0000950134-08-005823.txt : 20130114
0000950134-08-005823.hdr.sgml : 20130114
20080401172500
ACCESSION NUMBER: 0000950134-08-005823
CONFORMED SUBMISSION TYPE: 485APOS
PUBLIC DOCUMENT COUNT: 8
FILED AS OF DATE: 20080401
DATE AS OF CHANGE: 20080401
FILER:
COMPANY DATA:
COMPANY CONFORMED NAME: LAUDUS TRUST
CENTRAL INDEX KEY: 0000832545
IRS NUMBER: 680163788
STATE OF INCORPORATION: MA
FISCAL YEAR END: 0331
FILING VALUES:
FORM TYPE: 485APOS
SEC ACT: 1940 Act
SEC FILE NUMBER: 811-05547
FILM NUMBER: 08730447
BUSINESS ADDRESS:
STREET 1: 211 MAIN STREET
CITY: SAN FRANCISCO
STATE: CA
ZIP: 94105
BUSINESS PHONE: 1-800-648-5300
MAIL ADDRESS:
STREET 1: 211 MAIN STREET
CITY: SAN FRANCISCO
STATE: CA
ZIP: 94105
FORMER COMPANY:
FORMER CONFORMED NAME: BARR ROSENBERG SERIES TRUST
DATE OF NAME CHANGE: 19961003
FORMER COMPANY:
FORMER CONFORMED NAME: ROSENBERG SERIES TRUST
DATE OF NAME CHANGE: 19920703
FORMER COMPANY:
FORMER CONFORMED NAME: ROSENBERG SMALL CAPITALIZATION FUND
DATE OF NAME CHANGE: 19881030
FILER:
COMPANY DATA:
COMPANY CONFORMED NAME: LAUDUS TRUST
CENTRAL INDEX KEY: 0000832545
IRS NUMBER: 680163788
STATE OF INCORPORATION: MA
FISCAL YEAR END: 0331
FILING VALUES:
FORM TYPE: 485APOS
SEC ACT: 1933 Act
SEC FILE NUMBER: 033-21677
FILM NUMBER: 08730448
BUSINESS ADDRESS:
STREET 1: 211 MAIN STREET
CITY: SAN FRANCISCO
STATE: CA
ZIP: 94105
BUSINESS PHONE: 1-800-648-5300
MAIL ADDRESS:
STREET 1: 211 MAIN STREET
CITY: SAN FRANCISCO
STATE: CA
ZIP: 94105
FORMER COMPANY:
FORMER CONFORMED NAME: BARR ROSENBERG SERIES TRUST
DATE OF NAME CHANGE: 19961003
FORMER COMPANY:
FORMER CONFORMED NAME: ROSENBERG SERIES TRUST
DATE OF NAME CHANGE: 19920703
FORMER COMPANY:
FORMER CONFORMED NAME: ROSENBERG SMALL CAPITALIZATION FUND
DATE OF NAME CHANGE: 19881030
0000832545
S000022479
Laudus Mondrian International Equity Fund
C000065023
Institutional Shares
C000065024
Select Shares
C000065025
Investor Shares
S000022480
Laudus Mondrian Global Equity Fund
C000065026
Institutional Shares
C000065027
Select Shares
C000065028
Investor Shares
485APOS
1
f39030e485apos.txt
POST-EFFECTIVE AMENDMENT TO FORM N-1A
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON APRIL 1, 2008
REGISTRATION NOS. 33-21677;
811-5547
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM N-1A
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
PRE-EFFECTIVE AMENDMENT NO. [ ]
POST-EFFECTIVE AMENDMENT NO. 63 [x]
REGISTRATION STATEMENT UNDER
THE INVESTMENT COMPANY ACT OF 1940
AMENDMENT NO. 66 [x]
LAUDUS TRUST
(Exact Name of Registrant as Specified in Charter)
P. O. BOX 8032
BOSTON, MA 02266
(Address of Principal Executive Offices) (Zip code)
800.648.5300
(Registrant's Telephone Number, including Area Code)
NAME AND ADDRESS OF AGENT FOR SERVICE: COPIES TO:
-------------------------------------- ----------
KOJI E. FELTON TIMOTHY W. LEVIN, ESQ. JOHN LODER, Esq.
Charles Schwab Investment Management, Inc. Morgan, Lewis & Bockius LLP Ropes & Gray
101 Montgomery Street 1701 Market Street One International Place
San Francisco, CA 94104 Philadelphia, PA 19103 Boston, MA 02110-2624
Approximate Date of Proposed Public Offering: Continuous.
It is proposed that this filing will become effective (check appropriate box):
[ ] Immediately upon filing pursuant to paragraph (b)
[ ] On (date) pursuant to paragraph (b)
[ ] 60 days after filing pursuant to paragraph (a)(1)
[x] On June 15, 2008 pursuant to paragraph (a)(1)
[ ] 75 days after filing pursuant to paragraph (a)(2)
[ ] On (date) pursuant to paragraph (a)(2) of Rule 485
================================================================================
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY
NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER
TO SELL THESE SECURITIES AND IS NOT SOLICITING AN OFFER TO BUY THESE SECURITIES
IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
PROSPECTUS
2008
(LAUDUS FUNDS LOGO)
COMMAND PERFORMANCE(TM)
LAUDUS MONDRIAN INTERNATIONAL EQUITY FUND
LAUDUS MONDRIAN GLOBAL EQUITY FUND
ADVISER
Charles Schwab Investment Management, Inc.
SUBADVISER
Mondrian Investment Partners Limited
The Securities and Exchange Commission has not approved or disapproved of the
shares described in this prospectus or determined whether this prospectus is
accurate or complete. Any representation to the contrary is a crime. Please see
the inside front cover of this prospectus for important privacy policy
information.
SHAREHOLDER SERVICES
1.866.452.8387 Institutional Shares
1.866.452.8387 Registered Investment Professionals
1.800.447.3332 Investor and Select Shares
WWW.LAUDUS.COM
THIS IS NOT PART OF THE PROSPECTUS
LAUDUS FUNDS PRIVACY POLICY--A COMMITMENT TO YOUR PRIVACY
At the Laudus Funds ("Laudus") our most important asset is our relationship with
you. We are honored that you have entrusted us with your financial affairs, and
we are committed to safeguarding the privacy of information we maintain about
you. Establishing and adhering to an effective privacy policy is an important
part of that dedication.
Below, you will find details about Laudus' commitment to protecting your
privacy, including the types of information we collect about you, and how we use
and share that information.
Our privacy policy applies only to those individual shareholders who have a
direct customer relationship with us. Shareholders purchasing or owning shares
of the Laudus Funds through their bank, broker or other financial institution
should consult that financial institution's privacy policies, as that financial
institution's policies apply to you and ours will not.
YOUR PRIVACY IS NOT FOR SALE
Simply put, we do not and will not sell your personal information to anyone, for
any reason, at any time.
HOW WE COLLECT INFORMATION ABOUT YOU
We collect personal information about you in a number of ways.
- APPLICATION AND REGISTRATION INFORMATION.
We collect information from you when you open an account. We may also collect
information from consumer reporting agencies in the account-opening process. The
information we collect may include your name, address, phone number, e-mail
address, Social Security number, employment information and date of birth.
- ACCOUNT HISTORY.
Once you have opened an account with us, we collect and maintain personal
information about your account activity, including your transactions. This
information allows us to administer your account.
- THIRD-PARTY INFORMATION PROVIDERS.
We may collect information about you from information services and consumer
reporting agencies to verify your identity.
WEBSITE USAGE
When you visit our Website, our computer may use devices known as "cookies,"
graphic interchange format files (GIFs), or other similar Web tools to enhance
your Web experience. These tools enable us to recognize you when you return to
our site, to maintain your Web session while you browse, as well as help us
provide you with a better, more personalized experience at Laudus.
HOW WE SHARE INFORMATION ABOUT YOU
We provide access to information about you to our affiliated companies, outside
companies and other third parties in certain limited circumstances, including:
- to help us process transactions for your account;
- when we use another company to provide services for us, such as printing and
mailing your account statements;
- when we believe that disclosure is required or permitted under law. For
example, we may be required to disclose personal information to cooperate with
regulatory or law enforcement authorities to resolve consumer disputes, to
perform credit/authentication checks, or for risk control.
STATE LAWS
We will comply with state laws that apply to the disclosure or use of
information about you.
SAFEGUARDING YOUR INFORMATION, MAINTAINING YOUR TRUST
We take precautions to ensure the information we collect about you is protected
and is accessed only by authorized individuals or organizations.
Companies we use to provide support services are contractually obligated to
maintain strict confidentiality and are not permitted to transfer such
information to a third party except as required by law or as permitted by law to
enable them to perform the specific services we have requested.
We restrict access to personal information by our employees and agents. Our
employees are trained about privacy and are required to safeguard personal
information.
We maintain physical, electronic and procedural safeguards to protect personal
information.
TEAMING UP AGAINST IDENTITY THEFT
Identity theft is a serious concern to all of us. Safeguarding information to
help protect you from identity theft is our priority. Laudus takes steps to
protect you from identity theft by:
- utilizing client identification and authentication procedures before
initiating transactions;
- ensuring our employees are trained to safeguard personal information about
you.
You can also help protect your identity and accounts. Here are a few steps to
remember:
- Laudus will never request your account number, login password, or Social
Security number in either a non-secure or unsolicited e-mail communication;
- shred documents that contain personal information;
- check your credit report regularly for unauthorized activity and protect your
personal identification numbers (PINs) or personal data.
GREATER ACCURACY MEANS BETTER PROTECTION
We are committed to keeping accurate, up-to-date records to help ensure the
integrity of the information we maintain about you. If you identify an
inaccuracy in this information, or you need to make a change to it, please
contact us promptly by calling 1.800.447.3332.
A COMMITMENT TO KEEPING YOU INFORMED
We will provide you with advance notice of important changes to our
information-sharing practices.
CONTACT US WITH QUESTIONS
If you have any questions or concerns, please contact us by email at
clientcommunications@laudusfunds.com or call 1.800.447.3332.
This Privacy Policy is issued by Laudus Trust, on behalf of Laudus Mondrian
International Equity Fund and Laudus Mondrian Global Equity Fund.
TABLE OF CONTENTS
PAGE
INVESTMENT OBJECTIVES, PRINCIPAL INVESTMENT STRATEGIES AND
SUMMARY OF PRINCIPAL RISKS.................................. 2
LAUDUS MONDRIAN INTERNATIONAL EQUITY FUND................... 3
FEES AND EXPENSES......................................... 7
LAUDUS MONDRIAN GLOBAL EQUITY FUND.......................... 8
FEES AND EXPENSES......................................... 12
PERFORMANCE INFORMATION FOR THE SUBADVISER'S OTHER
ACCOUNTS.................................................... 13
MANAGEMENT OF THE FUNDS..................................... 16
MULTIPLE CLASSES............................................ 17
PURCHASING SHARES........................................... 18
INDIVIDUAL RETIREMENT ACCOUNTS.............................. 20
REDEEMING SHARES............................................ 20
EXCHANGING AND CONVERTING SHARES............................ 22
HOW THE TRUST PRICES SHARES OF THE FUNDS.................... 23
DISTRIBUTIONS............................................... 23
TAXES....................................................... 23
DISCLOSURE OF PORTFOLIO SECURITIES INFORMATION.............. 24
1
INVESTMENT OBJECTIVES, PRINCIPAL INVESTMENT STRATEGIES
AND SUMMARY OF PRINCIPAL RISKS
The following is a description of the investment objectives and principal
investment strategies of the:
- Laudus Mondrian International Equity Fund
- Laudus Mondrian Global Equity Fund
(each, a "Fund" and, collectively, the "Funds"). Each of the Funds is a series
of Laudus Trust (the "Trust"), an open-end management investment company
offering multiple portfolios with different investment objectives and
strategies. Except as explicitly described otherwise, the investment objective
and policies of each of the Funds may be changed without shareholder approval.
