Document:

exv10w1

	 	 	 
	

	 	
DEPARTMENT OF THE TREASURY

WASHINGTON. D.C. 20220

March 23, 2010

Mr. Robert Benmosche

President and Chief Executive Officer

American International Group, Inc.

70 Pine Street

27th Floor

New York, NY, 10270

			
	          Re:	 	Proposed Compensation Payments and Structures for Senior

Executive Officers and Most Highly Compensated Employees

(“Covered Employees 1-25”)

Dear Mr. Benmosche:

          Pursuant to the Department of the Treasury’s Interim Final Rule on TARP Standards for
Compensation and Corporate Governance, the Office of the Special Master has completed its review of
your 2010 compensation submission on behalf of the senior executive officers and next 20 most
highly compensated employees (“Covered Employees 1-25”) of American International Group, Inc.
(“AIG”). Attached as Annex A is a Determination Memorandum (accompanied by Exhibits I and II)
providing the determinations of the Special Master with respect to 2010 compensation for those
employees. 31 C.F.R. § 30.16(a)(3)(i).

          The Interim Final Rule requires the Special Master to determine whether the
compensation structure for each Covered Employee 1-25 “will or may result in payments that are
inconsistent with the purposes of section 111 of EESA or TARP, or are otherwise contrary to the
public interest.” Id. On October 22, 2009, the Special Master issued a Determination
Memorandum containing principles designed to ensure that 2009 compensation for AIG’s Covered
Employees 1-25 satisfies this public interest standard.

          The principles established for 2009 must continue to govern compensation at the
five remaining recipients of exceptional assistance in 2010. Generally, these principles require
that:

	 	•	 	There can be no guarantee of any “bonus” or “retention” awards among the
compensation structures approved by the Special Master.
	 
	 	•	 	Base salary paid in cash should not exceed $500,000 per year, except in appropriate
cases for good cause shown. The majority of each individual’s base salary will be paid
in the form of stock that will immediately vest, in accordance with the Interim Final
Rule, but will only be redeemable in three equal, annual installments beginning on the
second anniversary of the date stock salary is
earned, with each installment redeemable one year early if AIG repays its federal
obligations.

 

 

	 	•	 	Total compensation for each individual must be appropriate when compared with total
compensation provided to persons in similar positions or roles at similar entities, and
should generally target the 50th percentile of total compensation for such similarly
situated employees.
	 
	 	•	 	If—and only if—grants of incentives are appropriate in light of AIG’s circumstances
at the end of 2010 and a particular Covered Employee achieves objective performance
metrics developed and reviewed in consultation with the Office of the Special Master,
the employee may be eligible for a long-term incentive grant. These incentives must be
granted in restricted stock that will be forfeited unless the employee stays with AIG
for at least three years following grant, and may only be redeemed in 25% installments
for each 25% of AIG’s TARP obligations that are repaid. Long-term incentive grants must
not exceed one third of a Covered Employee’s annual compensation.
	 
	 	•	 	Any and all incentive compensation paid to these employees will be subject to
recovery or “clawback” if the payments are based on materially inaccurate financial
statements, any other materially inaccurate performance metrics, or if the employee is
terminated due to misconduct that occurred during the period in which the incentive was
earned.
	 
	 	•	 	“Other” compensation and perquisites, and supplemental executive retirement plans,
must remain subject to the limitations described in the 2009 determinations.

          AIG’s submissions followed these important principles to some extent, but modifications are
required to make certain that compensation for AIG’s Covered Employees 1-25 satisfies the public
interest standard. Accordingly, the compensation structures approved by the Special Master vary in
the following respects from AIG’s proposals:

	 	•	 	The number of Covered Employees 1-25 earning more than $500,000 in cash salary will
be five, rather than 10, as proposed by AIG.
	 
	 	•	 	For AIG Financial Products executives who received cash “retention” awards in 2010,
cash salaries generally have been frozen at the levels set in the October 22, 2009,
determination, with a single exception capped at $450,000.
	 
	 	•	 	Overall compensation packages will be reduced to levels more appropriate in
comparison with total compensation provided to employees in similar positions or roles
at similarly situated companies.
	 
	 	•	 	A greater portion of overall compensation must be allocated to incentive
compensation that must be paid in long-term restricted stock and that may be granted
only upon the achievement of objective performance goals.
	 
	 	•	 	All stock salary must be redeemable only in three equal, annual installments, with
each installment redeemable one year earlier if AIG repays its federal obligations. AIG
has informed the Office of the Special Master that a repayment of federal obligations
occurred on March 19, 2010. Accordingly, upon certification of that repayment by AIG’s
compensation committee, the redemption of each installment of stock salary may be
accelerated by one year.

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          As described in the attached Determination Memorandum, AIG must also continue to observe the
following prescriptions described in the Special Master’s 2009 determinations:

	 	•	 	The achievement of any performance objectives must be certified by the compensation
committee of AIG’s Board of Directors, which is composed solely of independent
directors. These performance objectives must be reviewed and approved by the Office of
the Special Master.
	 
	 	•	 	The employees will be prohibited from engaging in any hedging or derivative
transactions involving AIG stock that would undermine the long-term performance
incentives created by the compensation structures.
	 
	 	•	 	AIG may not provide a tax “gross up” of any kind to these employees.

These requirements are described in detail in the attached Determination Memorandum.

          Pursuant to the Interim Final Rule, AIG may, within 30 days of the date hereof, request in
writing that the Special Master reconsider the determinations set forth in the Determination
Memorandum. If the Company does not request reconsideration within 30 days, these initial
determinations will be treated as final determinations. Id. § 30.16(c)(1).

Very truly yours,

Kenneth R. Feinberg

Office of the Special Master

for TARP Executive Compensation

Enclosures

			
	cc:	 	Jeffrey Hurd, Esq.

Marc R. Trevino, Esq.

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ANNEX A

DETERMINATION MEMORANDUM

I. Introduction

          The Emergency Economic Stabilization Act of 2008, as amended by the American Recovery and
Reinvestment Act of 2009 (“EESA”), requires the Secretary of the Treasury to establish standards
related to executive compensation and corporate governance for institutions receiving financial
assistance under the Troubled Asset Relief Program (“TARP”). Through the Department of the
Treasury’s Interim Final Rule on TARP Standards for Compensation and Corporate Governance (the
“Rule”), the Secretary delegated to the Office of the Special Master for TARP Executive
Compensation (the “Office of the Special Master”) responsibility for reviewing compensation
structures of certain employees at institutions that received exceptional financial assistance
under TARP (“Exceptional Assistance Recipients”). 31 C.F.R. § 30.16(a); id. § 30.16(a)(3). For
these employees, the Special Master must determine whether the compensation structure will or may
result in payments “inconsistent with the purposes of section 111 of EESA or TARP, or...otherwise
contrary to the public interest.” Id. § 30.16(a)(3)(i).

          American International Group, Inc. (“AIG” or the “Company”), one of five remaining Exceptional
Assistance Recipients, has submitted to the Special Master proposed 2010 compensation structures
(the “Proposed Structures”) for review pursuant to Section 30.16(a)(3)(i) of the Rule. These
compensation structures apply to five employees that the Company has identified for 2010 as senior
executive officers (the “Senior Executive Officers,” or “SEOs”) for purposes of the Rule, and 17
employees the Company has identified as among the most highly compensated employees of the Company
for purposes of the Rule (the “Most Highly Compensated Employees,” and, together with the SEOs, the
“Covered Employees”). Three employees who otherwise would have been included in the Most Highly
Compensated Employees departed the Company prior to the date of this memorandum.

          The Special Master has completed the review of the Company’s Proposed Structures for the
Covered Employees pursuant to the principles set forth in the Rule. Id. § 30.16(b)(l).
This Determination Memorandum sets forth the determinations of the Special Master, pursuant to
Section 30.16(a)(3)(i) of the Rule, with respect to the Covered Employees.

II. Background

          On June 15, 2009, the Department of the Treasury (“Treasury”) promulgated the Rule, creating
the Office of the Special Master and delineating its responsibilities. The Rule requires that each
Exceptional Assistance Recipient submit proposed compensation structures for each Senior Executive
Officer and Most Highly Compensated Employee. 31 C.F.R. § 30.16(a)(3)(i).

          On October 22, 2009, after reviewing submissions of proposed compensation structures from AIG,
the Special Master issued determinations regarding 2009 compensation structures, and amounts
potentially payable thereunder, for AIG’s senior executive officers and certain most highly
compensated employees (the “2009 Determinations”). The 2009 Determinations included principles
designed to ensure that 2009 compensation for the applicable employees would not “result in
payments that are inconsistent with the purposes of section 111 of EESA or TARP, or

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are otherwise contrary to the public interest.” 31 C.F.R. § 30.16(a)(3). The 2009
Determinations applied only to those individuals identified by the Company as subject to the
Special Master’s mandatory jurisdiction to review and approve compensation structures and payments,
see id., for 2009 and only with respect to compensation for services provided to AIG for 2009.

          On December 14, 2009, the Special Master requested from each remaining Exceptional Assistance
Recipient, including AIG, certain data and documentary information necessary to facilitate the
Special Master’s review of the Company’s 2010 compensation structures. The request required AIG to
submit data describing its proposed compensation structures, and the payments that would result
from the proposals, concerning each Covered Employee.

          In addition, the Rule authorizes the Special Master to request information from an Exceptional
Assistance Recipient “under such procedures as the Special Master may determine.” Id. §
30.16(d). AIG was required to submit competitive market data indicating how the amounts
payable under AIG’s proposed compensation structures relate to the amounts paid to persons in
similar positions or roles at similar entities. AIG was also required to submit a range of
documentation, including information related to proposed performance metrics, internal policies
designed to curb excessive risk, and certain previously existing compensation plans and agreements.

          AIG submitted this information to the Office of the Special Master on January 15, 2010.
Following a preliminary review of the submission, on February 2, 2010, the Special Master
determined that AIG’s submission was substantially complete for purposes of the Rule. Id. §
30.16(a)(3)(i). The Office of the Special Master then commenced a formal review of AIG’s
proposed compensation structures for the Covered Employees. The Rule provides that the Special
Master is required to issue a compensation determination within 60 days of receipt of a
substantially complete submission. Id.

          The Office of the Special Master’s review of the Company’s proposals was aided by analysis
from a number of internal and external sources, including:

	 	•	 	Treasury personnel detailed to the Office of the Special Master, including executive
compensation specialists with significant experience in reviewing, analyzing, designing
and administering executive compensation plans, and attorneys with experience in
matters related to executive compensation;
	 
	 	•	 	Competitive market data provided by the Company in connection with its submission to
the Office of the Special Master;
	 
	 	•	 	External information on comparable compensation structures extracted from the U.S.
Mercer Benchmark Database-Executive; and
	 
	 	•	 	External information on comparable compensation structures extracted from Equilar’s
ExecutiveInsight database (which includes information drawn from publicly filed proxy
statements) and Equilar’s Top 25 Survey Summary Report (which includes information from
a survey on the pay of highly compensated employees).

