may close the hearing in his or her sole discretion upon deciding he or she has heard sufficient evidence to satisfy issuance of an award. In reaching a decision, the arbitrator shall have no authority to ignore, change, modify, add to or delete from any provision of this Plan, but instead is limited to interpreting this Plan. The arbitrator's award shall be rendered as expeditiously as possible, and unless the arbitrator rules within seven days after the close of the hearing, he will be deemed to have ruled in favor of the Participant. If the arbitrator finds that any payment is due to the Participant from the Company, the arbitrator shall order the Company to pay that amount to the Participant within 48 hours after the decision is rendered. The award of the arbitrator shall be final and binding upon the Participant and the Company. Judgment upon the award rendered by the arbitrator may be entered in any court in any State of the United States. In the case of any arbitration regarding this Agreement, the Participant shall be awarded the Participant's costs, including attorney's fees. Such fee award may not be offset against the deferred compensation due hereunder. The Company shall pay the arbitrator's fee and all necessary expenses of the hearing, including stenographic reporter if employed. 6.9 Termination and Amendment. The Committee may from time to time amend, suspend or terminate the Plan, in whole or in part, and if the Plan is suspended or terminated, the Committee may reinstate any or all of its provisions. Except as otherwise required by law, the Committee may delegate to the Administrator all or any of its foregoing powers to amend, suspend, or terminate the Plan. Any such amendment, suspension, or termination may affect future deferrals without the consent of any Participant or Beneficiary. However, with respect to deferrals that have already occurred, no amendment, suspension or termination may impair the right of a Participant or a designated Beneficiary to receive payment of the related deferred compensation in accordance with the - 11 - terms of the Plan prior to the effective date of such amendment, suspension or termination, unless the affected Participant or Beneficiary gives his express written consent to the change. 6.10 Applicable Law. The Plan shall be construed and governed in accordance with applicable federal law and, to the extent not preempted by such federal law, the laws of the State of California. - 12 - EX-10 12 exh10_273.txt EXHIBIT 10.273 Exhibit 10.273 Executive Deferred Compensation Plan of U.S. Trust Corporation As Amended and Restated effective as of January 1, 2001, and incorporating action taken as of December 31, 2004 1. Purpose The Plan hereinafter set forth represents a continuation of the Executive Deferred Compensation Plan maintained by U.S. Trust Corporation before its merger with the Charles Schwab Corporation pursuant to the Agreement and Plan of Merger dated as of January 12, 2000. The purpose of the Plan is to provide: (a) Eligible Officers with an opportunity to defer payment of certain portions of their compensation, at their election, in accordance with the provisions herein set forth; and (b) for the mandatory deferral of a portion of the incentive compensation payable to certain employees of the Corporation and its Affiliated Companies. The Plan is intended to constitute an unfunded plan maintained primarily for the purpose of providing deferred compensation for "a select group of management or highly compensated employees" within the meaning of Sections 201(2), 301(a)(3) and 401(a)(1) of the Employee Retirement Income Security Act of 1974, as amended ("ERISA"). 2. Definitions As used herein, the following terms shall have the following meanings: "Account" or "Accounts" shall mean the account or accounts established for a Participant pursuant to Section 4. "Affiliated Companies" shall mean United States Trust Company of New York and each other direct or indirect subsidiary of U.S. Trust Corporation. "Award" shall mean any award made to a Participant under the Executive Incentive Plan of U.S. Trust Corporation (EIP) or the Annual Incentive Plan of U.S. Trust Corporation. "Beneficiary" shall mean the person or persons designated by a Participant in accordance with Section 8 to receive any amount payable under the Plan by reason of his or her death. "Board of Directors" shall mean the Board of Directors of U.S. Trust Corporation. "Change in Control" shall mean that any of the following events has occurred after the Merger Closing Date. (i) 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"); (ii) A change in the composition of the Board of Directors of the Company, 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 of Directors of the Company 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; (iii) 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. "Code" shall mean the Internal Revenue Code of 1986, as amended. "Committee" shall mean the Committee, as constituted from time to time, appointed by the senior management of the Company to administer the Plan. "Company" shall mean The Charles Schwab Corporation, a Delaware Corporation. "Corporation" shall mean U.S. Trust Corporation, a wholly owned subsidiary of the Company. "Eligible Compensation" shall mean, with respect to any Eligible Officer for any Plan Year beginning on or after January 1, 2001, (i) the portion of any Award that becomes payable in cash to the Eligible Officer during such year as reduced by any