The Funds are advised by Charles Schwab Investment Management, Inc. ("CSIM" or
the "Adviser"). Mondrian Investment Partners Limited ("Mondrian" or the
"Subadviser") acts as subadviser to the Funds.
This section also contains the principal risks of each Fund. Please be sure to
read this additional information BEFORE you invest.
2
LAUDUS MONDRIAN INTERNATIONAL EQUITY FUND
TICKER SYMBOL:
INVESTMENT OBJECTIVE
The Fund seeks long-term capital appreciation.
PRINCIPAL INVESTMENT STRATEGIES
The Fund pursues its investment objective primarily by investing in equity
securities of non-U.S. large capitalization issuers, including the securities of
emerging market companies, that, in the Subadviser's opinion, are undervalued at
the time of purchase based on fundamental value analysis employed by the
Subadviser. Equity securities in which the Fund may invest include, but are not
limited to, common stocks, preferred stocks, convertible securities, index
related securities, certain non-traditional equity securities and warrants. The
Fund may purchase securities of non-U.S. issuers directly or indirectly in the
form of American, European or Global depository receipts or other securities
representing underlying shares of non-U.S. issuers. The Fund may also purchase
other investment funds, including, but not limited to registered funds including
exchange-traded funds (ETFs), unregistered funds and real estate investment
trusts (REIT's).
For purposes of investments to be made by the Fund, large capitalization
companies will be defined to mean issuers that have a market capitalization of
more than $11 billion at the time of purchase. This level is subject to market
movements and is regularly reviewed by the Subadviser. The Fund is considered
"non-diversified", which means that it may invest in the securities of
relatively few issuers. The Fund will hold approximately 30-40 securities at any
given time.
Under normal circumstances, the Fund will invest at least 80% of its net assets
(including, for this purpose, any borrowings for investment purposes) in equity
securities. The Fund will notify its shareholders at least 60 days before
changing this policy. While the Fund will not concentrate more than 25% of its
assets in any single industry, the Fund may in aggregate have a greater than 25%
allocation in the "financial services" sector, which comprises several
industries.
The Subadviser's approach in selecting investments for the Fund is primarily
oriented to individual stock selection and is value driven. In selecting stocks
for the Fund, the Subadviser identifies those stocks that it believes will
provide capital appreciation over a market cycle, taking into consideration
movements in the price of the individual security and the impact of currency
fluctuation on a United States domiciled, dollar-based investor. The Subadviser
conducts fundamental research on a global basis in order to identify securities
that, in the Subadviser's opinion, have the potential for long-term capital
appreciation. This research effort generally centers on a value-oriented
dividend discount methodology with respect to individual securities and market
analysis that isolates value across country boundaries. The approach focuses on
future anticipated dividends and discounts the value of those dividends back to
what they would be worth if they were being received today. In addition, the
analysis typically includes a comparison of the values and current market prices
of different possible investments. The Subadviser's general management strategy
emphasizes long-term holding of securities, although securities may be sold in
the Subadviser's discretion without regard to the length of time they have been
held.
Investments will be made mainly in marketable securities of companies located in
developed countries including but not limited to Australia, Belgium, Canada,
Denmark, Finland, France, Germany, Hong Kong, Ireland, Italy, Japan, the
Netherlands, New Zealand, Norway, Singapore, Spain, Sweden, Switzerland and the
United Kingdom.
The Fund considers an "emerging country" to be any country except the United
States, Canada, and those in the Morgan Stanley Capital International EAFE
Index.
In considering possible emerging countries in which the Fund may invest, the
Subadviser places particular emphasis on certain factors, such as economic
conditions (including growth trends, inflation rates and trade balances),
regulatory and currency controls, accounting standards and political and social
conditions.
Currency considerations carry a special risk for a portfolio of international
securities. The Fund may invest in securities issued in any currency and may
hold foreign currency. Securities of issuers within a given country may be
denominated in the currency of another country or in multinational currency
units, including the Euro. The Subadviser primarily uses a purchasing power
parity approach to evaluate currency risk. In this regard, the Fund may carry
out hedging activities and may invest in forward foreign currency contracts to
hedge currency risks associated with the purchase of individual securities
denominated in a particular currency. Under normal circumstances, hedging is
undertaken defensively back into the base currency of the Fund.
The Fund may also invest in debt securities issued by governments or by their
agencies, instrumentalities or political subdivisions, or by corporate entities,
all of which may be high-yield, high-risk fixed income securities rated lower
than BBB by S&P and Baa by Moody's or, if unrated, considered to be of
equivalent quality. In addition, for temporary defensive purposes, the Fund may
invest in high-quality debt instruments.
3
The Fund may buy and sell portfolio securities actively. As a result, the Fund's
portfolio turnover rate and transaction costs will rise, which may lower Fund
performance and increase the likelihood of capital gain distributions. The
turnover rate may also be affected by cash requirements from redemptions of the
Fund's shares.
For temporary defensive purposes, during unusual economic or market conditions
or for liquidity purposes, the Fund may invest up to 100% of its assets in cash,
money market instruments, repurchase agreements and other short-term
obligations. When the Fund engages in such activities, it may not achieve its
investment objective.
PRINCIPAL RISKS
Market Risk. Stock and bond markets and the values of the securities owned by
the Fund rise and fall daily. As with any investment whose performance is tied
to these markets, the value of your investment in the Fund will fluctuate, which
means that you could lose money.
Equity Risk. The prices of equity securities rise and fall daily. These price
movements may result from factors affecting individual companies, industries or
the securities market as a whole. Individual companies may report poor results
or be negatively affected by industry and/or economic trends and developments.
The prices of securities issued by such companies may suffer a decline in
response. In addition, the equity market tends to move in cycles which may cause
stock prices to fall over short or extended periods of time.
Large-Cap Risk. Many of the risks of this Fund are associated with its
investments in the large-cap segments of the stock market. Large-cap stocks tend
to go in and out of favor based on market and economic conditions. During a
period when large-cap stocks fall behind other types of investments--bonds or
small-cap stocks for instance--the Fund's performance also will lag those
investments.
Sector Risk. The Fund is also subject to the risk that the securities of issuers
in the financial services sector that the Fund purchases will underperform other
market sectors or the market as a whole. To the extent that the Fund's
investments are focused in issuers conducting business in the same sector, the
Fund is subject to risk associated with legislative or regulatory changes,
adverse market conditions and/or increased competition affecting that sector.
Management Risk. As with all actively managed funds, the strategy of the Fund's
managers--its Adviser and Subadviser--may not achieve their desired results. For
example, with value stocks, the market might fail to recognize the true worth of
an undervalued company, or a manager might misjudge that worth. With growth
stocks, whose prices depend largely on expectations of companies' future growth,
a manager's expectations may prove to be unfounded.
Debt Securities Risk. Bond prices generally fall when interest rates rise. Bonds
with longer maturities tend to be more sensitive to this risk. Fund performance
also could be affected if an issuer or guarantor of a bond held by the fund
fails to make timely principal or interest payments or otherwise honor its
obligations. Lower-quality bonds are considered speculative with respect to its
issuer's ability to make timely payments or otherwise honor its obligations. In
addition, prices of lower-quality bonds tend to be more volatile than those of
investment-grade bonds, and may fall based on bad news about the issuer, an
industry or the overall economy. Mortgage- or asset-backed securities are
subject to the risk that these bonds may be paid off earlier or later than
expected. Either situation could cause the fund to hold securities paying lower
than market rates of interest, which could hurt the fund's yield or share price.
Also, bonds of foreign issuers may be more volatile than those of comparable
bonds from U.S. issuers, for reasons ranging from limited issuer information to
the risk of political upheaval. The fund's use of mortgage dollar rolls could
cause the fund to lose money if the price of the mortgage-backed securities sold
fall below the agreed upon repurchase price, or if the counterparty is unable to
honor the agreement.
Interest Rate Risk. The Fund is subject to the risk that interest rates rise and
fall over time. As with any investment whose yield reflects current interest
rates, the Fund's yield will change over time. During periods when interest
rates are low, the Fund's yield (and total return) also may be low. When
interest rates rise, bond prices usually fall which could cause the Fund's share
price to fall. The longer the Fund's dollar-weighted average maturity, the more
sensitive to interest rate movements its share price is likely to be.
Credit Risk. The Fund is subject to the risk that a decline in the credit
quality of a portfolio investment could cause the Fund's share price to fall.
The Fund could lose money if the issuer or guarantor of a portfolio investment
or the counterparty to a derivatives contract fails to make timely principal or
interest payments or otherwise honor its obligations. Securities rated below
investment-grade (junk bonds) involve greater risks of default or downgrade and
are more volatile than investment-grade securities. Below investment-grade
securities involve greater risk of price declines than investment-grade
securities due to actual or perceived changes in an issuer's creditworthiness.
In addition, issuers of below investment-grade securities may be more
susceptible than other issuers to economic downturns. Such securities are
subject to the risk that the issuer may not be able to pay interest or
4
dividends and ultimately to repay principal upon maturity. Discontinuation of
these payments could substantially adversely affect the market value of the
securities.
Prepayment and Extension Risk. The Fund's investments are subject to the risk
that the securities may be paid off earlier or later than expected. Either
situation could cause the Fund to hold securities paying lower-than-market rates
of interest, which could hurt the Fund's yield or share price. In addition,
rising interest rates tend to extend the duration of certain fixed income
securities, making them more sensitive to changes in interest rates. As a
result, in a period of rising interest rates, the Fund may exhibit additional
volatility. This is known as extension risk. When interest rates decline,
borrowers may pay off their fixed income securities sooner than expected. This
can reduce the returns of the Fund because the Fund will have to reinvest that
money at the lower prevailing interest rates. This is known as prepayment risk.
Foreign Investment Risk. Investments in securities of foreign issuers involve
certain risks that are more significant than those associated with investments
in securities of U.S. issuers. These include risks of adverse changes in foreign
economic, political, regulatory and other conditions, or changes in currency
exchange rates or exchange control regulations (including limitations on
currency movements and exchanges). In certain countries, legal remedies
available to investors may be more limited than those available with respect to
investments in the United States. The securities of some foreign companies may
be less liquid and at times more volatile than securities of comparable U.S.
companies. A fund with foreign investments may also experience more rapid or
extreme changes in value than a fund that invests solely in securities of U.S.
companies because the securities markets of many foreign countries are
relatively small, with a limited number of companies representing a small number
of industries. There also is the risk that the cost of buying, selling, and
holding foreign securities, including brokerage, tax, and custody costs, may be
higher than those involved in domestic transactions.