          The Special Master considered these sources, in light of the statutory and regulatory
standards described in Part III below, when evaluating the Company’s proposed compensation
structures for the Covered Employees for 2010.

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III. Statutory And Regulatory Standards

          The Rule requires that the Special Master determine for each of the Covered Employees whether
AIG’s proposed compensation structure, including amounts payable or potentially payable under the
compensation structure, “will or may result in payments that are inconsistent with the purposes of
section 111 of EESA or TARP, or are otherwise contrary to the public interest.” 31 C.F.R. §
30.16(a)(3) (as applied to Covered Employees of Exceptional Assistance Recipients, the “Public
Interest Standard”). The Rule requires that the Special Master consider six principles when making
these compensation determinations:

	 	(1)	 	Risk. The compensation structure should avoid incentives that
encourage employees to take unnecessary or excessive risks that could threaten the
value of the Exceptional Assistance Recipient, including incentives that reward
employees for short-term or temporary increases in value or performance; or similar
measures that may undercut the long-term value of the Exceptional Assistance Recipient.
Compensation packages should be aligned with sound risk management. Id. §
30.16(b)(1)(i).
	 
	 	(2)	 	Taxpayer return. The compensation structure and amount payable
should reflect the need for the Exceptional Assistance Recipient to remain a
competitive enterprise, to retain and recruit talented employees who will contribute to
the recipient’s future success, so that the Company will ultimately be able to repay
its TARP obligations. Id. § 30.16(b)(1)(ii).
	 
	 	(3)	 	Appropriate allocation. The compensation structure should
appropriately allocate the components of compensation such as salary and short-term and
long-term performance incentives, as well as the extent to which compensation is
provided in cash, equity, or other types of compensation such as executive pensions, or
other benefits, or perquisites, based on the specific role of the employee and other
relevant circumstances, including the nature and amount of current compensation,
deferred compensation, or other compensation and benefits previously paid or awarded.
Id. § 30.16(b)(1)(iii).
	 
	 	(4)	 	Performance-based compensation. An appropriate portion of the
compensation should be performance-based over a relevant performance period.
Performance-based compensation should be determined through tailored metrics that
encompass individual performance and/or the performance of the Exceptional Assistance
Recipient or a relevant business unit taking into consideration specific business
objectives. Performance metrics may relate to employee compliance with relevant
corporate policies. In addition, the likelihood of meeting the performance metrics
should not be so great that the arrangement fails to provide an adequate incentive for
the employee to perform, and performance metrics should be measurable, enforceable, and
actually enforced if not met. Id. § 30.16(b)(1)(iv).
	 
	 	(5)	 	Comparable structures and payments. The compensation structure, and
amounts payable where applicable, should be consistent with, and not excessive taking
into account, compensation structures and amounts for persons in similar positions or
roles at similar entities that are similarly situated, including, as applicable,
entities competing in the same markets and similarly situated entities that are
financially distressed or that are contemplating or undergoing reorganization.
Id. § 30.16(b)(1)(v).

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	 	(6)	 	Employee contribution to TARP recipient value. The compensation structure and
amount payable should reflect the current or prospective contributions of an employee
to the value of the Exceptional Assistance Recipient, taking into account multiple
factors such as revenue production, specific expertise, compliance with company policy
and regulation (including risk management), and corporate leadership, as well as the
role the employee may have had with respect to any change in the financial health or
competitive position of the recipient. Id. § 30.16(b)(1)(vi).

          The Rule provides that the Special Master shall have discretion to determine the
appropriate weight or relevance of a particular principle depending on the facts and circumstances
surrounding the compensation structure or payment for a particular employee. Id. § 30.16(b). To the
extent two or more principles may appear inconsistent in a particular situation, the Rule requires
that the Special Master exercise his discretion in determining the relative weight to be accorded
to each principle. Id.

          The Rule provides that the Special Master may, in the course of applying these principles,
take into account other compensation structures and other compensation earned, accrued, or paid,
including compensation and compensation structures that are not subject to the restrictions of
section 111 of EESA. For example, the Special Master may consider payments obligated to be made by
the Company pursuant to certain legally binding rights under valid written employment contracts
entered into prior to enactment of the statute and the accompanying Rule. Id. § 30.16(a)(3).

IV. Compensation Structures And Payments

A. AIG Proposals

          AIG has provided the Office of the Special Master with detailed information concerning its
proposed 2010 compensation structures for the Covered Employees, including amounts proposed to be
paid under the compensation structure for each Covered Employee (the “Proposed Structures”).

          AIG supported its proposal with detailed assessments of each Covered Employee’s tenure and
responsibilities at the Company and historical compensation structure. The submission also included
market data that, according to the Company, indicated that the amounts potentially payable to each
employee were comparable to the compensation payable to persons in similar positions or roles at a
“peer group” of entities selected by the Company. Of the 13 employees listed as Covered Employees
for 2009, 8 remain on the list of Covered Employees for 2010, and 14 employees are new entrants to
the group.

          1. AIG Corporate and Operating Units

          Each of the five Senior Executive Officers and 11 of the Most Highly Compensated Employees
serve in either AIG’s corporate offices or as a senior executive of an AIG subsidiary other than
AIG Financial Products (“AIGFP”). The Proposed Structures for employees in this group generally
included cash salaries of $500,000 or more, and stock salary and long-term restricted stock with
terms and conditions consistent with the 2009 Determinations.

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               a. Cash Salary and Cash “Retention” Awards

          AIG proposed that employees new to the Covered Employee group generally continue to receive
cash salaries at the rates paid to them in 2009, with the proposed rates ranging from $350,000 to
$1,500,000. For 3 of the 4 corporate employees remaining in the Covered Employee group from 2009,
the Company proposed raising cash salaries. (The exception was the Chief Executive Officer.) The
proposed raises were substantial and would result in 100% to 140% increases over the cash salaries
approved by the Special Master in 2009. AIG’s submission argued that the proposed cash salaries
could be justified by reference to the compensation of persons in similar positions or roles at
similar entities.

          AIG has indicated that it intends to pay “retention” awards to 8 Covered Employees in this
group in 2010. The “retention” awards are paid under agreements asserted to provide legally binding
rights under valid written employee contracts, see 31 C.F.R. § 30.10(e)(2), that was thus not
subject to the review of the Special Master.

               b. Stock Salary

          AIG proposed stock salaries in amounts ranging from $200,000 to $7,740,000 for corporate and
operating unit employees who are new to the Covered Employee group. For 3 of the 4 corporate
employees remaining in the Covered Employee group from 2009, the Company proposed raising stock
salaries. The proposed raises would result in 65% to 87% increases over the stock salaries approved
by the Special Master in 2009. As required by the Rule, the stock units proposed to be used for
stock salary would be fully vested upon grant.

          Consistent with the 2009 Determinations, AIG proposed that stock salary granted to Covered
Employees in this group would only be redeemable in three equal, annual installments beginning on
the second anniversary of grant, with each installment redeemable one year earlier if AIG repays
its federal obligations.

               c. Annual Long-Term Incentive Awards

          AIG proposed that most Covered Employees would be eligible to receive annual long-term
incentive awards representing approximately 10% their total 2010 compensation, payable in long-term
restricted stock units that generally would vest only if the Covered Employee remains employed by
the Company on the third anniversary of the grant date. As required by the Rule, these awards would
be paid only in 25% installments for each 25% of AIG’s TARP obligations that are repaid.

               d. “Other” Compensation and Perquisites

          AIG proposed payments of “other” compensation, as well as perquisites, to the Covered
Employees. These proposed payments varied in value.

               e. Non-Qualified Deferred Compensation

          AIG proposed that the Special Master revisit the requirement in the 2009 Determinations that
Covered Employees must not accrue additional amounts under “non-qualified deferred compensation”
plans for 2010 (with the exception of employee-funded elective deferrals).

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     2. AIG Financial Products

     Six of the Most Highly Compensated Employees for 2010 are executives of AIGFP. The Proposed
Structures for employees in this group consisted of cash salaries of $500,000 and stock salaries
ranging from $1,000,000 to $3,000,000. Unlike the proposed stock salary for corporate and operating
unit employees, the stock salary proposed for AIGFP Covered Employees would be redeemable on the
first anniversary of grant. No long-term restricted stock was proposed for these Covered Employees,
in light of the Company’s intention to wind down AIGFP’s operations.

     In addition, each of the AIGFP Covered Employees has received a cash “retention” award in 2010
under an agreement asserted to provide a legally binding right under a valid written employee
contract, see id., that thus was not subject to the approval of the Special Master.

B. Determinations of the Special Master

     The Special Master has reviewed the Proposed Structures in detail by application of the
principles set forth in the Rule and described in Part III above. The Special Master’s review also
made use of the resources described in Part II. In light of this review, the Special Master has
determined that the principles established for 2009, which reflect the Public Interest Standard and
are set forth in the 2009 Determinations, must continue to govern compensation in 2010.

     After reviewing the Proposed Structures, the Special Master has concluded that they are in
some respects consistent with the general principles established in the 2009 Determinations;
however, certain aspects of the Proposed Structures and amounts potentially payable under the
Proposed Structures require modification to ensure that they are consistent with the Public
Interest Standard.

     The Special Master has determined, in light of the considerations that follow, that the
compensation structures described in Exhibits I and II to this Determination Memorandum will not,
by virtue of either their structural design or the amounts potentially payable under them, result
in payments inconsistent with the Public Interest Standard.

     1. AIG Corporate and Operating Units

          a. Cash Salary and Cash “Retention” Awards

     The Special Master reviewed AIG’s proposed cash salaries in light of the principle that
compensation structures should generally be comparable to “compensation structures and amounts for
persons in similar positions or roles at similar entities,” 31 C.F.R. § 30.16(b)(1)(v). Based in
part upon this principle, the Special Master concluded in 2009 that cash salaries generally should
not target a level above the 50th percentile as compared to persons in similar positions or roles
at similar entities, because such levels of cash salaries balance the need to attract and retain
talent with the need for compensation structures that reflect the circumstances of Exceptional
Assistance Recipients.

     The Special Master also reviewed AIG’s proposed cash salaries in light of the principle that
compensation structures should be “performance-based over a relevant performance period,”

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id.
§ 30.16(b)(1)(iv). Based in part upon this principle, the 2009 Determinations concluded
that, other than in exceptional cases for good cause shown, a Covered Employee’s cash salary should
not exceed $500,000.

     In addition, the Special Master may take into account compensation structures, such as
legally binding rights under valid employment contracts, that are not subject to review by the
Special Master. Id. § 30.16(a)(3). Of the employees in this group, eight are asserted to be
entitled to substantial cash payments in 2010 pursuant to previously existing “retention” awards.
As noted in the 2009 Determinations, similar “retention” awards at other Exceptional Assistance
Recipients were amended to provide compensation in a manner consistent with the Public Interest
Standard; however, discussions with AIG officials have not resulted in agreements to restructure
these arrangements. Instead, for each Covered Employee with a cash “retention” award payable in
2010, the Special Master has considered the “retention” award when assessing the cash salary AIG
proposed for that employee.

