-----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, TbzCE+4goxjdWoHUZT64+zwktgMHRuzwba+H571E7TU9kq5aw3t4p76lIrvvZBwZ IDQYFI3xzeWmy6QJhSnEag== 0001047469-98-012181.txt : 19980331 0001047469-98-012181.hdr.sgml : 19980331 ACCESSION NUMBER: 0001047469-98-012181 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 20 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980327 SROS: NYSE 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: SEC FILE NUMBER: 001-09700 FILM NUMBER: 98577119 BUSINESS ADDRESS: STREET 1: 101 MONTGOMERY ST CITY: SAN FRANCISCO STATE: CA ZIP: 94104 BUSINESS PHONE: 4156277000 MAIL ADDRESS: STREET 1: 101 MONTGOMERY ST CITY: SAN FRANCISCO STATE: CA ZIP: 94104 10-K 1 10-K 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, 1997 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) 101 Montgomery Street, San Francisco, CA 94104 (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 - $0.01 par value New York Stock Exchange, Inc. Pacific Exchange, Inc. 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. [ ] As of March 12, 1998, the aggregate market value of the voting stock held by nonaffiliates of the registrant was $8,112,875,618. 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 Common Stock held by affiliates. The number of shares of Common Stock outstanding as of March 12, 1998 was 267,742,421* shares. DOCUMENTS INCORPORATED BY REFERENCE Part I and II of this Form 10-K incorporate certain information contained in the registrant's 1997 Annual Report to Stockholders by reference to portions of that document. Part III of this Form 10-K incorporates certain information contained in the registrant's definitive proxy statement for its annual meeting of stockholders to be held May 11, 1998 by reference to portions of that document. * Reflects the September 1997 three-for-two common stock split. THE CHARLES SCHWAB CORPORATION Annual Report On Form 10-K For Fiscal Year Ended December 31, 1997 TABLE OF CONTENTS Part I Item 1. Business --------------------------------------------------------------------------------------------- 1 Item 2. Properties ------------------------------------------------------------------------------------------- 9 Item 3. Legal Proceedings ------------------------------------------------------------------------------------ 9 Item 4. Submission of Matters to a Vote of Security Holders -------------------------------------------------- 9 Part II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters -------------------------------- 10 Item 6. Selected Financial Data ------------------------------------------------------------------------------ 10 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations ---------------- 10 Item 7A. Quantitative and Qualitative Disclosures About Market Risk ------------------------------------------- 10 Item 8. Financial Statements and Supplementary Data ---------------------------------------------------------- 10 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ----------------- 11 Part III Item 10. Directors and Executive Officers of the Registrant --------------------------------------------------- 11 Item 11. Executive Compensation ------------------------------------------------------------------------------- 14 Item 12. Security Ownership of Certain Beneficial Owners and Management --------------------------------------- 14 Item 13. Certain Relationships and Related Transactions ------------------------------------------------------- 14 Part IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K -------------------------------------- 14 Exhibit Index ---------------------------------------------------------------------------------- 15 Signatures ------------------------------------------------------------------------------------- 21 Index to Financial Statement Schedules --------------------------------------------------------- F-1
THE CHARLES SCHWAB CORPORATION PART I Item 1. Business (a) General Development of Business. The Charles Schwab Corporation (CSC) was incorporated in 1986 and engages, through its subsidiaries, in securities brokerage and related financial services. As used herein, the "Company" refers to CSC and its subsidiaries. CSC's principal subsidiary, Charles Schwab & Co., Inc. (Schwab), is a securities broker-dealer. Schwab was incorporated in 1971, and entered the discount brokerage business in 1974. Mayer & Schweitzer, Inc. (M&S), a subsidiary acquired in 1991, is a market maker in Nasdaq and other securities that provides trade execution services to broker-dealers and institutional customers. Other subsidiaries of CSC include Charles Schwab Investment Management, Inc. (CSIM), The Charles Schwab Trust Company (CSTC) and Charles Schwab Europe (formerly known as ShareLink). CSIM, incorporated in 1989, acts as the investment adviser for Schwab's proprietary mutual funds. The Company refers to certain funds for which CSIM is the investment adviser as the SchwabFunds-Registered Trademark-. CSTC, incorporated in 1992, provides custody services for independent investment managers and serves as trustee for employee benefit plans, primarily 401(k) plans. Charles Schwab Europe, acquired in 1995 to expand the Company's international operations, is a retail discount securities brokerage firm located in the United Kingdom. New developments in the Company's business during 1997 include the continued expansion of products and services tailored to meet customers' varying investment and financial needs. During 1997, Schwab announced alliances with three investment banking firms to provide certain of its customers initial and secondary public stock offerings managed by these firms. Additionally, the Company began to offer access to futures and commodities trading to certain of its most active customers. The Company is also enhancing the ways it helps investors develop and evaluate their investment choices. In 1997, the Company introduced a number of new Internet-based investment services, including the Asset Allocation Toolkit-TM- for portfolio allocation guidance, and the Mutual Fund OneSource-Registered Trademark- Online and Market Buzz-TM- sites for research and information. The Company also broadened its multi-channel delivery systems to make investing more accessible to more people. During 1997, Schwab introduced a speech recognition telephone trading service that enables customers to trade any of the funds in the Mutual Fund Marketplace-Registered Trademark- using vocal commands. During 1997, the Company's Board of Directors declared a three-for-two common stock split, distributed September 1997, effected in the form of a stock dividend. Share and per share information throughout this report have been restated. The Board increased the quarterly cash dividend 20% to $.04 per share in 1997. (b) Financial Information About Industry Segments. The Company operates in a single industry segment: securities brokerage and related financial services. Fees received from the Company's proprietary mutual funds represented approximately 12% of the Company's consolidated revenues in 1997. As of December 31, 1997, approximately 28% of Schwab's total customer accounts were located in California. The next highest geographic concentrations of total customer accounts were approximately 8% in Florida, 7% in New York and 6% in Texas. (c) Narrative Description of Business. The Company's strategy is to attract and retain customer assets by focusing on a number of areas within the financial services industry -- retail brokerage, mutual funds, support services for independent investment managers, equity securities market-making and 401(k) defined contribution plans. To pursue its strategy and its objective of long-term profitable growth, the Company plans to continue to leverage its competitive advantages. These advantages include a nationally recognized brand, a broad range of products and services, multi-channel delivery systems and an ongoing investment in technology. The Company's primary focus is serving retail investors, directly or through independent investment managers, who want access to a broad selection of products and services, as well as investment news and information, tailored to meet their financial needs. The Company, through Schwab, serves over 4.8 million active customer accounts(a). Customer assets totaled $353.7 billion at December 31, 1997. The Company, through Schwab and M&S, engages in market-making activities in exchange-listed, Nasdaq and other equity securities. Regulatory changes and changes in industry customs and practices are significantly impacting these market-making activities. See "Management's Discussion and Analysis of Results of Operations and Financial Condition" in the Company's 1997 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report, and "Regulation" below. The Company's business, like that of other securities brokerage firms, is directly affected by the fluctuations in securities trading volumes and price levels that occur in fundamentally cyclical financial markets. Such fluctuations are affected by many national and international economic and political factors that cannot be predicted, including broad trends in business and finance, the availability of credit and capital, legislation and regulation affecting the United States and international business and financial communities, currency values, and the level and volatility of interest rates. - -------- (a) Accounts with balances or activity within the preceding twelve months.
=================================================================================================================================== Sources of Revenues (Dollar amounts in thousands) Year Ended December 31, ------------------------------------------------------------------------------------- 1997 1996 1995 --------------------------- --------------------------- --------------------------- Type of Revenue Amount Percent Amount Percent Amount Percent --------------------------- --------------------------- --------------------------- Commissions Listed securities $ 527,321 22.9% $ 423,232 22.9% $ 356,069 25.1% Nasdaq 465,137 20.2% 393,882 21.3% 283,024 19.9% Options 103,372 4.5% 66,210 3.5% 53,333 3.8% Mutual funds 78,193 3.5% 70,805 3.8% 58,470 4.1% ----------------------------------------------------------------------------------------------------------------------------- Commissions 1,174,023 51.1% 954,129 51.5% 750,896 52.9% ----------------------------------------------------------------------------------------------------------------------------- Mutual fund service fees 427,673 18.6% 311,067 16.8% 218,784 15.4% Interest revenue Margin loans to customers 489,197 21.3% 339,433 18.3% 264,025 18.6% Investments, customer-related 380,443 16.5% 316,760 17.1% 283,031 19.9% Other 30,395 1.4% 24,667 1.4% 21,064 1.6% Interest expense (546,483) (23.8%) (425,872) (23.0%) (357,223) (25.2%) ----------------------------------------------------------------------------------------------------------------------------- Interest revenue, net of interest expense 353,552 15.4% 254,988 13.8% 210,897 14.9% ----------------------------------------------------------------------------------------------------------------------------- Principal transactions 257,985 11.2% 256,902 13.9% 191,392 13.5% Other 85,517 3.7% 73,836 4.0% 47,934 3.3% ----------------------------------------------------------------------------------------------------------------------------- Total $2,298,750 100.0% $1,850,922 100.0% $1,419,903 100.0% ============================================================================================================================= This table should be read in connection with the Company's consolidated financial statements and notes in the Company's 1997 Annual Report to Stockholders, which are incorporated herein by reference to Exhibit No. 13.1 of this report. ===================================================================================================================================
Shifts in customer investment preferences or in customer usage of Schwab's multi-channel delivery systems also could reduce trading revenues, which include commission and principal transaction revenues. Since trading revenues continue to represent a majority of the Company's revenues, the Company may experience significant variations in revenues from period to period. The Company adjusts its expenses in anticipation of and in response to changes in financial market conditions and customer trading patterns. Certain of the Company's expenses (including variable compensation, portions of communications, and commissions, clearance and floor brokerage) vary directly with changes in financial performance or customer trading activity. Expenses relating to the level of temporary employees, contractors, overtime hours, professional services, and advertising and market development are adjustable over the short term to help the Company achieve its financial objectives. Additionally, developmental spending (including branch openings, product and service rollouts, and technology enhancements) is discretionary and can be altered in response to market conditions. However, a significant portion of the Company's expenses such as salaries and wages, occupancy and equipment, and depreciation and amortization do not vary directly, at least in the short term, with fluctuations in revenues or securities trading volumes. Also, the Company views its developmental spending as essential for future growth and therefore tries to avoid major adjustments in such spending unless faced with a sustained slowdown in customer trading activity. Given the nature of the Company's revenues and expenses, and the economic and competitive factors discussed in this report, the Company's earnings and common stock price may be subject to significant volatility from period to period. The Company's results for any period are not necessarily indicative of results for a future period. The table above sets forth on a comparative basis the Company's revenues for the three years ended December 31, 1997. Competition The Company faces significant competition from companies seeking to attract customer financial assets, including full-commission brokerage firms, discount brokerage firms, mutual fund companies and banks. Certain of these competitors have significantly greater financial resources and offer a wider range of services and financial products than the Company, particularly given the continued consolidation within the financial services industry. In addition, the recent expansion and customer acceptance of conducting financial transactions online has attracted competition from software development companies and providers of online services. In 1997, price competition continued to intensify in the area of online investing as competitors sought to gain market share in this rapidly growing area. The Company experienced declines in its average commission per revenue trade as the proportion of its customers using electronic brokerage channels, which provide discounts from the Company's standard commission rates, has increased. As the Company focuses on further enhancements to its electronic service offering, average commission per revenue trade is expected to continue to decline. The Company primarily competes on the basis of quality of customer service, breadth of products and services offered at prices that management believes represent superior value, accessibility to the Company through its multi-channel delivery systems, and technological innovation and expertise. Most discount brokerage firms and online-only financial services providers charge commissions lower than Schwab. Full-commission brokerage firms also offer discounted commissions to selected retail brokerage customers. Many brokerage firms employ substantial funds in advertising and direct solicitation of customers to increase their market share of commission dollars and other securities-related income. Such competition may negatively impact the Company's customer asset growth, revenue growth and profit margin. Advertising and Marketing Programs The Company's nationwide advertising and marketing programs are designed to distinguish the Schwab brand as well as its products and services. The Company's advertising and market development expense was $130 million in 1997, compared to $84 million in 1996 and $53 million in 1995. Expenditures for these programs helped Schwab open 1,164,000 new accounts in 1997, compared to 985,000 in 1996 and 698,000 in 1995. New customer accounts represent a significant portion of the growth in customer assets, which the Company believes is critical to growth in revenues. Accounts opened during 1997 generated 17% of Schwab's commission revenues during the year, compared to 16% in 1996 and 13% in 1995. Schwab advertises regularly in financially-oriented newspapers and periodicals and occasionally in general circulation publications. Schwab advertisements appear regularly on national and local cable television and periodically on radio and independent television stations. Schwab also engages extensively in targeted direct mail advertising through monthly statement "inserts" and special mailings. In its advertising, as well as in promotional events such as press appearances, Schwab has promoted the name and likeness of its Chairman, Mr. Schwab. The Company has an agreement with Mr. Schwab by which he, subject to certain limitations, has assigned to the Company and Schwab all service mark, trademark, and trade name rights in his name (and variations thereon) and likeness. Products and Services The Company offers both a broad range of products and services tailored to meet customers' varying investment and financial needs, as well as access to extensive investment news and information. Accounts and Features. The Company offers the purchase and sale of securities which include exchange-listed, Nasdaq and other equity securities, options, mutual funds, unit investment trusts, variable annuities and fixed income investments, including United States Treasuries, zero-coupon bonds, listed and OTC corporate bonds, municipal bonds, GNMAs and CDs. In 1997, the Company began to offer certain of its customers initial and secondary public stock offerings, and access to futures and commodities trading. Customers approved for margin transactions may borrow a portion of the price of certain securities purchased through Schwab, or may sell securities short. Customers must have specific approval to trade options; as of December 31, 1997, 258,000 accounts were so approved. To write uncovered options, customers must go through an additional approval process and must maintain a significantly higher level of equity in their brokerage accounts. Because Schwab does not pay interest on cash balances in basic brokerage accounts, it provides customers with an option to have cash balances in their accounts automatically swept, on a weekly basis, into certain SchwabFunds-Registered Trademark- money market funds. A customer may receive additional services by qualifying for and opening a Schwab One-Registered Trademark- brokerage account. A customer may access available funds in his or her Schwab One account either with a personal check or a VISA-Registered Trademark- debit card. When a Schwab One customer is approved for margin trading, the checks and debit card also provide access to margin cash available. For cash balances awaiting investment, Schwab pays interest to Schwab One customers. Alternatively, qualifying Schwab One customers seeking tax-exempt income may elect to have cash balances swept into state-specific municipal tax-exempt SchwabFunds money market funds or a tax-exempt municipal trust (for Florida taxpayers only). Schwab acts as custodian, as well as broker, for Individual Retirement Accounts (IRAs). In Schwab IRAs, cash balances are swept daily into one of three SchwabFunds money market funds. During 1997, active IRAs increased 20% to 1,604,000 accounts and customer assets in all IRAs increased 35% to $88.2 billion. Schwab also acts as custodian and broker for Keogh accounts. Customer Financing. Customers' securities transactions are conducted on either a cash or margin basis. Generally, a customer buying securities in a cash-only brokerage account is required to make payment by settlement date, usually three business days after the trade is executed. However, for purchases of certain types of securities, such as certain mutual fund shares, a customer must have a cash or money market fund balance in his or her account sufficient to pay for the trade prior to execution. When selling securities, a customer is required to deliver the securities, and is entitled to receive the proceeds, on settlement date. In an account authorized for margin trading, Schwab may lend its customer a portion of the market value of certain securities up to the limit imposed by the Federal Reserve Board, which for most equity securities is initially 50%. Such loans are collateralized by the securities in the customer's account. Short sales of securities represent sales of borrowed securities and create an obligation to purchase the securities at a later date. Customers may sell securities short in a margin account subject to minimum equity and applicable margin requirements and the availability of such securities to be borrowed and delivered. Interest on margin loans to customers provides an important source of revenue to Schwab. During 1997, Schwab's outstanding margin loans to customers averaged $6.4 billion. In permitting a customer to engage in transactions, Schwab faces credit risk if the customer fails to meet his or her obligations in the event of adverse changes in the market value of the securities positions in his or her account. Under applicable rules and regulations for margin transactions, Schwab, in the event of such an adverse change, requires the customer to deposit additional securities or cash, so that the amount of the customer's obligation is not greater than specified percentages of the cash and market values of the securities in the account. As a matter of policy, Schwab generally requires its customers to maintain higher percentages of collateral values than the minimum percentages required under these regulations. Schwab may use cash balances in customer accounts to extend margin credit to other customers. Pursuant to the requirements of Rule 15c3-3 of the Securities Exchange Act of 1934, the portion of such cash balances not used to extend margin credit (increased or decreased by certain other customer-related balances) must be held in segregated investment accounts. The balances in these segregated investment accounts must be invested in qualified interest-bearing securities. To the extent customer cash balances are available for use by Schwab at interest costs lower than Schwab's costs of borrowing from alternative sources, Schwab's cost of funds is reduced and its net income is enhanced. Such interest savings contribute substantially to Schwab's profitability and, if a significant reduction of customer cash balances were to occur, Schwab's borrowings from other sources may have to increase and such profitability would decline. To the extent Schwab's customers elect to have cash balances in their brokerage accounts swept into certain SchwabFunds money market funds, the cash balances available to Schwab for investments or for financing margin loans are reduced. However, Schwab receives mutual fund service fees from such funds based on the daily average invested balances. See also "Management's Discussion and Analysis of Results of Operations and Financial Condition" in the Company's 1997 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report, and "Regulation" below. Mutual Funds. At December 31, 1997, Schwab's Mutual Fund OneSource-Registered Trademark- service enabled customers to trade 825 mutual funds in 121 fund families without incurring transaction fees. The service allows investors to access multiple mutual fund companies, avoid brokerage transaction fees, and achieve investment diversity among fund families. In addition, investors' record keeping and investment monitoring are simplified through one consolidated statement. Fees received by Schwab for providing services, including record keeping and shareholder services, from the Mutual Fund OneSource program are based upon daily balances of customer assets invested in the participating funds through Schwab and are paid by the funds and/or fund sponsors. Customer assets held by Schwab that have been purchased through the Mutual Fund OneSource-Registered Trademark- service, excluding Schwab's proprietary funds, totaled $56.6 billion at the end of 1997. Schwab's Mutual Fund Marketplace-Registered Trademark- (including Mutual Fund OneSource) provides customers with the ability to invest in nearly 1,400 mutual funds in 219 fund families sponsored by third parties. Customer assets invested in the Mutual Fund Marketplace, excluding the Mutual Fund OneSource service, totaled $48.0 billion at the end of 1997. Schwab charges a transaction fee on trades placed in the funds included in the Mutual Fund Marketplace (except on trades through the Mutual Fund OneSource service). These fees are recorded as commission revenues. Commissions from customer transactions in mutual fund shares comprised approximately 7% of Schwab's total commission revenues during the last three years. Schwab's proprietary funds, collectively referred to as the SchwabFunds-Registered Trademark-, include money market funds, equity index funds, bond funds, asset allocation funds, and funds that primarily invest in stock, bond and money market funds. Qualifying Schwab customers may elect to have cash balances in their brokerage accounts automatically invested in certain SchwabFunds money market funds. Customer assets invested in the SchwabFunds were $55.8 billion at the end of 1997. Fees received by the Company from the SchwabFunds, for providing transfer agent services, shareholder services, administration and investment management, are based upon daily balances of customer assets invested in these funds. Market Making In Nasdaq and Exchange-Listed Securities. M&S provides trade execution services in Nasdaq and other securities to broker-dealers, including Schwab, and institutional customers. As a market maker in Nasdaq and other securities, M&S generally executes customer trades as principal. While substantially all Nasdaq security trades originated by the customers of Schwab are directed to M&S, the majority of M&S' trading volume comes from parties other than Schwab. Schwab has specialist operations on the Pacific Exchange and the Boston Stock Exchange to make markets in exchange-listed securities. The majority of trades originated by the customers of Schwab in exchange-listed securities for which Schwab makes a market are directed to these operations. At December 31, 1997, Schwab had 14 specialists on the Pacific Exchange and 3 specialists on the Boston Stock Exchange that collectively made markets in 900 and 100 securities, respectively. In the normal course of their market making in exchange-listed, Nasdaq and other securities, Schwab and M&S maintain inventories in such securities on both a long and short basis. While long inventory positions represent Schwab's and M&S' ownership of securities, short inventory positions represent obligations of Schwab and M&S to deliver specified securities at a contracted price, which may differ from market prices prevailing at the time of completion of the transaction. Accordingly, long or short inventory positions may result in gains or losses as market values of such securities fluctuate. See also "Management's Discussion and Analysis of Results of Operations and Financial Condition -- Market Risk" in the Company's 1997 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report, and "Regulation" below. Services for Independent Investment Managers. To attract the business of accounts managed by independent investment managers, Schwab has a dedicated business unit which includes experienced registered representatives assigned to individual managers. Independent investment managers participating in this program who custody customer accounts at Schwab may use SchwabLink-Registered Trademark- and the SchwabLink Web-TM- site for investment managers. SchwabLink is a computer-based information network which enables investment managers to access information about their customers' accounts directly from Schwab's computer databases and to enter their customers' trades online. The SchwabLink Web site enables investment managers to use the Internet to communicate directly with Schwab service teams, as well as receive news and information. During 1997, Schwab customer assets held in accounts managed by over 5,300 active independent investment managers increased $32.9 billion, or 45%, to a total of $105.8 billion. Independent investment managers and other professional investors generated approximately 12% of Schwab's total commission revenues during the last three years. Retirement Plan Services. Schwab serves company 401(k) plans directly through a dedicated sales force, as well as indirectly through alliances with national and regional third-party administrators. Schwab offers SchwabPlan-TM-, a comprehensive 401(k) retirement plan, which enables employers to offer a wide range of investment options as well as employee education to their 401(k) retirement plan participants. During 1997, Schwab continued to develop its retirement plan services business, with customer assets in corporate 401(k) and other plans growing $4.9 billion, or 48%, to $15.1 billion. Multi-Channel Delivery Systems The Company differentiates itself with multi-channel delivery systems which allow customers to choose how they prefer to do business with the Company. In addition to its branch office network, the Company maintains four regional customer telephone service centers as well as electronic brokerage channels. Branch Office Network. At December 31, 1997, Schwab operated 272 domestic branch offices in 47 states, as well as a branch in each of the Commonwealth of Puerto Rico and the United Kingdom. In addition, in 1997, the Company opened new offices in Hong Kong and the Cayman Islands. The Company's office network plays a key role in building its business. With the customer service support of regional customer telephone service centers and electronic brokerage channels, branch personnel are focusing a significant portion of their time on business development. Customers can use branch offices to open accounts, deliver and receive checks and securities, obtain market information, place orders, and obtain related customer services in person, yet most branch activities are conducted by telephone and mail. The Company is enhancing the ways in which it may help investors by using the branch office network to assist investors in developing asset allocation strategies and evaluating their investment choices. Branch staff also refer investors who desire additional guidance to independent investment managers through the Schwab AdvisorSource-TM- service. Regional Customer Telephone Service Centers. Schwab's four regional customer telephone service centers, located in Indianapolis, Denver, Phoenix and Orlando, handle customer trading and service calls twenty-four hours-a-day, seven days-a-week. Customer orders placed during nonmarket hours are routed to appropriate markets the following business day. The capacity of the service centers allows the branch office network to be maintained at lower staffing levels and to focus on business development. The Company's customer service approach is to use teams led by registered representatives in the service centers, who work closely with branch office network personnel. Additionally, certain teams at these centers provide specialized services to active and affluent investors. Each registered representative has immediate access to the customer account and market-related information necessary to respond to customer inquiries. For most customer orders, registered representatives can enter the order and confirm the transaction immediately. As a result of this approach, the departure of a registered representative generally does not result in a loss of customers for the Company. Electronic Brokerage Channels. Customers are able to obtain financial information and execute trades on an automated basis through the Company's electronic brokerage channels that provide both online and automated telephonic access. These channels are designed to provide added convenience for customers and minimize Schwab's costs of responding to and processing routine customer transactions. To assist customers in using online channels, the Company maintains two online customer support centers that operate both during and after normal market hours. Online channels include PC-based services such as SchwabLink-Registered Trademark-, and the Charles Schwab Web Site-TM- (formerly known as SchwabNOW!-TM-) -- an information and trading service on the Internet. The Company's online channels handled 37% of total trades in 1997. Automated telephonic channels include TeleBroker-Registered Trademark- -- Schwab's touch-tone telephone trading service, and VoiceBroker-TM- -- Schwab's voice recognition quote service. Schwab's automated telephonic channels handled 73% of total customer calls received in 1997. Trades placed through electronic brokerage channels provide discounts from the Company's standard commission rates. Information Systems Schwab's operations rely heavily on its information processing and communications systems. Schwab's system for processing a securities transaction is highly automated. Registered representatives equipped with online computer terminals can access customer account information, obtain securities prices and related information, and enter orders online. To support its multi-channel delivery systems, as well as other applications such as clearing functions, account administration, record keeping and direct customer access to investment information, Schwab maintains a sophisticated computer network connecting all of the branch offices and regional customer telephone service centers. Schwab's computers are also linked to the major registered United States securities exchanges, M&S, the National Securities Clearing Corporation and The Depository Trust Company. Failure of Schwab's information processing or communications systems for a significant period of time could limit Schwab's ability to process its large volume of transactions accurately and rapidly. This could cause Schwab to be unable to satisfy its obligations to customers and other securities firms, and could result in regulatory violations. External events, such as an earthquake or power failure, loss of external information feeds, such as security price information, as well as internal malfunctions, such as those that could occur during the implementation of system modifications, could render part or all of such systems inoperative. To enhance the reliability of the system and integrity of data, Schwab maintains carefully monitored backup and recovery functions. These include logging of all critical files intraday, duplication and storage of all critical data outside of its central computer site every 24 hours, and maintenance of facilities for backup and communications in San Francisco. They also include the maintenance and periodic testing of a disaster recovery plan that management believes would permit Schwab to recommence essential computer operations if its central computer site were to become inaccessible. To reduce the exposure to system failures caused by external factors, including earthquakes, the Company's primary data center is located in Phoenix. Many existing computer programs use only two digits to identify a specific year and therefore may not accurately recognize the upcoming change in the century. If not corrected, many computer applications could fail or create erroneous results by or at the year 2000. Due to the Company's dependence on computer technology to operate its business, and the dependence of the financial services industry on computer technology, the nature and impact of Year 2000 processing failures on the Company's business could be material. The Company is currently modifying its computer systems in order to enable its systems to process data and transactions incorporating year 2000 dates without material errors or interruptions. See also "Management's Discussion and Analysis of Results of Operations and Financial Condition -- Year 2000" in the Company's 1997 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report. Clearing and Account Maintenance Schwab performs clearing services for all securities transactions in customer accounts. Schwab clears the vast majority of customer transactions through the facilities of the National Securities Clearing Corporation or the Options Clearing Corporation. Certain other transactions, such as mutual fund transactions and transactions in securities not eligible for settlement through a clearing corporation, are settled directly with the mutual funds or other financial institutions. Schwab is obligated to settle transactions with clearing corporations, mutual funds and other financial institutions even if Schwab's customer fails to meet his or her obligations to Schwab. In addition, for transactions that do not settle through a clearing corporation, Schwab takes the risk of the other party's failure to settle the trade. See "Financial Instruments with Off-Balance-Sheet and Credit Risk" note in the Notes to Consolidated Financial Statements in the Company's 1997 Annual Report to Stockholders, which are incorporated herein by reference to Exhibit No. 13.1 of this report. Employees As of December 31, 1997, the Company had full-time, part-time and temporary employees, and persons employed on a contract basis that represented the equivalent of 12,700 full-time employees. Regulation The securities industry in the United States is subject to extensive regulation under both Federal and state laws. The Securities and Exchange Commission (SEC) is the Federal agency charged with administration of the Federal securities laws. Schwab and M&S are registered as broker-dealers with the SEC. Schwab and CSIM are registered as investment advisers with the SEC. Additionally, Schwab is regulated by the Commodities Futures Trading Commission (CFTC) with respect to its introduced futures and commodities trading activities. Much of the regulation of broker-dealers has been delegated to self-regulatory organizations, principally the National Association of Securities Dealers (NASD) and the national securities exchanges such as the New York Stock Exchange (NYSE), which has been designated by the SEC as Schwab's primary regulator with respect to its securities activities. The NASD has been designated by the SEC as M&S' primary regulator with respect to its securities activities. During 1997, the Chicago Board Options Exchange (CBOE) was Schwab's designated primary regulator with respect to options trading activities; the NYSE has been designated as such for 1998 and 1999. The National Futures Association has been designated by the CFTC as Schwab's primary regulator with respect to its introduced futures and commodities trading activities. These self-regulatory organizations adopt rules (subject to approval by the SEC or CFTC) governing the industry and conduct periodic examinations of broker-dealers. Securities firms are also subject to regulation by state securities authorities in the states in which they do business. Schwab was registered as a broker-dealer in 50 states, the District of Columbia and Puerto Rico as of December 31, 1997. M&S was registered as a broker-dealer in 32 states and the District of Columbia as of December 31, 1997. The principal purpose of regulations and discipline of broker-dealers and investment advisers is the protection of customers and the securities markets, rather than protection of creditors and stockholders of broker-dealers and investment advisers. The regulations to which broker-dealers and investment advisers are subject cover all aspects of the securities business, including sales methods, trading practices among broker-dealers, uses and safekeeping of customers' funds and securities, capital structure of securities firms, record keeping, fee arrangements, disclosure to clients, and the conduct of directors, officers and employees. Additional legislation, changes in rules promulgated by the SEC and by self-regulatory organizations or changes in the interpretation or enforcement of existing laws and rules may directly affect the method of operation and profitability of broker-dealers and investment advisers. The SEC, CFTC, self-regulatory organizations and state securities authorities may conduct civil or administrative proceedings which can result in censure, fine, cease and desist orders, or suspension or expulsion of a broker-dealer or an investment adviser, its officers, or employees. Schwab and M&S have been the subject of such administrative proceedings. In August 1996, the SEC adopted certain new rules and rule amendments, known as the Order Handling Rules, which have significantly altered the manner in which orders related to both Nasdaq and listed securities are handled. These rules were implemented in phases between January 20, 1997 and October 13, 1997. Additionally, in June 1997, most major United States securities markets, including Nasdaq and the NYSE, began quoting and trading securities in increments of one-sixteenth dollar per share instead of one-eighth dollar per share for most securities, and these markets are currently considering further changes to reduce the increments by which securities are priced. Mainly as a result of these regulatory changes and changes in industry customs and practices, average revenue per principal transaction declined during 1997 as compared to 1996. Since the change to trading securities in increments of one-sixteenth dollar per share was not implemented until June 1997 and the Order Handling Rules were not fully implemented until October 1997, the Company expects M&S' average revenue per principal transaction for 1998 to be materially less than the average during substantially all of 1997. Recent and future regulatory changes, changes in industry customs and practices, and changes in trading systems are expected to continue to result in declines in average revenue per principal transaction, and are expected to have a material adverse impact on M&S' revenues and profit margin. See "Management's Discussion and Analysis of Results of Operations and Financial Condition -- Revenues -- Principal Transactions" and "Commitments and Contingent Liabilities" note in the Notes to Consolidated Financial Statements in the Company's 1997 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report. As registered broker-dealers and NASD member organizations, Schwab and M&S are required by Federal law to belong to the Securities Investor Protection Corporation (SIPC), which provides, in the event of the liquidation of a broker-dealer, protection for securities held in customer accounts held by the firm of up to $500,000 per customer, subject to a limitation of $100,000 for claims of between-investment cash balances. SIPC is funded through assessments on registered broker-dealers. In addition, in 1997, Schwab purchased from a private surety company additional account protection of up to $99.5 million per customer, as defined, for customer securities positions only. Stocks, bonds, mutual funds and money market funds are considered securities and are protected on a share basis for the purposes of SIPC protection and the additional protection (i.e., protected securities may either be replaced or converted into an equivalent market value as of the date a SIPC trustee is appointed). Neither SIPC protection nor the additional protection applies to fluctuations in the market value of securities. Schwab is also authorized by the Municipal Securities Rulemaking Board to conduct transactions in municipal securities on behalf of its customers and has obtained certain additional registrations with the SEC and state regulatory agencies necessary to permit it to engage in certain other activities incidental to its brokerage business. Margin lending by Schwab and M&S is subject to the margin rules of the Board of Governors of the Federal Reserve System and the NYSE. Under such rules, broker-dealers are limited in the amount they may lend in connection with certain purchases and short sales of securities and are also required to impose certain maintenance requirements on the amount of securities and cash held in margin accounts. In addition, those rules and rules of the CBOE govern the amount of margin customers must provide and maintain in writing uncovered options. As a California state-chartered trust company, CSTC is primarily regulated by the California State Banking Department. Since it provides employee benefit plan trust services, CSTC is also required to comply with the Employee Retirement Income Security Act of 1974 (ERISA) and, consequently, is subject to oversight by both the Internal Revenue Service and Department of Labor. CSTC is required under ERISA to maintain a fidelity bond for the protection of employee benefit trusts for which it serves as trustee. Charles Schwab Limited, a subsidiary of Schwab, is registered as an arranger with the Securities and Futures Authority (SFA) in the United Kingdom, and engages in business development activities on behalf of Schwab. Charles Schwab Europe is registered as a broker-dealer with the SFA in the United Kingdom. Net Capital Requirements As registered broker-dealers, Schwab and M&S are subject to the Uniform Net Capital Rule (Rule 15c3-1) promulgated by the SEC (the Net Capital Rule), which has also been adopted through incorporation by reference in NYSE Rule 325. Schwab is a member firm of the NYSE and the NASD, and M&S is a member firm of the NASD. The Net Capital Rule specifies minimum net capital requirements and is designed to ensure the general financial soundness and liquidity of broker-dealers. Failure to maintain the required net capital may subject a firm to suspension or expulsion by the NYSE and the NASD, certain punitive actions by the SEC and other regulatory bodies, and ultimately may require a firm's liquidation. Because CSC itself is not a registered broker-dealer, it is not subject to the Net Capital Rule. However, if Schwab failed to maintain specified levels of net capital, such failure would constitute a default by CSC under certain debt covenants. "Net capital" is essentially defined as net worth (assets minus liabilities), plus qualifying subordinated borrowings, less certain deductions that result from excluding assets that are not readily convertible into cash and from conservatively valuing certain other assets. These deductions include charges that discount the value of firm security positions to reflect the possibility of adverse changes in market value prior to disposition. The Net Capital Rule requires notice of equity capital withdrawals to be provided to the SEC prior to and subsequent to withdrawals exceeding certain sizes. Such rule prohibits withdrawals that would reduce a broker-dealer's net capital to an amount less than 25% of its deductions required by the Net Capital Rule as to its security positions. The Net Capital Rule also allows the SEC, under limited circumstances, to restrict a broker-dealer from withdrawing equity capital for up to 20 business days. Schwab and M&S have elected the alternative method of calculation under paragraph (a)(1)(ii) of the Net Capital Rule, which requires a broker-dealer to maintain minimum net capital equal to 2% of its "aggregate debit items," computed in accordance with the Formula for Determination of Reserve Requirements for Brokers and Dealers (Rule 15c3-3 of the Securities Exchange Act of 1934). "Aggregate debit items" are assets that have as their source transactions with customers, primarily margin loans. Under the alternative method of the Net Capital Rule, a broker-dealer may not (a) pay, or permit the payment or withdrawal of, any subordinated borrowings or (b) pay cash dividends or permit equity capital to be removed if, after giving effect to such payment, withdrawal, or removal, its net capital would be less than 5% of its aggregate debit items. Under NYSE Rule 326, Schwab is required to reduce its business if its net capital is less than 4% of aggregate debit items for more than 15 consecutive business days; NYSE Rule 326 also prohibits the expansion of business if net capital is less than 5% of aggregate debit items for more than 15 consecutive business days. The provisions of NYSE Rule 326 also become operative if capital withdrawals (including scheduled maturities of subordinated borrowings during the following six months) would result in a reduction of a firm's net capital to the levels indicated. If compliance with applicable net capital rules were to limit Schwab's or M&S' operations and their ability to repay subordinated debt to CSC, this in turn could limit CSC's ability to repay debt, pay cash dividends and purchase shares of its outstanding stock. See "Management's Discussion and Analysis of Results of Operations and Financial Condition -- Liquidity and Capital Resources - -- Liquidity" in the Company's 1997 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report. At December 31, 1997, Schwab was required to maintain minimum net capital under the Net Capital Rule of $156 million and had total regulatory net capital of $823 million. At December 31, 1997, the amounts in excess of 2%, 4% and 5% of aggregate debit items were $667 million, $512 million and $434 million, respectively. At December 31, 1997, M&S was required to maintain minimum net capital under the Net Capital Rule of $1 million and had total regulatory net capital of $5 million. At December 31, 1997, the amount in excess of its minimum required net capital was $4 million. Item 2. Properties The Company's corporate headquarters are located in a 28-story building at 101 Montgomery Street in San Francisco, California. The building contains 296,000 square feet and is leased by Schwab under a term expiring in the year 2010. Schwab has three successive five-year options to renew the lease at then current market rates. In 1997, Schwab entered into a lease for 396,000 square feet of office space located at 211 Main Street in San Francisco, California. The lease expires in 2018 and includes two ten-year extension options at then current market rates. In addition to these locations, Schwab also leases space in other buildings for its San Francisco operations aggregating 755,000 additional square feet at year-end 1997. M&S' headquarters are located in leased office space in Jersey City, New Jersey. All of the Company's branch offices are located in leased premises, generally with lease expiration dates five to ten years from inception. The Company has four regional customer telephone service centers. The Company owns the service centers located in Phoenix and Indianapolis, with 330,000 and 164,000 square feet, respectively. The Company leases the service centers located in Orlando and Denver, with 217,000 and 163,000 square feet, respectively. The Company owns its primary data center facility located in Phoenix with 105,000 square feet. Item 3. Legal Proceedings The information required to be furnished pursuant to this item is set forth under the caption "Commitments and Contingent Liabilities" in the Notes to Consolidated Financial Statements in the Company's 1997 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report. Item 4. Submission of Matters to a Vote of Security Holders No matters were submitted to a vote of the Company's security holders during the fourth quarter of 1997. PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters The Company's common stock is listed on the NYSE and the Pacific Exchange under the ticker symbol SCH. The number of common stockholders of record as of March 12, 1998 was 6,667. The other information required to be furnished pursuant to this item is set forth under the caption "Quarterly Financial Information (Unaudited)" in the Company's 1997 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report. Item 6. Selected Financial Data The information required to be furnished pursuant to this item is set forth under the caption "Selected Financial and Operating Data" in the Company's 1997 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The information required to be furnished pursuant to this item is set forth under the caption "Management's Discussion and Analysis of Results of Operations and Financial Condition" in the Company's 1997 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report. Average balances and interest rates for the fourth quarters of 1997 and 1996 are summarized as follows (dollars in millions):
Three Months Ended December 31, 1997 1996 ---- ---- Interest-Earning Assets (customer-related): Investments: Average balance outstanding $ 6,353 $ 6,544 Average interest rate 5.42% 5.33% Margin loans to customers: Average balance outstanding $ 7,702 $ 4,812 Average interest rate 7.74% 7.55% Average yield on interest-earning assets 6.69% 6.27% Funding Sources (customer-related and other): Interest-bearing customer cash balances: Average balance outstanding $ 11,180 $ 9,137 Average interest rate 4.63% 4.42% Other interest-bearing sources: Average balance outstanding $ 1,217 $ 926 Average interest rate 4.43% 4.24% Average noninterest-bearing portion $ 1,658 $ 1,293 Average interest rate on funding sources 4.07% 3.90% Summary: Average yield on interest-earning assets 6.69% 6.27% Average interest rate on funding sources 4.07% 3.90% - ----------------------------------------------------------------- Average net interest margin 2.62% 2.37% =================================================================
The increase in interest revenue, net of interest expense, from the fourth quarter of 1996 to the fourth quarter of 1997 was primarily due to higher levels of average earning assets. Item 7A. Quantitative and Qualitative Disclosures About Market Risk The information required to be furnished pursuant to this item is set forth under the caption "Management's Discussion and Analysis of Results of Operations and Financial Condition -- Market Risk" in the Company's 1997 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report. Item 8. Financial Statements and Supplementary Data The information required to be furnished pursuant to this item is set forth in the Consolidated Financial Statements and under the caption "Quarterly Financial Information (Unaudited)" in the Company's 1997 Annual Report to Stockholders, which are incorporated herein by reference to Exhibit No. 13.1 of this report. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Not applicable. 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 within 120 days after December 31, 1997 (the Proxy Statement) under the captions "The Board of Directors" and "Principal Stockholders." Information regarding Lawrence J. Stupski has been omitted from the Proxy Statement, pursuant to Instruction 3 to Item 401(a) of Regulation S-K, due to his retirement as Vice Chairman and Director effective January 1998 and May 1998, respectively. Executive Officers of the Registrant The following table provides certain information about each of the Company's current executive officers. Executive officers are elected by and serve at the discretion of the Company's Board of Directors. However, Mr. Schwab has an employment agreement with the Company through March 2001, which includes an automatic renewal feature that, as of each March 31, extends the agreement for an additional year unless either party elects to not extend the agreement.
============================================================================================================================== Executive Officers of the Registrant Name Age Title ---- --- ----- Charles R. Schwab 60 Chairman, Co-Chief Executive Officer, and Director David S. Pottruck 49 President, Co-Chief Executive Officer, Chief Operating Officer, and Director Timothy F. McCarthy 46 President and Chief Operating Officer, Charles Schwab & Co., Inc. Karen W. Chang 49 Enterprise President - General Investor Services John Philip Coghlan 46 Enterprise President - Retirement Plan Services Linnet F. Deily 52 Enterprise President - Services for Investment Managers Lon Gorman 49 Enterprise President - Capital Markets and Trading Daniel O. Leemon 44 Executive Vice President and Chief Strategy Officer Dawn Gould Lepore 43 Executive Vice President and Chief Information Officer Susanne D. Lyons 40 Enterprise President - Retail Investor Specialized Services Gideon Sasson 42 Enterprise President - Electronic Brokerage Steven L. Scheid 44 Executive Vice President and Chief Financial Officer Tom Decker Seip 48 Enterprise President - Mutual Funds and International Luis E. Valencia 53 Executive Vice President and Chief Administrative Officer ==============================================================================================================================
Mr. Schwab has been Co-Chief Executive Officer of the Company since January 1, 1998, and Chairman and a director of the Company since its incorporation in 1986. Mr. Schwab was Chief Executive Officer of the Company from 1986 to 1997. Mr. Schwab was a founder of Schwab in 1971 and has been its Chairman since 1978. Mr. Schwab is currently a director of The Gap, Inc., Transamerica Corporation, Siebel Systems, Inc., AirTouch Communications, Inc. and a trustee of The Charles Schwab Family of Funds, Schwab Investments, Schwab Capital Trust and Schwab Annuity Portfolios, all registered investment companies. Mr. Pottruck has been Co-Chief Executive Officer of the Company since January 1, 1998, Chief Operating Officer and a director of the Company since 1994, and President of the Company since 1992. Mr. Pottruck has been Chief Executive Officer of Schwab since 1992 and was President of Schwab from 1988 to 1997. Mr. Pottruck joined Schwab in 1984. Mr. Pottruck was named a director of Decibel Instruments, Inc., McKesson Corporation and Preview Travel, Inc. in 1997. Mr. McCarthy has been President and Chief Operating Officer of Schwab and First Executive Vice President of the Company since September 1997. Mr. McCarthy was Executive Vice President - Financial Products and International Group of the Company and Schwab from 1996 to 1997, and was Executive Vice President - Mutual Funds of the Company and Schwab and Chief Executive Officer of CSIM from 1995 to 1997. Before joining Schwab in 1995, Mr. McCarthy was Chief Executive Officer of Jardine Fleming Unit Trusts Ltd., a mutual fund company, from 1994 to 1995. From 1987 to 1994, Mr. McCarthy held various executive positions with Fidelity Investments, including President of Fidelity Investments Advisor Group, President of National Financial Institutional Services and Executive Director of Fidelity Brokerage Group. Ms. Chang has been Enterprise President - General Investor Services of Schwab and Executive Vice President of the Company since October 1997. Ms. Chang was Executive Vice President - Retail Branch Network of the Company and Schwab from 1996 to 1997 and Senior Vice President - Retail Branch Network of the Company and Schwab from 1994 to 1996. Prior to joining Schwab in 1994, Ms. Chang was Senior Marketing Vice President of American Express Company from 1989 to 1994. Mr. Coghlan has been Enterprise President - Retirement Plan Services of Schwab since October 1997 and Executive Vice President of the Company since 1992. Mr. Coghlan was Executive Vice President of Schwab and General Manager of Schwab Institutional from 1992 to 1997. Mr. Coghlan joined Schwab in 1986, became Vice President in 1988 and became Senior Vice President in 1990. Ms. Deily has been Enterprise President - Services for Investment Managers of Schwab and Executive Vice President of the Company since October 1997. Ms. Deily was Executive Vice President and General Manager - Services for Investment Managers of the Company and Schwab from 1996 to 1997. Before joining Schwab in 1996, Ms. Deily was Chairman, President and Chief Executive Officer of First Interstate Bank of Texas from 1991 to 1996. Mr. Gorman has been Enterprise President - Capital Markets and Trading of Schwab and Executive Vice President of the Company since October 1997. Mr. Gorman was Executive Vice President - Capital Markets and Trading of the Company and Schwab from 1996 to 1997. Before joining Schwab in 1996, Mr. Gorman was a Managing Director of Credit Suisse First Boston Corporation from 1988 to 1996. Mr. Leemon has been Executive Vice President and Chief Strategy Officer of the Company and Schwab since 1995. Before joining Schwab in 1995, Mr. Leemon held various positions with The Boston Consulting Group, Inc., a management consulting firm, from 1989 to 1995, including Vice President from 1990. Ms. Lepore has been Executive Vice President and Chief Information Officer of the Company and Schwab since 1993. Ms. Lepore joined Schwab in 1983 and became Senior Vice President in 1989. Ms. Lyons has been Enterprise President - Retail Investor Specialized Services of Schwab and Executive Vice President of the Company since October 1997. Ms. Lyons was Executive Vice President - Retail Marketing of the Company and Schwab from 1996 to 1997 and Senior Vice President - Active Trader of the Company and Schwab from 1994 to 1996. Ms. Lyons was Senior Vice President - Retail Service Delivery of the Company and Schwab from 1993 to 1994 and Senior Vice President - Retail Marketing of the Company and Schwab from 1992 to 1993. Ms. Lyons joined Schwab in 1992. Mr. Sasson has been Enterprise President - Electronic Brokerage of Schwab and Executive Vice President of the Company since November 1997. Mr. Sasson was Senior Vice President - Electronic Brokerage of the Company and Schwab from 1995 to 1997. Before joining Schwab in 1995, Mr. Sasson was Vice President - Information Services of International Business Machines Corporation in 1995. Mr. Sasson was Vice President, Systems Engineering of FYI Online, a joint venture of MCI Communications Corporation and Equifax, Inc., from 1992 to 1995. Mr. Scheid has been Executive Vice President and Chief Financial Officer of the Company and Schwab since 1996. Before joining Schwab in 1996, Mr. Scheid was Executive Vice President of Finance of First Interstate Bancorp from 1994 to 1996 and was Principal Financial Officer from 1995 to 1996. From 1990 to 1994, Mr. Scheid was Chief Financial Officer of First Interstate Bank of Texas. Mr. Seip has been Enterprise President - Mutual Funds and International of Schwab and Executive Vice President of the Company since October 1997, and Chief Executive Officer of CSIM since December 1997. Mr. Seip was Executive Vice President - Retail Brokerage of the Company and Schwab from 1994 to 1997. Mr. Seip was President of CSIM from 1992 to 1994 and Chief Operating Officer of CSIM from 1991 to 1994. From 1992 to 1994, Mr. Seip was Executive Vice President - Mutual Funds and Fixed Income Products of the Company and Schwab. Mr. Seip joined Schwab in 1983. Mr. Valencia has been Executive Vice President and Chief Administrative Officer of the Company and Schwab since 1996. From 1994 to 1996, Mr. Valencia was Executive Vice President - Human Resources of the Company and Schwab. Before joining Schwab in 1994, Mr. Valencia served as a Managing Director of Commercial Credit Company, a subsidiary of Travelers Group Inc. engaged in consumer finance for Travelers Group Inc., from 1993 to 1994. From 1975 to 1993, Mr. Valencia held various positions with Citicorp, including President and Chief Executive Officer of Transaction Technology, a subsidiary of Citicorp, from 1990 to 1993. 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 captions "Director Compensation," "Executive Compensation," "Employment and Severance Agreements," "Executive Compensation Table," "Option Grants," "Options Exercised" and "Certain Transactions." Item 12. Security Ownership of Certain Bene- ficial Owners and Management The information required to be furnished pursuant to this item is incorporated by reference from portions of the Proxy Statement under the caption "Principal Stockholders." 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 the caption "Certain Transactions." PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K (a) Documents filed as part of this Report 1. Financial Statements The financial statements and independent auditors' report are set forth in the Company's 1997 Annual Report to Stockholders, which are incorporated herein by reference to Exhibit No. 13.1 of this report and are listed below: Consolidated Statement of Income Consolidated Balance Sheet Consolidated Statement of Cash Flows Consolidated Statement of Stockholders' Equity Notes to Consolidated Financial Statements Independent Auditors' Report 2. Financial Statement Schedules The financial statement schedules required to be furnished pursuant to this item are listed in the accompanying index appearing on page F-1. (b) Reports on Form 8-K On December 24, 1997, the Registrant filed a Current Report on Form 8-K relating to (i) fourth quarter and year-end expected earnings and (ii) announcement of the settlement of certain class-action litigation. (c) Exhibits The exhibits listed below are filed as part of this annual report on Form 10-K. Exhibit Number Exhibit - -------------------------------------------------------------------------------- 3.7 Third Restated Certificate of Incorporation, as amended on May 6, 1996, of the Registrant, filed as Exhibit 3.7 to the Registrant's Form 10-Q for the quarter ended September 30, 1996 and incorporated herein by reference. 3.8 Second Restated Bylaws, as amended on July 17, 1996, of the Registrant, filed as Exhibit 3.8 to the Registrant's Form 10-Q for the quarter ended September 30, 1996 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. * 10.20 License Agreements dated April 18, 1979 and April 11, 1983 between International Business Machines Corporation and Charles Schwab & Co., Inc. * 10.22 License Agreement dated as of February 28, 1979 between Applied Data Research, Inc. and Beta Systems, Inc. and Assignment, dated February 21, 1979. * 10.23 License Agreement dated as of February 21, 1979 between Beta Systems, Inc. and Charles Schwab & Co., Inc. * 10.25 333 Bush Street Office Lease dated July 29, 1987 between 333 Bush Street Associates and Charles Schwab & Co., Inc. * 10.34 Form of Indemnification Agreement entered into between Registrant and certain members of the Board of Directors of Registrant, filed as Exhibit 10.34 to the Registrant's Form 10-K for the year ended December 31, 1993 and incorporated herein by reference. 10.57 Registration Rights and Stock Restriction Agreement, dated as of March 31, 1987, between the Registrant and the holders of the Common Stock, filed as Exhibit 4.23 to Registrant's Registration Statement No. 33-16192 on Form S-1 and incorporated herein by reference. 10.72 Restatement of Assignment and License, as amended January 25, 1988, among Charles Schwab & Co., Inc., Charles R. Schwab and the Registrant, filed as Exhibit 10.72 to the Registrant's Form 10-K for the year ended December 31, 1994 and incorporated herein by reference. 10.87 Trust Agreement under the Charles Schwab Profit Sharing and Employee Stock Ownership Plan, effective November 1, 1990, dated October 25, 1990, filed as Exhibit 10.87 to the Registrant's Form 10-Q for the quarter ended September 30, 1995 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, 1996 and incorporated herein by reference. 10.116 Second Amendment to the Trust Agreement for the Charles Schwab Profit Sharing and Employee Stock Ownership Plan effective July 1, 1992, dated June 30, 1992, filed as Exhibit 10.116 to the Registrant's Form 10-Q for the quarter ended June 30, 1997 and incorporated herein by reference. 10.120 ESOP Loan Agreement, effective as of January 19, 1993, between Registrant and The Charles Schwab Profit Sharing and Employee Stock Ownership Plan and Trust. + 10.132 Charles Schwab & Co., Inc. Long-Term Incentive Plan III, as Amended, effective January 1, 1994, filed as Exhibit 10.132 to Registrant's Form 10-K for the year ended December 31, 1993 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. + 10.143 Form of Nonstatutory Stock Option Agreement, filed as Exhibit 10.143 to the Registrant's Form 10-Q for the quarter ended September 30, 1994 and incorporated herein by reference. + 10.144 Form of Incentive Stock Option Agreement, filed as Exhibit 10.144 to the Registrant's Form 10-Q for the quarter ended September 30, 1994 and incorporated herein by reference. + 10.146 Annual Executive Individual Performance Plan dated as of January 1, 1995, filed as Exhibit 10.146 to the Registrant's Form 10-K for the year ended December 31, 1994 and incorporated herein by reference. + 10.147 Corporate Executive Bonus Plan dated as of January 1, 1995 (formerly the Annual Executive Bonus Plan), filed as Exhibit 10.147 to the Registrant's Form 10-K for the year ended December 31, 1994 and incorporated herein by reference.+ 10.149 Employment Agreement dated as of March 31, 1995 between the Registrant and Charles R. Schwab, filed as Exhibit 10.149 to the Registrant's Form 10-K for the year ended December 31, 1994 and incorporated herein by reference. + 10.152 The Charles Schwab Profit Sharing and Employee Stock Ownership Plan, amended July 6, 1995, effective January 1, 1995 and April 1, 1995, filed as Exhibit 10.152 in the Registrant's Form 10-Q for the quarter ended June 30, 1995 and incorporated herein by reference. + 10.155 Forms of Restricted Share Award Agreements, incorporating performance vesting provisions and/or supplemental cash payment provisions, filed as Exhibit 10.155 in the Registrant's Form 10-Q for the quarter ended September 30, 1995 and incorporated herein by reference. + 10.156 Agreement of Sale, dated as of September 18, 1995, as amended by letter agreement dated September 21, 1995 and by Second Amendment to Agreement of Sale dated September 22, 1995, between American Express Company and Charles Schwab & Co., Inc., regarding American Express Western Regional Operations Center located at 2423 Lincoln Drive, Phoenix, Arizona, filed as Exhibit 10.156 in the Registrant's Form 10-Q for the quarter ended September 30, 1995 and incorporated herein by reference. 10.157 The Charles Schwab Corporation Directors' Deferred Compensation Plan, effective January 1, 1996, filed as Exhibit 10.157 to the Registrant's Form 10-K for the year ended December 31, 1995 and incorporated herein by reference. + 10.158 Credit Agreement dated June 28, 1996 between the Registrant and the banks listed therein, filed as Exhibit 10.158 to the Registrant's Form 10-Q for the quarter ended June 30, 1996 and incorporated herein by reference. 10.159 The Charles Schwab Corporation Executive Officer Stock Option Plan (1987), as amended September 17, 1996, with form of Non-Qualified Stock Option Agreement (Executive Officer Stock Option Plan (1987)) attached, filed as Exhibit 10.159 to the Registrant's Form 10-Q for the quarter ended September 30, 1996 and incorporated herein by reference. + 10.160 The Charles Schwab Corporation 1987 Stock Option Plan, as amended September 17, 1996, with form of Non-Qualified Stock Option Agreement (General Management Plan) attached (supersedes Exhibit 10.73), filed as Exhibit 10.160 to the Registrant's Form 10-Q for the quarter ended September 30, 1996 and incorporated herein by reference. + 10.161 The Charles Schwab Corporation 1992 Stock Incentive Plan, as amended September 17, 1996 (supersedes Exhibit 10.141), filed as Exhibit 10.161 to the Registrant's Form 10-Q for the quarter ended September 30, 1996 and incorporated herein by reference. + 10.162 The Charles Schwab Corporation Deferred Compensation Plan, as amended September 17, 1996, filed as Exhibit 10.162 to the Registrant's Form 10-Q for the quarter ended September 30, 1996 and incorporated herein by reference. + 10.163 Lease of 101 Montgomery Street between 101 Montgomery Street Co. and Charles Schwab & Co., Inc. dated October 8, 1996, filed as Exhibit 10.163 to the Registrant's Form 10-K for the year ended December 31, 1996 and incorporated herein by reference. 10.164 Office Lease of Pacific Telesis Center Telesis Tower between Post- Montgomery Associates and Charles Schwab & Co., Inc. dated October 4, 1996, filed as Exhibit 10.164 to the Registrant's Form 10-K for the year ended December 31, 1996 and incorporated herein by reference. 10.166 The Charles Schwab Corporation 1987 Executive Officer Stock Option Plan, restated to include amendments through February 26, 1997, with form of Non-Qualified Stock Option Agreement (Executive Officer Stock Option Plan (1987)) attached, (supersedes Exhibit 10.159) filed as Exhibit 10.166 to the Registrant's Form 10-Q for the quarter ended March 31, 1997 and incorporated herein by reference. + 10.167 The Charles Schwab Corporation 1987 Stock Option Plan, restated to include amendments through February 26, 1997, with form of Non-Qualified Stock Option Agreement attached, (supersedes Exhibit 10.160) filed as Exhibit 10.167 to the Registrant's Form 10-Q for the quarter ended March 31, 1997 and incorporated herein by reference. + 10.168 Charles Schwab Profit Sharing and Employee Stock Ownership Plan, as amended through December 13, 1996 (supersedes Exhibit 10.152) filed as Exhibit 10.168 to the Registrant's Form 10-Q for the quarter ended June 30, 1997 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, 1997 and incorporated herein by reference. + 10.170 The Charles Schwab Corporation 1992 Stock Incentive Plan Restated as of May 12, 1997 (supersedes Exhibit 10.161) filed as Exhibit 10.170 to the Registrant's Form 10-Q for the quarter ended June 30, 1997 and incorporated herein by reference. + 10.171 Form of Restricted Shares Award Agreement of The Charles Schwab Corporation 1992 Stock Incentive Plan (supersedes Exhibit 4.6 to the Registrant's Registration Statement No. 33-54701 on Form S-8) filed as Exhibit 10.171 to the Registrant's Form 10-Q for the quarter ended June 30, 1997 and incorporated herein by reference. + 10.172 Form of Nonstatutory Stock Option Agreement of The Charles Schwab Corporation 1992 Stock Incentive Plan (supersedes Exhibit 10.143) filed as Exhibit 10.172 to the Registrant's Form 10-Q for the quarter ended June 30, 1997 and incorporated herein by reference. + 10.173 Form of Nonstatutory Stock Option and Performance Unit Agreement of The Charles Schwab Corporation 1992 Stock Incentive Plan filed as Exhibit 10.173 to the Registrant's Form 10-Q for the quarter ended June 30, 1997 and incorporated herein by reference. + 10.174 Form of Incentive Stock Option Agreement of The Charles Schwab Corporation 1992 Stock Incentive Plan (supersedes Exhibit 10.144) filed as Exhibit 10.174 to the Registrant's Form 10-Q for the quarter ended June 30, 1997 and incorporated herein by reference. + 10.175 Form of Restricted Shares Award Agreement with performance vesting conditions of The Charles Schwab Corporation 1992 Stock Incentive Plan (supersedes Exhibit 10.155) filed as Exhibit 10.175 to the Registrant's Form 10-Q for the quarter ended June 30, 1997 and incorporated herein by reference. + 10.176 Form of Nonstatutory Stock Option Agreement of The Charles Schwab Corporation 1987 Stock Option Plan (supersedes Form of Non-Qualified Stock Option Agreement in Exhibit 10.167) filed as Exhibit 10.176 to the Registrant's Form 10-Q for the quarter ended June 30, 1997 and incorporated herein by reference. + 10.177 Form of Incentive Stock Option Agreement of The Charles Schwab Corporation 1987 Stock Option Plan filed as Exhibit 10.177 to the Registrant's Form 10-Q for the quarter ended June 30, 1997 and incorporated herein by reference. + 10.178 Form of Restricted Shares Award Agreement of The Charles Schwab Corporation 1987 Stock Option Plan filed as Exhibit 10.178 to the Registrant's Form 10-Q for the quarter ended June 30, 1997 and incorporated herein by reference. + 10.179 Form of Nonstatutory Stock Option Agreement of The Charles Schwab Corporation 1987 Executive Officer Stock Option Plan (supersedes Form of Non-Qualified Stock Option Agreement in Exhibit 10.166) filed as Exhibit 10.179 to the Registrant's Form 10-Q for the quarter ended June 30, 1997 and incorporated herein by reference. + 10.180 Form of Restricted Shares Award Agreement of The Charles Schwab Corporation 1987 Executive Officer Stock Option Plan filed as Exhibit 10.180 to the Registrant's Form 10-Q for the quarter ended June 30, 1997 and incorporated herein by reference. + 10.181 Commercial office lease of 211 Main Street between Main Plaza, LLC and Charles Schwab & Co., Inc. dated August 8, 1997 filed as Exhibit 10.181 to the Registrant's Form 10-Q for the quarter ended September 30, 1997 and incorporated herein by reference. 10.182 The Charles Schwab Corporation Corporate Executive Bonus Plan, amended and restated, effective January 1, 1996 (supersedes Exhibit 10.147) filed as Exhibit 10.182 to the Registrant's Form 10-Q for the quarter ended September 30, 1997 and incorporated herein by reference. + 10.185 The Charles Schwab Corporation Senior Executive Severance Policy, effective December 7, 1995 filed as Exhibit 10.185 to the Registrant's Form 10-Q for the quarter ended September 30, 1997 and incorporated herein by reference. + 10.186 The Charles Schwab Corporation 1987 Stock Option Plan, as amended October 22, 1997, with form of Non-Qualified Stock Option Agreement (General Management Plan) attached (supersedes Exhibit 10.160). + 10.187 The Charles Schwab Corporation 1992 Stock Incentive Plan (Restated to include Amendments through October 22, 1997) (supersedes Exhibit 10.170 to the Registrant's Form 10-Q for the quarter ended June 30, 1997). + 10.188 The Charles Schwab Corporation Executive Officer Stock Option Plan (1987), as amended October 22, 1997, with form of Non-Qualified Stock Option Agreement (Executive Officer Stock Option Plan (1987) attached (supersedes Exhibit 10.159). + 10.189 Annual Executive Individual Performance Plan as amended January 1, 1998. + 10.190 The Charles Schwab Corporation Employee Stock Incentive Plan dated October 22, 1997. + 10.191 Form of Restricted Shares Award Agreement of The Charles Schwab Corporation 1992 Stock Incentive Plan (supersedes Exhibit 10.171). + 10.192 Form of Nonstatutory Stock Option Agreement of The Charles Schwab Corporation 1992 Stock Incentive Plan (supersedes Exhibit 10.172). + 10.193 Form of Nonstatutory Stock Option and Performance Unit Agreement of The Charles Schwab Corporation 1992 Stock Incentive Plan (supersedes Exhibit 10.173). + 10.194 Form of Incentive Stock Option Agreement of The Charles Schwab Corporation 1992 Stock Incentive Plan (supersedes Exhibit 10.174). + 10.195 Charles Schwab Profit Sharing and Employee Stock Ownership Plan, as amended through December 1, 1997 (supersedes Exhibit 10.168). + 11.1 Computation of Earnings Per Share. 12.1 Computation of Ratio of Earnings to Fixed Charges. 13.1 Portions of The Charles Schwab Corporation 1997 Annual Report to Stockholders, which have been incorporated herein by reference. Except for such portions, such annual report is not deemed to be "filed" herewith. 21.1 Subsidiaries of the Registrant. 23.1 Independent Auditors' Consent. 27.1 Financial Data Schedule (electronic only). 27.2 Restated Financial Data Schedule (electronic only). 27.3 Restated Financial Data Schedule (electronic only). * Incorporated by reference to the identically-numbered exhibit to Registrant's Registration Statement No. 33-16192 on Form S-1, as amended and declared effective on September 22, 1987. + Management contract or compensatory plan. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 27, 1998. THE CHARLES SCHWAB CORPORATION (Registrant) BY: /s/ CHARLES R. SCHWAB ------------------------- Charles R. Schwab Chairman, Co-Chief Executive Officer and Director Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated, on March 27, 1998. Signature Title --------- ----- /s/ CHARLES R. SCHWAB Chairman, Co-Chief Executive Officer - ----------------------- and Director Charles R. Schwab (principal executive officer) /s/ DAVID S. POTTRUCK Co-Chief Executive Officer, - ------------------------ Chief Operating Officer, President and Director David S. Pottruck (principal executive officer) /s/ STEVEN L. SCHEID Executive Vice President - ------------------------ and Chief Financial Officer Steven L. Scheid (principal financial and accounting officer) /s/ NANCY H. BECHTLE Director - ------------------------ Nancy H. Bechtle /s/ C. PRESTON BUTCHER Director - ------------------------ C. Preston Butcher /s/ DONALD G. FISHER Director - ------------------------ Donald G. Fisher /s/ ANTHONY M. FRANK Director - ------------------------ Anthony M. Frank /s/ FRANK C. HERRINGER Director - ------------------------ Frank C. Herringer /s/ STEPHEN T. McLIN Director - ------------------------ Stephen T. McLin /s/ GEORGE P. SHULTZ Director - ------------------------ George P. Shultz /s/ LAWRENCE J. STUPSKI Director - ------------------------ Lawrence J. Stupski /s/ ROGER O. WALTHER Director - ------------------------ Roger O. Walther THE CHARLES SCHWAB CORPORATION Index to Financial Statement Schedules Page ---- Independent Auditors' Report F-2 Schedule I - Condensed Financial Information of Registrant: Condensed Balance Sheet F-3 Condensed Statement of Income F-4 Condensed Statement of Cash Flows F-5 Notes to Condensed Financial Statements F-6 Schedule II - Valuation and Qualifying Accounts F-7 Schedules not listed are omitted because of the absence of the conditions under which they are required or because the information is included in the Company's consolidated financial statements and notes in the Company's 1997 Annual Report to Stockholders, which are incorporated herein by reference to Exhibit No. 13.1 of this report. F-1 INDEPENDENT AUDITORS' REPORT - ------------------------------ To the Stockholders and Board of Directors of The Charles Schwab Corporation: We have audited the consolidated financial statements of The Charles Schwab Corporation and subsidiaries (the Company) as of December 31, 1997 and 1996, and for each of the three years in the period ended December 31, 1997, and have issued our report thereon dated February 23, 1998; such consolidated financial statements and report are included in your 1997 Annual Report to Stockholders and are incorporated herein by reference. Our audits also included the financial statement schedules of the Company appearing on pages F-3 through F-7. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein. DELOITTE & TOUCHE LLP San Francisco, California February 23, 1998 F-2