Foreign government securities can involve a high degree of risk. The
governmental entity that controls the repayment of sovereign debt may not be
able or willing to repay the principal and/or interest when due in accordance
with the terms of the debt. A governmental entity's willingness or ability to
repay principal and interest due in a timely manner may be affected by, among
other factors, its cash flow situation, the extent of its foreign reserves, the
availability of sufficient foreign exchange on the date a payment is due, the
relative size of the debt service burden to the economy as a whole, the
governmental entity's policy toward the International Monetary Fund, and the
political constraints to which a governmental entity may be subject.
Governmental entities also may depend on expected disbursements from foreign
governments, multilateral agencies and others to reduce principal and interest
arrearages on their debt.
Emerging Markets Risk. Emerging markets may be more likely to experience
political turmoil or rapid changes in market or economic conditions than more
developed countries. Emerging market countries often have less uniformity in
accounting and reporting requirements, unreliable securities valuation and
greater risk associated with the custody of securities. It is sometimes
difficult to obtain and enforce court judgments in such countries and there is
often a greater potential for nationalization and/or expropriation of assets by
the government of an emerging market country. In addition, the financial
stability of issuers (including governments) in emerging market countries may be
more precarious than in other countries. As a result, there will tend to be an
increased risk of price volatility associated with the Fund's investments in
emerging market countries, which may be magnified by currency fluctuations
relative to the U.S. dollar.
Currency Risk. As a result of its investments in securities denominated in,
and/or receiving revenues in, foreign currencies, the Fund will be subject to
currency risk. This is the risk that those currencies will decline in value
relative to the U.S. Dollar, or, in the case of hedging positions, that the U.S.
Dollar will decline in value relative to the currency hedged. In either event,
the dollar value of an investment in the Fund would be adversely affected.
Currency exchange rates may fluctuate in response to factors extrinsic to that
country's economy, which makes the forecasting of currency market movements
extremely difficult. Currency rates in foreign countries may fluctuate
significantly over short periods of time for a number of reasons, including
changes in interest rates, intervention (or failure to intervene) by U.S. or
foreign governments, central banks or supranational entities such as the
International Monetary Fund, or by the imposition of currency controls or other
political developments in the United States or abroad. These can result in
losses to the Fund if it is unable to deliver or receive currency or funds in
settlement of obligations and could also cause hedges it has entered into to be
rendered useless, resulting in full currency exposure as well as incurring
transaction costs.
Forward contracts on foreign currencies are not traded on exchanges; rather, a
bank or dealer will act as agent or as principal in order to make or take future
delivery of a specified lot of a particular currency for the Fund's account. The
Fund is subject to the risk of a principal's failure, inability or refusal to
perform with respect to such contracts.
Convertible Securities Risk. A convertible security is a bond, debenture, note,
preferred stock or other security that may be converted into or exercised for a
prescribed amount of common stock at a specified time and price. Convertible
securities provide an opportunity for equity participation, with the potential
for a higher dividend or interest yield and lower price volatility compared to
common stock. The value of a convertible security is influenced by changes in
interest rates, with investment value declining as interest rates increase and
increasing as interest rates decline, and the credit standing of the issuer. The
price of a convertible
5
security will also normally vary in some proportion to changes in the price of
the underlying common stock because of the conversion or exercise feature.
Derivatives Risk. The Fund may use derivatives to enhance returns or hedge
against market declines. Examples of derivatives are options, futures, options
on futures, swaps and warrants. An option is the right to buy or sell an
instrument at a specific price before a specific date. A future is an agreement
to buy or sell a financial instrument at a specific price on a specific day. A
swap is an agreement whereby two parties agree to exchange payment streams
calculated in relation to a rate, index, instrument or certain securities and a
predetermined amount. A credit default swap is an agreement in which the seller
agrees to make a payment to the buyer in the event of a specified credit event
in exchange for a fixed payment or series of fixed payments. A warrant is a
security that gives the holder the right, but not the obligation, to subscribe
for newly created equity issues of the issuing company or a related company at a
fixed price either on a certain date or during a set period. Changes in the
value of a warrant do not necessarily correspond to changes in the value of its
underlying security. The price of a warrant may be more volatile than the price
of its underlying security, and a warrant may offer greater potential for
capital appreciation as well as capital loss. Warrants do not entitle a holder
to dividends or voting rights with respect to the underlying security and do not
represent any rights in the assets of the issuing company.
The Fund's use of derivative instruments involves risks different from or
possibly greater than, the risks associated with investing directly in
securities and other traditional investments. Certain of these risks, such as
credit risk, leverage risk, market risk and management risk, are discussed
elsewhere in this section. The Fund's use of derivatives is also subject to
liquidity risk, lack of availability risk, valuation risk, correlation risk and
tax risk. Liquidity risk is the risk that the Fund may not be able to purchase
or liquidate a particular derivative at an advantageous time or place. Lack of
availability risk is the risk that suitable derivative transactions may not be
available in all circumstances for risk management or other purposes. Valuation
risk is the risk that a particular derivative may be valued incorrectly.
Correlation risk is the risk that changes in the value of the derivative may not
correlate perfectly with the underlying asset, rate or index. Tax risk is the
risk that the use of derivatives may cause the Fund to realize higher amounts of
short-term capital gain. These risks could cause the Fund to lose more than the
principal amount invested.
Investments In Exchange-Traded Funds. The Fund may purchase shares of ETFs to
gain exposure to a particular portion of the market while awaiting an
opportunity to purchase securities directly. When the Fund invests in an ETF, in
addition to directly bearing the expenses associated with its own operations, it
will bear a pro rata portion of the ETF's expenses. Therefore, it may be more
costly to own an ETF than to own the underlying securities directly. In
addition, while the risks of owning shares of an ETF generally reflect the risks
of owning the underlying securities the ETF is designed to track, lack of
liquidity in an ETF can result in its value being more volatile than the
underlying portfolio securities.
Real estate investment risk. Although the Fund may not invest directly in real
estate, it may invest in securities of real estate companies and companies
related to the real estate industry. The Fund has a policy of concentrating its
investments in real estate companies and companies related to the real estate
industry. As such, the Fund is subject to risks associated with the direct
ownership of real estate securities and an investment in the Fund will be
closely linked to the performance of the real estate markets. These risks
include, among others, declines in the value of real estate; risks related to
general and local economic conditions; possible lack of availability of mortgage
funds; overbuilding, extended vacancies of properties; defaults by borrowers or
tenants, particularly during an economic downturn; increasing competition;
increases in property taxes and operating expenses; changes in zoning laws;
losses due to costs resulting from the clean-up of environmental problems;
liability to third parties for damages resulting from environmental problems;
casualty or condemnation losses; limitations on rents; changes in market and
sub-market values and the appeal of properties to tenants; and changes in
interest rates.
Leverage Risk. Certain Fund transactions, such as derivatives, may give rise to
a form of leverage and may expose the Fund to greater risk. Leverage tends to
magnify the effect of any decrease or increase in the value of the Fund's
portfolio securities. The use of leverage may cause the Fund to liquidate
portfolio positions when it would not be advantageous to do so in order to
satisfy its obligations.
Securities Lending. The Fund may lend its portfolio securities to earn
additional income. Any loans of portfolio securities by the Fund are fully
collateralized. However, if the borrowing institution defaults, the Fund's
performance could be reduced.
Non-Diversification Risk. The Fund is non-diversified and, as such, may invest a
greater percentage of its assets in the securities in a single issuer than a
fund that is diversified. A non-diversified fund is more susceptible to risks
associated with a single economic, political or regulatory occurrence than a
diversified fund.
PERFORMANCE INFORMATION
Because the Fund is new, no performance figures are given. This information will
appear in a future version of the Fund's prospectus.
6
FEES AND EXPENSES
These tables describe the fees and expenses that you may pay if you buy and hold
shares of the Fund.
INSTITUTIONAL SELECT INVESTOR
------------- ------ --------
SHAREHOLDER FEES (paid directly from your investment):
Maximum Sales Charge (Load) Imposed on Purchases............ N/A N/A N/A
Maximum Deferred Sales Charge (Load)........................ N/A N/A N/A
Maximum Sales Charge (Load) Imposed on Reinvested
Dividends................................................. N/A N/A N/A
Redemption Fee (charged only to shares redeemed or exchanged
within 30 days of purchase) a............................. 2.00% 2.00% 2.00%
Exchange Fee................................................ N/A N/A N/A
------------------------
a The Trust reserves the right, in its sole discretion, to waive this fee when,
in its judgment, such waiver would be in the best interests of the Trust or
the Fund. See "Redeeming Shares." The Fund charges no other redemption fees.
ANNUAL FUND OPERATING EXPENSES (expenses that are deducted from Fund assets) and
EXAMPLE
The Example is intended to help you compare the cost of investing in the Fund
with the cost of investing in other funds. It assumes that you invest $10,000 in
the Fund for the time periods indicated and then redeem all of your shares at
the end of those periods. It also assumes that your investment has a 5% return
each year, that the Fund's operating expenses stay the same and that all
dividends and distributions are reinvested. Your actual costs may be higher or
lower.
ANNUAL OPERATING EXPENSES
------------------------------------------------------------------------------------------
INSTITUTIONAL SELECT INVESTOR
------------- ------ --------
Management Fees
Distribution and Shareholder Service (12b-1) Fees None None 0.25%
Other Expenses b
----- ----- -----
Total Annual Fund Operating Expenses
Less Fee Waiver and/or Expense Reimbursement c
----- ----- -----
Net Expenses
===== ===== =====
EXAMPLE
-------------------------------------------------------
AFTER AFTER
1 YEAR 3 YEARS
------ -------
Institutional
Select
Investor
------------------------
b "Other expenses" are based on estimated amounts for the current fiscal year.
c Pursuant to the Adviser's contractual undertaking (the "Expense Limitation
Agreement") to waive its management fee and bear certain expenses for the
Institutional, Select and Investor classes when the operating expenses reach
, respectively (exclusive of nonrecurring account fees, fees on
securities transactions such as exchange fees, dividends and interest on
securities sold short, service fees, interest, taxes, brokerage commissions,
other expenditures which are capitalized in accordance with generally
accepted accounting principles, and other extraordinary expenses not incurred
in the ordinary course of the Fund's business). The Expense Limitation
Agreement will be in place until at least July 30, 2010. The Adviser may, but
is not required to, extend the Agreement for additional years. Any amounts
waived or reimbursed in a particular fiscal year will be subject to
reimbursement by the Fund to the Adviser during the next two fiscal years to
the extent that the repayment will not cause the Fund's Net Expenses to
exceed the current limit (as stated in the Expense Limitation Agreement)
during the respective year.
7
LAUDUS MONDRIAN GLOBAL EQUITY FUND
TICKER SYMBOL:
INVESTMENT OBJECTIVE
The Fund seeks long-term capital appreciation.