     Accordingly, the Special Master has determined that the proposed cash salaries would not be
consistent with the Public Interest Standard because they generally exceeded $500,000 and do not
appropriately consider the amounts payable in 2010 to Covered Employees under previously existing
cash “retention” awards. The cash salaries that the Special Master has determined to be consistent
with the Public Interest Standard for these employees are described in Exhibits I and II.

          b. Stock Salary

     The Special Master reviewed the amount of stock salary AIG proposed to pay these Covered
Employees in light of the principles that compensation structures should generally be comparable to
“compensation structures and amounts for persons in similar positions or roles at similar
entities,” id. § 30.16(b)(1)(v), and that a “compensation structure, and amount payable...should
reflect the current or prospective contributions of an employee to the value of the [Company],” id.
§ 30.16(b)(1)(vi). The Special Master found that the amounts of stock salary proposed by AIG were
excessive in comparison to payments provided to persons in similar positions or roles at similar
entities, and that such payments would be inconsistent with the
 Public Interest Standard. The stock salaries that the Special Master has determined are
consistent with the Public Interest Standard for such employees for 2010 are set forth in Exhibit
I.

     In addition, the Special Master reviewed AIG’s proposed stock salary in light of the
principle that AIG must be able to maintain and attract the necessary employees to remain
competitive in the marketplace. See id. § 30.16(b)(1)(ii). Based in part upon this principle, in
the 2009 Determinations the Special Master approved a stock salary structure reflecting the value
of a “basket” of four AIG insurance subsidiaries. Following the 2009 Determinations, the Special
Master also approved the use of common stock for 2009 stock salary.

     Since the 2009 Determinations, AIG has entered into agreement to dispose of some of the
subsidiaries covered by the previously approved “basket.” Accordingly, for 2010 stock salary, AIG
proposed an alternative “basket” with a structure designed to serve as proxy for the long-term
value of the Company. The “basket” would reflect the value of common stock and so-called “hybrid”
securities that, unlike Treasury’s preferred stock, are traded regularly, and therefore can be
valued in a consistent and transparent manner using market pricing. In light of

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the principles that
compensation structures “should avoid incentives to take unnecessary or excessive risks,” id. §
30.16(b)(1)(i), and be allocated in a manner that aligns “the interest of the employee with the
interests of shareholders and taxpayers,” id. § 3016(b)(1)(iii), the Special Master has determined
that the payment of stock salary designed to serve as a proxy for the long-term value of the
Company. The terms and conditions of the “basket” units will be determined by AIG subject to the
approval of the Office of the Special Master.1 The units are described in further detail
in Exhibits I and II.

     Finally, the Special Master reviewed the structure of AlG’s proposal for stock salary in light
of the principle that compensation structures should align performance incentives with long-term
value creation rather than short-term profits. See id. § 30.16(b)(1)(i). In light of this
principle, the 2009 Determinations concluded that stock salary may only be redeemable in three
equal, annual installments beginning on the second anniversary of grant, with each installment
redeemable one year earlier in the event AlG repays its federal obligations. The Proposed
Structures were consistent with this requirement. AlG has informed the Office of the Special Master
that the Company completed a corporate transaction that resulted in the repayment of
approximately $568 million to the Federal Reserve Bank of New York. Accordingly, upon
certification of that repayment by AlG’s compensation committee, each redemption date of 2009 and
2010 stock salary may be accelerated by one year.2

	 	c.	 	Annual Long-Term Incentive Awards

     The Special Master reviewed AIG’s proposed annual long-term incentive awards in light of the
principle that performance-based compensation should be payable “over a relevant performance
period,” id. Based in part upon this principle, the 2009 Determinations require long-term
incentives to be paid in the form of long-term restricted stock, and permit such awards

 

			
	1	 	The Covered Employees generally may not be
paid a “bonus,” or receive payments pursuant to an “incentive plan,” except in
limited circumstances prescribed by the Rule. The provisions of the Rule
addressing compensation in the form of salary paid in property (such as stock)
indicate that such payments will not constitute an “incentive plan” for
purposes of the Rule if the payments are made pursuant to “an arrangement under
which an employee receives a restricted stock unit that is analogous to TARP
recipient stock,” 31 C.F.R. § 30.1. Under the Rule, “a unit is analogous to
stock if the unit is based upon stock of the TARP recipient...and the term
‘TARP recipient stock’ with respect to a particular employee recipient means
the stock of a corporation...that is an ‘eligible issuer of service recipient
stock’” for purposes of certain federal taxation regulations, id. The Rule also
provides that “[t]he Special Master shall have responsibility for interpreting”
the Rule. Id. § 30.16(a)(1). AIG’s proposed “basket” units comprising common
stock and debt securities are designed to approximate the long-term value of
the Company, and thus to align employees incentives with the taxpayer, while
avoiding incentives for excessive risk taking. Accordingly, under these
limited, unique circumstances, and without determining whether the “basket”
units comprise “stock of a corporation...that is an ‘eligible issuer of
service recipient stock’” under the Rule, the Special Master has concluded that
AIG’s proposed units constitute “restricted stock unit[s] that are analogous to
TARP recipient stock” for purposes of the Rule. Id. § 30.1.
	 
	2	 	The terms and conditions of stock salary and
long-term restricted stock proposed for the Chief Executive Officer are
described in the August 16, 2009, Letter Agreement with Robert H. Benmosche
pursuant to which Mr. Benmosche was appointed Chief Executive Officer of AIG.
The Special Master initially determined that the compensation structure under
the Letter Agreement was consistent with the Public Interest Standard on
October 2, 2009. See Letter to Compensation and Management Resources Committee,
American International Group, Oct. 2, 2009, available at
 http://www.financialstability.gov/docs/RobertBenmoscheDeterminationLetter.pdf.
For the reasons provided therein, the Special Master has affirmed that
compensation potentially payable to Mr. Benmosche in 2010 under his Letter
Agreement and as described in Exhibit I is consistent with the Public Interest
Standard.

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to be paid if, and only if, objective performance metrics are achieved and the employee
continues to provide services to the company for three years following the date of grant.

     The structure of AIG’s proposed annual long-term incentive awards is generally consistent
with the 2009 Determinations. Under the Proposed Structures, annual long-term incentive awards for
2010 will be payable only upon the achievement of specified, objective performance criteria to be
provided to the Office of the Special Master and the employee continues to provide services to the
Company for three years following the date of grant. In addition, as required by the Rule, these
awards may only be redeemed in 25% installments for each 25% of AIG’s TARP obligations that are
repaid.

     The Special Master also reviewed the target amounts of annual long-term incentive awards AIG
proposed for the Covered Employees in this group in light of the principle that an “appropriate
portion of the compensation should be performance-based,” id. § 30.16(b)(1)(iv), and based on
“performance metrics [that are] measurable, enforceable, and actually enforced if not met.” Id. The
Proposed Structures failed to meet these principles because they generally allocated no more than
10% of a Covered Employee’s compensation to long-term restricted stock based on the achievement of
performance measures. As described in Exhibits I and II, the structures the Special Master has
determined to be consistent with the Public Interest Standard include more substantial allocations
to annual long-term incentive awards payable only upon the achievement of specified, objective
performance criteria to be developed and reviewed in consultation with the Office of the Special
Master.

     Finally, the Company requested that different vesting terms apply in the case of employees who
provide two years of service after the grant of an incentive—the minimum service period required by
the Rule—but retire prior to providing three years of service, which is the length of service
required by the 2009 Determinations. The Special Master has concluded that the Company’s succession
planning and the timing of individual employees’ retirement

 dates should not be unduly dependent on compensation structures in light of the principles
that compensation structures and the amounts payable thereunder should reflect “the current or
prospective contributions of an employee to the value of the TARP recipient” and “the need for the
TARP recipient to remain a competitive enterprise, to retain ... talented employees who will
contribute to the TARP recipient’s future success.” Id. § 30.16(b)(1). Accordingly, for the
foregoing reasons and the reasons provided in the 2009 Determinations, the Special Master has
determined that the long-term incentive awards described in Exhibits I and II will not result in
payments that would be inconsistent with the Public Interest Standard.

          d. “Other” Compensation and Perquisites

     The 2009 Determinations generally require that perquisites and “other” compensation provided
to a Covered Employee be limited to $25,000 on an annual basis, and the Proposed Structures are
consistent with this requirement. For the reasons provided in the 2009 Determinations, and as
described in Exhibit II, any exceptions to this limitation will require that the Company provide to
the Office of the Special Master an independent justification for the payment that is satisfactory
to the Special Master.

A9

 

          e. Non-Qualified Deferred Compensation

     For the reasons provided in the 2009 Determinations, Covered Employees will not accrue in 2010
additional amounts under supplemental executive retirement plans and
other “non-qualified deferred
compensation” plans, as described in Exhibit II.

          f. Severance Plans

     For the reasons provided in the 2009 Determinations, the Company must ensure that 2010
compensation structures for these employees do not result in an increase in the amounts payable
pursuant to these arrangements.

     2. AIG Financial Products

     In the 2009 Determinations, the Special Master emphasized the importance of the ongoing
discussions with the Company regarding the full satisfaction of the pledge by AIGFP employees to
return $45 million of the cash “retention” payments they received in 2009. Because of the
unresolved nature of those discussions, the Special Master determined that no payments of
additional 2009 compensation to the applicable employees, other than continuation of cash salaries,
would be consistent with the Public Interest Standard.

     Each of the AIGFP Covered Employees received another substantial cash “retention” payment in
2010. In light of these “retention” payments, which may be taken into account in determining 2010
compensation structures, see id. § 30.16(a)(3)(i), the Special Master has concluded that the
proposed $500,000 cash base salaries for AIGFP employees would generally not be consistent with the
Public Interest Standard. Accordingly, the cash salaries for AIGFP Covered Employees set forth on
Exhibit I are frozen at the levels paid at the conclusion of fiscal year 2008, per the 2009
Determinations, with one exception where a $450,000 salary has been approved for an employee in
light of his critical role.

     Each of the AIGFP Covered Employees also pledged to participate in the $45 million repayment
described above. AIG has informed the Office of the Special Master that, as of the date hereof, it
has received, offset or withheld at least $45 million. The Special Master has concluded that,
conditioned upon certification by the chair of the Company’s compensation committee that at least
$45 million of “retention” payments has been received, offset or withheld by the Company, the
payment of additional, non-cash compensation to AIGFP Covered Employees for service provided in
2010 will not be inconsistent with the Public Interest Standard, so long as the compensation
otherwise satisfies the principles set forth in the Rule and described in Part III. Accordingly,
the Special Master reviewed the amounts and structure of stock compensation proposed for this group
of employees in light of those principles.