amount that is contributed to the 401(k) Plan on the Eligible Officer's behalf with respect to such Award pursuant to the Eligible Officer's election under the applicable provisions of the 401(k) Plan; (ii) the portion of any Mandatory Deferred Contribution that becomes vested and payable in cash to a Participant during such year; and (iii) the portion of any commissions (including any "trail" commissions and any commission "overrides") that is payable in cash to the Eligible Officer during such year (but, in the case of any amount payable during such year with respect to commissions that were earned prior to the start of such year, only to the extent of such of those commissions as were earned after the date on which the Eligible Officer filed his or her deferral election for such year under Section 3), exclusive of the amount of any such commissions that are included in the Eligible Officer's base compensation for any Plan Year pursuant to the Eligible Officer's election, and the portion of any bonus or incentive payments that is payable in cash to the Eligible Officer pursuant to any employment agreement between the Eligible Officer and the Corporation or any of its - 2 - Affiliated Companies, to the extent earned during such year, regardless of the year in which such bonus or incentive payments are payable. "Eligible Officer" shall mean any officer of the Corporation or any of its Affiliated Companies at or above the rank of Vice President: (a) whose wages (excluding the amount of any Stock Option Cashout Payment) subject to FICA-HI exceeded $170,000 for the Plan Year immediately preceding the Plan Year in which such officer makes a deferral election under Section 3; or (b) whose base salary as of October 1 of the Plan Year in which such officer makes a deferral election under Section 3 when aggregated with AIP/EIP target bonus amount for such year, regardless of the year in which such bonus amount is payable, exceeds $300,000; or (c) who has been credited with a Mandatory Deferred Contribution. For any Plan Year beginning on or after January 1, 2001, the $170,000 referred to in the preceding sentence shall be adjusted to the extent necessary for such amount to equal the of the limitation on annual compensation in effect for such year under section 401(a)(17) of the Code. "401(k) Plan" shall mean the U.S. Trust Corporation 401(k) Plan. "401(k) Plan Year" shall mean the "Plan Year" as defined in the 401(k) Plan. "Mandatory Deferred Contribution" shall mean the amount credited by the Corporation or an Affiliated Company to a Participant's Account. "Merger Closing Date" shall mean May 31, 2000. "Participant" shall mean any (i) Eligible Officer who has made an election under Section 3 hereof (or under Section 3 of the Prior Plan) to defer any portion of his or her Eligible Compensation for any Plan Year, (ii) person who has made an election under the Prior Plan to defer any portion of his or her 1995 Cashout Payments (as defined in Section 4 of the Prior Plan), (iii) person whose Account or Accounts have been credited with a Supplemental ESOP Contribution amount for any 401(k) Plan Year pursuant to Section 5 of the Prior Plan, or (iv) any person whose Mandatory Deferred Contribution Account has been credited with a Mandatory Deferred Contribution pursuant to Section 5 hereof. "Plan" shall mean the Executive Deferred Compensation Plan of U.S. Trust Corporation, as set forth herein and as amended from time to time. "Plan Year" shall mean each calendar year. "Prior Plan" shall mean the Executive Deferred Compensation Plan of U.S. Trust Corporation, as in effect prior to the Merger Closing Date. - 3 - "Retirement" shall mean a Participant's termination of employment with the Corporation and its Affiliated Companies for any reason other than death if, as of the date of the Participant's termination of employment, (i) the Participant has attained age 65, or (ii) the Participant has attained age sixty (60) and is credited with at least ten (10) "Years of Service" (as defined in the Retirement Plan), or (iii) the sum of Participant's age and the number of his or her "Years of Service", as defined in the 401(k) Plan, is at least equal to 80. In addition, in the case of any Participant who becomes entitled to receive benefit payments under the long-term disability plan maintained by the Corporation or any of its Affiliated Companies and who continues to receive payments under such plan throughout the entire period ending on the date on which Participant first meets the age, or the age of service, requirements set forth in clause (i), (ii) or (iii) above, such Participant shall be treated, for purposes of the Plan, as having terminated employment with the Corporation and its Affiliated Companies as a result of Retirement, on the first day of the month following the date on which the Participant first meets such requirements. In applying clause (ii) and (iii) above for this purpose, the Participant's "Years of Service" shall include the number of calendar years (or part thereof) during which the Participant has received benefits payments under such long-term disability plan. "Statutory Limitations" shall mean, with respect to any 401(k) Plan Year, the limitations imposed under sections 401(a)(17) and 415 of the Code with respect to the amount of compensation that may be taken into account in calculating contributions on behalf of any Member, and the amount of contributions that may be allocated to a Member's account, under the 401(k) Plan for