PRINCIPAL INVESTMENT STRATEGIES
The Fund pursues its investment objective primarily by investing in equity
securities of both U.S. and non-U.S. issuers, including the securities of
emerging market companies, that, in the Subadviser's opinion, are undervalued at
the time of purchase based on fundamental value analysis employed by the
Subadviser. Equity securities in which the Fund may invest include, but are not
limited to, common stocks, preferred stocks, convertible securities, index
related securities, certain non-traditional equity securities and warrants. The
Fund may purchase securities of non-U.S. issuers directly or indirectly in the
form of American, European or Global depository receipts or other securities
representing underlying shares of non-U.S. issuers. The Fund may also purchase
other investment funds, including, but not limited to registered funds,
including exchange-traded funds (ETFs), unregistered funds and real estate
investment trusts (REIT's).
Under normal circumstances, the Fund will invest at least 80% of its net assets
(including, for this purpose, any borrowings for investment purposes) in equity
securities. The Fund will notify its shareholders at least 60 days before
changing this policy. While the Fund will not concentrate more than 25% of its
assets in any single industry, the Fund may in aggregate have a greater than 25%
allocation in the "financial services" sector, which comprises several
industries.
The Subadviser's approach in selecting investments for the Fund is primarily
oriented to individual stock selection and is value driven. In selecting stocks
for the Fund, the Subadviser identifies those stocks that it believes will
provide capital appreciation over a market cycle, taking into consideration
movements in the price of the individual security and the impact of currency
fluctuation on a United States domiciled, dollar-based investor. The Subadviser
conducts fundamental research on a global basis in order to identify securities
that, in the Subadviser's opinion, have the potential for long-term capital
appreciation. This research effort generally centers on a value-oriented
dividend discount methodology with respect to individual securities and market
analysis that isolates value across country boundaries. The approach focuses on
future anticipated dividends and discounts the value of those dividends back to
what they would be worth if they were being received today. In addition, the
analysis typically includes a comparison of the values and current market prices
of different possible investments. The Subadviser's general management strategy
emphasizes long-term holding of securities, although securities may be sold in
the Subadviser's discretion without regard to the length of time they have been
held.
Investments will be made mainly in marketable securities of companies located in
developed countries including but not limited to Australia, Belgium, Canada,
Finland, France, Germany, Hong Kong, Ireland, Italy, Japan, the Netherlands, New
Zealand, Norway, Singapore, Spain, Sweden, Switzerland, the United Kingdom and
the United States.
The Fund considers an "emerging country" to be any country, except the United
States, Canada, and those in the Morgan Stanley Capital International EAFE
Index.
In considering possible emerging countries in which the Fund may invest, the
Subadviser places particular emphasis on certain factors, such as economic
conditions (including growth trends, inflation rates and trade balances),
regulatory and currency controls, accounting standards and political and social
conditions.
Currency considerations carry a special risk for a portfolio of global
securities. The Fund may invest in securities issued in any currency and may
hold foreign currency. Securities of issuers within a given country may be
denominated in the currency of another country or in multinational currency
units, including the Euro. The Subadviser primarily uses a purchasing power
parity approach to evaluate currency risk. In this regard, the Fund may carry
out hedging activities, and may invest in forward foreign currency contracts to
hedge currency risks associated with the purchase of individual securities
denominated in a particular currency. Under normal circumstances, hedging is
undertaken defensively back into the base currency of the Fund.
The Fund may also invest in debt securities issued by governments or by their
agencies, instrumentalities or political subdivisions, or by corporate entities,
all of which may be high-yield, high-risk fixed income securities rated lower
than BBB by S&P and Baa by Moody's or, if unrated, considered to be of
equivalent quality. In addition, for temporary defensive purposes, the Fund may
invest in high-quality debt instruments.
The Fund may buy and sell portfolio securities actively. As a result, the Fund's
portfolio turnover rate and transaction costs will rise, which may lower Fund
performance and increase the likelihood of capital gain distributions. The
turnover rate may also be affected by cash requirements from redemptions of the
Fund's shares.
8
For temporary defensive purposes, during unusual economic or market conditions
or for liquidity purposes, the Fund may invest up to 100% of its assets in cash,
money market instruments, repurchase agreements and other short-term
obligations. When the Fund engages in such activities, it may not achieve its
investment objective.
PRINCIPAL RISKS
Market Risk. Stock and bond markets and the values of the securities owned by
the Fund rise and fall daily. As with any investment whose performance is tied
to these markets, the value of your investment in the Fund will fluctuate, which
means that you could lose money.
Equity Risk. The prices of equity securities rise and fall daily. These price
movements may result from factors affecting individual companies, industries or
the securities market as a whole. Individual companies may report poor results
or be negatively affected by industry and/or economic trends and developments.
The prices of securities issued by such companies may suffer a decline in
response. In addition, the equity market tends to move in cycles which may cause
stock prices to fall over short or extended periods of time.
Large-Cap Risk. Many of the risks of this Fund are associated with its
investments in the large-cap segments of the stock market. Large-cap stocks tend
to go in and out of favor based on market and economic conditions. During a
period when large-cap stocks fall behind other types of investments--bonds or
small-cap stocks for instance--the Fund's performance also will lag those
investments.
Sector Risk. The Fund is also subject to the risk that the securities of issuers
in the financial services sector that the Fund purchases will underperform other
market sectors or the market as a whole. To the extent that the Fund's
investments are focused in issuers conducting business in the same sector, the
Fund is subject to risk associated with legislative or regulatory changes,
adverse market conditions and/or increased competition affecting that sector.
Management Risk. As with all actively managed funds, the strategy of the Fund's
managers--its Adviser and Subadviser--may not achieve their desired results. For
example, with value stocks, the market might fail to recognize the true worth of
an undervalued company, or a manager might misjudge that worth. With growth
stocks, whose prices depend largely on expectations of companies' future growth,
a manager's expectations may prove to be unfounded.
Debt Securities Risk. Bond prices generally fall when interest rates rise. Bonds
with longer maturities tend to be more sensitive to this risk. Fund performance
also could be affected if an issuer or guarantor of a bond held by the fund
fails to make timely principal or interest payments or otherwise honor its
obligations. Lower-quality bonds are considered speculative with respect to its
issuer's ability to make timely payments or otherwise honor its obligations. In
addition, prices of lower-quality bonds tend to be more volatile than those of
investment-grade bonds, and may fall based on bad news about the issuer, an
industry or the overall economy. Mortgage- or asset-backed securities are
subject to the risk that these bonds may be paid off earlier or later than
expected. Either situation could cause the fund to hold securities paying lower
than market rates of interest, which could hurt the fund's yield or share price.
Also, bonds of foreign issuers may be more volatile than those of comparable
bonds from U.S. issuers, for reasons ranging from limited issuer information to
the risk of political upheaval. The fund's use of mortgage dollar rolls could
cause the fund to lose money if the price of the mortgage-backed securities sold
fall below the agreed upon repurchase price, or if the counterparty is unable to
honor the agreement.
Interest Rate Risk. The Fund is subject to the risk that interest rates rise and
fall over time. As with any investment whose yield reflects current interest
rates, the Fund's yield will change over time. During periods when interest
rates are low, the Fund's yield (and total return) also may be low. When
interest rates rise, bond prices usually fall which could cause the Fund's share
price to fall. The longer the Fund's dollar-weighted average maturity, the more
sensitive to interest rate movements its share price is likely to be.
Credit Risk. The Fund is subject to the risk that a decline in the credit
quality of a portfolio investment could cause the Fund's share price to fall.
The Fund could lose money if the issuer or guarantor of a portfolio investment
or the counterparty to a derivatives contract fails to make timely principal or
interest payments or otherwise honor its obligations. Securities rated below
investment-grade (junk bonds) involve greater risks of default or downgrade and
are more volatile than investment-grade securities. Below investment-grade
securities involve greater risk of price declines than investment-grade
securities due to actual or perceived changes in an issuer's creditworthiness.
In addition, issuers of below investment-grade securities may be more
susceptible than other issuers to economic downturns. Such securities are
subject to the risk that the issuer may not be able to pay interest or dividends
and ultimately to repay principal upon maturity. Discontinuation of these
payments could substantially adversely affect the market value of the
securities.
Prepayment and Extension Risk. The Fund's investments are subject to the risk
that the securities may be paid off earlier or later than expected. Either
situation could cause the Fund to hold securities paying lower-than-market rates
of interest, which could hurt
9
the Fund's yield or share price. In addition, rising interest rates tend to
extend the duration of certain fixed income securities, making them more
sensitive to changes in interest rates. As a result, in a period of rising
interest rates, the Fund may exhibit additional volatility. This is known as
extension risk. When interest rates decline, borrowers may pay off their fixed
income securities sooner than expected. This can reduce the returns of the Fund
because the Fund will have to reinvest that money at the lower prevailing
interest rates. This is known as prepayment risk.
Foreign Investment Risk. Investments in securities of foreign issuers involve
certain risks that are more significant than those associated with investments
in securities of U.S. issuers. These include risks of adverse changes in foreign
economic, political, regulatory and other conditions, or changes in currency
exchange rates or exchange control regulations (including limitations on
currency movements and exchanges). In certain countries, legal remedies
available to investors may be more limited than those available with respect to
investments in the United States. The securities of some foreign companies may
be less liquid and at times more volatile than securities of comparable U.S.
companies. A fund with foreign investments may also experience more rapid or
extreme changes in value than a fund that invests solely in securities of U.S.
companies because the securities markets of many foreign countries are
relatively small, with a limited number of companies representing a small number
of industries. There also is the risk that the cost of buying, selling, and
holding foreign securities, including brokerage, tax, and custody costs, may be
higher than those involved in domestic transactions.
Foreign government securities can involve a high degree of risk. The
governmental entity that controls the repayment of sovereign debt may not be
able or willing to repay the principal and/or interest when due in accordance
with the terms of the debt. A governmental entity's willingness or ability to
repay principal and interest due in a timely manner may be affected by, among
other factors, its cash flow situation, the extent of its foreign reserves, the
availability of sufficient foreign exchange on the date a payment is due, the
relative size of the debt service burden to the economy as a whole, the
governmental entity's policy toward the International Monetary Fund, and the
political constraints to which a governmental entity may be subject.
Governmental entities also may depend on expected disbursements from foreign
governments, multilateral agencies and others to reduce principal and interest
arrearages on their debt.
Emerging Markets Risk. Emerging markets may be more likely to experience
political turmoil or rapid changes in market or economic conditions than more
developed countries. Emerging market countries often have less uniformity in
accounting and reporting requirements, unreliable securities valuation and
greater risk associated with the custody of securities. It is sometimes
difficult to obtain and enforce court judgments in such countries and there is
often a greater potential for nationalization and/or expropriation of assets by
the government of an emerging market country. In addition, the financial
stability of issuers (including governments) in emerging market countries may be
more precarious than in other countries. As a result, there will tend to be an
increased risk of price volatility associated with the Fund's investments in
emerging market countries, which may be magnified by currency fluctuations
relative to the U.S. dollar.
Currency Risk. As a result of its investments in securities denominated in,
and/or receiving revenues in, foreign currencies, the Fund will be subject to
currency risk. This is the risk that those currencies will decline in value
relative to the U.S. Dollar, or, in the case of hedging positions, that the U.S.
Dollar will decline in value relative to the currency hedged. In either event,
the dollar value of an investment in the Fund would be adversely affected.