================================================================================================================================= THE CHARLES SCHWAB CORPORATION (PARENT COMPANY ONLY) Condensed Financial Information of Registrant Condensed Balance Sheet (In thousands) December 31, 1997 1996 ---- ---- Assets Cash and cash equivalents $ 79,802 $ 74,785 Advances to subsidiaries 350,606 250,276 Investments in subsidiaries, at equity 1,083,122 820,289 Other assets 4,618 5,004 ------------------------------------------------------------------------------------------------------------------------ Total $ 1,518,148 $ 1,150,354 ======================================================================================================================== Liabilities and Stockholders' Equity Accrued expenses and other liabilities $ 12,031 $ 17,799 Borrowings 361,000 278,000 ------------------------------------------------------------------------------------------------------------------------ Total liabilities 373,031 295,799 Stockholders' equity 1,145,117 854,555 ------------------------------------------------------------------------------------------------------------------------ Total $ 1,518,148 $ 1,150,354 ======================================================================================================================== See Notes to Condensed Financial Statements. =================================================================================================================================
F-3
================================================================================================================================= SCHEDULE I THE CHARLES SCHWAB CORPORATION (PARENT COMPANY ONLY) Condensed Financial Information of Registrant Condensed Statement of Income (In thousands) Year Ended December 31, 1997 1996 1995 ---- ---- ---- Interest revenue $ 30,699 $ 26,287 $ 18,879 Interest expense (20,546) (19,091) (13,886) ------------------------------------------------------------------------------------------------------------------------- Net interest revenue 10,153 7,196 4,993 Other revenues 544 268 1,032 Other income (expenses) 4,423 (3,400) (2,984) ------------------------------------------------------------------------------------------------------------------------- Income before income tax expense and equity in earnings of subsidiaries 15,120 4,064 3,041 Income tax expense 5,692 1,568 1,235 ------------------------------------------------------------------------------------------------------------------------- Income before equity in earnings of subsidiaries 9,428 2,496 1,806 Equity in earnings of subsidiaries Equity in undistributed earnings of subsidiaries 199,869 154,922 134,418 Dividends paid by subsidiaries 60,980 76,385 36,380 ------------------------------------------------------------------------------------------------------------------------- Total 260,849 231,307 170,798 Net income $ 270,277 $ 233,803 $ 172,604 ========================================================================================================================= See Notes to Condensed Financial Statements. =================================================================================================================================
F-4
================================================================================================================================= SCHEDULE I THE CHARLES SCHWAB CORPORATION (PARENT COMPANY ONLY) Condensed Financial Information of Registrant Condensed Statement of Cash Flows (In thousands) Year Ended December 31, 1997 1996 1995 ---- ---- ---- Cash flows from operating activities Net income $ 270,277 $ 233,803 $ 172,604 Noncash items included in net income: Equity in undistributed earnings of subsidiaries (199,869) (154,922) (134,418) Change in other assets 279 (157) (50) Change in accrued expenses and other liabilities (4,122) (7,805) 4,455 ------------------------------------------------------------------------------------------------------------------ Net cash provided by operating activities 66,565 70,919 42,591 ------------------------------------------------------------------------------------------------------------------ Cash flows from investing activities Advances to subsidiaries (51,939) (8,554) (25,042) Increase in net investment in subsidiaries (50,614) (10,132) (16,206) Cash payments for businesses acquired (1,200) (4,709) (63,696) Other (1,720) ------------------------------------------------------------------------------------------------------------------ Net cash used by investing activities (103,753) (23,395) (106,664) ------------------------------------------------------------------------------------------------------------------ Cash flows from financing activities Proceeds from borrowings 111,000 64,000 70,000 Repayment of borrowings (28,000) (26,000) Dividends paid (37,091) (31,495) (24,249) Purchase of treasury stock (18,234) (28,171) (17,345) Proceeds from stock options exercised and other 14,530 7,729 12,972 ------------------------------------------------------------------------------------------------------------------ Net cash provided (used) by financing activities 42,205 (13,937) 41,378 ------------------------------------------------------------------------------------------------------------------ Increase (decrease) in cash and cash equivalents 5,017 33,587 (22,695) Cash and cash equivalents at beginning of year 74,785 41,198 63,893 ------------------------------------------------------------------------------------------------------------------ Cash and cash equivalents at end of year $ 79,802 $ 74,785 $ 41,198 ================================================================================================================== See Notes to Condensed Financial Statements. =================================================================================================================================
F-5 SCHEDULE I THE CHARLES SCHWAB CORPORATION (PARENT COMPANY ONLY) Condensed Financial Information of Registrant Notes to Condensed Financial Statements 1. Introduction and basis of presentation The condensed financial statements of The Charles Schwab Corporation (the Parent Company) should be read in conjunction with the consolidated financial statements of The Charles Schwab Corporation and subsidiaries (the Company) and notes thereto found in the Company's 1997 Annual Report to Stockholders, which are incorporated herein by reference to Exhibit No. 13.1 of this report. 2. Supplemental cash flow information Certain information affecting the cash flows of the Parent Company follows (in thousands):
Year ended December 31, 1997 1996 1995 ---- ---- ---- Income taxes paid (received) $ 2,608 $ (48) $ (182) ========= ========= ========= Interest paid: Borrowings $ 18,773 $ 16,887 $ 11,101 Other 364 339 183 --------- --------- --------- Total interest paid $ 19,137 $ 17,226 $ 11,284 ========= ========= =========
3. Common stock split The Company's Board of Directors declared a three-for-two common stock split, distributed September 1997, effected in the form of a stock dividend. F-6
================================================================================================================================= SCHEDULE II THE CHARLES SCHWAB CORPORATION Valuation and Qualifying Accounts (In thousands) Additions Balance at ------------------------ Balance at Beginning Charged End Description of Year to Expense Other Written off of Year ----------- ------- ---------- ----- ----------- ------- For the year ended December 31, 1997: Allowance for doubtful accounts $ 5,518 $ 3,896 $ 195 $(1,892) $ 7,717 ======================================================================= For the year ended December 31, 1996: Allowance for doubtful accounts $ 3,700 $ 2,651 $ 99 $ (932) $ 5,518 ======================================================================= For the year ended December 31, 1995: Allowance for doubtful accounts $ 3,204 $ 1,349 $ 272 $(1,125) $ 3,700 ======================================================================= =================================================================================================================================
F-7 EX-10.120 2 EXHIBIT 10.120 EXHIBIT 10.120 ESOP LOAN AGREEMENT by and between THE CHARLES SCHWAB CORPORATION and THE CHARLES SCHWAB PROFIT SHARING AND EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST Effective as of January 19, 1993 TABLE OF CONTENTS ESOP LOAN AGREEMENT. . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 ARTICLE I. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 The ESOP Loan. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 1.1 Loan to Borrower. . . . . . . . . . . . . . . . . . . . . . . . . 2 1.2 Use of Proceeds . . . . . . . . . . . . . . . . . . . . . . . . . 2 1.3 Promissory Note.. . . . . . . . . . . . . . . . . . . . . . . . . 2 1.4 Interest. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 ARTICLE 2. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Time for Repayment . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 2.1 Repayments of Principal.. . . . . . . . . . . . . . . . . . . . . 3 2.2 Payment of Interest.. . . . . . . . . . . . . . . . . . . . . . . 3 2.3 Prepayment. . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 2.4 Not Payable on Demand.. . . . . . . . . . . . . . . . . . . . . . 4 2.5 Limitation on Repayment.. . . . . . . . . . . . . . . . . . . . . 4 ARTICLE 3. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Representations and Warranties of the Borrower . . . . . . . . . . . . . 5 3.1 Authorizations. . . . . . . . . . . . . . . . . . . . . . . . . . 5 3.2 Compliance with Obligations and Laws. . . . . . . . . . . . . . . 5 3.3 Restrictions on Transfer. . . . . . . . . . . . . . . . . . . . . 6 ARTICLE 4. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 Representations and Warranties of the Company. . . . . . . . . . . . . . 7 4.1 Due Incorporation.. . . . . . . . . . . . . . . . . . . . . . . . 8 4.2 Corporate Authority.. . . . . . . . . . . . . . . . . . . . . . . 8 4.3 Compliance with Laws and Obligations. . . . . . . . . . . . . . . 8 4.4 Company Sales.. . . . . . . . . . . . . . . . . . . . . . . . . . 8 4.5 Exempt Loans. . . . . . . . . . . . . . . . . . . . . . . . . . . 9 ARTICLE 5. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 Pledge of Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 5.1 Pledge. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 5.2 Release of Shares from Pledge.. . . . . . . . . . . . . . . . . . 9 5.3 Default.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 5.4 Miscellaneous.. . . . . . . . . . . . . . . . . . . . . . . . . . 11 ARTICLE 6. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 Miscellaneous. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 6.1 Amendments, Consents, Waivers and Modifications.. . . . . . . . . 11 6.2 No Waiver . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 6.3 Survival of covenants, Etc., Successors and Assigns.. . . . . . . 12 6.4 Communications. . . . . . . . . . . . . . . . . . . . . . . . . . 12 6.5 Entire Agreement. . . . . . . . . . . . . . . . . . . . . . . . . 13 6.6 Governing Law.. . . . . . . . . . . . . . . . . . . . . . . . . . 13 6.7 Headings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 6.8 Counterparts. . . . . . . . . . . . . . . . . . . . . . . . . . . 13 6.9 Severability. . . . . . . . . . . . . . . . . . . . . . . . . . . 13 6.10 Capacity of Trustee. . . . . . . . . . . . . . . . . . . . . . . 13
-i- ESOP LOAN AGREEMENT THIS AGREEMENT, effective as of 1/19, 1993, by and between CHARLES SCHWAB & CO., INC., a California corporation (the "Company"), and THE CHARLES SCHWAB PROFIT SHARING AND EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST (the "Borrower"). W I T N E S S E T H: WHEREAS, the borrower has been established by the Company to provide stock ownership interests to eligible employees, and the Borrower is designed to qualify as an employee stock ownership plan under Section 4975(e)(7) of the Internal Revenue Code of 1986, as amended (the "Code"), and Section 407(d)(6) of the Employee Retirement Income Security Act of 1974, as amended ("ERISA"); and WHEREAS, the Borrower wishes to acquire common shares of the Company or an affiliate (the common shares of the Company are hereinafter referred to as "Company Stock" and the common shares acquired hereunder by the Borrower are referred to herein as the "Shares"); and WHEREAS, the Borrower desires to borrow, and the Company desires to lend, the sum of $15,000,000 (such amount hereinafter referred to as the "Principal Amount" and such loan as the "ESOP -1- Loan") in order to finance the Borrower's purchases of Company Stock; NOW, THEREFORE, the parties hereto agree as follows: ARTICLE I THE ESOP LOAN 1.1 LOAN TO BORROWER. Subject to the terms and conditions herein set forth, the Company agrees to lend to the Borrower the Principal Amount. 1.2 USE OF PROCEEDS. The Borrower hereby agrees that it will use the entire proceeds of the ESOP Loan to acquire Company Stock through open market purchases or from the Company, to the extent the Company makes such Company Stock available for purchase. 1.3 PROMISSORY NOTE. The indebtedness of the Borrower for the Principal Amount is evidenced by a promissory note (the "Promissory Note") between the Company and the Borrower in the form attached hereto. 1.4 INTEREST. Interest (including interest on overdue payments) shall accrue on the unpaid Principal Amount at the simple interest rate of seven and nine tenths percent (7.9%) per annum. -2- ARTICLE 2 TIME FOR REPAYMENT 2.1 REPAYMENTS OF PRINCIPAL. The borrower shall make principal payments to the Company on the ESOP Loan according to the following schedule:
Principal Payment Due Date ----------------- -------- $ 623,899 December 31, 1994 $ 673,187 December 31, 1995 $ 726,368 December 31, 1996 $ 783,751 December 31, 1997 $ 845,668 December 31, 1998 $ 912,476 December 31, 1999 $ 984,561 December 31, 2000 $ 1,062,341 December 31, 2001 $ 1,146,266 December 31, 2002 $ 1,236,821 December 31, 2003 $ 1,334,530 December 31, 2004 $ 1,439,958 December 31, 2005 $ 1,553,715 December 31, 2006 $ 1,676,458 December 31, 2007
2.2 PAYMENT OF INTEREST. Interest shall be payable on the outstanding daily unpaid Principal Amount from the date of execution of this Agreement until payment in full. Such payment shall be made in annual installments. 2.3 PREPAYMENT. The Borrower may prepay principal in whole or in part at any time, without any premium or penalty. Any such prepayment shall be applied to the principal installments in the manner determined by the Company in its sole discretion. -3- 2.4 NOT PAYABLE ON DEMAND. Under no circumstances will the outstanding balance of the ESOP Loan be payable on demand, except in the event of default. For this purpose, the only event of default shall be the Borrower's failure to make the payments specified in Sections 2.1 or 2.2. 2.5 LIMITATION ON REPAYMENT. Notwithstanding anything to the contrary contained herein, in the absence of default, payments of principal and interest on the ESOP Loan shall not exceed the sum of all contributions that are made by the Company or any affiliated corporation to the Borrower to meet its obligations under this Agreement, any earnings on such contributions and any cash dividends on the Shares (whether or not such shares have been released from pledge at the time the dividend is paid), less payments made in prior years. In no event shall the Company have any right to any assets of the Borrower other than (a) contributions that are made to the Borrower to meet its obligations hereunder, (b) earnings attributable to the investment of such contributions, (c) any cash dividends on the Shares and (d) the Shares remaining subject to pledge under Article 5, but only to the extent permitted under Section 5.3. -4- ARTICLE 3 REPRESENTATIONS AND WARRANTIES OF THE BORROWER The Plan Administrator (as defined in the Charles Schwab Profit Sharing and Employee Stock Ownership Plan (the "Plan")), on behalf of the Borrower, as of the date thereof, represents and warrants as follows: 3.1 AUTHORIZATIONS. The Borrower is an employee stock ownership plan established by the Charles Schwab & Co., which, through the trustee of the Borrower (the "Trustee"), as directed by the Plan Administrator, has all requisite power and authority to execute, deliver and perform its obligations under this Agreement. This Agreement has been duly authorized by all necessary action on the part of the Plan Administrator and the Trustee; this Agreement has been duly executed and delivered by the Borrower and constitutes, a legal, valid and binding obligation of the Borrower, enforceable in accordance with its terms, subject to bankruptcy, insolvency, reorganization and other similar laws affecting creditors' rights generally and subject, as to enforceability, to general equitable principles (regardless of whether enforcement is sought in proceeding in equity or at law). 3.2 COMPLIANCE WITH OBLIGATIONS AND LAWS. Neither the execution and delivery by the Trustee of this Agreement, nor the consummation of the transactions contemplated hereby, nor -5- compliance by the Borrower with its obligations hereunder, will conflict with, or result in a breach or violation of, or constitute a default under, any provision of the Borrower or any law, rule, regulation, order, injunction or decree of any court, administrative authority or arbitrator applicable to the Borrower. 3.3 RESTRICTIONS ON TRANSFER. If Borrower purchases Shares directly from the Company, and not through open market purchases, Borrower understands that such Shares will not have been registered under the Securities Act of 1933, as amended ("Securities Act"), and that such Shares are not freely tradeable and must be held indefinitely unless registered under the Securities Act or an exemption from registration is available. Borrower further understands that although an exemption from registration may be available pursuant to Rule 144 promulgated under the Securities Act, satisfaction of a number of conditions is required to make a sale under that exemption, and that, even if Rule 144 is applicable in whole or in part, in no event may Borrower sell the Shares to the public under such rule prior to the expiration of a two year period after purchase, that any such sales must be limited in amount and that sales can only be made in full compliance with the provisions of the Rule. Borrower represents that it is acquiring the Shares for its own account and not with the view to distribution within the meaning of the Securities Act, other than as may be effected in compliance with the Securities Act and rules and -6- regulations promulgated thereunder. The Company may affix to the certificates representing the Shares a legend substantially as follows and such additional legends as the Company reasonably may determine: These securities have not been registered under the Securities Act of 1933, as amended, and have been taken by the issuer for its own account and not with a view to their distribution. Said securities may not be sold or transferred unless (a) they have been registered under said Act or (b) the transfer agent (or the Company, if it is then acting as its own transfer agent) is presented with either a written opinion of counsel satisfactory to the Company or a "no-action" letter of the Securities and Exchange Commission to the effect that such registration is not required under the circumstances of such sale or transfer. ARTICLE 4 REPRESENTATIONS AND WARRANTIES OF THE COMPANY The Company, as of the date hereof, represents and warrants as follows: -7- 4.1 DUE INCORPORATION. The Company is a corporation duly incorporated, validly existing and in good standing under the laws of the State of Delaware. 4.2 CORPORATE AUTHORITY. The Company has all requisite power and authority to execute, deliver and perform its obligations under this Agreement. The Company has taken all corporate action to establish the Borrower and to authorize this Agreement. This Agreement has been duly executed and delivered by the Company and is a legal, valid and binding obligation of the Company, enforceable in accordance with its terms, subject to bankruptcy, insolvency, reorganization and other similar laws affecting creditors' rights generally and subject, as to enforceability, to general equitable principles (regardless of whether enforcement is sought in a proceeding in equity or at law). 4.3 COMPLIANCE WITH LAWS AND OBLIGATIONS. Neither the execution of this Agreement nor the fulfillment of any of the Company's obligations under this Agreement will conflict with, or result in a breach or violation of, or constitute a default under any law, rule, regulation, order, injunction, or any other obligation, loan, contract or agreement of the Company. 4.4 COMPANY SALES. To the extent that any of the Shares are purchased by the Borrower from the Company, such Shares shall, as of -8- the date of such purchase, be duly authorized and validly issued by the Company. 4.5 EXEMPT LOANS. The ESOP Loan is an exempt loan within the meaning of Treas. Reg. Section 54.4975-7(b). ARTICLE 5 PLEDGE OF SHARES 5.1 PLEDGE. Upon the terms and conditions contained herein, the Borrower does hereby agree to pledge the Shares upon their receipt thereof to the Company as security for the payment of the ESOP Loan. Such Shares shall nonetheless be retained by the Trustee and held in a suspense account pursuant to the Plan. As long as there is no failure to make payments of principal or interest due under the ESOP Loan, the Borrower shall receive and retain all cash dividends paid with respect to the Shares and exercise all voting rights with respect to the Shares. 5.2 RELEASE OF SHARES FROM PLEDGE. Within ten days after each payment of principal and/or interest under the ESOP Loan, a number of the Shares shall be released from pledge hereunder. The number of Shares to be so released shall be calculated by multiplying the number of Shares held by the Company under the pledge (immediately before the release) by a fraction. The numerator of the fraction shall be the amount of principal and interest represented by such payment on the -9- ESOP Loan. The denominator of the fraction shall be the sum of the numerator and the remaining unpaid principal and interest of the ESOP Loan. 5.3 DEFAULT. In the event of a failure to make payments of principal or interest due under the ESOP Loan, which failure is not cured within 30 days, the Company shall have the right , at any time thereafter, to repurchase, sell or otherwise convert to cash all or any portion of the Shares remaining subject to pledge; provided, however, that such Shares may be so applied by the Company only upon and to the extent of the Borrower's failure to meet the payment schedule of the Promissory Note (without regard to any acceleration of such payment schedule as a result of the failure to pay), and that the Company shall give the Borrower 15 days' written notice of its intent to repurchase or sell such Shares pursuant to this Section 5.3. The Company shall apply the proceeds thereby obtained first to the payment of its reasonable expenses incurred in effecting such sale or other disposition, including but not limited to attorneys' and brokers' fees, and thereafter to the payment of the liabilities of the Borrower to the Company under the ESOP Loan. Any surplus remaining in the hands of the Company after the payment of such expenses and such liabilities shall be returned by the Company to the Borrower. A repurchase of Shares by the Company shall be based upon the then -10- prevailing market price of Company Stock on the New York Stock Exchange. 5.4 MISCELLANEOUS. No delay or failure of the Company in exercising any right, power or privilege hereunder shall affect such right, power or privilege; nor shall any single or partial exercise thereof nor any abandonment or discontinuance of steps to enforce such a right, power or privilege preclude any further exercise thereof or any other right, power or privilege of the Company. The rights and remedies of the Company hereunder are cumulative and not exclusive. Any waiver, permit, consent or approval of any kind by the Company of any breach or default hereunder, or any such waiver of any provisions or conditions hereof, must be in writing and shall be effective only to the extent set forth in such writing. ARTICLE 6 MISCELLANEOUS 6.1 AMENDMENTS, CONSENTS, WAIVERS AND MODIFICATIONS. No amendment or waiver of any provision of this Agreement shall be effective unless set forth in an instrument in writing signed by both parties to this Agreement. 6.2 NO WAIVER. No course of dealing between the Company and the Borrower in exercising any rights or obligations hereunder shall be construed as a waiver of any rights of the Company or of the Borrower. -11- 6.3 SURVIVAL OF COVENANTS, ETC., SUCCESSORS AND ASSIGNS. So long as any portion of the Principal Amount shall be outstanding, all covenants, agreements, representations and warranties made by the Company and the Borrower in this Agreement and in any certificate or other document delivered pursuant hereto shall inure to the benefit of the Company or the Borrower, as the case may be, and shall be binding upon any successors and assigns of the Borrower or the Company, as the case may be. 6.4 COMMUNICATIONS. All notices and other communications which are required or may be given hereunder shall be in writing, shall be effective upon receipt, and shall be deemed to have been duly given if delivered personally or sent by cable, telegram, telex or facsimile or by registered or certified mail, postage prepaid, sent to the following addresses: If to the Company: The Charles Schwab Corporation 101 Montgomery Street San Francisco, California 94104 If to the Borrower: Plan Administrator of the Charles Schwab Profit Sharing and Employee Stock Ownership Plan 101 Montgomery Street San Francisco, California 94104 with a copy to: The Charles Schwab Trust Company Trustee of the Charles Schwab Profit Sharing and Employee Stock Ownership Plan P.O. Box 193931 San Francisco, California 94119 -12- Such address may be changed from time to time by notice to the Borrower and the Trustee, in the case of the Company, by notice to the Company and the Trustee, in the case of the Borrower and by notice to the Company and the Borrower, in the case of the Trustee. 6.5 ENTIRE AGREEMENT. This Agreement, including attachments thereto, constitutes the entire agreement between the parties hereto with respect to the ESOP Loan. 6.6 GOVERNING LAW. This Agreement shall be governed by, and interpreted in accordance with, the substantive laws of the State of California, except as preempted by ERISA. 6.7 HEADINGS. The table of contents and headings of the sections and subsections of this Agreement are inserted for convenience only and shall not be deemed to constitute a part hereof. 6.8 COUNTERPARTS. This Agreement may be executed in one or more counterparts each of which will be deemed to constitute an original and shall become effective when one or more counterparts have been signed by each party hereto and delivered to the other party. 6.9 SEVERABILITY. The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability or any other provision hereunder. 6.10 CAPACITY OF TRUSTEE. The Charles Schwab Trust Company is executing this Agreement only in its capacity as Trustee for the Borrower and not in its individual capacity. -13- IN WITNESS WHEREOF, the Company and the Trustee, on behalf of the Borrower, have executed this ESOP Loan Agreement as of this 19th day of January, 1993. THE CHARLES SCHWAB THE CHARLES SCHWAB TRUST CORPORATION COMPANY, AS TRUSTEE OF THE CHARLES SCHWAB PROFIT SHARING AND EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST By /s/ Charles R. Schwab By /s/ Chris V. Dodds ADMINISTRATIVE COMMITTEE AS PLAN ADMINSISTRATOR OF THE CHARLES SCHWAB PROFIT SHARING AND EMPLOYEE STOCK OWNERSHIP PLAN By /s/ A. John Gambs -14- EX-10.186 3 EXHIBIT 10.186 EXHIBIT 10.186 THE CHARLES SCHWAB CORPORATION 1987 STOCK OPTION PLAN (RESTATED TO INCLUDE AMENDMENTS THROUGH OCTOBER 22, 1997) ARTICLE 1. INTRODUCTION. The purpose of the 1987 Stock Option Plan, as Amended and Restated (the "Plan") is to enable The Charles Schwab Corporation and its subsidiaries to attract and retain directors, officers, and other key employees and to provide such persons with additional incentive to advance the interests of the Company. The Plan was initially adopted on March 24, 1987, and was amended on July 29, 1987, April 17, 1989, September 17, 1996 and October 22, 1997. The Plan is hereby restated and amended as of October 22, 1997, and the terms of this Restatement shall apply to all awards granted under the Plan on or after such date. The Plan shall terminate not more than ten (10) years from the date the Plan initially was adopted. The Plan will provide for Awards in the form of Restricted Shares, Performance Share Awards or Options, which may constitute incentive stock options or nonstatutory stock options. The Plan shall be governed by, and construed in accordance with, the laws of the State of Delaware. ARTICLE 2. ADMINISTRATION. 2.1 THE COMMITTEE. The Plan shall be administered by the Committee. The Committee shall consist of two or more Non-Employee Directors, who shall be appointed by the Board. 2.2 COMMITTEE RESPONSIBILITIES. The Committee shall select the Key Employees who are to receive Awards under the Plan, determine the amount, vesting requirements and other conditions of such Awards, may interpret the Plan, and make all other decisions relating to the operation of the Plan. The Committee may adopt such rules or guidelines as it deems appropriate to implement the Plan. The Committee's determinations under the Plan shall be final and binding on all persons. ARTICLE 3. LIMITATION ON AWARDS. The aggregate number of Restricted Shares, Performance Share Awards and Options awarded under the Plan shall not exceed 1,616,000 (including those shares awarded prior to the amendment of the Plan). If any Restricted Shares, Performance Share Awards or Options are forfeited, or if any Performance Share Awards terminate for any other reason without the associated Common Shares being issued, or if any Options terminate for any other reason before being exercised, then such Restricted Shares, Performance Share Awards or Options shall again become available for Awards under the Plan. The limitation of this Article 3 shall be subject to adjustment pursuant to Article 10. Any Common Shares issued pursuant to the Plan may be authorized but unissued shares or treasury shares. ARTICLE 4. ELIGIBILITY. 4.1 GENERAL RULE. Key Employees shall be eligible for designation as Participants by the Committee. 4.2 TEN-PERCENT STOCKHOLDERS. A Key Employee who owns more than 10 percent of the total combined voting power of all classes of outstanding stock of the Company or any of its Subsidiaries shall not be eligible for the grant of an ISO unless (a) the Exercise price under such ISO is at least 110 percent of the Fair Market Value of a Common Share on the date of grant and (b) such ISO by its terms is not exercisable after the expiration of five years from the date of grant. 4.3 ATTRIBUTION RULES. For purposes of Section 4.2, in determining stock ownership, a Key Employee shall be deemed to own the stock owned, directly or indirectly, by or for his or her brothers, sisters, spouse, ancestors or lineal descendants. Stock owned, directly or indirectly, by or for a corporation, partnership, estate or trust shall be deemed to be owned proportionately by or for its stockholders, partners or beneficiaries. Stock with respect to which the Key Employee holds an option shall not be counted. 4.4 OUTSTANDING STOCK. For purposes of Section 4.2, "outstanding stock" shall include all stock actually issued and outstanding immediately after the grant of the ISO to the Key Employee. "Outstanding stock" shall not include treasury shares or shares authorized for issuance under outstanding options held by the Key Employee or by any other person. ARTICLE 5. OPTIONS. 5.1 STOCK OPTION AGREEMENT. Each grant of an Option under the Plan shall be evidenced by a Stock Option Agreement between the Optionee and the Company. Such Option shall be subject to all applicable terms and conditions of the Plan, and may be subject to any other terms and conditions which are not inconsistent with the Plan and which the Committee deems appropriate for inclusion in a Stock Option Agreement. The provisions of the various Stock Option Agreements entered into under the Plan need not be identical. The Committee may designate all or any part of an Option as an ISO. The Committee may designate all or any part of an Option as an ISO (or, in the case of a Key Employee who is subject to the tax laws of a foreign jurisdiction, as an option qualifying for favorable tax treatment under the laws of such foreign jurisdiction). 5.2 OPTIONS NONTRANSFERABILITY. No Option granted under the Plan shall be transferable by the Optionee other than by will or the laws of descent and distribution. An Option may be exercised during the lifetime of the Optionee only by him or her. No Option or interest therein may be transferred, assigned, pledged or hypothecated by the Optionee during his or her lifetime, whether by operation of law or otherwise, or be made subject to execution, attachment or similar process. 2 5.3 NUMBER OF SHARES. Each Stock Option Agreement shall specify the number of Common Shares subject to the Option and shall provide for the adjustment of such number in accordance with Article 10. Each Stock Option Agreement shall also specify whether the Option is an ISO or an NSO. 5.4 EXERCISE PRICE. Each Stock Option Agreement shall specify the Exercise Price. The Exercise Price under an Option shall not be less than 100 percent of the Fair Market Value of a Common Share on the date of grant, except as otherwise provided in Section 4.2. Subject to the preceding sentence, the Exercise Price under any Option shall be determined by the Committee. The Exercise Price shall be payable in accordance with Article 6. 5.5 EXERCISABILITY AND TERM. Each Stock Option Agreement shall specify the date when all or any installment of the Option is to become exercisable. The Stock Option Agreement shall also specify the term of the Option. The term of an ISO shall in no event exceed 10 years from the date of grant, and Section 4.2 may require a shorter term. Subject to the preceding sentence, the Committee shall determine when all or any part of an Option is to become exercisable and when such Option is to expire; provided that, in appropriate cases, the Company shall have the discretion to extend the term of an Option or the time within which, following termination of employment, an Option may be exercised, or to accelerate the exercisability of an Option. A Stock Option Agreement may provide for expiration prior to the end of its term in the event of the termination of the Optionee's employment and shall provide for the suspension of vesting when an employee is on a leave of absence for a period in excess of six months in appropriate cases, as determined by the Company; provided that the exercisability of Options shall be accelerated in the event of the Participant's death or Disability and, in the case of Retirement, the exercisability of all outstanding Options shall be accelerated, other than any Options that had been granted within two years of the date of the Optionee's Retirement. NSOs may also be awarded in combination with Restricted Shares, and such an Award may provide that the NSOs will not be exercisable unless the related Restricted Shares are forfeited. In addition, NSOs granted under this Section 5 may be granted subject to forfeiture provisions which provide for forfeiture of the Option upon the exercise of tandem awards, the terms of which are established in other programs of the Company. 5.6 LIMITATION ON AMOUNT OF ISOS. The aggregate fair market value (determined at the time the ISO is granted) of the Common Shares with respect to which ISOs are exercisable for the first time by the Optionee during any calendar year (under all incentive stock option plans of the Company) shall not exceed $100,000; provided, however, that all or any portion of an Option which cannot be exercised as an ISO because of such limitation shall be treated as an NSO. 5.7 EFFECT OF CHANGE IN CONTROL. The Committee (in its sole discretion) may determine, at the time of granting an Option, that such Option shall become fully exercisable as to all Common Shares subject to such Option immediately preceding any Change in Control with respect to the Company. 3 5.8 RESTRICTIONS ON TRANSFER OF COMMON SHARES. Any Common Shares issued upon exercise of an Option shall be subject to such special forfeiture conditions, rights of repurchase, rights of first refusal and other transfer restrictions as the Committee may determine. Such restrictions shall be set forth in the applicable Stock Option Agreement and shall apply in addition to any general restrictions that may apply to all holders of Common Shares. 5.9 AUTHORIZATION OF REPLACEMENT OPTIONS. Concurrently with the grant of any Option to a Participant, the Committee may authorize the grant of Replacement Options. If Replacement Options have been authorized by the Committee with respect to a particular award of Options (the "Underlying Options"), the Option Agreement with respect to the Underlying Options shall so state, and the terms and conditions of the Replacement Options shall be provided therein. The grant of any Replacement Options shall be effective only upon the exercise of the Underlying Options through the use of Common Shares pursuant to Section 6.2 or Section 6.3. The number of Replacement Options shall equal the number of Common Shares used to exercise the Underlying Options, and, if the Option Agreement so provides, the number of Common Shares used to satisfy any tax withholding requirements incident to the exercise of the Underlying Options in accordance with Section 12.2. Upon the exercise of the Underlying Options, the Replacement Options shall be evidenced by an amendment to the Underlying Option Agreement. Notwithstanding the fact that the Underlying Option may be an ISO, a Replacement Option is not intended to qualify as an ISO. The Exercise Price of a Replacement Option shall be no less than the Fair Market Value of a Common Share on the date the grant of the Replacement Option becomes effective. The term of each Replacement Option shall be equal to the remaining term of the Underlying Option. No Replacement Options shall be granted to Optionees when Underlying Options are exercised pursuant to the terms of the Plan and the Underlying Option Agreement following termination of the Optionee's employment. The Committee, in its sole discretion, may establish such other terms and conditions for Replacement Options as it deems appropriate. 5.10 OPTIONS GRANTED TO NON-UNITED STATES KEY EMPLOYEES. In the case of Key Employees who are subject to the tax laws of a foreign jurisdiction, the Company may issue Options to such Key Employees that contain terms required to conform with any requirements for favorable tax treatment imposed by the laws of such foreign jurisdiction, or as otherwise may be required by the laws of such foreign jurisdiction. The terms of any such Options shall be governed by the Plan, subject to the terms of any Addendum to the Plan specifically applicable to such Options. ARTICLE 6. PAYMENT FOR OPTION SHARES. 6.1 GENERAL RULE. The entire Exercise Price of Common Shares issued upon exercise of Options shall be payable in cash at the time when such Common Shares are purchased, except as follows: (a) In the case of an ISO granted under the Plan, payment shall be made only pursuant to the express provisions of the applicable Stock Option Agreement. However, 4 the Committee may specify in the Stock Option Agreement that payment may be made pursuant to Section 6.2 or 6.3. (b) In the case of an NSO, the Committee may at any time accept payment pursuant to Section 6.2 or 6.3. 6.2 SURRENDER OF STOCK. To the extent that this Section 6.2 is applicable, payment for all or any part of the Exercise Price may be made with Common Shares which are surrendered to the Company. Such Common Shares shall be valued at their Fair Market Value on the date when the new Common Shares are purchased under the Plan. In the event that the Common Shares being surrendered are Restricted Shares that have not yet become vested, the same restrictions shall be imposed upon the new Common Shares being purchased. 6.3 EXERCISE/SALE. To the extent this Section 6.3 is applicable, payment may be made by the delivery (on a form prescribed by the Company) of an irrevocable direction to Charles Schwab & Co., Inc. to sell Common Shares (including the Common Shares to be issued upon exercise of the Options) and to deliver all or part of the sales proceeds to the Company in payment of all or part of the Exercise Price and any withholding taxes. ARTICLE 7. RESTRICTED SHARES AND PERFORMANCE SHARE AWARDS. 7.1 TIME, AMOUNT AND FORM OF AWARDS. The Committee may grant Restricted Shares or Performance Share Awards with respect to an Award Year during such Award Year or at any time thereafter. Each such Award shall be evidenced by a Stock Award Agreement between the Award recipient and the Company. The amount of each Award of Restricted Shares or Performance Share Awards shall be determined by the Committee. Awards under the Plan may be granted in the form of Restricted Shares or Performance Share Awards or in any combination thereof, as the Committee shall determine at its sole discretion at the time of the grant. Restricted Shares or Performance Share Awards may also be awarded in combination with NSOs, and such an Award may provide that the Restricted Shares or Performance Share Awards will be forfeited in the event that the related NSOs are exercised. 7.2 PAYMENT FOR RESTRICTED SHARE AWARDS. To the extent that an Award is granted in the form of Restricted Shares, the Award recipient, as a condition to the grant of such Award, shall be required to pay the Company in cash an amount equal to the par value of such Restricted Shares. 7.3 VESTING OR ISSUANCE CONDITIONS. Each Award of Restricted Shares shall become vested, in full or in installments, upon satisfaction of the conditions specified in the Stock Award Agreement. Common Shares shall be issued pursuant to Performance Share Awards in full or in installments upon satisfaction of the issuance conditions specified in the Stock Award Agreement. The Committee shall select the vesting conditions in the case of Restricted Shares, or issuance conditions in the case of Performance Share Awards, which may be based upon the Participant's service, the Participant's performance, the Company's performance or such other 5 criteria as the Committee may adopt; provided that, in the case of an Award of Restricted Shares where vesting is based entirely on the Participant's service, (i) vesting shall be accelerated in the event of the Participant's death or Disability; (ii) in the case of Retirement, vesting shall be accelerated for all Restricted Shares that had been granted more than two years prior to the date of the Participant's Retirement; and (iii) vesting shall be suspended when an employee is on a leave of absence for a period in excess of six months in appropriate cases, as determined by the Company. The Committee, in its sole discretion, may determine, at the time of making an Award of Restricted Shares, that such Award shall become fully vested in the event that a Change in Control occurs with respect to the Company. The Committee, in its sole discretion, may determine, at the time of making a Performance Share Award, that the issuance conditions set forth in such Award shall be waived in the event that a Change in Control occurs with respect to the Company. 7.4 FORM OF SETTLEMENT OF PERFORMANCE SHARE AWARDS. Settlement of Performance Share Awards shall only be made in the form of Common Shares. Until a Performance Share Award is settled, the number of Performance Share Awards shall be subject to adjustment pursuant to Article 10. 7.5 DEATH OF RECIPIENT. Any Common Shares that are to be issued pursuant to a Performance Share Award after the recipient's death shall be delivered or distributed to the recipient's beneficiary or beneficiaries. Each recipient of a Performance Share Award under the Plan shall designate one or more beneficiaries for this purpose by filing the prescribed form with the Company. A beneficiary designation may be changed by filing the prescribed form with the Company at any time before the Award recipient's death. If no beneficiary was designated or if no designated beneficiary survives the Award recipient, then any Common Shares that are to be issued pursuant to a Performance Share Award after the recipient's death shall be delivered or distributed to the recipient's estate. The Committee, in its sole discretion, shall determine the form and time of any distribution(s) to a recipient's beneficiary or estate. ARTICLE 8. CLAIMS PROCEDURES. Claims for benefits under the Plan shall be filed in writing with the Committee on forms supplied by the Committee. Written notice of the disposition of a claim shall be furnished to the claimant within 90 days after the claim is filed. If the claim is denied, the notice of disposition shall set forth the specific reasons for the denial, citations to the pertinent provisions of the Plan, and, where appropriate, an explanation as to how the claimant can perfect the claim. If the claimant wishes further consideration of his or her claim, the claimant may appeal a denied claim to the Committee (or to a person designated by the Committee) for further review. Such appeal shall be filed in writing with the Committee on a form supplied by the Committee, together with a written statement of the claimant's position, no later than 90 days following receipt by the claimant of written notice of the denial of his or her claim. If the claimant so requests, the Committee shall schedule a hearing. A decision on review shall be made after a full and fair review of the claim and shall be delivered in writing to the claimant no later than 60 days after the Committee's receipt of the notice of appeal, unless special circumstances (including the need to hold a hearing) require an extension of time for processing the appeal, in which case a written 6 decision on review shall be delivered to the claimant as soon as possible but not later than 120 days after the Committee's receipt of the appeal notice. The claimant shall be notified in writing of any such extension of time. The written decision on review shall include specific reasons for the decision, written in a manner calculated to be understood by the claimant, and shall specifically refer to the pertinent Plan provisions on which it is based. All determinations of the Committee shall be final and binding on Participants and their beneficiaries. ARTICLE 9. VOTING RIGHTS AND DIVIDENDS. 9.1 RESTRICTED SHARES. (a) All holders of Restricted Shares who are not Named Executive Officers shall have the same voting, dividend, and other rights as the Company's other stockholders. (b) During the period of restriction, Named Executive Officers holding Restricted Shares granted hereunder shall be credited with all regular cash dividends paid with respect to all Restricted Shares while they are so held. If a dividend is paid in the form of cash, such cash dividend shall be credited to Named Executive Officers subject to the same restrictions on transferability and forfeitability as the Restricted Shares with respect to which they were paid. If any dividends or distributions are paid in shares of Common Stock, the shares of Common Stock shall be subject to the same restrictions on transferability and forfeitability as the Restricted Shares with respect to which they were paid. Subject to the succeeding paragraph, and to the restrictions on vesting and the forfeiture provisions, all dividends credited to a Named Executive Officer shall be paid to the Named Executive Officer within forty-five (45) days following the full vesting of the Restricted Shares with respect to which such dividends were earned. In the event that any dividend constitutes a "derivative security" or an "equity security" pursuant to Rule 16(a) under the Exchange Act, such dividend shall be subject to a vesting period equal to the longer of: (i) the remaining vesting period of the Restricted Shares with respect to which the dividend is paid; or (ii) six (6) months. The Committee shall establish procedures for the application of this provision. Named Executive Officers holding Restricted Shares shall have the same voting rights as the Company's other stockholders. 9.2 PERFORMANCE SHARE AWARDS. The holders of Performance Share Awards shall have no voting or dividend rights until such time as any Common Shares are issued pursuant thereto, at which time they shall have the same voting, dividend and other rights as the Company's other stockholders. ARTICLE 10. PROTECTION AGAINST DILUTION; ADJUSTMENT OF AWARDS. 10.1 GENERAL. In the event of a subdivision of the outstanding Common Shares, a declaration of a dividend payable in Common Shares, a declaration of a dividend payable in a 7 form other than Common Shares, a combination or consolidation of the outstanding Common Shares (by reclassification or otherwise) into a lesser number of Common Shares, a recapitalization, a spinoff or a similar occurrence, the Committee shall make appropriate adjustments in one or more of (a) the number of Options, Restricted Shares and Performance Share Awards available for future Awards under Article 3, (b) the number of Performance Share Awards included in any prior Award which has not yet been settled, (c) the number of Common Shares covered by each outstanding Option or (d) the Exercise Price under each outstanding Option. 10.2 REORGANIZATIONS. In the event that the Company is a party to a merger or other reorganization, outstanding Options, Restricted Shares and Performance Share Awards shall be subject to the agreement of merger or reorganization. Such agreement may provide, without limitation, for the assumption of outstanding Awards by the surviving corporation or its parent, for their continuation by the Company (if the Company is a surviving corporation), for accelerated vesting or for settlement in cash. 10.3 RESERVATION OF RIGHTS. Except as provided in this Article 10, a Participant shall have no rights by reason of any subdivision or consolidation of shares of stock of any class, the payment of any stock dividend or any other increase or decrease in the number of shares of stock of any class. Any issue by the Company of shares of stock of any class, or securities convertible into shares of stock of any class, shall not affect, and no adjustment by reason thereof shall be made with respect to, the number or Exercise Price of Common Shares subject to an Option. The grant of an Award pursuant to the Plan shall not affect in any way the right or power of the Company to make adjustments, reclassifications, reorganizations or changes of its capital or business structure, to merge or consolidate or to dissolve, liquidate, sell or transfer all or any part of its business or assets. ARTICLE 11. LIMITATION OF RIGHTS. 11.1 EMPLOYMENT RIGHTS. Neither the Plan nor any Award granted under the Plan shall be deemed to give any individual a right to remain employed by the Company or any Subsidiary. The Company and its Subsidiaries reserve the right to terminate the employment of any employee at any time, with or without cause, subject only to a written employment agreement (if any). 11.2 STOCKHOLDERS' RIGHTS. A Participant shall have no dividend rights, voting rights or other rights as a stockholder with respect to any Common Shares covered by his or her Award prior to the issuance of a stock certificate for such Common Shares. No adjustment shall be made for cash dividends or other rights for which the record date is prior to the date when such certificate is issued, except as expressly provided in Articles 7, 9 and 10. 11.3 CREDITORS' RIGHTS. A holder of Performance Share Awards shall have no rights other than those of a general creditor of the Company. Performance Share Awards represent unfunded and unsecured obligations of the Company, subject to the terms and conditions of the applicable Stock Award Agreement. 8 11.4 GOVERNMENT REGULATIONS. Any other provision of the Plan notwithstanding, the obligations of the Company with respect to Common Shares to be issued pursuant to the Plan shall be subject to all applicable laws, rules and regulations, and such approvals by any governmental agencies as may be required. The Company reserves the right to restrict, in whole or in part, the delivery of Common Shares pursuant to any Award until such time as: (a) Any legal requirements or regulations have been met relating to the issuance of such Common Shares or to their registration, qualification or exemption from registration or qualification under the Securities Act of 1933, as amended, or any applicable state securities laws; and (b) Satisfactory assurances have been received that such Common Shares, when issued, will be duly listed on the New York Stock Exchange or any other securities exchange on which Common Shares are then listed. ARTICLE 12. WITHHOLDING TAXES. 12.1 GENERAL. To the extent required by applicable federal, state, local or foreign law, the recipient of any payment or distribution under the Plan shall make arrangements satisfactory to the Company for the satisfaction of any withholding tax obligations that arise by reason of such payment or distribution. The Company shall not be required to make such payment or distribution until such obligations are satisfied. 12.2 NONSTATUTORY OPTIONS, RESTRICTED SHARES OR PERFORMANCE SHARE AWARDS. The Committee may permit an Optionee who exercises NSOs, or who receives Awards of Restricted Shares, or who receives Common Shares pursuant to the terms of a Performance Share Award, to satisfy all or part of his or her withholding tax obligations by having the Company withhold a portion of the Common Shares that otherwise would be issued to him or her under such Awards. Such Common Shares shall be valued at their Fair Market Value on the date when taxes otherwise would be withheld in cash. The payment of withholding taxes by surrendering Common Shares to the Company, if permitted by the Committee, shall be subject to such restrictions as the Committee may impose, including any restrictions required by rules of the Securities and Exchange Commission. ARTICLE 13. ASSIGNMENT OR TRANSFER OF AWARD. 13.1 GENERAL RULE. Any Award granted under the Plan shall not be anticipated, assigned, attached, garnished, optioned, transferred or made subject to any creditor's process, whether voluntarily, involuntarily or by operation of law, except to the extent specifically permitted by Section 13.2. 13.2 EXCEPTIONS TO GENERAL RULE. Notwithstanding Section 13.1, this Plan shall not preclude (i) a Participant from designating a beneficiary to succeed, after the Participant's death, to those of the Participant's Awards (including without limitation, the right to exercise any 9 unexercised Options) as may be determined by the Company from time to time in its sole discretion, (ii) a transfer of any Award hereunder by will or the laws of descent or distribution, or (iii) a voluntary transfer of an Award (other than an ISO) to a trust or partnership for the exclusive benefit of one or more members of the Participant's family, but only if the Participant has sole investment control over such trust or partnership. ARTICLE 14. FUTURE OF PLANS. 14.1 TERM OF THE PLAN. The Plan, as set forth herein, shall become effective on February 26, 1997. The Plan shall remain in effect until it is terminated under Section 15.2, except that no Awards shall be made after March 24, 1997. 14.2 AMENDMENT OR TERMINATION. The Board may at any time terminate this Plan, and the Board or the Committee make such modifications of the Plan as it shall deem advisable; provided, however, that any amendment of the Plan shall be subject to the approval of the Company's stockholders to the extent required by applicable laws, regulations or rules. 14.3 EFFECT OF AMENDMENT OR TERMINATION. No Award shall be made under the Plan after the termination thereof. The termination of the Plan, or any amendment thereof, shall not affect any Option, Restricted Share or Performance Share Award previously granted under the Plan. ARTICLE 15. DEFINITIONS. 15.1 "Award" means any award of an Option, a Restricted Share or a Performance Share Award under the Plan. 15.2 "Award Year" means a fiscal year beginning January 1 and ending December 31 with respect to which an Award may be granted. 15.3 "Board" means the Company's Board of Directors, as constituted from time to time. 15.4 "Change in Control" means the occurrence of any of the following events after the effective date of the Plan as set out in Section 15.1: (a) A change in control required to be reported pursuant to Item 6(e) of Schedule 14A of Regulation 14A under the Exchange Act; (b) A change in the composition of the Board, as a result of which fewer than two-thirds of the incumbent directors are directors who either (i) had been directors of the Company 24 months prior to such change or (ii) were elected, or nominated for election, to the Board with the affirmative votes of at least a majority of the directors who had been directors of the Company 24 months prior to such change and who were still in office at the time of the election or nomination; 10 (c) Any "person" (as such term is used in sections 13(d) and 14(d) of the Exchange Act) becomes the beneficial owner, directly or indirectly, of securities of the Company representing 20 percent or more of the combined voting power of the Company's then outstanding securities ordinarily (and apart from rights accruing under special circumstances) having the right to vote at elections of directors (the "Base Capital Stock"); provided, however, that any change in the relative beneficial ownership of securities of any person resulting solely from a reduction in the aggregate number of outstanding shares of Base Capital Stock, and any decrease thereafter in such person's ownership of securities, shall be disregarded until such person increases in any manner, directly or indirectly, such person's beneficial ownership of any securities of the Company. 15.5 "Code" means the Internal Revenue Code of 1986, as amended. 15.6 "Committee" means the Compensation Committee of the Board, as constituted from time to time. 15.7 "Common Share" means one share of the common stock of the Company. 15.8 "Company" means The Charles Schwab Corporation, a Delaware corporation. 15.9 "ERISA" means the Employee Retirement Income Security Act of 1974, as amended. 15.10 "Exchange Act" means the Securities Exchange Act of 1934, as amended. 15.11 "Exercise Price" means the amount for which one Common Share may be purchased upon exercise of an Option, as specified by the Committee in the applicable Stock Option Agreement. 15.12 "Fair Market Value" means the market price of a Common Share, determined by the committee as follows: (a) If the Common Share was traded on a stock exchange on the date in question, then the Fair Market Value shall be equal to the closing price reported by the applicable composite-transactions report for such date; (b) If the Common Share was traded over-the-counter on the date in question and was classified as a national market issue, then the Fair Market Value shall be equal to the last transaction price quoted by the NASDAQ system for such date; (c) If the Common Share was traded over-the-counter on the date in question but was not classified as a national market issue, then the Fair Market Value shall be equal to the 11 mean between the last reported representative bid and asked prices quoted by the NASDAQ system for such date; and (d) If none of the foregoing provisions is applicable, then the Fair Market Value shall be determined by the Committee in good faith on such basis as it deems appropriate. 15.13 "ISO" means an incentive stock option described in section 422(b) of the Code. 15.14 "Key Employee" means a key common-law employee of the Company or any Subsidiary, as determined by the Committee. 15.15 "Named Executive Officer" means a Participant who, as of the date of vesting of an Award is one of a group of "covered employees," as defined in the Regulations promulgated under Code Section 162(m), or any successor statute. 15.16 "Non-Employee Director" means a member of the Board who is not a common-law employee. 15.17 "NSO" means an employee stock option not described in sections 422 through 424 of the Code. 15.18 "Option" means an ISO or NSO or, in the case of a Key Employee who is subject to the tax laws of a foreign jurisdiction, an option qualifying for favorable tax treatment under the laws of such jurisdiction, including a Replacement Option, granted under the Plan and entitling the holder to purchase one Common Share. 15.19 "Optionee" means an individual, or his or her estate, legatee or heirs at law that holds an Option. 15.20 "Participant" means a Non-Employee Director or Key Employee who has received an Award. 15.21 "Performance Share Award" means the conditional right to receive in the future one Common Share, awarded to a Participant under the Plan. 15.22 "Plan" means this 1987 Stock Option Plan of The Charles Schwab Corporation, as it may be amended from time to time. 15.23 "Replacement Option" means an Option that is granted when a Participant uses a Common Share held or to be acquired by the Participant to exercise an Option and/or to satisfy tax withholding requirements incident to the exercise of an Option. 15.24 "Restricted Share" means a Common Share awarded to a Participant under the Plan. 12 15.25 "Stock Award Agreement" means the agreement between the Company and the recipient of a Restricted Share or Performance Share Award which contains the terms, conditions and restrictions pertaining to such Restricted Share or Performance Share Award. 15.26 "Stock Option Agreement" means the agreement between the Company and an Optionee which contains the terms, conditions and restrictions pertaining to his or her option. 15.27 "Subsidiary" means any corporation, if the Company and/or one or more other Subsidiaries own not less than 50 percent of the total combined voting power of all classes of outstanding stock of such corporation. A corporation that attains the status of a Subsidiary on a date after the adoption of the Plan shall be considered a Subsidiary commencing as of such date. 15.28. "Retirement" shall mean any termination of employment of an Optionee for any reason other than death at any time after the Optionee has attained fifty (50), but only if, at the time of such termination, the Participant has been credited with at least seven (7) Years of Service under the Charles Schwab Profit Sharing and Employee Stock Ownership Plan. The foregoing definition shall apply to all Stock Option Agreements entered into pursuant to the Plan, irrespective of any definition to the contrary contained in any such Stock Option Agreement. 15.29 "Disability" means the inability to engage in any substantial gainful activity considering the Participant's age, education and work experience by reason of any medically determined physical or mental impairment that has continued without interruption for a period of at least six months and that can be expected to be of long, continued and indefinite duration. All determinations as to whether a Participant has incurred a Disability shall be made by the Employee Benefits Administration Committee of the Company, the findings of which shall be final, binding and conclusive. 13 ADDENDUM A The provisions of the Plan, as amended by the terms of this Addendum A, shall apply to the grant of Approved Options to Key U.K. Employees. 1. For purposes of this Addendum A, the following definitions shall apply in addition to those set out in section 16 of the Plan: APPROVED OPTION Means a stock option designed to qualify as an approved executive share option under the Taxes Act; INLAND REVENUE means the Board of the Inland Revenue in the United Kingdom. KEY U.K. EMPLOYEE means a designated employee of Sharelink Investment Services plc or any subsidiary (as that term is defined in the Companies Act 1985 of the United Kingdom, as amended) of which Sharelink Investment Services plc has control for the purposes of section 840 of the Taxes Act; TAXES ACT means the Income and Corporation Taxes Act 1988 of the United Kingdom. 2. An Approved Option may only be granted to a Key U.K. Employee who: (i) is employed on a full-time basis; and (ii) does not fall within the provisions of paragraph 8 of Schedule 9 to the Taxes Act. For purposes of this section 2(i) of Addendum A, "full-time" shall mean an employee who is required to work 20 hours per week, excluding meal breaks. 3. No Approved Option may be granted to a Key U.K. Employee if it would cause the aggregate of the exercise price of all subsisting Approved Options granted to such employee under the Plan, or any other subsisting options granted to such employee under any other share option scheme approved under Schedule 9 of the Taxes Act and established by the Company or an associated company, to exceed the higher of (a) one hundred thousand pounds sterling and (b) four times such employee's relevant emoluments for the current or preceding year of assessment (whichever is greater); but where there were no relevant emoluments for the previous year of assessment, the limit shall be the higher of one hundred thousand pounds sterling) or four times such employee's relevant emoluments for the period of twelve months beginning with the first day during the current year of assessment in respect of which there are relevant emoluments. For the purpose of this section 3 of Addendum A, "associated company" means an associated company within the meaning of section 416 of the Taxes Act; "relevant 14 emoluments" has the meaning given by paragraph 28(4) of Schedule 9 to the Taxes Act and "year of assessment" means a year beginning on any April 6 and ending on the following April 5. 4. Common Shares issued pursuant to the exercise of Approved Options must satisfy the conditions specified in paragraphs 10 to 14 of Schedule 9 to the Taxes Act. 5. Notwithstanding the provisions of Section 5.4 of the Plan, the exercise price of an Approved Option shall not be less than 100 percent of the closing price of a Common Share as reported in the New York Stock Exchange Composite Index on the date of grant. 6. No Approved Option may be exercised at any time by a Key U.K. Employee when that Key U.K. Employee falls within the provisions of paragraph 8 of Schedule 9 to the Taxes Act. If at any time the shares under an Approved Option cease to comply with the conditions in paragraphs 10 to 14 of Schedule 9 to the Taxes Act, then all Approved Options then outstanding shall lapse and cease to be exercisable from the date of the shares ceasing so to comply, and no optionee shall have any cause of action against the Company, Sharelink Investment Services plc or any subsidiary of the Company or any other person in respect thereof. 7. An Approved Option may contain such other terms, provisions and conditions as may be determined by the Committee consistent with the Plan, provided that the approved option otherwise complies with the requirements for approved executive option schemes specified in Schedule 9 of the Taxes Act. 8. In relation to an Approved Option, notwithstanding the terms of section 10.1 of the Plan, no adjustment shall be made pursuant to section 10.1 of the Plan to any outstanding Approved Options without the prior approval of the Inland Revenue. 9. In relation to an Approved Option any Key U.K. Employee shall make arrangements satisfactory to the Company for the satisfaction of any tax withholding or deduction -- at -- source obligations that arise by reason of the grant to him or her of such option, or its subsequent exercise. 10. In relation to an Approved Option, in addition to the provisions set out in section 15.2 of the Plan, no amendment which affects any of the provisions of the Plan relating to Approved Options shall be effective until approved by the Inland Revenue, except for such amendment as are required to obtain and maintain the approval of Inland Revenue pursuant to Schedule 9 to the Taxes Act. 15 NON-OUALIFIED STOCK OPTION AGREEMENT (1987 Stock Option Plan, as first amended) THIS AGREEMENT, made as of this _____ of _________, 19__, by and between The Charles Schwab Corporation, a Delaware corporation ("Company"), and _______________ ("Optionee"). WITNESSETH: WHEREAS, there has been granted to Optionee, effective as of _________ __, 19____, a non-qualified stock option under the 1987 Stock Option Plan, as first amended, of the Company ("Option Plan"); NOW, THEREFORE, it is mutually agreed as follows: 1. The Optionee shall have a non-qualified stock option to acquire _____ shares of common stock of the Company (the "Shares"), at a price of $_______ per share. 2. Optionee acknowledges that paragraph 5(a) of the Option Plan imposes significant restrictions on Optionee's ability to exercise this option. 3. This is a non-statutory stock option and the provisions of paragraph 5(b) of the Option Plan are inapplicable to this Option. With that exception and except as provided in paragraphs 4, 5 and 6 below, the other terms of this option shall be the same as without limitation, vesting of Shares, limitations on exercise and transfer, and other restrictions. The Option Plan is attached hereto as Exhibit A and is incorporated herein by this reference. Optionee has read the Option Plan and, other than for the provisions of paragraph 5(b) of the Option Plan and as provided in paragraphs 4, 5 and 6 below, agrees to be bound by its terms. Without limitation, Optionee specifically acknowledges the representations, warranties and agreements contained in paragraph 6(e) of the Option Plan. 4. Notwithstanding paragraph 6(b) of the Option Plan, in the event Optionee's employment, service as a director or provision of independent contractor services with or for the Company and its subsidiaries terminates by reason of Optionee's death or permanent disability, all shares then not deemed to be Vested thereupon will be deemed immediately Vested. For this purpose, "permanent disability" will mean the reasonable determination by a qualified physician acceptable to the Company that the Optionee has an illness or incapacity that has disabled, or will disable, the Optionee from rendering his or her normal services to the company and its subsidiaries for a period of more than six (6) consecutive months in any consecutive twelve (12) month period. 16 5. If the Company fails to timely exercise its right to repurchase Unvested Shares, those Shares will be treated as Vested Shares. Options underlying Unvested Shares may not be exercised once vesting ceases. 6. Any notice to be given by the Optionee under the terms of the Option Plan shall be deemed to have been duly given, and effective upon receipt, if sent by Certified Mail, postage and certification prepaid, to The Charles Schwab Corporation, 101 Montgomery Street, San Francisco, California 94104, Attention: Corporate Secretary, except as superseded by a different address noticed to Optionee. IN WITNESS WHEREOF, the parties have caused this Agreement to be executed as of the day and year referred to above. BY: ---------------------------------------- on Behalf of The Charles Schwab Corporation ("Company") ---------------------------------------- Optionee Attachments: (1) Spousal Consent (2) Exhibit A: 1987 Stock Option Plan, as first amended. 17 EX-10.187 4 EXHIBIT 10.187 EXHIBIT 10.187 THE CHARLES SCHWAB CORPORATION 1992 STOCK INCENTIVE PLAN (RESTATED TO INCLUDE AMENDMENTS THROUGH OCTOBER 22, 1997) ARTICLE 1. INTRODUCTION. The Plan was adopted by the Board of Directors on March 26, 1992. The purpose of the Plan is to promote the long-term success of the Company and the creation of incremental stockholder value by (a) encouraging Non-Employee Directors and Key Employees to focus on long-range objectives, (b) encouraging the attraction and retention of Non-Employee Directors and Key Employees with exceptional qualifications and (c) linking Non-Employee Directors and Key Employees directly to stockholder interests. The Plan seeks to achieve this purpose by providing for Awards in the form of Restricted Shares, Performance Share Awards or Options, which may constitute incentive stock options or nonstatutory stock options. The Plan shall be governed by, and construed in accordance with, the laws of the State of Delaware. ARTICLE 2. ADMINISTRATION. 2.1 THE COMMITTEE. The Plan shall be administered by the Committee. The Committee shall consist of two or more Non-Employee Directors, who shall be appointed by the Board. 2.2 COMMITTEE RESPONSIBILITIES. The Committee shall select the Key Employees who are to receive Awards under the Plan, determine the amount, vesting requirements and other conditions of such Awards, may interpret the Plan, and make all other decisions relating to the operation of the Plan. The Committee may adopt such rules or guidelines as it deems appropriate to implement the Plan. The Committee's determinations under the Plan shall be final and binding on all persons. ARTICLE 3. LIMITATION ON AWARDS. The aggregate number of Restricted Shares, Performance Share Awards and Options awarded under the Plan shall not exceed 29,150,000 (including those shares awarded prior to the amendment of the Plan). If any Restricted Shares, Performance Share Awards or Options are forfeited, or if any Performance Share Awards terminate for any other reason without the associated Common Shares being issued, or if any Options terminate for any other reason before being exercised, then such Restricted Shares, Performance Share Awards or Options shall again become available for Awards under the Plan. The limitation of this Article 3 shall be subject to adjustment pursuant to Article 10. Any Common Shares issued pursuant to the Plan may be authorized but unissued shares or treasury shares. Subject to the overall limit on the aggregate shares set forth above, the following limitations shall apply: (a) The maximum number of Common Shares which may be granted subject to an Option to any one Participant in any one fiscal year shall be 500,000; and (b) The maximum number of Restricted Shares or Performance Share Awards which may be granted to any one Participant in any one fiscal year shall be 200,000. ARTICLE 4. ELIGIBILITY. 4.1 GENERAL RULE. Key Employees and Non-Employee Directors shall be eligible for designation as Participants by the Committee. 4.2 NON-EMPLOYEE DIRECTORS. In addition to any awards pursuant to Section 4.1, Non-Employee Directors shall be entitled to receive the automatic NSOs described in this Section 4.2. (a) Each Non-Employee Director shall receive a Non-Officer Stock Option covering 2,500 Common Shares for each Award Year with respect to which he or she serves as a Non-Employee Director on the grant date described in subsection (b) below; provided that the Non-Officer Stock Option shall cover 1,500 shares if the Exercise Price determined as of the grant date, is $35 or more; (b) The NSO for a particular Award Year shall be granted to each Non-Employee Director as of May 15 of each Award Year, and if May 15 is not a business day, then the grant shall be made on and as of the next succeeding business day; (c) Each NSO shall be exercisable in full at all times during its term; (d) The term of each NSO shall be 10 years; provided, however, that any unexercised NSO shall expire on the date that the Optionee ceases to be a Non-Employee Director or a Key Employee for any reason other than death or disability. If an Optionee ceases to be a Non-Employee Director or Key Employee on account of death or disability, any unexercised NSO shall expire on the earlier of the date 10 years after the date of grant or one year after the date of death or disability of such Director; and (e) The Exercise Price under each NSO shall be equal to the Fair Market Value on the date of grant and shall be payable in any of the forms described in Article 6. 4.3 TEN-PERCENT STOCKHOLDERS. A Key Employee who owns more than 10 percent of the total combined voting power of all classes of outstanding stock of the Company or any of its Subsidiaries shall not be eligible for the grant of an ISO unless (a) the Exercise price under such ISO is at least 110 percent of the Fair Market Value of a Common Share on the date of grant and (b) such ISO by its terms is not exercisable after the expiration of five years from the date of grant. 4.4 ATTRIBUTION RULES. For purposes of Section 4.3, in determining stock ownership, a Key Employee shall be deemed to own the stock owned, directly or indirectly, by or for his or her brothers, sisters, spouse, ancestors or lineal descendants. Stock owned, directly or indirectly, by or for a corporation, partnership, estate or trust shall be deemed to be owned proportionately 2 by or for its stockholders, partners or beneficiaries. Stock with respect to which the Key Employee holds an option shall not be counted. 4.5 OUTSTANDING STOCK. For purposes of Section 4.3, "outstanding stock" shall include all stock actually issued and outstanding immediately after the grant of the ISO to the Key Employee. "Outstanding stock" shall not include treasury shares or shares authorized for issuance under outstanding options held by the Key Employee or by any other person. ARTICLE 5. OPTIONS. 