     AIG proposed that these Covered Employees be granted stock salary that would be redeemable on
the first anniversary of the grant date. AIG argued that the shorter redemption period would be
appropriate in light of the anticipated wind down of AIGFP. Stock salary, however, is required by
the Rule to be fully vested at grant, so the departure of an employee as the result of reductions
in force in connection with the wind-down will not result in forfeiture of earned stock salary. In
addition, the services provided by AIGFP Covered Employees in 2010 have the potential to continue
affecting the value of AIG long after the employees’ departure.

A10

 

Thus, redemption of an AIGFP Covered Employee’s stock salary on the first anniversary of grant
would result in compensation that is not “performance-based over a relevant performance period.”
Id. § 30.16(b)(1)(iv). Accordingly, the stock salary that the Special Master has determined to be
consistent with the Public Interest Standard for AIGFP Covered Employees has the same structure, as
described in Exhibits I and II, as the stock salary provided to Covered Employees at the Company’s
corporate and operating units: it may only be redeemable in three equal, annual installments
beginning on the second anniversary of grant, with each installment redeemable one year earlier if
AIG repays its federal obligations.

     3. Departed Employees

     Three employees who would have been Covered Employees had they remained employed are no longer
employed by the Company. With respect to those employees, the Special Master has determined that
the payment of stock salaries and cash salaries at the rates in effect on January 1, 2010, through
the date of the termination of employment, and payment of up to $25,000 in perquisites and “other”
compensation are consistent with the Public Interest Standard. No other payments to these employees
of any kind would be consistent with the Public Interest Standard. Any exceptions to this
limitation will require that the Company provide to the Office of the Special Master an independent
justification for the payment that is satisfactory to the Special Master.3

V. Corporate Governance

     As noted in Part III above, the Rule requires the Special Master to consider the extent to
which compensation structures are “performance-based over a relevant performance period,” 31
C.F.R. §30.16(b)(1)(iv). In light of the importance of this principle, the Special Master
required as part of the 2009 Determinations that AIG take certain corporate governance steps to
ensure that the compensation structures for the Covered Employees, and the amounts payable or
potentially payable under those structures, are consistent with the Public Interest Standard.

     The Special Master has determined that these same corporate governance requirements,
which are detailed in Section V of the 2009 Determinations, must continue to apply in 2010. Among
other requirements, AIG must:

	 	•	 	Ensure that employees are prohibited from engaging in any derivative or similar
transaction with respect to AIG stock that would undermine the long-term performance
incentives created by the compensation structures set forth in
Exhibits I and II.
	 
	 	•	 	Maintain a compensation committee comprised exclusively of independent directors,
which must discuss, evaluate, and review with AIG’s senior risk officers any risks that
could threaten the value of AIG. Id. § 30.4; id. § 30.5.

 

			
	3	 	AIG has informed the Office of the Special
Master that one of the departed employees was stationed overseas. With respect
to that employee, the Special Master has determined that payments in connection
with his repatriation, limited to those expressly contemplated by the letter
agreement confirming his overseas assignment, are consistent with the Public
Interest Standard.

A11

 

	 	•	 	Ensure that the compensation committee discloses to Treasury an annual narrative
description of whether AIG, its board of directors, or the committee has engaged a
compensation consultant during the past three years; and, if so, the types of services
provided by the compensation consultant or any affiliate, including any “benchmarking”
or comparisons employed to identify certain percentile levels of pay. Id. § 30.11(c).
	 
	 	•	 	Provide to Treasury an annual disclosure of any perquisite whose total value for
AIG’s fiscal year exceeds $25,000 for each of the Covered Employees, as well as a
narrative description of the amount and nature of these perquisites, the recipient of
these perquisites and a justification for offering these perquisites (including a
justification for offering the perquisite, and not only for offering the perquisite
with a value that exceeds $25,000). Id. § 30.11(b).
	 
	 	•	 	Ensure that any incentive award paid to a Covered Employee is subject to a clawback
if the award was based on materially inaccurate financial statements (which includes,
but is not limited to, statements of earnings, revenues, or gains) or any other
materially inaccurate performance metric criteria. AIG must exercise its clawback
rights except to the extent that it is unreasonable to do so. Id. § 30.8.
	 
	 	•	 	AIG was required to adopt an excessive or luxury expenditures policy, provide that
policy to the Treasury, and post it on AIG’s website. If AIG’s board of directors makes
any material amendments to this policy, within ninety days of the adoption of the
amended policy, the board of directors must provide the amended
policy to Treasury and post the amended policy on its Internet website. Id. §
30.12.
	 
	 	•	 	Except as explicitly permitted under the Rule, AIG is prohibited from providing
(formally or informally) tax gross-ups to any of the Covered Employees. Id. § 30.11(d).
	 
	 	•	 	AIG’s chief executive officer and chief financial officer must provide written
certification of the Company’s compliance with the various requirements of section 111
of EESA. The precise nature of the required certification is identified in the Rule.
Id. § 30.15 Appx. B.

VI. Conclusion

     The Special Master has reviewed the Proposed Structures for the Covered Employees for 2010 in
light of the principles described in the 2009 Determinations, which in turn reflect the Public
Interest Standard. On the basis of that review, the Special Master has determined that the Proposed
Structures submitted by AIG are to some extent consistent with the 2009 Determinations but require
certain modifications in order to meet the Public Interest Standard.

     The Special Master has separately reviewed the compensation structures set forth in
Exhibits I and II in light of the principles set forth at 31
C.F.R. § 30. 16(b). Pursuant to the authority vested in the Special Master by the Rule,
and in accordance with Section 30.16(a)(3) thereof, the Special Master hereby determines that the
compensation structures set forth in Exhibits I and
II, including the
amounts payable or potentially payable under such compensation

A12

 

structures, will not result in
payments that are inconsistent with the purposes of section 111 of EESA or TARP, and will not
otherwise be contrary to the public interest.

     Pursuant to the Interim Final Rule, AIG may, within 30 days of the date hereof, request in
writing that the Special Master reconsider the determinations set forth in this Determination
Memorandum. The request for reconsideration must specify a factual error or relevant new
information not previously considered, and must demonstrate that such error or lack of information
resulted in a material error in the initial determinations. If AIG does not request reconsideration
within 30 days, the determinations set forth herein will be treated as final determinations. ld. §
30.16(c)(l).

     The foregoing determinations are limited to the compensation structures and employees
described in Exhibits I and II, and shall not be relied upon with respect to any other employee.
The determinations are limited to the authority vested in the Special Master by Section
30.16(a)(3)(i) of the Rule, and shall not constitute, or be construed to constitute, the
judgment of the Office of the Special Master or Treasury with respect to the compliance of any
compensation structure with any other provision of the Rule. Moreover, this Determination
Memorandum has relied upon, and is qualified in its entirety by, the accuracy of the materials
submitted by the Company to the Office of the Special Master, and the absence of any material
misstatement or omission in such materials.

     Finally, the foregoing determinations are limited to the compensation structures
described herein, and no further compensation of any kind payable to any Covered Employee without
the prior approval of the Special Master would be consistent with the Public Interest Standard.

A13

 

EXHIBIT I

COVERED EMPLOYEES

2010 Compensation

Company Name: American International Group, Inc.

	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 
	 	 	 	 	 	 	Stock Salary	 	Long-Term Restricted Stock	 	 
	 	 	 	 	 	 	(Performance based: The	 	(Performance based: Awarded	 	 
	 	 	 	 	 	 	stock vests at grant and is	 	based on achievement of	 	 
	 	 	 	 	 	 	redeemable in three equal,	 	objective performance goals.	 	Total Direct Compensation
	 	 	 	 	 	 	annual installments	 	Generally vests after 3 years of	 	(Cash salary + stock
	 	 	 	 	 	 	beginning on the 2nd	 	service. Transferability dependent	 	salary + long-term
	Employee ID	 	Cash Salary	 	anniversary of grant. )	 	on TARP repayment.)	 	restricted stock.)
	1
	 	$	3,000,000	 	 	$	4,000,000	 	 	$	3,500,000	 	 	$	10,500,000	 
	133
	 	$	450,000	 	 	$	4,062,500	 	 	$	1,500,000	 	 	$	6,012,500	 
	134
	 	$	700,000	 	 	$	3,050,000	 	 	$	1,250,000	 	 	$	5,000,000	 
	145
	 	$	177,799	 	 	$	3,322,201	 	 	$	0	 	 	$	3,500,000	 
	147
	 	$	241,933	 	 	$	758,067	 	 	$	0	 	 	$	1,000,000	 
	157
	 	$	125,000	 	 	$	3,468,750	 	 	$	0	 	 	$	3,593,750	 
	163
	 	$	495,000	 	 	$	4,485,000	 	 	$	1,020,000	 	 	$	6,000,000	 
	182
	 	$	450,000	 	 	$	3,062,500	 	 	$	0	 	 	$	3,512,500	 
	186
	 	$	450,000	 	 	$	1,437,500	 	 	$	625,000	 	 	$	2,512,500	 
	188
	 	$	100,000	 	 	$	3,500,000	 	 	$	0	 	 	$	3,600,000	 
	192
	 	$	700,000	 	 	$	2,000,000	 	 	$	0	 	 	$	2,700,000	 
	196
	 	$	495,000	 	 	$	3,731,250	 	 	$	1,375,000	 	 	$	5,601,250	 
	206
	 	$	700,000	 	 	$	5,000,000	 	 	$	1,900,000	 	 	$	7,600,000	 
	217
	 	$	1,500,000	 	 	$	2,520,000	 	 	$	1,980,000	 	 	$	6,000,000	 
	236
	 	$	475,000	 	 	$	2,156,250	 	 	$	875,000	 	 	$	3,506,250	 
	237
	 	$	495,000	 	 	$	3,656,250	 	 	$	850,000	 	 	$	5,001,250	 
	243
	 	$	500,000	 	 	$	1,300,000	 	 	$	0	 	 	$	1,800,000	 
	261
	 	$	475,000	 	 	$	4,568,750	 	 	$	0	 	 	$	5,043,750	 
	267
	 	$	495,000	 	 	$	5,149,000	 	 	$	1,156,000	 	 	$	6,800,000	 
	534
	 	$	312,500	 	 	$	0	 	 	$	0	 	 	$	312,500	 
	1056
	 	$	475,000	 	 	$	2,967,932	 	 	$	854,000	 	 	$	4,296,932	 
	1057
	 	$	442,874	 	 	$	2,117,126	 	 	$	640,000	 	 	$	3,200,000	 

Comparison of 2010 Compensation to Prior Year Compensation

• Overall: Overall cash decreased $22.2M or 63% and total direct compensation increased $1.9M
or 2%.

• The 4 corporate and operating unit executives remaining in the Top 25 from 2009: Cash
salaries increased $0.5M or 12% and total direct compensation increased $3.3M or 12%.

• The 12 corporate and operating executives new to the Top 25 in 2010: Overall cash
compensation decreased $23M or 77% and total direct compensation decreased $17.2M or 25% from
2009.