Currency exchange rates may fluctuate in response to factors extrinsic to that
country's economy, which makes the forecasting of currency market movements
extremely difficult. Currency rates in foreign countries may fluctuate
significantly over short periods of time for a number of reasons, including
changes in interest rates, intervention (or failure to intervene) by U.S. or
foreign governments, central banks or supranational entities such as the
International Monetary Fund, or by the imposition of currency controls or other
political developments in the United States or abroad. These can result in
losses to the Fund if it is unable to deliver or receive currency or funds in
settlement of obligations and could also cause hedges it has entered into to be
rendered useless, resulting in full currency exposure as well as incurring
transaction costs. Forward contracts on foreign currencies are not traded on
exchanges; rather, a bank or dealer will act as agent or as principal in order
to make or take future delivery of a specified lot of a particular currency for
the Fund's account. The Fund is subject to the risk of a principal's failure,
inability or refusal to perform with respect to such contracts.
Convertible Securities Risk. A convertible security is a bond, debenture, note,
preferred stock or other security that may be converted into or exercised for a
prescribed amount of common stock at a specified time and price. Convertible
securities provide an opportunity for equity participation, with the potential
for a higher dividend or interest yield and lower price volatility compared to
common stock. The value of a convertible security is influenced by changes in
interest rates, with investment value declining as interest rates increase and
increasing as interest rates decline, and the credit standing of the issuer. The
price of a convertible security will also normally vary in some proportion to
changes in the price of the underlying common stock because of the conversion or
exercise feature.
Derivatives Risk. The Fund may use derivatives to enhance returns or hedge
against market declines. Examples of derivatives are options, futures, options
on futures, swaps and warrants. An option is the right to buy or sell an
instrument at a specific price before a specific date. A future is an agreement
to buy or sell a financial instrument at a specific price on a specific day. A
swap is
10
an agreement whereby two parties agree to exchange payment streams calculated in
relation to a rate, index, instrument or certain securities and a predetermined
amount. A credit default swap is an agreement in which the seller agrees to make
a payment to the buyer in the event of a specified credit event in exchange for
a fixed payment or series of fixed payments. A warrant is a security that gives
the holder the right, but not the obligation, to subscribe for newly created
equity issues of the issuing company or a related company at a fixed price
either on a certain date or during a set period. Changes in the value of a
warrant do not necessarily correspond to changes in the value of its underlying
security. The price of a warrant may be more volatile than the price of its
underlying security, and a warrant may offer greater potential for capital
appreciation as well as capital loss. Warrants do not entitle a holder to
dividends or voting rights with respect to the underlying security and do not
represent any rights in the assets of the issuing company.
The Fund's use of derivative instruments involves risks different from or
possibly greater than, the risks associated with investing directly in
securities and other traditional investments. Certain of these risks, such as
credit risk, leverage risk, market risk and management risk, are discussed
elsewhere in this section. The Fund's use of derivatives is also subject to
liquidity risk, lack of availability risk, valuation risk, correlation risk and
tax risk. Liquidity risk is the risk that the Fund may not be able to purchase
or liquidate a particular derivative at an advantageous time or place. Lack of
availability risk is the risk that suitable derivative transactions may not be
available in all circumstances for risk management or other purposes. Valuation
risk is the risk that a particular derivative may be valued incorrectly.
Correlation risk is the risk that changes in the value of the derivative may not
correlate perfectly with the underlying asset, rate or index. Tax risk is the
risk that the use of derivatives may cause the Fund to realize higher amounts of
short-term capital gain. These risks could cause the Fund to lose more than the
principal amount invested.
Investments In Exchange-Traded Funds. The Fund may purchase shares of ETFs to
gain exposure to a particular portion of the market while awaiting an
opportunity to purchase securities directly. When the Fund invests in an ETF, in
addition to directly bearing the expenses associated with its own operations, it
will bear a pro rata portion of the ETF's expenses. Therefore, it may be more
costly to own an ETF than to own the underlying securities directly. In
addition, while the risks of owning shares of an ETF generally reflect the risks
of owning the underlying securities the ETF is designed to track, lack of
liquidity in an ETF can result in its value being more volatile than the
underlying portfolio securities.
Real estate investment risk. Although the Fund may not invest directly in real
estate, it may invest in securities of real estate companies and companies
related to the real estate industry. The Fund has a policy of concentrating its
investments in real estate companies and companies related to the real estate
industry. As such, the Fund is subject to risks associated with the direct
ownership of real estate securities and an investment in the Fund will be
closely linked to the performance of the real estate markets. These risks
include, among others, declines in the value of real estate; risks related to
general and local economic conditions; possible lack of availability of mortgage
funds; overbuilding; extended vacancies of properties; defaults by borrowers or
tenants, particularly during an economic downturn; increasing competition;
increases in property taxes and operating expenses; changes in zoning laws;
losses due to costs resulting from the clean-up of environmental problems;
liability to third parties for damages resulting from environmental problems;
casualty or condemnation losses; limitations on rents; changes in market and
sub-market values and the appeal of properties to tenants; and changes in
interest rates.
Leverage Risk. Certain Fund transactions, such as derivatives, may give rise to
a form of leverage and may expose the Fund to greater risk. Leverage tends to
magnify the effect of any decrease or increase in the value of the Fund's
portfolio securities. The use of leverage may cause the Fund to liquidate
portfolio positions when it would not be advantageous to do so in order to
satisfy its obligations.
Securities Lending. The Fund may lend its portfolio securities to earn
additional income. Any loans of portfolio securities by the Fund are fully
collateralized. However, if the borrowing institution defaults, the Fund's
performance could be reduced.
PERFORMANCE INFORMATION
Because the Fund is new, no performance figures are given. This information will
appear in a future version of the Fund's prospectus.
11
FEES AND EXPENSES
These tables describe the fees and expenses that you may pay if you buy and hold
shares of the Fund.
INSTITUTIONAL SELECT INVESTOR
------------- ------ --------
SHAREHOLDER FEES (paid directly from your investment):
Maximum Sales Charge (Load) Imposed on Purchases............ N/A N/A N/A
Maximum Deferred Sales Charge (Load)........................ N/A N/A N/A
Maximum Sales Charge (Load) Imposed on Reinvested
Dividends................................................. N/A N/A N/A
Redemption Fee (charged only to shares redeemed or exchanged
within 30 days of purchase) a............................. 2.00% 2.00% 2.00%
Exchange Fee................................................ N/A N/A N/A
------------------------
a The Trust reserves the right, in its sole discretion, to waive this fee when,
in its judgment, such waiver would be in the best interests of the Trust or
the Fund. See "Redeeming Shares." The Fund charges no other redemption fees.
ANNUAL FUND OPERATING EXPENSES (expenses that are deducted from Fund assets) and
EXAMPLE
The Example is intended to help you compare the cost of investing in the Fund
with the cost of investing in other funds. It assumes that you invest $10,000 in
the Fund for the time periods indicated and then redeem all of your shares at
the end of those periods. It also assumes that your investment has a 5% return
each year, that the Fund's operating expenses stay the same and that all
dividends and distributions are reinvested. Your actual costs may be higher or
lower.
ANNUAL OPERATING EXPENSES
------------------------------------------------------------------------------------------
INSTITUTIONAL SELECT INVESTOR
------------- ------ --------
Management Fees
Distribution and Shareholder Service (12b-1) Fees None None 0.25%
Other Expenses b
----- ----- -----
Total Annual Fund Operating Expenses
Less Fee Waiver and/or Expense Reimbursement c
----- ----- -----
Net Expenses
===== ===== =====
EXAMPLE
-------------------------------------------------------
AFTER AFTER
1 YEAR 3 YEARS
------ -------
Institutional
Select
Investor
------------------------
b "Other expenses" are based on estimated amounts for the current fiscal year.
c Pursuant to the Adviser's contractual undertaking (the "Expense Limitation
Agreement") to waive its management fee and bear certain expenses for the
Institutional, Select and Investor classes when the operating expenses reach
, respectively (exclusive of nonrecurring account fees, fees on
securities transactions such as exchange fees, dividends and interest on
securities sold short, service fees, interest, taxes, brokerage commissions,
other expenditures which are capitalized in accordance with generally
accepted accounting principles, and other extraordinary expenses not incurred
in the ordinary course of the Fund's business). The Expense Limitation
Agreement will be in place until at least July 30, 2010. The Adviser may, but
is not required to, extend the Agreement for additional years. Any amounts
waived or reimbursed in a particular fiscal year will be subject to
reimbursement by the Fund to Adviser during the next two fiscal years to the
extent that the repayment will not cause the Fund's Net Expenses to exceed
the current limit (as stated in the Expense Limitation Agreement) during the
respective year.
12
PERFORMANCE INFORMATION FOR THE SUBADVISER'S
OTHER INTERNATIONAL EQUITY ACCOUNTS
Mondrian also serves as adviser to other international equity accounts (the
"Other International Equity Accounts") that have investment objectives, policies
and strategies that are substantially similar to those of the Laudus Mondrian
International Equity Fund. THE INFORMATION BELOW DOES NOT REPRESENT THE
HISTORICAL PERFORMANCE OF THE LAUDUS MONDRIAN INTERNATIONAL EQUITY FUND AND
SHOULD NOT BE CONSIDERED A PREDICTION OF ITS FUTURE PERFORMANCE. The performance
of the Laudus Mondrian International Equity Fund may vary from the performance
of the Other International Equity Accounts. The performance information shown
below is based on a composite of all of Mondrian's accounts with investment
objectives, policies and strategies that are substantially similar to those of
the Laudus Mondrian International Equity Fund and has been adjusted to give
effect to the annualized net expenses of the Investor Shares of the Laudus
Mondrian International Equity Fund (as set forth in the Annual Fund Operating
Expenses table, above). None of the Other International Equity Accounts have
been registered under the 1940 Act and therefore they are not subject to certain
investment restrictions imposed by the 1940 Act. If the Other International
Equity Accounts had been registered under the 1940 Act, their performance and
the composite performance might have been adversely affected. In addition, the
Other International Equity Accounts were not subject to Subchapter M of the
Internal Revenue Code. If the Other International Equity Accounts had been
subject to Subchapter M, their performance and the composite performance might
have been adversely affected. As noted below, the returns in the bar chart
reflect adjustments for the fees and expenses of Investor Shares of the Laudus
Mondrian International Equity Fund, which has a higher expense ratio than the
Select Shares and Institutional Shares.
The bar chart and table below show:
- Changes in the Other International Equity Accounts' performance from
year to year since inception; and
- How the Other International Equity Accounts' average annual returns over
one year, and since inception compare to those of a broad-based
securities market index.
YEARLY PERFORMANCE (%)--OTHER INTERNATIONAL EQUITY ACCOUNTS (ADJUSTED FOR FEES
AND NET EXPENSES OF INVESTOR SHARES)
YEARLY PERFORMANCE
(BAR CHART)
ANNUAL RETURN (%)
43.24% 19.39% 11.67% 31.38% 8.78%
-10.09% -10.23%
2001 2002 2003 2004 2005 2006 2007
CALENDAR YEAR
During all periods shown in the bar graph, the Other International Equity
Accounts' highest quarterly return was %, for the quarter ended , and
their lowest quarterly return was %, for the quarter ended .
PERFORMANCE TABLE
This table shows how the Other International Equity Accounts' performance
compares with the returns of a broad-based securities market index.