such year. "Stock Option Cashout Payment" shall mean the payment made upon the consummation of the merger of U.S. Trust Corporation with the Charles Schwab Corporation to an Eligible Officer with respect to shares subject to any unexercised stock options granted to the Eligible Officer under the 1995 Stock Option Plan of U.S. Trust Corporation. "Vesting Date" shall mean with respect to any amount credited to a Participant's Mandatory Deferred Contribution Account, the date as of which such amount becomes vested under the terms of the Executive Incentive Plan of U.S. Trust Corporation, the applicable commission arrangement or the applicable employment contract as the case may be. 3. Deferral of Eligible Compensation With respect to each Plan Year beginning on or after January 1, 2001, an Eligible Officer may elect to have payment of any part or all of his or her Eligible Compensation for such year deferred, and to have payment of such portion made under the terms of this Plan. Any such election shall be made in accordance with the following rules: (a) A deferral election shall be made in writing in the manner prescribed by the Committee for such purpose. (b) In the deferral election, the Eligible Officer (i) shall specify, by amount or percentage (which must be an even multiple of 5%), the portion of his or her Eligible - 4 - Compensation the Eligible Officer wishes to defer (the amounts so deferred are hereinafter referred to as the Eligible Officer's "Deferred Amount"). (c) An Eligible Officer's election to defer payment of any amount credited to his or her Mandatory Contribution Account must be made at least one year prior to the Vesting Date of such amount. An Eligible Officer's election to defer any other Eligible Compensation for any Plan Year beginning on or after January 1, 2001, shall be filed with the Committee no later than December 15 of the preceding Plan Year, or by such other date as the Committee may determine in its discretion. (d) Any deferral election made by an Eligible Officer with respect to his or her Eligible Compensation for a Plan Year shall be irrevocable. (e) Notwithstanding any other provision herein to the contrary, a deferral election otherwise permitted to be made hereunder shall be subject to the following requirements: (i) No amount may be deferred pursuant to an Eligible Officer's election unless such amount equals or exceeds $1,000; (ii) No portion of an Eligible Officer's Eligible Compensation may be deferred hereunder to the extent that any tax is required to be withheld from such portion pursuant to applicable federal, state or local law; (iii) No portion of an Eligible Officer's Eligible Compensation may be deferred hereunder to the extent that such portion has been earned prior to the date on which the Eligible Officer's election to defer such portion has been filed with the Committee; and (iv) No amount may be deferred pursuant to an Eligible Officer's election hereunder for a period of 12 months (or such other period required by IRS regulations) following the Eligible Officer's receipt of a hardship withdrawal under the 401(k) Plan. Notwithstanding any other provision of the Plan, effective as of December 31, 2004, no amount of Eligible Compensation may be deferred under the Plan. 4. Accounts There shall be maintained on the books and records of the Corporation, for bookkeeping purposes only, separate Accounts for each Participant, to reflect the Participant's interest under the Plan, including all amounts credited to each Participant under the Prior Plan. Such Accounts shall be established and maintained in accordance with the following provisions: (a) A Mandatory Deferred Contribution Account shall be established and maintained for each Participant who is credited with a Mandatory Deferred Contribution to the Plan on or after January 1, 2001. - 5 - (b) A Vested Mandatory Deferred Contribution Account shall be established and maintained for each Participant who elects under Section 3 to have payment deferred with respect to any portion of his or her Mandatory Deferred Contribution Account. (c) A Participant's Accounts shall be credited with the Deferral Amount that the Participant has specified in his or her election under Section 3(b). Such amount shall be credited to the Participant's Account as of the first business day of the calendar month following the month in which the amount in question would have been paid to the Participant had the Participant not elected under Section 3 to have payment of such amount deferred under this Plan. A Participant's Account shall be adjusted to reflect all Earnings (as defined in paragraph (a) of Section 6) or interest to be credited to such Accounts pursuant to Section 6, all transfers to or from such Accounts pursuant to Section 6(d)(ii) or (e), and all payments made with respect to the Participant's Account balances pursuant to Section 7. (d) Other than amounts credited to a Participant's Mandatory Deferred Contribution Account under Section 4(c), which shall vest in accordance with the applicable Vesting Date and Awards deferred under this Plan a Participant's interest in each of his or her Accounts shall be fully vested and nonforfeitable at all times. 