5.1 STOCK OPTION AGREEMENT. Each grant of an Option under the Plan shall be evidenced by a Stock Option Agreement between the Optionee and the Company. Such Option shall be subject to all applicable terms and conditions of the Plan, and may be subject to any other terms and conditions which are not inconsistent with the Plan and which the Committee deems appropriate for inclusion in a Stock Option Agreement. The provisions of the various Stock Option Agreements entered into under the Plan need not be identical. The Committee may designate all or any part of an Option as an ISO, except for Options granted to Non-Employee Directors under Section 4.2. The Committee may designate all or any part of an Option as an ISO (or, in the case of a Key Employee who is subject to the tax laws of a foreign jurisdiction, as an option qualifying for favorable tax treatment under the laws of such foreign jurisdiction), except for Options granted to Non-Employee Directors under section 4.2. 5.2 OPTIONS NONTRANSFERABILITY. No Option granted under the Plan shall be transferable by the Optionee other than by will or the laws of descent and distribution. An Option may be exercised during the lifetime of the Optionee only by him or her. No Option or interest therein may be transferred, assigned, pledged or hypothecated by the Optionee during his or her lifetime, whether by operation of law or otherwise, or be made subject to execution, attachment or similar process. 5.3 NUMBER OF SHARES. Each Stock Option Agreement shall specify the number of Common Shares subject to the Option and shall provide for the adjustment of such number in accordance with Article 10. Each Stock Option Agreement shall also specify whether the Option is an ISO or an NSO. 5.4 EXERCISE PRICE. Each Stock Option Agreement shall specify the Exercise Price. The Exercise Price under an Option shall not be less than 100 percent of the Fair Market Value of a Common Share on the date of grant, except as otherwise provided in Section 4.3. Subject to the preceding sentence, the Exercise Price under any Option shall be determined by the Committee. The Exercise Price shall be payable in accordance with Article 6. 5.5 EXERCISABILITY AND TERM. Each Stock Option Agreement shall specify the date when all or any installment of the Option is to become exercisable. The Stock Option Agreement shall also specify the term of the Option. The term of an ISO shall in no event exceed 10 years from the date of grant, and Section 4.3 may require a shorter term. Subject to the preceding sentence, the Committee shall determine when all or any part of an Option is to 3 become exercisable and when such Option is to expire; provided that, in appropriate cases, the Company shall have the discretion to extend the term of an Option or the time within which, following termination of employment, an Option may be exercised, or to accelerate the exercisability of an Option. A Stock Option Agreement may provide for expiration prior to the end of its term in the event of the termination of the Optionee's employment and shall provide for the suspension of vesting when an employee is on a leave of absence for a period in excess of six months in appropriate cases, as determined by the Company; provided that the exercisability of Options shall be accelerated in the event of the Participant's death or Disability and, in the case of Retirement, the exercisability of all outstanding Options shall be accelerated, other than any Options that had been granted within two years of the date of the Optionee's Retirement. Except as provided in Section 4.2, NSOs may also be awarded in combination with Restricted Shares, and such an Award may provide that the NSOs will not be exercisable unless the related Restricted Shares are forfeited. In addition, NSOs granted under this Section 5 may be granted subject to forfeiture provisions which provide for forfeiture of the Option upon the exercise of tandem awards, the terms of which are established in other programs of the Company. 5.6 LIMITATION ON AMOUNT OF ISOS. The aggregate fair market value (determined at the time the ISO is granted) of the Common Shares with respect to which ISOs are exercisable for the first time by the Optionee during any calendar year (under all incentive stock option plans of the Company) shall not exceed $100,000; provided, however, that all or any portion of an Option which cannot be exercised as an ISO because of such limitation shall be treated as an NSO. 5.7 EFFECT OF CHANGE IN CONTROL. The Committee (in its sole discretion) may determine, at the time of granting an Option, that such Option shall become fully exercisable as to all Common Shares subject to such Option immediately preceding any Change in Control with respect to the Company. 5.8 RESTRICTIONS ON TRANSFER OF COMMON SHARES. Any Common Shares issued upon exercise of an Option shall be subject to such special forfeiture conditions, rights of repurchase, rights of first refusal and other transfer restrictions as the Committee may determine. Such restrictions shall be set forth in the applicable Stock Option Agreement and shall apply in addition to any general restrictions that may apply to all holders of Common Shares. 5.9 AUTHORIZATION OF REPLACEMENT OPTIONS. Concurrently with the grant of any Option to a Participant (other than NSOs granted pursuant to Section 4.2), the Committee may authorize the grant of Replacement Options. If Replacement Options have been authorized by the Committee with respect to a particular award of Options (the "Underlying Options"), the Option Agreement with respect to the Underlying Options shall so state, and the terms and conditions of the Replacement Options shall be provided therein. The grant of any Replacement Options shall be effective only upon the exercise of the Underlying Options through the use of Common Shares pursuant to Section 6.2 or Section 6.3. The number of Replacement Options shall equal the number of Common Shares used to exercise the Underlying Options, and, if the Option Agreement so provides, the number of Common Shares used to satisfy any tax withholding requirements incident to the exercise of the Underlying Options in accordance with Section 13.2. 4 Upon the exercise of the Underlying Options, the Replacement Options shall be evidenced by an amendment to the Underlying Option Agreement. Notwithstanding the fact that the Underlying Option may be an ISO, a Replacement Option is not intended to qualify as an ISO. The Exercise Price of a Replacement Option shall be no less than the Fair Market Value of a Common Share on the date the grant of the Replacement Option becomes effective. The term of each Replacement Option shall be equal to the remaining term of the Underlying Option. No Replacement Options shall be granted to Optionees when Underlying Options are exercised pursuant to the terms of the Plan and the Underlying Option Agreement following termination of the Optionee's employment. The Committee, in its sole discretion, may establish such other terms and conditions for Replacement Options as it deems appropriate. 5.10 OPTIONS GRANTED TO NON-UNITED STATES KEY EMPLOYEES. In the case of Key Employees who are subject to the tax laws of a foreign jurisdiction, the Company may issue Options to such Key Employees that contain terms required to conform with any requirements for favorable tax treatment imposed by the laws of such foreign jurisdiction, or as otherwise may be required by the laws of such foreign jurisdiction. The terms of any such Options shall be governed by the Plan, subject to the terms of any Addendum to the Plan specifically applicable to such Options. ARTICLE 6. PAYMENT FOR OPTION SHARES. 6.1 GENERAL RULE. The entire Exercise Price of Common Shares issued upon exercise of Options shall be payable in cash at the time when such Common Shares are purchased, except as follows: (a) In the case of an ISO granted under the Plan, payment shall be made only pursuant to the express provisions of the applicable Stock Option Agreement. However, the Committee may specify in the Stock Option Agreement that payment may be made pursuant to Section 6.2 or 6.3. (b) In the case of an NSO, the Committee may at any time accept payment pursuant to Section 6.2 or 6.3. 6.2 SURRENDER OF STOCK. To the extent that this Section 6.2 is applicable, payment for all or any part of the Exercise Price may be made with Common Shares which are surrendered to the Company. Such Common Shares shall be valued at their Fair Market Value on the date when the new Common Shares are purchased under the Plan. In the event that the Common Shares being surrendered are Restricted Shares that have not yet become vested, the same restrictions shall be imposed upon the new Common Shares being purchased. 6.3 EXERCISE/SALE. To the extent this Section 6.3 is applicable, payment may be made by the delivery (on a form prescribed by the Company) of an irrevocable direction to Charles Schwab & Co., Inc. to sell Common Shares (including the Common Shares to be issued upon 5 exercise of the Options) and to deliver all or part of the sales proceeds to the Company in payment of all or part of the Exercise Price and any withholding taxes. ARTICLE 7. RESTRICTED SHARES AND PERFORMANCE SHARE AWARDS. 7.1 TIME, AMOUNT AND FORM OF AWARDS. The Committee may grant Restricted Shares or Performance Share Awards with respect to an Award Year during such Award Year or at any time thereafter. Each such Award shall be evidenced by a Stock Award Agreement between the Award recipient and the Company. The amount of each Award of Restricted Shares or Performance Share Awards shall be determined by the Committee. Awards under the Plan may be granted in the form of Restricted Shares or Performance Share Awards or in any combination thereof, as the Committee shall determine at its sole discretion at the time of the grant. Restricted Shares or Performance Share Awards may also be awarded in combination with NSOs, and such an Award may provide that the Restricted Shares or Performance Share Awards will be forfeited in the event that the related NSOs are exercised. 7.2 PAYMENT FOR RESTRICTED SHARE AWARDS. To the extent that an Award is granted in the form of Restricted Shares, the Award recipient, as a condition to the grant of such Award, shall be required to pay the Company in cash an amount equal to the par value of such Restricted Shares. 7.3 VESTING OR ISSUANCE CONDITIONS. Each Award of Restricted Shares shall become vested, in full or in installments, upon satisfaction of the conditions specified in the Stock Award Agreement. Common Shares shall be issued pursuant to Performance Share Awards in full or in installments upon satisfaction of the issuance conditions specified in the Stock Award Agreement. The Committee shall select the vesting conditions in the case of Restricted Shares, or issuance conditions in the case of Performance Share Awards, which may be based upon the Participant's service, the Participant's performance, the Company's performance or such other criteria as the Committee may adopt; provided that, in the case of an Award of Restricted Shares where vesting is based entirely on the Participant's service, (i) vesting shall be accelerated in the event of the Participant's death or Disability; (ii) in the case of Retirement, vesting shall be accelerated for all Restricted Shares that had been granted more than two years prior to the date of the Participant's Retirement; and (iii) vesting shall be suspended when an employee is on a leave of absence for a period in excess of six months in appropriate cases, as determined by the Company. The Committee, in its sole discretion, may determine, at the time of making an Award of Restricted Shares, that such Award shall become fully vested in the event that a Change in Control occurs with respect to the Company. The Committee, in its sole discretion, may determine, at the time of making a Performance Share Award, that the issuance conditions set forth in such Award shall be waived in the event that a Change in Control occurs with respect to the Company. 7.4 FORM OF SETTLEMENT OF PERFORMANCE SHARE AWARDS. Settlement of Performance Share Awards shall only be made in the form of Common Shares. Until a Performance Share 6 Award is settled, the number of Performance Share Awards shall be subject to adjustment pursuant to Article 10. 7.5 DEATH OF RECIPIENT. Any Common Shares that are to be issued pursuant to a Performance Share Award after the recipient's death shall be delivered or distributed to the recipient's beneficiary or beneficiaries. Each recipient of a Performance Share Award under the Plan shall designate one or more beneficiaries for this purpose by filing the prescribed form with the Company. A beneficiary designation may be changed by filing the prescribed form with the Company at any time before the Award recipient's death. If no beneficiary was designated or if no designated beneficiary survives the Award recipient, then any Common Shares that are to be issued pursuant to a Performance Share Award after the recipient's death shall be delivered or distributed to the recipient's estate. The Committee, in its sole discretion, shall determine the form and time of any distribution(s) to a recipient's beneficiary or estate. ARTICLE 8. CLAIMS PROCEDURES. Claims for benefits under the Plan shall be filed in writing with the Committee on forms supplied by the Committee. Written notice of the disposition of a claim shall be furnished to the claimant within 90 days after the claim is filed. If the claim is denied, the notice of disposition shall set forth the specific reasons for the denial, citations to the pertinent provisions of the Plan, and, where appropriate, an explanation as to how the claimant can perfect the claim. If the claimant wishes further consideration of his or her claim, the claimant may appeal a denied claim to the Committee (or to a person designated by the Committee) for further review. Such appeal shall be filed in writing with the Committee on a form supplied by the Committee, together with a written statement of the claimant's position, no later than 90 days following receipt by the claimant of written notice of the denial of his or her claim. If the claimant so requests, the Committee shall schedule a hearing. A decision on review shall be made after a full and fair review of the claim and shall be delivered in writing to the claimant no later than 60 days after the Committee's receipt of the notice of appeal, unless special circumstances (including the need to hold a hearing) require an extension of time for processing the appeal, in which case a written decision on review shall be delivered to the claimant as soon as possible but not later than 120 days after the Committee's receipt of the appeal notice. The claimant shall be notified in writing of any such extension of time. The written decision on review shall include specific reasons for the decision, written in a manner calculated to be understood by the claimant, and shall specifically refer to the pertinent Plan provisions on which it is based. All determinations of the Committee shall be final and binding on Participants and their beneficiaries. ARTICLE 9. VOTING RIGHTS AND DIVIDENDS. 9.1 RESTRICTED SHARES. (a) All holders of Restricted Shares who are not Named Executive Officers shall have the same voting, dividend, and other rights as the Company's other stockholders. 7 (b) During the period of restriction, Named Executive Officers holding Restricted Shares granted hereunder shall be credited with all regular cash dividends paid with respect to all Restricted Shares while they are so held. If a dividend is paid in the form of cash, such cash dividend shall be credited to Named Executive Officers subject to the same restrictions on transferability and forfeitability as the Restricted Shares with respect to which they were paid. If any dividends or distributions are paid in shares of Common Stock, the shares of Common Stock shall be subject to the same restrictions on transferability and forfeitability as the Restricted Shares with respect to which they were paid. Subject to the succeeding paragraph, and to the restrictions on vesting and the forfeiture provisions, all dividends credited to a Named Executive Officer shall be paid to the Named Executive Officer within forty-five (45) days following the full vesting of the Restricted Shares with respect to which such dividends were earned. In the event that any dividend constitutes a "derivative security" or an "equity security" pursuant to Rule 16(a) under the Exchange Act, such dividend shall be subject to a vesting period equal to the longer of: (i) the remaining vesting period of the Restricted Shares with respect to which the dividend is paid; or (ii) six (6) months. The Committee shall establish procedures for the application of this provision. Named Executive Officers holding Restricted Shares shall have the same voting rights as the Company's other stockholders. 9.2 PERFORMANCE SHARE AWARDS. The holders of Performance Share Awards shall have no voting or dividend rights until such time as any Common Shares are issued pursuant thereto, at which time they shall have the same voting, dividend and other rights as the Company's other stockholders. ARTICLE 10. PROTECTION AGAINST DILUTION; ADJUSTMENT OF AWARDS. 10.1 GENERAL. In the event of a subdivision of the outstanding Common Shares, a declaration of a dividend payable in Common Shares, a declaration of a dividend payable in a form other than Common Shares, a combination or consolidation of the outstanding Common Shares (by reclassification or otherwise) into a lesser number of Common Shares, a recapitalization, a spinoff or a similar occurrence, the Committee shall make appropriate adjustments in one or more of (a) the number of Options, Restricted Shares and Performance Share Awards available for future Awards under Article 3, (b) the number of Performance Share Awards included in any prior Award which has not yet been settled, (c) the number of Common Shares covered by each outstanding Option or (d) the Exercise Price under each outstanding Option. 10.2 REORGANIZATIONS. In the event that the Company is a party to a merger or other reorganization, outstanding Options, Restricted Shares and Performance Share Awards shall be subject to the agreement of merger or reorganization. Such agreement may provide, without limitation, for the assumption of outstanding Awards by the surviving corporation or its parent, 8 for their continuation by the Company (if the Company is a surviving corporation), for accelerated vesting or for settlement in cash. 10.3 RESERVATION OF RIGHTS. Except as provided in this Article 10, a Participant shall have no rights by reason of any subdivision or consolidation of shares of stock of any class, the payment of any stock dividend or any other increase or decrease in the number of shares of stock of any class. Any issue by the Company of shares of stock of any class, or securities convertible into shares of stock of any class, shall not affect, and no adjustment by reason thereof shall be made with respect to, the number or Exercise Price of Common Shares subject to an Option. The grant of an Award pursuant to the Plan shall not affect in any way the right or power of the Company to make adjustments, reclassifications, reorganizations or changes of its capital or business structure, to merge or consolidate or to dissolve, liquidate, sell or transfer all or any part of its business or assets. ARTICLE 11. LIMITATION OF RIGHTS. 11.1 EMPLOYMENT RIGHTS. Neither the Plan nor any Award granted under the Plan shall be deemed to give any individual a right to remain employed by the Company or any Subsidiary. The Company and its Subsidiaries reserve the right to terminate the employment of any employee at any time, with or without cause, subject only to a written employment agreement (if any). 11.2 STOCKHOLDERS' RIGHTS. A Participant shall have no dividend rights, voting or other rights as a stockholder with respect to any Common Shares covered by his or her Award prior to the issuance of such Common Shares, whether by issuance of a certificate, book entry or other procedure. No adjustment shall be made for cash dividends or other rights for which the record date is prior to the date when such certificate is issued, except as expressly provided in Articles 7, 9 and 10. 11.3 CREDITORS' RIGHTS. A holder of Performance Share Awards shall have no rights other than those of a general creditor of the Company. Performance Share Awards represent unfunded and unsecured obligations of the Company, subject to the terms and conditions of the applicable Stock Award Agreement. 11.4 GOVERNMENT REGULATIONS. Any other provision of the Plan notwithstanding, the obligations of the Company with respect to Common Shares to be issued pursuant to the Plan shall be subject to all applicable laws, rules and regulations, and such approvals by any governmental agencies as may be required. The Company reserves the right to restrict, in whole or in part, the delivery of Common Shares pursuant to any Award until such time as: (a) Any legal requirements or regulations have been met relating to the issuance of such Common Shares or to their registration, qualification or exemption from registration or qualification under the Securities Act of 1933, as amended, or any applicable state securities laws; and 9 (b) Satisfactory assurances have been received that such Common Shares, when issued, will be duly listed on the New York Stock Exchange or any other securities exchange on which Common Shares are then listed. ARTICLE 12. LIMITATION OF PAYMENTS. 12.1 BASIC RULE. Any provision of the Plan to the contrary notwithstanding, in the event that the independent auditors most recently selected by the Board (the "Auditors") determine that any payment or transfer in the nature of compensation to or for the benefit of a Participant, whether paid or payable (or transferred or transferable) pursuant to the terms of this Plan or otherwise (a "Payment"), would be nondeductible for federal income tax purposes because of the provisions concerning "excess parachute payments" in section 280G of the Code, then the aggregate present value of all Payments shall be reduced (but not below zero) to the Reduced Amount; provided, however, that the Committee, at the time of making an Award under this Plan or at any time thereafter, may specify in writing that such Award shall not be so reduced and shall not be subject to this Article 12. For purposes of this Article 12, the "Reduced Amount" shall be the amount, expressed as a present value, which maximizes the aggregate present value of the Payments without causing any Payment to be nondeductible by the Company because of section 280G of the Code. 12.2 REDUCTION OF PAYMENTS. If the Auditors determine that any Payment would be nondeductible because of section 280G of the Code, then the Company shall promptly give the Participant notice to that effect and a copy of the detailed calculation thereof and of the Reduced Amount, and the Participant may then elect, in his or her sole discretion, which and how much of the Payments shall be eliminated or reduced (as long as after such election, the aggregate present value of the Payments equals the Reduced Amount) and shall advise the Company in writing of his or her election within 10 days of receipt of notice. If no such election is made by the Participant within such 10-day period, then the Company may elect which and how much of the Payments shall be eliminated or reduced (as long as after such election the aggregate present value of the Payments equals the Reduced Amount) and shall notify the Participant promptly of such election. For purposes of this Article 12, present value shall be determined in accordance with section 280G(d)(4) of the Code. All determinations made by the Auditors under this Article 12 shall be binding upon the Company and the Participant and shall be made within 60 days of the date when a Payment becomes payable or transferable. As promptly as practicable following such determination and the elections hereunder, the Company shall pay or transfer to or for the benefit of the Participant such amounts as are then due to him or her under the Plan, and shall promptly pay or transfer to or for the benefit of the Participant in the future such amounts as become due to him or her under the Plan. 12.3 OVERPAYMENTS AND UNDERPAYMENTS. As a result of uncertainty in the application of section 280G of the Code at the time of an initial determination by the Auditors hereunder, it is possible that Payments will have been made by the Company which should not have been made (an "Overpayment") or that additional Payments which will not have been made by the Company could have been made (an "Underpayment"), consistent in each case with the calculation of the Reduced Amount hereunder. In the event that the Auditors, based upon the assertion of a 10 deficiency by the Internal Revenue Service against the Company or the Participant which the Auditors believe has a high probability of success, determine that an Overpayment has been made, such Overpayment shall be treated for all purposes as a loan to the Participant which he or she shall repay to the Company on demand, together with interest at the applicable federal rate provided in section 7872(f)(2) of the Code; provided, however, that no amount shall be payable by the Participant to the Company if and to the extent that such payment would not reduce the amount which is subject to taxation under section 4999 of the Code. In the event that the Auditors determine that an Underpayment has occurred, such Underpayment shall promptly be paid or transferred by the Company to or for the benefit of the Participant, together with interest at the applicable federal rate provided in section 7872(f)(2) of the Code. 12.4 RELATED CORPORATIONS. For purposes of this Article 12, the term "Company" shall include affiliated corporations to the extent determined by the Auditors in accordance with section 280G(d)(5) of the Code. ARTICLE 13. WITHHOLDING TAXES. 13.1 GENERAL. To the extent required by applicable federal, state, local or foreign law, the recipient of any payment or distribution under the Plan shall make arrangements satisfactory to the Company for the satisfaction of any withholding tax obligations that arise by reason of such payment or distribution. The Company shall not be required to make such payment or distribution until such obligations are satisfied. 13.2 NONSTATUTORY OPTIONS, RESTRICTED SHARES OR PERFORMANCE SHARE AWARDS. The Committee may permit an Optionee who exercises NSOs, or who receives Awards of Restricted Shares, or who receives Common Shares pursuant to the terms of a Performance Share Award, to satisfy all or part of his or her withholding tax obligations by having the Company withhold a portion of the Common Shares that otherwise would be issued to him or her under such Awards. Such Common Shares shall be valued at their Fair Market Value on the date when taxes otherwise would be withheld in cash. The payment of withholding taxes by surrendering Common Shares to the Company, if permitted by the Committee, shall be subject to such restrictions as the Committee may impose, including any restrictions required by rules of the Securities and Exchange Commission. ARTICLE 14. ASSIGNMENT OR TRANSFER OF AWARD. 14.1 GENERAL RULE. Any Award granted under the Plan shall not be anticipated, assigned, attached, garnished, optioned, transferred or made subject to any creditor's process, whether voluntarily, involuntarily or by operation of law, except to the extent specifically permitted by Section 14.2. 14.2 EXCEPTIONS TO GENERAL RULE. Notwithstanding Section 14.1, this Plan shall not preclude (i) a Participant from designating a beneficiary to succeed, after the Participant's death, to those of the Participant's Awards (including without limitation, the right to exercise any unexercised Options) as may be determined by the Company from time to time in its sole 11 discretion, (ii) a transfer of any Award hereunder by will or the laws of descent or distribution, or (iii) a voluntary transfer of an Award (other than an ISO) to a trust or partnership for the exclusive benefit of one or more members of the Participant's family, but only if the Participant has sole investment control over such trust or partnership. ARTICLE 15. FUTURE OF PLANS. 15.1 TERM OF THE PLAN. The Plan, as set forth herein, shall become effective on May 8, 1992. The Plan shall remain in effect until it is terminated under Section 15.2, except that no ISOs shall be granted after May 7, 2002. 15.2 AMENDMENT OR TERMINATION. The Committee may, at any time and for any reason, amend or terminate the Plan; provided, however, that any amendment of the Plan shall be subject to the approval of the Company's stockholders to the extent required by applicable laws, regulations or rules. 15.3 EFFECT OF AMENDMENT OR TERMINATION. No Award shall be made under the Plan after the termination thereof. The termination of the Plan, or any amendment thereof, shall not affect any Option, Restricted Share or Performance Share Award previously granted under the Plan. ARTICLE 16. DEFINITIONS. 16.1 "Award" means any award of an Option, a Restricted Share or a Performance Share Award under the Plan. 16.2 "Award Year" means a fiscal year beginning January 1 and ending December 31 with respect to which an Award may be granted. 16.3 "Board" means the Company's Board of Directors, as constituted from time to time. 16.4 "Change in Control" means the occurrence of any of the following events after the effective date of the Plan as set out in Section 15.1: (a) A change in control required to be reported pursuant to Item 6(e) of Schedule 14A of Regulation 14A under the Exchange Act; (b) A change in the composition of the Board, as a result of which fewer than two-thirds of the incumbent directors are directors who either (i) had been directors of the Company 24 months prior to such change or (ii) were elected, or nominated for election, to the Board with the affirmative votes of at least a majority of the directors who had been directors of the Company 24 months prior to such change and who were still in office at the time of the election or nomination; 12 (c) Any "person" (as such term is used in sections 13(d) and 14(d) of the Exchange Act) becomes the beneficial owner, directly or indirectly, of securities of the Company representing 20 percent or more of the combined voting power of the Company's then outstanding securities ordinarily (and apart from rights accruing under special circumstances) having the right to vote at elections of directors (the "Base Capital Stock"); provided, however, that any change in the relative beneficial ownership of securities of any person resulting solely from a reduction in the aggregate number of outstanding shares of Base Capital Stock, and any decrease thereafter in such person's ownership of securities, shall be disregarded until such person increases in any manner, directly or indirectly, such person's beneficial ownership of any securities of the Company. 16.5 "Code" means the Internal Revenue Code of 1986, as amended. 16.6 "Committee" means the Compensation Committee of the Board, as constituted from time to time. 16.7 "Common Share" means one share of the common stock of the Company. 16.8 "Company" means The Charles Schwab Corporation, a Delaware corporation. 16.9 "ERISA" means the Employee Retirement Income Security Act of 1974, as amended. 16.10 "Exchange Act" means the Securities Exchange Act of 1934, as amended. 16.11 "Exercise Price" means the amount for which one Common Share may be purchased upon exercise of an Option, as specified by the Committee in the applicable Stock Option Agreement. 16.12 "Fair Market Value" means the market price of a Common Share, determined by the committee as follows: (a) If the Common Share was traded on a stock exchange on the date in question, then the Fair Market Value shall be equal to the closing price reported by the applicable composite-transactions report for such date; (b) If the Common Share was traded over-the-counter on the date in question and was classified as a national market issue, then the Fair Market Value shall be equal to the last transaction price quoted by the NASDAQ system for such date; (c) If the Common Share was traded over-the-counter on the date in question but was not classified as a national market issue, then the Fair Market Value shall be equal to the 13 mean between the last reported representative bid and asked prices quoted by the NASDAQ system for such date; and (d) If none of the foregoing provisions is applicable, then the Fair Market Value shall be determined by the Committee in good faith on such basis as it deems appropriate. 16.13 "ISO" means an incentive stock option described in section 422(b) of the Code. 16.14 "Key Employee" means a key common-law employee of the Company or any Subsidiary, as determined by the Committee. 16.15 "Named Executive Officer" means a Participant who, as of the date of vesting of an Award is one of a group of "covered employees," as defined in the Regulations promulgated under Code Section 162(m), or any successor statute. 16.16 "Non-Employee Director" means a member of the Board who is not a common-law employee. 16.17 "NSO" means an employee stock option not described in sections 422 through 424 of the Code. 16.18 "Option" means an ISO or NSO or, in the case of a Key Employee who is subject to the tax laws of a foreign jurisdiction, an option qualifying for favorable tax treatment under the laws of such jurisdiction, including a Replacement Option, granted under the Plan and entitling the holder to purchase one Common Share. 16.19 "Optionee" means an individual, or his or her estate, legatee or heirs at law that holds an Option. 16.20 "Participant" means a Non-Employee Director or Key Employee who has received an Award. 16.21 "Performance Share Award" means the conditional right to receive in the future one Common Share, awarded to a Participant under the Plan. 16.22 "Plan" means this 1992 Stock Incentive Plan of The Charles Schwab Corporation, as it may be amended from time to time. 16.23 "Replacement Option" means an Option that is granted when a Participant uses a Common Share held or to be acquired by the Participant to exercise an Option and/or to satisfy tax withholding requirements incident to the exercise of an Option. 16.24 "Restricted Share" means a Common Share awarded to a Participant under the Plan. 14 16.25 "Stock Award Agreement" means the agreement between the Company and the recipient of a Restricted Share or Performance Share Award which contains the terms, conditions and restrictions pertaining to such Restricted Share or Performance Share Award. 16.26 "Stock Option Agreement" means the agreement between the Company and an Optionee which contains the terms, conditions and restrictions pertaining to his or her option. 16.27 "Subsidiary" means any corporation, if the Company and/or one or more other Subsidiaries own not less than 50 percent of the total combined voting power of all classes of outstanding stock of such corporation. A corporation that attains the status of a Subsidiary on a date after the adoption of the Plan shall be considered a Subsidiary commencing as of such date. 16.28. "Retirement" shall mean any termination of employment of an Optionee for any reason other than death at any time after the Optionee has attained fifty (50), but only if, at the time of such termination, the Participant has been credited with at least seven (7) Years of Service under the Charles Schwab Profit Sharing and Employee Stock Ownership Plan. The foregoing definition shall apply to all Stock Option Agreements entered into pursuant to the Plan, irrespective of any definition to the contrary contained in any such Stock Option Agreement. 16.29 "Disability" means the inability to engage in any substantial gainful activity considering the Participant's age, education and work experience by reason of any medically determined physical or mental impairment that has continued without interruption for a period of at least six months and that can be expected to be of long, continued and indefinite duration. All determinations as to whether a Participant has incurred a Disability shall be made by the Employee Benefits Administration Committee of the Company, the findings of which shall be final, binding and conclusive. 15 ADDENDUM A The provisions of the Plan, as amended by the terms of this Addendum A, shall apply to the grant of Approved Options to Key U.K. Employees. 1. For purposes of this Addendum A, the following definitions shall apply in addition to those set out in section 16 of the Plan: APPROVED OPTION Means a stock option designed to qualify as an approved executive share option under the Taxes Act; INLAND REVENUE means the Board of the Inland Revenue in the United Kingdom. KEY U.K. EMPLOYEE means a designated employee of Sharelink Investment Services plc or any subsidiary (as that term is defined in the Companies Act 1985 of the United Kingdom, as amended) of which Sharelink Investment Services plc has control for the purposes of section 840 of the Taxes Act; TAXES ACT means the Income and Corporation Taxes Act 1988 of the United Kingdom. 2. An Approved Option may only be granted to a Key U.K. Employee who: (i) is employed on a full-time basis; and (ii) does not fall within the provisions of paragraph 8 of Schedule 9 to the Taxes Act. For purposes of this section 2(i) of Addendum A, "full-time" shall mean an employee who is required to work 20 hours per week, excluding meal breaks. 3. No Approved Option may be granted to a Key U.K. Employee if it would cause the aggregate of the exercise price of all subsisting Approved Options granted to such employee under the Plan, or any other subsisting options granted to such employee under any other share option scheme approved under Schedule 9 of the Taxes Act and established by the Company or an associated company, to exceed the higher of (a) one hundred thousand pounds sterling and (b) four times such employee's relevant emoluments for the current or preceding year of assessment (whichever is greater); but where there were no relevant emoluments for the previous year of assessment, the limit shall be the higher of one hundred thousand pounds sterling or four times such employee's relevant emoluments for the period of twelve months beginning with the first day during the current year of assessment in respect of which there are relevant emoluments. For the purpose of this section 3 of Addendum A, "associated company" means an associated company within the meaning of section 416 of the Taxes Act; "relevant 16 emoluments" has the meaning given by paragraph 28(4) of Schedule 9 to the Taxes Act and "year of assessment" means a year beginning on any April 6 and ending on the following April 5. 4. Common Shares issued pursuant to the exercise of Approved Options must satisfy the conditions specified in paragraphs 10 to 14 of Schedule 9 to the Taxes Act. 5. Notwithstanding the provisions of Section 5.4 of the Plan, the exercise price of an Approved Option shall not be less than 100 percent of the closing price of a Common Share as reported in the New York Stock Exchange Composite Index on the date of grant. 6. No Approved Option may be exercised at any time by a Key U.K. Employee when that Key U.K. Employee falls within the provisions of paragraph 8 of Schedule 9 to the Taxes Act. If at any time the shares under an Approved Option cease to comply with the conditions in paragraphs 10 to 14 of Schedule 9 to the Taxes Act, then all Approved Options then outstanding shall lapse and cease to be exercisable from the date of the shares ceasing so to comply, and no optionee shall have any cause of action against the Company, Sharelink Investment Services plc or any subsidiary of the Company or any other person in respect thereof. 7. An Approved Option may contain such other terms, provisions and conditions as may be determined by the Committee consistent with the Plan, provided that the approved option otherwise complies with the requirements for approved executive option schemes specified in Schedule 9 of the Taxes Act. 8. In relation to an Approved Option, notwithstanding the terms of section 10.1 of the Plan, no adjustment shall be made pursuant to section 10.1 of the Plan to any outstanding Approved Options without the prior approval of the Inland Revenue. 9. In relation to an Approved Option any Key U.K. Employee shall make arrangements satisfactory to the Company for the satisfaction of any tax withholding or deduction -- at -- source obligations that arise by reason of the grant to him or her of such option, or its subsequent exercise. 10. In relation to an Approved Option, in addition to the provisions set out in section 15.2 of the Plan, no amendment which affects any of the provisions of the Plan relating to Approved Options shall be effective until approved by the Inland Revenue, except for such amendment as are required to obtain and maintain the approval of Inland Revenue pursuant to Schedule 9 to the Taxes Act. 17 EX-10.188 5 EXHIBIT 10.188 EXHIBIT 10.188 THE CHARLES SCHWAB CORPORATION 1987 EXECUTIVE OFFICER STOCK OPTION PLAN (RESTATED TO INCLUDE AMENDMENTS THROUGH OCTOBER 22, 1997) ARTICLE 1. INTRODUCTION. The purpose of the 1987 Executive Stock Option Plan, as Amended and Restated (the "Plan") is to enable The Charles Schwab Corporation and its subsidiaries to attract and retain directors, officers, and other key employees and to provide such persons with additional incentive to advance the interests of the Company. The Plan was initially adopted on March 24, 1987, and was amended on September 17, 1996 and October 22, 1997. The Plan is hereby restated and amended as of October 22, 1997, and the terms of this Restatement shall apply to all awards granted under the Plan on or after such date. The Plan shall terminate not more than ten (10) years from the date the Plan initially was adopted. The Plan will provide Awards in the form of Restricted Shares, Performance Share Awards or Options. The Plan shall be governed by, and construed in accordance with, the laws of the State of Delaware. ARTICLE 2. ADMINISTRATION. 2.1 THE COMMITTEE. The Plan shall be administered by the Committee. The Committee shall consist of two or more Non-Employee Directors, who shall be appointed by the Board. 2.2 COMMITTEE RESPONSIBILITIES. The Committee shall select the Key Employees who are to receive Awards under the Plan, determine the amount, vesting requirements and other conditions of such Awards, may interpret the Plan, and make all other decisions relating to the operation of the Plan. The Committee may adopt such rules or guidelines as it deems appropriate to implement the Plan. The Committee's determinations under the Plan shall be final and binding on all persons. ARTICLE 3. LIMITATION ON AWARDS. The aggregate number of Restricted Shares, Performance Share Awards and Options awarded under the Plan shall not exceed 1,284,000 (including those shares awarded prior to the amendment of the Plan). If any Restricted Shares, Performance Share Awards or Options are forfeited, or if any Performance Share Awards terminate for any other reason without the associated Common Shares being issued, or if any Options terminate for any other reason before being exercised, then such Restricted Shares, Performance Share Awards or Options shall again become available for Awards under the Plan. The limitation of this Article 3 shall be subject to adjustment pursuant to Article 10. Any Common Shares issued pursuant to the Plan may be authorized but unissued shares or treasury shares. ARTICLE 4. ELIGIBILITY. 4.1 GENERAL RULE. Key Employees shall be eligible for designation as Participants by the Committee. ARTICLE 5. OPTIONS. 5.1 STOCK OPTION AGREEMENT. Each grant of an Option under the Plan shall be evidenced by a Stock Option Agreement between the Optionee and the Company. Such Option shall be subject to all applicable terms and conditions of the Plan, and may be subject to any other terms and conditions which are not inconsistent with the Plan and which the Committee deems appropriate for inclusion in a Stock Option Agreement. The provisions of the various Stock Option Agreements entered into under the Plan need not be identical. 5.2 OPTIONS NONTRANSFERABILITY. No Option granted under the Plan shall be transferable by the Optionee other than by will or the laws of descent and distribution. An Option may be exercised during the lifetime of the Optionee only by him or her. No Option or interest therein may be transferred, assigned, pledged or hypothecated by the Optionee during his or her lifetime, whether by operation of law or otherwise, or be made subject to execution, attachment or similar process. 5.3 NUMBER OF SHARES. Each Stock Option Agreement shall specify the number of Common Shares subject to the Option and shall provide for the adjustment of such number in accordance with Article 10. 5.4 EXERCISE PRICE. Each Stock Option Agreement shall specify the Exercise Price. The Exercise Price under an Option shall not be less than 100 percent of the Fair Market Value of a Common Share on the date of grant. Subject to the preceding sentence, the Exercise Price under any Option shall be determined by the Committee. The Exercise Price shall be payable in accordance with Article 6. 5.5 EXERCISABILITY AND TERM. Each Stock Option Agreement shall specify the date when all or any installment of the Option is to become exercisable. The Stock Option Agreement shall also specify the term of the Option. Subject to the preceding sentence, the Committee shall determine when all or any part of an Option is to become exercisable and when such Option is to expire; provided that, in appropriate cases, the Company shall have the discretion to extend the term of an Option or the time within which, following termination of employment, an Option may be exercised, or to accelerate the exercisability of an Option. A Stock Option Agreement may provide for expiration prior to the end of its term in the event of the termination of the Optionee's employment and shall provide for the suspension of vesting when an employee is on a leave of absence for a period in excess of six months in appropriate cases, as determined by the Company; provided that the exercisability of Options shall be accelerated in the event of the Participant's death or Disability and, in the case of Retirement, the exercisability of all outstanding Options shall be accelerated, other than any Options that had been granted within two years of the date of the Optionee's Retirement. Options may also be 2 awarded in combination with Restricted Shares, and such an Award may provide that the Options will not be exercisable unless the related Restricted Shares are forfeited. In addition, Options granted under this Section 5 may be granted subject to forfeiture provisions which provide for forfeiture of the Option upon the exercise of tandem awards, the terms of which are established in other programs of the Company. 5.6 EFFECT OF CHANGE IN CONTROL. The Committee (in its sole discretion) may determine, at the time of granting an Option, that such Option shall become fully exercisable as to all Common Shares subject to such Option immediately preceding any Change in Control with respect to the Company. 5.7 RESTRICTIONS ON TRANSFER OF COMMON SHARES. Any Common Shares issued upon exercise of an Option shall be subject to such special forfeiture conditions, rights of repurchase, rights of first refusal and other transfer restrictions as the Committee may determine. Such restrictions shall be set forth in the applicable Stock Option Agreement and shall apply in addition to any general restrictions that may apply to all holders of Common Shares. 5.8 AUTHORIZATION OF REPLACEMENT OPTIONS. Concurrently with the grant of any Option to a Participant, the Committee may authorize the grant of Replacement Options. If Replacement Options have been authorized by the Committee with respect to a particular award of Options (the "Underlying Options"), the Option Agreement with respect to the Underlying Options shall so state, and the terms and conditions of the Replacement Options shall be provided therein. The grant of any Replacement Options shall be effective only upon the exercise of the Underlying Options through the use of Common Shares pursuant to Section 6.2 or Section 6.3. The number of Replacement Options shall equal the number of Common Shares used to exercise the Underlying Options, and, if the Option Agreement so provides, the number of Common Shares used to satisfy any tax withholding requirements incident to the exercise of the Underlying Options in accordance with Section 12.2. Upon the exercise of the Underlying Options, the Replacement Options shall be evidenced by an amendment to the Underlying Option Agreement. The Exercise Price of a Replacement Option shall be no less than the Fair Market Value of a Common Share on the date the grant of the Replacement Option becomes effective. The term of each Replacement Option shall be equal to the remaining term of the Underlying Option. No Replacement Options shall be granted to Optionees when Underlying Options are exercised pursuant to the terms of the Plan and the Underlying Option Agreement following termination of the Optionee's employment. The Committee, in its sole discretion, may establish such other terms and conditions for Replacement Options as it deems appropriate. ARTICLE 6. PAYMENT FOR OPTION SHARES. 6.1 GENERAL RULE. The entire Exercise Price of Common Shares issued upon exercise of Options shall be payable in cash at the time when such Common Shares are purchased, except that the Committee may at any time accept payment pursuant to Section 6.2 or 6.3. 6.2 SURRENDER OF STOCK. To the extent that this Section 6.2 is applicable, payment for all or any part of the Exercise Price may be made with Common Shares which are surrendered to 3 the Company. Such Common Shares shall be valued at their Fair Market Value on the date when the new Common Shares are purchased under the Plan. In the event that the Common Shares being surrendered are Restricted Shares that have not yet become vested, the same restrictions shall be imposed upon the new Common Shares being purchased. 6.3 EXERCISE/SALE. To the extent this Section 6.3 is applicable, payment may be made by the delivery (on a form prescribed by the Company) of an irrevocable direction to Charles Schwab & Co., Inc. to sell Common Shares (including the Common Shares to be issued upon exercise of the Options) and to deliver all or part of the sales proceeds to the Company in payment of all or part of the Exercise Price and any withholding taxes. ARTICLE 7. RESTRICTED SHARES AND PERFORMANCE SHARE AWARDS. 7.1 TIME, AMOUNT AND FORM OF AWARDS. The Committee may grant Restricted Shares or Performance Share Awards with respect to an Award Year during such Award Year or at any time thereafter. Each such Award shall be evidenced by a Stock Award Agreement between the Award recipient and the Company. The amount of each Award of Restricted Shares or Performance Share Awards shall be determined by the Committee. Awards under the Plan may be granted in the form of Restricted Shares or Performance Share Awards or in any combination thereof, as the Committee shall determine at its sole discretion at the time of the grant. Restricted Shares or Performance Share Awards may also be awarded in combination with Options, and such an Award may provide that the Restricted Shares or Performance Share Awards will be forfeited in the event that the related Options are exercised. 7.2 PAYMENT FOR RESTRICTED SHARE AWARDS. To the extent that an Award is granted in the form of Restricted Shares, the Award recipient, as a condition to the grant of such Award, shall be required to pay the Company in cash an amount equal to the par value of such Restricted Shares. 7.3 VESTING OR ISSUANCE CONDITIONS. Each Award of Restricted Shares shall become vested, in full or in installments, upon satisfaction of the conditions specified in the Stock Award Agreement. Common Shares shall be issued pursuant to Performance Share Awards in full or in installments upon satisfaction of the issuance conditions specified in the Stock Award Agreement. The Committee shall select the vesting conditions in the case of Restricted Shares, or issuance conditions in the case of Performance Share Awards, which may be based upon the Participant's service, the Participant's performance, the Company's performance or such other criteria as the Committee may adopt; provided that, in the case of an Award of Restricted Shares where vesting is based entirely on the Participant's service, (i) vesting shall be accelerated in the event of the Participant's death or Disability; (ii) in the case of Retirement, vesting shall be accelerated for all Restricted Shares that had been granted more than two years prior to the date of the Participant's Retirement; and (iii) vesting shall be suspended when an employee is on a leave of absence for a period in excess of six months in appropriate cases, as determined by the Company. The Committee, in its sole discretion, 4 may determine, at the time of making an Award of Restricted Shares, that such Award shall become fully vested in the event that a Change in Control occurs with respect to the Company. The Committee, in its sole discretion, may determine, at the time of making a Performance Share Award, that the issuance conditions set forth in such Award shall be waived in the event that a Change in Control occurs with respect to the Company. 7.4 FORM OF SETTLEMENT OF PERFORMANCE SHARE AWARDS. Settlement of Performance Share Awards shall only be made in the form of Common Shares. Until a Performance Share Award is settled, the number of Performance Share Awards shall be subject to adjustment pursuant to Article 10. 7.5 DEATH OF RECIPIENT. Any Common Shares that are to be issued pursuant to a Performance Share Award after the recipient's death shall be delivered or distributed to the recipient's beneficiary or beneficiaries. Each recipient of a Performance Share Award under the Plan shall designate one or more beneficiaries for this purpose by filing the prescribed form with the Company. A beneficiary designation may be changed by filing the prescribed form with the Company at any time before the Award recipient's death. If no beneficiary was designated or if no designated beneficiary survives the Award recipient, then any Common Shares that are to be issued pursuant to a Performance Share Award after the recipient's death shall be delivered or distributed to the recipient's estate. The Committee, in its sole discretion, shall determine the form and time of any distribution(s) to a recipient's beneficiary or estate. ARTICLE 8. CLAIMS PROCEDURES. Claims for benefits under the Plan shall be filed in writing with the Committee on forms supplied by the Committee. Written notice of the disposition of a claim shall be furnished to the claimant within 90 days after the claim is filed. If the claim is denied, the notice of disposition shall set forth the specific reasons for the denial, citations to the pertinent provisions of the Plan, and, where appropriate, an explanation as to how the claimant can perfect the claim. If the claimant wishes further consideration of his or her claim, the claimant may appeal a denied claim to the Committee (or to a person designated by the Committee) for further review. Such appeal shall be filed in writing with the Committee on a form supplied by the Committee, together with a written statement of the claimant's position, no later than 90 days following receipt by the claimant of written notice of the denial of his or her claim. If the claimant so requests, the Committee shall schedule a hearing. A decision on review shall be made after a full and fair review of the claim and shall be delivered in writing to the claimant no later than 60 days after the Committee's receipt of the notice of appeal, unless special circumstances (including the need to hold a hearing) require an extension of time for processing the appeal, in which case a written decision on review shall be delivered to the claimant as soon as possible but not later than 120 days after the Committee's receipt of the appeal notice. The claimant shall be notified in writing of any such extension of time. The written decision on review shall include specific reasons for the decision, written in a manner calculated to be understood by the claimant, and shall specifically refer to the pertinent Plan provisions on which it is based. All determinations of the Committee shall be final and binding on Participants and their beneficiaries. 5 ARTICLE 9. VOTING RIGHTS AND DIVIDENDS. 9.1 RESTRICTED SHARES. (a) All holders of Restricted Shares who are not Named Executive Officers shall have the same voting, dividend, and other rights as the Company's other stockholders. (b) During the period of restriction, Named Executive Officers holding Restricted Shares granted hereunder shall be credited with all regular cash dividends paid with respect to all Restricted Shares while they are so held. If a dividend is paid in the form of cash, such cash dividend shall be credited to Named Executive Officers subject to the same restrictions on transferability and forfeitability as the Restricted Shares with respect to which they were paid. If any dividends or distributions are paid in shares of Common Stock, the shares of Common Stock shall be subject to the same restrictions on transferability and forfeitability as the Restricted Shares with respect to which they were paid. Subject to the succeeding paragraph, and to the restrictions on vesting and the forfeiture provisions, all dividends credited to a Named Executive Officer shall be paid to the Named Executive Officer within forty-five (45) days following the full vesting of the Restricted Shares with respect to which such dividends were earned. In the event that any dividend constitutes a "derivative security" or an "equity security" pursuant to Rule 16(a) under the Exchange Act, such dividend shall be subject to a vesting period equal to the longer of: (i) the remaining vesting period of the Restricted Shares with respect to which the dividend is paid; or (ii) six (6) months. The Committee shall establish procedures for the application of this provision. Named Executive Officers holding Restricted Shares shall have the same voting rights as the Company's other stockholders. 9.2 PERFORMANCE SHARE AWARDS. The holders of Performance Share Awards shall have no voting or dividend rights until such time as any Common Shares are issued pursuant thereto, at which time they shall have the same voting, dividend and other rights as the Company's other stockholders. ARTICLE 10. PROTECTION AGAINST DILUTION; ADJUSTMENT OF AWARDS. 10.1 GENERAL. In the event of a subdivision of the outstanding Common Shares, a declaration of a dividend payable in Common Shares, a declaration of a dividend payable in a form other than Common Shares, a combination or consolidation of the outstanding Common Shares (by reclassification or otherwise) into a lesser number of Common Shares, a recapitalization, a spinoff or a similar occurrence, the Committee shall make appropriate adjustments in one or more of (a) the number of Options, Restricted Shares and Performance Share Awards available for future Awards under Article 3, (b) the number of Performance Share Awards included in any prior Award which has not yet been settled, (c) the number of Common 6 Shares covered by each outstanding Option or (d) the Exercise Price under each outstanding Option. 10.2 REORGANIZATIONS. In the event that the Company is a party to a merger or other reorganization, outstanding Options, Restricted Shares and Performance Share Awards shall be subject to the agreement of merger or reorganization. Such agreement may provide, without limitation, for the assumption of outstanding Awards by the surviving corporation or its parent, for their continuation by the Company (if the Company is a surviving corporation), for accelerated vesting or for settlement in cash. 10.3 RESERVATION OF RIGHTS. Except as provided in this Article 10, a Participant shall have no rights by reason of any subdivision or consolidation of shares of stock of any class, the payment of any stock dividend or any other increase or decrease in the number of shares of stock of any class. Any issue by the Company of shares of stock of any class, or securities convertible into shares of stock of any class, shall not affect, and no adjustment by reason thereof shall be made with respect to, the number or Exercise Price of Common Shares subject to an Option. The grant of an Award pursuant to the Plan shall not affect in any way the right or power of the Company to make adjustments, reclassifications, reorganizations or changes of its capital or business structure, to merge or consolidate or to dissolve, liquidate, sell or transfer all or any part of its business or assets. ARTICLE 11. LIMITATION OF RIGHTS. 11.1 EMPLOYMENT RIGHTS. Neither the Plan nor any Award granted under the Plan shall be deemed to give any individual a right to remain employed by the Company or any Subsidiary. The Company and its Subsidiaries reserve the right to terminate the employment of any employee at any time, with or without cause, subject only to a written employment agreement (if any). 11.2 STOCKHOLDERS' RIGHTS. A Participant shall have no dividend rights, voting rights or other rights as a stockholder with respect to any Common Shares covered by his or her Award prior to the issuance of a stock certificate for such Common Shares. No adjustment shall be made for cash dividends or other rights for which the record date is prior to the date when such certificate is issued, except as expressly provided in Articles 7, 9 and 10. 11.3 CREDITORS' RIGHTS. A holder of Performance Share Awards shall have no rights other than those of a general creditor of the Company. Performance Share Awards represent unfunded and unsecured obligations of the Company, subject to the terms and conditions of the applicable Stock Award Agreement. 11.4 GOVERNMENT REGULATIONS. Any other provision of the Plan notwithstanding, the obligations of the Company with respect to Common Shares to be issued pursuant to the Plan shall be subject to all applicable laws, rules and regulations, and such approvals by any governmental agencies as may be required. The Company reserves the right to restrict, in whole or in part, the delivery of Common Shares pursuant to any Award until such time as: 7 (a) Any legal requirements or regulations have been met relating to the issuance of such Common Shares or to their registration, qualification or exemption from registration or qualification under the Securities Act of 1933, as amended, or any applicable state securities laws; and (b) Satisfactory assurances have been received that such Common Shares, when issued, will be duly listed on the New York Stock Exchange or any other securities exchange on which Common Shares are then listed. ARTICLE 12. WITHHOLDING TAXES. 12.1 GENERAL. To the extent required by applicable federal, state, local or foreign law, the recipient of any payment or distribution under the Plan shall make arrangements satisfactory to the Company for the satisfaction of any withholding tax obligations that arise by reason of such payment or distribution. The Company shall not be required to make such payment or distribution until such obligations are satisfied. 12.2 NONSTATUTORY OPTIONS, RESTRICTED SHARES OR PERFORMANCE SHARE AWARDS. The Committee may permit an Optionee who exercises Options, or who receives Awards of Restricted Shares, or who receives Common Shares pursuant to the terms of a Performance Share Award, to satisfy all or part of his or her withholding tax obligations by having the Company withhold a portion of the Common Shares that otherwise would be issued to him or her under such Awards. Such Common Shares shall be valued at their Fair Market Value on the date when taxes otherwise would be withheld in cash. The payment of withholding taxes by surrendering Common Shares to the Company, if permitted by the Committee, shall be subject to such restrictions as the Committee may impose, including any restrictions required by rules of the Securities and Exchange Commission. ARTICLE 13. ASSIGNMENT OR TRANSFER OF AWARD. 13.1 GENERAL RULE. Any Award granted under the Plan shall not be anticipated, assigned, attached, garnished, optioned, transferred or made subject to any creditor's process, whether voluntarily, involuntarily or by operation of law, except to the extent specifically permitted by Section 13.2. 13.2 EXCEPTIONS TO GENERAL RULE. Notwithstanding Section 13.1, this Plan shall not preclude (i) a Participant from designating a beneficiary to succeed, after the Participant's death, to those of the Participant's Awards (including without limitation, the right to exercise any unexercised Options) as may be determined by the Company from time to time in its sole discretion, (ii) a transfer of any Award hereunder by will or the laws of descent or distribution, or (iii) a voluntary transfer of an Award to a trust or partnership for the exclusive benefit of one or more members of the Participant's family, but only if the Participant has sole investment control over such trust or partnership. 8 ARTICLE 14. FUTURE OF PLANS. 14.1 TERM OF THE PLAN. The Plan, as set forth herein, shall become effective on February 26, 1997. The Plan shall remain in effect until it is terminated under Section 14.2, except that no Awards shall be granted after March 24, 1997. 14.2 AMENDMENT OR TERMINATION. The Board may at any time terminate this Plan, and the Board or the Committee make such modifications of the Plan as it shall deem advisable; provided, however, that any amendment of the Plan shall be subject to the approval of the Company's stockholders to the extent required by applicable laws, regulations or rules. 14.3 EFFECT OF AMENDMENT OR TERMINATION. No Award shall be made under the Plan after the termination thereof. The termination of the Plan, or any amendment thereof, shall not affect any Option, Restricted Share or Performance Share Award previously granted under the Plan. ARTICLE 15. DEFINITIONS. 15.1 "Award" means any award of an Option, a Restricted Share or a Performance Share Award under the Plan. 15.2 "Award Year" means a fiscal year beginning January 1 and ending December 31 with respect to which an Award may be granted. 15.3 "Board" means the Company's Board of Directors, as constituted from time to time. 15.4 "Change in Control" means the occurrence of any of the following events after the effective date of the Plan as set out in Section 14.1: (a) A change in control required to be reported pursuant to Item 6(e) of Schedule 14A of Regulation 14A under the Exchange Act; (b) A change in the composition of the Board, as a result of which fewer than two-thirds of the incumbent directors are directors who either (i) had been directors of the Company 24 months prior to such change or (ii) were elected, or nominated for election, to the Board with the affirmative votes of at least a majority of the directors who had been directors of the Company 24 months prior to such change and who were still in office at the time of the election or nomination; (c) Any "person" (as such term is used in sections 13(d) and 14(d) of the Exchange Act) becomes the beneficial owner, directly or indirectly, of securities of the Company representing 20 percent or more of the combined voting power of the Company's then outstanding securities ordinarily (and apart from rights accruing under special circumstances) having the right to vote at elections of directors (the "Base Capital 9 Stock"); provided, however, that any change in the relative beneficial ownership of securities of any person resulting solely from a reduction in the aggregate number of outstanding shares of Base Capital Stock, and any decrease thereafter in such person's ownership of securities, shall be disregarded until such person increases in any manner, directly or indirectly, such person's beneficial ownership of any securities of the Company. 15.5 "Code" means the Internal Revenue Code of 1986, as amended. 15.6 "Committee" means the Compensation Committee of the Board, as constituted from time to time. 15.7 "Common Share" means one share of the common stock of the Company. 15.8 "Company" means The Charles Schwab Corporation, a Delaware corporation. 15.9 "ERISA" means the Employee Retirement Income Security Act of 1974, as amended. 15.10 "Exchange Act" means the Securities Exchange Act of 1934, as amended. 15.11 "Exercise Price" means the amount for which one Common Share may be purchased upon exercise of an Option, as specified by the Committee in the applicable Stock Option Agreement. 15.12 "Fair Market Value" means the market price of a Common Share, determined by the committee as follows: (a) If the Common Share was traded on a stock exchange on the date in question, then the Fair Market Value shall be equal to the closing price reported by the applicable composite-transactions report for such date; (b) If the Common Share was traded over-the-counter on the date in question and was classified as a national market issue, then the Fair Market Value shall be equal to the last transaction price quoted by the NASDAQ system for such date; (c) If the Common Share was traded over-the-counter on the date in question but was not classified as a national market issue, then the Fair Market Value shall be equal to the mean between the last reported representative bid and asked prices quoted by the NASDAQ system for such date; and (d) If none of the foregoing provisions is applicable, then the Fair Market Value shall be determined by the Committee in good faith on such basis as it deems appropriate. 10 15.13 "Key Employee" means a key common-law employee of the Company or any Subsidiary, as determined by the Committee. 15.14 "Named Executive Officer" means a Participant who, as of the date of vesting of an Award is one of a group of "covered employees," as defined in the Regulations promulgated under Code Section 162(m), or any successor statute. 15.15 "Non-Employee Director" means a member of the Board who is not a common-law employee. 15.16 "Option" means an employee stock option not described in sections 422 through 424 of the Code, including a Replacement Option, granted under the Plan and entitling the holder to purchase one Common Share. 15.17 "Optionee" means an individual, or his or her estate, legatee or heirs at law that holds an Option. 15.18 "Participant" means a Non-Employee Director or Key Employee who has received an Award. 15.19 "Performance Share Award" means the conditional right to receive in the future one Common Share, awarded to a Participant under the Plan. 15.20 "Plan" means this 1987 Executive Stock Option Plan of The Charles Schwab Corporation, as it may be amended from time to time. 15.21 "Replacement Option" means an Option that is granted when a Participant uses a Common Share held or to be acquired by the Participant to exercise an Option and/or to satisfy tax withholding requirements incident to the exercise of an Option. 15.22 "Restricted Share" means a Common Share awarded to a Participant under the Plan. 15.23 "Stock Award Agreement" means the agreement between the Company and the recipient of a Restricted Share or Performance Share Award which contains the terms, conditions and restrictions pertaining to such Restricted Share or Performance Share Award. 15.24 "Stock Option Agreement" means the agreement between the Company and an Optionee which contains the terms, conditions and restrictions pertaining to his or her option. 15.25 "Subsidiary" means any corporation, if the Company and/or one or more other Subsidiaries own not less than 50 percent of the total combined voting power of all classes of outstanding stock of such corporation. A corporation that attains the status of a Subsidiary on a date after the adoption of the Plan shall be considered a Subsidiary commencing as of such date. 11 15.26. "Retirement" shall mean any termination of employment of an Optionee for any reason other than death at any time after the Optionee has attained fifty (50), but only if, at the time of such termination, the Participant has been credited with at least seven (7) Years of Service under the Charles Schwab Profit Sharing and Employee Stock Ownership Plan. The foregoing definition shall apply to all Stock Option Agreements entered into pursuant to the Plan, irrespective of any definition to the contrary contained in any such Stock Option Agreement. 15.27 "Disability" means the inability to engage in any substantial gainful activity considering the Participant's age, education and work experience by reason of any medically determined physical or mental impairment that has continued without interruption for a period of at least six months and that can be expected to be of long, continued and indefinite duration. All determinations as to whether a Participant has incurred a Disability shall be made by the Employee Benefits Administration Committee of the Company, the findings of which shall be final, binding and conclusive. 12 NON-QUALIFIED STOCK OPTION AGREEMENT (Executive Officer Stock Option Plan (1987)) THIS AGREEMENT made as of this ____ day of _________, 19____, by and between The Charles Schwab Corporation, a Delaware corporation ("Company") and ______________________________ ("Optionee"). WITNESSETH: WHEREAS, there has been granted to Optionee, effective as of __________, 19___, a non-qualified stock option under the Executive Officer Stock Option Plan (1987) of the Company ("Option Plan"); NOW THEREFORE, it is mutually agreed as follows: 1. The Optionee shall have a non-qualified stock option to acquire ________ shares of common stock of the company (the "Shares"), at a price of $_______ per share. 2. Except as provided in paragraphs 3 and 4 below, the other terms of this option shall be the same as all of those provided for in the Option Plan, which include, without limitation, vesting of Shares, limitations on exercise and transfer, and other restrictions. The Option Plan is attached hereto as Exhibit A and is incorporated herein by this reference. Optionee has read the Option Plan and, other than as provided in paragraphs 3 and 4 below, agrees to be bound by its terms. Without limitation, Optionee specifically acknowledges the representations, warranties and agreements contained in paragraph 6(e) of the Option Plan. 3. Notwithstanding paragraph 6(b) of the Option Plan, in the event Optionee's employment or service as a director with or for the Company and its subsidiaries terminates by reason of Optionee's death or permanent disability, all Shares then not deemed to be Vested thereupon will be deemed immediately Vested. For this purpose, "permanent disability" will mean the reasonable determination by a qualified physician acceptable to the company that the Optionee has an illness or incapacity that has disabled, or will disable, the Optionee from rendering his or her normal services to the Company and its subsidiaries for a period of more than six (6) consecutive months in any consecutive twelve (12) month period. 4. Upon exercise of this Option, the Company will extend to the Optionee rights under that certain Registration Rights and Stock Restriction Agreement dated as of March 31, 1987, as amended, subject to the Optionee's agreement to be bound by the terms thereof. 5. Any notice to be given by the Optionee under the terms of the Option Plan shall be deemed to have been duly given, and effective upon the receipt, if sent by Certified Mail, postage and certification prepaid, to The Charles Schwab Corporation, 101 Montgomery, San Francisco, California 94104, Attention: Corporate Secretary, except as superseded by a different address noticed to Optionee. 13 IN WITNESS WHEREOF, the parties have caused this Agreement to be executed as of the day and year referred to above. THE CHARLES SCHWAB CORPORATION ("Company") By: ------------------------------------------- ----------------------------------------------- "Optionee" Attachment (1) Spousal Consent (2) Exhibit A: 1987 Stock Option Plan 14 EX-10.189 6 EXHIBIT 10.189 EXHIBIT 10.189 ANNUAL EXECUTIVE INDIVIDUAL PERFORMANCE PLAN RESTATED AND AMENDED AS OF JANUARY 1, 1998 The Annual Executive Individual Performance Plan (the "Plan") provides for the payment of annual bonuses to Participants consisting of executive officers of The Charles Schwab Corporation (the "Company"), other than the Chairman, Vice Chairman and President. The Compensation Committee of the Board of Directors (the "Committee") shall select the executive officers who will participate in the Plan. The amount available for payments under the Plan will consist of the sum of two components. The first component is an amount equal to the sum of the bonuses payable to each Participant for the year pursuant to the Corporate Executive Bonus Plan (the "Formula Plan Bonus Total"). The second component is calculated by multiplying the sum of (i) the first component, plus (ii) the Formula Bonus Plan Total, by 60%. For purposes of calculating both Components, the Formula Plan Bonus Total shall be increased by any reductions in distributions determined by the Committee pursuant to Article III, Section 5 of the Corporate Executive Bonus Plan, and, at the discretion of the Committee, the Formula Plan Bonus Total may be recomputed by excluding from the calculation of the Company's net revenue growth or consolidated pre-tax profit margin the amount of any items of income and expense that the Committee determines to be extraordinary (such as the impact of mergers and acquisitions during the year and other one-time nonoperating items). The Committee shall determine the amounts to be paid to the Participants hereunder. Such determination shall be based on the Committee's evaluation, in its sole discretion and upon the recommendation of the Chairman and President, of the Participant's individual contribution to the attainment of the Company's performance objectives. The Committee has the discretion to pay out less than the total amount available for payment hereunder. All amounts payable pursuant to the Plan shall be paid within the first ninety (90) days of the year following the year in which they are earned; however, a recipient who is eligible to participate in The Charles Schwab Corporation Deferred Compensation Plan may elect to defer payments pursuant to the terms of that plan. The Plan is administered by the Committee. All decisions regarding the operation of the Plan and payments thereunder shall be made by the Committee, in its sole and absolute discretion, which decisions shall be final, conclusive and binding. The Committee may amend or terminate the Plan at any time and for any reason, without stockholder approval. Nothing contained herein shall be construed as a guarantee of continued employment of any participant hereunder. The Plan shall be construed and governed in accordance with the laws of the State of California. 2 EX-10.190 7 EXHIBIT 10.190 EXHIBIT 10.190 THE CHARLES SCHWAB CORPORATION EMPLOYEE STOCK INCENTIVE PLAN ARTICLE 1. INTRODUCTION. The Plan was adopted by the Board of Directors on October 22, 1997. The purpose of the Plan is to promote the long-term success of the Company and the creation of incremental stockholder value by (a) encouraging Employees to focus on long-range objectives, (b) encouraging the attraction and retention of Employees with exceptional qualifications and (c) linking Employees directly to stockholder interests. The Plan seeks to achieve this purpose by providing for Awards in the form of Restricted Shares or Options. The Plan shall be governed by, and construed in accordance with, the laws of the State of Delaware. ARTICLE 2. ADMINISTRATION. 2.1 THE COMMITTEE. The Plan shall be administered by the Committee. The Committee shall consist of two or more non-employee Directors, who shall be appointed by the Board. 