• The 6 Financial Products executives: Cash base salaries are frozen at fiscal year 2008
levels, with one exception who remains below $500,000; 91% of total compensation is
now delivered over 4 years and tied to company performance versus 0% in 2009.

 

Note 1: Amounts reflected in this Exhibit do not include amounts the Company has
asserted to be payable pursuant to legally binding rights under valid employment contracts, see 31
C.F.R § 30.10(e)(2).

Note 2: The terms of stock salary and any long-term restricted stock delivered to Employee 1, the
CEO, are provided in a letter agreement the Special
Master approved in a determination dated October 2, 2009. See supra
Determination Memorandum note 1. Stock salary may not be redeemed until the
fifth anniversary of the date it is earned. Long-term restricted stock generally will be
forfeited if the CEO does not serve for at least two years after the grant date, and cannot be
redeemed until AIG repays its TARP obligations.

Note 3:
The total number of Covered Employees may be less than 25 because of separations from
service since January 1, 2010.

E1

 

EXHIBIT II

TERMS AND CONDITIONS OF PAYMENTS AND STRUCTURES

CONSISTENT WITH THE PUBLIC INTEREST STANDARD

     The following general terms and conditions shall govern the compensation structures described
in Exhibit I. The Special Master’s determination that those structures are consistent with the
Public Interest Standard is qualified in its entirety by the Company’s adherence to these terms and
conditions.

	•	 	Salary payments. Cash and stock base salaries reflect the annual rate for the employee and
are effective as of January 1, 2010, and in the case of stock salary are payable on a nunc pro
tunc basis from that date. To the extent the Special Master’s determinations for 2010 reduce
an employee’s previous cash or stock salary rate, payments in excess of that rate prior to the
date hereof must be offset by reductions to prospective 2010 cash salary payments or to any
stock salary payable with respect to 2010.

	•	 	Stock compensation generally. For purposes of the Determination Memorandum, “stock”
compensation includes common stock and stock units (or, for stock salary only, the securities
referenced by the “basket” described below). Notwithstanding any transferability restrictions
applicable to any stock compensation described in the Determination Memorandum, (1) an amount
of stock sufficient to cover an employee’s tax withholding obligations may become immediately
transferable to the extent necessary to satisfy the employee’s obligations, and (2) to the
extent permitted by the Rule, stock may become immediately transferable upon an employee’s
death or separation from service resulting from disability, as defined in the Company’s
broad-based long-term disability plan.

	•	 	Stock salary. Stock salary must be determined as a dollar amount through the date salary is
earned, be accrued at the same time or times as the salary would otherwise be paid in cash,
and vest immediately upon grant, with the number of shares based on the fair market value on
the date of award. Stock granted as stock salary may only be redeemed in three equal, annual
installments as described in the Determination Memorandum. Whether a nunc pro tunc grant or
payment that is labeled stock salary is considered salary or a bonus for purposes of the Rule
is determined based on all the facts and circumstances. As described in Part IV, stock salary
may be granted in the form of stock units reflecting the value of a “basket” of AIG common
stock and other securities. The terms and conditions of these “basket” units will be
determined by AIG subject to the approval of the Office of the Special Master.

	•	 	Long-term restricted stock. Long-term restricted stock may only be granted upon the
achievement of objective performance criteria developed and reviewed in consultation with the
Office of the Special Master. The compensation committee must certify (1) the achievement of
such criteria, and (2) that the grant of incentives is appropriate in light of AIG’s overall
circumstances at the time. Such stock must be forfeited unless conditioned upon the employee’s
continued employment through the third anniversary of grant, unless a termination of
employment results from death or disability; provided, however, that all or a portion of such
stock (or similar stock granted with respect to 2009 service)
may, for good cause certified by the Company’s compensation committee, continue to vest if
the employee retires on or after the second anniversary of the grant date. The term
“retirement” must meet an objective standard established in consultation with the Office of
the Special Master.

	•	 	Other compensation and perquisites. No more than $25,000 in total other compensation and
perquisites may be provided to any Covered Employee, absent exceptional circumstances for good
cause shown, as defined by pertinent SEC regulations.

	•	 	Supplemental executive retirement plans and non-qualified deferred compensation plans. No
amounts may be accrued under supplemental executive retirement plans, and no Company
contributions may be made to other “non-qualified deferred compensation” plans, as defined by
pertinent SEC regulations, for 2010. For the avoidance of doubt, neither the foregoing
limitation nor the corresponding limitation in the 2009
Determinations (1) applies to
employee-funded elective deferral arrangements, or (2) precludes continuing recognition of age
and service credit for Company employees for the purposes of vesting in previously accrued
benefits under any plans referred to in this paragraph.

	•	 	Qualified Plans. For the avoidance of doubt, the Special Master has determined that
participation by the Covered Employees in broad-based, tax-qualified retirement and health and
welfare plans is consistent with the Public Interest Standard, and amounts payable under such
plans are not counted against the $25,000 limit on other compensation and perquisites.

E2exv4w1

Exhibit 4.1

EXHIBIT A

COMMON STOCK PURCHASE WARRANT

XENONICS HOLDINGS, INC.

	 	 	 
	Warrant Shares:          

	 	Initial Exercise Date: October ___, 2010
	 

	 	Issue Date: April ___, 2010

          THIS COMMON STOCK PURCHASE WARRANT (the “Warrant”) certifies that, for value received,
                   (the “Holder”) is entitled, upon the terms and subject to the limitations on
exercise and the conditions hereinafter set forth, at any time on or after October ___, 2010 (the
“Initial Exercise Date”) and on or prior to the close of business on the 5 year anniversary
of the Initial Exercise Date (the “Termination Date”) but not thereafter, to subscribe for
and purchase from Xenonics Holdings, Inc., a Nevada corporation (the “Company”), up to
          shares (the “Warrant Shares”) of Common Stock. The purchase price of one share of
Common Stock under this Warrant shall be equal to the Exercise Price, as defined in Section 2(b).

     Section 1. Definitions. Capitalized terms used and not otherwise defined
herein shall have the meanings set forth in that certain Securities Purchase Agreement (the
“Purchase Agreement”), dated April 1, 2010, among the Company and the purchasers signatory
thereto.

     Section 2. Exercise.

     a) Exercise of the purchase rights represented by this Warrant may be made, in whole or
in part, at any time or times on or after the Initial Exercise Date and on or before the
Termination Date by delivery to the Company (or such other office or agency of the Company
as it may designate by notice in writing to the registered Holder at the address of the
Holder appearing on the books of the Company) of a duly executed facsimile copy of the
Notice of Exercise Form annexed hereto. Within three (3) Trading Days following the date of
exercise as aforesaid, the Holder shall deliver the aggregate Exercise Price for the shares
specified in the applicable Notice of Exercise by wire transfer or cashier’s check drawn on
a United States bank unless the cashless exercise procedure specified in Section 2(c) below
is specified in the applicable Notice of Exercise. Notwithstanding anything herein to the
contrary, the Holder shall not be required to physically surrender this Warrant to the
Company until the Holder has purchased all of the Warrant Shares available hereunder and the
Warrant has been exercised in full, in which case, the Holder shall surrender this Warrant
to the Company for cancellation within three (3) Trading Days of the date the final Notice
of Exercise is delivered to the Company. Partial exercises of this Warrant resulting in
purchases of a portion of the total number of Warrant Shares available hereunder shall have
the effect of lowering the outstanding number of Warrant Shares purchasable hereunder in an
amount equal to the applicable number of Warrant Shares purchased. The Holder and the
Company shall maintain records showing the number of Warrant Shares purchased and

1

 

the date of such purchases. The Company shall deliver any objection to any Notice of Exercise
Form within 1 Business Day of receipt of such notice. The Holder and any assignee, by
acceptance of this Warrant, acknowledge and agree that, by reason of the provisions of this
paragraph, following the purchase of a portion of the Warrant Shares hereunder, the number
of Warrant Shares available for purchase hereunder at any given time may be less than the
amount stated on the face hereof.

     b) Exercise Price. The exercise price per share of the Common Stock under this
Warrant shall be $0.65, subject to adjustment hereunder (the “Exercise Price”).

     c) Cashless Exercise. If at the time of exercise hereof there is no effective
registration statement registering, or the prospectus contained therein is not available for
the issuance of the Warrant Shares to the Holder and all of the Warrant Shares are not then
registered for resale by Holder into the market at market prices from time to time on an
effective registration statement for use on a continuous basis (or the prospectus contained
therein is not available for use), then this Warrant may also be exercised, in whole or in
part, at such time by means of a “cashless exercise” in which the Holder shall be entitled
to receive a certificate for the number of Warrant Shares equal to the quotient obtained by
dividing [(A-B) (X)] by (A), where:

	 	(A)	 	= the VWAP on the Trading Day immediately preceding the date
on which Holder elects to exercise this Warrant by means of a “cashless
exercise,” as set forth in the applicable Notice of Exercise;
	 
	 	(B)	 	= the Exercise Price of this Warrant, as adjusted hereunder;
and
	 
	 	(X)	 	= the number of Warrant Shares that would be issuable upon
exercise of this Warrant in accordance with the terms of this Warrant if such
exercise were by means of a cash exercise rather than a cashless exercise.

     “VWAP” means, for any date, the price determined by the first of the following
clauses that applies: (a) if the Common Stock is then listed or quoted on a Trading Market,
the daily volume weighted average price of the Common Stock for such date (or the nearest
preceding date) on the Trading Market on which the Common Stock is then listed or quoted as
reported by Bloomberg L.P. (based on a Trading Day from 9:30 a.m. (New York City time) to
4:02 p.m. (New York City time)), (b) if the OTC Bulletin Board is not a Trading Market, the
volume weighted average price of the Common Stock for such date (or the nearest preceding
date) on the OTC Bulletin Board, (c) if the Common Stock is not then listed or quoted for
trading on the OTC Bulletin Board and if prices for the Common Stock are then reported in
the “Pink Sheets” published by Pink OTC Markets, Inc. (or a similar organization or agency
succeeding to its functions of reporting prices), the most recent bid price per share of the
Common Stock so reported, or (d) in all other cases, the fair market value of a share of
Common Stock as determined by an independent appraiser selected in good faith by the Company
and reasonably acceptable to the Holders of a majority in interest of the Securities then
outstanding and reasonably acceptable to the Company, the fees and expenses of which shall be paid by
the Company.