5. Mandatory Deferred Contributions (a) There shall be credited to the Mandatory Deferred Contribution Account an amount equal to the amount of the Mandatory Deferred Contribution awarded to the Participant. (b) As of the Vesting Date of any Mandatory Deferred Contributions with respect to which a deferral election has been made under Section 3, the Participant's Vested Mandatory Deferred Contribution Account shall be credited with an amount equal to the amount of the Mandatory Deferred Contribution that the Participant has elected to defer. (c) Notwithstanding any other provision of the Plan, effective as of December 31, 2004, no Mandatory Deferred Contributions shall be made to the Plan and no amount shall be credited to the Mandatory Deferred Contribution Account of any Participant. 6. Crediting of Earnings Until payment with respect to a Participant's Accounts has been made in full, the Participant's Accounts shall be credited with Earnings or interest in accordance with the following provisions: (a) As of the last day of each calendar month, each part of the balance of a Participant's Account for which a separate Earnings Credit Option (as hereinafter defined) is in effect pursuant to the Participant's election hereunder shall be credited with an amount determined by multiplying such part of the balance of the Participant's Account by a percentage corresponding to the Applicable Rate of Return (as hereinafter defined) for such month under such Earnings Credit Option. The amount so credited (which may be positive or negative depending on whether the Applicable - 6 - Rate of Return for the month is positive or negative) is referred to herein as "Earnings". (b) For purposes of this Section 6, the term "Earnings Credit Option" shall mean, as of any date of reference, any one of the following: the S&P 500 Index, the Lehman Bros. Government/Corporate Bond Index, and the IBC's Money Fund Report First Tier Average. Notwithstanding the foregoing, the Committee may at any time, in its sole discretion, determine (i) that any option referred to in the preceding paragraph shall cease to constitute an Earnings Crediting Option for purposes of the Plan, or (ii) that any other index or hypothetical investment fund or referenced rate of return shall constitute an Earnings Crediting Option for purposes of this Plan. Participants shall be notified in writing, at least 45 days in advance, of any change in the Plan's Earnings Crediting Options. (c) The "Applicable Rate of Return" for any month shall mean (i) in the case of the S&P 500 Index, the percentage, as determined by the Committee, by which (A) the value of such Index as of the last business day of such month, as adjusted to reflect all income earned for such month on the securities included in such Index, exceeds, or is less than, (B) the value of such Index as of the last business day of the immediately preceding month, determined without taking such adjustment into account; (ii) in the case of the Lehman Bros. Government/Corporate Bond Index, the percentage, as determined by the Committee, by which the value of such Index as of the last business day of such month, exceeds, or is less than, the value of such Index as of the last business day of the immediately preceding month; (iii) in the case of the IBC's Money Fund Report First Tier Average, the rate of return corresponding to the 7-day compounded yield for such Average, for the period ending on, or most recently prior to, the last day of such month; and (iv) in the case of any other Earnings Crediting Option, the rate of return applicable for such month, as determined by the Committee in its sole discretion. (d) A Participant may make elections with respect to the Earnings Crediting Options that are to apply on and after January 1, 2001 with respect to his or her Account in accordance with the following rules: (i) A Participant may elect to have any part or all of the balance of any such Account credited with Earnings under any Earnings Crediting Option available under the Plan at the time of his or her election. (ii) In the case of a Participant for whom an Account was maintained on December 31, 2000, pursuant to the Prior Plan, the Earnings Crediting Option in effect, such date shall continue to apply until changed by the Participant pursuant to Section 6(d)(iii). Each Eligible Officer who becomes a Participant on or at any time after January 1, 2001 shall make an initial election as to the Earnings Crediting Options that are to apply with respect to his or her Account in the manner prescribed by the Committee. In such election, the Participant shall specify, by percentages (which must be an even multiple of 5%), the respective parts of the balance of such Account that are to be credited with Earnings under each of the Earnings Crediting Options - 7 - designated by the Participant. If a Participant has failed to make a timely election as to the Earnings Crediting Options that are to apply to any Account prior to the date as of which an amount is first credited to such Account, the Participant shall be deemed to have selected the IBC's Money Fund Report First Tier Average as the Earnings Crediting Option to apply to the entire balance of such Account. (iii) The Earnings Crediting Options selected (or deemed to have been selected) by a Participant with respect to an Account shall remain in effect for that Account (and shall apply to all additional amounts allocated to such Account pursuant to any elections made by the Participant hereunder with respect to any subsequent Plan Years) until the Participant changes his or her election as to the Earnings Crediting Options for that Account in accordance with clause (iv) below. (iv) A Participant may change the Earnings Crediting Options that are to apply with respect to the balance