2.2 COMMITTEE RESPONSIBILITIES. The Committee shall select the Employees who are to receive Awards under the Plan, determine the amount, vesting requirements and other conditions of such Awards, may interpret the Plan, and make all other decisions relating to the operation of the Plan. The Committee may adopt such rules or guidelines as it deems appropriate to implement the Plan, and may, in its discretion, delegate any of its responsibilities to such parties as it deems proper. The Committee's determinations under the Plan shall be final and binding on all persons. ARTICLE 3. LIMITATION ON AWARDS. The aggregate number of Restricted Shares and Options awarded under the Plan shall be determined by the Board from time to time. If any Restricted Shares or Options are forfeited, or if any Options terminate for any other reason before being exercised, then such Restricted Shares or Options shall again become available for Awards under the Plan. The limitation of this Article 3 shall be subject to adjustment pursuant to Article 10. Any Common Shares issued pursuant to the Plan may be authorized but unissued shares or treasury shares. ARTICLE 4. ELIGIBILITY. GENERAL RULE. The Committee shall make all determinations concerning the Employees who shall be eligible to participate in the Plan, and the awards to each Participant. ARTICLE 5. OPTIONS. 5.1 STOCK OPTION AGREEMENT. Each grant of an Option under the Plan shall be evidenced by a Stock Option Agreement between the Optionee and the Company. Such Option shall be subject to all applicable terms and conditions of the Plan, and may be subject to any other terms and conditions which are not inconsistent with the Plan and which the Committee deems appropriate for inclusion in a Stock Option Agreement. The provisions of the various Stock Option Agreements entered into under the Plan need not be identical. In the case of an Employee who is subject to the tax laws of a foreign jurisdiction, the Committee may designate all or any part of an Option as an option qualifying for favorable tax treatment under the laws of such foreign jurisdiction. 5.2 OPTIONS NONTRANSFERABILITY. No Option granted under the Plan shall be transferable by the Optionee other than by will or the laws of descent and distribution. An Option may be exercised during the lifetime of the Optionee only by him or her. No Option or interest therein may be transferred, assigned, pledged or hypothecated by the Optionee during his or her lifetime, whether by operation of law or otherwise, or be made subject to execution, attachment or similar process. 5.3 NUMBER OF SHARES. Each Stock Option Agreement shall specify the number of Common Shares subject to the Option and shall provide for the adjustment of such number in accordance with Article 10. 5.4 EXERCISE PRICE. Each Stock Option Agreement shall specify the Exercise Price. The Exercise Price under an Option shall not be less than 100 percent of the Fair Market Value of a Common Share on the date of grant. Subject to the preceding sentence, the Exercise Price under any Option shall be determined by the Committee. The Exercise Price shall be payable in accordance with Article 6. 5.5 EXERCISABILITY AND TERM. Each Stock Option Agreement shall specify the date when all or any installment of the Option is to become exercisable. The Stock Option Agreement shall also specify the term of the Option. Subject to the preceding sentence, the Committee shall determine when all or any part of an Option is to become exercisable and when such Option is to expire; provided that, in appropriate cases, the Company shall have the discretion to extend the term of an Option or the time within which, following termination of employment, an Option may be exercised, or to accelerate the exercisability of an Option. A Stock Option Agreement may provide for expiration prior to the end of its term in the event of the termination of the Optionee's employment and may provide for the suspension of vesting when an employee is on a leave of absence for a period in excess of six months in appropriate cases; provided that the exercisability of Options shall be accelerated in the event of the Participant's death or Disability and, in the case of Retirement, the exercisability of all outstanding Options shall be accelerated, other than any Options that had been granted within two years of the date of the Optionee's Retirement. Options may also be awarded in combination with Restricted Shares, and such an Award may provide that the Options will not be exercisable unless the related Restricted Shares are forfeited. In addition, Options granted under this Section 5 may be granted subject to forfeiture provisions which provide for forfeiture of the Option upon the exercise of tandem awards, the terms of which are established in other programs of the Company. 5.6 EFFECT OF CHANGE IN CONTROL. The Committee (in its sole discretion) may determine, at the time of granting an Option, that such Option shall become fully exercisable as to all Common Shares subject to such Option immediately preceding any Change in Control with respect to the Company. 2 5.7 RESTRICTIONS ON TRANSFER OF COMMON SHARES. Any Common Shares issued upon exercise of an Option shall be subject to such special forfeiture conditions, rights of repurchase, rights of first refusal and other transfer restrictions as the Committee may determine. Such restrictions shall be set forth in the applicable Stock Option Agreement and shall apply in addition to any general restrictions that may apply to all holders of Common Shares. 5.8 AUTHORIZATION OF REPLACEMENT OPTIONS. Concurrently with the grant of any Option to a Participant, the Committee may authorize the grant of Replacement Options. If Replacement Options have been authorized by the Committee with respect to a particular award of Options (the "Underlying Options"), the Option Agreement with respect to the Underlying Options shall so state, and the terms and conditions of the Replacement Options shall be provided therein. The grant of any Replacement Options shall be effective only upon the exercise of the Underlying Options through the use of Common Shares pursuant to Section 6.2 or Section 6.3. The number of Replacement Options shall equal the number of Common Shares used to exercise the Underlying Options, and, if the Option Agreement so provides, the number of Common Shares used to satisfy any tax withholding requirements incident to the exercise of the Underlying Options in accordance with Section 13.2. Upon the exercise of the Underlying Options, the Replacement Options shall be evidenced by an amendment to the Underlying Option Agreement. The Exercise Price of a Replacement Option shall be no less than the Fair Market Value of a Common Share on the date the grant of the Replacement Option becomes effective. The term of each Replacement Option shall be equal to the remaining term of the Underlying Option. No Replacement Options shall be granted to Optionees when Underlying Options are exercised pursuant to the terms of the Plan and the Underlying Option Agreement following termination of the Optionee's employment. The Committee, in its sole discretion, may establish such other terms and conditions for Replacement Options as it deems appropriate. 5.9 OPTIONS GRANTED TO NON-UNITED STATES EMPLOYEES. In the case of Employees who are subject to the tax laws of a foreign jurisdiction, the Company may issue Options to such Employees that contain terms required to conform with any requirements for favorable tax treatment imposed by the laws of such foreign jurisdiction, or as otherwise may be required by the laws of such foreign jurisdiction. The terms of any such Options shall be governed by the Plan, subject to the terms of any Addendum to the Plan specifically applicable to such Options. ARTICLE 6. PAYMENT FOR OPTION SHARES. 6.1 GENERAL RULE. The entire Exercise Price of Common Shares issued upon exercise of Options shall be payable in cash at the time when such Common Shares are purchased, except that the Committee may at any time accept payment pursuant to Section 6.2 or 6.3. 6.2 SURRENDER OF STOCK. To the extent that this Section 6.2 is applicable, payment for all or any part of the Exercise Price may be made with Common Shares which are surrendered to the Company. Such Common Shares shall be valued at their Fair Market Value on the date when the new Common Shares are purchased under the Plan. In the event that the Common Shares being surrendered are Restricted Shares that have not yet become vested, the same restrictions shall be imposed upon the new Common Shares being purchased. 3 6.3 EXERCISE/SALE. To the extent this Section 6.3 is applicable, payment may be made by the delivery (on a form prescribed by the Company) of an irrevocable direction to Charles Schwab & Co., Inc. to sell Common Shares (including the Common Shares to be issued upon exercise of the Options) and to deliver all or part of the sales proceeds to the Company in payment of all or part of the Exercise Price and any withholding taxes. ARTICLE 7. RESTRICTED SHARES. 7.1 TIME, AMOUNT AND FORM OF AWARDS. The Committee may grant Restricted Shares with respect to an Award Year during such Award Year or at any time thereafter. Each such Award shall be evidenced by a Stock Award Agreement between the Award recipient and the Company. The amount of each Award of Restricted Shares shall be determined by the Committee. Restricted Shares may also be awarded in combination with Options, and such an Award may provide that the Restricted Shares will be forfeited in the event that the related Options are exercised. 7.2 PAYMENT FOR RESTRICTED SHARE AWARDS. To the extent that an Award is granted in the form of Restricted Shares, the Award recipient, as a condition to the grant of such Award, shall be required to pay the Company in cash an amount equal to the par value of such Restricted Shares. 7.3 VESTING OR ISSUANCE CONDITIONS. Each Award of Restricted Shares shall become vested, in full or in installments, upon satisfaction of the conditions specified in the Stock Award Agreement. The Committee shall select the vesting conditions in the case of Restricted Shares which may be based upon the Participant's service, the Participant's performance, the Company's performance or such other criteria as the Committee may adopt; provided that, in the case of an Award of Restricted Shares where vesting is based entirely on the Participant's service, (i) vesting shall be accelerated in the event of the Participant's death or Disability; (ii) in the case of Retirement, vesting shall be accelerated for all Restricted Shares that had been granted more than two years prior to the date of the Participant's Retirement; and (iii) vesting shall be suspended when an employee is on a leave of absence for a period in excess of six months in appropriate cases, as determined by the Company. The Committee, in its sole discretion, may determine, at the time of making an Award of Restricted Shares, that such Award shall become fully vested in the event that a Change in Control occurs with respect to the Company. ARTICLE 8. CLAIMS PROCEDURES. Claims for benefits under the Plan shall be filed in writing with the Committee on forms supplied by the Committee. Written notice of the disposition of a claim shall be furnished to the claimant within 90 days after the claim is filed. If the claim is denied, the notice of disposition shall set forth the specific reasons for the denial, citations to the pertinent provisions of the Plan, and, where appropriate, an explanation as to how the claimant can perfect the claim. If the claimant wishes further consideration of his or her claim, the claimant may appeal a denied claim to the Committee (or to a person designated by the Committee) for further review. Such appeal shall be filed in writing with the Committee on a form supplied by the Committee, together with a written statement of the claimant's position, no later than 90 days following receipt by the claimant of written notice of the denial of his or her claim. If the claimant so requests, the Committee shall schedule a hearing. A decision on review shall be made after a full and fair review of the claim and 4 shall be delivered in writing to the claimant no later than 60 days after the Committee's receipt of the notice of appeal, unless special circumstances (including the need to hold a hearing) require an extension of time for processing the appeal, in which case a written decision on review shall be delivered to the claimant as soon as possible but not later than 120 days after the Committee's receipt of the appeal notice. The claimant shall be notified in writing of any such extension of time. The written decision on review shall include specific reasons for the decision, written in a manner calculated to be understood by the claimant, and shall specifically refer to the pertinent Plan provisions on which it is based. All determinations of the Committee shall be final and binding on Participants and their beneficiaries. ARTICLE 9. VOTING RIGHTS AND DIVIDENDS. All holders of Restricted Shares shall have the same voting, dividend, and other rights as the Company's other stockholders. ARTICLE 10. PROTECTION AGAINST DILUTION; ADJUSTMENT OF AWARDS. 10.1 GENERAL. In the event of a subdivision of the outstanding Common Shares, a declaration of a dividend payable in Common Shares, a declaration of a dividend payable in a form other than Common Shares, a combination or consolidation of the outstanding Common Shares (by reclassification or otherwise) into a lesser number of Common Shares, a recapitalization, a spinoff or a similar occurrence, the Committee shall make appropriate adjustments in one or more of (a) the number of Options and Restricted Shares available for future Awards under Article 3, (b) the number of Common Shares covered by each outstanding Option or (c) the Exercise Price under each outstanding Option. 10.2 REORGANIZATIONS. In the event that the Company is a party to a merger or other reorganization, outstanding Options and Restricted Shares shall be subject to the agreement of merger or reorganization. Such agreement may provide, without limitation, for the assumption of outstanding Awards by the surviving corporation or its parent, for their continuation by the Company (if the Company is a surviving corporation), for accelerated vesting or for settlement in cash. 10.3 RESERVATION OF RIGHTS. Except as provided in this Article 10, a Participant shall have no rights by reason of any subdivision or consolidation of shares of stock of any class, the payment of any stock dividend or any other increase or decrease in the number of shares of stock of any class. Any issue by the Company of shares of stock of any class, or securities convertible into shares of stock of any class, shall not affect, and no adjustment by reason thereof shall be made with respect to, the number or Exercise Price of Common Shares subject to an Option. The grant of an Award pursuant to the Plan shall not affect in any way the right or power of the Company to make adjustments, reclassifications, reorganizations or changes of its capital or business structure, to merge or consolidate or to dissolve, liquidate, sell or transfer all or any part of its business or assets. ARTICLE 11. LIMITATION OF RIGHTS. 11.1 EMPLOYMENT RIGHTS. Neither the Plan nor any Award granted under the Plan shall be deemed to give any individual a right to remain employed by the Company or any Subsidiary. 5 The Company and its Subsidiaries reserve the right to terminate the employment of any employee at any time, with or without cause, subject only to a written employment agreement (if any). 11.2 STOCKHOLDERS' RIGHTS. A Participant shall have no dividend rights, voting or other rights as a stockholder with respect to any Common Shares covered by his or her Award prior to the issuance of such Common Shares, whether by issuance of a certificate, book entry or other procedure. No adjustment shall be made for cash dividends or other rights for which the record date is prior to the date when such certificate is issued, except as expressly provided in Articles 7, 9 and 10. 11.3 GOVERNMENT REGULATIONS. Any other provision of the Plan notwithstanding, the obligations of the Company with respect to Common Shares to be issued pursuant to the Plan shall be subject to all applicable laws, rules and regulations, and such approvals by any governmental agencies as may be required. The Company reserves the right to restrict, in whole or in part, the delivery of Common Shares pursuant to any Award until such time as: (a) Any legal requirements or regulations have been met relating to the issuance of such Common Shares or to their registration, qualification or exemption from registration or qualification under the Securities Act of 1933, as amended, or any applicable state securities laws; and (b) Satisfactory assurances have been received that such Common Shares, when issued, will be duly listed on the New York Stock Exchange or any other securities exchange on which Common Shares are then listed. ARTICLE 12. WITHHOLDING TAXES. 12.1 GENERAL. To the extent required by applicable federal, state, local or foreign law, the recipient of any payment or distribution under the Plan shall make arrangements satisfactory to the Company for the satisfaction of any withholding tax obligations that arise by reason of such payment or distribution. The Company shall not be required to make such payment or distribution until such obligations are satisfied. 12.2 WITHHOLDING ON OPTIONS OR RESTRICTED SHARES. The Committee may permit an Optionee who exercises Options, or who receives Awards of Restricted Shares, to satisfy all or part of his or her withholding tax obligations by having the Company withhold a portion of the Common Shares that otherwise would be issued to him or her under such Awards. Such Common Shares shall be valued at their Fair Market Value on the date when taxes otherwise would be withheld in cash. The payment of withholding taxes by surrendering Common Shares to the Company, if permitted by the Committee, shall be subject to such restrictions as the Committee may impose, including any restrictions required by rules of the Securities and Exchange Commission. ARTICLE 13. ASSIGNMENT OR TRANSFER OF AWARD. Any Award granted under the Plan shall not be anticipated, assigned, attached, garnished, optioned, transferred or made subject to any creditor's process, whether voluntarily, involuntarily or by operation of law. However, this Article 13 shall not preclude (i) a Participant from designating a 6 beneficiary to succeed, after the Participant's death, to those of the Participant's Awards (including without limitation, the right to exercise any unexercised Options) as may be determined by the Company from time to time in its sole discretion, or (ii) a transfer of any Award hereunder by will or the laws of descent or distribution. ARTICLE 14. FUTURE OF PLANS. 14.1 TERM OF THE PLAN. The Plan, as set forth herein, shall become effective on October 22, 1997. The Plan shall remain in effect until it is terminated under Section 14.2. 14.2 AMENDMENT OR TERMINATION. The Committee may, at any time and for any reason, amend or terminate the Plan. 14.3 EFFECT OF AMENDMENT OR TERMINATION. No Award shall be made under the Plan after the termination thereof. The termination of the Plan, or any amendment thereof, shall not adversely affect the rights of any holder of any Option or Restricted Shares previously granted under the Plan. ARTICLE 15. DEFINITIONS. 15.1 "Award" means any award of an Option or a Restricted Share under the Plan. 15.2 "Award Year" means a fiscal year beginning January 1 and ending December 31 with respect to which an Award may be granted. 15.3 "Board" means the Company's Board of Directors, as constituted from time to time. 15.4 "Change in Control" means the occurrence of any of the following events after the effective date of the Plan as set out in Section 14.1: (a) A change in control required to be reported pursuant to Item 6(e) of Schedule 14A of Regulation 14A under the Exchange Act; (b) A change in the composition of the Board, as a result of which fewer than two-thirds of the incumbent directors are directors who either (i) had been directors of the Company 24 months prior to such change or (ii) were elected, or nominated for election, to the Board with the affirmative votes of at least a majority of the directors who had been directors of the Company 24 months prior to such change and who were still in office at the time of the election or nomination; (c) Any "person" (as such term is used in sections 12(d) and 13(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 7 ownership of securities, shall be disregarded until such person increases in any manner, directly or indirectly, such person's beneficial ownership of any securities of the Company. 15.5 "Code" means the Internal Revenue Code of 1986, as amended. 15.6 "Committee" means the Compensation Committee of the Board, as constituted from time to time. 15.7 "Common Share" means one share of the common stock of the Company. 15.8 "Company" means The Charles Schwab Corporation, a Delaware corporation. 15.9 "Disability" means the inability to engage in any substantial gainful activity considering the Participant's age, education and work experience by reason of any medically determined physical or mental impairment that has continued without interruption for a period of at least six months and that can be expected to be of long, continued and indefinite duration. All determinations as to whether a Participant has incurred a Disability shall be made by the Committee, the findings of which shall be final, binding and conclusive. 15.10 "Employee" means a common-law employee, other than an officer of the Company or any Subsidiary, as determined by the Committee. 15.11 "ERISA" means the Employee Retirement Income Security Act of 1974, as amended. 15.12 "Exchange Act" means the Securities Exchange Act of 1934, as amended. 15.13 "Exercise Price" means the amount for which one Common Share may be purchased upon exercise of an Option, as specified by the Committee in the applicable Stock Option Agreement. 15.14 "Fair Market Value" means the market price of a Common Share, determined by the committee as follows: (a) If the Common Share was traded on a stock exchange on the date in question, then the Fair Market Value shall be equal to the closing price reported by the applicable composite-transactions report for such date; (b) If the Common Share was traded over-the-counter on the date in question and was classified as a national market issue, then the Fair Market Value shall be equal to the last transaction price quoted by the NASDAQ system for such date; (c) If the Common Share was traded over-the-counter on the date in question but was not classified as a national market issue, then the Fair Market Value shall be equal to the mean between the last reported representative bid and asked prices quoted by the NASDAQ system for such date; and 8 (d) If none of the foregoing provisions is applicable, then the Fair Market Value shall be determined by the Committee in good faith on such basis as it deems appropriate. 15.15 "Option" means an employee stock option, other than an option described in sections 422 through 424 of the Code, including a Replacement Option, granted under the Plan and entitling the holder to purchase one Common Share. 15.16 "Optionee" means an individual, or his or her estate, legatee or heirs at law that holds an Option. 15.17 "Participant" means an Employee who has received an Award. 15.18 "Plan" means this Charles Schwab Employee Stock Incentive Plan, as it may be amended from time to time. 15.19 "Replacement Option" means an Option that is granted when a Participant uses a Common Share held or to be acquired by the Participant to exercise an Option and/or to satisfy tax withholding requirements incident to the exercise of an Option. 15.20 "Restricted Share" means a Common Share awarded to a Participant under the Plan. 15.21. "Retirement" shall mean any termination of employment of an Optionee for any reason other than death at any time after the Optionee has attained fifty (50), but only if, at the time of such termination, the Participant has been credited with at least seven (7) Years of Service under the Charles Schwab Profit Sharing and Employee Stock Ownership Plan. The foregoing definition shall apply to all Stock Option Agreements entered into pursuant to the Plan, irrespective of any definition to the contrary contained in any such Stock Option Agreement. 15.22 "Stock Award Agreement" means the agreement between the Company and the recipient of a Restricted Share which contains the terms, conditions and restrictions pertaining to such Restricted Share. 15.23 "Stock Option Agreement" means the agreement between the Company and an Optionee which contains the terms, conditions and restrictions pertaining to his or her option. 15.24 "Subsidiary" means any corporation, if the Company and/or one or more other Subsidiaries own not less than 50 percent of the total combined voting power of all classes of outstanding stock of such corporation. A corporation that attains the status of a Subsidiary on a date after the adoption of the Plan shall be considered a Subsidiary commencing as of such date. 9 EX-10.191 8 EXHIBIT 10.191 EXHIBIT 10.191 THE CHARLES SCHWAB CORPORATION 1992 STOCK INCENTIVE PLAN RESTRICTED SHARES AWARD AGREEMENT THIS AGREEMENT is entered into between The Charles Schwab Corporation, a Delaware corporation (the "Company") and __________ (the "Employee"). WITNESSETH: WHEREAS, the Company has adopted The Charles Schwab Corporation 1992 Stock Incentive Plan (the "Plan"), which provides for the granting of restricted shares of Common Stock of the Company ("Restricted Shares") to key employees of the Company and its Subsidiaries; and WHEREAS, the Compensation Committee of the Board of Directors of the Company (the "Committee"), which is responsible for the administration of the Plan, has authorized the granting of an award of Restricted Shares to the Employee, effective as of _____________________; and WHEREAS, this Agreement is prepared in conjunction with and pursuant to the terms of the Plan and, although all of the terms of the Plan and the definitions used in this Plan have not been set forth herein, such terms and definitions are incorporated herein and made a part hereof by reference, and, except as otherwise expressly stated herein, the provisions of the Plan shall govern any interpretation of this Agreement; and WHEREAS, the Employee has accepted the grant of Restricted Shares and agreed to the terms and conditions hereinafter stated; NOW, THEREFORE, the Employee and the Company agree to the provisions set forth in the Agreement. The Employee signifies agreement with all of the terms and conditions of this Agreement by failing to provide written objection to the Company to any of the terms hereunder within 30 days of receipt of this Agreement, and in any event by accepting any dividends paid with respect to the Restricted Shares granted hereunder. 1. GRANT OF RESTRICTED SHARES. The Company hereby grants to the Employee, as a separate incentive in connection with his or her employment and not in lieu of any salary or other cash compensation for his or her services, an award of __________ Restricted Shares, effective _____________, subject to all the terms and conditions in this Agreement and the Plan. 2. RESTRICTION ON TRANSFER. The Restricted Shares awarded pursuant to this Agreement shall be issued in the name of The Employee and held by the Secretary of the Company as escrow agent (the "Escrow Agent"), and, except to the extent specifically provided herein, shall not be sold, transferred, otherwise disposed of, pledged or otherwise hypothecated until the date such Restricted Shares become vested pursuant to paragraph 3 hereof (the "Restriction on Transfer"). The Company may instruct the transfer agent for its Common Stock to place a legend on the certificates representing the Restricted Shares or otherwise note its records as to the restrictions on transfer set forth in this Agreement and the Plan. The certificate or certificates representing such shares shall be delivered by the Escrow Agent to The Employee only after the shares become vested on the date specified in paragraph 3 and after all other terms and conditions in this Agreement have been satisfied. Notwithstanding the foregoing, to the extent specifically permitted by the Plan, the Restricted Shares may be transferred by gift, subject to the Restriction on Transfer and the vesting conditions set forth herein. 3. VESTING OF SHARES. The Restricted Shares awarded by this Agreement shall become vested as follows: Effective as of the date hereof (the "Grant Date"), the Restricted Shares shall be 0% vested. If the Employee is employed for a continuous period beginning on the date hereof and ending on the third anniversary of the Grant Date, 50% of the Restricted Shares shall become vested. If the Employee shall continue to be employed for a continuous period ending on the fourth anniversary of the Grant Date, an additional 50% of the Restricted Shares shall become vested, so that at such time all of the Restricted Shares subject to this Agreement shall be then vested. Notwithstanding the foregoing, in the event of the Employee's death or Disability, 100% of the Restricted Shares shall be then vested, and in the event of the Employee's Retirement after the second anniversary of the Grant Date, 100% of the Restricted Shares shall be then vested. For purposes of this Agreement, Retirement shall mean a termination of employment of the Employee at any time after the Employee (i) has attained fifty (50) years of age, and (ii) has completed seven (7) years of service, as determined pursuant to the terms of the Charles Schwab Profit Sharing and Employee Stock Ownership Plan. Notwithstanding the 2 foregoing, however, the accrual of vesting pursuant to this paragraph is contingent upon the Employee's satisfactory job performance, and the Company may, in its sole discretion, upon notice to the Employee, suspend or delay the vesting of the Restricted Shares hereunder for any period of time in the event that the Company determines, within its sole discretion, that the Employee's performance is unsatisfactory. Moreover, the continued accrual of vesting pursuant to this paragraph shall be suspended during the period of time in which the Optionee is on a leave of absence of more than six months for any reason other than (i) medical reasons, (ii) pregnancy disability, (iii) a leave qualifying under the Family and Medical Leave Act, or (iv) workers' compensation. Upon the vesting of Restricted Shares hereunder, the certificate or certificates representing such Restricted Shares shall be delivered to the Employee. 4. CHANGE IN CONTROL. Upon the determination of the Committee that a Change in Control of the Company has occurred, or in the event of the liquidation or dissolution of the Company, the Restricted Shares shall become fully vested and the Restriction on Transfer shall be lifted, notwithstanding any other provision of this Agreement, and the certificate or certificates representing such Restricted Shares shall be delivered to the Employee. 5. DISCRETION OF COMMITTEE. The Committee may decide, in its absolute discretion, to lift at any time the Restriction on Transfer or to accelerate the vesting of the Restricted Shares, and the certificate or certificates representing such Restricted Shares shall be delivered to the Employee. 6. DELIVERY OF SHARES TO ESTATE OF DECEASED EMPLOYEE. Any distribution or delivery to be made to the Employee under this Agreement shall, if the Employee is then deceased, be made to the Employee's estate in accordance with the terms of Section 7.5 of the Plan. 7. CONDITIONS TO ISSUANCE OF SHARES. The Restricted Shares deliverable to the Employee may be either previously authorized but unissued shares or issued shares which have been reacquired by the Company. The Company shall not be required to issue any certificate or certificates for Restricted Shares hereunder prior to fulfillment of all of the following conditions: (a) The admission of such shares to listing on all stock exchanges on which such class of stock is then listed; 3 (b) The completion of any registration or other qualification of such shares under any State or federal law or under the rulings or regulations of the Securities and Exchange Commission or any other governmental regulatory body, which the Committee shall, in its absolute discretion, deem necessary or advisable; (c) The obtaining of any approval or other clearance from any State or federal governmental agency, which the Committee shall, in its absolute discretion, determine to be necessary or advisable; and (d) The lapse of such reasonable period of time following the date of the grant of the Restricted Shares as the Committee may establish from time to time for reasons of administrative convenience. Neither the Employee nor any person claiming under or through the Employee shall be, or have any of the rights or privileges of, a stockholder of the Company in respect of any Restricted Shares deliverable hereunder unless and until certificates representing such shares shall have been issued, recorded on the records of the Company or its transfer agents or registrars, and delivered to the Employee or the Escrow Agent. Except as provided in paragraph 8, after such issuance, recordation and delivery, the Employee shall have all rights of a stockholder of the Company with respect to voting such Restricted Shares and receipt of dividends and distributions on such Restricted Shares. 8. CERTAIN ADJUSTMENTS TO SHARES. In the event that as a result of a stock dividend, stock split, reclassification, recapitalization, combination of shares or the adjustment in capital stock of the Company or otherwise, or as a result of a merger, consolidation, spin-off or other reorganization, the Company's Common Stock shall be increased, reduced or otherwise changed, and by virtue of any such change the Employee shall in his or her capacity as owner of Restricted Shares which have been awarded to him or her (the "Prior Shares") be entitled to new or additional or different shares or securities (other than rights or warrants to purchase securities), such new or additional or different shares or securities shall thereupon be considered to be Restricted Shares and shall be subject to all of the conditions and restrictions which were applicable to the Prior Shares pursuant to the Plan. If the Employee receives rights or warrants with respect to any Prior Shares, such rights or warrants may be held or exercised by the Employee, provided that until such exercise any such rights or warrants and 4 after such exercise any shares or other securities acquired by the exercise of such rights or warrants shall be considered to be Restricted Shares and shall be subject to all of the conditions and restrictions which were applicable to the Prior Shares pursuant to the Plan. The Committee in its absolute discretion at any time may lift the Restriction on Transfer of all or any portion of such new or additional shares of stock or securities, rights or warrants to purchase securities or shares or other securities acquired by the exercise of such rights or warrants. 9. CONTRIBUTION OF PAR VALUE TO CAPITAL OF THE COMPANY. Notwithstanding the provisions of Section 7.2 of the Plan, the Company will contribute to the capital of the Company on behalf of the Employee, as an Award recipient, an amount equal to the par value of the Restricted Shares issued to the Employee hereunder. 10. TAX WITHHOLDING. To the extent required by applicable federal, state, local or foreign law, the Employee shall make arrangements satisfactory to the Company for the satisfaction of any withholding tax obligations that arise by reason of the awarding or vesting of the Restricted Shares hereunder, or by reason of any election made by the Employee pursuant to Section 83(b) of the Internal Revenue Code, and no Share certificates shall be issued to the Employee unless such obligation is satisfied. 11. PLAN SHALL CONTROL. This Agreement is subject to all the terms and provisions of the Plan. In the event of a conflict between any provisions of this Agreement and any provisions of the Plan, the provisions of the Plan shall govern. Terms used in this Agreement that are not defined in this Agreement shall have the meaning set forth in the Plan. 12. POWERS OF THE COMMITTEE. The Committee shall have the power to interpret and construe the Plan and this Agreement and to adopt such rules for the administration, interpretation and application of the Plan as are consistent therewith and to interpret or revoke any such rules. All actions taken and all interpretations and determinations made by the Committee in good faith shall be final and binding upon the Employee, the Employee's estate, the Company and all other interested persons. No member of the Committee shall be personally liable for any action, determination or interpretation made in good faith with respect to the Plan or this Agreement. 5 13. NO EFFECT ON OTHER BENEFIT PLANS. Nothing herein contained shall affect the Employee's right to participate in and receive benefits under and in accordance with the then current provisions of any pension, insurance or other Employee welfare plan or program of the Company or any Subsidiary. 14. NONASSIGNABILITY. So long as the Restriction on Transfer is in effect, except to the extent specifically permitted by this Agreement, the Restricted Shares herein granted and the rights and privileges conferred hereby shall not be transferred, assigned, pledged or hypothecated in any way (whether by operation or law or otherwise) and shall not be subject to sale under execution, attachment or similar process. Upon any attempt to transfer, assign, pledge, hypothecate or otherwise dispose of such award or any right or privilege conferred hereby, contrary to the provisions hereof, or upon any attempted sale under any execution, attachment or similar process upon the rights and privileges conferred hereby, such award and the rights and privileges conferred hereby shall immediately become null and void. 15. SUCCESSORS AND ASSIGNS. Subject to the limitation on the transferability of the Restricted Shares contained herein, this Agreement shall be binding upon and inure to the benefit of the heirs, legatees, legal representatives, successor and assigns of the Employee and the Company. 16. NOTICES. Any notice to be given to the Company under the terms of this Agreement shall be addressed to the Company, in care of its Secretary, at 101 Montgomery Street, San Francisco, California 94104, or at such other address as the Company may hereafter designate in writing. Any notice to be given to the Employee shall be addressed to the Employee at the address set forth beneath the Employee's signature hereto, or at such other address as the Employee may hereafter designate in writing. Any such notice shall be deemed to have been duly given if and when enclosed in a properly sealed envelope, addressed as aforesaid, registered or certified and deposited, postage and registry fee prepaid, in a United States post office. 17. SEVERABILITY. In the event that any provision of this Agreement shall be held invalid or unenforceable, such provision shall be severable from, and such invalidity or unenforceability shall not be construed to have any effect on, the remaining provisions of this Agreement. 18. GOVERNING LAW. This Agreement shall be construed in accordance with the laws of the State of California. 6 EX-10.192 9 EXHIBIT 10.192 EXHIBIT 10.192 THE CHARLES SCHWAB CORPORATION 1992 STOCK INCENTIVE PLAN NONSTATUTORY STOCK OPTION AGREEMENT THIS AGREEMENT is entered into as of ______________________ between THE CHARLES SCHWAB CORPORATION, a Delaware corporation (the "Company"), and ________________(the "Optionee"). W I T N E S S E T H: WHEREAS, the Board has adopted and the stockholders of the Company have approved The Charles Schwab Corporation 1992 Stock Incentive Plan, as amended (the "Plan") in order to provide selected Key Employees and Non-Employee Directors with an opportunity to acquire Common Shares; and WHEREAS, the Committee has determined that the Optionee is a Key Employee and that it would be in the best interests of the Company and its stockholders to grant the stock option described in this Agreement (the "Option") to the Optionee as an inducement to enter into or remain in the service of the Company or its subsidiaries and as an incentive for extraordinary efforts during such service: NOW, THEREFORE, the Optionee and the Company agree to the provisions set forth in this Agreement. The Optionee signifies agreement with all of the terms and conditions of this Agreement by failing to provide written objection to the Company to any of the terms hereunder within 30 days of receipt of this Agreement, and in any event by exercising an Option granted hereunder. SECTION 1. GRANT OF OPTION. (a) OPTION. On the terms and conditions stated below, the Company hereby grants to the Optionee the option to purchase _____ Common Shares for the amount of $_____ per Common Share (the "Exercise Price"), which is agreed to be 100% of the Fair Market Value thereof on the Date of Grant. The number of Common Shares subject to this Option and the Exercise Price shall be subject to adjustment under certain limited circumstances as provided in Article 10 of the Plan. (b) 1992 STOCK INCENTIVE PLAN. This Option is granted pursuant to the Plan, the provisions of which are incorporated into this Agreement by reference, and a copy of which is available upon request at no charge to the Optionee from the Company. In the event of any inconsistency between the provisions of the Plan and the provisions of this Agreement, the provisions of the Plan shall prevail. (c) TAX TREATMENT. This Option is not intended to qualify as an incentive stock option described in Section 422(b) of the Code. (d) EXPIRATION DATE. Notwithstanding any other provision contained herein, this Option shall expire not later than the date immediately preceding the tenth anniversary of the Date of Grant. SECTION 2. NO TRANSFER OR ASSIGNMENT OF OPTION. Except as otherwise provided in this Agreement or as permitted by the Plan, this Option, and any interest therein, shall not be transferred, assigned, pledged or hypothecated in any way (whether by operation of law or otherwise) and shall not be subject to sale under execution, attachment or similar process. SECTION 3. RIGHT TO EXERCISE OPTION. (a) VESTING. This Option shall become exercisable by the Optionee with respect to the total number of Common Shares subject to this Option as set forth under Section 1(a) above (the "Total Award Common Shares"), subject to the continued employment of the Optionee by the Company or its subsidiaries on each date either set forth below, and subject to the provisions of Section 3(e) hereof, in annual increments of the Total Award Common Shares beginning on the first anniversary of the Date of Grant, such that (i) no portion of this Option will be exercisable prior to such first anniversary of the Date of Grant; (ii) upon and after such first anniversary of the Date of Grant, the Optionee may purchase up to twenty-five percent (25%) of the Total Award Common Shares, provided the optionee has been continually employed by the Company or its subsidiaries since the date of grant; (iii) upon and after the second, third and fourth anniversaries of the Date of Grant, respectively, the Optionee may purchase an additional twenty-five percent (25%) of the Total Award Common Shares, provided in each case that the Optionee has been continually employed by the Company or its subsidiaries since the Date of Grant. (b) MINIMUM NUMBER OF SHARES. This Option shall be exercisable for at least 100 Common Shares (without regard to adjustments to the number of Common Shares subject to this Option pursuant to Article 10 of the Plan) or, if less, (i) the number of shares with respect to which this Option has become vested under Section 3(a) above, or (ii) all of the remaining Common Shares subject to this Option. (c) FULL VESTING ON CHANGE IN CONTROL. Notwithstanding subparagraph (a) hereof, this Option shall become fully exercisable as to the Total Award Common Shares 2 immediately preceding any Change in Control with respect to the Company. In the event that the Committee determines that a Change in Control is likely to occur, the Company shall so advise the Optionee, and the provisions of this subparagraph (c) shall take effect as of the date ten (10) days prior to the anticipated date of such Change in Control. (d) ACCELERATED VESTING IN CERTAIN CASES. Notwithstanding subparagraph (a) hereof, if the Optionee terminates employment with the Company and its subsidiaries on account of death or Disability, all options granted hereunder shall become fully exerciseable, and if the Optionee terminates employment with the Company and its subsidiaries on account of Retirement, all options granted hereunder shall become fully exerciseable, but only if such Retirement occurs at least two (2) years after the date of grant. (e) VESTING CONTINGENT ON SATISFACTORY PERFORMANCE. Notwithstanding subparagraph (a) hereof, the continued accrual of vesting pursuant to subparagraph (a) is contingent upon the Optionee's satisfactory job performance, and the Company may, in its sole discretion, upon notice to the Optionee suspend or delay the vesting of Options hereunder for any period of time in the event that the Company determines, within its sole discretion, that the Optionee's performance is unsatisfactory. (f) SUSPENSION OF VESTING DURING CERTAIN LEAVES OF ABSENCE. Notwithstanding subparagraph (a) hereof, the continued accrual of vesting pursuant to subparagraph (a) shall be suspended during the period of time in which the Optionee is on a leave of absence of more than six months for any reason other than (i) medical reasons, (ii) pregnancy disability, (iii) a leave qualifying under the Family and Medical Leave Act, or (iv) workers' compensation. SECTION 4. EXERCISE OF OPTION. (a) NOTICE OF EXERCISE. The Optionee or the Optionee's representative may exercise this Option by giving written notice to the Company (or its designee) pursuant to Section 9(d). The notice shall specify the election to exercise this Option, the date of exercise, the number of Common Shares for which it is being exercised and the form of payment. The notice shall be signed by the person or persons exercising this Option. In the event that this Option is being exercised by the representative of the Optionee, the notice shall be accompanied by proof satisfactory to the Company of the representative's right to exercise this Option. The Purchase Price for Common Shares shall be paid in a form that conforms to Sections 6.1 through 6.3 of the Plan at the time such notice is given. (b) ISSUANCE OF SHARES. After receiving a proper notice of exercise, the Company shall cause to be issued a certificate or certificates for the Common Shares so purchased, registered in the name of the person exercising this Option. The Company shall cause such certificate or certificates to be delivered to or upon the order of the person exercising this Option. 3 SECTION 5. TERM. (a) BASIC TERM. This Option shall in any event expire on the date specified in Section 1(d). (b) TERMINATION OF EMPLOYMENT. Subject only to the provisions of Section 3(d), upon the Optionee's termination of employment with the Company and its subsidiaries for any reason, whether as a result of a voluntary or involuntary event of termination of employment (including a termination of employment as may be provided for or determined under an employment contract, if any, entered into between the Company or its subsidiary and the Optionee) (each, a "Termination Event"), no unvested portion of the Total Award Common Shares thereafter shall vest or become exercisable. With respect to the vested or exercisable portion of the Total Award Common Shares as of the date of such a Termination Event, this Option shall expire on the earlier of (i) the expiration date specified in Section 1(d) or (ii) whichever of the following is applicable: (A) in the case of a Termination Event resulting from death or Disability, the date one year following such Termination Event; (B) in the case of a Termination Event resulting from Retirement, the date two years following such Termination Event; or (C) in all other cases, the date three (3) months following such Termination Event. (c) DIVESTMENT OF OPTIONS. Notwithstanding anything to the contrary contained herein, this Option shall immediately become forfeited and expire in the event that the Company terminates the Optionee's employment on account of conduct inimical to the best interests of the Company, including, without limitation, conduct constituting a violation of law or Company policy, fraud, theft, conflict of interest, dishonesty or harassment. The determination whether the Optionee's employment has been terminated on account of conduct inimical to the best interests of the Company shall be made by the Company in its sole discretion. SECTION 6. LEGALITY OF INITIAL ISSUANCE. No Common Shares shall be issued upon the exercise of this Option unless and until the Company has determined that: (a) A registration statement for the Common Shares is effective under the Securities Act or an exemption from the registration requirements thereof has been perfected; (b) Any applicable listing requirement of any stock exchange on which Common Shares are listed has been satisfied; and (c) Any other applicable provisions of state or federal law have been satisfied. SECTION 7. NO REGISTRATION RIGHTS. 4 The Company may, but shall not be obligated to, register or qualify the Common Shares for resale or other disposition by the Optionee under the Securities Act or any other applicable law. SECTION 8. RESTRICTIONS ON TRANSFER OF SHARES. (a) RESTRICTIONS. Regardless of whether the offering and sale of Common Shares under the Plan have been registered under the Securities Act or have been registered or qualified under the securities laws of any state, the Company may impose restrictions upon the sale, pledge or other transfer of such Common Shares (including the placement of appropriate legends on stock certificates) if, in the judgment of the Company and its counsel, such restrictions are necessary or desirable in order to achieve compliance with the provisions of the Securities Act, the securities laws of any state or any other law. (b) INVESTMENT INTENT AT EXERCISE. If the Common Shares under the Plan are not registered under the Securities Act but an exemption is available which requires an investment representation or other representation, the Optionee shall represent and agree at the time of exercise that the Common Shares being acquired upon exercising this Option are being acquired for investment, and not with a view to the sale or distribution thereof, and shall make such other representations as are deemed necessary or appropriate by the Company and its counsel. (c) ADMINISTRATION. Any determination by the Company and its counsel in connection with any of the matters set forth in this Section 8 shall be conclusive and binding on the Optionee and all other persons. SECTION 9. MISCELLANEOUS PROVISIONS. (a) WITHHOLDING TAXES. To the extent required by applicable federal, state, local or foreign law, the Optionee shall make arrangements satisfactory to the Company for the satisfaction of any withholding tax obligations that arise by reason of the exercise of an Option hereunder, and no Option may be exercised unless such obligation is satisfied. (b) RIGHTS AS A STOCKHOLDER. Neither the Optionee nor the Optionee's representative shall have any rights as a stockholder with respect to any Common Shares subject to this Option until certificates for such Common Shares have been issued in the name of the Optionee or the Optionee's representative. (c) NO EMPLOYMENT RIGHTS. Nothing in this Agreement shall be construed as giving the Optionee the right to be retained as an employee of the Company or its subsidiaries. 5 The Company reserves the right to terminate the Optionee's employment at any time for any reason, subject only to the terms of any written employment contract entered into between the Company and the Optionee. (d) NOTICE. Any notice required by the terms of this Agreement shall be given in writing and shall be deemed effective upon personal delivery or upon deposit with the appropriate postal service, by registered or certified mail with postage and fees prepaid and addressed to the party entitled to such notice at the address shown below such party's signature on this Agreement, or at such other address as such party may designate by ten (10) days advance written notice to the other party to this Agreement. Notwithstanding the foregoing, no notice of exercise, as required by Section 4(a), shall be effective until actual receipt thereof by the Company or its designee. (e) ENTIRE AGREEMENT. This Agreement and the Plan constitute the entire agreement between the parties hereto with regard to the subject matter hereof; provided, however, that in the event of any inconsistency or conflict between any provision hereof and the terms of the Plan, the terms of the Plan shall control. (f) CHOICE OF LAW. This Agreement shall be governed by, and construed in accordance with, the laws of the State of California, as such laws are applied to contracts entered into and performed in such State. SECTION 10. DEFINITIONS. (a) Capitalized terms defined in the Plan shall have the same meaning when used in this Agreement. (b) "CHANGE IN CONTROL" shall mean the occurrence of any of the following events after the effective date of the Plan as set out in Section 15.1 of the Plan: (1) A change in control required to be reported pursuant to Item 6(e) of Schedule 14A of Regulation 14A under the Securities Exchange Act of 1934, as amended (the "Exchange Act"); (2) A change in the composition of the Company's Board of Directors (the "Board"), as a result of which fewer than two-thirds of the incumbent directors are directors who either (i) had been directors of the Company 24 months prior to such change or (ii) were elected, or nominated for election, to the Board with the affirmative votes of at least a majority of the directors who had been directors of the Company 24 months prior to such change and who were still in office at the time of the election or nomination; (3) Any "person" (as such term is used in Sections 13(d) and 14(d) of the Exchange Act) becomes the beneficial owner, directly or indirectly, of securities of the Company representing 20 percent or more of the combined voting power of the Company's then outstanding securities ordinarily (and apart from rights accruing under special circumstances) 6 having the right to vote at elections of directors (the "Base Capital Stock"); provided, however, that any change in the relative beneficial ownership of securities of any person resulting solely from a reduction in the aggregate number of outstanding shares of Base Capital Stock, and any decrease thereafter in such person's ownership of securities, shall be disregarded until such person increases in any manner, directly or indirectly, such person's beneficial ownership of any securities of the Company. (c) "COMMON SHARE" shall mean one share of the common stock of the Company. (d) "DATE OF GRANT" shall mean the date of this Agreement, which is the date first written above. (e) "FAIR MARKET VALUE" shall mean the market price of a Common Share, determined by the Committee as follows: (1) If the Common Share was traded on a stock exchange on the date in question, then the Fair Market Value shall be equal to the closing price reported by the applicable composite-transactions report for such date; (2) If the Common Share was traded over-the-counter on the date in question and was classified as a national market issue, then the Fair Market Value shall be equal to the last transaction price quoted by the NASDAQ system for such date; (3) If the Common Share was traded over-the-counter on the date in question but was not classified as a national market issue, then the Fair Market Value shall be equal to the mean between the last reported representative bid and asked prices quoted by the NASDAQ system for such date; and (4) If none of the foregoing provisions is applicable, then the Fair Market Value shall be determined by the Committee in good faith on such basis as it deems appropriate. (f) "PURCHASE PRICE" shall mean the Exercise Price multiplied by the number of Common Shares with respect to which this Option is being exercised. (g) "RETIREMENT" shall mean a termination of employment of the Optionee occurring at any time after the Optionee (i) has attained fifty (50) years of age, and (ii) completed seven (7) years of service, as determined pursuant to the terms of the Charles Schwab Profit Sharing and Employee Stock Ownership Plan. (h) "SECURITIES ACT" shall mean the Securities Act of 1933, as amended. 7 EX-10.193 10 EXHIBIT 10.193 EXHIBIT 10.193 THE CHARLES SCHWAB CORPORATION 1992 STOCK INCENTIVE PLAN NONSTATUTORY STOCK OPTION AND PERFORMANCE UNIT AGREEMENT THIS AGREEMENT is entered into as of ______________________ between THE CHARLES SCHWAB CORPORATION, a Delaware corporation (the "Company"), and _______________(the "Optionee"). W I T N E S S E T H: WHEREAS, the Board has adopted and the stockholders of the Company have approved The Charles Schwab Corporation 1992 Stock Incentive Plan, as amended (the "Plan") in order to provide selected Key Employees and Non-Employee Directors with an opportunity to acquire Common Shares; and WHEREAS, the Committee has determined that the Optionee is a Key Employee and that it would be in the best interests of the Company and its stockholders to grant the stock option described in this Agreement (the "Option") and the Performance Units described in this Agreement (the "Performance Units") to the Optionee as an inducement to enter into or remain in the service of the Company or its subsidiaries and as an incentive for extraordinary efforts during such service: NOW, THEREFORE, the Optionee and the Company agree to the provisions set forth in this Agreement. The Optionee signifies agreement with all of the terms and conditions of this Agreement by failing to provide written objection to the Company to any of the terms hereunder within 30 days of receipt of this Agreement, and in any event by exercising an Option or a Performance Unit granted hereunder. SECTION 1. GRANT OF OPTION AND PERFORMANCE UNITS. (a) OPTION. On the terms and conditions stated below, the Company hereby grants to the Optionee the option to purchase ______ Common Shares for the amount of $_____ per Common Share (the "Exercise Price"), which is agreed to be 100% of the Fair Market Value thereof on the Date of Grant. The number of Common Shares subject to this Option and the Exercise Price shall be subject to adjustment under certain limited circumstances as provided in Article 10 of the Plan. (b) PERFORMANCE UNITS. On the terms and conditions stated below, the Company hereby grants to the Optionee _______ Performance Units, as defined herein. Each Performance Unit shall entitle the Optionee to a cash payment, equal to the Net Performance Unit Value, determined as of the most recent valuation. Net Performance Unit Value shall be determined on an annual basis (or at more frequent intervals as the Company may determine from time to time in its sole discretion), and shall be communicated to the Optionee within a reasonable time following the determination of such value. (c) TANDEM ISSUANCE OF OPTION AND PERFORMANCE UNITS. Each Performance Unit shall be issued in tandem with an Option to acquire one share hereunder, so that the exercise of a Performance Unit will result in the cancellation of the Option associated with such Performance Unit, and the exercise of an Option will result in the cancellation of the Performance Unit associated with such Option. Performance Units will expire on the date three (3) months following the fifth anniversary of the date the Performance Unit was granted. Upon the expiration of a Performance Unit, the Option associated with such Performance Unit shall remain exercisable until such Option otherwise expires pursuant to the terms of this Agreement. (d) 1992 STOCK INCENTIVE PLAN. This Option is granted pursuant to the Plan, the provisions of which are incorporated into this Agreement by reference, and a copy of which is available upon request at no charge to the Optionee from the Company. In the event of any inconsistency between the provisions of the Plan and the provisions of this Agreement, the provisions of the Plan shall prevail. (e) TAX TREATMENT. This Option is not intended to qualify as an incentive stock option described in Section 422(b) of the Code. (f) EXPIRATION DATE. Notwithstanding any other provision contained herein, this Option shall expire not later than the date immediately preceding the tenth anniversary of the Date of Grant. SECTION 2. NO TRANSFER OR ASSIGNMENT OF OPTION. Except as otherwise provided in this Agreement or as permitted by the Plan, this Option, and any interest therein, shall not be transferred, assigned, pledged or hypothecated in any way (whether by operation of law or otherwise) and shall not be subject to sale under execution, attachment or similar process. SECTION 3. RIGHT TO EXERCISE OPTION AND PERFORMANCE UNITS. (a) VESTING. This Option shall become exercisable by the Optionee with respect to the total number of Common Shares subject to this Option as set forth under Section 1(a) above (the "Total Award Common Shares"), subject to the continued employment of the Optionee by the Company or its subsidiaries on each date either set forth below, and subject to the provisions of Section 3(e) hereof, in annual increments of the Total Award Common Shares beginning on the first anniversary of the Date of Grant, such that (i) no portion of this 2 Option will be exercisable prior to such first anniversary of the Date of Grant; (ii) upon and after such first anniversary of the Date of Grant, the Optionee may purchase up to twenty-five percent (25%) of the Total Award Common Shares, provided the optionee has been continually employed by the Company or its subsidiaries since the date of grant; (iii) upon and after the second, third and fourth anniversaries of the Date of Grant, respectively, the Optionee may purchase an additional twenty-five percent (25%) of the Total Award Common Shares, provided in each case that the Optionee has been continually employed by the Company or its subsidiaries since the Date of Grant. (b) MINIMUM NUMBER OF SHARES AND PERFORMANCE UNITS. This Option shall be exercisable for at least 100 Common Shares (without regard to adjustments to the number of Common Shares subject to this Option pursuant to Article 10 of the Plan) or, if less, (i) the number of shares with respect to which this Option has become vested under Section 3(a) above, or (ii) all of the remaining Common Shares subject to this Option. Performance Units shall be exercisable in minimum increments of 100 or, if less, (i) the number of Performance Units which have become vested under Section 3(a) above or (ii) all of the remaining Performance Units granted hereunder. (c) FULL VESTING ON CHANGE IN CONTROL. Notwithstanding subparagraph (a) hereof, this Option shall become fully exercisable as to the Total Award Common Shares, and all Performance Units granted hereunder shall become fully exercisable, immediately preceding any Change in Control with respect to the Company. In the event that the Committee determines that a Change in Control is likely to occur, the Company shall so advise the Optionee, and the provisions of this subparagraph (c) shall take effect as of the date ten (10) days prior to the anticipated date of such Change in Control. (d) ACCELERATED VESTING IN CERTAIN CASES. Notwithstanding subparagraph (a) hereof, if the Optionee terminates employment with the Company and its subsidiaries on account of death or Disability, all options and Performance Units granted hereunder shall become fully exerciseable. Moreover, if the Optionee terminates employment with the Company and its subsidiaries on account of Retirement, all options and Performance Units granted hereunder shall become fully exerciseable, but only if such Retirement occurs at least two (2) years after the date of grant. (e) VESTING CONTINGENT ON SATISFACTORY PERFORMANCE. Notwithstanding subparagraph (a) hereof, the continued accrual of vesting pursuant to subparagraph (a) is contingent upon the Optionee's satisfactory job performance, and the Company may, in its sole discretion, upon notice to the Optionee suspend or delay the vesting of Options and Performance Shares hereunder for any period of time in the event that the Company determines, within its sole discretion, that the Optionee's performance is unsatisfactory. (f) SUSPENSION OF VESTING DURING CERTAIN LEAVES OF ABSENCE. Notwithstanding subparagraph (a) hereof, the continued accrual of vesting pursuant to subparagraph (a) shall be suspended during the period of time in which the Optionee is on a leave of absence of more than six months for any reason other than (i) medical reasons, (ii) 3 pregnancy disability, (iii) a leave qualifying under the Family and Medical Leave Act, or (iv) workers' compensation. SECTION 4. EXERCISE OF OPTION AND PERFORMANCE UNITS. (a) NOTICE OF EXERCISE. The Optionee or the Optionee's representative may exercise this Option or any Performance Units by giving written notice to the Company or its designee pursuant to Section 9(d). The notice shall specify the election to exercise this Option and/or Performance Units (as the case may be), the date of exercise, the number of Common Shares for which the Option is being exercised, the number of Performance Units being exercised, and the form of payment (if this Option is being exercised). The notice shall be signed by the person or persons exercising this Option or Performance Units. In the event that this Option or Performance Units are being exercised by the representative of the Optionee, the notice shall be accompanied by proof satisfactory to the Company of the representative's right to exercise this Option. The Purchase Price for Common Shares shall be paid in a form that conforms to Sections 6.1 through 6.3 of the Plan at the time such notice is given. (b) ISSUANCE OF SHARES. After receiving a proper notice of exercise of an Option, the Company shall cause to be issued a certificate or certificates for the Common Shares so purchased, registered in the name of the person exercising this Option. The Company shall cause such certificate or certificates to be delivered to or upon the order of the person exercising this Option. (c) EXERCISE OF PERFORMANCE UNIT. After receiving a proper notice of exercise of Performance Units, the Company shall cause to be paid to the Optionee, within one month of exercise, an amount equal to the Net Performance Unit Value for each Performance Unit so exercised, less any applicable tax withholdings. SECTION 5. TERM. (a) BASIC TERM. This Option shall in any event expire on the date specified in Section 1(f). (b) TERMINATION OF EMPLOYMENT. Subject only to the provisions of Section 3(d), upon the Optionee's termination of employment with the Company and its subsidiaries for any reason, whether as a result of a voluntary or involuntary event of termination of employment (including a termination of employment as may be provided for or determined under an employment contract, if any, entered into between the Company or its subsidiary and the Optionee) (each, a "Termination Event"), no unvested portion of the Total Award Common Shares or Performance Units thereafter shall vest or become exercisable. With respect to the vested or exercisable portion of the Total Award Common Shares or Performance Units as of the date of such a Termination Event, this Option shall expire on the earlier of (i) the expiration date specified in Section 1(f) or (ii) whichever of the following is applicable: (A) in the case of a 4 Termination Event resulting from death or Disability, the date one year following such Termination Event; (B) in the case of a Termination Event resulting from Retirement, the date two years following such Termination Event; or (C) in all other cases, the date three (3) months following such Termination Event. (c) DIVESTMENT OF OPTIONS. Notwithstanding anything to the contrary contained herein, this Option and all Performance Units shall immediately become forfeited and expire in the event that the Company terminates the Optionee's employment on account of conduct inimical to the best interests of the Company, including, without limitation, conduct constituting a violation of law or Company policy, fraud, theft, conflict of interest, dishonesty or harassment. The determination whether the Optionee's employment has been terminated on account of conduct inimical to the best interests of the Company shall be made by the Company in its sole discretion. SECTION 6. LEGALITY OF INITIAL ISSUANCE. No Common Shares shall be issued upon the exercise of this Option unless and until the Company has determined that: (a) A registration statement for the Common Shares is effective under the Securities Act or an exemption from the registration requirements thereof has been perfected; (b) Any applicable listing requirement of any stock exchange on which Common Shares are listed has been satisfied; and (c) Any other applicable provisions of state or federal law have been satisfied. SECTION 7. NO REGISTRATION RIGHTS. The Company may, but shall not be obligated to, register or qualify the Common Shares for resale or other disposition by the Optionee under the Securities Act or any other applicable law. SECTION 8. RESTRICTIONS ON TRANSFER OF SHARES. (a) RESTRICTIONS. Regardless of whether the offering and sale of Common Shares under the Plan have been registered under the Securities Act or have been registered or qualified under the securities laws of any state, the Company may impose restrictions upon the sale, pledge or other transfer of such Common Shares (including the placement of appropriate legends on stock certificates) if, in the judgment of the Company and its counsel, such 5 restrictions are necessary or desirable in order to achieve compliance with the provisions of the Securities Act, the securities laws of any state or any other law. (b) INVESTMENT INTENT AT EXERCISE. If the Common Shares under the Plan are not registered under the Securities Act but an exemption is available which requires an investment representation or other representation, the Optionee shall represent and agree at the time of exercise that the Common Shares being acquired upon exercising this Option are being acquired for investment, and not with a view to the sale or distribution thereof, and shall make such other representations as are deemed necessary or appropriate by the Company and its counsel. (c) ADMINISTRATION. Any determination by the Company and its counsel in connection with any of the matters set forth in this Section 8 shall be conclusive and binding on the Optionee and all other persons. SECTION 9. MISCELLANEOUS PROVISIONS (a) WITHHOLDING TAXES. To the extent required by applicable federal, state, local or foreign law, the Optionee shall make arrangements satisfactory to the Company for the satisfaction of any withholding tax obligations that arise by reason of the exercise of an Option hereunder, and no Option may be exercised unless such obligation is satisfied. (b) RIGHTS AS A STOCKHOLDER. Neither the Optionee nor the Optionee's representative shall have any rights as a stockholder with respect to any Common Shares subject to this Option until certificates for such Common Shares have been issued in the name of the Optionee or the Optionee's representative. (c) NO EMPLOYMENT RIGHTS. Nothing in this Agreement shall be construed as giving the Optionee the right to be retained as an employee of the Company or its subsidiaries. The Company reserves the right to terminate the Optionee's employment at any time for any reason, subject only to the terms of any written employment contract entered into between the Company and the Optionee. (d) NOTICE. Any notice required by the terms of this Agreement shall be given in writing and shall be deemed effective upon personal delivery or upon deposit with the appropriate postal service, by registered or certified mail with postage and fees prepaid and addressed to the party entitled to such notice at the address shown below such party's signature on this Agreement, or at such other address as such party may designate by ten (10) days advance written notice to the other party to this Agreement. Notwithstanding the foregoing, no notice of exercise, as required by Section 4(a), shall be effective until actual receipt thereof by the Company or its designee. (e) ENTIRE AGREEMENT. This Agreement and the Plan constitute the entire agreement between the parties hereto with regard to the subject matter hereof; provided, however, that in the event of any inconsistency or conflict between any provision hereof and the terms of the Plan, the terms of the Plan shall control. 6 (f) CHOICE OF LAW. This Agreement shall be governed by, and construed in accordance with, the laws of the State of California, as such laws are applied to contracts entered into and performed in such State. SECTION 10. DEFINITIONS. (a) Capitalized terms defined in the Plan shall have the same meaning when used in this Agreement. (b) "CHANGE IN CONTROL" shall mean the occurrence of any of the following events after the effective date of the Plan as set out in Section 15.1 of the Plan: (1) A change in control required to be reported pursuant to Item 6(e) of Schedule 14A of Regulation 14A under the Securities Exchange Act of 1934, as amended (the "Exchange Act"); (2) A change in the composition of the Company's Board of Directors (the "Board"), as a result of which fewer than two-thirds of the incumbent directors are directors who either (i) had been directors of the Company 24 months prior to such change or (ii) were elected, or nominated for election, to the Board with the affirmative votes of at least a majority of the directors who had been directors of the Company 24 months prior to such change and who were still in office at the time of the election or nomination; and (3) Any "person" (as such term is used in Sections 13(d) and 14(d) of the Exchange Act) becomes the beneficial owner, directly or indirectly, of securities of the Company representing 20 percent or more of the combined voting power of the Company's then outstanding securities ordinarily (and apart from rights accruing under special circumstances) having the right to vote at elections of directors (the "Base Capital Stock"); provided, however, that any change in the relative beneficial ownership of securities of any person resulting solely from a reduction in the aggregate number of outstanding shares of Base Capital Stock, and any decrease thereafter in such person's ownership of securities, shall be disregarded until such person increases in any manner, directly or indirectly, such person's beneficial ownership of any securities of the Company. (c) "COMMON SHARE" shall mean one share of the common stock of the Company. (d) "DATE OF GRANT" shall mean the date of this Agreement, which is the date first written above. (e) "FAIR MARKET VALUE" shall mean the market price of a Common Share, determined by the Committee as follows: 7 (1) If the Common Share was traded on a stock exchange on the date in question, then the Fair Market Value shall be equal to the closing price reported by the applicable composite-transactions report for such date; (2) If the Common Share was traded over-the-counter on the date in question and was classified as a national market issue, then the Fair Market Value shall be equal to the last transaction price quoted by the NASDAQ system for such date; (3) If the Common Share was traded over-the-counter on the date in question but was not classified as a national market issue, then the Fair Market Value shall be equal to the mean between the last reported representative bid and asked prices quoted by the NASDAQ system for such date; and (4) If none of the foregoing provisions is applicable, then the Fair Market Value shall be determined by the Committee in good faith on such basis as it deems appropriate. (f) "NET PERFORMANCE UNIT VALUE" shall mean the difference between the Performance Unit Value and the Cost Basis, determined as follows: (1) Performance Unit Value shall mean (A) the difference between the After Tax Net Income and the Targeted Return on Stockholders' Equity, multiplied by (B) the Grant Funding Rate; (2) Cost Basis shall mean the Performance Unit Value as of the end of the fiscal quarter immediately preceding the Date of Grant; (3) After Tax Net Income shall mean the cumulative after tax net income (determined without reduction for accrued obligations pursuant to Performance Units), as measured from January 1 of the year of the Date of Grant, and otherwise subject to such adjustments as may be determined by the Company in its sole discretion; (4) Targeted Return on Stockholders' Equity shall mean a cumulative 20% annual targeted level of return on stockholders' equity, measured from January 1 of the year of the Date of Grant. Targeted Return on Stockholders' Equity is increased on a quarterly basis during the term of the Performance Unit by adding to the prior quarter's Targeted Return on Stockholders' Equity an amount equal to 5% of the ending actual consolidated stockholder's equity balance (determined as of the end of the preceding fiscal year); and (5) Grant Funding Rate shall mean a percentage, determined from time to time by the Company, to provide a level of funding for the Plan. While the Company generally intends that the Grant Funding Rate will remain fixed for the five year term of each Performance Unit, the Company reserves the right, within its sole discretion, to change the Grant Funding Rate at any time. 8 (g) "PURCHASE PRICE" shall mean the Exercise Price multiplied by the number of Common Shares with respect to which this Option is being exercised. (h) "RETIREMENT" shall mean a termination of employment of the Optionee occurring at any time after the Optionee (i) has attained fifty (50) years of age, and (ii) completed seven (7) years of service, as determined pursuant to the terms of the Charles Schwab Profit Sharing and Employee Stock Ownership Plan. (i) "SECURITIES ACT" shall mean the Securities Act of 1933, as amended. 