Charles Schwab 2010 Annual Report Download - page 88

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THE CHARLES SCHWAB CORPORATION
Notes to Consolidated Financial Statements
(Tabular Amounts in Millions, Except Per Share Data, Option Price Amounts, Ratios, or as Noted)
The Company previously disclosed receipt of an SEC Wells notice in October 2009 that included potential charges against CSIM and
Schwab Investments relating to the Total Bond Market Fund; that matter has been resolved as part of the January 11, 2011 settlement
described above relating to the Bond Fund.
15. Financial Instruments Subject to Of
f
-Balance Sheet Risk, Credit Risk, or Market Risk
Securities lending: Through Schwab, the Company loans client securities temporarily to other brokers in connection with its securities
lending activities. The Company receives cash as collateral for the securities loaned. Increases in security prices may cause the fair
value of the securities loaned to exceed the amount of cash received as collateral. In the event the counterparty to these transactions
does not return the loaned securities or provide additional cash collateral, the Company may be exposed to the risk of acquiring the
securities at prevailing market prices in order to satisfy its client obligations. The Company mitigates this risk by requiring credit
approvals for counterparties, monitoring the fair value of securities loaned, and requiring additional cash as collateral when necessary.
The fair value of Schwab’s client securities pledged in securities lending transactions to other broker-dealers was $1.2 billion and
$871 million at December 31, 2010 and 2009, respectively. Additionally, Schwab borrows securities from other broker-dealers to
fulfill short sales by clients. The fair value of these borrowed securities was $113 million and $274 million at December 31, 2010 and
2009, respectively.
Client trade settlement: The Company is obligated to settle transactions with brokers and other financial institutions even if the
Company’s clients fail to meet their obligations to the Company. Clients are required to complete their transactions on settlement
date, generally three business days after the trade date. If clients do not fulfill their contractual obligations, the Company may incur
losses. The Company has established procedures to reduce this risk by requiring deposits from clients in excess of amounts prescribed
by regulatory requirements for certain types of trades, and therefore the potential for Schwab to make payments under these client
transactions is remote. Accordingly, no liability has been recognized for these transactions.
M
argin lending: Schwab provides margin loans to its clients which are collateralized by securities in their brokerage accounts.
Schwab may be liable for the margin requirement of its client margin securities transactions. As clients write options or sell securities
short, the Company may incur losses if the clients do not fulfill their obligations and the collateral in client accounts is not sufficient
to fully cover losses which clients may incur from these strategies. To mitigate this risk, the Company monitors required margin
levels and clients are required to deposit additional collateral, or reduce positions to meet minimum collateral requirements. Clients
with margin loans have agreed to allow Schwab to pledge collateralized securities in their brokerage accounts in accordance with
federal regulations. Schwab was allowed, under such regulations, to pledge securities with a fair value of $15.0 billion and
$11.4 billion at December 31, 2010 and 2009, respectively. The fair value of Schwab’s client securities pledged to fulfill the short
sales of its clients was $1.4 billion and $1.2 billion at December 31, 2010 and 2009, respectively. The fair value of Schwab’s client
securities pledged to fulfill Schwab’s proprietary short sales, which resulted from facilitating clients’ dividend reinvestment elections,
was $99 million and $33 million at December 31, 2010 and 2009, respectively. Schwab has also pledged a portion of its securities
owned in order to fulfill the short sales of clients and in connection with securities lending transactions to other broker-dealers. The
fair value of these pledged securities was not material at December 31, 2010 or 2009. The Company may also pledge client securities
to fulfill client margin requirements for open option contracts established with the OCC. The fair value of these pledged securities to
the OCC was $1.2 billion and $647 million at December 31, 2010 and 2009, respectively.
Financial instruments held for trading purposes: The Company maintains inventories in securities on a long and short basis relating
to its fixed income operations. The Company could incur losses or gains as a result of changes in the fair value of these securities. To
mitigate the risk of losses, long and short positions are marked to fair value and monitored by management to assure compliance with
limits established by the Company.
R
esale and repurchase agreements: Schwab enters into collateralized resale agreements principally with other broker-dealers, which
could result in losses in the event the counterparty fails to purchase the securities held as collateral for the cash advanced and the fair
value of the securities declines. To mitigate this risk, Schwab requires that the counterparty deliver securities to a custodian, to be
held as collateral, with a fair value in excess of the resale price. Schwab also sets standards for
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