of an Account, or with respect to any Deferred Amounts to be credited to such Account for any Plan Year pursuant to the Participant's election, by making a new election hereunder with respect to the balance of that Account, or with respect to such Deferred Amounts in the manner prescribed by the Committee. The Participant shall specify, in the same manner as described in clause (ii) above, the respective parts of the balance of such Account, or portions of such Deferred Amounts, that are to be credited with Earnings under each of the Earnings Crediting Options designated by the Participant. Any new election made by a Participant hereunder with respect to the balance of any Account shall become effective as of the first day of the calendar month following the date on which such election is made, provided that it is at least 2 business days prior to such first day. Any new election made by a Participant hereunder with respect to Deferred Amounts to be credited to such Account for any Plan Year shall be effective as of the date such amounts are credited to such Account under Section 4. The Earnings Crediting Options selected by the Participant in such new election shall remain in effect with respect to the Participant's Account until the Participant again changes his or her election with respect to that Account in accordance with this clause (iv). (e) If payment with respect to any Account maintained for a Participant is to be made in form of annual installments pursuant to Section 7 with respect to such Account, such Account shall continue to be credited with Earnings or interest in accordance with the provisions of this Section 6 until all payments required to have been made with respect to such Account have been made. For this purpose, any such payments shall be deemed to have been made pro rata from the respective portions of the balance of such Account that are subject to separate Earnings Crediting Options. 7. Payment of Account Balances Payment with respect to a Participant's Account balances shall be made in accordance with the following provisions: - 8 - (a) Except for the nonvested portion of a Participant's Mandatory Deferred Contribution Account, a Participant's Account balances shall become payable upon the earliest to occur of the following events (hereinafter referred to as "Payment Events"): (i) the Participant's death, (ii) the Participant's Retirement, (iii) the Participant's termination of employment with the Corporation and its Affiliated Companies or the Company for any reason other than death or Retirement, and (iv) the occurrence of a Change in Control (b) Amounts credited to a Participant's Mandatory Deferred Contribution Account shall become payable in the form of a single lump sum cash payment as soon as practicable following the Vesting Date applicable to such amounts unless a Participant elects at least one year prior to such Vesting Date to defer payment with respect to such amounts pursuant to Section 3. (c) Unless at the time a Participant's Account becomes payable there is in effect for the Participant an election under (d) below, payment with respect to such Account shall be made in the form of a single lump cash payment. Such payment shall be made to the Participant or, if the Participant's Account becomes payable by reason of his or her death, to the Participant's Beneficiary. Payment shall be made on the last business day of March of the Plan Year following the year in which the Participant's termination of employment occurs. The amount so payable shall be equal to the balance of the Participant's Account determined as of the last day of February. (d) A Participant may elect to have payment with respect to the balance of his or her Account, or with respect to any percentage of such balance (which must be an even multiple of 10%) as the Participant specifies in such election, made to the Participant, or in the event of the Participant's death, to his or her Beneficiary, in the form of a series of 5, 10, or 15 annual installments, payable in the manner described in Section 7(d), if the Participant's Account becomes payable as a result of the Participant's Retirement, or as a result of the Participant's death while he or she is still employed with the Corporation or any of its Affiliated Companies but after the Participant has met the age, or the age and service, requirements for eligibility for Retirement stated in the definition of such term contained in Section 2. An election under this Section 7(c) shall be made in writing, on a form that is provided by the Committee for such purpose and that is filed by the Participant with the Committee at least one year prior to the date on which the Participant's termination of employment occurs. Any election so made may be revoked, and a new election may be made hereunder after such revocation. Any such revocation or new election shall be made in the same manner, and by the same date, as described in the second preceding sentence. No election or revocation of an election made hereunder shall be given effect unless it is made within the time prescribed herein. (e) If a Participant's Account becomes payable in the form of a series of 5, 10 or 15 annual installments pursuant to the Participant's election under Section 7(d), such payments shall be made in accordance with the following provisions: (i) the first such installment payment shall be made on the last business day of March of the Plan Year following the year in which the Participant's - 9 - termination of