9 EX-10.194 11 EXHIBIT 10.194 EXHIBIT 10.194 THE CHARLES SCHWAB CORPORATION 1992 STOCK INCENTIVE PLAN INCENTIVE STOCK OPTION AGREEMENT THIS AGREEMENT is entered into as of _____________________ between THE CHARLES SCHWAB CORPORATION, a Delaware corporation (the "Company"), and _____________________ (the "Optionee"). W I T N E S S E T H: WHEREAS, the Board has adopted and the stockholders of the Company have approved The Charles Schwab Corporation 1992 Stock Incentive Plan, as amended (the "Plan") in order to provide selected Key Employees and Non-Employee Directors with an opportunity to acquire Common Shares; and WHEREAS, the Committee has determined that the Optionee is a Key Employee and that it would be in the best interests of the Company and its stockholders to grant the stock option described in this Agreement (the "Option") to the Optionee as an inducement to enter into or remain in the service of the Company or its subsidiaries and as an incentive for extraordinary efforts during such service: NOW, THEREFORE, the Optionee and the Company agree to the provisions set forth in this Agreement. The Optionee signifies agreement with all of the terms and conditions of this Agreement by failing to provide written objection to the Company to any of the terms hereunder within 30 days of receipt of this Agreement, and in any event by exercising an Option granted hereunder. SECTION 1. GRANT OF OPTION. (a) OPTION. On the terms and conditions stated below, the Company hereby grants to the Optionee the option to purchase _____ Common Shares for the amount of $_____ per Common Share (the "Exercise Price"), which is agreed to be 100% of the Fair Market Value thereof on the Date of Grant. The number of Common Shares subject to this Option and the Exercise Price shall be subject to adjustment under certain limited circumstances as provided in Article 10 of the Plan. (b) 1992 STOCK INCENTIVE PLAN. This Option is granted pursuant to the Plan, the provisions of which are incorporated into this Agreement by reference, and a copy of which is available upon request at no charge to the Optionee from the Company. In the event of any inconsistency between the provisions of the Plan and the provisions of this Agreement, the provisions of the Plan shall prevail. (c) TAX TREATMENT. This Option is intended to qualify as an incentive stock option described in Section 422(b) of the Code. (d) EXPIRATION DATE. Notwithstanding any other provision contained herein, this Option shall expire not later than the date immediately preceding the tenth anniversary of the Date of Grant. SECTION 2. NO TRANSFER OR ASSIGNMENT OF OPTION. Except as otherwise provided in this Agreement or as permitted by the Plan, this Option, and any interest therein, shall not be transferred, assigned, pledged or hypothecated in any way (whether by operation of law or otherwise) and shall not be subject to sale under execution, attachment or similar process. SECTION 3. RIGHT TO EXERCISE OPTION. (a) VESTING. This Option shall become exercisable by the Optionee with respect to the total number of Common Shares subject to this Option as set forth under Section 1(a) above (the "Total Award Common Shares"), subject to the continued employment of the Optionee by the Company or its subsidiaries on each date either set forth below, and subject to the provisions of Section 3(e) hereof, in annual increments of the Total Award Common Shares beginning on the first anniversary of the Date of Grant, such that (i) no portion of this Option will be exercisable prior to such first anniversary of the Date of Grant; (ii) upon and after such first anniversary of the Date of Grant, the Optionee may purchase up to twenty-five percent (25%) of the Total Award Common Shares, provided the optionee has been continually employed by the Company or its subsidiaries since the date of grant; (iii) upon and after the second, third and fourth anniversaries of the Date of Grant, respectively, the Optionee may purchase an additional twenty-five percent (25%) of the Total Award Common Shares, provided in each case that the Optionee has been continually employed by the Company or its subsidiaries since the Date of Grant. (b) MINIMUM NUMBER OF SHARES. This Option shall be exercisable for at least 100 Common Shares (without regard to adjustments to the number of Common Shares subject to this Option pursuant to Article 10 of the Plan) or, if less, (i) the number of shares with respect to which this Option has become vested under Section 3(a) above, or (ii) all of the remaining Common Shares subject to this Option. (c) FULL VESTING ON CHANGE IN CONTROL. Notwithstanding subparagraph (a) hereof, this Option shall become fully exercisable as to the Total Award Common Shares immediately preceding any Change in Control with respect to the Company. In the event that the 2 Committee determines that a Change in Control is likely to occur, the Company shall so advise the Optionee, and the provisions of this subparagraph (c) shall take effect as of the date ten (10) days prior to the anticipated date of such Change in Control. (d) ACCELERATED VESTING IN CERTAIN CASES. Notwithstanding subparagraph (a) hereof, if the Optionee terminates employment with the Company and its subsidiaries on account of death or Disability, all options granted hereunder shall become fully exerciseable. Moreover, if the Optionee terminates employment with the Company and its subsidiaries on account of Retirement, all options granted hereunder shall become fully exerciseable, but only if such Retirement occurs at least two (2) years after the date of grant. (e) VESTING CONTINGENT ON SATISFACTORY PERFORMANCE. Notwithstanding subparagraph (a) hereof, the continued accrual of vesting pursuant to subparagraph (a) is contingent upon the Optionee's satisfactory job performance, and the Company may, in its sole discretion, upon notice to the Optionee suspend or delay the vesting of Options hereunder for any period of time in the event that the Company determines, within its sole discretion, that the Optionee's performance is unsatisfactory. (f) SUSPENSION OF VESTING DURING CERTAIN LEAVES OF ABSENCE. Notwithstanding subparagraph (a) hereof, the continued accrual of vesting pursuant to subparagraph (a) shall be suspended during the period of time in which the Optionee is on a leave of absence of more than six months for any reason other than (i) medical reasons, (ii) pregnancy disability, (iii) a leave qualifying under the Family and Medical Leave Act, or (iv) workers' compensation. SECTION 4. EXERCISE OF OPTION. (a) NOTICE OF EXERCISE. The Optionee or the Optionee's representative may exercise this Option by giving written notice to the Company (or its designee) pursuant to Section 9(d). The notice shall specify the election to exercise this Option, the date of exercise, the number of Common Shares for which it is being exercised and the form of payment. The notice shall be signed by the person or persons exercising this Option. In the event that this Option is being exercised by the representative of the Optionee, the notice shall be accompanied by proof satisfactory to the Company of the representative's right to exercise this Option. The Purchase Price for Common Shares shall be paid in a form that conforms to Sections 6.1 through 6.3 of the Plan at the time such notice is given. (b) ISSUANCE OF SHARES. After receiving a proper notice of exercise, the Company shall cause to be issued a certificate or certificates for the Common Shares so purchased, registered in the name of the person exercising this Option. The Company shall cause such certificate or certificates to be delivered to or upon the order of the person exercising this Option. 3 SECTION 5. TERM. (a) BASIC TERM. This Option shall in any event expire on the date specified in Section 1(d). (b) TERMINATION OF EMPLOYMENT. Subject only to the provisions of Section 3(d), upon the Optionee's termination of employment with the Company and its subsidiaries for any reason, whether as a result of any voluntary or involuntary event of termination of employment (including a termination of employment as may be provided for or determined under an employment contract, if any, entered into between the Company or its subsidiary and the Optionee) (each, a "Termination Event"), no unvested portion of the Total Award Common Shares thereafter shall vest or become exercisable. With respect to the vested or exercisable portion of the Total Award Common Shares as of the date of such a Termination Event, this Option shall expire on the earlier of (i) the expiration date specified in Section 1(d) or (ii) whichever of the following is applicable: (A) in the case of a Termination Event resulting from death or Disability, the date one year following such Termination Event; or (B) in all other cases, the date three (3) months following such Termination Event. (c) DIVESTMENT OF OPTIONS. Notwithstanding anything to the contrary contained herein, this Option shall immediately become forfeited and expire in the event that the Company terminates the Optionee's employment on account of conduct inimical to the best interests of the Company, including, without limitation, conduct constituting a violation of law or Company policy, fraud, theft, conflict of interest, dishonesty or harassment. The determination whether the Optionee's employment has been terminated on account of conduct inimical to the best interests of the Company shall be made by the Company in its sole discretion. SECTION 6. LEGALITY OF INITIAL ISSUANCE. No Common Shares shall be issued upon the exercise of this Option unless and until the Company has determined that: (a) A registration statement for the Common Shares is effective under the Securities Act or an exemption from the registration requirements thereof has been perfected; (b) Any applicable listing requirement of any stock exchange on which Common Shares are listed has been satisfied; and (c) Any other applicable provisions of state or federal law have been satisfied. SECTION 7. NO REGISTRATION RIGHTS. 4 The Company may, but shall not be obligated to, register or qualify the Common Shares for resale or other disposition by the Optionee under the Securities Act or any other applicable law. SECTION 8. RESTRICTIONS ON TRANSFER OF SHARES. (a) RESTRICTIONS. Regardless of whether the offering and sale of Common Shares under the Plan have been registered under the Securities Act or have been registered or qualified under the securities laws of any state, the Company may impose restrictions upon the sale, pledge or other transfer of such Common Shares (including the placement of appropriate legends on stock certificates) if, in the judgment of the Company and its counsel, such restrictions are necessary or desirable in order to achieve compliance with the provisions of the Securities Act, the securities laws of any state or any other law. (b) INVESTMENT INTENT AT EXERCISE. If the Common Shares under the Plan are not registered under the Securities Act but an exemption is available which requires an investment representation or other representation, the Optionee shall represent and agree at the time of exercise that the Common Shares being acquired upon exercising this Option are being acquired for investment, and not with a view to the sale or distribution thereof, and shall make such other representations as are deemed necessary or appropriate by the Company and its counsel. (c) ADMINISTRATION. Any determination by the Company and its counsel in connection with any of the matters set forth in this Section 8 shall be conclusive and binding on the Optionee and all other persons. SECTION 9. MISCELLANEOUS PROVISIONS. (a) WITHHOLDING TAXES. To the extent required by applicable federal, state, local or foreign law the Optionee shall make arrangements satisfactory to the Company for the satisfaction of any withholding tax obligations that arise by reason of the exercise of an Option hereunder and no Option may be exercised unless such obligation is satisfied. (b) RIGHTS AS A STOCKHOLDER. Neither the Optionee nor the Optionee's representative shall have any rights as a stockholder with respect to any Common Shares subject to this Option until certificates for such Common Shares have been issued in the name of the Optionee or the Optionee's representative. (c) NO EMPLOYMENT RIGHTS. Nothing in this Agreement shall be construed as giving the Optionee the right to be retained as an employee of the Company or its subsidiaries. The Company reserves the right to terminate the Optionee's employment at any time for any reason, subject only to the terms of any written employment contract entered into between the Company and the Optionee. 5 (d) NOTICE. Any notice required by the terms of this Agreement shall be given in writing and shall be deemed effective upon personal delivery or upon deposit with the appropriate postal service, by registered or certified mail with postage and fees prepaid and addressed to the party entitled to such notice at the address shown below such party's signature on this Agreement, or at such other address as such party may designate by ten (10) days advance written notice to the other party to this Agreement. Notwithstanding the foregoing, no notice of exercise, as required by Section 4(a), shall be effective until actual receipt thereof by the Company or its designee. (e) ENTIRE AGREEMENT. This Agreement and the Plan constitute the entire agreement between the parties hereto with regard to the subject matter hereof; provided, however, that in the event of any inconsistency or conflict between any provision hereof and the terms of the Plan, the terms of the Plan shall control. (f) CHOICE OF LAW. This Agreement shall be governed by, and construed in accordance with, the laws of the State of California, as such laws are applied to contracts entered into and performed in such State. SECTION 10. DEFINITIONS. (a) Capitalized terms defined in the Plan shall have the same meaning when used in this Agreement. (b) "CHANGE IN CONTROL" shall mean the occurrence of any of the following events after the effective date of the Plan as set out in Section 15.1 of the Plan: (1) A change in control required to be reported pursuant to Item 6(e) of Schedule 14A of Regulation 14A under the Securities Exchange Act of 1934, as amended (the "Exchange Act"); (2) A change in the composition of the Company's Board of Directors (the "Board"), as a result of which fewer than two-thirds of the incumbent directors are directors who either (i) had been directors of the Company 24 months prior to such change or (ii) were elected, or nominated for election, to the Board with the affirmative votes of at least a majority of the directors who had been directors of the Company 24 months prior to such change and who were still in office at the time of the election or nomination; (3) Any "person" (as such term is used in Sections 13(d) and 14(d) of the Exchange Act) becomes the beneficial owner, directly or indirectly, of securities of the Company representing 20 percent or more of the combined voting power of the Company's then outstanding securities ordinarily (and apart from rights accruing under special circumstances) having the right to vote at elections of directors (the "Base Capital Stock"); provided, however, that any change in the relative beneficial ownership of securities of any person resulting solely from a reduction in the aggregate number of outstanding shares of Base Capital Stock, and any decrease thereafter in such person's ownership of securities, shall be disregarded until such 6 person increases in any manner, directly or indirectly, such person's beneficial ownership of any securities of the Company. (c) "COMMON SHARE" shall mean one share of the common stock of the Company. (d) "DATE OF GRANT" shall mean the date of this Agreement, which is the date first written above. (e) "FAIR MARKET VALUE" shall mean the market price of a Common Share, determined by the Committee as follows: (1) If the Common Share was traded on a stock exchange on the date in question, then the Fair Market Value shall be equal to the closing price reported by the applicable composite-transactions report for such date; (2) If the Common Share was traded over-the-counter on the date in question and was classified as a national market issue, then the Fair Market Value shall be equal to the last transaction price quoted by the NASDAQ system for such date; (3) If the Common Share was traded over-the-counter on the date in question but was not classified as a national market issue, then the Fair Market Value shall be equal to the mean between the last reported representative bid and asked prices quoted by the NASDAQ system for such date; and (4) If none of the foregoing provisions is applicable, then the Fair Market Value shall be determined by the Committee in good faith on such basis as it deems appropriate. (f) "PURCHASE PRICE" shall mean the Exercise Price multiplied by the number of Common Shares with respect to which this Option is being exercised. (g) "RETIREMENT" shall mean a termination of employment of the Optionee occurring at any time after the Optionee (i) has attained fifty (50) years of age, and (ii) completed seven (7) years of service, as determined pursuant to the terms of the Charles Schwab Profit Sharing and Employee Stock Ownership Plan. (h) "SECURITIES ACT" shall mean the Securities Act of 1933, as amended. 7 EX-10.195 12 EXHIBIT 10.195 EXHIBIT 10.195 CHARLES SCHWAB PROFIT SHARING AND EMPLOYEE STOCK OWNERSHIP PLAN AS AMENDED THROUGH DECEMBER 1, 1997 CHARLES SCHWAB PROFIT SHARING AND EMPLOYEE STOCK OWNERSHIP PLAN AS AMENDED THROUGH DECEMBER 1, 1997 TABLE OF CONTENTS
Section Page - ------- ----- 1 Introduction and Purpose..................................... 1 2 Definitions.................................................. 2 3 Participation................................................ 14 4 Employer Contributions....................................... 16 5 Salary Reduction Agreements and Rollover Contributions....... 23 6 Allocation of Contributions.................................. 29 7 Special ESOP Provisions...................................... 30 8 Investment of Contributions, Valuations and Participants' Cash Contribution Accounts................................. 37 9 Retirement Dates............................................. 39 10 Eligibility for Payment of Accounts and Vested Interests.... 40 11 Method of Payment of Accounts and Withdrawals................ 44 12 Maximum Amount of Allocation................................. 56 13 Voting Rights................................................ 59 14 Designation of Beneficiaries................................. 63 15 Administration of the Plan................................... 64 16 Expenses..................................................... 69 17 Employer Participation....................................... 70 18 Amendment or Termination of the Plan......................... 73 19 Top-Heavy Plan Requirements.................................. 76 20 General Limitations and Provisions........................... 82 21 Application to Puerto Rico Employees......................... 91
CHARLES SCHWAB PROFIT SHARING AND EMPLOYEE STOCK OWNERSHIP PLAN AS AMENDED THROUGH DECEMBER 1, 1997 SECTION 1. INTRODUCTION AND PURPOSE 1.1 The Plan Sponsor has established and maintains the Plan to enable each Participant to benefit, in accordance with the terms of the Plan, from contributions made by the Employer and from any increases in the value of the Plan assets through investment of such assets. The Plan is comprised of three parts: (i) a Section 401(k) plan, (ii) a profit sharing plan and (iii) an employee stock ownership plan. The purpose of the employee stock ownership plan portion of the Plan is to align Employees' interests with the interests of shareholders. It is anticipated that Employer contributions to the employee stock ownership plan will be invested primarily or entirely in Shares of The Charles Schwab Corporation, that the employee stock ownership plan may acquire such Shares of The Charles Schwab Corporation from time to time with the proceeds of one or more Exempt Loans, the repayment of which may be secured in part by a pledge of the Shares of The Charles Schwab Corporation acquired with those loan proceeds, and that Employer contributions to the employee stock ownership plan may be used in full or in substantial part to the payment of interest on, and retirement of principal of, such Exempt Loans. This Plan is a restatement of the Charles Schwab Profit Sharing and Employee Stock Ownership Plan, which was initially effective as of October 1, 1983. The effective date of this restatement is December 13, 1996. The rights of any person who terminated employment or who retired on or before the effective date of this restated Plan or any provision hereof, including his or her eligibility for benefits and the time and form in which benefits, if any, will be paid, shall be determined solely under the terms of the Plan provisions as in effect on the date of his or her termination of employment or retirement, unless such person is thereafter reemployed and 1 again becomes a Participant. The rights of any other person shall be determined solely under the terms of this restated Plan, except as may otherwise be required by law. The Plan and Trust are intended to qualify as a plan and trust which are qualified and exempt from taxation under Sections 401(a) and 501(a) of the Code. The Plan is intended to qualify in part as a profit sharing plan (as defined in Section 401(a)(27) of the Code) and in part as a stock bonus plan and an employee stock ownership plan (as defined by Section 4975(e)(7) of the Code and Section 407(d)(6) of the Act) designed to invest primarily in shares of stock of the Employer which meet the requirements for "qualifying employer securities" under Section 4975(e)(8) of the Code and Section 407(d)(5) of the Act. All provisions of the Plan and Trust shall be construed accordingly. All Trust Fund assets acquired under the Plan as a result of debt incurred to purchase Shares, Employer contributions, income and other additions to the Trust Fund shall be administered, distributed, forfeited and otherwise governed by the provisions of the Plan. It is intended that the Trust associated with the Plan be exempt from federal income taxation pursuant to the provisions of Section 501(a) of the Code. Subject to the provisions of Section 16 of the Plan, the assets of the Plan shall be applied exclusively for the purposes of providing benefits to Participants and Beneficiaries under the Plan and for defraying expenses incurred in the administration of the Plan and its corresponding Trust. SECTION 2. DEFINITIONS When used herein the following terms shall have the following meanings: 2.1 "Account" means the account or accounts established and maintained on behalf of a Participant pursuant to (i) Section 6.1 with respect to the Participant's Cash Contribution Account and (ii) Section 7.1 with respect to the Participant's ESOP Account. 2.2 "Act" means the Employee Retirement Income Security Act of 1974, as now in effect or as hereafter amended. 2 2.3 "Actual Deferral Percentage" means the average of the ratios (calculated separately for each Employee) for each Plan Year of (a) the amount of Elective Contributions and Matching Contributions or Qualified Nonelective Contributions (if the Committee determines to take such Matching Contributions or such Qualified Nonelective Contributions into account when calculating Actual Deferral Percentage) on behalf of each Employee for the relevant Plan Year to (b) the Employee's compensation (as defined in Treasury Regulation 1.415-2(d)(10) or in such other manner as is prescribed under Section 414(s) of the Code) while a Participant for the relevant Plan Year. 2.4 "Affiliated Employer" means any corporation which is included in a controlled group of corporations (within the meaning of Section 414(b) of the Code) which includes the Plan Sponsor, any trade or business (whether or not incorporated) which is under common control with the Plan Sponsor (within the meaning of Section 414(c) of the Code), any organization included in the same affiliated service group (within the meaning of Section 414(m) of the Code) as the Plan Sponsor and any other entity required to be aggregated with the Plan Sponsor pursuant to the Regulations under Section 414(o) of the Code; except that for purposes of applying the provisions of Sections 12 and 19 with respect to the limitations on contributions, Section 415(h) of the Code shall apply. 2.5 "Beneficiary" means the beneficiary or beneficiaries designated by a Participant pursuant to Section 14 to receive the amount, if any, payable under the Plan upon the death of such Participant. 2.6 "Board of Directors" means the board of directors of Charles Schwab & Co., Inc. 2.7 "Break in Service" means a Plan Year (or for purposes of determining membership in the Plan pursuant to Section 3, the Computation Period) during which an individual has not completed more than 500 Hours of Service, as determined by the Committee in accordance with the Regulations. A Break in Service shall be deemed to have commenced on the first day of the Plan Year in which it occurs. Solely for purposes of determining whether a 3 Break in Service has occurred, an individual shall be credited with the Hours of Service which such individual would have completed but for a maternity or paternity absence, as determined by the Committee in accordance with this Section 2.7 and the Code and Regulations; provided, however, that the total Hours of Service so credited shall not exceed 501 Hours of Service and that the individual shall timely provide the Committee with such information as it shall require. Hours of Service credited for a maternity or paternity absence shall be credited at eight Hours of Service per day and shall be credited entirely (i) in the Plan Year or Computation Period in which the absence began if such Hours of Service are necessary to prevent a Break in Service in such Plan Year, or (ii) in the following Plan Year or Computation Period. For purposes of this Section 2.7, maternity or paternity absence shall mean an absence from work by reason of the individual's pregnancy, the birth of the individual's child or the placement of a child with the individual in connection with adoption of the child by such individual, or for purposes of caring for a child for the period immediately following such birth or adoption. 2.8 "Cash Contribution Account" means the account or accounts established and maintained on behalf of a Participant pursuant to Section 6.1 with respect to the Participant's Elective Contributions, Matching Contributions, Profit Sharing Contributions, Qualified Nonelective Contributions or Rollover Contributions. 2.9 "Code" means the Internal Revenue Code of 1986, as now in effect or as hereafter amended. All citations to sections of the Code are to such sections as they may from time to time be amended or renumbered. 2.10 "Committee" means the Administrative Committee of the Employer provided for in Section 15. For purposes of the Act, the Employer shall be the "named fiduciary" (with respect to the matters for which it is hereby responsible under the Plan) of the Plan, and the Employer shall be the "plan administrator" of the Plan within the meaning of Section 3(16)(A) of the Act. 2.11 "Compensation" means a Participant's W-2 compensation related to services rendered to the Employer, excluding (i) living allowances, (ii) travel or commuting allowances, 4 (iii) reimbursements for financial planning, (iv) amounts that are paid as a result of participation in the Employer's Long-Term Incentive Plan, (v) employee referral awards, (vi) special incentive awards (other than regular bonus programs), (vii) reimbursements for relocation expenses, (viii) commissions (other than "dual commissions", commissions based on trading results that are paid to traders who are also salaried and commissions where the Participant's only form of remuneration is commissions), (ix) income items attributable to the taxable portion of employee benefits and any cash payments made as a result of an Employee's election not to receive insured benefits pursuant to the Company's Pre-Tax Contribution Plan, (x) amounts paid as short term disability benefits, (xi) any income items reflecting grants in aid, and (xii) compensation in excess of $150,000 (adjusted for cost of living to the extent permitted by Section 401(a)(17) of the Code and Regulations). For purposes of determining the whole percentage of Compensation for which a Participant may make a Salary Reduction Agreement, and not for any other purposes, subparagraph (ix) hereof shall be disregarded. Compensation shall be determined prior to reduction for any contributions pursuant to such Participant's election under Section 5.1, and any elective contributions made by the Employer on behalf of the Participant in the Plan Year that are not includable in gross income under Section 125 of the Code. 2.12 "Computation Period" means a 12 consecutive month period beginning on the day an individual first performs an Hour of Service or first performs an Hour of Service following a Break in Service. Thereafter, the Computation Period shall be the Plan Year, commencing with the Plan Year that includes the day immediately following the last day of the Computation Period determined pursuant to the first sentence hereof. 2.13 "Contribution Percentage" means the average of the ratios (calculated separately for each Participant for each Plan Year) of (a)(i) Matching Contributions, if any, made by the Employer on behalf of a Participant and (ii) Elective Contributions, (if the Committee elects to take into account Elective Contributions when calculating the Contribution Percentage) to (b) the Employee's compensation (as defined in Section 1.415-2(d)(10) of the Regulations or in such 5 other manner as is prescribed under Section 414(s) of the Code) while a Participant for the relevant Plan Year. 2.14 "Deferred Retirement Date" shall have the meaning set forth in Section 9.2. 2.15 "Disability" means the inability to engage in any substantial gainful activity considering the Participant's age, education and work experience by reason of any medically determined physical or mental impairment that has continued without interruption for a period of at least six months and that can be expected to be of long, continued and indefinite duration. The determination of the Committee as to whether a Participant has a Disability shall be final, binding and conclusive. 2.16 "Effective Date" means October 1, 1983. 2.17 "Elective Contributions" means contributions made to the Trust Fund pursuant to a Participant's Salary Reduction Agreement entered into pursuant to Section 5.1, and which are considered tax deferred under Section 401(k) of the Code. 2.18 "Elective Contribution Subaccount" means the account established and maintained on behalf of a Participant pursuant to Section 6.2(a) with respect to his or her Elective Contributions and Qualified Nonelective Contributions. 2.19 "Employee" means any "regular employee" of the Employer who is paid through United States payroll and for whom the Employer is required to withhold United States Federal employment taxes excluding (i) any person covered by any other pension, profit sharing or retirement plan to which any Employer or Affiliated Employer is required to contribute either directly or indirectly, (ii) any nonresident alien individual who received no earned income (within the meaning of Section 911(d)(2)) from the Employer which constitutes income from sources within the United States, (iii) any employee who is included in a unit of employees covered by a negotiated collective bargaining agreement which does not provide for his or her membership in the Plan, (iv) any individual who provides services to the Employer pursuant to an independent contractor agreement, irrespective of whether such individual is subsequently retroactively reclassified as a common law employee for periods during which the Employer 6 originally classified such individual as an independent contractor, and (v) any individual who provides services to the Employer pursuant to an agreement between the Employer and a temporary agency or other leasing organization. A director of the Employer is not eligible for membership in the Plan unless such director is also an Employee. A leased employee (within the meaning of Section 414(n) of the Code) is not eligible for membership in the Plan unless the Employer designates such individual as eligible for membership in the Plan. 2.20 "Employer" means Charles Schwab & Co., Inc. and any Participating Employer which adopts this Plan subject to the approval of the Board of Directors. 2.21 "ESOP Account" means the account established and maintained on behalf of a Participant pursuant to Section 7.1 with respect to his or her ESOP Contributions. 2.22 "ESOP Contributions" means the Employer contributions, if any, made to the Plan on behalf of a Participant pursuant to Section 4.2(c). 2.23 "ESOP/Profit Sharing Entry Date" means the first day of each calendar month. 2.24 "Exempt Loan" means any loan to the Plan or Trust not prohibited by Section 4975(c) of the Code and Section 406 of the Act because the loan meets the requirements set forth in Section 4975(d)(3) of the Code, Section 408(b)(3) of the Act and the Regulations promulgated thereunder, the proceeds of which loan are used within a reasonable time after receipt by the Trust Fund only for any or all of the following purposes: (a) to acquire Shares; (b) to repay the same Exempt Loan; or (c) to repay any previous Exempt Loan. 2.25 "Highly Compensated Participant" means any Participant who, during the relevant period, is treated as a highly compensated employee under Section 414(q) of the Code. For purposes of determining which Employee is a Highly Compensated Participant, the look-back determination shall be made on the basis of the calendar year. The Plan shall comply with the procedures of Treasury Regulation 1.401(k)-1(f) to the extent applicable. For purposes of determining which Employee is a Highly Compensated Participant: 7 (A) Highly Compensated Participant means a Participant who performs Services during the determination year and is described in one or more of the following groups: (1) An Employee who is a five percent (5%) owner, as defined in Section 416(i)(1) of the Code, at any time during the determination year or the look-back year. (2) An Employee who: (a) had compensation from the Employer in excess of $80,000 (indexed as referenced in Section 414(q)(1) of the Code) during the look-back year and (b) if the Employer elects the application of this Subsection 2.25(A)(2) for such look-back year, such Employee was in the "top-paid group" for the look-back year. (B) For purposes of this Section: (1) The determination year is the Plan Year for which the determination of who is a Highly Compensated Participant is being made. (2) The look-back year is the calendar year ending with or within the determination year. (3) The "top-paid group" consists of the top twenty percent (20%) of Employees ranked on the basis of compensation received during the look-back year. For purposes of determining the number of Employees in the top-paid group, Employees described in Section 414(q)(5) of the Code and the Regulations promulgated thereunder are excluded. (4) For purposes of this Section 2.25, the term "compensation" means compensation as defined in Section 414(q)(4) of the Code. (5) Employers aggregated under Section 414(b), (c), (m), or (o) of the Code are treated as a single employer. (6) Highly Compensated Participants include a former Employee who had a separation year prior to the determination year and who was a Highly Compensated Participant for either (A) the determination year in which the Employee separated from Service or (B) any determination year ending on or after the Employee's 55th birthday. With respect to an Employee who separated from Service before January 1, 1987, an Employee 8 will be included as a Highly Compensated Participant only if the Employee was a five percent (5%) owner or received Compensation in excess of $50,000 during (1) the determination year in which the Employee separated from Service (or the year preceding such separation year) or (2) any year ending on or after such Employee's 55th birthday (or the last year ending before such Employee's 55th birthday). 2.26 "Hours of Service" means hours during the applicable Computation Period in which an individual performs Service or is treated as performing Service and, except in the case of military service or as otherwise determined by the Committee, for which the Participant is directly or indirectly entitled to payment. For all purposes under the Plan, (i) an individual scheduled to work more than twenty hours per week shall be credited (under rules determined by the Committee, uniformly applicable to all individuals similarly situated and in accordance with the Regulations) with 190 Hours of Service for each calendar month in which the individual would otherwise be credited with one or more Hours of Service and (ii) an individual who is scheduled to work less than twenty hours per week shall be credited with Hours of Service for the applicable period in which such Hours of Service accrue in accordance with Labor Department Regulation 29 CFR Section 2530.200b-2(c), which regulation is incorporated herein by reference. Hours of Service for reasons other than the performance of duties shall be credited in accordance with Labor Department Regulation 29 CFR Section 2530.200b-2(b), which regulation is incorporated herein by reference. The term "Service" includes performance of duties (or periods which are treated as the performance of duties) for the Employer or for any Affiliated Employer (under rules determined by the Committee, uniformly applicable to all individuals similarly situated and in accordance with the Regulations) for which an individual is entitled to receive credit for "Service", including (i) vacation, (ii) holiday, (iii) absence authorized by the Employer for sickness or incapacity (including disability or leave of absence), (iv) layoff, (v) jury duty, (vi) if and to the extent required by the Military Selective Service Act, as amended or any other federal law, service in the Armed Forces of the United States and (vii) an approved leave of absence 9 granted by the Employer to an individual on or after August 5, 1993 pursuant to the Family Medical Leave Act, but only if such individual returns to work for the Employer at the end of such approved leave. Service also includes periods of time for which back pay, irrespective of mitigation of damages, is awarded or agreed to by the Employer or any Affiliated Employer; provided that such award or agreement is not already credited as Service under either of the preceding two sentences. Service may also include any period of a Participant's prior employment by an organization upon such terms and conditions as the Committee may approve and subject to any required IRS approval. Notwithstanding the foregoing, (i) Hours of Service credited with respect to an individual's service with BankAmerica Corporation or a related corporation between January 11, 1983 and March 31, 1987 shall be considered Service only if such individual was employed by the Employer prior to November 24, 1993, (ii) Hours of Service credited with respect to an individual's service with BankAmerica Corporation or a related corporation prior to January 11, 1983 shall be considered Service, but only if such individual was employed by the Employer prior to April 1, 1987, (iii) Hours of Service credited with respect to service with Mayer & Schweitzer, Inc. prior to July 1, 1991 shall be considered Service, and (iv) Service shall include service with The Rose Company prior to April 1, 1989, service with Performance Technologies, Inc. prior to August 31, 1994, service with TrustMark, Inc. prior to July 31, 1995, and service with Hampton Pension Services, Inc. prior to November 6, 1995. 2.27 "IRS" means the United States Internal Revenue Service. 2.28 "Labor Department" means the United States Department of Labor. 2.29 "Matching Contribution" means any Employer contribution, if any, made to the Plan on behalf of a Participant pursuant to Section 4.2(a). 2.30 "Matching Contribution Subaccount" means the account established and maintained on behalf of a Participant pursuant to Section 6.2(b) with respect to the Participant's Matching Contributions. 2.31 "Normal Retirement Date" shall have the meaning set forth in Section 9.1. 10 2.32 "Participant" means any Employee who has satisfied the eligibility requirements of Section 3 below. 2.33 "Participating Employer" means Charles Schwab & Co., Inc. or any other Affiliated Employer, the board of directors or equivalent governing body of which shall adopt the Plan and Trust Agreement by appropriate action with the written consent of the Board of Directors. By its adoption of this Plan, a Participating Employer shall be deemed to appoint Charles Schwab, & Co., Inc., the Committee and the Trustee its exclusive agent to exercise on its behalf all of the power and authority conferred by this Plan upon the Employer. The authority of Charles Schwab & Co., Inc., the Committee and the Trustee to act as such agent shall continue until the Plan is terminated as to the Participating Employer and the relevant Trust Fund assets have been distributed by the Trustee as provided in Section 17 of this Plan. 2.34 "Plan" means this Charles Schwab Profit Sharing and Employee Stock Ownership Plan as the same is stated herein and as it may be amended from time to time. 2.35 "Plan Sponsor" means The Charles Schwab Corporation. 2.36 "Plan Year" means the calendar year. 2.37 "Profit Sharing Contribution" means the Employer contribution, if any, made to the Plan on behalf of a Participant pursuant to Section 4.2(b)(ii). 2.38 "Profit Sharing Subaccount" means the account established and maintained on behalf of a Participant pursuant to Section 6.2(c) with respect to the Participant's Profit Sharing Contributions. 2.39 "Purchasing Agent" means the agent designated by the Trustee to enter into certain transactions with respect to Shares hereunder. 2.40 "Qualified Nonelective Contribution" means the Employer contribution, if any, made to the Plan on behalf of a Participant pursuant to Section 4.2(b)(i). 2.41 "Regulations" means the applicable regulations issued under the Code or the Act by the IRS, the Labor Department or any other governmental authority and any temporary rules or releases promulgated by such authorities pending the issuance of such regulations. 11 2.42 "Restated Effective Date" shall mean January 1, 1994. 2.43 "Retirement Date" means the Participant's Normal or Deferred Retirement Date which has become effective pursuant to Section 9 below. 2.44 "Rollover Subaccount" means the account established and maintained on behalf of a Participant pursuant to Section 6.2(d) with respect to the Participant's Rollover Contributions. 2.45 "Rollover Contribution" means any contribution made by an Employee pursuant to Section 5.6. 2.46 "Salary Reduction Agreement" means an agreement between a Participant and the Employer entered into pursuant to Section 5.1. 2.47 "Section 401(k) Entry Date" means April 1 and October 1 of each calendar year. 2.48 "Shares" means (i) with respect to Plan assets acquired with the proceeds of an Exempt Loan, the common stock issued by The Charles Schwab Corporation or any successor corporation thereto meeting the requirements of both Section 4975(e)(8) of the Code and Section 407(d)(5) of the Act for "qualifying employer securities," and (ii) with respect to Plan assets other than those acquired with the proceeds of an Exempt Loan, stock issued by The Charles Schwab Corporation or any successor corporation thereto, of any type, kind or class meeting the requirements of Section 407(d)(5) of the Act for "qualifying employer securities". All valuations of Shares, where such Shares are not readily tradable on an established securities market and where such valuations relate to activities carried on by the Plan, shall be made by one or more independent appraisers retained by the Committee, who meet the requirements, if any, of the Code and Regulations. To the extent and in the manner required by the Code and Regulations, all independent appraisers, if any, making appraisals pursuant to the foregoing sentence shall be registered with the IRS. 2.49 "Surviving Spouse" means the survivor of a Participant to whom such Participant was legally married on the date of the Participant's death. 2.50 "Suspense Subfund" means the subfund established under Section 7.3. 12 2.51 "Taxable Compensation" means the W-2 compensation paid to an individual for Service during any period under consideration. 2.52 "Taxable Year" means the calendar year. 2.53 "Total Break in Service" means a period of five or more consecutive Computation Periods in which a Participant incurs a Break in Service, with respect to a Participant who did not have a nonforfeitable right to any portion of his or her Profit Sharing Subaccount or ESOP Account prior to the beginning of the first such Computation Period. 2.54 "Trustee" means the Trustee selected by the Employer to hold the funds contributed by the Employer to provide benefits under the Plan or any successor or substitute. 2.55 "Trust Agreement" means the Charles Schwab Profit Sharing and Employee Stock Ownership Plan Trust Agreement, as it may from time to time be amended, and such additional and successor trust agreements as may be executed. 2.56 "Trust Fund" means the funds held by the Trustee from which payments to the Trustee are made to provide benefits under the Plan. 2.57 "Valuation Date" means the last day of each Plan Year or such interim periods as the Committee may designate from time to time. 2.58 "Vested Interest" means the portion of a Participant's Account which has become nonforfeitable pursuant to Section 10.3 below. 2.59 "Year of Eligibility Service" means a Computation Period during which an Employee completes at least 1,000 Hours of Service. 2.60 "Year of Service" means a Computation Period during which an individual completed at least 1,000 Hours of Service or satisfied any alternative requirement, as determined by the Committee from time to time in accordance with the Regulations. 13 SECTION 3. PARTICIPATION 3.1 COMMENCEMENT OF PARTICIPATION. (a) An Employee who is a Participant as of the date immediately preceding the Restated Effective Date shall continue to be a Participant of the Plan as of the Restated Effective Date. (b) An Employee who is not a Participant on the Restated Effective Date and who (A) is in Service on the Restated Effective Date or (B) commences Service on or after the Restated Effective Date shall be eligible to become a Participant of the Plan for purposes of: (i) Elective Contributions, Matching Contributions and Qualified Nonelective Contributions on the first Section 401(k) Entry Date coincident with or next following his or her commencement of Service; and (ii) Profit Sharing Contributions and ESOP Contributions on the first ESOP/Profit Sharing Entry Date coincident with or next following the date on which he or she completes a Year of Eligibility Service. (c) An Employee who is eligible to become a Participant, but declines to participate in the Plan, may become a Participant as of any subsequent Section 401(k) Entry Date or ESOP/Profit Sharing Entry Date. (d) An Employee who satisfies the requirements of Section 3.1(b)(ii) for participation but who terminates Service prior to becoming a Participant in the Plan and subsequently becomes an Employee again prior to incurring a Break in Service will become a Participant in the Plan for all purposes as of the first day on which such individual again becomes an Employee. 3.2 CESSATION OF PARTICIPATION. A Participant shall cease to be a Participant upon the earliest to occur of (i) the Participant's retirement on his or her Retirement Date, (ii) the Participant's death or Disability or (iii) the Participant's termination of Service prior to his or her Retirement Date followed by a Break in Service. A Participant who, without any Break in 14 Service, ceases to be an Employee for any reason, shall not cease to be a Participant, provided that, notwithstanding any other provision of the Plan, and except as provided in Section 4.3, no contribution shall be made for the benefit of such Participant, no contributions under the Plan shall be allocated, added or otherwise credited to the Account of such Participant, and no contributions, forfeitures or Shares released from a Suspense Subfund shall be allocated, added or otherwise credited to the Account of such Participant on or after the date on which such Participant ceases to be an Employee and before the first day of the Plan Year coincident with or preceding the date, if any, on which such Participant again resumes Service as an Employee. 3.3 READMISSION AFTER CESSATION OF PARTICIPATION. A Participant who has incurred a Total Break in Service and subsequently returns to Service shall be treated as a new Employee for all purposes of the Plan. In all other cases, a former Participant who returns to Service following a Break in Service shall again become a Participant as of the first date of such former Participant's return to Service, except that (i) such Participant shall not be eligible to commence Elective Contributions until the first Section 401(k) Entry Date or ESOP/Profit Sharing Entry Date coincident with or next following the date the Participant returns to Service, and (ii) if such former Participant is not then an Employee, such former Participant shall again become a Participant as of the first day on which such former Participant again becomes an Employee. 3.4 WAIVER OF PARTICIPATION. An individual who has satisfied the requirements for participation set forth in Section 3.1 may permanently waive participation in the Plan, but only if such individual is on temporary transfer of employment to a Participating Employer from an Affiliated Employer that is not a Participating Employer. 15 SECTION 4. EMPLOYER CONTRIBUTIONS 4.1 ELECTIVE CONTRIBUTIONS. The Employer shall, subject to the limitations of Sections 5 and 12, contribute to the Trust Fund for each Plan Year on behalf of all Participants the total amount of Elective Contributions designated to be contributed pursuant to Salary Reduction Agreements under Section 5.1. Such contributions shall be paid in cash by the Employer to the Trustee as soon as practicable, but in no event later than 90 days from the date on which such amounts otherwise would have been payable to the Participant in cash. 4.2 EMPLOYER CONTRIBUTIONS. (a) Subject to the limitations of Section 12, the Employer shall contribute Matching Contributions to the Trust Fund on behalf of all Participants for whom Elective Contributions have been made equal to a percentage of such Elective Contributions made for each such Participant. The percentage (and, if desired, a maximum dollar amount) of Matching Contributions shall be determined from time to time by the Board of Directors and communicated to the Participants. (b) Subject to the limitations of Section 12, for any Plan Year, the Board of Directors may designate (i) a percentage of the aggregate Compensation of all Participants or a fixed dollar amount to be contributed to the Plan as Qualified Nonelective Contributions on behalf of certain Participants who are not Highly Compensated Participants and may designate (ii) a percentage of the aggregate Compensation of all Participants or a fixed dollar amount to be contributed to the Plan as Profit Sharing Contributions on behalf of all Employees who are or would be Participants but for their election not to make Elective Contributions. Provided, however, that effective as of January 1, 1995, no further Profit Sharing Contributions shall be made to the Plan. (c) Subject to the limitations of Section 12, and the provisions of any applicable loan or contribution agreement, the Employer shall contribute to the Trust Fund for each Plan Year as ESOP Contributions such sum as the Board of Directors may, in its sole 16 discretion, determine, which sum may be zero. All or any part of the contributions made under this Section 4.2(c) may be applied to repay any outstanding Exempt Loan. The Committee may, subject to any pledge or similar agreement, direct or determine the proportions of such contributions which are applied to repay each such Exempt Loan and, with respect to any particular Exempt Loan, the proportion of such contribution to be applied to repay principal and interest on such Exempt Loan. 4.3 ALLOCATION OF MATCHING CONTRIBUTIONS, PROFIT SHARING CONTRIBUTIONS AND ESOP CONTRIBUTIONS. Matching Contributions shall only be allocated to those Participants employed on the last day of the Plan Year. Profit Sharing Contributions and ESOP Contributions shall only be allocated to Participants who are members of the Allocation Group for the Plan Year. For purposes of Sections 4 and 7, the term "Allocation Group" means the group consisting of (i) each Participant who completed at least One Thousand (1,000) Hours of Service during the Plan Year and is employed by the Employer as of the last day of the Plan Year, and (ii) each Participant whose employment with the Employer terminated during the Plan Year by reason of Disability, death or retirement on or after the Participant's Retirement Date. Profit Sharing Contributions and ESOP Contributions shall be allocated among the Accounts of Participants who are members of the Allocation Group for the Plan Year in the same proportion that a Participant's Compensation during the Plan Year bears to the total Compensation during the Plan Year of all Participants who are members of the Allocation Group for such Plan Year. For purposes of the preceding sentence, Compensation earned by a Participant prior to the Participant's entry into the Plan pursuant to Section 3.1(b)(ii) shall not be taken into account. 4.4 TIMING OF EMPLOYER CONTRIBUTIONS. (a) Any Profit Sharing Contributions, Qualified Nonelective Contributions and ESOP Contributions shall be deemed made on account of a Taxable Year if (i) the Board of Directors determines the amount of such contribution by appropriate action and announces the amount in writing to its Employees within 30 days after the end of such Taxable Year, (ii) the Employer designates such amount in writing as payment on account of such Taxable Year or 17 (iii) the Employer claims such amount as a deduction on its federal tax return for such Taxable Year. (b) Profit Sharing Contributions, Matching Contributions, and, subject to the provisions of any Exempt Loan, ESOP Contributions for any particular Taxable Year may be paid to the Trustee in installments, but in any event such contributions shall be paid no later than the due date for the Employer's federal income tax return for such Taxable Year. The Employer may, during any Taxable Year, make advance payments toward its contributions for such Taxable Year. Any income, earnings or appreciation earned by any amount contributed by the Employer prior to the end of the Plan Year shall be treated as part of the Profit Sharing Contributions, Matching Contributions, or ESOP Contributions, as the case may be, for such Plan Year. On or about the date of such payment the Committee shall be advised of the amount of such payment upon which its allocation pursuant to Section 4.3 is to be calculated. 4.5 FORFEITURES. Forfeitures of Profit Sharing Contributions arising during the Plan Year pursuant to Section 10 shall be used to reduce the amount of Matching Contributions made for such Plan Year pursuant to Section 4.2(a). Forfeitures of Shares attributable to ESOP Contributions (or ESOP Contributions) arising during the Plan Year pursuant to Section 10 shall be reallocated as ESOP Contributions on the last day of the Plan Year in which such forfeiture occurs to all Participants entitled to receive Shares attributable to ESOP Contributions (or ESOP Contributions), in the same proportion as contributions are allocated pursuant to Sections 4.3 and 7.2. Provided, in either case, that forfeitures shall first be used to fund adjustments to Participants' Accounts required to correct operational errors, to the extent directed by the Committee, or to fund any amounts to be recredited to a Participant's Account pursuant to Section 10.5. 4.6 CONTRIBUTION PERCENTAGE TEST. (a) Participant's Contribution Percentages must satisfy at least one of the following tests: 18 (1) The Contribution Percentage for the Highly Compensated Participants shall not exceed the Contribution Percentage of all other Participants for the preceding Plan Year multiplied by 1.25; or (2) (A) The excess of the Contribution Percentage for the Highly Compensated Participants over the Contribution Percentage of all other Participants for the preceding Plan Year shall not be more than two percentage points and (B) the Contribution Percentage for Highly Compensated Participants shall not be more than the Contribution Percentage for all other Participants for the preceding Plan Year multiplied by 2. (b) The Employer may elect to apply the foregoing tests by using current Plan Year data rather than utilize data from the preceding Plan Year. If such an election is made, it may not be changed except as provided by Secretary of the Treasury. Notwithstanding the foregoing, for the 1997 Plan Year, the Employer may rely on the transitional relief set forth in Internal Revenue Service Notice 97-2 to use current Plan Year data to apply the foregoing tests. (c) All Matching Contributions and Elective Contributions that are made under two or more plans that are aggregated for purposes of Sections 401(a)(4) and 410(b) of the Code are to be treated as made under a single plan; and if two or more plans are permissively aggregated such plans shall satisfy Sections 401(a)(4) and 410(b) as though they were a single plan in accordance with Section 410(m) of the Code and Section 1.401(m)-1 of the Regulations. (d) For purposes of this Section 4.6, Matching Contributions are taken into account for a Plan Year only if (i) made on account of the Participant's Elective Contributions for the Plan Year, (ii) allocated to the Participant's Account during the Plan Year and (iii) paid to the Trust Fund prior to the end of the twelfth month following the close of the Plan Year. (e) In applying the tests set forth in this Section 4.6, the following rules shall apply: 19 (1) In the case of an Employee who receives no Matching Contributions, the Matching Contributions that are to be included in determining the Participant's Contribution Percentage are zero; (2) The availability of Matching Contributions shall not discriminate in favor of Highly Compensated Participants. (3) The distribution of excess aggregate contributions will include the income allocable thereto and shall be made on the basis of the amount of Matching Contributions (and Elective Contributions, if the Regulations permit and the Committee elects to take into account Elective Contributions when calculating the Contribution Percentage) made on behalf of each such Highly Compensated Participant. The income allocable to the excess aggregate contributions includes income for the Plan Year for which the excess aggregate contributions were made in accordance with Section 1.401(m)-1(e)(3)(ii) of the Regulations. (4) A Participant shall include any Employee who is directly or indirectly eligible to receive an allocation of Matching Contributions and includes (i) an Employee who would be a Participant but for the failure to make required contributions and (ii) a Participant whose right to receive Matching Contributions has been suspended because of an election (other than certain one-time elections) not to participate. (f) For Plan Years commencing after December 31, 1998 for which the Employer uses Section 410(b)(4)(B) of the Code to test minimum coverage compliance, the Employer may exclude from consideration all Participants (other than Highly Compensated Participants) who have not met the minimum age and service requirements of Section 410(a)(1)(A) of the Code in determining whether the tests set forth in Subsection 4.6(a) are met. 4.7 DISTRIBUTION OF EXCESS AGGREGATE CONTRIBUTIONS. (a) The Committee shall determine as of the end of the Plan Year, and at such other time or times in its discretion, whether one of the Contribution Percentages of Section 4.6 is satisfied for such Plan Year. If neither of the tests set forth in Section 4.6 is satisfied, the Committee shall distribute the excess aggregate contributions in the manner described in this 20 Section 4.7. For purposes of this Section 4.7, "excess aggregate contributions" means, with respect to any Plan Year and with respect to any Participant, the excess of the aggregate amount of (i) Matching Contributions (and any earnings and losses allocable thereto prior to distribution) and (ii) the Elective Contributions (if the Regulations permit and the Committee elects to take into account Elective Contributions when calculating the Participant's Contribution Percentage) of Highly Compensated Participants for such Plan Year, over the maximum amount of such contributions that could be made on behalf of Participants without violating the requirements of Section 4.6. The amount of each Highly Compensated Participant's excess aggregate contributions shall be determined by reducing the Matching Contributions of all Highly Compensated Participants whose Contribution Percentage as adjusted by this Section 4.7 are at the highest percentage rate for the Plan Year on a pro rata basis by one hundredth of one percent (0.01%). The Committee shall continue to utilize this procedure until one of the tests of Section 4.6 is satisfied. (b) If the Committee is required to distribute excess aggregate contributions for any Highly Compensated Participant for a Plan Year in order to satisfy the requirements of Section 4.6, then the Committee shall distribute such excess aggregate contributions with respect to such Highly Compensated Participants to the extent practicable before April 15th of the Plan Year next following the Plan Year for which such excess aggregate contributions were made, but in no event later than the end of the Plan Year following such Plan Year. For each of such Participants, the amounts so distributed shall be made in the following order of priority: (i) by distributing Matching Contributions and earnings thereon, to the extent necessary; and (ii) by distributing Elective Contributions (to the extent such amounts are included in the Contribution Percentage), and earnings thereon. All such distributions shall be made to Highly Compensated Participants on the basis of the respective portions of such amounts attributable to each such Highly Compensated 21 Participant. No spousal consent shall be required of any married Participant who receives a refund of excess aggregate contributions. 4.8 AGGREGATE LIMIT FOR CONTRIBUTION PERCENTAGE AND ACTUAL DEFERRAL PERCENTAGE. (a) The sum of the Contribution Percentage and the Actual Deferral Percentage for Highly Compensated Participants for the Plan Year shall not exceed the "aggregate limit" defined in this Section 4.8. (b) The term "aggregate limit" means the greater of (1) or (2) below: (1) The sum of (a) the greater of the Actual Deferral Percentage for all Participants other than the Highly Compensated Participants or the Contribution Percentage for all Participants other than the Highly Compensated Participants, for the Plan Year multiplied by 1.25 and (b) the lesser of such Actual Deferral Percentage or Contribution Percentage plus 2, but not greater than 2 multiplied by the lesser of such Actual Deferral Percentage or Contribution Percentage. (2) The sum of (a) the lesser of the Actual Deferral Percentage for all Participants other than the Highly Compensated Participants or the Contribution Percentage for all Participants other than the Highly Compensated Participants, for the Plan Year multiplied by 1.25 and (b) the greater of such Actual Deferral Percentage or Contribution percentage plus 2, but not greater than 2 multiplied by the greater of such Actual Deferral Percentage or Contribution Percentage. (c) If the aggregate limit is exceeded, the Committee shall determine whether to: (i) make Qualified Nonelective Contributions to permit the satisfaction of the test set forth in subsection (a) hereof; (ii) reduce the Contribution Percentage of the Highly Compensated Participants as set forth in Section 4.7; or (iii) reduce the Actual Deferral Percentage of the Highly Compensated Participants as set forth in Section 5.5. 22 SECTION 5. SALARY REDUCTION AGREEMENTS AND ROLLOVER CONTRIBUTIONS 5.1 SALARY REDUCTION AGREEMENTS. (a) A Participant may elect to make Elective Contributions in any Plan Year by entering into a written Salary Reduction Agreement with the Employer. Each Salary Reduction Agreement shall provide that a portion of the Participant's Compensation shall be paid through payroll deduction to the Trust Fund as an Elective Contribution pursuant to Section 4.1 rather than paid currently to the Participant. The Salary Reduction Agreement shall provide for Elective Contributions equal to any whole percentage between one percent (1%) and fifteen percent (15%) of a Participant's Compensation in any payroll period, not to exceed the limitation set forth in Section 402(g) of the Code (adjusted automatically for increases in accordance with the Regulations). Notwithstanding the foregoing provisions of this Section 5.1, the Committee may, but need not, adopt a procedure to enable Participants to make lump sum Elective Contributions under the Plan through payroll deductions. No Salary Reduction Agreement shall be effective unless the Participant has filed a written investment direction pursuant to Section 8.3. (b) A Salary Reduction Agreement will be taken into account for any Plan Year only if it relates to Compensation that would have been received by the Participant in the Plan Year (but for the deferral election). (c) In the event that the aggregate amount of Elective Contributions by a Participant exceeds the limitation described in subsection (a) of this Section 5.1, the amount of such excess, increased by any income and decreased by any losses attributable thereto, shall be refunded to the Participant no later than the April 15th of the calendar year following the calendar year for which the Elective Contributions were made. If a Participant also participates, in any calendar year, in any other plans subject to the limitations set forth in Section 402(g) of the Code and has made excess deferrals under this Plan when combined with the other plans 23 subject to such limits, to the extent the Participant designates, in writing submitted to the Committee no later than the March 1 of the calendar year next following the calendar year for which the Elective Contributions were made, any Elective Contributions under this Plan as excess deferrals, the amount of such designated excess, increased by any income and decreased by any losses attributable thereto, shall be refunded to the Participant no later than the April 15 of the calendar year next following the calendar year for which the Elective Contributions were made. 5.2 CHANGE OR SUSPENSION OF SALARY REDUCTION AGREEMENTS. Subject to Section 5.1, a Participant may enter into or change his or her Salary Reduction Agreement on each Section 401(k) Entry Date, effective as of the first day of the Section 401(k) Entry Date, in accordance with rules determined by the Committee. In addition, a Participant may also suspend his or her Salary Reduction Agreement at any time, in accordance with rules determined by the Committee. A Participant who suspends his or her Salary Reduction Agreement in accordance with this Section 5.2 may enter into a new Salary Reduction Agreement effective as of the next succeeding Section 401(k) Plan Entry Date. A Participant's most recent Salary Reduction Agreement shall continue unchanged from year to year unless the Participant notifies the Committee in writing of a change in such Salary Reduction Agreement in accordance with the rules determined by the Committee. 5.3 Actual Deferral Percentage Test. (a) Participants' Elective Contributions must satisfy at least one of the following tests: (1) The Actual Deferral Percentage for the Highly Compensated Participants shall not exceed the Actual Deferral Percentage of all other Participants for the preceding Plan Year multiplied by 1.25; or (2) (A) The excess of the Actual Deferral Percentage for the Highly Compensated Participants over the Actual Deferral Percentage of all other Participants for the preceding Plan Year shall not be more than two percentage points, and (B) the Actual Deferral 24 Percentage for the Highly Compensated Participants shall not be more than the Actual Deferral Percentage for all other Participants for the preceding Plan Year multiplied by 2. (b) The Employer may elect to apply the foregoing tests by using current Plan Year data rather than utilize data from the preceding Plan Year. If such an election is made, it may not be changed except as provided by Secretary of the Treasury. Notwithstanding the foregoing, for the 1997 Plan Year, the Employer may rely on the transitional relief set forth in Internal Revenue Service Notice 97-2 to use current Plan Year data to apply the foregoing tests. (c) All Elective Contributions that are made under two or more plans that are aggregated for purposes of Sections 401(a)(4) and 410(b) of the Code are to be treated as made under a single plan; and if two or more plans are permissively aggregated, such plans shall satisfy Sections 401(a)(4) and 410(b) as though they were a single plan in accordance with Section 410(k) of the Code and Section 1.401(k)-1 of the Regulations. For purposes of calculating the Actual Deferral Percentage of any Highly Compensated Participant all cash or deferred arrangements of the Employer or any Affiliated Employer in which such Highly Compensated Participant participates shall be treated as one cash or deferred arrangement. (d) In applying the tests set forth in this Section 5.3, the following rules shall apply: (1) In the case of a Participant who makes no Elective Contributions, the Elective Contributions that are to be included in determining the Participant's Actual Deferral Percentage are zero; (2) The distribution of excess contributions will include the income allocable thereto and shall be made on the basis of the amount of Elective Contributions on behalf of each such Highly Compensated Participant. The income allocable to the excess contributions includes income for the Plan Year for which the excess contributions were made in accordance with Section 1.401(k)-1(f)(4)(ii) of the Regulations. (e) For Plan Years commencing after December 31, 1998 for which the Employer uses Section 410(b)(4)(B) of the Code to test minimum coverage compliance, the 25 Employer may exclude from consideration all Participants (other than Highly Compensated Participants) who have not met the minimum age and service requirements of Section 410(a)(1)(A) of the Code in determining whether the tests set forth in Subsection 5.3(a) are met. 5.4 AMENDMENT OR REVOCATION OF SALARY REDUCTION AGREEMENT BY COMMITTEE. The Committee shall determine as of the end of the Plan Year, and at such other time or times in its discretion, whether one of the Actual Deferral Percentage tests of Section 5.3 will be satisfied for such Plan Year. In the event that neither of such Actual Deferral Percentage Tests is satisfied, the Committee may amend or revoke the Salary Reduction Agreement of any Participant at any time if it determines that such an amendment or revocation is necessary to ensure that at least one of the Actual Deferral Percentage tests of Section 5.3 will be satisfied for any Plan Year. The determination of whether it is necessary to amend or revoke any Salary Reduction Agreement shall be made pursuant to Section 5.3 and the procedure for such amendment or revocation shall be determined pursuant to Section 5.5(a). 5.5 DISTRIBUTION OF EXCESS CONTRIBUTIONS. (a) If neither of the tests set forth in Section 5.3 are satisfied, the Committee shall in its discretion, to the extent permissible under the Code and the Regulations, refund the excess contributions in the manner described in Section 5.5(b). For purposes of this Section 5.5, "excess contributions" means, with respect to any Plan Year, the excess of the aggregate amount of Elective Contributions (and any earnings and losses allocable thereto prior to distribution) made by Highly Compensated Participants for such Plan Year, over the maximum amount of such Elective Contributions that could be made by such Highly Compensated Participants without violating the requirements of Section 5.3. (b) If required in order to comply with the provisions of Subsection 5.3 and the Code, the Committee shall refund excess contributions for a Plan Year. The distribution of such excess contributions shall be made to Highly Compensated Participants, to the extent practicable, before the March 15th of the Plan Year next following the Plan Year for which such excess contributions were made, but in no event later than the end of the Plan Year next 26 following such Plan Year. Any such distribution shall be made to each Highly Compensated Participant whose Elective Contributions are the highest for the Plan Year, until one of the tests of Section 5.3 is satisfied. Matching Contributions attributable to Elective Contributions returned to a Highly Compensated Participant shall be distributed as provided in Section 4.6. 5.6 ROLLOVER CONTRIBUTIONS. (a) A Participant may make a Rollover Contribution to the Plan in accordance with rules established by the Committee uniformly applied consisting of an eligible rollover distribution, as defined in Section 11.8(b), from a plan qualified under Section 401(a) of the Code or an individual retirement account qualified under Section 408(a) of the Code (no part of which is attributable to any source other than an eligible rollover distribution from a qualified plan under Section 401(a) of the Code); provided such eligible rollover distribution is in cash and contributed to the Plan on or before the 60th day after the day in which such Participant received such eligible rollover distribution. If a Participant elects to make a Rollover Contribution, the Committee may require such evidence, assurances, opinions and certifications, including a statement from the previous plan that such plan was a qualified plan, that the Committee may deem necessary to establish to its satisfaction that the amounts to be contributed qualify as an eligible rollover distribution and will not affect the qualification of the Plan or the tax-exempt status of the Trust under Sections 401(a) and 501(a) of the Code, respectively. Except as otherwise permitted by Section 5.7, in no event shall any assets be transferred to this Plan from any profit sharing, pension or retirement plan that would cause this Plan to become a "transferee" plan (within the meaning set forth in Section 401(a)(11)(B) of the Code). (b) Any Rollover Contribution shall be allocated to the appropriate Participant's Rollover Contribution Subaccount which shall be established and separately accounted for. A Participant shall have at all times a nonforfeitable right in the amount credited to his or her Rollover Contribution Subaccount. (c) Each request by a Participant to make a Rollover Contribution shall be subject to review by the Committee which shall make a case by case determination that each 27 Rollover Contribution meets the requirements set forth in Section 5.6(a), and such other requirements or conditions as the Committee may, from time to time and in its sole discretion, impose; provided, however, that any determination made by the Committee pursuant to this Section 5.6 shall not have the effect of discriminating in favor of Participants who are officers, shareholders or who are Highly Compensated Participants. 5.7 TRUSTEE-TO-TRUSTEE TRANSFER OF ASSETS. Notwithstanding anything in Section 5.6 to the contrary, in the event of an acquisition by the Employer or the Plan Sponsor of a company which maintains a plan and trust which are qualified under Sections 401(a) and 501(a) of the Code, respectively, the Board of Directors may (but shall not be required to) authorize a "trustee-to-trustee" transfer of assets from such qualified plan into the Plan and Trust Fund. The Trustee may require such evidence, assurances, opinions and certifications, including a statement from the acquired company's plan that such plan and trust are qualified under Sections 401(a) and 501(a) of the Code, which the Trustee may deem necessary to establish to its satisfaction that the amounts to be transferred will not affect the qualification of the Plan or the tax-exempt status of the Trust under Sections 401(a) and 501(a) of the Code, respectively. 28 SECTION 6. ALLOCATION OF CONTRIBUTIONS 6.1 ESTABLISHMENT OF CASH CONTRIBUTION ACCOUNT. The Committee shall establish and maintain or cause to be established and maintained with respect to each Participant a Cash Contribution Account showing his or her interest under the Plan and in the Trust Fund and all relevant data pertaining thereto. Each Participant shall be furnished with a written statement of his or her Cash Contribution Account at least once annually and upon any distribution to him or her. In maintaining the Cash Contribution Accounts under the Plan, the Committee can conclusively rely on the valuations of the Trust Fund in accordance with the Plan. The establishment and maintenance of, or allocations and credits to, the Cash Contribution Account of any Participant shall not vest in any Participant any right, title or interest in and to any Plan assets or benefits, except at the time or times and upon the terms and conditions and to the extent expressly set forth in the Plan and in accordance with the terms of the Trust Fund. 6.2 ESTABLISHMENT OF SUBACCOUNTS. Each Participant's Cash Contribution Account shall contain each of the following applicable subaccounts therein: (a) All Elective Contributions on behalf of a Participant under Section 4.1 and Qualified Nonelective Contributions on behalf of a Participant under Section 4.2(b)(i) shall be credited to the Participant's Elective Contribution Subaccount. (b) All Matching Contributions on behalf of a Participant under Section 4.2(a) shall be allocated and credited to the Participant's Matching Contribution Subaccount. (c) All Profit Sharing Contributions on behalf of a Participant under Section 4.2(b)(ii) shall be allocated and credited to the Participant's Profit Sharing Subaccount. (d) All Rollover Contributions on behalf of a Participant under Section 5.6 shall be allocated and credited to the Participant's Rollover Contribution Subaccount. 29 SECTION 7. SPECIAL ESOP PROVISIONS 7.1 INVESTMENT OF ESOP ACCOUNTS. The ESOP Accounts of all Participants shall be invested exclusively in Shares, except for cash or cash equivalent investments held (a) for the limited purpose of making Plan distributions to Participants and Beneficiaries, (b) pending the investment by the Purchasing Agent of contributions or other cash receipts in Shares, (c) pending use to repay an Exempt Loan, (d) for purposes of paying, under the terms described in the Plan or Trust Agreement, fees and expenses incurred with respect to the Plan or Trust and not paid for by the Participating Employers or (e) in the form of de minimis cash balances. Neither any Participating Employer nor the Purchasing Agent, the Committee or the Trustee shall have any responsibility or duty to time any transaction involving Shares in order to anticipate market conditions or changes in stock value, nor shall any such person have any responsibility or duty to sell Shares held in the ESOP Accounts (or otherwise to provide investment management for Shares held in the ESOP Accounts) in order to maximize return or minimize loss. Participating Employer contributions made in cash, and other cash received by the Trustee, may be used by the Purchasing Agent to acquire Shares from shareholders of the Employer or directly from the Employer. 7.2 ALLOCATION TO ESOP ACCOUNTS. (a) Subject to the provisions of Section 4, the ESOP Account maintained for each Participant will be credited as of the last day of each Plan Year with the Participant's allocable share of: (i) Shares purchased by the Purchasing Agent using cash contributed by or on behalf of the Participating Employer employing such Participant (or contributed directly to the Trust Fund) and (ii) Shares released from the Suspense Subfund pursuant to Section 7.3 and allocable to the contribution made by or on behalf of such Participating Employer pursuant to Section 7.4. 30 (b) Shares attributable to ESOP Contributions shall be allocated among the Accounts of Participants who are members of the Allocation Group for the Plan Year in the same proportion that a Participant's Compensation during the Plan Year bears to the total Compensation during the Plan Year of all Participants who are members of the Allocation Group for such Plan Year. For purposes of the preceding sentence, Compensation earned by a Participant prior to the Participant's entry into the Plan pursuant to Section 3.1(b)(ii) shall not be taken into account. (c) Shares contributed directly to the Trust Fund for a Plan Year shall be allocated under Section 7.2(a)(i) in the same proportion as Shares purchased by the Trust Fund and allocated under Section 7.2(b). 