2

 

     Under no circumstances will the Company be required to net cash settle this Warrant
upon its exercise.

     d) Mechanics of Exercise.

     i. Delivery of Certificates Upon Exercise. Certificates for
 shares purchased hereunder shall be transmitted by the Transfer Agent to the
Holder by crediting the account of the Holder’s prime broker with the
Depository Trust Company through its Deposit Withdrawal Agent Commission
(“DWAC”) system if the Company is then a participant in such system
and either (A) there is an effective Registration Statement permitting the
issuance of the Warrant Shares to or resale of the Warrant Shares by Holder
or (B) this Warrant is being exercised via cashless exercise, and otherwise
by physical delivery to the address specified by the Holder in the Notice of
Exercise by the date that is three (3) Trading Days after the latest of (A)
the delivery to the Company of the Notice of Exercise Form, (B) surrender of
this Warrant (if required) and (C) payment of the aggregate Exercise Price
as set forth above (including by cashless exercise, if permitted) (such
date, the “Warrant Share Delivery Date”). This Warrant shall be
deemed to have been exercised on the first date on which all of the
foregoing have been delivered to the Company. The Warrant Shares shall be
deemed to have been issued, and Holder or any other person so designated to
be named therein shall be deemed to have become a holder of record of such
 shares for all purposes, as of the date the Warrant has been exercised, with
payment to the Company of the Exercise Price (or by cashless exercise, if
permitted) and all taxes required to be paid by the Holder, if any, pursuant
to Section 2(d)(vi) prior to the issuance of such shares, having been paid.

     ii. Delivery of New Warrants Upon Exercise. If this Warrant
shall have been exercised in part, the Company shall, at the request of a
Holder and upon surrender of this Warrant certificate, at the time of
delivery of the certificate or certificates representing Warrant Shares,
deliver to Holder a new Warrant evidencing the rights of Holder to purchase
the unpurchased Warrant Shares called for by this Warrant, which new Warrant
shall in all other respects be identical with this Warrant.

     iii. Rescission Rights. If the Company fails to cause the
Transfer Agent to transmit to the Holder a certificate or the certificates
representing the Warrant Shares pursuant to Section 2(d)(i) by the Warrant
Share Delivery Date, then, the Holder will have the right to rescind such
exercise.

     iv. Compensation for Buy-In on Failure to Timely Deliver
Certificates Upon Exercise. In addition to any other rights available
to the Holder, if the Company fails to cause the Transfer Agent to transmit
to the

3

 

Holder a certificate or the certificates representing the Warrant
Shares pursuant to an exercise on or before the Warrant Share Delivery Date,
and if after such date the Holder is required by its broker to purchase (in
an open market transaction or otherwise) or the Holder’s brokerage firm
otherwise purchases, shares of Common Stock to deliver in satisfaction of a
sale by the Holder of the Warrant Shares which the Holder anticipated
receiving upon such exercise (a “Buy-In”), then the Company shall
(A) pay in cash to the Holder the amount, if any, by which (x) the Holder’s
total purchase price (including brokerage commissions, if any) for the
 shares of Common Stock so purchased exceeds (y) the amount obtained by
multiplying (1) the number of Warrant Shares that the Company was required
to deliver to the Holder in connection with the exercise at issue times (2)
the price at which the sell order giving rise to such purchase obligation
was executed, and (B) at the option of the Holder, either reinstate the
portion of the Warrant and equivalent number of Warrant Shares for which
such exercise was not honored (in which case such exercise shall be deemed
rescinded) or deliver to the Holder the number of shares of Common Stock
that would have been issued had the Company timely complied with its
exercise and delivery obligations hereunder. For example, if the Holder
purchases Common Stock having a total purchase price of $11,000 to cover a
Buy-In with respect to an attempted exercise of shares of Common Stock with
an aggregate sale price giving rise to such purchase obligation of $10,000,
under clause (A) of the immediately preceding sentence the Company shall be
required to pay the Holder $1,000. The Holder shall provide the Company
written notice indicating the amounts payable to the Holder in respect of
the Buy-In and, upon request of the Company, evidence of the amount of such
loss. Nothing herein shall limit a Holder’s right to pursue any other
remedies available to it hereunder, at law or in equity including, without
limitation, a decree of specific performance and/or injunctive relief with
respect to the Company’s failure to timely deliver certificates representing
 shares of Common Stock upon exercise of the Warrant as required pursuant to
the terms hereof.

     v. No Fractional Shares or Scrip. No fractional shares or
scrip representing fractional shares shall be issued upon the exercise of
this Warrant. As to any fraction of a share which the Holder would
otherwise be entitled to purchase upon such exercise, the Company shall, at
its election, either pay a cash adjustment in respect of such final fraction
in an amount equal to such fraction multiplied by the Exercise Price or
round up to the next whole share.

     vi. Charges, Taxes and Expenses. Issuance of certificates for
Warrant Shares shall be made without charge to the Holder for any issue
or transfer tax or other incidental expense in respect of the issuance
of such certificate, all of which taxes and expenses shall be paid by the
Company, and such certificates shall be issued in the name of the Holder

4

 

or in such name or names as may be directed by the Holder; provided,
however, that in the event certificates for Warrant Shares are to be
issued in a name other than the name of the Holder, this Warrant when
surrendered for exercise shall be accompanied by the Assignment Form
attached hereto duly executed by the Holder and the Company may require, as
a condition thereto, the payment of a sum sufficient to reimburse it for any
transfer tax incidental thereto.

     vii. Closing of Books. The Company will not close its
stockholder books or records in any manner which prevents the timely
exercise of this Warrant, pursuant to the terms hereof.

     e) Holder’s Exercise Limitations. The Company shall not effect any exercise of
this Warrant, and a Holder shall not have the right to exercise any portion of this Warrant,
pursuant to Section 2 or otherwise, to the extent that after giving effect to such issuance
after exercise as set forth on the applicable Notice of Exercise, the Holder (together with
the Holder’s Affiliates, and any other Persons acting as a group together with the Holder or
any of the Holder’s Affiliates), would beneficially own in excess of the Beneficial
Ownership Limitation (as defined below). For purposes of the foregoing sentence, the number
of shares of Common Stock beneficially owned by the Holder and its Affiliates shall include
the number of shares of Common Stock issuable upon exercise of this Warrant with respect to
which such determination is being made, but shall exclude the number of shares of Common
Stock which would be issuable upon (i) exercise of the remaining, nonexercised portion of
this Warrant beneficially owned by the Holder or any of its Affiliates and (ii) exercise or
conversion of the unexercised or nonconverted portion of any other securities of the Company
(including, without limitation, any other Common Stock Equivalents) subject to a limitation
on conversion or exercise analogous to the limitation contained herein beneficially owned by
the Holder or any of its Affiliates. Except as set forth in the preceding sentence, for
purposes of this Section 2(e), beneficial ownership shall be calculated in accordance with
Section 13(d) of the Exchange Act and the rules and regulations promulgated thereunder, it
being acknowledged by the Holder that the Company is not representing to the Holder that
such calculation is in compliance with Section 13(d) of the Exchange Act and the Holder is
solely responsible for any schedules required to be filed in accordance therewith. To the
extent that the limitation contained in this Section 2(e) applies, the determination of
whether this Warrant is exercisable (in relation to other securities owned by the Holder
together with any Affiliates) and of which portion of this Warrant is exercisable shall be
in the sole discretion of the Holder, and the submission of a Notice of Exercise shall be
deemed to be the Holder’s determination of whether this Warrant is exercisable (in relation
to other securities owned by the Holder together with any Affiliates) and of which portion
of this Warrant is exercisable, in each case subject to the Beneficial Ownership Limitation,
and the Company shall have no obligation to verify or confirm the accuracy of such
determination. In addition, a determination as to any group status as contemplated above
shall be determined in accordance with Section 13(d) of the
Exchange Act and the rules and regulations promulgated thereunder. For purposes of
this Section 2(e), in determining the number of outstanding shares of Common Stock, a Holder
may rely on the number of outstanding shares of Common Stock as reflected in

5

 

(A) the Company’s most recent periodic or annual report filed with the Commission, as the case may
be, (B) a more recent public announcement by the Company or (C) a more recent written notice
by the Company or the Transfer Agent setting forth the number of shares of Common Stock
outstanding. Upon the written or oral request of a Holder, the Company shall within two
Trading Days confirm orally and in writing to the Holder the number of shares of Common
Stock then outstanding. In any case, the number of outstanding shares of Common Stock shall
be determined after giving effect to the conversion or exercise of securities of the
Company, including this Warrant, by the Holder or its Affiliates since the date as of which
such number of outstanding shares of Common Stock was reported. The “Beneficial
Ownership Limitation” shall be 4.99% of the number of shares of the Common Stock
outstanding immediately after giving effect to the issuance of shares of Common Stock
issuable upon exercise of this Warrant. The Holder, upon not less than 61 days’ prior
notice to the Company, may increase or decrease the Beneficial Ownership Limitation
provisions of this Section 2(e), provided that the Beneficial Ownership Limitation in no
event exceeds 9.99% of the number of shares of the Common Stock outstanding immediately
after giving effect to the issuance of shares of Common Stock upon exercise of this Warrant
held by the Holder and the provisions of this Section 2(e) shall continue to apply. Any
such increase or decrease will not be effective until the 61st day after such
notice is delivered to the Company. The provisions of this paragraph shall be construed and
implemented in a manner otherwise than in strict conformity with the terms of this Section
2(e) to correct this paragraph (or any portion hereof) which may be defective or
inconsistent with the intended Beneficial Ownership Limitation herein contained or to make
changes or supplements necessary or desirable to properly give effect to such limitation.
The limitations contained in this paragraph shall apply to a successor holder of this
Warrant.

     Section 3. Certain Adjustments.

     a) Stock Dividends and Splits. If the Company, at any time while this Warrant
is outstanding: (i) pays a stock dividend or otherwise makes a distribution or distributions
on shares of its Common Stock or any other equity or equity equivalent securities payable in
 shares of Common Stock (which, for avoidance of doubt, shall not include any shares of
Common Stock issued by the Company upon exercise of this Warrant), (ii) subdivides
outstanding shares of Common Stock into a larger number of shares, (iii) combines (including
by way of reverse stock split) outstanding shares of Common Stock into a smaller number of
 shares, or (iv) issues by reclassification of shares of the Common Stock any shares of
capital stock of the Company, then in each case the Exercise Price shall be multiplied by a
fraction of which the numerator shall be the number of shares of Common Stock (excluding
treasury shares, if any) outstanding immediately before such event and of which the
denominator shall be the number of shares of Common Stock outstanding immediately after such
event, and the number of shares issuable upon exercise of this Warrant shall be
proportionately adjusted such that the aggregate Exercise Price of this Warrant shall remain
unchanged. Any adjustment made pursuant to this Section 3(a) shall become effective
immediately after the record date for the determination of stockholders entitled to receive such dividend or
distribution and shall become effective immediately after the effective date in the case of
a subdivision, combination or re-classification.