employment occurs, and the remaining installment payments shall be made on the last business day of March of each succeeding Plan Year. (ii) the amount of each such installment payment shall be determined by dividing (A) the balance of the Participant's Account determined as of the last day of the Plan Year preceding the year in which such payment is to be made, by (B) the number of installment payments remaining to be made. The last such installment payment shall include earnings credited to the Account for the month preceding the month in which such payment is made. (iii) if the Participant should die before receiving all installment payments required to be made with respect to his or her Account, any installment payments remaining to be made at the date of the Participant's death shall be made to the Participant's Beneficiary in the same form, at the same times, and in the same amounts, as such payments would have been made to the Participant (A) if he or she had not died, and (B), in the case of installment payments required to be made to a Beneficiary due to the death of a Participant occurring before the Participant had received any such payments, if the Participant's employment had terminated as a result of Retirement on the date of his or death. (f) Notwithstanding any previous provision in this Section 7 to the contrary, payments with respect to a Participant's Account shall be subject to the following special rules: upon occurrence of a Change in Control the balance of each Participant's Account shall become immediately due and payable. Payment with respect to such balance shall be made to the Participant or, if the Participant has died, to his or her Beneficiary, in the form of a single lump sum cash payment. Payment shall be made as soon as practicable after the occurrence of such Change in Control. The amount so payable shall be equal to the balance of the Participant's Account determined as of the last day of the month preceding the month in which payment is made. (g) Notwithstanding any other provision in this Section 7 to the contrary, payment with respect to any part or all of the Participant's Account balances may be made to the Participant of, if applicable, the Participant's Beneficiary, on any date earlier than the date on which such payment is to be made pursuant to such other provisions of this Section 7 if (i) the Participant, or his or her Beneficiary, requests such early payment and (ii) the Committee, in its sole discretion, determines that such early payment is necessary to help the Participant, or his or her Beneficiary, meet an "unforeseeable emergency" within the meaning of Section 1.457-2(h)(4) of the federal income tax regulations. The amount that may be so paid may not exceed the amount necessary to meet such emergency. There shall be deducted from the amount of any payment otherwise required to be made under the Plan all Federal, state and local taxes required by law to be withheld with respect to such payment. 8. Designation and Change of Beneficiary - 10 - Each Participant shall file with the Committee a written designation of one or more persons as the Beneficiary who shall be entitled to receive any amount payable under the Plan by reason of his or her death. A Participant may, from time to time, revoke or change his or her Beneficiary designation without the consent of any previously designated Beneficiary by filing a new designation with the Committee. The last such designation received by the Committee shall be controlling; provided, however, that no designation, or change or revocation thereof, shall be effective unless received by the Committee prior to the Participant's death and in no event shall it be effective as of a date prior to such receipt. If at the date of a Participant's death, there is no designation of a Beneficiary in effect for the Participant pursuant to the provisions of this Section 8, or if no Beneficiary designated by the Participant in accordance with the provisions hereof survives to receive any amount payable under the Plan by reason of the Participant's death, the Participant's estate shall be treated as the Participant's Beneficiary for purposes of the Plan. 9. Payments to Persons Other Than Participants If the Committee shall find that any Participant or Beneficiary to whom any amount is payable under the Plan is unable to care for his or her affairs because of illness, accident or legal incapacity, then, if the Committee so directs, such amount may be paid to such Participant's or Beneficiary's spouse, child or other relative, an institution maintaining or having custody of such person, or any person deemed by the Committee to be a proper recipient on behalf of such Participant, unless a prior claim therefore has been made by a duly appointed legal representative of the Participant or Beneficiary. Any payment made under this Section 9 shall be a complete discharge of the liability of the Corporation with respect to such payment. 