7.3 SUSPENSE SUBFUND FOR ESOP ACCOUNTS. Shares acquired by the Participants' ESOP Accounts through an Exempt Loan shall be added to and maintained in the Suspense Subfund and shall thereafter be released from the Suspense Subfund and allocated to Participants' ESOP Accounts as provided in Sections 7.3 and 7.4. Shares acquired for the Trust Fund with the proceeds of an Exempt Loan shall be released from the Suspense Subfund as the Exempt Loan is repaid, in accordance with the provisions of this Section 7.3. (a) For each Plan Year until the Exempt Loan is fully repaid, the number of Shares released from the Suspense Subfund shall equal the number of unreleased Shares immediately before such release for the current Plan Year multiplied by the "Release Fraction." As used herein, the term "Release Fraction" shall mean a fraction, the numerator of which is the amount of principal and interest paid on the Exempt Loan for such current Plan Year and the denominator of which is the sum of the numerator plus the principal and interest to be paid on such Exempt Loan for all future years during the term of such Exempt Loan (determined without reference to any possible extensions or renewals thereof). For purposes of computing the denominator of the Release Fraction, if the interest rate on the Exempt Loan is variable, the interest to be paid in subsequent Plan Years shall be calculated by assuming that the interest rate 31 in effect as of the end of the applicable Plan Year will be the interest rate in effect for the remainder of the term of the Exempt Loan. Notwithstanding the foregoing, in the event such Exempt Loan shall be repaid with the proceeds of a subsequent Exempt Loan (the "Substitute Loan"), such repayment shall not operate to release all such Shares in the Suspense Subfund, but, rather, such release shall be effected pursuant to the foregoing provisions of this Section 7.3(a) on the basis of payments of principal and interest on such Substitute Loan. (b) If required by any pledge or similar agreement, or if permitted by such pledge or agreement and required by the Committee pursuant to a one-time, irrevocable designation (which shall be made, if at all, in connection with the making of an Exempt Loan) by the Committee, then, in lieu of applying the provisions of Section 7.3(a) hereof with respect to an Exempt Loan, Shares shall be released from the Suspense Subfund as the principal amount of such Exempt Loan is repaid (without regard to interest payments), provided the following three conditions are satisfied: (i) The Exempt Loan shall provide for annual payments of principal and interest at a cumulative rate that is not less rapid at any time than level annual payments of such amounts for ten years; (ii) The interest portion of any payment shall be disregarded only to the extent it would be treated as interest under standard loan amortization tables; and (iii) If the Exempt Loan is renewed, extended or refinanced, the sum of the expired duration of the Exempt Loan and the renewal, extension or new Exempt Loan period shall not exceed ten years. (c) If at any time there is more than one Exempt Loan outstanding, then separate accounts may be established under the Suspense Subfund for each such Exempt Loan. Each Exempt Loan for which a separate account is maintained may be treated separately for purposes of the provisions governing the release of Shares from the Suspense Subfund under this Section 7.3 (including for purposes of determining whether Section 7.3(a) or Section 7.3(b) 32 governs the release of Shares from any particular Suspense Subfund) and for purposes of the provisions governing the application of Participating Employer contributions to repay an Exempt Loan under Section 4.2. (d) All Shares released from the Suspense Subfund during any Plan Year shall be allocated among Participants as prescribed by Section 7.4. 7.4 DISPOSITION OF SHARES RELEASED FROM SUSPENSE SUBFUND. (a) Shares released from the Suspense Subfund for a Plan Year in accordance with Section 7.3 shall be held in the Trust Fund on an unallocated basis until allocated by the Committee as of last day of the Plan Year. Shares released from the Suspense Subfund on account of a payment for a Plan Year of principal or interest on an Exempt Loan, to the extent payment is made with contributions for such Plan Year, shall be allocated under Section 7.2(a)(ii) in the same proportion as Shares purchased with contributions under Section 7.2(b). (b) (i) Shares released from the Suspense Subfund on account of the payment for a Plan Year of principal or interest on an Exempt Loan to the extent such payment is made with dividends paid on Shares allocated to ESOP Accounts, shall be allocated in the same proportion as dividends used to pay principal or interest on such Exempt Loan would have been allocated under Section 7.9(b) had such dividends not been so used; and (ii) Subject to Section 4.2, Shares released from the Suspense Subfund on account of the payment of principal or interest on an Exempt Loan, to the extent such payment is made with dividends on Shares not allocated to Accounts, shall be allocated to those ESOP Accounts and in the same proportion as Shares released pursuant to Section 7.4(b)(i); provided that Shares so released shall be otherwise allocated if necessary to satisfy the requirements of the Code (other than Section 404(k)) and any Regulations thereunder. (c) All Shares in the Trust Fund, other than the Shares held in the Suspense Subfund as of the last day of any Plan Year, must be allocated to ESOP Accounts as of the last day of any Plan Year. 33 7.5 LIMITATIONS ON ALLOCATIONS TO ESOP ACCOUNTS. Notwithstanding the foregoing provisions of this Section 7: (a) If more than one-third of all ESOP Contributions for a Plan Year which are deductible only under Section 404(a)(9) of the Code would be allocated, in the aggregate, to Participants described in Section 414(q) of the Code, then the Committee may reduce such allocations pro rata in an amount sufficient to ensure that such ESOP Contributions will be deductible with respect to such Plan Year; and (b) Any contributions which are prevented from being allocated due to the restriction contained in Section 7.5(a) shall be allocated as of the last day of the Plan Year pursuant to Sections 7.2 and 7.4 as though those Participants described in Section 414(q) of the Code did not participate in the Plan. 7.6 ACQUISITION OF SHARES. (a) Notwithstanding the foregoing provisions of this Section 7, in the event that Shares are acquired in a transaction to which Section 1042 of the Code applies, then, in accordance with the Regulations, such Shares shall not be allocated, directly or indirectly, to prohibited individuals as defined in Section 409(n)(1) of the Code for the duration of the nonallocation period (as defined in Section 409(n)(3)(C) of the Code). (b) If Shares are prevented from being allocated due to the prohibition contained in Section 7.6(a), the allocation of Shares attributable to ESOP Contributions (or ESOP Contributions) otherwise provided under Section 7.2 shall be adjusted to reflect such result. 7.7 EFFECT OF CHANGE IN PLAN SPONSOR'S CAPITALIZATION. Any Shares received by the Trustee as a result of a stock split, dividend, conversion, or as a result of a reorganization or other recapitalization of the Plan Sponsor shall be allocated as of the day on which the Shares are received by the Trustee in the same manner as the Shares to which they are attributable are then allocated. 34 7.8 TRUSTEE AND COMMITTEE DISCRETION TO ENGAGE IN TRANSACTIONS IN SHARES. Neither the Purchasing Agent, the Trustee nor the Committee shall be required to engage in any transaction, including, without limitation, directing the purchase or sale of Shares, which it determines in its sole discretion may subject itself, its Participants, the Plan, any Participating Employer, or any Participant to liability under federal or other state laws. 7.9 VALUATION OF ESOP ACCOUNTS. (a) Subject to the requirements of Section 7.9(b), the fair market value of the assets of the ESOP Accounts shall be determined as of each Valuation Date, in accordance with generally accepted valuation methods and practices including, but not limited to, in the case of Shares, the use of one or more independent appraisers. (b) The value of a Participant's ESOP Account as of any Valuation Date shall equal the sum of: (i) The aggregate value (as determined under Section 7.9(a)) of all Shares and dividends on Shares previously allocated to such Participant's ESOP Account as of such Valuation Date; and (ii) Subject to Section 7.9(c), the aggregate value (as determined under Section 7.10(a)) of dividends, if any, received during the Plan Year on Shares allocated to such Participant's ESOP Account. (iii) Such Participant's allocable portion (determined in accordance with the rules set forth in Section 7.4 for determining Participant's allocable portion of Shares released from the Suspense Subfund) of the earnings, if any, on all amounts contributed to the Trust Fund for purposes other than the repayment of an Exempt Loan. (c) Except as provided in Section 7.7, dividends payable, if any, with respect to Shares held by the Participant's ESOP Account will be, in the discretion of the Committee and in conformity with the terms of the Shares on which such dividends are paid, (i) used for the purpose of repaying one or more Exempt Loans, (ii) distributed from the Trust Fund to Participants or their Beneficiaries not later than 90 days after the close of the Plan Year in which 35 they are paid to the Trust Fund, (iii) paid directly to such Participants or their Beneficiaries, (iv) retained in the Trust Fund and allocated pursuant to Section 7.9(b), or (v) paid or utilized in a combination of any or all of the foregoing four options. (d) The Committee shall establish accounting procedures for the purpose of making the allocations, valuations and adjustments to Participant's ESOP Accounts in accordance with the provisions of the Plan. From time to time, the Committee may modify its accounting procedures for the purpose of achieving equitable and nondiscriminatory allocations among the ESOP Accounts of Participants in accordance with the provisions of the Plan. 7.10 ROLE OF PURCHASING AGENT. (a) All purchases of Shares made by the Trust Fund shall be made by the Purchasing Agent. The Trustee shall forward to the Purchasing Agent all amounts contributed to the employee stock ownership plan, and all amounts to be invested in Shares pursuant to participant investment directions given pursuant to Sections 8.3, 8.4 and 8.5. Amounts to be invested in Shares shall be invested in Shares in the amount, in the manner and at the price determined by the Purchasing Agent in its sole discretion, provided such price shall be the fair market value of such Shares at the time of purchase. The Purchasing Agent shall in its sole discretion select the broker-dealer through which the purchase of such Shares shall be executed. The Purchasing Agent shall also invest any cash dividends received on any Shares which are allocated to Participants' Accounts and held as part of the Plan as provided in Section 5.05(c) of the Trust Agreement. (b) The Purchasing Agent shall sell Shares only at the direction of the Trustee, which shall issue such instructions only at the direction of the Committee; provided that such Committee direction shall not be required for any sales of Shares required pursuant to the participant investment directions given pursuant to Sections 8.3, 8.4 or 8.5, or pursuant to the provisions of Section 13.5 or 13.6. 36 SECTION 8. INVESTMENT OF CONTRIBUTIONS, VALUATIONS AND PARTICIPANTS' CASH CONTRIBUTION ACCOUNTS 8.1 DELIVERY OF CONTRIBUTIONS TO TRUST FUND. All monies, securities or other property contributed to Participants' Cash Contribution Accounts shall be delivered to the Trustee under the Trust Fund, to be managed, invested, reinvested and distributed in accordance with the Plan and the Trust Fund. 8.2 PARTICIPANTS' RIGHT TO SELECT INVESTMENTS. Each Participant shall have the right to invest his or her Cash Contribution Account among one or more investment funds selected by the Company, which may include a fund established for investment in Shares. 8.3 PARTICIPANT INVESTMENT ELECTION. As of any date permitted by the Committee, a Participant may, in accordance with the rules of the Committee uniformly applied, specify the percentage (in minimum multiples as may be determined from time to time by the Committee) of contributions which are made to the Participant's Cash Contribution Account that shall be invested in investment funds selected by the Committee. An investment election may be made separately with respect to (i) the aggregate of the Participant's Elective Contribution Subaccount, Matching Contribution Subaccount, and Rollover Contribution Subaccount and (ii) the Participant's Profit Sharing Subaccount. 8.4 CHANGE IN INVESTMENT ELECTION FOR FUTURE CONTRIBUTIONS. Any investment direction specified by a Participant shall be deemed to be a continuing direction until changed. A Participant may change an investment direction as to future contributions made by such Participant or on his or her behalf to the subaccounts of his or her Cash Contribution Account as of any day permitted by the Committee in accordance with the rules of the Committee uniformly applied. 8.5 CHANGE IN INVESTMENT ELECTION FOR PRIOR CONTRIBUTIONS. As of any date permitted by the Committee, a Participant may change the percentages (in minimum multiples as may be determined from time to time by the Committee) in which the investment of the portion of his or 37 her Cash Contribution Account attributable to prior contributions shall be allocated among the funds maintained by the Trustee. Such changes of investment allocation may be made separately with respect to (i) the aggregate of the Participant's Elective Contribution Subaccount, Matching Contribution Subaccount, and Rollover Contribution Subaccount, and (ii) the Participant's Profit Sharing Subaccount. 8.6 VALUATION OF CASH CONTRIBUTION ACCOUNTS. (a) As of each Valuation Date, Participants' Cash Contribution Accounts shall be valued pursuant to the terms of the Plan. Such valuation shall be conclusive and binding upon all persons having an interest in the Trust Fund. (b) The Committee shall adjust the value of each Elective Contribution Subaccount, Matching Contribution Subaccount, Profit Sharing Subaccount, or Rollover Contribution Subaccount, as the case may be, maintained under Participants' Cash Contribution Accounts as of each Valuation Date to reflect the effect of income received and accrued, realized and unrealized profits and losses, and all other transactions of the preceding period. Such adjustments shall be made with respect to the period since the next preceding Valuation Date by (i) deducting from each such Subaccount the total of all payments made from such Subaccount during such period, (ii) adding to or deducting from, as the case may be, each such Subaccount such proportion of each item of income, profit or loss as the amount in such Subaccount as of the next preceding Valuation Date bears to the total of the amounts in all of such Participants' Elective Contribution Subaccount, Matching Contribution Subaccount, Profit Sharing Subaccount, or Rollover Contribution Subaccount, as the case may be, as of the preceding Valuation Date and (iii) adding contributions to each such Elective Contribution Subaccount, Matching Contribution Subaccount, Profit Sharing Subaccount, or Rollover Contribution Subaccount, as the case may be, pursuant to Sections 4 and 5 of the Plan. In making such allocations, the Committee can conclusively rely on the valuations of the Subaccounts by the Trustee in accordance with the Plan and the Trust. 38 SECTION 9. RETIREMENT DATES 9.1 NORMAL RETIREMENT DATE. The Normal Retirement Date of a Participant shall be his or her 65th birthday. Upon attainment of his or her Normal Retirement Date, a Participant shall have a nonforfeitable right to 100% of his or her Account. 9.2 DEFERRED RETIREMENT DATE. A Participant who remains in Service after his or her Normal Retirement Date may retire on a Deferred Retirement Date which shall be the first day of the month coincident with or next following his or her termination of Service or as specified in a written application to the Committee. 39 SECTION 10. ELIGIBILITY FOR PAYMENT OF ACCOUNTS AND VESTED INTERESTS 10.1 PARTICIPANTS' RIGHT TO ACCOUNT UPON TERMINATION DUE TO RETIREMENT, DEATH OR DISABILITY. (a) A Participant shall have a nonforfeitable right to his or her Account upon the occurrence of any of the following events while employed by the Employer: (i) attainment of his or her Retirement Date; (ii) his or her death; or (iii) his or her Disability. (b) Upon the termination of Service of any Participant on or after his or her Retirement Date or by reason of his or her death or Disability ("Terminated Participant"), the Terminated Participant (or, in the event of the Participant's death, his or her Beneficiary) shall be entitled to an amount equal to the Terminated Participant's Account, including any subsequent contribution allocated to the Terminated Participant's Account pursuant to Sections 6 or 7 with respect to the Plan Year in which the Participant's Service is terminated. The Participant's Account shall be distributable, in accordance with the methods and rules of distribution described in Section 11, as soon as practicable following the Participant's termination of Service. The value of the Participant's Account shall be determined as of the Valuation Date coincident with or immediately preceding the date of distribution of the Participant's Account. 10.2 PARTICIPANTS' RIGHT TO ACCOUNT UPON OTHER TERMINATION OF SERVICE. Upon the termination of Service of any Participant prior to his or her Retirement Date for any reason other than death or Disability, the Terminated Participant shall be entitled to receive an amount equal to the sum of (i) 100% of the Participant's Elective Contribution Subaccount, Matching Contribution Subaccount, and Rollover Contribution Subaccount and (ii) the Participant's Vested Interest in his or her Profit Sharing Subaccount and ESOP Account, including the Participant's Vested Interest in any subsequent contribution allocated to the Participant's Account pursuant to 40 Sections 6 or 7 with respect to the Plan Year in which the Participant's Service terminated. The Participant's Account shall be distributable, in accordance with the methods and rules of distribution described in Section 11, as soon as practicable following the Valuation Date immediately following the Participant's termination of Service. The value of the Participant's Account shall be determined as of the Valuation Date coincident with or immediately preceding the date of distribution of the Participant's Account. If such Terminated Participant's Vested Interest is less than 100 percent, the non-vested balance of such Participant's Profit Sharing Subaccount and ESOP Account shall be forfeited and reallocated pursuant to Section 4.5 as of the last day of the earlier of (i) the Plan Year in which the Participant's Account is distributed, or (ii) the Plan Year in which the Participant incurs a Total Break in Service. 10.3 VESTING SCHEDULE FOR DETERMINING VESTED INTERESTS. For all purposes of this Plan, a Participant's Vested Interest in his or her Profit Sharing Subaccount and ESOP Account shall consist of (i) the Participant's percentage of his or her Profit Sharing Subaccount and (ii) the percentage of the Participant's ESOP Account, both as determined from the following vesting schedule on the basis of the number of Years of Service which the Participant has completed as of the date of the Participant's termination of Service. VESTING SCHEDULE
Years of Service Percentage ---------------- ---------- Less than three years 0% Three years but less than four years 25% Four years but less than five years 50% Five years or more 100%
10.4 BREAKS IN SERVICE. If a Participant's Service is terminated prior to his or her Retirement Date for any reason other than the Participant's death or Disability prior to completing three Years of Service, and such Participant incurs a Total Break in Service, such Participant shall not be entitled to any benefit attributable to amounts allocated to the Participant's Profit Sharing Subaccount or ESOP Account prior to such Total Break in Service. 41 If a Participant returns to Service, Years of Service before such return shall be counted, in addition to Years of Service following such return, in determining the Participant's Vested Interest in the amount credited to the Participant's Profit Sharing Subaccount or ESOP Account subsequent to the Participant's return to Service. If such Participant does not complete one Year of Service following his or her return, then the Participant shall not be entitled to any further benefit under the Plan and the non-vested balance of any Profit Sharing Contribution or ESOP Contributions credited or recredited to such Participant's Profit Sharing Subaccount or ESOP Account subsequent to the Participant's return shall be forfeited and reallocated pursuant to Section 4.5 upon the Participant's termination of Service. All forfeitures shall occur in conformity with the ordering rules of Section 54.4975-11(d) of the Regulations. 10.5 PARTICIPANT'S RIGHT TO RESTORATION OF ACCOUNT UPON RETURN TO SERVICE. If a Terminated Participant who had a vested interest in such Participant's Profit Sharing Subaccount or ESOP Account returns to Service prior to incurring a Total Break in Service, the non-vested balance of the Terminated Participant's Account, if any, forfeited pursuant to Section 10.2 shall be recredited to such Participant's Account, provided that, not later than the fifth anniversary of the first date on which the Participant is subsequently employed, such Participant repays the full amount of any distribution made to the Participant upon his or her prior termination of Service. Any amount so repaid, together with any non-vested portion of such Participant's Account recredited pursuant to this Section 10.5, shall be invested in the Trust Fund. If such Participant fails to make a repayment of any distributed amounts pursuant to this Section 10.5, the non-vested portion of such Participant's Account, if any, shall not be recredited. 10.6 PARTICIPANT'S RIGHT TO ACCOUNT UPON DEATH AFTER TERMINATION OF SERVICE. Subject to the provisions of Section 10, if a Terminated Participant dies before payment of the full value of his or her Account from the Trust Fund, an amount equal to the current value of the unpaid portion of the Participant's Vested Interest in his or her Account, including any subsequent contribution allocated to the Terminated Participant's Account pursuant to Sections 6 or 7 with respect to the Plan Year in which the Participant's Service is terminated, shall be distributable, in 42 accordance with the methods and rules of distribution described in Section 11, as soon as practicable following the Participant's death. The value of the Participant's Account shall be determined as of the Valuation Date coincident with or immediately preceding the date of distribution of the Participant's Account. 10.7 AMENDMENT OF VESTING SCHEDULE. If the vesting schedule contained in Section 10.3 is amended, each Participant who has completed at least three (3) Years of Service may elect, during the election period specified in this Section, to have his or her vested percentage determined without regard to such amendment. For purposes of this Section, the election period shall begin as of the date on which the amendment changing the vesting schedule is adopted, and shall end on the latest of the following dates: (i) the date occurring sixty (60) days after the Plan amendment is adopted; (ii) the date which is sixty (60) days after the day on which the Plan amendment becomes effective; (iii) the date which is sixty (60) days after the day the Participant is issued written notice of the Plan amendment by the Committee; or (iv) such later date as may be specified by the Committee. The election provided for in this Section shall be made in writing and shall be irrevocable when made. 10.8 DISTRIBUTION FOLLOWING ATTAINMENT OF AGE 59-1/2 TO FORMER PARTICIPANTS OF THE HAMPTON PENSION SERVICES, INC. 401(k) RETIREMENT SAVINGS PLAN. A Participant who was employed by Hampton Pension Services, Inc. on November 6, 1995 shall be entitled to receive, at any time following the date such Participant attains age 59-1/2, a distribution of all or any portion of the Participant's Account, to the extent attributable to any amounts that were transferred to the Plan from such Participant's former account in The Hampton Pension Services, Inc. 401(k) Retirement Savings Plan. 43 SECTION 11. METHOD OF PAYMENT OF ACCOUNTS AND WITHDRAWALS 11.1 METHODS OF PAYMENT. Any benefit payable under the Plan, except as otherwise provided in Section 11.2 shall be payable as soon as practicable following the last day of the calendar month in which falls a Participant's termination of Service (or other event requiring a distribution under the Plan), in one lump sum payment from the Trust Fund, provided that the Participant may elect to direct the Committee to directly transfer all or any portion of his or her "eligible rollover distribution" (as defined in Section 11.8 below) to another tax-qualified plan pursuant to Section 401(a)(31) of the Code. A Participant who has no Vested Interest in his or her Account upon his or her termination of Service will be deemed to have received a full distribution of his or her Account as of such date. A Participant may also elect to receive a distribution of his or her Account as soon as practicable following the first anniversary of the last day of the calendar month in which occurs such termination of Service (or other event requiring a distribution under the Plan), or as soon as practicable following the Participant's Normal Retirement Date. Subject to the provisions of Section 11.3 with respect to the distribution of Shares, any distribution hereunder shall be made in cash; provided, however, that pursuant to procedures adopted from time to time by the Committee, a Participant may elect to receive a distribution in the form of shares of the assets in which such Participant's Account was invested immediately prior to the distribution, but only if such distribution is made directly to a rollover IRA established with the Employer as custodian. 11.2 COMMENCEMENT OF PAYMENT. Notwithstanding any other provision of the Plan to the contrary, (i) if a Participant has a Vested Interest in his or her Account with a value of $3,500 or less it shall be distributed in one lump sum as soon as is administratively feasible following the last day of the calendar month in which such Participant's termination of employment occurs, and (ii) if a Participant has a Vested Interest in his or her Account with a value of more than 44 $3,500 it shall not commence to be distributed without the consent of the Participant before the Participant's Normal Retirement Date. In the absence of receipt of such consent by the Committee, payment of the benefit to such Participant shall commence as soon as practicable after the Participant's attainment of his or her Normal Retirement Date, which benefit shall be in an amount equal to the value of the Participant's distributable Account as of the Valuation Date coincident with or immediately following the Participant's attainment of his or her Normal Retirement Date. In any case where distribution of any benefit amount from the Participant's Cash Contribution Account is to be deferred, the Committee shall either (i) establish or cause to be established a special account for the benefit of the former Participant, to be invested by the Trustee in a fixed investment account established by the Trustee or (ii) cause all amounts in the Participant's Cash Contribution Account deferred by the Participant to be invested at the Participant's election in the same manner as the normal Cash Contribution Accounts maintained for Participants under to the Plan. 11.3 SPECIAL RULES FOR DISTRIBUTION OF SHARES. (a) Distribution of a Participant's Vested Interest from his or her Account which is invested in Shares will be made entirely in whole Shares, with the value of any fractional interest in Shares paid in cash; provided, that pursuant to procedures adopted from time to time by the Committee, a Participant may elect to receive such distribution in the form of cash. Any cash or other property in a Participant's ESOP Account will be used by the Purchasing Agent to acquire Shares, valued as of the last day of the calendar month in which occurs (i) the Participant's election to receive a distribution of his or her Account pursuant to Section 11.1, (ii) the Participant's termination of Service, in the case of a distribution pursuant to Section 11.2(i), or (iii) the Participant's Normal Retirement Date (or the Participant's death, if earlier), in the case of a distribution pursuant to Section 11.2(ii) to a Participant who failed to consent to a distribution prior to his or her Normal Retirement Date (the "Share Conversion Date"). Notwithstanding the foregoing, if applicable corporate charter or bylaw provisions restrict 45 ownership of substantially all outstanding Shares to Employees or to a plan or trust described in Section 401(a) of the Code, then any distribution of a Participant's Vested Interest in the Participant's ESOP Account shall be in cash. When a distribution consists in whole or in part of Shares, and if such Shares consists of more than one class of securities, the distribution of such Shares shall consist of substantially the same proportion of each such class of Shares as such classes of Shares represent proportions of the Participant's Account. If the record date for dividends payable with respect to Shares distributable to a Participant occurs following the Share Conversion Date, such dividends shall not be considered attributable to such Shares, but shall be considered as earnings of the Fund and allocated among Participants' Accounts pursuant to Section 8.6(b). (b) Notwithstanding anything in Section 11 to the contrary, in the discretion of the Committee, Section 11.1 may not apply to Shares held in a Participant's ESOP Account until the close of the Plan Year in which any Exempt Loan used to acquire such Shares is repaid in full. (c) If at the time of distribution, Shares distributed from the Trust Fund that were acquired with the proceeds of an Exempt Loan are not treated as "readily tradable on an established market" within the meaning of Section 409(h) of the Code and Regulations, such Shares shall be subject to a put option in the hands of a Qualified Holder by which such Qualified Holder may sell all or any part of such Shares to the Trust. Should the Trust decline to purchase all or any part of such Shares, the Employer shall purchase those Shares that the Trust declines to purchase. The put option shall be subject to the following conditions: (i) The term "Qualified Holder" shall mean the Participant or Beneficiary receiving the distribution of such Shares, any other party to whom the Shares are transferred by gift or reason of death, or any trustee of an individual retirement account (as defined under Code Section 408) to which all or any portion of the distributed Shares is transferred pursuant to a tax-free "rollover" transaction satisfying the requirements of Sections 402 and 408 of the Code. 46 (ii) During the 60-day period following any distribution of such Shares, a Qualified Holder shall have the right to require the Trust or the Employer to purchase all or a portion of the distributed Shares held by the Qualified Holder. The purchase price to be paid for any such Shares shall be their fair market value determined as of the Valuation Date coinciding with or immediately preceding the exercise of the put option under this Section 11.3(c)(ii), provided that in the case of a transaction between the Plan and a "disqualified person" within the meaning of Section 4975(e)(2) of the Code, such fair market value shall be determined as of the date of the transaction. (iii) If a Qualified Holder shall fail to exercise such put option, the put option shall temporarily lapse upon the expiration of the 60-day period. As soon as practicable following the last day of the Plan Year in which the 60-day option period expires, the Employer shall notify the non-electing Qualified Holder (if he or she is then a shareholder of record) of the valuation of the Shares as of that date. During the 60-day period immediately following receipt of such valuation notice, the Qualified Holder shall again have the right to require the Employer to purchase all or any portion of the distributed Shares. The purchase price to be paid therefor shall be based on the valuation of the Shares as of the Valuation Date coinciding with or immediately preceding the exercise of the option under this Section 11.3(c)(iii), provided that in the case of a transaction between the Plan and a "disqualified person" within the meaning of Section 4975(e)(2) of the Code, such fair market value shall be determined as of the date of the transaction. (iv) The foregoing put options under Section 11.3(c)(ii) and (iii) hereof shall be effective solely against the Employer and shall not obligate the Plan or Trust in any manner. (v) Except as otherwise required or permitted by the Code, the put options under this Section 11.3(c) shall satisfy the requirements of Section 54.4975-7(b) of the Treasury Regulations to the extent, if any, that such requirements apply to such put options. 47 If a Qualified Holder exercises a put option under this Section 11.3(c), payment for the Shares shall be made in substantially equal annual payments over a period beginning not later than 30 days after the exercise of the put option and not exceeding five years (provided that adequate security and reasonable interest are provided with respect to unpaid amounts). Except as provided in this Section 11.3(c) or in Section 11.2, no shares acquired with the proceeds of an Exempt Loan may be subject to a put, call or other option, or buy-sell or similar arrangement while held by or distributed from the Plan. The rights and protections set forth in this Section 11.3(c) shall be non-terminable. 11.4 PAYMENTS TO SURVIVING SPOUSE OR BENEFICIARY. If a Participant or former Participant dies before the commencement of his or her benefits under the Plan, such Participant's or former Participant's Vested Interest in his or her Account is payable in full to his or her Surviving Spouse. If such Participant has no Surviving Spouse, he or she may designate a Beneficiary pursuant to Section 14. A Participant may with the written consent of his or her spouse elect to designate a Beneficiary other than or in addition to his or her spouse. The written consent of the spouse must acknowledge the effect of such election and must be witnessed by a representative of the Plan or a notary public. Any such election may not be changed without spousal consent. Such an election or revocation must be made in accordance with the procedures developed by the Committee in accordance with the Code and Regulations. 11.5 LATEST DATE FOR COMMENCEMENT OF BENEFITS. (a) Payments will commence no later than 60 days following the latest of the close of the Plan Year in which: (i) the Participant attains his or her Normal Retirement Date, (ii) occurs the 10th anniversary of the year in which the Participant commenced participation in the Plan, or (iii) the Participant terminates his or her Service with the Employer. 48 (b) Notwithstanding the provisions of the foregoing sentence, if the amount payable cannot be ascertained, or, subject to the provisions of Section 20.6, the Participant cannot be located after reasonable efforts, a payment retroactive to the date determined under the foregoing sentence may be made not later than 60 days after the earliest date on which the amount of such payment can be ascertained under the Plan or the date on which the Participant is located (whichever is applicable). (c) Notwithstanding any other provision of the Plan, benefits payable to a Participant who is a five percent (5%) owner, as defined in Section 416 of the Code with respect to the Plan Year ending in the calendar year in which the Participant attains age 70 1/2, shall commence no later than April 1st of the calendar year following the calendar year in which such Participant attains age 70 1/2. Commencing July 1, 1997, to the extent permitted by the Code and Regulations, Participants who are not five percent (5%) owners may elect to commence distribution of their benefits on April 1st of the calendar year following the later of the calendar year in which such Participant attains age 70 1/2 or the calendar year following the calendar year in which such Participant retires. (d) If a Participant dies before benefits have commenced, distributions to any Surviving Spouse or Beneficiary shall be made as soon as administratively feasible, but not later than five years after such Participant's death. In the event that payment is made to the Participant's Surviving Spouse, such distribution shall not commence later than the date on which such Participant would have had to commence distributions under Section 401(a)(9) of the Code (or, in either case, on any later date prescribed by Regulations). If the Participant's Surviving Spouse dies after such Participant's death but before distribution has been made to such Surviving Spouse, the Section 11.5(d) shall be applied to require payment of any benefits as if such Surviving Spouse were the Participant. (e) Pursuant to Regulations, any benefit paid to a child shall be treated as if paid to a Participant's Surviving Spouse if such amount would become payable to such Surviving Spouse on the child's attaining majority, or other designated event permitted by Regulations. 49 11.6 REDIRECTION OF INVESTMENT OF ESOP ACCOUNT. Effective March 1, 1990, upon both attaining age 50 and completing five Years of Service, a Participant shall be permitted to direct the Plan to transfer all or any portion of the Vested Interest in the Participant's ESOP Account to the Participant's Cash Contribution Account. Under rules prescribed by the Committee, such directions shall be permitted during semi-annual periods, to be determined by the Committee, effective as soon as administratively feasible, but not later than 30 days from the date on which such direction is given, and shall be made in ten percent (10%) increments of the Participant's Vested Interest in his or her ESOP Account. In the event that the Participant's Account does not provide at least three investment options to the Participant other than investment in Shares, the Committee shall provide diversification options to any Participant required to be given such diversification options under Section 401(a)(28)(B) of the Code in a manner consistent with the Code. Notwithstanding the foregoing, the ability to make transfers may be restricted by the Committee to the extent necessary to comply with any applicable federal securities laws (including Rule 144); provided, however, that in no event shall a Participant be prevented from transferring any amount necessary in order to meet the diversification requirements set forth in Section 401(a)(28)(B) of the Code. 11.7 HARDSHIP WITHDRAWALS. (a) A Participant who is an Employee may elect to withdraw all or any portion of the Vested Interest in his or her Cash Contribution Account attributable to Elective Contributions (but excluding any earnings on Elective Contributions accruing after December 31, 1988), Profit Sharing Contributions (if, and only if, the withdrawal is occasioned by a life threatening illness to the Participant) by giving written notice thereof to the Committee specifying such date, which shall not be less than 30 days following the date such notice is given to the Committee. Such notice shall designate that the hardship withdrawal shall be withdrawn from the investment funds in which the Participant has directed investment of the Participant's Cash Contribution Account. (b) The Committee may authorize a hardship withdrawal only for: 50 (i) medical expenses described in Section 213(d) of the Code incurred or immediately anticipated by the Participant, the Participant's spouse, or any dependents of the Participant (as defined in Section 152 of the Code); (ii) the purchase (excluding mortgage payments) of a principal residence of the Participant; (iii) the payment of tuition and related educational fees for the next 12 months of post-secondary education for the Participant or the Participant's spouse, children, or dependents; or (iv) the need to prevent the eviction of the Participant from the Participant's principal residence or foreclosure on the mortgage of the Participant's principal residence. (c) A hardship withdrawal may be authorized only to the extent necessary to satisfy the hardship. A distribution will be deemed to be necessary to satisfy the hardship only if the distribution is not in excess of the amount of the immediate and heavy financial need of the Participant and such Participant's tax obligations as a result of such distribution and the Employee certifies in writing that such a hardship exists (and the Committee has no knowledge to the contrary); provided that the Committee may set stricter standards for making such determination on a nondiscriminatory basis; and provided further that the Participant must obtain the written consent of his or her spouse to the extent required by law. The Committee's decision shall be final and binding on the Participant. (d) In the event that a Participant's Vested Interest is less than 100% at the time of making a withdrawal from his Profit Sharing Subaccount pursuant to Section 11.7(a), the Participant's Vested Interest in his or her Profit Sharing Subaccount at any relevant time thereafter shall be equal to an amount ("X") determined by the following formula: X = P [AB + (R x D)] - (R x D). For purposes of applying the formula: P is the Participant's Vested Interest at the relevant time, AB is the balance of the Participant's Profit Sharing Subaccount at the relevant time; D is the amount distributed to the Participant pursuant to Section 11.7(a); and 51 R is the ratio of the Participant's Profit Sharing Subaccount balance at the relevant time to the Participant's Profit Sharing Subaccount balance immediately after the distribution pursuant to Section 11.7(a). 11.8 DIRECT ROLLOVERS TO ANOTHER QUALIFIED PLAN OR IRA. (a) This Section 11.8 applies to distributions made on or after January 1, 1993. Notwithstanding any provision of the Plan to the contrary that would otherwise limit a distributee's election under this Section 11.8, a distributee may elect, at the time and in the manner prescribed by the Committee, to have any portion of an eligible rollover distribution paid directly to an eligible retirement plan specified by the distributee in a direct rollover. (b) An eligible rollover distribution is any distribution of all or any portion of the balance to the credit of the distributee, except that an eligible rollover distribution does not include: any distribution that is one of a series of substantially equal periodic payments (not less frequently than annually) made for the life (or life expectancy) of the distributee or the joint lives (or joint life expectancies) of the distributee and the distributee's designated Beneficiary, or for a specified period of ten years or more; any distribution to the extent such distribution is required under Section 401(a)(9) of the Code; and the portion of any distribution that is not includable in gross income (determined without regard to the exclusion for net unrealized appreciation with respect to employer securities). (c) An eligible retirement plan is an individual retirement account described in section 408(a) of the Code, an individual retirement annuity described in section 408(b) of the Code, an annuity plan described in section 403(a) of the Code or a qualified trust described in section 401(a) of the Code, that accepts the distributee's eligible rollover distribution. However, in the case of an eligible rollover distribution to the surviving spouse, an eligible retirement plan is an individual retirement account or individual retirement annuity. (d) A distributee includes a Participant or former Participant. In addition, the Participant's or former Participant's Surviving Spouse and the Participant's or former Participant's spouse or former spouse who is the alternate payee under a qualified domestic relations order, as 52 defined in Section 414(p) of the Code, are distributees with regard to the interest of the Surviving Spouse, spouse or former spouse. (e) A direct rollover is a payment by the Plan to the eligible retirement plan specified by the distributee. (f) If a distribution is one to which Sections 401(a)(11) and 417 of the Code do not apply, such distribution may commence less than 30 days after the notice required under Section 1.411(a)-11(c) of the Regulations is given, provided that: (1) the Committee clearly informs the Participant that the Participant has a right to a period of at least 30 days after receiving the notice to consider the decision of whether or not to elect a distribution (and, if applicable, a particular distribution option), and (2) the Participant, after receiving the notice, affirmatively elects a distribution. 11.9 CERTAIN SECURITIES LAW RESTRICTIONS. Any distribution of Shares pursuant to this Section 11 shall be subject to all applicable laws, rules and regulations and to such approvals by stock exchanges or governmental agencies as may be deemed necessary or appropriate by the Board of Directors. Each distributee may be required to give the Employer a written representation that such distributee will not be involved in a violation of state or federal securities laws, including the Securities Act of 1933, as amended; the form of such written representation will be prescribed by the Board of Directors. 11.10 PARTICIPANT LOANS. (a) Upon a Participant's written request the Committee may direct the Trustee to make a loan to such Participant from such Participant's Account. Loans to Participants pursuant to this Section 11.10 shall be administered by the Committee and shall be subject to a Participant Loan Policy and such other procedures as may be adopted from time to time by the Committee. The Company shall not have the discretion to refuse a loan request, so long as the 53 terms of the loan comply with the requirements of this Section 11.10 and the Participant Loan Policy. The terms of the loan shall be determined by the Committee, subject to the limits set forth in this Section, and shall be evidenced by the Participant's promissory note. Loans shall be held in a segregated Account of the Trust. An Employee who has made a Rollover Contribution shall be considered a Participant for purposes of this Section, even if such Employee has not yet become a Participant pursuant to Section 3. (b) The aggregate outstanding balance of all loans to a Participant from this Plan and all other qualified plans maintained by the Employer, when added to any principal repayments on any participant loans made within the twelve-month period preceding the date on which the loan is made, may not exceed the lesser of (i) $50,000 or (ii) 50% of the vested interest in the Participant's Account as of the day of making the loan. (c) Principal and interest shall be repaid in level, periodic installments by payroll deductions not less frequent than quarterly over a definite period of time not to exceed five (5) years, provided, however, that in the case of a loan the proceeds of which are used by the Participant to acquire a principal residence of the Participant, the loan may be repayable over a reasonable period of time in excess of five (5) years as determined by the Committee. (d) All loans shall be secured by a lien on the Participant's interest in the trust. The amount of the loan may not exceed fifty percent (50%) of the value of the Participant's vested Account balance at the time the loan is made. The Committee may determine that any distribution made pursuant to the Plan shall be reduced by an amount up to the outstanding principal and interest balance of the loan. 54 (e) Any loan made pursuant to this Section 11.10 must not constitute a prohibited transaction as defined in Section 4975 of the Code. (f) Loan repayments will be suspended under the Plan as permitted under Section 414(u)(4) of the Code. 55 SECTION 12. MAXIMUM AMOUNT OF ALLOCATION 12.1 SECTION 415 LIMITATIONS. Annual additions to a Participant's Account with respect to any Plan Year may not exceed the limitations set forth in Section 415 of the Code, which are incorporated herein by reference. For these purposes, (i) "annual additions" shall have the meaning set forth in Section 415(c)(2) of the Code, as modified elsewhere in the Code and the Regulations, (ii) the limitation year shall mean the Plan Year unless any other twelve consecutive month period is designated pursuant to a written resolution adopted by the Employer, (iii) "compensation" shall have the meaning elected by the Employer pursuant to Section 415(c)(3) of the Code, and (iv) "annual additions" shall include annual additions under all other defined contribution plans maintained by the Employer or any Affiliated Employer. Effective for Plan Years beginning on or after January 1, 1998, "compensation" shall be computed without reduction for a Participant's elective deferrals under Section 402(g)(3) of the Code or for contributions made by the Employer or the Participant under Section 125 of the Code. If the requirements of Section 7.5(a) are satisfied, the term "annual additions" shall not include any amounts credited to the Participant's Account (i) resulting from rollover contributions, (ii) due to Participating Employer contributions relating to interest payments on an Exempt Loan deductible under Section 404(a)(9)(B) of the Code, or (iii) attributable to a forfeiture of Shares acquired with the proceeds of an Exempt Loan. Effective for limitation years commencing prior to January 1, 1999, if a Participant in the Plan also participates in any defined benefit plan (as defined in Sections 414(j) and 415(k) of the Code) maintained by the Employer or any Affiliated Employer, in the event that in any Plan Year the sum of the Participant's Defined Benefit Fraction (as defined in Section 415(e)(2) of the 56 Code) and the Participant's Defined Contribution Fraction (as defined in Section 415(e)(3) of the Code) exceed 1.0, the benefit under such defined benefit plan or plans shall be reduced in accordance with the provisions of that plan or those plans, so that the sum of such fractions with respect to the Participant will not exceed 1.0. If this reduction does not ensure that the limitation set forth in Section 12.1 is not exceeded, then the annual addition to any defined contribution plan, other than the Plan, shall be reduced in accordance with the provisions of that plan but only to the extent necessary to ensure that such limitation is not exceeded. 57 12.2 REFUND OR FORFEITURE OF AMOUNTS IN EXCESS OF SECTION 415 LIMITS. (a) In the event that amounts which would otherwise be allocated to a Participant's Account under the Plan must be reduced by reason of the limitations of Section 12.1, then such reduction shall be made in the following order or priority, but only to the extent necessary: (i) first the Participant's Profit Sharing Contributions shall be forfeited and reallocated pursuant to this Section 12.2; and then (ii) the Participant's Matching Contributions shall be forfeited and reallocated pursuant to this Section 12.2; and then (iii) the Participant's Elective Contributions shall be refunded to the Participant; and then (iv) Shares allocated to the Participant's Account attributable to ESOP Contributions shall be forfeited and reallocated pursuant to this Section 12.2. (b) Forfeitures arising under the Plan and allocable to such Participant in respect of such Plan Year shall be reallocated to the Accounts of other Participants as of the end of the Plan Year for which such reduction is made in the manner provided under Section 4.5 above. (c) If, with respect to any Plan Year, there is an excess contribution on account of the limitations contained in this Section 12.2, and such excess cannot be fully allocated in accordance with Section 12.2(b) because of the limitations prescribed in this Section 12, the amount of such excess which cannot be so allocated shall be held in suspense and allocated in the succeeding Plan Year prior to any other contributions by the Employer for such Plan Year. 58 SECTION 13. VOTING RIGHTS 13.1 VOTING OF SHARES IN GENERAL. Except as otherwise required by the Act, the Code and the Regulations, all voting rights of Shares held in Participants' Accounts shall be exercised by the Purchasing Agent only as directed by the Participants or their Beneficiaries in accordance with the provisions of this Section 13. 13.2 VOTING OF ALLOCATED SHARES. (a) If any Participating Employer has a registration-type class of securities (as defined in Section 409(e)(4) of the Code or any successor statute thereto), then, with respect to all corporate matters submitted to shareholders, all Shares (including fractional interests in Shares) allocated and credited to the Accounts of Participants shall be voted in accordance with the directions of such Participants as given to the Purchasing Agent (subject to the provisions of Sections 13.4 and 13.6). (b) If no Participating Employer has a registration-type class of securities (as defined in Section 409(e)(4) of the Code or any successor statute thereto), then, only with respect to corporate matters relating to a corporate merger or consolidation, recapitalization, reclassification, liquidation, dissolution, sale of substantially all assets of a trade or business, or such other similar transaction that Regulations require, all Shares allocated and credited to the Accounts of Participants shall be voted only in accordance with the directions of such Participants as given to the Purchasing Agent. Any allocated Shares with respect to which Participants are entitled to vote pursuant to this Section 13.2 and for which such directions are not received by the Purchasing Agent shall not be voted by the Purchasing Agent. The Purchasing Agent shall vote all Shares held in the Trust Fund allocated to the Accounts of Participants from whom voting instructions are not required to be solicited under Section 13.2 only as the Purchasing Agent directs in the Purchasing Agent's sole discretion in accordance with the Act, after the Purchasing Agent determines such action to be in the best interests of the Participants and their Beneficiaries. 59 13.3 MECHANICS OF VOTING ALLOCATED SHARES. If Participants are entitled under Section 13.2 to direct the vote with respect to allocated Shares, then, at least 30 days before each annual or special shareholders' meeting of the Employer (or, if such schedule cannot be met, as early as practicable before such meeting), the Committee shall furnish to each Participant a copy of the proxy solicitation material sent generally to shareholders, together with a form requesting confidential instructions concerning the manner in which the Shares allocated to such Participant's Account (including fractional Shares to 1/1000th of a Share) are to be voted. Upon timely receipt of such instructions, the Purchasing Agent (after combining votes of fractional Shares to give effect to the greatest extent possible to Participants' instructions) shall vote the Shares as instructed. The instructions received by the Purchasing Agent from each Participant shall be held by the Purchasing Agent in strict confidence and shall not be divulged or released to any person, including, without limitation, any officers or Employees of any Participating Employer, or of any other Employer. The Trustee, the Employer, the Purchasing Agent and the Committee shall not make recommendations to Participants on whether to vote or how to vote. 13.4 VOTING OF UNALLOCATED SHARES AND UNVOTED ALLOCATED SHARES. With respect to unallocated shares held in the Trust Fund and allocated shares held in the Trust Fund for which no voting instructions are received, the Purchasing Agent shall vote such Shares in the same proportions as the Shares for which Participant voting instructions have been received. 13.5 TENDER OR EXCHANGE OF ALLOCATED SHARES. The Committee shall notify each Participant of each tender or exchange offer for the Shares and utilize its best efforts to distribute or cause to be distributed to each Participant in a timely manner all information distributed to shareholders of the Employer in connection with any such tender or exchange offer. Each Participant shall have the right from time to time with respect to the Shares allocated to the Participant's Account (including fractional Shares to 1/1000th of a Share) to instruct the Purchasing Agent in writing as to the manner in which to respond to any tender or exchange offer which shall be pending or which may be made in the future for all Shares or any portion thereof. A Participant's instructions shall remain in force until superseded in writing by the 60 Participant. The Purchasing Agent shall tender or exchange whole Shares only as and to the extent so instructed. If the Purchasing Agent does not receive instructions from a Participant regarding any tender or exchange offer for Shares, the Purchasing Agent shall have no discretion in such matter and shall not tender or exchange any such Shares in response thereto. Unless and until Shares are tendered or exchanged, the individual instructions received by the Purchasing Agent from Participants shall be held by the Purchasing Agent in strict confidence and shall not be divulged or released to any person, including, without limitation, any officers or Employees of any Participating Employer, or of any other Employer; provided, however, that the Purchasing Agent shall advise the Employer, at any time upon request, of the total number of Shares not subject to instructions to tender or exchange. 13.6 TENDER OR EXCHANGE OF UNALLOCATED SHARES. The Purchasing Agent shall tender unallocated Shares held in the Trust Fund in proportion to the ratio that (A) the number of Shares with respect to which Participant instructions in favor of the tender have been received bears to (B) the number of shares with respect to which Participant instructions for or against the tender have been received, provided the Purchasing Agent determines that such action is consistent with its fiduciary obligations under the Act. Neither the Purchasing Agent, the Committee nor the Trustee shall have the discretion or power to sell, convey or transfer any unallocated Shares held in the Participant's Accounts in response to a tender or exchange offer unless a court of competent jurisdiction determines that the Purchasing Agent is authorized to sell, convey or transfer any unallocated Shares held in the Accounts in response to any tender or exchange offer. In exercising any discretion or power, the Purchasing Agent shall consider, to the extent permitted by applicable law, including the Regulations, not only the potential increase in value, if any, in the Accounts of the Participants as a result of a tender or exchange of the unallocated Shares, but also the impact of any change in the management or control of the Employer in the long run, including but not limited to whether Participants will receive larger or smaller employee benefits than at present under the Plan. 61 13.7 VOTING OF DECEASED PARTICIPANT'S SHARES. If this Section 13 applies to Shares allocated to the Account of a deceased Participant, such Participant's Beneficiary shall be entitled to direct the manner in which to respond to any tender or exchange offer as if such Beneficiary were the Participant. 62 SECTION 14. DESIGNATION OF BENEFICIARIES 14.1 DESIGNATION OF BENEFICIARY. Each Participant shall file with the Committee a written designation of one or more persons as the Beneficiary who shall be entitled to receive the amount, if any, payable under the Plan upon his or her death. A Participant may from time to time revoke or change his or her Beneficiary designation without the consent of any prior 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. A Participant's Beneficiary designation shall not be effective to the extent that payments to the Surviving Spouse are required pursuant to Section 11, and in no event shall it be effective as of a date prior to such receipt. 14.2 FAILURE TO DESIGNATE BENEFICIARY. If no such Beneficiary designation is in effect at the time of a Participant's death, or if no designated Beneficiary survives the Participant, the payment of the amount, if any, payable under the Plan upon his or her death shall be made to the Participant's Surviving Spouse, if any; or if the Participant has no Surviving Spouse, then to the Participant's children, if any, in equal shares; or if the Participant has no children, to the Participant's parents, if any, in equal shares; or if the Participant has no parents, to the Participant's brothers and sisters, if any, in equal shares. If the Participant has no brothers or sisters, payment shall be made to the Participant's estate. If the Committee is in doubt as to the right of any person to receive such amount, the Committee may direct the Trustee to retain such amount, without liability for any interest thereon, until the rights thereto are determined, or the Committee may direct the Trustee to pay such amount into any court of appropriate jurisdiction and such payment shall be a complete discharge of the liability of the Plan and the Trust Fund therefor. 63 SECTION 15. ADMINISTRATION OF THE PLAN 15.1 THE COMMITTEE. The Committee shall have general responsibility for the administration, interpretation and construction of the Plan. The Committee shall be responsible for establishing and maintaining Plan records, including responsibility for compliance with the Actual Deferral Percentage and Actual Contribution Percentage tests described in Sections 4.6 and 5.3, and the Committee shall be responsible for complying with the reporting and disclosure requirements of the Act. The Committee shall report to the Board of Directors, or to a committee of the Board of Directors designated for that purpose, periodically as shall be specified by the Board of Directors or such designated committee, with regard to the matters for which it is responsible under the Plan. 15.2 THE TRUSTEE. Except as otherwise provided in the Trust Agreement or the Plan, the Trustee may act only as directed by the Committee, the Employer or any other party, as applicable. The Trustee shall have responsibility under the Plan for the management and control of the assets of the Plan. The Committee shall periodically review the performance and methods of the Trustee. The Employer or the Committee shall have the power to appoint, remove or change the Trustee and, to the extent that the Trust Fund is invested in assets other than Shares, shall have the power to appoint or remove one or more investment advisers and to delegate to such adviser authority and discretion to manage (including the power to acquire and dispose of) the assets of the Plan, provided that (i) such adviser with such authority and discretion shall be either a bank or a registered investment adviser under the Investment Advisers Act of 1940, and shall acknowledge in writing that it is a fiduciary with respect to the Plan and (ii) the Committee shall periodically review the investment performance and methods of each adviser(s) with such authority and discretion. The Committee shall establish investment standards and policies and communicate the same to the Trustee. If annuities are to be purchased under the Plan, the Committee shall determine what contracts should be made available to terminated Participants or purchased by the Trust Fund. 64 15.3 COMMITTEE'S RESPONSIBILITY FOR ENTERING INTO EXEMPT LOANS AND VALUATION OF SHARES. The Committee shall have responsibility for directing the Trustee as to whether and under what terms it shall enter into an Exempt Loan and for directing the Purchasing Agent whether and under what terms it shall purchase or otherwise dispose of Shares. In the event that there is no generally recognized market for Shares, the Committee shall be the named fiduciary with responsibility for determining the fair market value of the Shares, provided, that any such determination shall be in accordance with applicable Regulations, if any, and the Committee shall, in making such determination, retain an independent appraiser to make such valuation on behalf of the Committee in accordance with Section 7.9. 15.4 COMMITTEE'S POWER TO ENGAGE OUTSIDE EXPERTS. The Committee may arrange for the engagement of such legal counsel, who may be counsel for the Employer, and make use of such agents and clerical or other personnel as they each shall require or may deem advisable for purposes of the Plan. The Committee may rely upon the written opinion of such counsel and the accountants engaged by the Committee and may delegate to any such agent of said Committee its authority to perform any act hereunder, including without limitation, those matters involving the exercise of discretion, provided that such delegation shall be subject to revocation at any time at the discretion of said Committee. The Committee shall engage such certified public accountants, who may be accountants for the Employer, as it shall require or may deem advisable for purposes of the Plan. 15.5 COMPOSITION OF COMMITTEE. The Committee shall consist of at least three members, each of whom shall be appointed by, shall remain in office at the will of, and may be removed, with or without cause, by the Board of Directors. Any member of said Committee may resign at any time. No member of said Committee shall be entitled to act on or decide any matter relating solely to himself or any of his or her rights or benefits under the Plan. The members of the Committee shall not receive any special compensation for serving in their capacities as members of such Committee but shall be reimbursed for any reasonable expenses incurred in connection therewith. Except as otherwise required by the Act, no bond or other security need be 65 required of the Committee or any member thereof in any jurisdiction. Any member of the Committee, or any agent to whom said Committee delegates any authority, and any other person or group of persons, may serve in more than one fiduciary capacity (including service both as a Trustee and administrator) with respect to the Plan. 15.6 ACTIONS OF COMMITTEE. The Committee shall elect or designate its own chairman, establish its own procedures and the time and place for its meetings and provide for the keeping of minutes of all meetings. A majority of the members of the Committee shall constitute a quorum for the transaction of business at a meeting of the Committee. Any action of the Committee may be taken upon the affirmative vote of a majority of the members of the Committee at a meeting or, at the direction of its Chairman, without a meeting, by mail, telephone or facsimile, provided that all of the members of the Committee are informed by mail or telephone of their right to vote on the proposal and of the outcome of the vote thereon. 15.7 DISBURSEMENT OF PLAN FUNDS. The Committee shall cause to be kept full and accurate accounts of receipts and disbursements of the Plan, shall cause to be deposited all funds of the Plan to the name and credit of the Plan in such depositories as may be designated by the Committee, shall cause to be disbursed the monies and funds of the Plan when so authorized by the Committee and shall generally perform such other duties as may be assigned to them from time to time by the Committee. 15.8 APPLICATION FOR BENEFITS. Each Participant or Beneficiary believing himself eligible for benefits under the Plan shall apply for such benefits by completing and filing with the Committee an application for benefits on a form supplied by the Committee. Before the date on which benefit payments commence, each such application must be supported by such information and data as the Committee deems relevant and appropriate. Evidence of age, marital status (and, in the appropriate instances, health, death or disability) and location of residence shall be required of all applicants for benefits. All claims for benefits under the Plan shall, within a reasonable period of time, be decided by one or more persons designated in writing by the chairman of the Committee. 66 15.9 DENIED CLAIMS FOR BENEFITS. In the event that any claim for benefits is denied in whole or in part, the Participant or Beneficiary whose claim has been so denied shall be notified of such denial in writing by the Committee. The notice advising of the denial shall specify the reason or reasons for denial, make specific reference to pertinent Plan provisions, describe any additional material or information necessary for the claimant to perfect the claim (explaining why such material or information is needed) and shall advise the Participant or Beneficiary, as the case may be, of the procedure for the appeal of such denial. All appeals shall be made by the following procedure: (a) The Participant or Beneficiary whose claim has been denied shall file with the Committee a notice of desire to appeal the denial. Such notice shall be filed within sixty (60) days of notification by the Committee of claim denial, shall be made in writing and shall set forth all of the facts upon which the appeal is based. Appeals not timely filed shall be barred. (b) The Committee shall, within thirty (30) days of receipt of the Participant's or Beneficiary's notice of appeal, establish a hearing date on which the Participant or Beneficiary may make an oral presentation to the Committee in support of his or her appeal. The Participant or Beneficiary shall be given not less than ten (10) days' notice of the date set for the hearing. (c) The Committee shall consider the merits of the claimant's written and oral presentations, the merits of any facts or evidence in support of the denial of benefits and such other facts and circumstances as the Committee shall deem relevant. If the claimant elects not to make an oral presentation, such election shall not be deemed adverse to the claimant's interest, and the Committee shall proceed as set forth below as though an oral presentation of the contents of the claimant's written presentation had been made. (d) The Committee shall render a determination upon the appealed claim which determination shall be accompanied by a written statement as to the reasons therefor. The determination so rendered shall be binding on all parties. (e) For all purposes under the Plan, such decisions on claims (where no review is requested) and decisions on review (where review is requested) shall be final, binding 67 and conclusive on all interested persons as to participation and benefit eligibility, the Employee's amount of Compensation and any other matter of fact or interpretation relating to the Plan. 15.10 INDEMNIFICATION. To the maximum extent permitted by law, no member of the Committee shall be personally liable by reason of any contract or other instrument executed by such member of the Committee or on his or her behalf in the Committee member's capacity as a member of such Committee nor for any mistake of judgment made in good faith, and the Employer shall indemnify and hold harmless, directly from its own assets (including the proceeds of any insurance policy the premiums of which are paid from the Employer's own assets), each member of the Committee and each other officer, employee or director of the Employer to whom any duty or power relating to the administration or interpretation of the Plan or to the management and control of the assets of the Plan may be delegated or allocated, against any cost or expense (including counsel fees) or liability (including any sum paid in settlement of a claim with the approval of the Employer) arising out of any act or omission to act in connection with the Plan unless arising out of such person's own fraud or willful misconduct. The Employer shall advance funds for legal expenses to the extent permitted by the Act. 15.11 AGENT FOR SERVICE OF PROCESS. The Committee or such other person as may from time to time be designated by the Committee shall be the agent for service of process under the Plan. 68 SECTION 16. EXPENSES 16.1 PAYMENT OF PLAN EXPENSES. The expenses incurred in the management and administration of the Plan shall be paid from the Trust Fund, except to the extent the Employer, in its sole discretion, may choose to pay such expenses from time to time; provided that any Trustee expenses paid to The Charles Schwab Trust Company shall be payable solely by the Employer. Such expenses shall include (i) the fees and expenses of any employee and of the Trustee for the performance of their duties under the Plan and Trust Fund (including but not limited to obtaining investment advice, record keeping services and legal services), (ii) the expenses incurred by the members of the Committee in the performance of their duties under the Plan (including reasonable compensation for any legal counsel, certified public accountants, consultants and agents, and cost of services rendered with respect to the Plan) and (iii) all other proper charges and disbursements of the Trustee or the members of the Committee (including settlements of claims or legal actions approved by counsel to the Plan). 16.2 EXPENSES ATTRIBUTABLE TO INVESTMENT OF PLAN ASSETS AND TAXES. Brokerage fees, transfer taxes and any other expenses incident to the purchase or sale of securities by the Trustee shall be deemed to be part of the cost of such securities, or deducted in computing the proceeds therefrom, as the case may be. Expenses attributable to investments of the Trust Fund shall be paid out of the Trust Fund, except to the extent the Employer, in its sole discretion, may choose to pay such expenses from time to time; provided that expense entirely attributable to any one investment or to any one investment fund shall be allocated pro rata in accordance with Account balances among Accounts invested in such investment or investment fund. Taxes, if any, of any and all kinds whatsoever which are levied or assessed on any assets held or income received by the Trustee shall be paid out of the Trust Fund. 69 SECTION 17. EMPLOYER PARTICIPATION 17.1 ADOPTION OF PLAN BY AFFILIATED EMPLOYER. Any Affiliated Employer may adopt the Plan and the Trust Fund by resolution of its board of directors or equivalent governing body provided that (i) the Board of Directors has not expressly disallowed participation by such Affiliated Employer in the Plan; (ii) the Affiliated Employer has not previously expressly declined to participate in the Plan; or (iii) the Affiliated Employer is not precluded from participating in the Plan by a legally binding written document that precludes such participation; and provided further that the Board of Directors consents to such adoption. Any Affiliated Employer which so adopts the Plan shall be deemed to appoint Charles Schwab & Co., Inc., the Committee and the Trustee its exclusive agents to exercise on its behalf all of the power and authority conferred under the Plan or the Trust Agreement. This authority shall continue until the Plan is terminated and the relevant Trust Fund assets have been distributed. 17.2 TERMINATION OF PARTICIPATION BY PARTICIPATING EMPLOYER. A Participating Employer may terminate its participation in the Plan by giving the Committee prior written notice specifying a termination date which shall be the last day of a month at least 60 days subsequent to the date such notice is received by the Committee. The Board of Directors may terminate any Participating Employer's participation in the Plan, as of any termination date specified by the Committee, for the failure of the Participating Employer to make proper contributions or to comply with any other provision of the Plan. 17.3 EFFECT OF TERMINATION OF PARTICIPATION BY PARTICIPATING EMPLOYER. Upon termination of the Plan as to any Participating Employer, such Participating Employer shall not make any further contributions under the Plan and no amount shall thereafter be payable under the Plan to or with respect to any Participants then employed by such Participating Employer, except as provided in this Section 17. To the maximum extent permitted by the Act, any rights of Participants no longer employed by such Participating Employer and of former Participants and their Beneficiaries and Surviving Spouses and other eligible survivors under the Plan shall 70 be unaffected by such termination and any transfer, distribution or other disposition of the assets of the Plan as provided in this Section 17 shall constitute a complete discharge of all liabilities under the Plan with respect to such Participating Employer's participation in the Plan and any Participant then employed by such Participating Employer. The interest of each such Participant who is in Service with such Participating Employer as of the termination date is the amount, if any, credited to his or her Account after payment of or provision for expenses and charges and appropriate adjustment of the Accounts of all such Participants for expenses and charges as described in Section 16, and all forfeitures shall be nonforfeitable as of the termination date, and upon receipt by the Committee of IRS approval of such termination, the full current value of such amount shall be paid from the Trust Fund in the manner described in Section 17.4 or transferred to a successor employee benefit plan which is qualified under Section 401(a) of the Code; provided, however, that in the event of any transfer of assets to a successor employee benefit plan the provisions of Section 17.4 will apply. No advances against such payments shall be made prior to such receipt of approval, but after such receipt the Committee, in its sole discretion, may direct the Trustee to make one or more advances in accordance with Section 11.1. All determinations, approvals and notifications referred to above shall be in form and substance and from a source satisfactory to the Committee. To the maximum extent permitted by the Act, the termination of the Plan as to any Participating Employer shall not in any way affect any other Participating Employer's participation in the Plan. 17.4 LIMITATIONS ON TRANSFER OF PLAN ASSETS TO SUCCESSOR PLAN. No transfer of the Plan's assets and liabilities to a successor employee benefit plan (whether by merger or consolidation with such successor plan or otherwise) shall be made unless each Participant would, if either the Plan or such successor plan then terminated, receive a benefit immediately after such transfer which (after taking account of any distributions or payments to such Participants as part of the same transaction) is equal to or greater than the benefit such Participant would have been entitled to receive immediately before such transfer if the Plan had then been 71 terminated. The Committee may also request appropriate indemnification from the employer or employers maintaining such successor plan before making such a transfer. 17.5 SHARES ALLOCATED TO SUSPENSE FUND EXCLUDED FROM TRANSFER OF PLAN ASSETS TO SUCCESSOR PLAN. Notwithstanding any provision of this Section 17 to the contrary, any Shares allocated to a Suspense Subfund shall not be transferred to a successor employee benefit plan except as is required or permitted by the Committee in accordance with the terms of an Exempt Loan and the Regulations. 72 SECTION 18. AMENDMENT OR TERMINATION OF THE PLAN 18.1 AMENDMENT, SUSPENSION OR TERMINATION OF PLAN. (a) Subject to the provisions of Section 18.1(b) and (c) hereof, the board of directors of the Plan Sponsor reserves the right at any time to suspend or terminate the Plan, any contributions thereunder, or any other agreement or arrangement forming a part of the Plan, in whole or in part and for any reason, and to adopt any amendment or modification thereto, all without the consent of any Participating Employer, Participant, Beneficiary, Surviving Spouse or other eligible survivor. Subject to the provisions of Section 18.1(b) and (c) hereof, the Board of Directors reserves the right at any time to amend or modify the Plan. Each Participating Employer by its adoption of the Plan shall be deemed to have delegated this authority to the Board of Directors. (b) The Board of Directors shall not make any amendment or modification which would (i) retroactively impair any rights to any benefit under the Plan which any Participant, Beneficiary, Surviving Spouse or other eligible survivor would otherwise have had at the date of such amendment by reason of the contributions theretofore made or (ii) make it possible for any part of the funds of the Plan (other than such part as is required to pay taxes, if any, and administration expenses as provided in Section 16) to be used for or diverted to any purposes other than for the exclusive benefit of Participants and their Beneficiaries and Surviving Spouses and other eligible survivors under the Plan prior to the satisfaction of all liabilities with respect thereto. 18.2 POWER TO RETROACTIVELY AMEND, SUSPEND OR TERMINATE PLAN PROVISIONS. Subject to the provisions of Section 18.1, any amendment, modification, suspension or termination of any provision of the Plan may be made retroactively if necessary or appropriate to qualify or maintain the Plan as a plan meeting the requirements of Sections 401(a) of the Code or any other applicable provision of law (including the Act) as now in effect or hereafter amended or adopted and the Regulations issued thereunder. 73 18.3 NOTICE OF AMENDMENT, SUSPENSION OR TERMINATION. Notice of any amendment, modification, suspension or termination of the Plan shall be given by the Board of Directors or the board of directors of the Plan Sponsor, as the case may be, to the Trustee and all Participating Employers. 18.4 EFFECT OF TERMINATION OF PLAN. Upon termination of the Plan, no Participating Employer shall make any further contributions under the Plan and no amount shall thereafter be payable under the Plan to or with respect to any Participant except as provided in this Section 18, and to the maximum extent permitted by the Act, transfers or distributions of the assets of the Plan as provided in this Section 18 shall constitute a complete discharge of all liabilities under the Plan. The provisions of the Plan which are necessary for the operation of the Plan and the distribution or transfer of the assets of the Plan shall remain in force. Upon receipt by the Committee of IRS approval of such termination, the full current value of such adjusted amount, and the full value of each account described in Sections 6.2 and 7.1 above, shall be paid from the Trust Fund to each Participant and former Participant (or, in the event of the death of a Participant or former Participant, to the Surviving Spouse or Beneficiary thereof) in any manner of distribution specified in Section 11 above, including payments which are deferred until the Participant's termination of Service, as the Committee shall determine. Without limiting the foregoing, any such distribution may be made in cash or in property, or both, as the Committee in its sole discretion may direct. All determinations, approvals and notifications referred to above shall be in form and substance and from a source satisfactory to the Committee. 18.5 PARTIAL TERMINATION OF PLAN. In the event that any governmental authority, including without limitation the IRS, determines that a partial termination (within the meaning of the Act) of the Plan has occurred or if there is a complete discontinuance of Employer contributions then (i) the interest of each Participant affected thereby in his or her Account shall become nonforfeitable as of the date of such partial termination or complete discontinuance of contributions and (ii) the provisions of Sections 18.2, 18.3 and 18.4 above, which in the opinion 74 of the Committee are necessary for the execution of the Plan and the allocation and distribution of the assets of the Plan, shall apply. 18.6 TRUST FOR EXCLUSIVE BENEFIT OF PARTICIPANT. In no event shall any part of the Trust Fund (other than such part as is required to pay taxes, if any, and administration expenses as provided in Section 16 above) be used for or diverted to any purposes other than for the exclusive benefit of Participants and their Beneficiaries and Surviving Spouses under the Plan. 75 SECTION 19. TOP-HEAVY PLAN REQUIREMENTS 19.1 TOP-HEAVY PLAN - IN GENERAL. For any Plan Year for which this Plan is a Top-Heavy Plan, the provisions of this Section 19 shall apply notwithstanding any other provisions of the Plan. 19.2 EFFECT OF TOP-HEAVY STATUS. Each Participant who (i) is a Non-Key Employee and (ii) is employed on the last day of the Plan Year, shall be entitled to have contributions allocated to his or her Account of not less than three percent (3%) of the Participant's Compensation (the "Minimum Contribution Percentage") regardless of (i) whether such Non-Key Employee has completed a Year of Service, and (ii) the amount of such Non-Key Employee's Compensation; provided, however, that the minimum contribution percentage for any Plan Year shall not exceed the percentage at which contributions are made under the Plan for the Plan Year for the Key Employee for whom such percentage is the highest for such Plan Year. For this purpose, such percentage shall be determined by dividing the contributions made for such Key Employee by so much of his or her Compensation (which solely for this purpose includes Elective Contributions made by the Employer for the Key Employee) for the Plan Year as does not exceed $150,000 (adjusted automatically for increases in accordance with the Regulations). Contributions taken into account under this Section 19.2 shall include contributions under this Plan and under all other defined contribution plans (as defined in Section 414(i) of the Code) required to be included in an Aggregation Group; provided, however, that such contributions shall not include (i) contributions to any defined contribution plan in the required aggregation group if such contributions enable such a defined contribution plan to meet the requirements of Sections 401(a)(4) or 410 of the Code or (ii) contributions under the Social Security Act or any other federal or state law. 76 19.3 TOP-HEAVY VESTING SCHEDULE. In the event that the Plan is a Top-Heavy Plan, all contributions shall be vested according to the following vesting schedule:
Years of Service Percentage ---------------- ---------- Less than two years 0% At least two years but less than three years 20% At least three years but less than four years 50% At least four years but less than five years 75% Five years or more 100%
19.4 DEFINITIONS. (a) "Top-Heavy Plan" means this Plan for any Plan Year if, as of the Determination Date, (i) the present value of the Accounts of all Participants who are Key Employees (excluding former Key Employees) exceeds 60 percent of the present value of all Participants' Accounts (excluding former Key Employees) or (ii) the Plan is required to be in an Aggregation Group which for such Plan Year is a Top-Heavy Group. In determining whether the Plan constitutes a Top-Heavy Plan, the Committee shall make the following adjustments: (i) When more than one plan is aggregated, the Committee shall determine separately for each plan as of any Determination Date, the present value of accrued benefits of all Participants and the value of Accounts of all Participants. (ii) Any such determination shall include the present value of distributions made to former Participants under the applicable plan (including a terminated plan) during the five-year period ending on the Determination Date, unless reflected in the value of the accrued benefits or the Accounts of such former Participants as of the Determination Date. (iii) Any such determination shall include any Rollover Contribution from any other plan as follows: 77 (A) If the Rollover Contribution is initiated by the Employee and made to or from a plan maintained by a corporation which is not an Affiliated Employer, the plan providing the distribution shall include such distribution in the value of such accrued benefit or Account. (B) If the Rollover Contribution is not initiated by the Employee or made from a plan maintained by an Affiliated Employer, the plan accepting the distribution shall include such distribution in the value of such accrued benefit or Account. (b) "Determination Date" means for any Plan Year the last day of the next preceding Plan Year. (c) "Aggregation Group" means all plans maintained by the Employer or any Affiliated Employer which are required to be aggregated or permitted to be aggregated. For purposes of this Section 19.4(c), (i) The group of plans that are required to be aggregated (the "required aggregation group") includes each plan of the Employer or any Affiliated Employer in which a Key Employee is a Participant, and each other plan of the Employer or any Affiliated Employer which enables a plan in which a Key Employee is a Participant to meet the requirements of Sections 401(a)(4) or 410 of the Code; and (ii) The group of plans that are permitted to be aggregated (the "permissive aggregation group") includes the required aggregation group plus one or more plans of the Employer or any Affiliated Employer that is not part of the required aggregation group and that the Committee certifies as constituting a plan within the permissive aggregation group. Such plan or plans may be added to the permissive aggregation group only if the permissive aggregation group would continue to meet the requirements of Sections 401(a)(4) and 410 of the Code. (d) "Top Heavy Group" means the Aggregation Group, if as of any Determination Date, the sum of (i) the present value of the accrued benefits of all Participants who are Key Employees under all defined benefit plans (within the meaning of Section 414(j) of the Code) 78 included in the Aggregation Group plus (ii) the aggregate value of the Accounts of all Participants who are Key Employees under all defined contribution plans (within the meaning of Section 414(i) of the Code) included in the Aggregation Group exceeds 60 percent of the sum of (i) the present value of the accrued benefits for all Participants (excluding former Key Employees), under all such defined benefit plans plus (ii) the aggregate value of the Accounts of all Participants (excluding former Key Employees) under all such defined contribution plans. If the Aggregation Group that is a Top-Heavy Group is a required aggregation group, each plan in the Aggregation Group will be a Top-Heavy Plan. If the Aggregation Group that is a Top-Heavy Group is a permissive aggregation group, only those plans that are part of the required aggregation group will be treated as a Top-Heavy Plan. If the Aggregation Group is not a Top-Heavy Group, no plan within such Aggregation Group will be a Top-Heavy Plan. For purposes of Section 19.4(a), the present value of accrued benefits under any defined benefit plan and the value of Accounts under any defined contribution plan shall be determined as of the Valuation Date that is coincident with the Determination Date in accordance with the Regulations. (e) "Key Employee" means any Employee or former Employee who, at any time during the Plan Year preceding the Determination Date or during any of the four preceding Plan Years, is or was one of the following: (i) An officer of the Employer or any Affiliated Employer having annual compensation (within the meaning of Section 414(q)(4)) greater than 50 percent of the amount in effect under Section 415(b)(1)(A) of the Code for any Plan Year (as adjusted for increases in the cost of living in accordance with the Regulations). For purposes of the preceding sentence there shall be treated as officers for any such Plan Year no more than the lesser of: (A) 50 Employees, or (B) the greater of three Employees or 10 percent of the Employees of the Employer or any Affiliated Employer; 79 (ii) One of the ten Employees owning (or considered as owning within the meaning of Section 318 of the Code) more than a five percent (5%) interest and one of the largest interests in the Employer or any Affiliated Employer. An Employee will not be considered such an owner for any Plan Year if the Employee's compensation (within the meaning of Section 414(q)(4)) is less than $30,000 (as adjusted for increases in the cost of living in accordance with the Regulations); for purposes of determining ownership pursuant to Section 19.4(e)(ii) the aggregation rules of Section 414(b), (c) and (m) of the Code apply. (iii) Any person who owns (or considered as owning within the meaning of Section 318 of the Code) more than a five percent interest in the Employer; (iv) Any person having compensation (within the meaning of Section 414(q)(4)) of more than $150,000, and owning (or considered as owning within the meaning of Section 318 of the Code) more than a one percent interest in the Employer. For purposes of this Section 19.4(e), a Beneficiary of a Key Employee shall be treated as a Key Employee and the interests inherited by such Beneficiary shall be treated the same as if owned by the Key Employee. (f) "Non-Key Employee" means any "Non-Key Employee" as defined in Section 416(i)(2) of the Code and the Regulations promulgated thereunder. 19.5 MAINTENANCE OF DEFINED BENEFIT PLAN IN ADDITION TO PLAN. Effective for limitation years commencing prior to January 1, 2000, in the event that the Plan is a Top-Heavy Plan for any Plan Year and the Employer also maintains a defined benefit plan (within the meaning of Section 414 of the Code) which provides benefits on behalf of Participants, then one of the two following provisions shall apply: (1) If the Plan is a Top-Heavy Plan for any Plan Year but would not be a "Top-Heavy Plan" for the Plan Year if "90 percent" were substituted for "60 percent" in Section 19.4(a), then Section 19.2 shall be applied for such Plan Year by substituting "four percent" for "three percent." 80 (2) If a Top-Heavy Plan would continue to be a "Top-Heavy Plan" for the Plan Year if "90 percent" were substituted for "60 percent", then the denominator of the defined contribution plan fraction shall be calculated for such Plan Year by substituting "1.0" for "1.25", except with respect to any Participant who is not entitled to an allocation of Employer contributions and does not receive any accruals under any defined benefit plan (within the meaning of Section 414(j) of the Code) maintained by the Employer. In the event that another defined contribution plan or a defined benefit plan maintained by the Employer provides contributions or benefits on behalf of Participants, the Committee shall take such other plan into account as a part of this Plan to the extent required by the Code and in accordance with the Regulations. 81 SECTION 20. GENERAL LIMITATIONS AND PROVISIONS 20.1 EXCLUSIVE BENEFIT OF PARTICIPANTS AND BENEFICIARIES. In no event shall any part of the funds of the Plan be used for or diverted to any purposes other than for the exclusive benefit of Participants and their Beneficiaries under the Plan except as permitted under Section 403(c) of the Act. Upon the transfer by a Participating Employer of any money to the Trustee, all interest of the Participating Employer therein shall cease and terminate. 20.2 NO RIGHTS TO CONTINUED EMPLOYMENT. Nothing contained in the Plan shall give any employee the right to be retained in the employment of the Employer or any Affiliated Employer or affect the right of the Employer or any Affiliated Employer to dismiss any employee. The adoption and maintenance of the Plan shall not constitute a contract between the Employer and any employee or be consideration for, or an inducement to or condition of, the employment of any employee. 20.3 TRUST SOLE SOURCE OF BENEFITS. The Trust Fund shall be the sole source of benefits under the Plan and, except as otherwise required by the Act, the Employer and the Committee assume no liability or responsibility for payment for such benefits, and each Participant, Surviving Spouse, Beneficiary or other person who shall claim the right to any payment under the Plan shall be entitled to look only to the Trust Fund for such payment and shall not have any right, claim or demand therefor against the Employer, the Committee, or any Participant thereof, or any employee or director of the Employer. 20.4 RISK OF DECREASE IN ASSETS. Each Participant, Beneficiary and Surviving Spouse shall assume all risk in connection with any decrease in the value of the assets of the Trust Fund and the Participants' Accounts or special accounts and neither the Employer nor the Committee shall be liable or responsible therefor. 20.5 INCAPACITY OF PARTICIPANT OR BENEFICIARY. If the Committee shall find that any person to whom any amount is payable under the Plan is unable to care for his or her affairs because of illness or accident, or is a minor, or has died, then any payment due such person or his 82 or her estate shall be made to his or her duly appointed legal representative. Any such payment shall be a complete discharge of the liability of the Plan and the Trust Fund therefor. 20.6 ANTIALIENATION; QUALIFIED DOMESTIC RELATIONS ORDERS. (a) Except insofar as may otherwise be required by law or pursuant to the terms of a Qualified Domestic Relations Order, as set forth in this Section 20.5, no amount payable at any time under the Plan and the Trust Fund shall be subject in any manner to alienation by anticipation, sale, transfer, assignment, bankruptcy, pledge, attachment, charge or encumbrance of any kind nor in any manner be subject to the debts or liabilities of any person, and any attempt to so alienate or subject any such amount, whether presently or thereafter payable, shall be void. If any person shall attempt to, or shall, alienate, sell, transfer, assign, pledge, attach, charge or otherwise encumber any amount payable under the Plan and Trust Fund, or any part thereof, or if by reason of his or her bankruptcy or other event happening at any such time such amount would be made subject to his or her debts or liabilities or would otherwise not be enjoyed by such person, then the Committee, if it so elects, may direct that such amount be withheld and that the same or any part thereof be paid or applied to or for the benefit of such person. (b) Upon receipt of notification of any judgment, decree or order (including approval of a property settlement agreement) which relates to the provision of child support, alimony payments, or marital property rights of a spouse, former spouse, child, or other dependent of a Participant and which is made pursuant to a state domestic relations law (including a community property law) (herein referred to as a "domestic relations order"), the Committee shall (i) notify the Participant and any prospective Alternate Payee named in the order of the receipt and date of receipt of such domestic relations order and of the Plan's procedures for determining the status of the domestic relations order as a Qualified Domestic Relations Order, and (ii) within a reasonable period after receipt of such order, determine whether it constitutes a Qualified Domestic Relations Order. The Plan's procedures for the determination of whether a domestic relations order constitutes a Qualified Domestic Relations 83 Order shall be set forth by the Committee in writing, shall provide for the notification of each person specified in that order as entitled to payment of benefits under the Plan (at the address included in the domestic relations order) of such procedures promptly upon receipt by the Committee of such domestic relations order, and shall permit the prospective Alternate Payee to designate a representative for receipt of copies of notices that are sent to the prospective Alternate Payee with respect to a domestic relations order. (c) During any period in which the issue of whether a domestic relations order is a Qualified Domestic Relations Order is being determined (by the Committee, by a court of competent jurisdiction, or otherwise), including the period beginning on the date of the Committee's receipt of the order, the Committee shall segregate in a separate account in the Plan or in an escrow account held by a Trustee the amounts, if any, which would have been payable to the Alternate Payee during such period if the order had been determined to constitute a Qualified Domestic Relations Order, provided that if no payments would otherwise be made under the Plan to the Alternate Payee or to the Participant or a Beneficiary of the Participant while the status of the order as a Qualified Domestic Relations Order is being determined, no segregation into a separate or escrow account shall be required. If a domestic relations order is determined to be a Qualified Domestic Relations Order within eighteen (18) months of the date of its receipt by the Committee (or from the beginning of any other period during which the issue of its being a Qualified Domestic Relations Order is being determined by the Committee) the Committee shall cause to be paid to the persons entitled thereto the amounts, if any, held in the separate or escrow account referred to above in one lump sum. If a domestic relations order is determined not be a Qualified Domestic Relations Order, or if the status of the domestic relations order as a Qualified Domestic Relations Order is not finally resolved within such eighteen month period, the Committee shall cause the separate account or escrow account balance to be returned, with interest thereon, to the Participant's Account or to be paid to the person or persons to whom such amount would have been paid if there had been no such domestic relations order, whichever shall 84 apply. Any subsequent determination that such domestic relations order is a Qualified Domestic Relations Order shall be prospective in effect only. (d) (i) Benefits payable to an Alternate Payee shall be payable in one lump sum and in no event shall such benefits continue beyond the lifetime of the Alternate Payee. Such payment may be made at the time specified in the Qualified Domestic Relations Order irrespective of whether the Participant has attained the "earliest retirement age" (within the meaning of Section 414(p)(4)(B) of the Code). In particular, no Alternate Payee shall have the right with respect to any benefit payable by reason of a Qualified Domestic Relations Order to (A) designate a beneficiary with respect to amounts becoming payable under the Plan, (B) elect a method of benefit distribution providing for benefits continuing beyond the Alternate Payee's lifetime, (C) provide survivorship benefits to a spouse or dependent of such Alternate Payee or to any other person, spouse, dependent or other person, or (D) transfer rights under the Qualified Domestic Relations Order by will or by state law of intestacy. (ii) None of the payments, benefits or rights of any Alternate Payee shall be subject to any claim of any creditor, and, in particular, to the fullest extent permitted by law, all such payments, benefits and rights shall be free from attachment, garnishment, trustee's process, or any other legal or equitable process available to any creditor of such Alternate Payee. No Alternate Payee shall have the right to alienate, anticipate, commute, pledge, encumber or assign any of the benefits or payments which he or she may expect to receive, contingently or otherwise, under the Plan. (iii) Alternate Payees shall not have any right to (A) borrow money under any Participant loan provisions under the Plan, (B) exercise any Participant investment direction rights or privileges under the Plan, (C) exercise any other election, privilege, option or direction rights of the Participant under the Plan except as specifically provided in the Qualified Domestic Relations Order, or (D) receive communications with respect to the Plan except as specifically provided by law, regulation or the Qualified Domestic Relations Order. 85 (iv) Each Alternate Payee shall advise the Committee in writing of each change of his or her name, address or marital status, and of each change in the provisions of the Qualified Domestic Relations Order or any circumstance set forth therein which may be material to the Alternate Payee's entitlement to benefits thereunder or the amount thereof. Until such written notice has been provided to the Committee, the Committee shall be (A) fully protected in not complying with, and in conducting the affairs of the Plan in a manner inconsistent with, the information set forth in the notice, and (B) required to act with respect to such notice prospectively only, and then only to the extent provided for in the Qualified Domestic Relations Order. The Committee shall not be required to modify or reverse any payment, transaction or application of funds occurring before the receipt of any notice that would have affected such payment, transaction or application of funds, nor shall the Committee or any other party be liable for any such payment, transaction or application of funds. (v) Except as specifically provided for in the Qualified Domestic Relations Order, an Alternate Payee shall have no right to interfere with the exercise by the Participant or by any Beneficiary of their respective rights, privileges and obligations under the Plan. (e) For purposes of this Plan, a Qualified Domestic Relations Order means any judgment, decree, or order (including approval of a property settlement agreement) which has been determined by the Committee in accordance with procedures established under the Plan, to constitute a qualified domestic relations order within the meaning of Section 414(p)(1) of the Code and Alternate Payee means any person entitled to current or future payment of benefits under the Plan pursuant to a Qualified Domestic Relations Order. 20.7 INABILITY TO LOCATE PARTICIPANT OR BENEFICIARY. If the Committee cannot ascertain the whereabouts of any person to whom a payment is due under the Plan, and if, after five years from the date such payment is due, a notice of such payment due is mailed to the last known address of such person, as shown on the records of the Committee or the Employer, and within three months after such mailing such person has not made written claim therefor, the Committee, 86 if it so elects, may direct that such payment and all remaining payments otherwise due to such person be canceled on the records of the Plan and the amount thereof applied to reduce the contributions of the Employer, and upon such cancellation, the Plan and the Trust Fund shall, to the maximum extent permitted by the Act, have no further liability therefor except that, in the event such person later notifies the Committee of his or her whereabouts and requests the payment or payments due to such person under the Plan, the amount so applied shall be paid to him or her as provided in Section 11. All elections, designations, requests, notices, instructions, and other communications from the Employer, a Participant, Beneficiary, Surviving Spouse or other person to the Committee required or permitted under the Plan shall be in such form as is prescribed from time to time by the Committee, shall be mailed or delivered to such location as shall be specified by the Committee, and shall be deemed to have been given and delivered only upon actual receipt thereof by the Committee at such location. 20.8 FAILURE TO RECEIVE IRS APPROVAL. Notwithstanding any other provision herein, if this Plan shall not be approved by the IRS under the provisions of the Code and the Regulations for any reason (including failure to comply with any condition for such approval imposed by the IRS) contributions made after the restatement of this Plan and prior to such denial shall be returned, without any liability to any person, within one year after the date of denial of such approval. 20.9 CONTRIBUTIONS CONDITIONED ON DEDUCTIBILITY. Notwithstanding any other provision herein, all contributions to the Trust Fund are expressly conditioned upon their deductibility under Section 404 of the Code and the Regulations, and in the event of the final disallowance of the deduction for any contribution, in whole or in part, then such contribution (to the extent the deduction is disallowed) shall upon direction of the Committee, which shall be given in conformity with the provisions of the Act, be returned, without liability to any person, within one year after such final disallowance. 20.10 MISTAKE OF FACT. Notwithstanding any other provisions herein, if any contribution is made by a mistake of fact, such contribution shall upon the direction of the Committee, which 87 shall be given in conformity with the provisions of the Act, be returned, without liability to any person, within one year after the payment of such contribution. 20.11 COMMUNICATIONS WITH COMMITTEE. All elections, designations, requests, notices, instructions, and other communications from the Employer, a Participant, Beneficiary, Surviving Spouse or other person to the Committee required or permitted under the Plan shall be in such form as is prescribed from time to time by such Committee, shall be mailed by first-class mail or delivered to such location as shall be specified by such Committee, and shall be deemed to have been given and delivered only upon actual receipt thereof by such Committee at such location. 20.12 COMMUNICATIONS WITH PARTICIPANTS AND BENEFICIARIES. All notices, statements, reports and other communications from the Employer or the Committee to any Employee, Participant, Surviving Spouse, Beneficiary or other person required or permitted under the Plan shall be deemed to have been duly given when delivered to, or when mailed by first-class mail, postage prepaid and addressed to, such Employee, Participant, Surviving Spouse, Beneficiary or other person at his or her address last appearing on the records of the Committee. 20.13 PRIOR SERVICE CREDIT. Upon such terms and conditions as the Committee may approve, and subject to any required IRS approval, benefits may be provided under the Plan to a Participant with respect to any period of the Participant's prior employment by any organization, and such benefits (and any Service credited with respect to such period of employment under Section 2.25) may be provided for, in whole or in part, by funds transferred, directly or indirectly (including a rollover from an individual retirement account), to the Trust Fund from an employee benefit plan of such organization which qualified under Section 401(a) of the Code. 20.14 GENDER AND NUMBER. Except where otherwise required by the context, whenever used in the Plan the masculine gender includes the feminine and the singular shall include the plural. 20.15 HEADINGS. The captions preceding the Sections of the Plan have been inserted solely as a matter of convenience and in no way define or limit the scope or intent of any provisions of the Plan. 88 20.16 GOVERNING LAW. The Plan and all rights thereunder shall be governed by and construed in accordance with the Act and, to the extent not inconsistent therewith, the laws of the State of California. 20.17 SEVERABILITY OF PROVISIONS. If any provision of the Plan shall be held invalid or unenforceable, such invalidity or unenforceability shall not affect any other provisions hereof, and the Plan shall be construed and enforced as if such provisions had not been included. 20.18 HEIRS, ASSIGNS AND PERSONAL REPRESENTATIVES. The Plan shall be binding upon the heirs, executors, administrators, successors and assigns of the parties, including each Participant and Beneficiary, present and future and all persons for whose benefit there exists any QDRO with respect to any Participant (except that no successor to the Plan Sponsor shall be considered a Plan Sponsor unless that successor adopts the Plan). 20.19 RELIANCE ON DATA AND CONSENTS. The Plan Sponsor, the Employer, each participating Employer, the Board of Directors, the Committee, the Trustee, all fiduciaries with respect to the Plan, and all other persons or entities associated with the operation of the Plan, the management of its assets, and the provision of benefits thereunder, may reasonably rely on the truth, accuracy and completeness of all data provided by any Participant, Surviving Spouse, Beneficiary, and Alternate Payee, including, without limitation, data with respect to age, health and marital status. Furthermore, the Plan Sponsor, the Employer, each participating Employer, the Board of Directors, the Committee, the Trustee, and all fiduciaries with respect to the Plan may reasonably rely on all consents, elections and designations filed with the Plan or those associated with the operation of the Plan and its corresponding Trust by any Participant, Surviving Spouse, Beneficiary, Alternate Payee, or any representative of any such person, without duty to inquire into the genuineness of any such consent, election or designation. None of the aforementioned persons or entities associated with the operation of the Plan, its assets and the benefits provided under the Plan shall have any duty to inquire into any such data, and all may rely on such data being current to the date of reference, it being the duty of the Participants, 89 Surviving Spouses, Beneficiaries and Alternate Payees to advise the appropriate parties of any change in such data. 20.20 QUALIFIED MILITARY SERVICE. Notwithstanding any provision of this Plan to the contrary, contributions, benefits and service credit with respect to qualified military service will be provided in accordance with Section 414(u) of the Code. 90 SECTION 21. APPLICATION TO PUERTO RICO EMPLOYEES 21.1 MODIFICATIONS APPLICABLE TO PUERTO RICO. The provisions of this Section shall govern the application of the provisions of the Plan to Participants who are employed by the Company in and are residents of the Commonwealth of Puerto Rico ("Puerto Rico Participants"): (a) Notwithstanding Section 2.25, the definition of "Highly Compensated Participant" shall be a Puerto Rico Participant employed by the Company who receives Compensation that exceeds the Compensation paid to two thirds of the Puerto Rico Participants, as provided in Section 165(e) of the Puerto Rico Income Tax Act; (b) The following shall apply in lieu of the second sentence of Section 5.1(a) hereof: The Salary Reduction Agreement shall provide for Elective Contributions equal to any whole percentage between one percent (1%) and ten Percent (10%) of a Participant's Compensation in any payroll period, not to exceed $7,500 (reduced by any contributions made by the Participant to an IRA) in any calendar year; (c) The Actual Deferral Percentage Test set forth in Section 5.3 shall be applied separately with respect to Puerto Rico Participants. For purposes of applying the Actual Deferral Percentage Test to Puerto Rico Participants, the definition of Highly Compensated Employee contained in subparagraph (a) hereof shall be used; and (d) For purposes of applying subparagraphs (b) and (c) of this Section 21.1, the definition of Compensation contained in Section 2.11 shall be applied without regard to clause (xii) thereof. In all other respects, the terms of this Plan shall apply to Puerto Rico Participants. 91 EX-11.1 13 EXHIBIT 11.1 THE CHARLES SCHWAB CORPORATION EXHIBIT 11.1 THE CHARLES SCHWAB CORPORATION COMPUTATION OF EARNINGS PER SHARE (In thousands, except per share amounts)
YEAR ENDED DECEMBER 31, 1997 1996 1995 ---- ---- ---- NET INCOME $270,277 $233,803 $172,604 - ----------------------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------------------- BASIC SHARES:* Weighted-average number of common shares outstanding 262,545 259,909 257,696 - ----------------------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------------------- DILUTED SHARES:* Weighted-average number of common shares outstanding 262,545 259,909 257,696 Common stock equivalent shares related to stock incentive plans 10,030 9,192 10,018 - ----------------------------------------------------------------------------------------------------------------------------- Weighted-average number of common and common equivalent shares outstanding 272,575 269,101 267,714 - ----------------------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------------------- EARNINGS PER SHARE:* Basic $ 1.03 $ .90 $ .67 Diluted $ .99 $ .87 $ .64 - ----------------------------------------------------------------------------------------------------------------------------- - -----------------------------------------------------------------------------------------------------------------------------
* Reflects the September 1997 three-for-two common stock split. SEE "EARNINGS PER SHARE" NOTE IN THE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS REGARDING THE ADOPTION OF STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 128 -- EARNINGS PER SHARE. EX-12.1 14 EXHIBIT 12.1 THE CHARLES SCHWAB CORPORATION EXHIBIT 12.1 THE CHARLES SCHWAB CORPORATION COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES (Dollar amounts in thousands, unaudited)
YEAR ENDED DECEMBER 31, 1997 1996 1995 1994 1993 - ----------------------------------------------------------------------------------------------------------------------------- EARNINGS BEFORE TAXES ON INCOME AND EXTRAORDINARY CHARGE $ 447,247 $394,063 $277,104 $224,343 $206,272 - ----------------------------------------------------------------------------------------------------------------------------- FIXED CHARGES Interest expense - customer 480,988 368,462 321,225 178,067 114,609 Interest expense - other 65,495 57,410 35,998 20,169 17,943 Interest portion of rental expense 26,045 23,051 20,810 17,102 15,428 - ----------------------------------------------------------------------------------------------------------------------------- Total fixed charges (A) 572,528 448,923 378,033 215,338 147,980 - ----------------------------------------------------------------------------------------------------------------------------- EARNINGS BEFORE TAXES ON INCOME, EXTRAORDINARY CHARGE AND FIXED CHARGES (B) $1,019,775 $842,986 $655,137 $439,681 $354,252 - ----------------------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------------------- RATIO OF EARNINGS TO FIXED CHARGES (B) DIVIDED BY (A)* 1.8 1.9 1.7 2.0 2.4 - ----------------------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------------------- RATIO OF EARNINGS TO FIXED CHARGES EXCLUDING CUSTOMER INTEREST EXPENSE** 5.9 5.9 5.9 7.0 7.2 - ----------------------------------------------------------------------------------------------------------------------------- - -----------------------------------------------------------------------------------------------------------------------------
* THE RATIO OF EARNINGS TO FIXED CHARGES IS CALCULATED IN A MANNER CONSISTENT WITH SEC REQUIREMENTS. FOR SUCH PURPOSES, "EARNINGS" CONSIST OF EARNINGS BEFORE TAXES ON INCOME, EXTRAORDINARY CHARGE AND FIXED CHARGES. "FIXED CHARGES" CONSIST OF INTEREST EXPENSE INCURRED ON PAYABLES TO CUSTOMERS, SUBORDINATED BORROWINGS, TERM DEBT, CAPITALIZED INTEREST AND ONE-THIRD OF RENTAL EXPENSE, WHICH IS ESTIMATED TO BE REPRESENTATIVE OF THE INTEREST FACTOR. ** BECAUSE INTEREST EXPENSE INCURRED IN CONNECTION WITH PAYABLES TO CUSTOMERS 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 AS ADJUSTED REFLECTS THE ELIMINATION OF SUCH INTEREST EXPENSE AS A FIXED CHARGE. EX-13.1 15 EXHIBIT 13.1 EXHIBIT 13.1 The Charles Schwab Corporation 1997 Annual Report to Stockholders (only those portions specifically incorporated by reference into The Charles Schwab Corporation 1997 Annual Report on Form 10-K)
THE CHARLES SCHWAB CORPORATION SELECTED FINANCIAL AND OPERATING DATA (IN MILLIONS, EXCEPT PER SHARE AMOUNTS AND RATIOS) Growth Rates ------------------------- Compounded Annual ---------- ------ 5-Year 1-Year 1992-1997 1996-1997 1997 (1) 1996 1995 1994 1993 - ----------------------------------------------------------------------------------------------------------------------------- OPERATING RESULTS Revenues 25% 24% $ 2,299 $ 1,851 $ 1,420 $ 1,065 $ 965 Expenses excluding interest 25% 27% $ 1,852 $ 1,457 $ 1,142 $ 841 $ 758 Net income 27% 16% $ 270 $ 234 $ 173 $ 135 $ 118 Basic earnings per share (2, 3) 27% 14% $ 1.03 $ .90 $ .67 $ .53 $ .45 Diluted earnings per share (2, 3) 26% 14% $ .99 $ .87 $ .64 $ .51 $ .44 Dividends declared per common share (2) 33% 16% $ .139 $ .120 $ .094 $ .064 $ .042 Weighted-average number of common shares outstanding (2, 4) 273 269 268 263 268 Trading revenues as a % of revenues (5) 62% 65% 66% 67% 75% Non-trading revenues as a % of revenues (5) 38% 35% 34% 33% 25% Effective income tax rate 39.6% 40.7% 37.7% 39.7% 39.7% - ----------------------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------------------- PERFORMANCE MEASURES Revenue growth 24% 30% 33% 10% 29% Pre-tax profit margin 19.5% 21.3% 19.5% 21.1% 21.4% After-tax profit margin 11.8% 12.6% 12.2% 12.7% 12.2% Return on stockholders' equity 27% 31% 31% 32% 37% - ----------------------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------------------- FINANCIAL CONDITION (AT YEAR END) Total assets 23% 20% $16,482 $13,779 $10,552 $ 7,918 $6,897 Borrowings 19% 27% $ 361 $ 284 $ 246 $ 171 $ 185 Stockholders' equity 35% 34% $ 1,145 $ 855 $ 633 $ 467 $ 379 - ----------------------------------------------------------------------------------------------------------------------------- - -----------------------------------------------------------------------------------------------------------------------------
(1) 1997 INCLUDES CHARGES FOR A LITIGATION SETTLEMENT OF $24 MILLION AFTER-TAX ($.09 PER SHARE FOR BOTH BASIC AND DILUTED EARNINGS PER SHARE). (2) REFLECTS THE SEPTEMBER 1997 THREE-FOR-TWO COMMON STOCK SPLIT. (3) BOTH BASIC AND DILUTED EARNINGS PER SHARE ARE NET OF THE EFFECT OF AN EXTRAORDINARY CHARGE IN 1993 OF $.03 PER SHARE. (4) AMOUNTS SHOWN ARE USED TO CALCULATE DILUTED EARNINGS PER SHARE. (5) TRADING REVENUES INCLUDE COMMISSION AND PRINCIPAL TRANSACTION REVENUES. NON-TRADING REVENUES INCLUDE MUTUAL FUND SERVICE FEES, NET INTEREST REVENUE AND OTHER REVENUES. CERTAIN PRIOR YEARS' REVENUES AND EXPENSES HAVE BEEN RECLASSIFIED TO CONFORM TO THE 1997 PRESENTATION. THE CHARLES SCHWAB CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION DESCRIPTION OF BUSINESS The Charles Schwab Corporation (CSC) and its subsidiaries (collectively referred to as the Company) provide securities brokerage and related financial services for over 4.8 million active customer accounts(a). Customer assets totaled $353.7 billion at December 31, 1997. CSC's principal subsidiary, Charles Schwab & Co., Inc. (Schwab), is a securities broker-dealer with 272 domestic branch offices in 47 states, as well as a branch in each of the Commonwealth of Puerto Rico and the United Kingdom. Schwab served an estimated 55% of the discount brokerage market in 1997, up from 52% in 1996(b). Another subsidiary, Mayer & Schweitzer, Inc. (M&S), a market maker in Nasdaq and other securities, provides trade execution services to broker-dealers and institutional customers. Other subsidiaries include Charles Schwab Investment Management, Inc., the investment advisor for Schwab's proprietary mutual funds, and Charles Schwab Europe (formerly known as ShareLink), a retail discount securities brokerage firm located in the United Kingdom. (CHART OMITTED) The Company's strategy is to attract, retain and grow customer assets by focusing on a number of areas within the financial services industry -- retail brokerage, mutual funds, support services for independent investment managers, equity securities market-making and 401(k) defined contribution plans. To pursue its strategy and its objective of long-term profitable growth, the Company plans to continue to leverage its competitive advantages. These advantages include a nationally recognized brand, a broad range of products and services, multi- channel delivery systems and an ongoing investment in technology. The Company's nationwide advertising and marketing programs are designed to distinguish the Schwab brand as well as its products and services. These programs helped the Company open 1,164,000 new accounts and gather $68.9 billion in net new customer assets during 1997. The Company offers both a broad range of value-oriented products and services tailored to meet customers' varying investment and financial needs, as well as access to extensive investment news and information. The Company's branch office network assists investors in developing asset allocation strategies and evaluating their investment choices. Branch staff also refer investors who desire additional guidance to independent investment managers through the Schwab AdvisorSource-TM- service. The Company's Mutual Fund Marketplace-Registered Trademark- provides customers with the ability to invest in nearly 1,400 mutual funds from 219 fund families, including 825 Mutual Fund OneSource-Registered Trademark- funds. The Company responds to changing customer needs with continued product and service innovations. During 1997, Schwab announced alliances with three investment banking firms to provide certain of its customers access to initial and secondary public stock offerings managed by these firms. Additionally, the Company began to offer access to futures and commodities trading to certain of its most active customers. The Company differentiates itself with multi-channel delivery systems which allow customers to choose how they prefer to do business with the Company. To enable customers to obtain services in person with a Company representative, the Company maintains a network of branch offices. Telephonic access to the Company is provided primarily through four regional customer telephone service centers and two online customer support centers that operate both during and after normal market hours. Additionally, customers are able to obtain financial information and execute trades on an automated basis through the Company's electronic brokerage channels that provide both online and telephonic access. Online channels include PC-based services such as SchwabLink-Registered Trademark- -- a service for investment managers, and the Charles Schwab Web Site-TM- (formerly known as SchwabNOW!-TM-) -- an information and trading service on the Internet. The Company's online channels handled 37% of total trades during 1997, up from 25% of total trades in 1996. Automated telephonic channels include TeleBroker-Registered Trademark- -- Schwab's touch-tone telephone trading service, and VoiceBroker-TM- -- Schwab's voice recognition quote service. Schwab's automated telephonic channels handled 73% of the 110 million customer calls received during 1997, up from 67% of the 97 million customer calls received in 1996. The Company's ongoing investment in technology is a key element in enhancing its delivery systems, providing fast and consistent customer service, and reducing processing costs. The Company uses technology to empower its customers to manage their financial affairs and is a forerunner in driving technological advancements in the financial services industry. In 1997, the Company introduced a number of new Internet-based investment services, including the Asset Allocation Toolkit-TM- for portfolio allocation guidance, and the Mutual Fund OneSource Online and Market Buzz-TM- sites for research and information. Schwab also introduced the SchwabLink Web-TM- site for independent investment managers, which enables them to use the Internet to communicate directly with Schwab service teams, as well as receive news and information tailored to their needs. In addition, the Company launched a service that allows customers of its Cayman Islands and Hong Kong subsidiaries to trade third- - --------------- (a) ACCOUNTS WITH BALANCES OR ACTIVITY WITHIN THE PRECEDING TWELVE MONTHS. (b) SOURCE: SECURITIES INDUSTRY ASSOCIATION BASED ON THE AVERAGE OF THE FIRST THREE QUARTERS OF EACH RESPECTIVE YEAR. 2 party mutual funds online and obtain information on mutual fund performance and fees, all through the Company's international Web site. Also during 1997, Schwab introduced a speech recognition telephone trading service that enables customers to trade any of the funds in the Mutual Fund Marketplace-Registered Trademark- using vocal commands. The Company faces significant competition from companies seeking to attract customer financial assets, including full commission brokerage firms, discount brokerage firms, mutual fund companies and banks. Certain of these competitors have significantly greater financial resources than the Company, particularly given the continued consolidation within the financial services industry. In addition, the recent expansion and customer acceptance of conducting financial transactions online has attracted competition from software development companies and providers of online services. In 1997, price competition continued to intensify in the area of online investing as competitors sought to gain market share in this rapidly growing area. The Company experienced declines in its average commission per revenue trade as the proportion of its customers using electronic brokerage channels, which provide discounts from the Company's standard commission rates, has increased. As the Company focuses on further enhancements to its electronic service offering, average commission per revenue trade is expected to continue to decline. These competitive factors may negatively impact the Company's revenue growth and profit margin. The Company's business, like that of other securities brokerage firms, is directly affected by the fluctuations in securities trading volumes and price levels that occur in fundamentally cyclical financial markets. Since transaction-based revenues continue to represent a majority of the Company's revenues, the Company may experience significant variations in revenues from period to period. The Company adjusts its expenses in anticipation of and in response to changes in financial market conditions and customer trading patterns. Certain of the Company's expenses (including variable compensation, portions of communications, and commissions, clearance and floor brokerage) vary directly with changes in financial performance or customer trading activity. Expenses relating to the level of temporary employees, contractors, overtime hours, professional services, and advertising and market development are adjustable over the short term to help the Company achieve its financial objectives. Additionally, developmental spending (including branch openings, product and service rollouts, and technology enhancements) is discretionary and can be altered in response to market conditions. However, a significant portion of the Company's expenses such as salaries and wages, occupancy and equipment, and depreciation and amortization do not vary directly, at least in the short term, with fluctuations in revenues or securities trading volumes. Also, the Company views its development spending as essential for future growth and therefore tries to avoid major adjustments in such spending unless faced with a sustained slowdown in customer trading activity. Given the nature of the Company's revenues and expenses, and the economic and competitive factors discussed above, the Company's earnings and common stock price may be subject to significant volatility from period to period. The Company's results for any period are not necessarily indicative of results for a future period. In addition to historical information, this Annual Report contains forward- looking statements that reflect management's objectives and expectations as of the date hereof. These statements relate to, among other things, the Company's strategy (see Description of Business), sources of liquidity (see Liquidity and Capital Resources -- Liquidity), capital expenditures and capital structure (see Liquidity and Capital Resources -- Cash Flows and Capital Resources), Year 2000 project (see Liquidity and Capital Resources -- Year 2000), and revenue growth, after-tax profit margin, and return on stockholders' equity (see Results of Operations and Looking Ahead). Achievement of the expressed 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 objectives and expectations. Important factors that may cause such differences are noted throughout this Annual Report and in the Company's Annual Report on Form 10-K and include, but are not limited to: the effect of customer trading patterns on Company revenues and earnings; changes in technology; computer system failures; risks associated with the Year 2000 computer systems conversions; the effects of competitors' pricing, product and service decisions and intensified competition; evolving regulation and changing industry customs and practices adversely affecting the Company; adverse results of litigation; changes in revenues and profit margin due to cyclical securities markets and interest rates; and a significant downturn in the securities markets over a short period of time or a sustained decline in securities prices and trading volumes. RESULTS OF OPERATIONS FINANCIAL OVERVIEW The Company achieved record revenues for the eighth consecutive year and record earnings for the seventh consecutive year in 1997. One of the factors contributing to this record performance was strong trading volumes in the securities markets during the year. The combined daily average share volume for the New York Stock Exchange (NYSE) and Nasdaq reached an all time high of 1,175 million shares in 1997, a 23% increase over 1996. The Standard & Poor's 500 Index (on a dividend reinvested basis) rose 33% during 1997. (CHART OMITTED) 3 Other key factors that contributed to the Company's financial performance in 1997 include: - - Assets in Schwab customer accounts rose $100.5 billion, or 40%, to a record $353.7 billion. This increase resulted from net new customer assets of $68.9 billion and net market gains of $31.6 billion. - - A record 1,164,000 new Schwab customer accounts were opened, an increase of 18% from 985,000 opened in 1996. - - Trading activity reached record levels as shown in the following table (in thousands):
- -------------------------------------------------------------------------------- Daily Average Trades 1997 1996 1995 - -------------------------------------------------------------------------------- Online 39.6 20.2 12.4 TeleBroker-Registered Trademark- 13.5 13.1 9.4 Regional customer telephone service centers, branch offices and other 52.9 47.9 36.8 - -------------------------------------------------------------------------------- Total (1) 106.0 81.2 58.6 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- % change 31% 39% 34% - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
(1) Includes Mutual Fund OneSource-Registered Trademark- daily average trades of 34.2 in 1997, 27.2 in 1996 and 17.8 in 1995. Revenues increased mainly due to higher customer trading volume and an increase in customer assets. Revenues of $2,299 million in 1997 grew 24% from 1996, exceeding management's annual long-term objective of 20% revenue growth, due to a 23% increase in commission revenues, as well as a 37% increase in mutual fund service fees and a 39% increase in interest revenue, net of interest expense (referred to as net interest revenue). Non-trading revenues (which consist of mutual fund service fees, net interest revenue, and other revenues) increased $227 million, or 35%, to $867 million in 1997. (CHART OMITTED) The Company's earnings rose 16% to $270 million, or $.99 diluted earnings per share, up from $234 million, or $.87 diluted earnings per share, in 1996. Share and per share information throughout this report have been restated to reflect the September 1997 three-for-two common stock split, effected in the form of a 50% stock dividend. The Company's 1997 results include charges for the settlement of a class- action lawsuit involving M&S and other firms engaged in making markets in Nasdaq securities. These charges totaled $24 million after-tax, or $.09 diluted earnings per share. Excluding these charges, the Company's earnings would have increased 26% from 1996. The Company's operating expenses increased 27% during 1997 to $1,852 million, primarily due to a 26% increase in compensation and benefits expense, a 54% increase in advertising and market development spending, and a 71% increase in other expenses primarily due to the litigation settlement. The Company's after-tax profit margin for 1997 was 11.8%, which was slightly lower than the 12.6% margin in 1996, and above the Company's annual long-term objective of 10%. Excluding the charges relating to the litigation settlement, the Company's after-tax profit margin would have been 12.8%. Net income plus depreciation and amortization increased 19% during 1997 to $395 million and capital expenditures decreased $20 million in 1997 to $139 million. Return on stockholders' equity was 27% in 1997, exceeding the Company's annual long-term objective of 20%. The Company's Board of Directors declared a cash dividend increase during 1997, raising the effective annual dividend rate 20%. REVENUES
- -------------------------------------------------------------------------------- Composition of Revenues 1997 1996 1995 - -------------------------------------------------------------------------------- Commissions 51% 52% 53% Mutual fund service fees 19 17 15 Net interest revenue 15 14 15 Principal transactions 11 14 13 Other 4 3 4 - -------------------------------------------------------------------------------- Total 100% 100% 100% - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
COMMISSIONS The Company earns commission revenues by executing customer trades. These revenues are affected by the number of customer accounts that traded, the average number of commission-generating trades per account, and the average commission per trade. Commission revenues were $1,174 million in 1997, compared to $954 million in 1996 and $751 million in 1995. (CHART OMITTED) As shown in the table below, from 1995 to 1997, the total number of customer revenue trades executed by the Company has increased over 78% as the Company's customer base has grown. From 1995 to 1997, average commission per revenue trade decreased 12%, mainly due to more trades placed through electronic brokerage channels, which provide discounts from the Company's standard commission rates. 4
- -------------------------------------------------------------------------------- Commissions Earned on Customer Revenue Trades 1997 1996 1995 - -------------------------------------------------------------------------------- Customer accounts that traded during the year (in thousands) 2,380 2,037 1,619 Average customer revenue trades per account 7.6 6.7 6.3 Total revenue trades (in thousands) 18,169 13,717 10,192 Average commission per revenue trade $ 64.27 $ 69.08 $ 73.11 Commissions earned on customer revenue trades (in millions) (1) $ 1,168 $ 947 $ 745 - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
(1) Excludes commissions on trades with specialists totaling $6 million in 1997, $7 million in 1996 and $6 million in 1995. In December 1997, the Company announced a plan to integrate its online and traditional brokerage services, and to reduce the price of online trades for most of its customers. As a result, the Company expects average commission per revenue trade to continue to decline. MUTUAL FUND SERVICE FEES The Company earns mutual fund service fees for record keeping and shareholder services provided to third-party funds, and for transfer agent services, shareholder services, administration and investment management provided to its proprietary funds. These fees are based upon daily balances of customer assets invested in third-party funds and upon the average daily net assets of its proprietary funds. Mutual fund service fees were $428 million in 1997, compared to $311 million in 1996 and $219 million in 1995. The increases from 1995 to 1997 were primarily due to significant increases in customer assets in funds purchased through Schwab's Mutual Fund OneSource-Registered Trademark- service, and in customer assets in Schwab's proprietary funds, collectively referred to as the SchwabFunds-Registered Trademark-. At December 31, 1997, Schwab's Mutual Fund OneSource service enabled customers to trade 825 mutual funds in 121 fund families without incurring transaction fees. The service allows investors to access multiple mutual fund companies, avoid brokerage transaction fees, and achieve investment diversity among fund families. In addition, investors' record keeping and investment monitoring are simplified through one consolidated statement. Customer assets held by Schwab that have been purchased through the Mutual Fund OneSource service, excluding Schwab's proprietary funds, were $56.6 billion, $39.2 billion and $23.9 billion at the end of 1997, 1996 and 1995, respectively. Additionally, customer assets invested in the Mutual Fund Marketplace- Registered Trademark-, excluding the Mutual Fund OneSource service, were $48.0 billion, $35.4 billion and $26.1 billion at the end of 1997, 1996 and 1995, respectively. Schwab charges a transaction fee on trades placed in the funds included in the Mutual Fund Marketplace (except on trades through the Mutual Fund OneSource service). These fees are recorded as commission revenues. The SchwabFunds include money market funds, equity index funds, bond funds, asset allocation funds, and funds that primarily invest in stock, bond and money market funds. Schwab customers may elect to have cash balances in their brokerage accounts automatically invested in certain SchwabFunds money market funds. Customer assets invested in the SchwabFunds were $55.8 billion, $43.1 billion and $31.7 billion at the end of 1997, 1996 and 1995, respectively. NET INTEREST REVENUE Net interest revenue is the difference between interest earned on assets (mainly margin loans to customers and investments) and interest paid on liabilities (mainly customer 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. Substantially all of the Company's net interest revenue is earned by Schwab. In clearing its customers' trades, Schwab holds cash balances payable to customers. In most cases, Schwab pays its customers interest on cash balances awaiting investment, and may invest these funds and earn interest revenue. Schwab also may lend funds to customers on a secured basis to purchase qualified securities -- a practice commonly known as "margin lending." Pursuant to Securities and Exchange Commission (SEC) regulations, customer cash balances that are not used for margin lending are segregated into an investment account that is maintained for the exclusive benefit of customers. When investing segregated customer cash balances, Schwab must adhere to SEC regulations that restrict investments to U.S. government securities, participation certificates and mortgage-backed securities guaranteed by the Government National Mortgage Association, certificates of deposit issued by U.S. banks and thrifts, and resale agreements collateralized by qualified securities. Schwab's policies for credit quality and maximum maturity requirements are more restrictive than these SEC regulations. In each of the last three years, resale agreements accounted for over 70% of Schwab's investments of segregated customer cash balances. The average maturities of Schwab's total investments of segregated customer cash balances were 63 days in 1997, 60 days in 1996 and 48 days in 1995. Net interest revenue was $354 million in 1997, compared to $255 million in 1996 and $211 million in 1995, as shown in the following table (in millions): 5
- -------------------------------------------------------------------------------- 1997 1996 1995 - -------------------------------------------------------------------------------- INTEREST REVENUE Margin loans to customers $489 $339 $264 Investments, customer-related 376 313 283 Other 35 29 21 - -------------------------------------------------------------------------------- Total 900 681 568 - -------------------------------------------------------------------------------- INTEREST EXPENSE Customer cash balances 481 368 321 Stock-lending activities 37 25 15 Borrowings 20 18 12 Other 8 15 9 - -------------------------------------------------------------------------------- Total 546 426 357 - -------------------------------------------------------------------------------- Net interest revenue $354 $255 $211 - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
The Company's interest-earning assets are financed primarily by interest- bearing customer cash balances. Other funding sources include noninterest- bearing customer cash balances, proceeds from stock-lending activities, borrowings, and stockholders' equity. Customer-related daily average balances, interest rates, and average net interest margin are summarized as follows (dollars in millions):
- -------------------------------------------------------------------------------- 1997 1996 1995 - -------------------------------------------------------------------------------- INTEREST-EARNING ASSETS (CUSTOMER-RELATED): Investments: Average balance outstanding $ 6,990 $5,883 $4,815 Average interest rate 5.38% 5.32% 5.88% Margin loans to customers: Average balance outstanding $ 6,367 $4,482 $3,221 Average interest rate 7.68% 7.57% 8.20% Average yield on interest-earning assets 6.48% 6.29% 6.81% FUNDING SOURCES (CUSTOMER-RELATED AND OTHER): Interest-bearing customer cash balances: Average balance outstanding $10,661 $8,377 $6,553 Average interest rate 4.51% 4.40% 4.90% Other interest-bearing sources: Average balance outstanding $ 1,122 $ 775 $ 457 Average interest rate 4.44% 4.37% 4.54% Average noninterest-bearing portion $ 1,574 $1,213 $1,026 Average interest rate on funding sources 3.97% 3.88% 4.26% SUMMARY: Average yield on interest-earning assets 6.48% 6.29% 6.81% Average interest rate on funding sources 3.97% 3.88% 4.26% - -------------------------------------------------------------------------------- Average net interest margin 2.51% 2.41% 2.55% - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
The increases in net interest revenue from 1995 to 1997 were primarily due to higher levels of average earning assets. Since the Company establishes the rates paid on customer cash balances and charged on margin loans, a substantial portion of its net interest margin is managed by the Company. However, the margin is highly influenced by external factors such as the interest rate environment and competition. As interest rates in general were higher in 1997 than in 1996, the Company's average net interest margin increased during 1997. To pay competitive yields to customers in a lower interest rate environment, the Company's average net interest margin declined from 1995 to 1996. PRINCIPAL TRANSACTIONS Principal transaction revenues are primarily comprised of net gains from market-making activities in Nasdaq securities. Factors that influence principal transaction revenues include the volume of customer trades, market price volatility, and changes in regulations, and industry customs and practices as discussed below. As a market maker in Nasdaq and other securities, M&S generally executes customer trades as principal. While substantially all Nasdaq security trades originated by the customers of Schwab are directed to M&S, the majority of M&S' trading volume comes from parties other than Schwab. Principal transaction revenues were $258 million in 1997, compared to $257 million in 1996 and $191 million in 1995. Revenues were essentially unchanged from 1996 to 1997 primarily due to greater share volume handled by M&S, substantially offset by lower average revenue per principal transaction (see discussion below). The increase from 1995 to 1996 was primarily due to greater share volume handled by M&S. In August 1996, the SEC adopted certain new rules and rule amendments, known as the Order Handling Rules, which have significantly altered the manner in which orders related to both Nasdaq and listed securities are handled. These rules were implemented in phases between January 20, 1997 and October 13, 1997. Additionally, in June 1997, most major U.S. securities markets, including Nasdaq and the NYSE, began quoting and trading securities in increments of one- sixteenth dollar per share instead of one-eighth dollar per share for most securities, and these markets are currently considering further changes to reduce the increments by which securities are priced. Mainly as a result of these regulatory changes and changes in industry customs and practices, average revenue per principal transaction declined during 1997 as compared to 1996. M&S' average revenue per principal transaction declined 42% from the first to the last quarter of 1997, while M&S' share volume increased 55% over the same period. Had M&S' average revenue per principal transaction not decreased in 1997 compared to 1996, M&S' principal transaction revenues would have been $80 million higher in 1997. Since the change to trading securities in increments of one-sixteenth dollar per share was not implemented until June 1997 and the Order Handling Rules were not fully implemented until October 1997, the Company expects M&S' average revenue per principal transaction for 1998 to be materially less than the average during substantially all of 1997. Recent and future regulatory changes, changes in 6 industry customs and practices, and changes in trading systems are expected to continue to result in declines in average revenue per principal transaction, and are expected to have a material adverse impact on M&S' revenues and profit margin. See "Commitments and Contingent Liabilities" note in the Notes to Consolidated Financial Statements regarding certain civil litigation relating to various principal transaction activities. Revenues relating to Schwab's specialist operations were $21 million in 1997, $14 million in 1996 and $9 million in 1995. OTHER REVENUES Other revenues include retirement plan services fees and other brokerage fees (mainly wire fees and minimum account balance fees). These revenues were $86 million in 1997, compared to $74 million in 1996 and $48 million in 1995. The increases from 1995 to 1997 were primarily due to increased customer activity and an increase in retirement plan balances. EXPENSES EXCLUDING INTEREST
- -------------------------------------------------------------------------------- Expenses Excluding Interest as a Percentage of Revenues 1997 1996 1995 - -------------------------------------------------------------------------------- Compensation and benefits 42% 41% 42% Communications 8 9 9 Occupancy and equipment 7 7 8 Advertising and market development 6 5 4 Depreciation and amortization 5 5 5 Commissions, clearance and floor brokerage 4 4 5 Professional services 3 3 3 Other 6 5 4 - -------------------------------------------------------------------------------- Total 81% 79% 80% - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
COMPENSATION AND BENEFITS Compensation and benefits expense includes salaries and wages, variable compensation, and related employee benefits and taxes. Employees receive variable compensation that is tied to the achievement of specified objectives relating primarily to revenue growth, profit margin and growth in customer assets. Therefore, a significant portion of compensation and benefits expense will fluctuate with these measures. (CHART OMITTED) Compensation and benefits expense was $962 million in 1997, compared to $766 million in 1996 and $594 million in 1995. Increases in compensation and benefits expense between 1995 and 1997 were generally due to a greater number of employees to support the Company's continued growth. The increase from 1995 to 1996 was also due to higher variable compensation resulting from the Company's financial performance. The following table shows a comparison of certain compensation and benefits components and employee data (in thousands):
- -------------------------------------------------------------------------------- 1997 1996 1995 - -------------------------------------------------------------------------------- Variable compensation as a % of compensation and benefits expense 23% 27% 24% Compensation for temporary employees, contractors and overtime hours as a % of compensation and benefits expense 14% 11% 12% Full-time equivalent employees(1) 12.7 10.4 9.2 Revenues per average full-time equivalent employee $198 $190 $185 - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