6

 

     b) [RESERVED]

     c) Subsequent Rights Offerings. If the Company, at any time while the Warrant
is outstanding, shall issue rights, options or warrants to all holders of Common Stock (and
not to the Holders) entitling them to subscribe for or purchase shares of Common Stock at a
price per share less than the VWAP on the record date mentioned below, then, the Exercise
Price shall be multiplied by a fraction, of which the denominator shall be the number of
 shares of the Common Stock outstanding on the date of issuance of such rights, options or
warrants plus the number of additional shares of Common Stock offered for subscription or
purchase, and of which the numerator shall be the number of shares of the Common Stock
outstanding on the date of issuance of such rights, options or warrants plus the number of
 shares which the aggregate offering price of the total number of shares so offered (assuming
receipt by the Company in full of all consideration payable upon exercise of such rights,
options or warrants) would purchase at such VWAP. Such adjustment shall be made whenever
such rights, options or warrants are issued, and shall become effective immediately after
the record date for the determination of stockholders entitled to receive such rights,
options or warrants.

     d) Pro Rata Distributions. If the Company, at any time while this Warrant is
outstanding, shall distribute to all holders of Common Stock (and not to the Holders)
evidences of its indebtedness or assets (including cash and cash dividends) or rights or
warrants to subscribe for or purchase any security other than the Common Stock (which shall
be subject to Section 3(b)), then in each such case the Exercise Price shall be adjusted by
multiplying the Exercise Price in effect immediately prior to the record date fixed for
determination of stockholders entitled to receive such distribution by a fraction of which
the denominator shall be the VWAP determined as of the record date mentioned above, and of
which the numerator shall be such VWAP on such record date less the then per share fair
market value at such record date of the portion of such assets or evidence of indebtedness
so distributed applicable to one outstanding share of the Common Stock as determined by the
Board of Directors in good faith. In either case the adjustments shall be described in a
statement provided to the Holder of the portion of assets or evidences of indebtedness so
distributed or such subscription rights applicable to one share of Common Stock. Such
adjustment shall be made whenever any such distribution is made and shall become effective
immediately after the record date mentioned above.

     e) Fundamental Transaction. If, at any time while this Warrant is outstanding,
(i) the Company, directly or indirectly, in one or more related transactions effects any
merger or consolidation of the Company with or into another Person, (ii) the Company,
directly or indirectly, effects any sale, lease, license, assignment, transfer, conveyance
or other disposition of all or substantially all of its assets in one or a series of related
transactions, (iii) any, direct or indirect, purchase offer, tender offer or exchange offer
(whether by the Company or another Person) is completed pursuant to which holders of Common
Stock are permitted to sell, tender or exchange their shares for other
securities, cash or property and has been accepted by the holders of 50% or more of the
outstanding Common Stock, (iv) the Company, directly or indirectly, in one or more related
transactions effects any reclassification, reorganization or recapitalization of the Common
Stock or any compulsory share exchange pursuant to which the Common Stock

7

 

is effectively converted into or exchanged for other securities, cash or property, (v) the Company,
directly or indirectly, in one or more related transactions consummates a stock or share
purchase agreement or other business combination (including, without limitation, a
reorganization, recapitalization, spin-off or scheme of arrangement) with another Person
whereby such other Person acquires more than 50% of the outstanding shares of Common Stock
(not including any shares of Common Stock held by the other Person or other Persons making
or party to, or associated or affiliated with the other Persons making or party to, such
stock or share purchase agreement or other business combination) (each a “Fundamental
Transaction”), then, upon any subsequent exercise of this Warrant, the Holder shall have
the right to receive, for each Warrant Share that would have been issuable upon such
exercise immediately prior to the occurrence of such Fundamental Transaction, at the option
of the Holder (without regard to any limitation in Section 2(e) on the exercise of this
Warrant), the number of shares of Common Stock of the successor or acquiring corporation or
of the Company, if it is the surviving corporation, and any additional consideration (the
“Alternate Consideration”) receivable as a result of such Fundamental Transaction by
a holder of the number of shares of Common Stock for which this Warrant is exercisable
immediately prior to such Fundamental Transaction (without regard to any limitation in
Section 2(e) on the exercise of this Warrant). For purposes of any such exercise, the
determination of the Exercise Price shall be appropriately adjusted to apply to such
Alternate Consideration based on the amount of Alternate Consideration issuable in respect
of one share of Common Stock in such Fundamental Transaction, and the Company shall
apportion the Exercise Price among the Alternate Consideration in a reasonable manner
reflecting the relative value of any different components of the Alternate Consideration.
If holders of Common Stock are given any choice as to the securities, cash or property to be
received in a Fundamental Transaction, then the Holder shall be given the same choice as to
the Alternate Consideration it receives upon any exercise of this Warrant following such
Fundamental Transaction. Notwithstanding anything to the contrary, in the event of a
Fundamental Transaction that is (1) an all cash transaction, (2) a “Rule 13e-3 transaction”
as defined in Rule 13e-3 under the Exchange Act, or (3) a Fundamental Transaction involving
a person or entity not traded on a national securities exchange, including, but not limited
to, the Nasdaq Global Select Market, the Nasdaq Global Market, or the Nasdaq Capital Market,
the Company or any Successor Entity (as defined below) shall, at the Holder’s option,
exercisable at any time concurrently with, or within 30 days after, the consummation of the
Fundamental Transaction, purchase this Warrant from the Holder by paying to the Holder an
amount of cash equal to the Black Scholes Value of the remaining unexercised portion of this
Warrant on the date of the consummation of such Fundamental Transaction. “Black Scholes
Value” means the value of this Warrant based on the Black and Scholes Option Pricing
Model obtained from the “OV” function on Bloomberg, L.P. (“Bloomberg”) determined as
of the day of consummation of the applicable Fundamental Transaction for pricing purposes
and reflecting (A) a risk-free interest rate corresponding to the U.S. Treasury rate for a
period equal to the time between the date of the public announcement of the applicable Fundamental Transaction and the Termination Date, (B) an
expected volatility equal to the greater of 100% and the 100 day volatility obtained from
the HVT function on Bloomberg as of the Trading Day immediately following the public
announcement of the applicable Fundamental Transaction, (C) the underlying

8

 

price per share used in such calculation shall be the sum of the price per share being offered in cash, if
any, plus the value of any non-cash consideration, if any, being offered in such Fundamental
Transaction and (D) a remaining option time equal to the time between the date of the public
announcement of the applicable Fundamental Transaction and the Termination Date. The
Company shall cause any successor entity in a Fundamental Transaction in which the Company
is not the survivor (the “Successor Entity”) to assume in writing all of the
obligations of the Company under this Warrant and the other Transaction Documents in
accordance with the provisions of this Section 3(e) pursuant to written agreements in form
and substance reasonably satisfactory to the Holder and approved by the Holder (without
unreasonable delay) prior to such Fundamental Transaction and shall, at the option of the
holder of this Warrant, deliver to the Holder in exchange for this Warrant a security of the
Successor Entity evidenced by a written instrument substantially similar in form and
substance to this Warrant which is exercisable for a corresponding number of shares of
capital stock of such Successor Entity (or its parent entity) equivalent to the shares of
Common Stock acquirable and receivable upon exercise of this Warrant (without regard to any
limitations on the exercise of this Warrant) prior to such Fundamental Transaction, and with
an exercise price which applies the exercise price hereunder to such shares of capital stock
(but taking into account the relative value of the shares of Common Stock pursuant to such
Fundamental Transaction and the value of such shares of capital stock, such number of shares
of capital stock and such exercise price being for the purpose of protecting the economic
value of this Warrant immediately prior to the consummation of such Fundamental
Transaction), and which is reasonably satisfactory in form and substance to the Holder. Upon
the occurrence of any such Fundamental Transaction, the Successor Entity shall succeed to,
and be substituted for (so that from and after the date of such Fundamental Transaction, the
provisions of this Warrant and the other Transaction Documents referring to the “Company”
shall refer instead to the Successor Entity), and may exercise every right and power of the
Company and shall assume all of the obligations of the Company under this Warrant and the
other Transaction Documents with the same effect as if such Successor Entity had been named
as the Company herein.

     f) Calculations. All calculations under this Section 3 shall be made to the
nearest cent or the nearest 1/100th of a share, as the case may be. For purposes of this
Section 3, the number of shares of Common Stock deemed to be issued and outstanding as of a
given date shall be the sum of the number of shares of Common Stock (excluding treasury
 shares, if any) issued and outstanding.

     g) Notice to Holder.

     i. Adjustment to Exercise Price. Whenever the Exercise Price is
adjusted pursuant to any provision of this Section 3, the Company shall
promptly mail to the Holder a notice setting forth the Exercise Price after
such adjustment and setting forth a brief statement of the facts requiring
such adjustment. If the Company enters into a Variable Rate
Transaction, despite the prohibition thereon in the Purchase Agreement, the
Company shall be deemed to have issued Common Stock or Common Stock

9

 

Equivalents at the lowest possible conversion or exercise price at which
such securities may be converted or exercised.

     ii. Notice to Allow Exercise by Holder. If (A) the Company
shall declare a dividend (or any other distribution in whatever form) on the
Common Stock, (B) the Company shall declare a special nonrecurring cash
dividend on or a redemption of the Common Stock, (C) the Company shall
authorize the granting to all holders of the Common Stock rights or warrants
to subscribe for or purchase any shares of capital stock of any class or of
any rights, (D) the approval of any stockholders of the Company shall be
required in connection with any reclassification of the Common Stock, any
consolidation or merger to which the Company is a party, any sale or
transfer of all or substantially all of the assets of the Company, or any
compulsory share exchange whereby the Common Stock is converted into other
securities, cash or property, or (E) the Company shall authorize the
voluntary or involuntary dissolution, liquidation or winding up of the
affairs of the Company, then, in each case, the Company shall cause to be
mailed to the Holder at its last address as it shall appear upon the Warrant
Register of the Company, at least 20 calendar days prior to the applicable
record or effective date hereinafter specified, a notice stating (x) the
date on which a record is to be taken for the purpose of such dividend,
distribution, redemption, rights or warrants, or if a record is not to be
taken, the date as of which the holders of the Common Stock of record to be
entitled to such dividend, distributions, redemption, rights or warrants are
to be determined or (y) the date on which such reclassification,
consolidation, merger, sale, transfer or share exchange is expected to
become effective or close, and the date as of which it is expected that
holders of the Common Stock of record shall be entitled to exchange their
 shares of the Common Stock for securities, cash or other property
deliverable upon such reclassification, consolidation, merger, sale,
transfer or share exchange; provided that the failure to mail such notice or
any defect therein or in the mailing thereof shall not affect the validity
of the corporate action required to be specified in such notice. To the
extent that any notice provided hereunder constitutes, or contains,
material, non-public information regarding the Company or any of the
Subsidiaries, the Company shall simultaneously file such notice with the
Commission pursuant to a Current Report on Form 8-K. The Holder shall
remain entitled to exercise this Warrant during the period commencing on the
date of such notice to the effective date of the event triggering such
notice except as may otherwise be expressly set forth herein.