10. Rights of Participants A Participant's rights and interests under the Plan shall be subject to the following provisions: (a) A Participant shall have the status of a general unsecured creditor of the Corporation with respect to his or her right to receive any payment under the Plan. The Plan shall constitute a mere promise by the Corporation to make payments in the future of the benefits provided for herein. It is intended that the arrangements reflected in this Plan be treated as unfunded for tax purposes, as well as for purposes of Title I of ERISA. (b) The Corporation may, but shall not be required to, purchase a life insurance policy or policies, to assist it in funding any of its payment obligations under the Plan. If any policy is so purchased, it shall, at all times, remain subject to the claims of the Corporation's creditors. No Participant or Beneficiary shall have any interest in, or rights with respect to, such policy. (c) A Participant's rights to payments under the Plan shall not be subject in any manner to anticipation, alienation, sale, transfer, assignment, pledge, encumbrance, attachment, or garnishment by creditors of the Participant or his or her Beneficiary. - 11 - (d) Neither the Plan nor any action taken hereunder shall be construed as giving any Participant any right to be retained in the employment of the Company, the Corporation or any of its Affiliated Companies. 11. Administration of the Plan The Plan shall be administered by the Committee. A majority of the members of the Committee shall constitute a quorum. The Committee may act at a meeting, including a telephone meeting, by action of a majority of the members present, or without a meeting by unanimous written consent. In addition to the responsibilities and powers assigned to the Committee elsewhere in the Plan, the Committee shall have the discretionary authority and power, in its discretion, to establish from time to time guidelines or regulations for the administration of the Plan, interpret the Plan, and make all determinations considered necessary or advisable for the administration of the Plan. The Committee may delegate any ministerial or nondiscretionary function pertaining to the administration of the Plan to any one or more officers of the Corporation. All decisions, actions or interpretations of the Committee under the Plan shall be final, conclusive and binding upon all parties. No member of the Committee shall be personally liable by reason of any contract or other instrument executed by such member or on his or her behalf in his or her capacity as a member of the Committee nor for any mistake of judgment made in good faith, and the Corporation shall indemnify and hold harmless each member of the Committee and each employee, officer, director or trustee of the Corporation or any of its Affiliated Companies to whom any duty or power relating to the administration or interpretation of the Plan may be delegated, against any cost or expense (including counsel fees) or liability (including any sum paid in settlement of a claim with the approval of the Board of Directors) arising out of any act or omission to act in connection with the Plan, unless arising out of such person's own fraud or bad faith. 12. Amendment or Termination The Board of Directors may, with prospective or retroactive effect, amend, suspend or terminate the Plan or any portion thereof at any time; provided, however, that no amendment of the Plan shall deprive any Participant of any rights to receive payment of any amounts due him or her under the terms of the Plan as in effect prior to such amendment without his or her written consent. Any amendment that the Board of Directors would be permitted to make pursuant to the preceding paragraph may also be made by the Committee where appropriate to facilitate the administration of the Plan or to comply with applicable law or any applicable rules and regulations of governing authorities provided that the cost of the Plan to the Corporation is not materially increased by such amendment. Notwithstanding any other provision in this Plan to the contrary, the Committee may terminate any Participant's participation in the Plan, and direct that an immediate payment be made with respect to the balances of the Participant's Accounts, if the Committee, in its sole discretion, determines that such termination of participation and payment are necessary in order to preserve the Plan's status as a plan of deferred compensation for "a select group of management or highly compensated employees" within the meaning of the applicable provisions of ERISA. - 12 - 13. Successor Corporation The obligations of the Corporation under the Plan shall be binding upon any successor corporation or organization succeeding to substantially all of the assets and business of the Corporation. 14. Governing Law The provisions of the Plan shall be governed by and construed in accordance with the laws of the State of New York. - 13 - EX-12 13 exh12_1.txt EXHIBIT 12.1
THE CHARLES SCHWAB CORPORATION EXHIBIT 12.1 Computation of Ratio of Earnings to Fixed Charges (Dollar amounts in millions, unaudited) Year Ended December 31, 2004 2003 2002 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------------ Earnings from continuing operations before taxes on earnings and extraordinary gain $ 645 $ 717 $ 249 $ 128 $ 1,016 - ------------------------------------------------------------------------------------------------------------------------------------ Fixed charges Interest expense: Brokerage client cash balances 113 76 164 678 1,057 Deposits from banking clients 105 96 94 128 155 Long-term debt 32 35 46 55 55 Short-term borrowings 18 13 20 27 20 Other 9 20 7 22 45 - ------------------------------------------------------------------------------------------------------------------------------------ Total 277 240 331 910 1,332 Interest portion of rental expense 82 87 82 88 69 - ------------------------------------------------------------------------------------------------------------------------------------ Total