(1) Includes full-time, part-time and temporary employees, and persons employed on a contract basis. The Company encourages and provides for employee ownership of the Company's common stock through its profit sharing and employee stock ownership plan, its stock incentive plans and an automatic investment plan. The Company's overall compensation structure is intended to attract, retain and reward highly qualified employees, and to align the interests of employees with those of stockholders. To further this alignment and in recognition of the Company's financial performance, the Company awarded all non-officer employees a stock option grant in 1997 which totaled options to buy 1,110,000 shares of common stock. The Company also awarded all non-officer employees a stock grant in 1996 which totaled 252,000 shares of common stock. At December 31, 1997, directors, management and employees, and their respective families, trusts and foundations, owned, including stock held for employees' benefit in the Company's profit sharing and employee stock ownership plan, approximately 37% of the Company's outstanding common stock. In addition, directors, management and employees held options to purchase common stock in an amount equal to approximately 8% of the Company's outstanding common stock at December 31, 1997. COMMUNICATIONS Communications expense includes telephone, postage, and news and quotation costs. This expense was $183 million in 1997, compared to $165 million in 1996 and $129 million in 1995. The increases from 1995 to 1997 primarily resulted from higher customer transaction volumes, including increased customer use of electronic channels. The increase from 1996 to 1997 was also due to additional leased telephone lines related to online service offerings. OCCUPANCY AND EQUIPMENT Occupancy and equipment expense includes the costs of leasing and maintaining the Company's office space, four regional customer telephone service centers, a primary data center and 272 domestic branch offices. It also includes lease and rental expenses on computer and other equipment. 7 Occupancy and equipment expense was $154 million in 1997, compared to $130 million in 1996 and $111 million in 1995. This trend reflects the Company's continued growth and expansion, and its commitment to customer service. The Company expanded its office space in 1997 and 1996, its primary data center in 1996, and each of its regional customer telephone service centers in 1995. Schwab opened 40 new branch offices in 1997, 9 in 1996 and 19 in 1995. ADVERTISING AND MARKET DEVELOPMENT Advertising and market development expense includes media, print and direct mail advertising expenses, and related production, printing and postage costs. This expense was $130 million in 1997, compared to $84 million in 1996 and $53 million in 1995. The increases from 1995 to 1997 were primarily a result of the Company's increased media spending relating to campaigns covering Mutual Fund OneSource-Registered Trademark- and online investing services, as well as new product and service offerings. Print and direct mail advertisements were also higher during this period. The Company's role as the official investment firm for the Professional Golf Association Tour also contributed to the increase from 1996 to 1997. DEPRECIATION AND AMORTIZATION Depreciation and amortization includes expenses relating to equipment and office facilities, property, goodwill, leasehold improvements and other intangibles. This expense was $125 million in 1997, compared to $98 million in 1996 and $69 million in 1995. The increases from 1995 to 1997 were primarily due to newly acquired data processing and telecommunication equipment which increased the Company's customer service capacity. Amortization expense related to intangible assets was $15 million in 1997, compared to $12 million in 1996 and $14 million in 1995. COMMISSIONS, CLEARANCE AND FLOOR BROKERAGE Commissions, clearance and floor brokerage expense includes fees paid to stock and option exchanges for trade executions, fees paid by M&S to broker- dealers for orders received for execution, and fees paid to clearing entities for trade processing. This expense was $92 million in 1997, compared to $81 million in 1996 and $77 million in 1995. The increases from 1995 to 1997 were due to increases in the trading volume processed by M&S and Schwab. PROFESSIONAL SERVICES Professional services expense includes fees paid to consultants engaged to support product, service and systems development, and legal and accounting fees. This expense was $70 million in 1997, compared to $52 million in 1996 and $41 million in 1995. The increases from 1995 to 1997 were primarily due to higher levels of consulting fees in many areas, including new and expanded products and services, systems development, and capacity expansion. OTHER EXPENSES Other expenses include those relating to travel and entertainment, errors and bad debts, registration fees for employees, and other miscellaneous expenses. None of these specific categories were more than 25% of total other expenses (except for the litigation settlement in 1997 -- see discussion in Financial Overview). These other expenses were $137 million in 1997, compared to $80 million in 1996 and $69 million in 1995. The increase from 1996 to 1997 was primarily due to the $39 million pre-tax charge for the litigation settlement, and higher travel and entertainment expense. The remainder of the increase from 1996 to 1997, and the increase from 1995 to 1996 were primarily due to higher volume-related expenses reflecting the Company's continued growth. TAXES ON INCOME The Company's effective income tax rate was 39.6% in 1997, 40.7% in 1996 and 37.7% in 1995. The effective income tax rate during 1995 was lower than in 1997 and 1996, primarily due to the settlement in 1995 of a U.S. Tax Court case. LIQUIDITY AND CAPITAL RESOURCES CSC operates as a holding company, conducting virtually all business through its wholly owned subsidiaries. The capital structure among CSC and its subsidiaries is designed to provide each entity with capital and liquidity consistent with its operations. A description of significant aspects of this structure for CSC and its two principal subsidiaries, Schwab and M&S, follows. LIQUIDITY SCHWAB Most of Schwab's assets are liquid, consisting primarily of short-term (i.e., less than 90 days) investment-grade, interest-earning investments (the majority of which are segregated for the exclusive benefit of customers pursuant to regulatory requirements), receivable from customers, and receivable from brokers, dealers and clearing organizations. Customer margin loans are demand loan obligations secured by readily marketable securities. Receivable from and payable 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 customer trading and margin borrowing activities are met primarily through cash balances in customer accounts, which were $12.7 billion, $10.9 billion and $8.4 billion at December 31, 1997, 1996 and 1995, respectively. Earnings from Schwab's operations are the primary source of liquidity for capital expenditures and investments in new services, marketing, and technology. Management believes that customer cash balances and operating earnings will continue to be the primary sources of liquidity for Schwab in the future. 8 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 amount requirement of $1 million. At December 31, 1997, Schwab had $823 million of net capital (11% of aggregate debit balances), which was $667 million in excess of its minimum required net capital and $434 million in excess of 5% of aggregate debit balances. Schwab has historically targeted net capital to be 10% of its aggregate debit balances, which primarily consist of customer margin loans. To achieve this target, as customer margin loans have grown, a larger portion of cash flows have been retained to support aggregate debit balances. To manage Schwab's regulatory capital position, CSC provides Schwab with a $400 million subordinated revolving credit facility maturing in September 1999, of which $315 million was outstanding at December 31, 1997. At year end, Schwab also had outstanding $25 million in fixed-rate subordinated term loans from CSC maturing in 1999. Borrowings under these subordinated lending arrangements qualify as regulatory capital for Schwab. For use in its brokerage operations, Schwab maintained uncommitted, unsecured bank credit lines totaling $595 million at December 31, 1997. The need for short-term borrowings arises primarily from timing differences between cash flow requirements and the scheduled liquidation of interest-bearing investments. Schwab used such borrowings for 11 days in 1997, 5 days in 1996 and 9 days in 1995, with the daily amounts borrowed averaging $85 million, $52 million and $24 million, respectively. These lines were unused at December 31, 1997. In 1997, Schwab entered into unsecured letter of credit agreements with five banks totaling $450 million to satisfy the margin requirement of customer option transactions with the Options Clearing Corporation. Schwab pays a fee to maintain these letter of credit agreements. M&S M&S' liquidity needs are generally met through earnings generated by its operations. Most of M&S' assets are liquid, consisting primarily of cash and cash equivalents, marketable securities, and receivable from brokers, dealers and clearing organizations. M&S' liquidity is affected by the same net capital regulatory requirements as Schwab (see discussion above). At December 31, 1997, M&S had $5 million of net capital (347% of aggregate debit balances), which was $4 million in excess of its minimum required net capital. M&S may borrow up to $35 million under a subordinated lending arrangement with CSC. Borrowings under this arrangement qualify as regulatory capital for M&S. This facility was unused in 1997. CSC CSC's liquidity needs are generally met through cash generated by its subsidiaries, as well as cash provided by external financing. As discussed above, Schwab and M&S 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 and maintaining Schwab's and M&S' net capital. CSC has liquidity needs that arise from its issued and outstanding $361 million Senior Medium-Term Notes, Series A (Medium-Term Notes), as well as from the funding of cash dividends, common stock repurchases, and acquisitions. The Medium-Term Notes have maturities ranging from 1998 to 2007 and fixed interest rates ranging from 5.67% to 7.72% with interest payable semiannually. The Medium-Term Notes are rated A3 by Moody's Investors Service and A- by Standard & Poor's Ratings Group. The rating by Standard & Poor's was raised to A- from BBB+ in October 1997. As of December 31, 1997, CSC had a prospectus supplement on file with the SEC enabling CSC to issue up to $196 million in Senior or Senior Subordinated Medium-Term Notes, Series A. At December 31, 1997, $85 million of these notes remained unissued. CSC may borrow under its $350 million committed, unsecured credit facility with a group of 11 banks through June 1998. The funds are available for general corporate purposes for which CSC pays a commitment fee on the unused balance. The terms of this facility require CSC to maintain minimum levels of stockholders' equity, and Schwab and M&S to maintain specified levels of net capital, as defined. The Company believes that these restrictions will not have a material effect on its ability to meet future dividend or funding requirements. This facility was unused in 1997. CASH FLOWS AND CAPITAL RESOURCES Net income plus depreciation and amortization was $395 million during 1997, up 19% from $332 million in 1996, allowing the Company to finance the majority of its growth with internally generated funds. Depreciation and amortization expense related to equipment, office facilities and property was $110 million in 1997 and $86 million in 1996. Amortization expense related to intangible assets was $15 million in 1997 and $12 million in 1996. (CHART OMITTED) The Company's capital expenditures were $139 million in 1997 and $160 million in 1996, or 6% and 9% of revenues, respectively. Capital expenditures in 1997 were for equipment relating to continued enhancements of its data processing and telecommunications systems, as well as leasehold improvements and additional office facilities to support the Company's growth. In addition, the Company 9 opened 40 new branch offices during 1997, compared to 9 branch offices opened in 1996. As has been the case in recent years, capital expenditures will vary from period to period as business conditions change. While management retains substantial flexibility to adjust capital expenditures as necessary, in general the level of future expenditures will be influenced by the rate of growth in customer assets and trading activities, staffing and facilities requirements, and availability of relevant technology to support innovation in products and services. Management currently anticipates that 1998 capital expenditures will be approximately $190 million. These planned expenditures include $110 million related to technology and $80 million for facilities expansion and improvements. During 1997, the Company: - Issued $111 million and repaid $28 million of Medium-Term Notes; - Paid common stock dividends of $37 million; - Repurchased 820,000 shares of its common stock for $18 million. The Company monitors both the relative composition and absolute level of its capital structure. The Company's total financial capital (borrowings plus stockholders' equity) at December 31, 1997 was $1,506 million, up $368 million, or 32%, from a year ago. At December 31, 1997, the Company had borrowings of $361 million, or 24% of total financial capital, that bear interest at a weighted-average rate of 6.65%. At December 31, 1997, the Company's stockholders' equity was $1,145 million, or 76% of total financial capital. Management currently anticipates that borrowings will remain below 30% of total financial capital. SHARE REPURCHASES The Company repurchased 820,000 shares of its common stock for $18 million in 1997, 1,621,500 shares for $28 million in 1996 and 1,310,700 shares for $17 million in 1995. Since the inception of the repurchase plan in 1988, the Company has repurchased 40,107,300 shares of its common stock for $164 million. At December 31, 1997, authorization granted by the Company's Board of Directors allows for future repurchases of 4,986,500 shares. The Company will continue to monitor opportunities to repurchase common stock in cases where the Company believes stockholder value would be enhanced. In considering opportunities to repurchase stock, the Company takes into account the dilutive effects of stock option exercises and stock grants. DIVIDEND POLICY As a result of the Company's continued earnings growth, the Board of Directors increased the quarterly dividend 20% to $.040 per share in 1997. Since the initial dividend in 1989, the Company has paid 35 consecutive quarterly dividends and has increased the dividend 10 times. Since 1989, dividends have increased by a 41% compounded annual growth rate. The Company paid common stock dividends of $.139 per share in 1997, $.120 per share in 1996 and $.094 per share in 1995. While the payment and amount of dividends are at the discretion of the Company's Board of Directors, the Company has historically targeted its cash dividend at approximately 10% of net income plus depreciation and amortization. (CHART OMITTED) YEAR 2000 Many existing computer programs use only two digits to identify a specific year and therefore may not accurately recognize the upcoming change in the century. If not corrected, many computer applications could fail or create erroneous results by or at the year 2000. Due to the Company's dependence on computer technology to operate its business, and the dependence of the financial services industry on computer technology, the nature and impact of Year 2000 processing failures on the Company's business could be material. The Company is currently modifying its computer systems in order to enable its systems to process data and transactions incorporating year 2000 dates without material errors or interruptions. The Company's Year 2000 compliance project began in 1996. The Company plans to have its significant systems modified by the end of 1998. The Company's progress under its comprehensive Year 2000 compliance plan is reviewed and monitored by senior management. The success of the Company's plan depends in part on parallel efforts being undertaken by other entities with which the Company's systems interact and therefore, the Company is taking steps to determine the status of these other entities' Year 2000 compliance. The Company's plan may also be affected by regulatory changes, changes in industry customs and practices, and changes in trading systems that would require other significant systems modifications, such as the potential shift of securities pricing from fractions to decimals and proposed order audit trail requirements. The Company's plan includes participation in industry-wide testing, and the Company is communicating its concerns regarding the timely compliance of all securities market participants to others with whom it does business, regulators, and industry groups. Additionally, the Company is formulating contingency plans to be implemented in the event that any other entity with which the Company's systems interact, or the Company itself, fails to achieve timely and adequate Year 2000 compliance. The Company currently estimates that it will cost approximately $35 million to $45 million to modify its core brokerage computer systems to be Year 2000 compliant. These expenditures will consist primarily of compensation for information technology employees and contractors dedicated to this project and related hardware and software costs. This estimate excludes the time that may be spent by 10 management and administrative staff in guiding and assisting the information technology effort described above or for bringing systems other than core brokerage computer systems into Year 2000 compliance. The Company expects to fund all Year 2000 related costs through operating cash flows. These costs are not expected to result in increased information technology expenditures because they will be funded through a reallocation of the Company's overall development spending. In accordance with generally accepted accounting principles, Year 2000 expenditures will be recognized as incurred. MARKET RISK The Company adopted SEC Release No. 33-7386, issued in 1997, which requires qualitative disclosures of market risk exposure and management of that exposure, and quantitative disclosures of the magnitude of market risk. See "Financial Instruments with Off-Balance-Sheet and Credit Risk" note in the Notes to Consolidated Financial Statements for additional information regarding financial instruments discussed below. FINANCIAL INSTRUMENTS HELD FOR TRADING PURPOSES The Company held government securities with a fair value of approximately $5 million at December 31, 1997. These securities, and the associated interest rate risk, are not material to the Company's financial position, results of operations or cash flows. Through Schwab and M&S, the Company maintains inventories in exchange- listed and Nasdaq securities on both a long and short basis. The fair value of these securities at December 31, 1997, was $52 million in long positions and $28 million in short positions. The potential loss in fair value, using a hypothetical 10% decline in prices, is estimated to be approximately $3 million due to the offset of losses in long positions with gains in short positions. In addition, the Company generally enters into exchange-traded option contracts to hedge against potential losses in inventory positions, thus reducing this potential loss exposure. This hypothetical 10% decline in prices would not be material to the Company's financial position, results of operations or cash flows. The notional amount of option contracts was not material to the Company's consolidated balance sheet at December 31, 1997. FINANCIAL INSTRUMENTS HELD FOR PURPOSES OTHER THAN TRADING For its working capital and reserves required to be segregated under federal or other regulations, the Company invests in money market funds, resale agreements, certificates of deposit, and commercial paper. Money market funds do not have maturity dates and do not present a material market risk. The other financial instruments, as shown in the following table, are fixed rate investments with short maturities and do not present a material interest rate risk (dollars in millions):
Principal amount Fair by maturity date value December 31, 1998 Thereafter 1997 - -------------------------------------------------------------------------------- Resale agreements (1) $5,107 $5,107 Weighted-average interest rate 5.72% Certificates of deposit $1,499 $1,499 Weighted-average interest rate 5.73% Commercial paper $ 221 $ 221 Weighted-average interest rate 6.42% - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
(1) Includes resale agreements of $4,707 million included in cash and investments required to be segregated under federal or other regulations and $400 million included in cash and cash equivalents. At December 31, 1997, CSC had $361 million aggregate principal amount of Medium-Term Notes, with fixed interest rates. The Company has no cash flow exposure regarding these Medium-Term Notes due to the fixed rate of interest. The fair value of these Medium-Term Notes at December 31, 1997, based on estimates of market rates for debt with similar terms and remaining maturities, approximated their carrying amount. The table below presents the principal amount of these Medium-Term Notes by year of maturity (dollars in millions):
Year Ended December 31, 1998 1999 2000 2001 2002 Thereafter - -------------------------------------------------------------------------------- Fixed rate $40 $40 $48 $39 $40 $154 Weighted-average interest rate 6.1% 6.8% 6.3% 7.0% 7.0% 6.7% - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
The Company maintains investments in mutual funds, approximately $32 million at December 31, 1997, to fund obligations under its deferred compensation plan. These investments match the Company's obligation under its deferred compensation plan, net of the income tax benefit. Any decrease in the fair value of these investments would result in a comparable decrease in the deferred compensation plan obligation and would not affect the Company's financial position, results of operations or cash flows. LOOKING AHEAD Management expects financial services to remain intensely competitive during 1998, as the industry's financial success and a continued trend of consolidation have attracted new competitors and strengthened existing ones. The Company believes that it possesses a number of competitive advantages that will enable it to pursue its strategy of attracting and retaining customer assets. As described more fully in the Description of Business section above, these competitive advantages include: a nationally 11 recognized brand, a broad line of products and services offered at prices that management believes represent superior value, multi-channel delivery systems, and the commitment and skills necessary to invest in technology intended to empower customers and reduce costs. Additionally, the Company's significant level of employee ownership aligns the interests of management with those of stockholders. While fundamentally cyclical financial markets may adversely impact the Company's financial results, management believes that the above competitive advantages, combined with recent trends affecting the characteristics and behavior of individual investors, will enable the firm to pursue its objective of long-term profitable growth. These trends include the advent of a new generation of investors who are currently entering their peak savings years, as well as the increased desire of many individuals to assume greater control over their financial affairs. Capitalizing on and strengthening the Company's competitive advantages requires significant operating expense outlays and capital expenditures. Management believes that these ongoing investments are critical to increasing the Company's market share and achieving its long-term financial objectives, which include annual growth in revenues of 20%, an after-tax profit margin of 10%, and a return on stockholders' equity of 20%. 12 THE CHARLES SCHWAB CORPORATION CONSOLIDATED STATEMENT OF INCOME (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Year Ended December 31, 1997 1996 1995 - ----------------------------------------------------------------------------------------------------------------------------- REVENUES Commissions $1,174,023 $ 954,129 $ 750,896 Mutual fund service fees 427,673 311,067 218,784 Interest revenue, net of interest expense of $546,483 in 1997, $425,872 in 1996 and $357,223 in 1995 353,552 254,988 210,897 Principal transactions 257,985 256,902 191,392 Other 85,517 73,836 47,934 - ----------------------------------------------------------------------------------------------------------------------------- Total 2,298,750 1,850,922 1,419,903 - ----------------------------------------------------------------------------------------------------------------------------- EXPENSES EXCLUDING INTEREST Compensation and benefits 961,824 766,377 594,105 Communications 182,739 164,756 128,554 Occupancy and equipment 154,181 130,494 110,977 Advertising and market development 129,550 83,987 52,772 Depreciation and amortization 124,682 98,342 68,793 Commissions, clearance and floor brokerage 91,933 80,674 77,061 Professional services 69,583 52,055 41,304 Other 137,011 80,174 69,233 - ----------------------------------------------------------------------------------------------------------------------------- Total 1,851,503 1,456,859 1,142,799 - ----------------------------------------------------------------------------------------------------------------------------- Income before taxes on income 447,247 394,063 277,104 Taxes on income 176,970 160,260 104,500 - ----------------------------------------------------------------------------------------------------------------------------- NET INCOME $ 270,277 $ 233,803 $ 172,604 - ----------------------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------------------- Weighted-average number of common shares outstanding (1, 2) 272,575 269,101 267,714 - ----------------------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------------------- EARNINGS PER SHARE (1) Basic $ 1.03 $ .90 $ .67 Diluted $ .99 $ .87 $ .64 - ----------------------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------------------- DIVIDENDS DECLARED PER COMMON SHARE (1) $ .139 $ .120 $ .094 - ----------------------------------------------------------------------------------------------------------------------------- - -----------------------------------------------------------------------------------------------------------------------------
(1) Reflects the September 1997 three-for-two common stock split. (2) Amounts shown are used to calculate diluted earnings per share. SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 13 THE CHARLES SCHWAB CORPORATION CONSOLIDATED BALANCE SHEET (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
December 31, 1997 1996 - ----------------------------------------------------------------------------------------------------------------------------- ASSETS Cash and cash equivalents $ 797,447 $ 633,317 Cash and investments required to be segregated under federal or other regulations (including resale agreements of $4,707,187 in 1997 and $6,069,930 in 1996) 6,774,024 7,235,971 Receivable from brokers, dealers and clearing organizations 267,070 230,943 Receivable from customers -- net 7,751,513 5,012,815 Securities owned -- at market value 282,569 127,866 Equipment, office facilities and property -- net 342,273 315,376 Intangible assets -- net 55,854 68,922 Other assets 210,957 153,558 - ----------------------------------------------------------------------------------------------------------------------------- Total $16,481,707 $13,778,768 - ----------------------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY Drafts payable $ 268,644 $ 225,136 Payable to brokers, dealers and clearing organizations 1,122,663 877,742 Payable to customers 13,106,202 11,176,836 Accrued expenses and other liabilities 478,032 360,683 Borrowings 361,049 283,816 - ----------------------------------------------------------------------------------------------------------------------------- Total liabilities 15,336,590 12,924,213 - ----------------------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------------------- Stockholders' equity: Preferred stock -- 9,940 shares authorized; $.01 par value per share; none issued Common stock -- 500,000 shares authorized; $.01 par value per share; 267,689 shares issued in 1997 and 1996 * 2,677 1,785 Additional paid-in capital 241,422 200,857 Retained earnings 955,496 723,085 Treasury stock -- 1,753 shares in 1997 and 5,087 shares in 1996, at cost * (35,401) (60,277) Unearned ESOP shares (2,769) (5,517) Unamortized restricted stock compensation (17,228) (8,658) Foreign currency translation adjustment 920 3,280 - ----------------------------------------------------------------------------------------------------------------------------- Total stockholders' equity 1,145,117 854,555 - ----------------------------------------------------------------------------------------------------------------------------- Total $16,481,707 $13,778,768 - ----------------------------------------------------------------------------------------------------------------------------- - -----------------------------------------------------------------------------------------------------------------------------
* Reflects the September 1997 three-for-two common stock split. SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 14 THE CHARLES SCHWAB CORPORATION CONSOLIDATED STATEMENT OF CASH FLOWS (IN THOUSANDS)
December 31, 1997 1996 1995 - ----------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 270,277 $ 233,803 $ 172,604 Noncash items included in net income: Depreciation and amortization 124,682 98,342 68,793 Compensation payable in common stock 24,385 26,693 3,307 Deferred income taxes (29,074) (5,214) (6,975) Other 3,047 4,526 302 Change in securities owned -- at market value (154,699) (14,344) (53,297) Change in other assets (25,934) (2,396) (39,610) Change in accrued expenses and other liabilities 153,234 48,964 141,431 - ----------------------------------------------------------------------------------------------------------------------------- Net cash provided before change in customer- related balances 365,918 390,374 286,555 - ----------------------------------------------------------------------------------------------------------------------------- Change in customer-related balances (excluding the effects of businesses acquired): Cash and investments required to be segregated under federal or other regulations 456,662 (1,796,722) (1,157,717) Receivable from brokers, dealers and clearing organizations (37,449) (81,517) (15,908) Receivable from customers (2,741,796) (1,066,802) (1,011,008) Drafts payable 43,908 11,069 89,909 Payable to brokers, dealers and clearing organizations 245,327 292,699 285,363 Payable to customers 1,935,507 2,608,577 1,775,434 - ----------------------------------------------------------------------------------------------------------------------------- Net change in customer-related balances (97,841) (32,696) (33,927) - ----------------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 268,077 357,678 252,628 - ----------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES Purchase of equipment, office facilities and property -- net (139,416) (159,812) (165,630) Cash payments for businesses acquired, net of cash received (1,200) (4,709) (68,244) Purchase of life insurance policies (39,628) - ----------------------------------------------------------------------------------------------------------------------------- Net cash used by investing activities (140,616) (164,521) (273,502) - ----------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from borrowings 111,000 64,000 70,000 Repayment of borrowings (33,649) (27,459) (2,781) Dividends paid (37,091) (31,495) (24,249) Purchase of treasury stock (18,234) (28,171) (17,345) Proceeds from loans on life insurance policies 38,297 Proceeds from stock options exercised and other 14,530 7,839 11,623 - ----------------------------------------------------------------------------------------------------------------------------- Net cash provided (used) by financing activities 36,556 (15,286) 75,545 - ----------------------------------------------------------------------------------------------------------------------------- Effect of exchange rate changes on cash and cash equivalents 113 450 (706) - ----------------------------------------------------------------------------------------------------------------------------- INCREASE IN CASH AND CASH EQUIVALENTS 164,130 178,321 53,965 CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 633,317 454,996 401,031 - ----------------------------------------------------------------------------------------------------------------------------- CASH AND CASH EQUIVALENTS AT END OF YEAR $ 797,447 $ 633,317 $ 454,996 - ----------------------------------------------------------------------------------------------------------------------------- - -----------------------------------------------------------------------------------------------------------------------------
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 15 THE CHARLES SCHWAB CORPORATION CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (IN THOUSANDS)
Common Stock Additional -------------------- Paid-In Retained Treasury Shares* Amount Capital Earnings Stock - ----------------------------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1994 256,344 $ 595 $166,103 $373,161 $(57,968) Net income 172,604 Dividends declared on common stock (24,249) Purchase of treasury stock (1,311) (17,345) Stock options exercised and restricted stock compensation awards 6,015 12,809 24,345 Three-for-two stock split effected in the form of a 50% stock dividend 297 (297) Two-for-one stock split effected in the form of a 100% stock dividend 893 (893) Amortization of restricted stock compensation awards ESOP shares released for allocation 1,390 206 Foreign currency translation adjustment - ----------------------------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1995 261,048 1,785 180,302 520,532 (50,968) - ----------------------------------------------------------------------------------------------------------------------------- Net income 233,803 Dividends declared on common stock (31,495) Purchase of treasury stock (1,621) (28,171) Stock options exercised and restricted stock compensation awards 3,175 10,180 18,862 Amortization of restricted stock compensation awards ESOP shares released for allocation 10,375 245 Foreign currency translation adjustment - ----------------------------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1996 262,602 1,785 200,857 723,085 (60,277) - ----------------------------------------------------------------------------------------------------------------------------- Net income 270,277 Dividends declared on common stock (37,091) Purchase of treasury stock (820) (18,234) Stock options exercised and restricted stock compensation awards 4,154 25,830 43,110 Three-for-two stock split effected in the form of a 50% stock dividend 892 (892) Amortization of restricted stock compensation awards ESOP shares released for allocation 14,735 117 Foreign currency translation adjustment - ----------------------------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1997 265,936 $2,677 $241,422 $955,496 $(35,401) - ----------------------------------------------------------------------------------------------------------------------------- Unamortized Foreign Unearned Restricted Currency ESOP Stock Translation Shares Compensation Adjustment Total - -------------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1994 $(10,174) $ (4,703) $ 467,014 Net income 172,604 Dividends declared on common stock (24,249) Purchase of treasury stock (17,345) Stock options exercised and restricted stock compensation awards (3,511) 33,643 Three-for-two stock split effected in the form of a 50% stock dividend Two-for-one stock split effected in the form of a 100% stock dividend Amortization of restricted stock compensation awards 1,140 1,140 ESOP shares released for allocation 777 2,373 Foreign currency translation adjustment $(2,286) (2,286) - -------------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1995 (9,397) (7,074) (2,286) 632,894 - -------------------------------------------------------------------------------------------------------------- Net income 233,803 Dividends declared on common stock (31,495) Purchase of treasury stock (28,171) Stock options exercised and restricted stock compensation awards (5,068) 23,974 Amortization of restricted stock compensation awards 3,484 3,484 ESOP shares released for allocation 3,880 14,500 Foreign currency translation adjustment 5,566 5,566 - -------------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1996 (5,517) (8,658) 3,280 854,555 - -------------------------------------------------------------------------------------------------------------- Net income 270,277 Dividends declared on common stock (37,091) Purchase of treasury stock (18,234) Stock options exercised and restricted stock compensation awards (14,179) 54,761 Three-for-two stock split effected in the form of a 50% stock dividend Amortization of restricted stock compensation awards 5,609 5,609 ESOP shares released for allocation 2,748 17,600 Foreign currency translation adjustment (2,360) (2,360) - -------------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1997 $ (2,769) $(17,228) $ 920 $1,145,117 - -------------------------------------------------------------------------------------------------------------
* Share amounts are presented net of treasury shares and reflect the September 1997 three-for-two common stock split. SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 16 THE CHARLES SCHWAB CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Tabular Amounts in Thousands, Except Per Share and Option Price Amounts) BASIS OF PRESENTATION The consolidated financial statements include The Charles Schwab Corporation (CSC) and its subsidiaries (collectively referred to as the Company). CSC is a holding company engaged, through its subsidiaries, in securities brokerage and related financial services. CSC's principal operating subsidiary, Charles Schwab & Co., Inc. (Schwab), is a securities broker-dealer with 272 domestic branch offices in 47 states, as well as a branch in each of the Commonwealth of Puerto Rico and the United Kingdom. Another subsidiary, Mayer & Schweitzer, Inc. (M&S), a market maker in Nasdaq and other securities, provides trade execution services to broker-dealers, including Schwab, and institutional customers. Other subsidiaries include Charles Schwab Investment Management, Inc., the investment advisor for Schwab's proprietary mutual funds, and Charles Schwab Europe (formerly known as ShareLink), a retail discount securities brokerage firm located in the United Kingdom. Certain items in prior years' financial statements have been reclassified to conform to the 1997 presentation. All material intercompany balances and transactions have been eliminated. SIGNIFICANT ACCOUNTING POLICIES SECURITIES TRANSACTIONS: Customers' securities transactions are recorded on a settlement date basis with related commission revenues and expenses recorded on a trade date basis. Principal transactions are recorded on a trade date basis. USE OF ESTIMATES: The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make certain estimates and assumptions that affect the reported amounts in the accompanying financial statements. Such estimates relate to useful lives of equipment, office facilities, buildings and intangible assets, fair value of financial instruments, allowance for doubtful accounts, future tax benefits and legal reserves. Actual results could differ from such estimates. COSTS associated with internally developed software, and the acquisition of new customer accounts are expensed as incurred. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS: The Company considers the amounts presented for financial instruments on the consolidated balance sheet to be reasonable estimates of fair value. CASH AND INVESTMENTS REQUIRED TO BE SEGREGATED UNDER FEDERAL OR OTHER REGULATIONS consist primarily of securities purchased under agreements to resell (resale agreements) and certificates of deposit. Resale agreements are accounted for as collateralized financing transactions and are recorded at their contractual amounts. Certificates of deposit are stated at cost, which approximates market. RECEIVABLE FROM CUSTOMERS that remain unsecured or partially secured for more than 30 days are substantially reserved for, and are stated net of allowance for doubtful accounts of $8 million and $6 million at December 31, 1997 and 1996, respectively. 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 seven 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 life of the lease. Equipment, office facilities and property are stated at cost net of accumulated depreciation and amortization of $366 million and $270 million at December 31, 1997 and 1996, respectively. INTANGIBLE ASSETS, including goodwill and customer lists, are amortized on a straight-line basis over three to fifteen years. Intangible assets are stated at cost net of accumulated amortization of $186 million and $175 million at December 31, 1997 and 1996, respectively. FOREIGN CURRENCY TRANSLATION: Assets and liabilities denominated in foreign currencies are translated at the exchange rate on the balance sheet date, while revenues and expenses are translated at average rates of exchange prevailing during the year. Translation adjustments are accumulated as a separate component of stockholders' equity. DERIVATIVES: The Company's derivatives activities were limited to exchange- traded option contracts to reduce market risk on inventories in Nasdaq and exchange-listed securities. The notional amount of such derivatives was not material to the Company's consolidated balance sheets at December 31, 1997 and 1996. INCOME TAXES: The Company files a consolidated U.S. federal income tax return and uses the asset and liability method in providing for income tax expense. Under this method, deferred tax assets and liabilities are recorded for 17 temporary differences between the tax basis of assets and liabilities and their recorded amounts for financial reporting purposes, using currently enacted tax law. COMMON STOCK SPLIT: Share and per share information presented in the financial statements and related notes have been restated to reflect the September 1997 three-for-two common stock split, effected in the form of a 50% stock dividend. CASH FLOWS: For purposes of reporting cash flows, the Company considers all highly liquid investments (including resale agreements) with original maturities of three months or less that are not required to be segregated under federal or other regulations to be cash equivalents. NEW ACCOUNTING STANDARDS: Statement of Financial Accounting Standards (SFAS) No. 125 -- Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, was adopted by the Company in 1997, except for certain financial assets for which the effective date has been delayed until 1998 by SFAS No. 127 -- Deferral of the Effective Date of Certain Provisions of FASB Statement No. 125. SFAS No. 125 provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities, and its adoption did not have an effect on the Company's financial position, results of operations, earnings per share or cash flows. The adoption of SFAS No. 127 will not have an effect on the Company's financial position, results of operations, earnings per share or cash flows. SFAS No. 130 -- Reporting Comprehensive Income, and SFAS No. 131 -- Disclosures about Segments of an Enterprise and Related Information, were issued in 1997 and are effective for fiscal years beginning after December 15, 1997. SFAS No. 130 establishes standards for the reporting and display of comprehensive income, which includes net income and changes in equity except those resulting from investments by, or distributions to, stockholders. SFAS No. 131 establishes standards for disclosures related to business operating segments. The adoption of these standards will not have an effect on the Company's financial position, results of operations, earnings per share or cash flows, but will impact financial statement disclosure. ACQUISITIONS During 1995, the Company completed several acquisitions. The largest acquisition was Charles Schwab Europe for $60 million, net of cash received. Because the acquisitions were accounted for using the purchase method of accounting, the operating results of the acquired companies are included in the consolidated results of the Company since the respective dates of acquisitions. The historical results of the acquired companies are not included in periods prior to such acquisitions. During 1997 and 1996, the Company made additional payments relating to a 1995 acquisition. SECURITIES OWNED Securities owned are recorded at market value and consist of the following:
December 31, 1997 1996 - -------------------------------------------------------------------------------- SchwabFunds-Registered Trademark- money market funds $161,175 $ 50,405 Equity and bond mutual funds 63,504 38,305 Equity and other securities 57,890 39,156 - -------------------------------------------------------------------------------- Total securities owned $282,569 $127,866 - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
The Company's positions in SchwabFunds money market funds arise from certain overnight funding of customers' redemption and check-writing activities. Equity and bond mutual funds include investments made by the Company to fund obligations under its deferred compensation plan. Equity and other securities include M&S' inventories in Nasdaq securities and Schwab's inventories in exchange-listed securities relating to its specialist operations. Securities sold, but not yet purchased of $28 million and $24 million at December 31, 1997 and 1996, respectively, consist of equity and other securities, and are recorded at market value in accrued expenses and other liabilities. PAYABLE TO BROKERS, DEALERS AND CLEARING ORGANIZATIONS Payable to brokers, dealers and clearing organizations consist primarily of securities loaned of $998 million and $776 million at December 31, 1997 and 1996, respectively. Securities loaned are recorded at the amount of cash collateral received. The market value of securities pledged under securities lending transactions approximated amounts due. PAYABLE TO CUSTOMERS The principal source of funding for Schwab's margin lending is cash balances in customer accounts. At December 31, 1997, Schwab was paying interest at 4.7% on $11,161 million of cash balances in customer brokerage accounts, which were included in payable to customers. At December 31, 1996, Schwab was paying interest at 4.5% on $9,392 million of such cash balances. 18 BORROWINGS Borrowings consist of the following:
December 31, 1997 1996 - -------------------------------------------------------------------------------- Medium-Term Notes $361,000 $278,000 Other 49 5,816 - -------------------------------------------------------------------------------- Total borrowings $361,049 $283,816 - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
At December 31, 1997, CSC had $361 million aggregate principal amount of Senior Medium-Term Notes, Series A (Medium-Term Notes) outstanding, with fixed interest rates ranging from 5.67% to 7.72% and maturities ranging from 1998 to 2007 as follows: - -------------------------------------------------------------------------------- 1998 $ 40,000 1999 40,000 2000 48,000 2001 39,000 2002 40,000 Thereafter 154,000 - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
The Medium-Term Notes carry a weighted-average interest rate of 6.65%. The fair value of the Medium-Term Notes at December 31, 1997 and 1996, based on estimates of market rates for debt with similar terms and remaining maturities, approximated their carrying amounts. As of December 31, 1997, CSC had a prospectus supplement on file with the Securities and Exchange Commission (SEC) enabling CSC to issue up to $196 million in Senior or Senior Subordinated Medium-Term Notes, Series A. At December 31, 1997, $85 million of these notes remained unissued. CSC may borrow under its $350 million committed, unsecured credit facility with a group of 11 banks through June 1998. The funds are available for general corporate purposes for which CSC pays a commitment fee on the unused balance. The terms of this facility require CSC to maintain minimum levels of stockholders' equity and Schwab and M&S to maintain specified levels of net capital, as defined. This facility was unused in 1997. For use in its brokerage operations, Schwab maintained uncommitted, unsecured bank credit lines totaling $595 million and $495 million at December 31, 1997 and 1996, respectively. There were no borrowings outstanding under these lines at December 31, 1997 and 1996. In 1997, Schwab entered into unsecured letter of credit agreements with five banks totaling $450 million to satisfy the margin requirement of customer option transactions with the Options Clearing Corporation. Schwab pays a fee to maintain these letter of credit agreements. TAXES ON INCOME Income tax expense is as follows:
Year Ended December 31, 1997 1996 1995 - -------------------------------------------------------------------------------- Current: Federal $179,110 $138,990 $ 96,742 State 26,934 26,484 14,733 - -------------------------------------------------------------------------------- Total current 206,044 165,474 111,475 - -------------------------------------------------------------------------------- Deferred: Federal (26,484) (4,881) (6,818) State (2,590) (333) (157) - -------------------------------------------------------------------------------- Total deferred (29,074) (5,214) (6,975) - -------------------------------------------------------------------------------- Total taxes on income $176,970 $160,260 $104,500 - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
The above amounts do not include the tax benefit from the exercise of stock options and the vesting of restricted stock awards, which for accounting purposes is credited directly to additional paid-in capital. Such tax benefits reduced income taxes paid by $34 million in 1997, $15 million in 1996 and $22 million in 1995. The temporary differences which created deferred tax assets and liabilities, included in other assets, and accrued expenses and other liabilities, are detailed below:
December 31, 1997 1996 - -------------------------------------------------------------------------------- Deferred Tax Assets: Reserves and allowances $33,456 $12,733 Deferred compensation 33,142 19,872 Depreciation and amortization 735 934 - -------------------------------------------------------------------------------- Total deferred assets 67,333 33,539 - -------------------------------------------------------------------------------- Deferred Tax Liabilities: State and local taxes (2,622) (923) Asset valuation differences (1,101) (3,289) Other (4,479) 816 - -------------------------------------------------------------------------------- Total deferred liabilities (8,202) (3,396) - -------------------------------------------------------------------------------- Net deferred tax asset $59,131 $30,143 - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
The Company determined that no valuation allowance against deferred tax assets at December 31, 1997 and 1996 was necessary. The effective income tax rate differs from the amount computed by applying the federal statutory income tax rate as follows:
Year Ended December 31, 1997 1996 1995 - -------------------------------------------------------------------------------- Federal statutory income tax rate 35.0% 35.0% 35.0% State income taxes, net of federal tax benefit 3.5 4.3 3.4 Other 1.1 1.4 (.7) - -------------------------------------------------------------------------------- Effective income tax rate 39.6% 40.7% 37.7% - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
19 STOCK OPTIONS AND RESTRICTED STOCK AWARDS The Company's stock incentive plans provide for granting options to employees, officers and directors, and restricted stock awards to employees and officers. In 1997, the Board of Directors approved a new stock incentive plan for granting options and restricted stock awards to non-officer employees. In January 1998, the Company granted over one million options under this plan to non-officer employees employed as of December 31, 1997. The Company expects to grant such options annually with the size of the grant based on Company and individual performance. Options are granted for the purchase of shares of common stock at not less than market value on the date of grant, and expire within either eight or ten years from the date of grant. Options generally vest over a four-year period from the date of grant. A summary of option activity follows:
1997 1996 1995 ------------------------- ------------------------- ----------------------- Weighted- Weighted- Weighted- Average Average Average Number Exercise Number Exercise Number Exercise of Options Price of Options Price of Options Price - ----------------------------------------------------------------------------------------------------------------------------- Outstanding at beginning of year 21,572 $ 7.57 23,164 $ 6.20 26,127 $ 3.72 Granted 4,033 $ 30.03 2,137 $ 16.83 3,943 $ 15.96 Exercised (3,474) $ 4.20 (2,838) $ 2.64 (5,788) $ 1.97 Canceled (417) $ 13.16 (891) $ 9.75 (1,118) $ 4.58 - ----------------------------------------------------------------------------------------------------------------------------- Outstanding at end of year 21,714 $ 12.17 21,572 $ 7.57 23,164 $ 6.20 - ----------------------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------------------- Exercisable at end of year 13,357 $ 6.29 13,871 $ 4.66 10,559 $ 3.05 - ----------------------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------------------- Available for future grant at end of year 15,981 4,422 5,902 - ----------------------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------------------- Weighted-average fair value of options granted during the year $ 13.31 $ 7.36 $ 7.14 - ----------------------------------------------------------------------------------------------------------------------------- - -----------------------------------------------------------------------------------------------------------------------------
The fair value of each option granted is estimated as of the grant date using the Black-Scholes option-pricing model with the following assumptions:
1997 1996 1995 - -------------------------------------------------------------------------------- Dividend yield .75% .75% .75% Expected volatility 44% 44% 44% Risk-free interest rate 6.2% 6.0% 6.0% Expected life (in years) 5 5 5 - --------------------------------------------------------------------------------
The following table summarizes information about options outstanding and exercisable:
December 31, 1997 - ----------------------------------------------------------------------------------------------------------------------------- Options Outstanding Options Exercisable -------------------------------------------------- ---------------------------- Weighted- Average Weighted- Weighted- Remaining Average Average Range of Number Contractual Exercise Number Exercise Exercise Prices of Options Life (in years) Price of Options Price - ----------------------------------------------------------------------------------------------------------------------------- $ 1.00 to $ 5.00 7,111 2.5 $ 2.81 7,111 $ 2.81 $ 5.01 to $17.00 7,549 6.7 $ 9.45 4,942 $ 8.35 $17.01 to $43.00 7,054 8.8 $ 24.53 1,304 $ 17.46 - ----------------------------------------------------------------------------------------------------------------------------- $ 1.00 to $43.00 21,714 6.0 $ 12.17 13,357 $ 6.29 - ----------------------------------------------------------------------------------------------------------------------------- - -----------------------------------------------------------------------------------------------------------------------------
The Company applies Accounting Principles Board Opinion No. 25 -- Accounting for Stock Issued to Employees, and related Interpretations in accounting for its stock option plans. Accordingly, no compensation expense has been recognized for the Company's options. Had compensation expense for the Company's options been determined based on the fair value at the grant dates for awards under those plans consistent with the method of SFAS No. 123 -- Accounting for Stock-Based Compensation, the Company's net income and earnings per share would have been reduced to the pro forma amounts presented below:
Year Ended December 31, 1997 1996 1995 - -------------------------------------------------------------------------------- Net Income: As reported $270,277 $233,803 $172,604 Pro forma $255,850 $227,401 $168,296 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Basic Earnings Per Share: As reported $ 1.03 $ .90 $ .67 Pro forma $ .97 $ .87 $ .65 Diluted Earnings Per Share: As reported $ .99 $ .87 $ .64 Pro forma $ .94 $ .85 $ .63 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
The pro forma effects on net income may not be representative of the pro forma effects on net income in future years because SFAS No. 123 is applicable only to options granted after December 31, 1994. The pro forma effect will not be fully reflected until 1999. Restricted stock awards are restricted from sale, and some vest based upon the Company achieving certain financial measures. The market value of shares associated with the restricted stock awards is recorded as unamortized restricted stock compensation and is amortized to compensation expense over the vesting periods, generally four years. 20 EMPLOYEE BENEFIT PLANS The Company has a profit sharing and employee stock ownership plan (Profit Sharing Plan), including a 401(k) salary deferral component, for eligible employees who have met certain service requirements. The Company matches certain employee contributions; additional contributions to this plan are at the discretion of the Company. Total Company contribution expense was $44 million in 1997, $36 million in 1996 and $32 million in 1995. In January 1993, the Profit Sharing Plan borrowed $15 million from the Company to purchase over 3 million shares of the Company's common stock. The note receivable from the Profit Sharing Plan had a balance of $2 million and $5 million at December 31, 1997 and 1996, respectively, bears interest at 7.9% and is due in annual installments through 2007. As the note is repaid, shares are released for allocation to eligible employees based on the proportion of debt service paid during the year. In accordance with Statement of Position No. 93-6 -- Employers' Accounting for Employee Stock Ownership Plans (the Statement), the Company recognizes as compensation and benefits expense the fair value of shares released for allocation to employees through the employee stock ownership plan (ESOP). Only released ESOP shares are considered outstanding for basic and diluted earnings per share computations. Dividends on allocated shares and unallocated shares are charged to retained earnings and compensation and benefits expense, respectively. Compensation and benefits expense related to shares released for allocation through the ESOP loan repayments was $17 million in 1997, $14 million in 1996 and $2 million in 1995. The increase from 1995 to 1997 was primarily due to higher employer ESOP contributions. The unallocated shares are recorded as unearned ESOP shares on the consolidated balance sheet. Under the "grandfather" provisions of the Statement, the Company did not apply the Statement to shares purchased by the ESOP prior to 1993. The ESOP share information is as follows:
December 31, 1997 1996 - -------------------------------------------------------------------------------- Allocated shares: Purchased prior to 1993 12,640 15,358 Purchased in 1993 and after 2,949 1,220 Shares released for allocation: Purchased in 1993 and after 681 1,729 Unreleased shares: Purchased in 1993 and after 597 1,196 - -------------------------------------------------------------------------------- Total ESOP shares 16,867 19,503 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Fair value of unreleased shares $25,020 $25,510 - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
The Company is the beneficiary of a life insurance program covering the majority of its employees. Under the program, the cash surrender value of insurance policies is recorded net of policy loans in other assets. At December 31, 1997 and 1996, policy loans with an interest rate of 8.0% totaled $81 million. EARNINGS PER SHARE The Company adopted SFAS No. 128 -- Earnings Per Share in 1997. This standard replaced previous earnings per share (EPS) reporting requirements and requires a dual presentation of basic and diluted EPS. 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. Earnings per share under the basic and diluted computations are as follows:
Year Ended December 31, 1997 1996 1995 - -------------------------------------------------------------------------------- Net Income $270,277 $233,803 $172,604 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Basic Shares: Weighted-average common shares outstanding 262,545 259,909 257,696 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Diluted Shares: Weighted-average common shares outstanding 262,545 259,909 257,696 Common stock equivalent shares related to stock incentive plans 10,030 9,192 10,018 - -------------------------------------------------------------------------------- Diluted weighted-average common shares outstanding 272,575 269,101 267,714 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Basic earnings per share $ 1.03 $ .90 $ .67 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Diluted earnings per share $ .99 $ .87 $ .64 - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
REGULATORY REQUIREMENTS Schwab and M&S are subject to the Uniform Net Capital Rule under the Securities Exchange Act of 1934 (the Rule) and each compute net capital under the alternative method permitted by this Rule, which requires the maintenance of minimum net capital, as defined, of the greater of 2% of aggregate debit balances arising from customer transactions or a minimum dollar amount, which is based on the type of business conducted by the broker-dealer. The minimum dollar amount for both Schwab and M&S is $1 million. Under the alternative method, a broker-dealer may not repay subordinated borrowings, pay cash dividends, or make any unsecured advances or loans to its parent or employees if such payment would result in net capital of less than 5% of aggregate debit balances or less than 120% of its minimum dollar amount requirement. At December 31, 1997, Schwab's net capital was $823 million (11% of aggregate debit balances), which was $667 million in excess of its minimum required net capital and $434 million in excess of 5% of aggregate debit balances. At December 31, 1997, M&S' net capital was $5 million (347% of aggregate debit 21 balances), which was $4 million in excess of its minimum required net capital. Schwab and Charles Schwab Europe had portions of their cash and investments segregated for the exclusive benefit of customers at December 31, 1997, in accordance with applicable regulations. M&S had no such cash reserve requirement at December 31, 1997. COMMITMENTS AND CONTINGENT LIABILITIES The Company has noncancelable operating leases for office space and equipment. Future minimum rental commitments under these leases at December 31, 1997 are as follows: - -------------------------------------------------------------------------------- 1998 $ 77,556 1999 75,529 2000 63,709 2001 58,938 2002 66,515 Thereafter 335,939 - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
Certain leases contain provisions for renewal options and rent escalations based on increases in certain costs incurred by the lessor. Rent expense was $104 million in 1997, $92 million in 1996 and $79 million in 1995. On December 24, 1997, M&S and 30 of the 31 other remaining defendants submitted for court approval a settlement agreement in a consolidated class action, IN RE: NASDAQ MARKET-MAKERS ANTITRUST LITIGATION, which is pending in the United States District Court for the Southern District of New York. The settlement would fully resolve alleged claims on behalf of certain persons who purchased or sold Nasdaq securities during the period May 1, 1989 through July 17, 1996 concerning the width of spreads between the bid and ask prices of certain Nasdaq securities. Pursuant to the settlement agreement, M&S paid approximately $1 million on December 31, 1997, and agreed that on September 30, 1998, it would contribute Treasury securities which would mature to a value of approximately $46 million on or before July 30, 1999. As of December 31, 1997, the Company has recognized all of the settlement charges for the litigation and does not expect to incur any charges relating to this settlement beyond 1997. The court granted preliminary approval of the settlement on December 31, 1997, and is expected to consider final approval in 1998. Between August 12, 1993 and November 17, 1995, Schwab was named as a defendant in eleven class action lawsuits in seven states. The class actions all purport to be brought on behalf of customers of Schwab who purchased or sold securities for which Schwab received payments from the market maker, stock dealer or third party who executed the transaction. The complaints generally allege that Schwab failed to disclose and remit such payments to members of the class, and generally seek damages equal to the payments received by Schwab. Through October 1997, one of the actions was voluntarily dismissed and five were resolved favorably to Schwab on the grounds that the claims asserted are preempted by federal law. In addition, on November 20, 1997, the Illinois Supreme Court ruled that the claims asserted in a case in that state were preempted by federal law. The remaining four cases are still pending in state courts in Texas, California and Louisiana. The action in Texas has been stayed. The action in California has been dismissed, and plaintiffs have filed an appeal. On June 30, 1995, a class was certified in the action in Civil District Court for the Parish of Orleans in Louisiana on behalf of Louisiana residents who purchased or sold securities through Schwab between February 1, 1985 and February 1, 1995 for which Schwab received monetary payments from the market maker or stock dealer who executed the transaction. The action is currently on appeal, by order of the Louisiana Supreme Court, from the trial court's denial of Schwab's motion to dismiss on the grounds of federal preemption. On August 16, 1995, a class was certified in the action in Civil District Court for the Parish of Natchitoches in Louisiana on behalf of residents of all states who purchased or sold securities through Schwab since 1985 for which Schwab received monetary payments from the market maker or the third party who executed the transaction. On August 26, 1997, the Natchitoches action was stayed pending a determination of the preemption issue by the Louisiana Court of Appeals. The ultimate outcome of the legal proceedings described above and the various other civil actions, arbitration proceedings, and claims pending against the Company cannot be determined at this time, and the results of these legal proceedings cannot be predicted with certainty. There can be no assurance that these legal proceedings will not have a material adverse effect on the results of operations in any future period, depending partly on the results for that period, and a substantial judgment could have a material adverse impact on the Company's financial condition and results of operations. However, it is the opinion of management, after consultation with outside legal counsel, that the ultimate outcome of these actions will not have a material adverse impact on the financial condition or operating results of the Company. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET AND CREDIT RISK Through Schwab and M&S, the Company loans customer 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 22 exceed the amount of cash received as collateral. In the event the counterparty to these transactions does not return the loaned securities, the Company may be exposed to the risk of acquiring the securities at prevailing market prices in order to satisfy its customer obligations. The Company mitigates this risk by requiring credit approvals for counterparties, by monitoring the market value of securities loaned on a daily basis and by requiring additional cash as collateral when necessary. The Company is obligated to settle transactions with brokers and other financial institutions even if its customers fail to meet their obligations to the Company. Customers are required to complete their transactions on settlement date, generally three business days after trade date. If customers do not fulfill their contractual obligations, the Company may incur losses. The Company has established procedures to reduce this risk by requiring deposits from customers in excess of amounts prescribed by regulatory requirements for certain types of trades. In the normal course of its margin lending activities, Schwab may be liable for the margin requirement of customer margin securities transactions. As customers write option contracts or sell securities short, the Company may incur losses if the customers do not fulfill their obligations and the collateral in customer accounts is not sufficient to fully cover losses which customers may incur from these strategies. To mitigate this risk, the Company monitors required margin levels daily and customers are required to deposit additional collateral, or reduce positions, when necessary. In its capacity as market maker, M&S maintains inventories in Nasdaq securities on both a long and short basis. While long inventory positions represent M&S ownership of securities, short inventory positions represent obligations of M&S to deliver specified securities at a contracted price, which may differ from market prices prevailing at the time of completion of the transaction. Accordingly, both long and short inventory positions may result in losses or gains to M&S as market values of securities fluctuate. Also, Schwab maintains inventories in exchange-listed securities on both a long and short basis relating to its specialist operations and 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 daily and are continuously monitored to assure compliance with limits established by the Company. Additionally, the Company may purchase exchange-traded option contracts to reduce market risk on these inventories. 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. CONCENTRATIONS Fees received from the Company's proprietary mutual funds represented approximately 12% of the Company's consolidated revenues in 1997. As of December 31, 1997, approximately 28% of Schwab's total customer accounts were located in California. SUPPLEMENTAL CASH FLOW INFORMATION
Year Ended December 31, 1997 1996 1995 - -------------------------------------------------------------------------------- CASH PAID: Income taxes $166,773 $145,113 $ 98,444 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Interest: Customer cash balances $479,504 $369,960 $ 319,645 Stock-lending activities 36,939 24,302 14,106 Borrowings 18,790 16,931 11,131 Other 10,749 9,670 4,833 - -------------------------------------------------------------------------------- Total interest $545,982 $420,863 $ 349,715 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- BUSINESSES ACQUIRED IN 1995 AND RESIDUAL PAYMENTS: Assets acquired $ 219,457 Liabilities assumed (138,204) Other $ 1,200 $ 4,709 (5,484) - -------------------------------------------------------------------------------- Cash payments 1,200 4,709 75,769 Cash received (7,525) - -------------------------------------------------------------------------------- Cash payments, net of cash received $ 1,200 $ 4,709 $ 68,244 - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
23 MANAGEMENT'S REPORT To Our Stockholders: Management of the Company is responsible for the preparation, integrity and objectivity of the consolidated financial statements and the other financial information presented in this annual report. To meet these responsibilities we maintain a system of internal control that is designed to provide reasonable assurance as to the integrity and reliability of the financial statements, the protection of Company and customer assets from unauthorized use, and the execution and recording of transactions in accordance with management's authorization. The system is augmented by careful selection of our managers, by organizational arrangements that provide an appropriate division of responsibility and by communications programs aimed at assuring that employees adhere to the highest standards of personal and professional integrity. The Company's internal audit function monitors and reports on the adequacy of and compliance with our internal controls, policies and procedures. Although no cost-effective internal control system will preclude all errors and irregularities, we believe the Company's system of internal control is adequate to accomplish the objectives set forth above. The consolidated financial statements have been prepared in conformity with generally accepted accounting principles and necessarily include some amounts that are based on estimates and our best judgments. The financial statements have been audited by the independent accounting firm of Deloitte & Touche LLP, who were given unrestricted access to the Company's financial records and related data. We believe that all representations made to Deloitte & Touche LLP during their audit were valid and appropriate. The Board of Directors through its Audit Committee, which is comprised entirely of nonmanagement directors, has an oversight role in the area of financial reporting and internal control. The Audit Committee periodically meets with Deloitte & Touche LLP, our internal auditors and Company management to discuss accounting, auditing, internal control over financial reporting and other matters. Charles R. Schwab Chairman of the Board and Co-Chief Executive Officer David S. Pottruck President, Co-Chief Executive Officer and Chief Operating Officer Steven L. Scheid Executive Vice President and Chief Financial Officer 24 INDEPENDENT AUDITORS' REPORT To the Stockholders and Board of Directors of The Charles Schwab Corporation: We have audited the accompanying consolidated balance sheets of The Charles Schwab Corporation and subsidiaries (the Company) as of December 31, 1997 and 1996, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of The Charles Schwab Corporation and subsidiaries at December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997 in conformity with generally accepted accounting principles. DELOITTE & TOUCHE LLP San Francisco, California February 23, 1998 25 THE CHARLES SCHWAB CORPORATION QUARTERLY FINANCIAL INFORMATION (UNAUDITED) (IN MILLIONS, EXCEPT PER SHARE DATA AND RATIOS)
Weighted- Basic Expenses Average Earnings Excluding Net Common Per Revenues (a) Interest Income Shares (b) Share - -------------------------------------------------------------------------------------------------------------------------------- 1997 BY QUARTER (d) Fourth DIVIDEND INCREASE $ 620.6 $ 516.3 $ 63.1 274.4 $.24 Third STOCK SPLIT 611.8 484.9 76.5 273.0 .29 Second 530.7 424.9 64.0 271.6 .24 First 535.7 425.4 66.7 271.2 .26 - -------------------------------------------------------------------------------------------------------------------------------- 1996 BY QUARTER Fourth $ 482.3 $ 383.1 $ 59.7 269.8 $.23 Third DIVIDEND INCREASE 430.0 333.4 57.1 269.4 .22 Second 491.8 373.1 70.1 268.9 .27 First 446.8 367.2 46.9 268.3 .18 - -------------------------------------------------------------------------------------------------------------------------------- 1995 BY QUARTER Fourth $ 394.8 $ 332.4 $ 42.6 269.8 $.17 Third DIVIDEND INCREASE/STOCK SPLIT 385.5 307.5 47.2 269.5 .18 Second 342.7 269.4 44.4 267.2 .17 First DIVIDEND INCREASE/STOCK SPLIT 296.9 233.5 38.4 264.2 .15 - -------------------------------------------------------------------------------------------------------------------------------- 1994 BY QUARTER Fourth $ 270.4 $ 214.4 $ 33.8 262.7 $.13 Third 248.1 196.5 31.2 261.3 .12 Second 258.2 205.1 32.1 262.6 .13 First DIVIDEND INCREASE 287.9 224.3 38.2 264.6 .15 - -------------------------------------------------------------------------------------------------------------------------------- 1993 BY QUARTER Fourth $ 257.5 $ 212.3 $ 28.5 269.3 $.11 Third 238.8 191.1 22.2(e) 268.5 .08(e) Second DIVIDEND INCREASE / STOCK SPLIT 232.4 180.4 31.6 266.9 .12 First 236.3 174.9 35.4 265.4 .14 - -------------------------------------------------------------------------------------------------------------------------------- Dividends Diluted Declared Range Range Earnings Per of Common of Price/ Per Common Stock Price Earnings Share Share Per Share Ratio (c) - -------------------------------------------------------------------------------------------------------------------------------- 1997 BY QUARTER (d) Fourth DIVIDEND INCREASE $.23 $.040 $44.25 - 29.25 45 - 30 Third STOCK SPLIT .28 .033 36.56 - 26.67 37 - 27 Second .23 .033 28.58 - 20.25 31 - 22 First .25 .033 28.00 - 20.25 30 - 22 - -------------------------------------------------------------------------------------------------------------------------------- 1996 BY QUARTER Fourth $.22 $.033 $21.92 - 15.00 25 - 17 Third DIVIDEND INCREASE .21 .033 17.92 - 13.25 22 - 16 Second .26 .027 17.67 - 14.58 23 - 19 First .18 .027 18.25 - 12.42 27 - 18 - -------------------------------------------------------------------------------------------------------------------------------- 1995 BY QUARTER Fourth $.15 $.027 $17.78 - 11.08 28 - 17 Third DIVIDEND INCREASE/STOCK SPLIT .17 .027 19.33 - 13.83 32 - 23 Second .17 .020 15.25 - 9.83 27 - 18 First DIVIDEND INCREASE/STOCK SPLIT .15 .020 11.00 - 7.36 21 - 14 - -------------------------------------------------------------------------------------------------------------------------------- 1994 BY QUARTER Fourth $.13 $.016 $ 8.22 - 6.14 16 - 12 Third .12 .016 6.86 - 5.64 14 - 11 Second .12 .016 7.53 - 5.50 16 - 12 First DIVIDEND INCREASE .14 .016 7.33 - 5.78 16 - 13 - -------------------------------------------------------------------------------------------------------------------------------- 1993 BY QUARTER Fourth $.11 $.011 $ 8.53 - 6.39 19 - 15 Third .08(e) .011 8.25 - 5.94 18 - 13 Second DIVIDEND INCREASE/STOCK SPLIT .12 .011 6.44 - 4.54 17 - 12 First .13 .009 5.52 - 3.69 17 - 11 - --------------------------------------------------------------------------------------------------------------------------------
ALL SHARE AND PER SHARE DATA REFLECT THE SEPTEMBER 1997 THREE-FOR-TWO COMMON STOCK SPLIT. (a) REVENUES ARE PRESENTED NET OF INTEREST EXPENSE. (b) AMOUNTS SHOWN ARE USED TO CALCULATE DILUTED EARNINGS PER SHARE. (c) 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. THE EXTRAORDINARY CHARGE IN 1993 (DESCRIBED BELOW) HAS BEEN EXCLUDED. (d) 1997 INCLUDES CHARGES FOR A LITIGATION SETTLEMENT OF $23.6 MILLION AFTER- TAX ($.09 PER SHARE FOR BOTH BASIC AND DILUTED EARNINGS PER SHARE). (e) NET INCOME AND EARNINGS PER SHARE ARE NET OF THE EFFECT OF A $6.7 MILLION ($.03 PER SHARE FOR BOTH BASIC AND DILUTED EARNINGS PER SHARE) EXTRAORDINARY CHARGE FROM THE EARLY RETIREMENT OF DEBT. 26 THE CHARLES SCHWAB CORPORATION CHART APPENDIX LIST In this appendix, the following descriptions of certain charts in portions of the Company's 1997 Annual Report to Stockholders that are omitted from the EDGAR Version are more specific with respect to the actual numbers, amounts and percentages than is determinable from the charts themselves. The Company submits such more specific descriptions only for the purpose of complying with the requirements for transmitting portions of this Annual Report on Form 10-K electronically via EDGAR; such more specific descriptions are not intended in any way to provide information that is additional to the information otherwise provided in portions of the Company's 1997 Annual Report to Stockholders. EDGAR Chart Description Version ----------------- Page Number - ----------- 2 Stacked bar chart titled "Assets in Schwab Customer Accounts" depicting the composition of assets in Schwab customer accounts at year end 1997, 1996, 1995, 1994 and 1993 (shown on the bottom axis) as follows (billions of dollars): Cash and Equivalents $60.9, $50.0, $37.9, $28.6 and $20.1, respectively; Mutual Fund Marketplace (registered trademark) $112.1, $78.3, $52.0, $32.2 and $26.2, respectively; Stocks (net of margin loans) $150.8, $98.5, $71.6, $46.1 and $39.5, respectively; Fixed Income Securities $29.9, $26.4, $20.2, $15.7 and $10.0, respectively; Assets in Schwab Customer Accounts (bar labeled) $353.7, $253.2, $181.7, $122.6 and $95.8, respectively. 3 Bar chart titled "Revenues" depicting the revenues for the fiscal years 1997, 1996 and 1995 (shown on the bottom axis) as follows (millions of dollars) (bar labeled): $2,299, $1,851 and $1,420, respectively. 4 Bar chart titled "Net Income" depicting the net income for the fiscal years 1997, 1996 and 1995 (shown on the bottom axis) as follows (millions of dollars) (bar labeled): $270, $234 and $173, respectively. 4 Stacked bar chart titled "Commissions" depicting the composition of commissions for the fiscal years 1997, 1996 and 1995 (shown on the bottom axis) as follows (millions of dollars): Listed $527, $423 and $348, respectively; Nasdaq $465, $394 and $283, respectively; Options $103, $66 and $53, respectively; Other $79, $71 and $67, respectively; Commissions (bar labeled) $1,174, $954 and $751, respectively. 7 Stacked bar chart titled "Compensation and Benefits" depicting the composition of compensation and benefits for the fiscal years 1997, 1996 and 1995 (shown on the bottom axis) as follows (millions of dollars): Salaries and Wages $601, $451 and $355, respectively; Variable Compensation $217, $205 and $144, respectively; Other Benefits $144, $110 and $95, respectively; Compensation and Benefits (bar labeled) $962, $766 and $594, respectively. 9 Bar chart titled "Net Income Plus Depreciation and Amortization" depicting the net income plus depreciation and amortization for the fiscal years 1997, 1996 and 1995 (shown on the bottom axis) as follows (millions of dollars) (bar labeled): $395, $332 and $241, respectively. 10 Bar chart titled "Dividends Declared Per Common Share" depicting the dividends declared per common share for the fiscal years 1997, 1996 and 1995 (shown on the bottom axis) as follows (bar labeled): $.139, $.120 and $.094, respectively. 27 EX-21.1 16 EXHIBIT 21.1 EXHIBIT 21.1 THE CHARLES SCHWAB CORPORATION SUBSIDIARIES OF THE REGISTRANT THE FOLLOWING IS A LISTING OF THE SIGNIFICANT SUBSIDIARIES OF THE REGISTRANT: SCHWAB HOLDINGS, INC., a Delaware corporation CHARLES SCHWAB & CO., INC., a California corporation CHARLES SCHWAB INVESTMENT MANAGEMENT, INC., a Delaware corporation THE FOLLOWING IS A LISTING OF CERTAIN OTHER SUBSIDIARIES OF THE REGISTRANT: THE CHARLES SCHWAB TRUST COMPANY, a California corporation CHARLES SCHWAB EUROPE (FORMERLY KNOWN AS SHARELINK), an England and Wales corporation MAYER & SCHWEITZER, INC., a New Jersey corporation EX-23.1 17 EXHIBIT 23-1 EXHIBIT 23.1 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in the following Registration Statements of The Charles Schwab Corporation of our reports dated February 23, 1998 appearing in and incorporated by reference in this Annual Report on Form 10-K of The Charles Schwab Corporation for the year ended December 31, 1997. Filed on Form S-8: Registration Statement No. 33-30260 (1987 Stock Option Plan) Registration Statement No. 33-37485 (Charles Schwab Profit Sharing and Employee Stock Ownership Plan) Registration Statement No. 33-45356 (Executive Officer Stock Option Plan (1987)) Registration Statement No. 33-54701 (1992 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)
Filed on Form S-3: Registration Statement No. 333-12727 (Debt Securities)
DELOITTE & TOUCHE LLP San Francisco, California March 27, 1998 EX-27.1 18 EXHIBIT 27-1
BD THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED STATEMENT OF INCOME AND CONSOLIDATED BALANCE SHEET OF THE COMPANY'S 1997 ANNUAL REPORT TO STOCKHOLDERS, WHICH ARE INCORPORATED HEREIN BY REFERENCE TO EXHIBIT NO. 13.1 OF THIS REPORT, FOR THE PERIOD ENDED DECEMBER 31, 1997, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 YEAR DEC-31-1997 DEC-31-1997 2,864,284 8,018,583 4,707,187 0 282,569 342,273 16,481,707 268,644 14,228,865 0 0 0 361,049 0 0 2,677 1,142,440 16,481,707 257,985 900,035 1,174,023 0 427,673 546,483 961,824 447,247 270,277 0 0 270,277 1.03 .99 Reflects the September 1997 three-for-two common stock split and prior Financial Data Schedules have not been restated for the recapitalization.
EX-27.2 19 EXHIBIT 27-2
BD THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED STATEMENT OF INCOME AND CONSOLIDATED BALANCE SHEET OF THE COMPANY'S 1996 ANNUAL REPORT TO STOCKHOLDERS (FILED AS EXHIBIT 13.1 TO FORM 10-K FOR THE PERIOD ENDED DECEMBER 31, 1996), INCORPORATED HEREIN BY REFERENCE, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 YEAR 9-MOS 6-MOS 3-MOS YEAR DEC-31-1996 DEC-31-1996 DEC-31-1996 DEC-31-1996 DEC-31-1995 DEC-31-1996 SEP-30-1996 JUN-30-1996 MAR-31-1996 DEC-31-1995 1,799,358 1,937,315 1,630,531 998,959 1,221,619 5,243,758 4,665,963 4,818,860 4,224,494 4,088,211 6,069,930 4,946,546 4,153,464 5,275,465 4,634,298 0 0 0 0 0 127,866 147,965 135,612 118,446 113,522 315,376 289,153 279,768 286,695 243,472 13,778,768 12,147,205 11,214,000 11,096,973 10,552,008 225,136 153,909 157,082 162,435 212,961 12,054,578 10,568,194 9,667,846 9,645,865 9,133,222 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 283,816 293,965 300,084 279,970 246,146 0 0 0 0 0 0 0 0 0 0 1,785 1,785 1,785 1,785 1,785 852,770 812,379 755,479 681,779 631,109 13,778,768 12,147,205 11,214,000 11,096,973 10,552,008 256,902 192,156 134,753 61,634 191,392 680,860 492,998 321,510 157,953 568,120 954,129 712,172 502,062 240,913 750,896 0 0 0 0 0 311,067 224,514 144,219 68,835 218,784 425,872 307,683 200,161 99,009 357,223 766,377 567,845 396,189 195,708 594,105 394,063 294,866 198,369 79,670 277,104 233,803 174,106 117,038 46,943 172,604 0 0 0 0 0 0 0 0 0 0 233,803 174,106 117,038 46,943 172,604 0.90 0.67 0.45 0.18 0.67 0.87 0.65 0.44 0.18 0.64 Reflects the September 1997 three-for-two common stock split and the adoption of Statement of Financial Accounting Standards No. 128 -- Earnings Per Share.
EX-27.3 20 EXHIBIT 27-3
BD THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED STATEMENT OF INCOME AND CONSOLIDATED BALANCE SHEET OF THE COMPANY'S 1997 ANNUAL REPORT TO STOCKHOLDERS, WHICH ARE INCORPORATED HEREIN BY REFERENCE TO EXHIBIT NO. 13.1 OF THIS REPORT, FOR THE PERIOD ENDED DECEMBER 31, 1997, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 9-MOS 6-MOS 3-MOS DEC-31-1997 DEC-31-1997 DEC-31-1997 SEP-30-1997 JUN-30-1997 MAR-31-1997 2,751,824 2,643,076 2,298,901 7,477,199 6,207,301 5,749,558 4,694,086 5,125,028 5,896,118 0 0 0 176,173 189,979 201,919 335,754 332,664 322,625 15,631,483 14,678,298 14,643,061 230,892 209,317 190,264 13,547,923 12,821,797 12,874,184 0 0 0 0 0 0 0 0 0 319,980 289,180 283,317 0 0 0 0 0 0 2,677 1,785 1,785 1,075,292 990,979 936,090 15,631,483 14,678,298 14,643,061 193,985 132,733 69,135 651,815 415,464 199,853 858,994 536,315 274,919 0 0 0 308,677 196,522 94,698 398,594 256,256 123,130 700,061 444,957 220,838 343,003 216,063 110,320 207,222 130,697 66,735 0 0 0 0 0 0 207,222 130,697 66,735 0.79 0.50 0.26 0.76 0.48 0.25 Reflects the September 1997 three-for-two common stock split and the adoption of Statement of Financial Accounting Standards No. 128 -- Earnings Per Share.
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