AVERAGE ANNUAL TOTAL RETURNS (FOR PERIODS ENDING DECEMBER 31, 2007) 1
PAST ONE PAST FIVE SINCE
YEAR YEARS INCEPTION
-------- --------- ---------
Other International Equity Accounts (adjusted for the fees
and expenses of Institutional Shares).....................
Other International Equity Accounts (adjusted for the fees
and expenses of Select Shares)............................
Other International Equity Accounts (adjusted for the fees
and expenses of Investor Shares)..........................
MSCI EAFE (Net) Index 2.....................................
------------------------
1 All returns are stated before the imposition of taxes. After-tax returns
would be lower than those shown.
2 Reflects no deduction for fees, expenses or taxes. The Morgan Stanley Capital
International Europe, Australasia, Far East (MSCI EAFE) (Net) Index is a free
float-adjusted market capitalization index that is designed to measure market
equity performance in 21 developed countries, excluding the U.S. and Canada,
and is net of dividends and taxes.
3 Inception: .
4 From: .
13
PERFORMANCE INFORMATION FOR THE SUBADVISER'S
OTHER GLOBAL EQUITY ACCOUNTS
Mondrian also serves as adviser to other global equity accounts (the "Other
Global Equity Accounts") that have investment objectives, policies and
strategies that are substantially similar to those of the Laudus Mondrian Global
Equity Fund. THE INFORMATION BELOW DOES NOT REPRESENT THE HISTORICAL PERFORMANCE
OF THE LAUDUS MONDRIAN GLOBAL EQUITY FUND AND SHOULD NOT BE CONSIDERED A
PREDICTION OF ITS FUTURE PERFORMANCE. The performance of the Laudus Mondrian
Global Equity Fund may vary from the performance of the Other Global Equity
Accounts. The performance information shown below is based on a composite of all
of Mondrian's accounts with investment objectives, policies and strategies that
are substantially similar to those of the Laudus Mondrian Global Equity Fund and
has been adjusted to give effect to the annualized net expenses of the Investor
Shares of the Laudus Mondrian Global Equity Fund (as set forth in the Annual
Fund Operating Expenses table, above). The majority of the Other Global Equity
Accounts have not been registered under the 1940 Act and therefore they are not
subject to certain investment restrictions imposed by the 1940 Act. If all of
the Other Global Equity Accounts had been registered under the 1940 Act, their
performance and the composite performance might have been adversely affected. In
addition, the majority of the Other Global Equity Accounts were not subject to
Subchapter M of the Internal Revenue Code. If all of the Other Global Equity
Accounts had been subject to Subchapter M, their performance and the composite
performance might have been adversely affected. As noted below, the returns in
the bar chart reflect adjustments for the fees and expenses of Investor Shares
of the Laudus Mondrian Global Equity Fund, which has a higher expense ratio than
the Select Shares and Institutional Shares.
The bar chart and table below show:
- Changes in the Other Global Equity Accounts' performance from year to
year over the last ten calendar years; and
- How the Other Global Equity Accounts' average annual returns over one
year, five years, and ten years compare to those of a broad-based
securities market index.
YEARLY PERFORMANCE (%)--OTHER GLOBAL EQUITY ACCOUNTS (ADJUSTED FOR FEES AND NET
EXPENSES OF INVESTOR SHARES)
YEARLY PERFORMANCE
(BAR CHART)
ANNUAL RETURN (%)
9.64% 5.66% 1.57% 36.68% 18.04% 8.15% 26.42% 6.54%
-9.43% -12.95%
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
CALENDAR YEAR
------------------------
During all periods shown in the bar graph, the Other Global Equity Accounts'
highest quarterly return was %, for the quarter ended , and their
lowest quarterly return was %, for the quarter ended .
PERFORMANCE TABLE
This table shows how the Other Global Equity Accounts' performance compares with
the returns of a broad-based securities market index.
AVERAGE ANNUAL TOTAL RETURNS (FOR PERIODS ENDING DECEMBER 31, 2007) 1
PAST ONE PAST FIVE PAST TEN SINCE
YEAR YEARS YEARS INCEPTION
-------- --------- -------- ---------
Other Global Equity Accounts (adjusted for the fees and
expenses of Institutional Shares).........................
Other Global Equity Accounts (adjusted for the fees and
expenses of Select Shares)................................
Other Global Equity Accounts (adjusted for the fees and
expenses of Investor Shares)..............................
MSCI World (Net) Index 2....................................
------------------------
1 All returns are stated before the imposition of taxes. After-tax returns
would be lower than those shown.
2 Reflects no deduction for fees, expenses or taxes. The Morgan Stanley Capital
International World (Net) Index is a free float-adjusted market
capitalization weighted index that is designed to measure the equity market
performance of developed markets and is net of dividends and taxes. As of
June 2007 the MSCI World (Net) Index consisted of the following 23 developed
market country indices: Australia, Austria, Belgium, Canada, Denmark,
Finland, France, Germany, Greece, Hong Kong, Ireland, Italy, Japan,
Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden,
Switzerland, the United Kingdom, and the United States.
3 Inception: .
4 From: .
14
During the period April 1991 to September 2004 this performance was achieved
with US stock selection input from Mondrian's former affiliate, Delaware
Investment Advisers ("DIA"). Mondrian had overall responsibility for the asset
allocation decisions between the US and non-US portions of this account. Shortly
after the MBO of Mondrain in September 2004, the services of DIA were no longer
utilised in the constituent portfolio of this account and the entire
responsibility for US stock selection for this account has resided with
Mondrian. From September 2004 to May 2007, the Mondrain Global Equity Account
consisted only of a Mondrain sponsored limited partnership with no external
investors.
15
MANAGEMENT OF THE FUNDS
The Trust's Board of Trustees oversees the general conduct of the Trust and the
Funds.
CSIM serves as the Funds' investment adviser and Mondrian serves as subadviser
to the Funds.
In its capacity as subadviser, Mondrian provides day-to-day portfolio management
services to the Funds, while, as adviser, CSIM supervises Mondrian and assumes
other functions, including managing the Funds' other affairs and business,
subject to the supervision of the Board of Trustees.
The Funds pay CSIM an advisory fee for these services on a monthly basis.
CSIM--and not the Funds--pays a portion of the advisory fees it receives to
Mondrian in return for its services.
The Laudus Mondrian International Equity Fund will pay CSIM an advisory fee of
% for the first of average daily net assets under management and
% of such assets over . The Laudus Mondrian Global Equity Fund
will pay CSIM an advisory fee of % for the first of average daily
net assets under management and % of such assets over .
As described in the "Annual Fund Operating Expenses" tables in the section
entitled "Fees and Expenses," CSIM has entered into an Expense Limitation
Agreement to reduce its management fees and bear certain expenses until July 30,
2010, to limit the total annual operating expenses of the Funds. Under that
agreement, any amounts waived or reimbursed in a particular fiscal year will be
subject to reimbursement by each Fund to CSIM during the next two fiscal years
to the extent that repayment will not cause the Funds' expenses to exceed the
current limit (as stated in the Expense Limitation Agreement) during the
respective year.
INVESTMENT ADVISER AND SUBADVISER
The investment adviser for the Funds is CSIM, 101 Montgomery Street, San
Francisco, CA 94104. Founded in 1989, CSIM today serves as investment adviser
for all of the Schwab Funds and Laudus Funds. As of December 31, 2007, CSIM
managed 74 mutual funds and approximately $236 billion in assets.
Mondrian's address is Fifth Floor, 10 Gresham Street, London EC2V 7JD. Mondrian
provides investment advisory services to a number of institutional investors. As
of December 31, 2007, Mondrian managed $64 billion in assets.
A discussion regarding the basis for the Board's approval of the Funds'
investment advisory and subadvisory agreements will be available in the Funds'
annual and/or semi-annual reports.
PORTFOLIO MANAGEMENT
Elizabeth Desmond, Russell Mackie and Nigel Bliss are responsible for the
day-to-day management of the Laudus Mondrian International Equity Fund. Ms.
Desmond, CFA, has been with Mondrian since 1991, where she is currently Director
and Chief Investment Officer--International Equities. Mr. Mackie has been with
Mondrian since 1997, where he is currently a Senior Portfolio Manager on the
European Equity Team. Mr. Bliss has been with Mondrian since July 1995. Mr.
Bliss is a Senior Portfolio Manager in Mondrian's Pacific Equity Team. Ms.
Desmond, Mr. Mackie and Mr. Bliss are members of the CFA Society of the United
Kingdom.
Nigel May, Brendan Baker and Andrew Porter are responsible for the day-to-day
management of the Laudus Mondrian Global Equity Fund. Mr. May, ASIP, has been
with Mondrian since 1991, where he is currently Director and Chief Investment
Officer--Global Equities. Mr. May is an Associate of the CFA Society of the
United Kingdom. Mr. Baker has been with Mondrian since 2001, where he is
currently a Senior Portfolio Manager on the North American equity team. Mr.
Porter has been with Mondrian since 2003, where he is currently a Portfolio
Manager on the Pacific Equity team. Mr. Porter is a CFA charterholder, a member
of the CFA Institute and a member of the CFA Society of the United Kingdom.
DISTRIBUTOR
Institutional Shares, Select Shares and Investor Shares of the Funds are offered
on a continuous basis through the Trust's principal underwriter, ALPS
Distributors, Inc. (the "Distributor"). The Distributor's principal offices are
located at 1625 Broadway, Suite 2200, Denver, Colorado 80202.
Investor Class Shares of the Trust are subject to an annual distribution and
shareholder service fee (a "Distribution and Shareholder Service Fee") of up to
0.25% of the Funds' Investor Shares' average daily net assets attributable
thereto in accordance with a distributor and shareholder service plan (a
"Distributor and Shareholder Service Plan") adopted by the Trustees pursuant to
Rule 12b-1 under the 1940 Act. The Distribution and Shareholder Service Fee is
intended to compensate the Distributor for services and expenses primarily
intended to result in the sale of Investor Shares and/or in connection with the
provision of direct client service, personal services, maintenance of
shareholder accounts and reporting services to holders of Investor Shares of the
Trust. The Distribution and Shareholder Service Fee will not be retained by the
Distributor but will instead be reallowed to financial intermediaries who
provide these services. Any amount not reallowed to financial intermediaries
will be waived or reimbursed to the applicable Fund. Although the Distributor
acts as principal underwriter for Institutional Shares and Select Shares of the
Fund, as
16
noted below, the Funds pay no fees to the Distributor in connection with such
shares under the Distribution and Shareholder Service Plan.
Expenses and services for which the Distributor or another intermediary or agent
may be compensated include, without limitation, expenses (including overhead and
telephone expenses) of, and compensation to, employees of the Distributor or of
intermediaries who engage in distribution or servicing of Investor Shares,
printing of prospectuses and reports for other than existing Investor Class
shareholders, advertising, preparing, printing and distributing sales literature
and forwarding communications from the Trust to such persons. The Distribution
and Shareholder Service Plan is of the type known as a "compensation" plan. This
means that the fees are payable to compensate the Distributor or intermediary
for services rendered even if the amount paid exceeds the Distributor's or
intermediary's expenses. Because these fees are paid out of each Fund's assets
on an ongoing basis, over time these fees will increase the cost of your
investment and may cost you more than other types of sales charges.