fixed charges (A) 359 327 413 998 1,401 - ------------------------------------------------------------------------------------------------------------------------------------ Earnings from continuing operations before taxes on earnings, extraordinary gain and fixed charges (B) $ 1,004 $ 1,044 $ 662 $ 1,126 $ 2,417 ==================================================================================================================================== Ratio of earnings to fixed charges (B) / (A)(1) 2.8 3.2 1.6 1.1 1.7 - ------------------------------------------------------------------------------------------------------------------------------------ Ratio of earnings to fixed charges excluding brokerage client interest expense(2) 3.6 3.9 2.0 1.4 4.0 - ------------------------------------------------------------------------------------------------------------------------------------ (1) The ratio of earnings to fixed charges is calculated in accordance with SEC requirements. For such purposes, "earnings" consist of earnings from continuing operations before taxes on earnings, 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-21 14 exh21_1.txt EXHIBIT 21.1 THE CHARLES SCHWAB CORPORATION EXHIBIT 21.1 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, 2004. 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 Charles Schwab Bank, National Association, a Nevada corporation 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, National Association, a Connecticut corporation EX-23 15 exh23_1.txt EXHIBIT 23.1 EXHIBIT 23.1 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We consent to the incorporation by reference in the following Registration Statements of The Charles Schwab Corporation of our report dated February 28, 2005 relating to the consolidated financial statements and financial statement schedule of The Charles Schwab Corporation and management's report on the effectiveness of internal control over financial reporting, appearing in this Annual Report on Form 10-K of The Charles Schwab Corporation for the year ended December 31, 2004. Filed on Form S-3: Registration Statement No. 333-114729 (Debt Securities, Junior Subordinated Debentures, Preferred Stock, Depositary Shares, Common Stock, Warrants, Purchase Contracts, and Units Consisting of Two or More Securities) 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 (U.S. Trust Corporation 401(k) Plan formerly known as the 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 February 28, 2005 EX-31 16 exh31_1.txt EXHIBIT 31.1 THE CHARLES SCHWAB CORPORATION Exhibit 31.1 CERTIFICATION PURSUANT TO RULE 13a-14(a)/15d-14(a), AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 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 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this 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 report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared; b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: February 28, 2005 /s/ Charles R. Schwab ---------------------- ------------------------------------ Charles R. Schwab Chairman and Chief Executive Officer EX-31 17 exh31_2.txt EXHIBIT 31.2 THE CHARLES SCHWAB CORPORATION Exhibit 31.2 CERTIFICATION PURSUANT TO RULE 13a-14(a)/15d-14(a), AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 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 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this 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 report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared; b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: February 28, 2005 /s/ Christopher V. Dodds ---------------------- ------------------------------ Christopher V. Dodds Executive Vice President and Chief Financial Officer EX-32 18 exh32_1.txt EXHIBIT 32.1 THE CHARLES SCHWAB CORPORATION Exhibit 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of The Charles Schwab Corporation (the Company) on Form 10-K for the year ended December 31, 2004 (the Report), I, Charles R. Schwab, Chairman and Chief Executive Officer of the Company, hereby certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company for the periods presented therein. /s/ Charles R. Schwab Date: February 28, 2005 - ------------------------------------ --------------------- Charles R. Schwab Chairman and Chief Executive Officer A signed original of this written statement required by Section 906 has been provided to The Charles Schwab Corporation and will be retained by The Charles Schwab Corporation and furnished to the Securities and Exchange Commission or its staff upon request. EX-32 19 exh32_2.txt EXHIBIT 32.2 THE CHARLES SCHWAB CORPORATION Exhibit 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of The Charles Schwab Corporation (the Company) on Form 10-K for the year ended December 31, 2004 (the Report), I, Christopher V. Dodds, Executive Vice President and Chief Financial Officer of the Company, hereby certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company for the periods presented therein. /s/ Christopher V. Dodds Date: February 28, 2005 - ----------------------------- -------------------- Christopher V. Dodds Executive Vice President and Chief Financial Officer A signed original of this written statement required by Section 906 has been provided to The Charles Schwab Corporation and will be retained by The Charles Schwab Corporation and furnished to the Securities and Exchange Commission or its staff upon request. -----END PRIVACY-ENHANCED MESSAGE-----