     Section 4. Transfer of Warrant.

     a) Transferability. This Warrant and all rights hereunder (including, without
limitation, any registration rights) are transferable, in whole or in part, upon surrender
of this Warrant at the principal office of the Company or its designated agent, together
with a written assignment of this Warrant substantially in the form attached hereto duly

10

 

executed by the Holder or its agent or attorney and funds sufficient to pay any transfer
taxes payable upon the making of such transfer. Upon such surrender and, if required, such
payment, the Company shall execute and deliver a new Warrant or Warrants in the name of the
assignee or assignees, as applicable, and in the denomination or denominations specified in
such instrument of assignment, and shall issue to the assignor a new Warrant evidencing the
portion of this Warrant not so assigned, and this Warrant shall promptly be cancelled. The
Warrant, if properly assigned in accordance herewith, may be exercised by a new holder for
the purchase of Warrant Shares without having a new Warrant issued.

     b) New Warrants. This Warrant may be divided or combined with other Warrants
upon presentation hereof at the aforesaid office of the Company, together with a written
notice specifying the names and denominations in which new Warrants are to be issued, signed
by the Holder or its agent or attorney. Subject to compliance with Section 4(a), as to any
transfer which may be involved in such division or combination, the Company shall execute
and deliver a new Warrant or Warrants in exchange for the Warrant or Warrants to be divided
or combined in accordance with such notice. All Warrants issued on transfers or exchanges
shall be dated the initial issuance date set forth on the first page of this Warrant and
shall be identical with this Warrant except as to the number of Warrant Shares issuable
pursuant thereto.

     c) Warrant Register. The Company shall register this Warrant, upon records to
be maintained by the Company for that purpose (the “Warrant Register”), in the name
of the record Holder hereof from time to time. The Company may deem and treat the
registered Holder of this Warrant as the absolute owner hereof for the purpose of any
exercise hereof or any distribution to the Holder, and for all other purposes, absent actual
notice to the contrary.

     d) Understandings or Arrangements. Such Holder is acquiring this Warrant as
principal for its own account and has no direct or indirect arrangement or understandings
with any other persons to distribute or regarding the distribution of such Warrant (this
representation and warranty not limiting such Holder’s right to sell the Warrant pursuant to
the Registration Statement or otherwise in compliance with applicable federal and state
securities laws.) Such Holder is acquiring this Warrant hereunder in the ordinary course of
its business.

     Section 5. Miscellaneous.

     a) No Rights as Stockholder Until Exercise. This Warrant does not entitle the
Holder to any voting rights, dividends or other rights as a stockholder of the Company prior
to the exercise hereof as set forth in Section 2(d)(i).

     b) Loss, Theft, Destruction or Mutilation of Warrant. The Company covenants
that upon receipt by the Company of evidence reasonably satisfactory to it of the loss,
theft, destruction or mutilation of this Warrant or any stock certificate relating to the
Warrant Shares, and in case of loss, theft or destruction, of indemnity or security
reasonably satisfactory to it (which, in the case of the Warrant, shall not include the

11

 

posting of any bond), and upon surrender and cancellation of such Warrant or stock
certificate, if mutilated, the Company will make and deliver a new Warrant or stock
certificate of like tenor and dated as of such cancellation, in lieu of such Warrant or
stock certificate.

     c) Saturdays, Sundays, Holidays, etc. If the last or appointed day for the
taking of any action or the expiration of any right required or granted herein shall not be
a Business Day, then, such action may be taken or such right may be exercised on the next
succeeding Business Day.

     d) Authorized Shares.

          The Company covenants that, during the period the Warrant is outstanding, it
will reserve from its authorized and unissued Common Stock a sufficient number of
shares to provide for the issuance of the Warrant Shares upon the exercise of any
purchase rights under this Warrant. The Company further covenants that its issuance
of this Warrant shall constitute full authority to its officers who are charged with
the duty of executing stock certificates to execute and issue the necessary
certificates for the Warrant Shares upon the exercise of the purchase rights under
this Warrant. The Company will take all such reasonable action as may be necessary
to assure that such Warrant Shares may be issued as provided herein without
violation of any applicable law or regulation, or of any requirements of the Trading
Market upon which the Common Stock may be listed. The Company covenants that all
Warrant Shares which may be issued upon the exercise of the purchase rights
represented by this Warrant will, upon exercise of the purchase rights represented
by this Warrant and payment for such Warrant Shares in accordance herewith, be duly
authorized, validly issued, fully paid and nonassessable and free from all taxes,
liens and charges created by the Company in respect of the issue thereof (other than
taxes in respect of any transfer occurring contemporaneously with such issue).

     Except and to the extent as waived or consented to by the Holder, the Company
shall not by any action, including, without limitation, amending its certificate of
incorporation or through any reorganization, transfer of assets, consolidation,
merger, dissolution, issue or sale of securities or any other voluntary action,
avoid or seek to avoid the observance or performance of any of the terms of this
Warrant, but will at all times in good faith assist in the carrying out of all such
terms and in the taking of all such actions as may be necessary or appropriate to
protect the rights of Holder as set forth in this Warrant against impairment.
Without limiting the generality of the foregoing, the Company will (i) not increase
the par value of any Warrant Shares above the amount payable therefor upon such
exercise immediately prior to such increase in par value, (ii) take all such action
as may be necessary or appropriate in order that the Company may validly and legally
issue fully paid and nonassessable Warrant Shares upon the exercise of this Warrant
and (iii) use commercially reasonable efforts to obtain all such authorizations,
exemptions or consents from any public regulatory body

12

 

having jurisdiction thereof, as may be, necessary to enable the Company to
perform its obligations under this Warrant.

     Before taking any action which would result in an adjustment in the number of
Warrant Shares for which this Warrant is exercisable or in the Exercise Price, the
Company shall obtain all such authorizations or exemptions thereof, or consents
thereto, as may be necessary from any public regulatory body or bodies having
jurisdiction thereof.

     e) Jurisdiction. All questions concerning the construction, validity,
enforcement and interpretation of this Warrant shall be determined in accordance with the
provisions of the Purchase Agreement.

     f) Restrictions. The Holder acknowledges that the Warrant Shares acquired upon
the exercise of this Warrant, if not registered, and the Holder does not utilize cashless
exercise, will have restrictions upon resale imposed by state and federal securities laws.

     g) Nonwaiver and Expenses. No course of dealing or any delay or failure to
exercise any right hereunder on the part of Holder shall operate as a waiver of such right
or otherwise prejudice Holder’s rights, powers or remedies. Without limiting any other
provision of this Warrant or the Purchase Agreement, if the Company willfully and knowingly
fails to comply with any provision of this Warrant, which results in any material damages to
the Holder, the Company shall pay to Holder such amounts as shall be sufficient to cover any
costs and expenses including, but not limited to, reasonable attorneys’ fees, including
those of appellate proceedings, incurred by Holder in collecting any amounts due pursuant
hereto or in otherwise enforcing any of its rights, powers or remedies hereunder.

     h) Notices. Any notice, request or other document required or permitted to be
given or delivered to the Holder by the Company shall be delivered in accordance with the
notice provisions of the Purchase Agreement.

     i) Limitation of Liability. No provision hereof, in the absence of any
affirmative action by Holder to exercise this Warrant to purchase Warrant Shares, and no
enumeration herein of the rights or privileges of Holder, shall give rise to any liability
of Holder for the purchase price of any Common Stock or as a stockholder of the Company,
whether such liability is asserted by the Company or by creditors of the Company.

     j) Remedies. The Holder, in addition to being entitled to exercise all rights
granted by law, including recovery of damages, will be entitled to specific performance of
its rights under this Warrant. The Company agrees that monetary damages would not be
adequate compensation for any loss incurred by reason of a breach by it of the provisions of
this Warrant and hereby agrees to waive and not to assert the defense in any action for
specific performance that a remedy at law would be adequate.

     k) Successors and Assigns. Subject to applicable securities laws, this Warrant
and the rights and obligations evidenced hereby shall inure to the benefit of and

13

 

be binding upon the successors and permitted assigns of the Company and the successors
and permitted assigns of Holder. The provisions of this Warrant are intended to be for the
benefit of any Holder from time to time of this Warrant and shall be enforceable by the
Holder or holder of Warrant Shares.

     l) Amendment. This Warrant may be modified or amended or the provisions hereof
waived with the written consent of the Company and the Holder.

     m) Severability. Wherever possible, each provision of this Warrant shall be
interpreted in such manner as to be effective and valid under applicable law, but if any
provision of this Warrant shall be prohibited by or invalid under applicable law, such
provision shall be ineffective to the extent of such prohibition or invalidity, without
invalidating the remainder of such provisions or the remaining provisions of this Warrant.

     n) Headings. The headings used in this Warrant are for the convenience of
reference only and shall not, for any purpose, be deemed a part of this Warrant.

********************

(Signature Pages Follow)

14

 

          IN WITNESS WHEREOF, the Company has caused this Warrant to be executed by its officer
thereunto duly authorized as of the date first above indicated.

	 	 	 	 	 
	 	XENONICS HOLDINGS, INC.

 	 
	 	By:  	 	 
	 	 	Name:  	 	 
	 	 	Title:  	 	 

15

 

	 	 	 	 	 

NOTICE OF EXERCISE

TO: XENONICS HOLDINGS, INC.

          (1) The undersigned hereby elects to purchase                      Warrant Shares of the Company pursuant
to the terms of the attached Warrant (only if exercised in full), and tenders herewith payment of
the exercise price in full, together with all applicable transfer taxes, if any.

          (2) Payment shall take the form of (check applicable box):

[ ] in lawful money of the United States; or

[ ] [if permitted] the cancellation of such number of Warrant Shares as is
necessary, in accordance with the formula set forth in subsection 2(c), to
exercise this Warrant with respect to the maximum number of Warrant Shares
purchasable pursuant to the cashless exercise procedure set forth in subsection
2(c).

          (3) Please issue a certificate or certificates representing said Warrant Shares in the name of
the undersigned or in such other name as is specified below:

                                                                  
    

The Warrant Shares shall be delivered to the following DWAC Account Number or by physical delivery
of a certificate to:

                                                                   
   

                                                                   
   

                                                                  
    

[SIGNATURE OF HOLDER]

	 	 	 	 	 	 	 	 	 
	Name of Investing Entity:

	 
	Signature of Authorized Signatory of Investing Entity:

	 
	Name of Authorized Signatory:

	 
	Title of Authorized Signatory:

	 
	Date:

 

 

ASSIGNMENT FORM

(To assign the foregoing warrant, execute

this form and supply required information.

Do not use this form to exercise the warrant.)

     FOR VALUE RECEIVED, [                    ] all of or [                    ] shares of the foregoing Warrant and all rights
evidenced thereby are hereby assigned to

                                                                   
                                  whose address is

 

.

 

Dated:                     ,    
                 

	 	 	 	 	 	 	 
	 

	 	Holder’s Signature:	 	 	 	 
	 

	 	 	 	 

	 	 
	 

	 	Holder’s Address:	 	 	 	 
	 

	 	 	 	 

	 	 
	 
	 	 	 	 	 	 
	 

	 	 	 	 

	 	 

Signature Guaranteed:
 

NOTE: The signature to this Assignment Form must correspond with the name as it appears on the
face of the Warrant, without alteration or enlargement or any change whatsoever, and must be
guaranteed by a bank or trust company. Officers of corporations and those acting in a fiduciary or
other representative capacity should file proper evidence of authority to assign the foregoing
Warrant.

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