CSIM may pay certain Intermediaries (as defined below) for performing
shareholder, recordkeeping, administrative, transfer agency or other services
for their customers. In addition, CSIM may pay certain Intermediaries for
providing distribution, marketing or promotional services. The payments
described by this paragraph are not paid by the Fund or their shareholders and
may be substantial.
MULTIPLE CLASSES
As indicated previously, the Funds offer three classes of shares in this
Prospectus to investors, with eligibility for purchase depending on the amount
invested in a particular Fund. The three classes of shares are Institutional
Shares, Select Shares and Investor Shares. The following table sets forth basic
investment and fee information for each class.
ANNUAL
DISTRIBUTION
MINIMUM AND
INITIAL FUND SUBSEQUENT SHAREHOLDER
NAME OF CLASS INVESTMENT* INVESTMENT* SERVICE FEE
------------- ------------ ----------- ------------
Institutional............................................... $500,000 None N/A
Select...................................................... $ 50,000 None N/A
Investor.................................................... $ 100 None 0.25%
------------------------
* Certain exceptions apply. See "Institutional Shares" and "Investor and Select
Shares" below.
Please note that Intermediaries (as defined below) may impose additional or
different conditions than the Funds on purchases, redemptions or exchanges of
Fund shares, including different initial, subsequent and maintenance investment
requirements.
INSTITUTIONAL SHARES
Institutional Shares may be purchased by institutions such as endowments and
foundations, plan sponsors of 401(a), 401(k), 457 and 403(b) benefit plans and
individuals, including clients of investment advisers. In order to be eligible
to purchase Institutional Shares, an investor must make an initial investment of
at least $500,000 in the particular Fund. Investment advisers may aggregate
investments across client accounts in order to reach this minimum investment
requirement. In its sole discretion, CSIM may waive this minimum investment
requirement. CSIM may waive this investment minimum for the benefit plans
described above, for certain wrap accounts, and for accounts held through
certain intermediaries. Institutional Shares are sold without any initial or
deferred sales charges and are not subject to any ongoing Distribution and
Shareholder Service Fee.
INVESTOR AND SELECT SHARES
Investor and Select Shares may be purchased by institutions, certain individual
retirement accounts and individuals. In order to be eligible to purchase
Investor and Select Shares, an investor must make an initial investment of at
least $100 and $50,000, respectively, in the particular Fund. In its sole
discretion, CSIM may waive this minimum investment requirement. CSIM may waive
this investment minimum for the benefit plans described above, and for accounts
held through certain intermediaries, including those who have made arrangements
with the Funds to offer shares to their clients as part of various asset
allocation programs. The minimum for Select Shares may also be waived for
certain other investors, including directors, officers and employees of Charles
Schwab and Mondrian. The Trustees have authorized the Trust to reimburse, out of
the Investor and Select Class assets of the Funds, financial intermediaries that
provide sub-accounting and sub-transfer agency services in connection with
Investor or Select Class shares of the Funds an amount up to 0.15% of the
average daily net assets of that class on an annual basis. In addition, as
described above, the Distribution and Shareholder Service Plan that the Trust
has adopted for Investor Shares permits the Trust to reimburse, out of the
Investor Class assets of the Funds, in an amount up to 0.25% of the average
daily net assets of that class on an annual basis, financial intermediaries that
provide services in connection with the distribution of Investor Class shares of
the Funds (see "Management of the Trust--Distributor").
GENERAL
Shares of the Funds may be sold to corporations or other institutions such as
trusts, foundations, broker-dealers or other intermediaries purchasing for the
accounts of others (collectively, "Intermediaries"). Investors purchasing and
redeeming shares of
17
the Funds through an Intermediary may be charged a transaction-based fee or
other fee for the services provided by the Intermediary. Each such Intermediary
is responsible for transmitting to its customers a schedule of any such fees and
information regarding any additional or different conditions with respect to
purchases and redemptions of Fund shares. Customers of Intermediaries should
read this Prospectus in light of the terms governing accounts with their
particular organization.
PURCHASING SHARES
The offering price for shares of each Fund is the net asset value per share next
determined after receipt of a purchase order. See "How the Trust Prices Shares
of the Funds."
If you place an order through an Intermediary, please consult with that
Intermediary to determine when your order will be executed. You receive either
the share price next calculated after your Intermediary has received your order,
if the Intermediary has such an arrangement with a Fund, or the share price next
calculated after a Fund receives your order from your Intermediary. Some
Intermediaries may require your orders prior to a specified cut-off time.
Investors may be charged an additional fee by their Intermediary if they effect
transactions through such persons.
If you deal directly with an Intermediary, you will have to follow the
Intermediary's procedures for transacting with a Fund. For more information
about how to purchase, sell, convert or exchange Fund shares through your
Intermediary, you should contact your Intermediary directly.
INITIAL INVESTMENTS BY WIRE
Subject to acceptance by the Trust, shares of a Fund may be purchased by wiring
federal funds. Please first contact the Trust at 1-800-447-3332 for complete
wiring instructions. Notification must be given to the Trust at 1-800-447-3332
prior to the close of the New York Stock Exchange ("NYSE") (generally 4:00 p.m.,
Eastern time) on the wire date. Federal funds purchases will be accepted only on
a day on which the Trust, the Distributor and the Custodian are all open for
business. A completed Account Application must be faxed to the Trust on the day
the wire is sent and must also be overnighted to the Trust at Laudus Trust, c/o
Boston Financial Data Services, Inc., P.O. Box 8032, Boston, Massachusetts
02266. Please call 1-800-447-3332 for details. Please note the minimum initial
investment requirements for each class as set forth above under "Multiple
Classes." In its sole discretion, CSIM may waive the minimum initial investment
requirements.
INITIAL INVESTMENTS BY MAIL
Subject to acceptance by the Trust, an account may be opened by completing and
signing an Account Application and mailing it, along with a check for the
purchase amount, to Laudus Trust, P.O. Box 8032, Boston, Massachusetts 02266.
The Fund(s) to be purchased should be specified on the Account Application. In
all cases, subject to acceptance by the Trust, payment for the purchase of
shares received by mail will be credited to a shareholder's account at the net
asset value per share of a Fund next determined after receipt, even though the
check may not yet have been converted into federal funds. Please note the
minimum initial investment requirements for each class as set forth above under
"Multiple Classes." In its sole discretion, CSIM may waive the minimum initial
investment requirements.
ADDITIONAL INVESTMENTS
Additional cash investments may be made at any time by mailing a check to the
Trust at the address noted under "Initial Investments by Mail" (payable to
Laudus Trust) or by wiring federal funds as noted under "Initial Investments by
Wire." Notification must be given at 1-800-447-3332 or to the appropriate
broker-dealer prior to the close of the NYSE (generally 4:00 p.m., Eastern time)
on the wire date. Please note each class' minimum additional investment
requirements as set forth above under "Multiple Classes." In its sole
discretion, CSIM may waive the minimum additional investment requirements.
INVESTMENTS IN-KIND (INSTITUTIONAL SHARES)
Institutional Shares may be purchased in exchange for common stocks or by a
combination of such common stocks and cash. Purchase of Institutional Shares of
a Fund in exchange for stocks is subject in each case to CSIM's and the
Subadviser's determination that the stocks to be exchanged are acceptable.
Securities accepted in exchange for Fund shares will be valued as set forth
under "How the Trust Prices Shares of the Funds" (generally the last quoted sale
price) as of the time of the next determination of net asset value after such
acceptance. All dividends, subscription or other rights which are reflected in
the market price of accepted securities at the time of valuation become the
property of the Fund and must be delivered to the Fund upon receipt by the
investor from the issuer. Generally, the exchange of common stocks for
Institutional Shares will be a taxable event for federal income tax purposes,
which will trigger gain or loss to an investor subject to federal income
taxation, measured by the difference between the value of the Institutional
Shares received and the investor's basis in the securities tendered.
Accordingly, you should consult your tax adviser before making such an in-kind
purchase.
A Fund will not accept securities in exchange for Fund shares unless: (i) CSIM
and the Subadviser believe the securities are appropriate investments for the
Fund; (ii) the investor represents and agrees that all securities offered to the
Fund are not subject to
18
any restrictions upon their sale by the Fund under the Securities Act of 1933,
or otherwise; and (iii) the securities may be acquired under the Fund's
investment restrictions.
Due to local restrictions, certain emerging markets may not permit in-kind
transactions.
CUSTOMER IDENTIFICATION AND VERIFICATION AND ANTI-MONEY LAUNDERING PROGRAM
Federal law requires all financial institutions to obtain, verify, and record
information that identifies each person who opens an account. Accounts for the
Funds are generally opened through other financial institutions or
Intermediaries. When you open your account through your financial institution or
Intermediary, you will have to provide your name, address, date of birth,
identification number and other information that will allow the financial
institution or Intermediary to identify you. This information is subject to
verification by the financial institution or Intermediary to ensure the identity
of all persons opening an account.
Your financial institution or Intermediary is required by law to reject your new
account application if the required identifying information is not provided.
Your financial institution or Intermediary may contact you in an attempt to
collect any missing information required on the application, and your
application may be rejected if they are unable to obtain this information. In
certain instances, your financial institution or Intermediary is required to
collect documents, which will be used solely to establish and verify your
identity.
The Funds will accept investments and your order will be processed at the NAV
next determined after receipt of your application in proper form (or upon
receipt of all identifying information required on the application). The Funds,
however, reserve the right to close and/or liquidate your account at the
then-current day's price if the financial institution or Intermediary through
which you open your account is unable to verify your identity. As a result, you
may be subject to a gain or loss on Fund shares and will be subject to
corresponding tax consequences.
Customer identification and verification is part of the Funds' overall
obligation to deter money laundering under Federal law. The Funds have adopted
an Anti-Money Laundering Compliance Program designed to prevent the Funds from
being used for money laundering or the financing of terrorist activities. In
this regard, the Funds reserve the right to (i) refuse, cancel or rescind any
purchase or exchange order, (ii) freeze any account and/or suspend account
services or (iii) involuntarily close your account in cases of threatening
conduct or suspected fraudulent or illegal activity. These actions will be taken
when, in the sole discretion of Fund management, they are deemed to be in the
best interest of the Funds or in cases when the Funds are requested or compelled
to do so by governmental or law enforcement authority. If your account is closed
at the request of governmental or law enforcement authority, you may not receive
proceeds of the redemption if the Funds are required to withhold such proceeds.
FREQUENT PURCHASES AND REDEMPTIONS OF FUND SHARES
Each Fund is intended for long-term investment and not for short-term or
excessive trading (collectively "market timing"). Market timing may adversely
impact a Fund's performance by disrupting the efficient management of the Fund,
increasing Fund transaction costs and taxes, causing the Fund to maintain higher
cash balances, and diluting the value of the Fund's shares.
In order to discourage market timing, each Fund's Board of Trustees has adopted
policies and procedures that are reasonably designed to reduce the risk of
market timing by Fund shareholders. Each Fund seeks to deter market timing
through several methods. These methods may include: fair value pricing,
imposition of redemption fees and trade activity monitoring. Fair value pricing
and redemption fees are discussed more thoroughly in the subsequent pages of
this prospectus and are considered to be key elements of the Funds' policy
regarding short term or excessive trading. Trade activity monitoring is risk
based and seeks to identify patterns of activity in amounts that might be
detrimental to a Fund.
