CONFIDENTIAL TREATMENT REQUESTED
BY THE CHARLES SCHWAB CORPORATION
UNDER 17 C.F.R. 200.83
April 28, 2005
Securities and Exchange Commission
450 Fifth Street, N.W.
Mail Stop 4-8
Washington, D.C. 20549
Attention: Mr. Paul Cline, Senior Accountant
Ms. Rebekah Moore, Staff Accountant
Re: The Charles Schwab Corporation
Form 10-K filed on March 2, 2005
Commission File No. 001-9700
Ladies and Gentlemen:
We have set forth below the response of The Charles Schwab Corporation (the
Company) to the comments in the letter from Mr. Paul Cline to Mr. Christopher V.
Dodds dated April 14, 2005 with respect to the above referenced periodic report.
For your convenience, we have repeated the comments in italics immediately
before the response. The Company is requesting confidential treatment of the
redacted portions of this letter (indicated by asterisks) in a separate letter
to the Freedom of Information Act Officer.
Consolidated Financial Statements
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Note 5. Discontinued Operations - page 41
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1. Please supplementally tell us, and revise your document to include a
disclosure of the specific factors you considered in determining that the
expected cash flows generated from the contract with UBS are not material
direct cash flows of the disposed component. In addition, supplementally
tell us the following related to the contract, and explain how you
considered each factor in determining that the contract did not constitute
significant continuing involvement in the disposed component:
o The significance of the contract or arrangement to the overall operations
of the disposed component
o The extent to which you are involved in the operations of the disposed
component
o The rights conveyed to each party by the contract
o The pricing terms of the contract or arrangement.
Refer to paragraph 42 of SFAS 144 and EITF 03-13.
The Company considered paragraph 42 of Statement 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, and Staff Accounting Bulletin topic
5-E, Accounting for Divestiture of a Subsidiary or Other Business Operation, in
determining that the relevant criteria were met for the purposes of classifying
the results of operations of its capital markets businesses as discontinued
operations as of September 30, 2004. We also considered the EITF Working Group's
ongoing deliberations of EITF 03-13, Applying the Conditions in Paragraph 42 of
FASB Statement No. 144 in Determining Whether to Report Discontinued Operations,
through September 30, 2004. We note that the final EITF consensus was not
ratified by the Financial Accounting Standards Board until November 30, 2004 and
that the consensus of EITF 03-13 is not required to be applied to disposals
until fiscal periods beginning after December 15, 2004. Nevertheless, we believe
the Company's accounting conclusion is consistent with the final EITF 03-13
consensus for the following reasons: the Company's continuing cash flows related
to the
CTR 000071
CONFIDENTIAL TREATMENT REQUESTED
BY THE CHARLES SCHWAB CORPORATION
UNDER 17 C.F.R. 200.83
Securities and Exchange Commission
April 28, 2005
Page 2 of 7
capital markets business are considered insignificant and the Company will have
no significant continuing involvement in the operations of the capital markets
business.
A description of the relevant terms of the sale transaction and the order
routing and execution services agreements with UBS relevant to this analysis are
summarized below, followed by the Company's evaluation pursuant to EITF 03-13.
Background
On August 31, 2004, The Charles Schwab Corporation (the Company), along with its
indirect subsidiaries CS Capital Markets & Co. and Schwab Associates & Co.,
entered into an agreement (Purchase Agreement) with UBS Securities LLC and UBS
Americas Inc. pursuant to which the Company agreed to sell its capital markets
business for $265 million in cash. Concurrently with the closing of that
transaction on October 29, 2004, the Company and Charles Schwab & Co., Inc.
(Schwab) entered into order routing and execution services agreements (Order
Routing Agreements) with UBS Securities LLC and Schwab Capital Markets L.P.
(together, UBS) for the handling of Schwab's equity and listed options order
flow. Either Schwab or UBS may terminate either of the Order Routing Agreements
for material breach by the other and in the event of certain changes in control
of UBS. If the Order Routing Agreements were terminated, or UBS is not meeting
minimum service levels or is otherwise unable to provide execution services, the
Company would direct its order flow to other market centers for execution since
the Company has eliminated its execution capabilities by virtue of selling and
exiting its capital markets businesses.
Order Routing
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Pursuant to the Order Routing Agreements, Schwab has committed to route
substantially all of the orders in equity securities and listed options to UBS
for order handling and execution for a term of eight years. The Company has
deferred $28 million of the purchase price, representing the fair value of the
Order Routing Agreements, to be recognized as revenue over the eight-year term
of the agreements. Certain orders are excluded from these agreements and are
therefore directed to other market centers for execution, including orders for
the accounts of CyberTrader, Inc.(R) and affiliates of U.S. Trust Corporation,
and certain orders for clients of Schwab Institutional, through which Schwab
provides custody, trading and support services to independent investment
advisors. These excluded orders were generally not handled by the capital
markets business prior to the sale and the Company does not receive compensation
from market-makers for these orders.
Generally, UBS will execute equity orders without commission or a commission
equivalent and without pass-through of third-party charges. Under
certain circumstances, charges may apply for the execution of orders that
require special handling or entail additional costs, as follows:
1. ***
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CONFIDENTIAL TREATMENT REQUESTED
BY THE CHARLES SCHWAB CORPORATION
UNDER 17 C.F.R. 200.83
Securities and Exchange Commission
April 28, 2005
Page 3 of 7
2. ***
Liquidated damages
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The Order Routing Agreements provide for liquidated damages if Schwab breaches
its commitments to route specified orders through UBS. Schwab has the ability to
direct the order flow in accordance with the contractual terms of the agreements
and does not anticipate defaulting on these agreements. Therefore, we have
assumed no cash outflow for liquidated damages.
Transition services
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Pursuant to the Purchase Agreement, Schwab will provide customary transition
services to UBS during a short period (now expected to end by December 2005,
although originally anticipated to be a shorter period of time) to ensure a
smooth transfer of the capital markets business and will be reimbursed for
actual costs incurred. These reimbursements of costs relate principally to
transition staffing and facilities charges. The gross cash flows related to
these costs are expected to total less than 1% of the total annualized 2004
expenses for the capital markets business, with the amounts diminishing over
approximately 12 months as the transition activities are completed. Amounts paid
by the Company to third parties on behalf of UBS during the transition period,
principally SEC fees and commission, clearance and floor brokerage fees, will be
passed through to UBS. ***
Service level standards
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The Order Routing Agreements stipulate minimum service level standards for
execution of trades as well as operations and technology service levels. ***
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CONFIDENTIAL TREATMENT REQUESTED
BY THE CHARLES SCHWAB CORPORATION
UNDER 17 C.F.R. 200.83
Securities and Exchange Commission
April 28, 2005
Page 4 of 7
1. Any changes to service levels are subject to mutual agreement.
2. A joint advisory committee was established as a forum for
discussion regarding routing and execution practices and resolution
of disputes. However, the committee does not have authority to bind
either party.
***
In addition, each of the Order Routing Agreements provides dispute resolution
procedures for addressing disputes relating to the placement or execution of an
order. The contracts provide for mutual good-faith efforts to resolve disputes,
and neither party has unilateral authority to impose a final determination.
EITF 03-13 Evaluation:
This section is formatted to mirror the examples of the application of the EITF
consensus on Issue 03-13 shown in Exhibit 03-13B to the consensus. The analysis
is summarized as follows:
1. ***
2. The $28 million deferred revenue assigned to the Order Routing
Agreements for accounting purposes does not represent a continuing
cash flow. If this amount were considered a prepayment for order
flow, the implied annual expense is not significant and therefore
it would not be considered a direct cash flow.
3. UBS will reimburse the Company for services provided to UBS during
a short transition period. This is not considered a continuation of
activities and is therefore not considered a direct cash flow.
4. *** This is neither a revenue-producing nor cost-generating
activity to the Company and is therefore not considered a direct
cash flow.
5. The Company does not have the ability to significantly influence
the operating and (or) financial policies of the capital markets
business.
Step 1: Are continuing cash flows expected to be generated by the Company?
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Yes. Continuing cash flows are being generated by the Company in the following
ways:
1. Fees paid to UBS's capital markets business related to ***.
2. Reimbursement of Company expenses for services provided to UBS
during a short transition period.
Pursuant to EITF 03-13, continuing cash flows are cash inflows or outflows that
are generated by the ongoing entity (the Company) and are associated with
activities involving a disposed component (the capital markets business). Based
upon this definition, the cash flows related to items 1 and 2, above, are
considered continuing cash flows.
CTR 000074
CONFIDENTIAL TREATMENT REQUESTED
BY THE CHARLES SCHWAB CORPORATION
UNDER 17 C.F.R. 200.83
Securities and Exchange Commission
April 28, 2005
Page 5 of 7
However, the $28 million deferred revenue assigned to the Order Routing
Agreements for accounting purposes does not represent a continuing cash flow
because the purchase price for the capital markets business was paid in full at
the closing of the sale. Even if this amount were considered a prepayment for
order flow, the implied annual expense to the capital markets business would be
$3.4 million, representing approximately 1% of the total annualized 2004 capital
markets expenses.
***
Step 2: Do the continuing cash flows result from a migration or continuation of
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activities?
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Yes. The Company will pay fees related to ***. These fees represent an expense
to the Company and are considered a continuation of activities, as defined in
the next paragraph. However, the reimbursement of Company costs for transition
services is not considered a continuation of activities.
Pursuant to EITF 03-13, continuation of activities refers to the continuation of
any revenue-producing or cost-generating activity through active involvement
with the disposed component (i.e., the capital markets business). The intention
of the criterion in paragraph 42(a) [of Statement 144] is to determine whether,
in substance, the ongoing entity continues either the revenue-producing
activities or the cost-generating activities of the disposed component after the
disposal transaction. The reimbursement of transition services costs is not
considered a continuation of activities because it is a passive activity that is
neither revenue-producing nor cost-generating to the Company.
Pursuant to EITF 03-13, migration refers to the ongoing entity (the Company)
generating revenues or incurring expenses from the sale of similar products or
services to specific customers of the disposed component. The cash inflows and
outflows related to the unique activities of the capital markets business have
been eliminated for the Company, including commissions earned on trades from
institutional clients, principal transaction revenues on OTC listed and NASDAQ
market-making operations, commission expense and floor-brokerage expense on
institutional client trading activity, and compensation and benefits to
institutional business employees. Therefore, there will be no "migration" of the
capital market business' revenues to the Company or Schwab following the sale.
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CONFIDENTIAL TREATMENT REQUESTED
BY THE CHARLES SCHWAB CORPORATION
UNDER 17 C.F.R. 200.83
Securities and Exchange Commission
April 28, 2005
Page 6 of 7
Step 3: Are the continuing cash flows significant?
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No. ***
Step 4: Does Schwab have significant continuing involvement in the operations of
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the capital markets business?
- ----------------------------
No. The Order Routing Agreements do not result in the Company having the ability
to significantly influence the operating and (or) financial policies of the
capital markets business of UBS after the sale based on the following:
1. The Order Routing Agreements are not significant. The fair value of
the agreements was determined to be approximately $28 million. Over
the eight year term of the Order Routing Agreements, the implied
annual expense to the capital markets business would be $3.4
million, representing approximately 1% of the total annualized 2004
capital markets expenses.
2. The Company has no significant ongoing involvement in the
operations of the capital markets business. Specifically:
a. The Company has no ownership interest in the capital markets
business or in UBS and no managerial authority or influence
over operating and financial policies of UBS following the
sale.
b. The Company has no authority over major contracts or customers
of the capital markets business or of UBS. Minimum service
level standards were stipulated in the Order Routing
Agreements and the Company has no unilateral authority to
modify these terms.
c. Provided that UBS is meeting minimum service levels, the
Company's responsibility is solely to direct order flow to
UBS, in contrast to the highly active involvement of the
capital markets business' ongoing management of order
execution. Even in circumstances in which UBS is not meeting
minimum service levels or is otherwise unable to execute
orders, the Company's role is limited to directing order flow
to other market centers for execution.
d. The Company's relationship with UBS under the Order Routing
Agreements is that of an arm's length customer. The agreements
provide for a joint advisory committee to monitor compliance
with agreed-upon service standards, but neither the committee
nor the Company has managerial authority over the operating
policies of the capital markets business.
e. The Company does not participate in any future profits of the
capital markets business or of UBS.
3. The Order Routing Agreements preclude the Company from exerting
significant influence over the operations or policies of the
capital markets business.
4. The Purchase Agreement and Order Routing Agreements were based on
arm's-length negotiations between the Company and UBS and
accordingly we believe these agreements were priced at market terms
at the time of the transaction.
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CONFIDENTIAL TREATMENT REQUESTED
BY THE CHARLES SCHWAB CORPORATION
UNDER 17 C.F.R. 200.83
Securities and Exchange Commission
April 28, 2005
Page 7 of 7
Conclusion
Because we consider the continuing cash flows from the Order Routing Agreements
and Purchase Agreement to be indirect cash flows and because the Company will
not have significant continuing involvement in the operations of the capital
markets business, classification as a discontinued operation is appropriate.
As requested, we will expand our disclosure in future filings to disclose the
factors considered in reaching this conclusion.
The Company's management acknowledges that:
o the Company is responsible for the adequacy and accuracy of the
disclosure in the filing;
o staff comments or changes to disclosure in response to staff
comments do not foreclose the Commission from taking any action with
respect to the filing; and
o the Company may not assert staff comments as a defense in any
proceeding initiated by the Commission or any person under the
federal securities laws of the United States.
Please call me at (415) 636-5414 or Geoffrey Huggins, Senior Vice President,
Accounting Policy, at (415) 636-3191 if you have any questions or comments
concerning this letter.
Sincerely,
/s/ Christopher V. Dodds
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Christopher V. Dodds
Executive Vice President & Chief Financial Officer
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