Although these methods are designed to discourage market timing, there can be no
guarantee that a Fund will be able to identify and restrict investors that
engage in such activities. In addition, some of these methods are inherently
subjective and involve judgment in their application. Each Fund and its service
providers seek to make these judgments and applications uniformly and in a
manner that they believe is consistent with interests of a Fund's long-term
shareholders. Each Fund may amend these policies and procedures in response to
changing regulatory requirements or to enhance the effectiveness of the program.
A Fund or its service providers maintain risk-based surveillance procedures
designed to detect market timing in fund shares in amounts that might be
detrimental to a Fund. Under these procedures, the Funds have requested that
service providers to the Funds monitor transactional activity in amounts and
frequency determined by the Funds to be significant to a Fund and in a pattern
of activity that potentially could be detrimental to a Fund. If a Fund, in its
sole discretion based on these or other factors, determines that a shareholder
has engaged in market timing, it may refuse to process future purchases or
exchanges into the Fund by that shareholder. These procedures may be modified
from time to time as appropriate to improve the detection of market timing and
to comply with applicable laws.
If trades are effected through a financial intermediary, each Fund or its
service providers will work with the intermediary to monitor possible market
timing activity. The Funds reserve the right to contact the intermediary to
provide certain shareholder transaction information and may require the
intermediary to restrict the shareholder from future purchases or exchanges in a
Fund. Transactions by Fund shareholders investing through intermediaries may
also be subject to the restrictions of the intermediary's own frequent
19
trading policies, which may differ from those of the Funds. The Funds may defer
to an intermediary's frequent trading policies with respect to those
shareholders who invest in the Funds through such intermediary. The Funds will
defer to an intermediary's policies only after the Funds determine that the
intermediary's frequent trading policies are reasonably designed to deter
transactional activity in amounts and frequency that are deemed to be
significant to a Fund and in a pattern of activity that potentially could be
detrimental to the Fund. Shareholders should consult with the intermediary to
determine if additional frequent trading restrictions apply to their Fund
transactions.
The Funds reserve the right to restrict, reject or cancel within a reasonable
time, without prior notice, any purchase or exchange order for any reason.
OTHER PURCHASE INFORMATION
An eligible shareholder may also participate in the Laudus Funds Automatic
Investment Program, an investment plan that automatically debits money from the
shareholder's bank account or an account at a broker or other Intermediary and
invests it in Investor Shares of one or more of the Funds through the use of
electronic funds transfers. Investors may commence their participation in this
program by making a minimum initial investment that satisfies the minimum
investment amount for Investor Shares and may elect to make subsequent
investments by transfers of a minimum of $50 into their established Fund
account. Intermediaries may establish different minimum subsequent transaction
amounts. You should contact the Trust or your Intermediary for more information
about the Laudus Funds Automatic Investment Program.
For purposes of calculating the purchase price of Fund shares, a purchase order
is received by the Trust on the day that it is in "good order" unless it is
rejected by the Transfer Agent. For a cash purchase order of Fund shares to be
in "good order" on a particular day, a check or money wire must be received on
or before the close of the NYSE (generally 4:00 p.m., Eastern time) on that day.
If the payment is received by the Trust after the deadline, the purchase price
of Fund shares will be based upon the next determination of net asset value of
Fund shares. No currency, third party checks, foreign checks, starter checks,
credit card checks, traveler's checks or money orders will be accepted. In the
case of a purchase in-kind of Institutional Shares, such purchase order will be
rejected if the investor's securities are not placed on deposit at DTC or other
appropriate depository, prior to 10:00 a.m., Eastern time.
The Trust reserves the right, in its sole discretion, to suspend the offering of
shares of a Fund or to reject purchase orders when, in its judgment, such
suspension or rejection would be in the best interests of the Trust or a Fund.
The Trust discourages market timing and maintains procedures designed to provide
reasonable assurances that such activity will be identified and terminated,
including the imposition of the redemption fee. You may be subject to a fee of
2% if you redeem or exchange your shares within 30 days of purchase. See
"Redeeming Shares." Purchases of each Fund's shares may be made in full or in
fractional shares of such Fund (calculated to three decimal places). In the
interest of economy and convenience, certificates for shares will not be issued.
A note on mailing procedures: If two or more members of a household own the
Funds, we economize on Fund expenses by sending only one financial report and
prospectus. If you need additional copies or do not want your mailings to be
"householded", please call the Trust at 1-800-447-3332 or write to the Trust.
INDIVIDUAL RETIREMENT ACCOUNTS
Investor Shares of the Funds may be used to fund individual retirement accounts
("IRAs"). The minimum initial investment for an IRA is $100. A special
application must be completed in order to create such an account.
Contributions to IRAs are subject to prevailing amount limits set by the
Internal Revenue Service. For more information about IRAs, call the Trust at
1-800-447-3332.
REDEEMING SHARES
Shares of the Funds may be redeemed by mail, or, if authorized by an investor in
an Account Application, by telephone. The value of shares redeemed may be more
or less than the original cost of those shares, depending on the market value of
the investment securities held by the particular Fund at the time of the
redemption and on any expenses and charges attributable thereto. CSIM may waive
the application of the short-term redemption fee, discussed above in the
"Purchasing Shares" section, for 401(a), 401(k), 457 and 403(b) retirement
plans, certain wrap accounts, charitable giving funds, unregistered separate
accounts and registered investment companies.
As noted above in the "Purchasing Shares" section, if you deal directly with an
Intermediary, you should contact your Intermediary for more information about
how to redeem Fund shares.
20
BY MAIL
The Trust will redeem its shares at the net asset value per share next
determined after the request is received in "good order." See "How the Trust
Prices Shares of the Funds." Requests should be addressed to Laudus Trust, P.O.
Box 8032, Boston, Massachusetts 02266.
To be in "good order," a request must include the following documentation:
(a) a letter of instruction specifying the number of shares or dollar
amount to be redeemed, signed by all registered owners of the shares in the
exact names in which they are registered;
(b) any required signature guarantees; and
(c) other supporting legal documents, if required, in the case of estates,
trusts, guardianships, custodianships, corporations, pension and profit
sharing plans and other organizations.
SIGNATURE GUARANTEES
To protect shareholder accounts, the Trust and the Transfer Agent from fraud,
signature guarantees may be required to enable the Trust to verify the identity
of the person who has authorized a redemption from an account. Signature
guarantees are required for: (1) redemptions where the proceeds are to be sent
to someone other than the registered shareholder(s) at the registered address,
(2) redemptions if your account address has changed within the last 10 business
days, (3) share transfer requests, and (4) redemptions where the proceeds are
wired in connection with bank instructions not already on file with the Transfer
Agent. Signature guarantees may be obtained from certain eligible financial
institutions, including but not limited to, the following: U.S. banks, trust
companies, credit unions, securities brokers and dealers, savings and loan
associations and participants in the Securities and Transfer Association
Medallion Program ("STAMP"), the Stock Exchange Medallion Program ("SEMP") or
the New York Stock Exchange Medallion Signature Program ("MSP"). Signature
guarantees from non-U.S. banks that do not include a stamp may require a U.S.
consulate stamp. Shareholders may contact the Trust at 1-800-447-3332 for
further details.
BY TELEPHONE
Provided the telephone redemption option has been authorized by an investor in
an Account Application, a redemption of shares may be requested by calling the
Trust at 1-800-447-3332 and requesting that the redemption proceeds be mailed to
the primary registration address or wired per the authorized instructions. If
the telephone redemption option or the telephone exchange option (as described
below) is authorized, the Transfer Agent may act on telephone instructions from
any person representing himself or herself to be a shareholder and believed by
the Transfer Agent to be genuine. The Transfer Agent's records of such
instructions are binding and the shareholder, not the Trust or the Transfer
Agent, bears the risk of loss in the event of unauthorized instructions
reasonably believed by the Transfer Agent to be genuine. The Transfer Agent will
employ reasonable procedures to confirm that instructions communicated are
genuine and, if it does not, it may be liable for any losses due to unauthorized
or fraudulent instructions. The procedures employed in connection with
transactions initiated by telephone include tape recording of telephone
instructions and requiring some form of personal identification prior to acting
upon instructions received by telephone. Payments on telephone redemptions will
be suspended for a period typically expected not to exceed 10 business days
following a telephonic address change.
SYSTEMATIC WITHDRAWAL PLAN
An owner of $12,000 or more of shares of a Fund may elect to have periodic
redemptions made from the investor's account to be paid on a monthly, quarterly,
semiannual or annual basis. The maximum payment per year is 12% of the account
value at the time of the election. The Trust will normally redeem a sufficient
number of shares to make the scheduled redemption payments on a date selected by
the shareholder. Depending on the size of the payment requested and fluctuation
in the net asset value, if any, of the shares redeemed, redemptions for the
purpose of making such payments may reduce or even exhaust the account. A
shareholder may request that these payments be sent to a predesignated bank or
other designated party. Capital gains and dividend distributions paid to the
account will automatically be reinvested at net asset value on the distribution
payment date.
EARLY REDEMPTIONS AND MARKET TIMING
Shares redeemed or exchanged within 30 days of purchase, which shall be
calculated to include the 30th day, will be subject to a fee of 2%, which is
intended to limit short-term trading in the Funds, or to the extent that
short-term trading persists, to impose the costs of that type of activity on the
shareholders who engage in it. Such fee will be paid to the Funds. The Trust
reserves the right, in its sole discretion, to waive such fee when, in its
judgment, such waiver would be in the best interests of the Trust or a Fund. The
Trust may waive the redemption fee for retirement plans, wrap accounts,
charitable giving funds, unregistered separate accounts and registered
investment companies. While the Funds discourage mutual fund market timing and
maintain procedures designed to provide reasonable assurances that such activity
will be identified and terminated, including the imposition of the redemption
fee described above, no policy or procedure can guarantee that all such activity
will in fact be identified or that such activity can be completely eliminated.
21
FURTHER REDEMPTION INFORMATION
The Trust will not make payment on redemptions of shares purchased by check
until payment of the purchase price has been collected, which may take up to
fifteen days after purchase. Shareholders can avoid this delay by utilizing the
wire purchase option.
The Funds reserve the right to redeem your shares in-kind in accordance with the
Funds' procedures and applicable regulatory requirements. If CSIM determines
that it would not be in the best interests of the remaining shareholders of a
Fund to make a redemption payment wholly or partly in cash, such Fund may
instead pay the redemption price in whole or in part by a distribution in-kind
of readily marketable securities held by such Fund. The Trust may commit itself
to pay in cash all requests for redemption by any shareholder of record, limited
in amount with respect to each shareholder during any 90-day period to the
lesser of: (i) $250,000, or (ii) one percent of the net asset value of such Fund
at the beginning of such period. Securities used to redeem Fund shares in-kind
will be valued in accordance with the Funds' procedures for valuation described
under "How the Trust Prices Shares of the Funds." Securities distributed by a
Fund in-kind will be selected by the Subadviser, under CSIM's supervision, in
light of each Fund's objective and generally will be a pro rata distribution of
each security held in a Fund's portfolio. Investors may incur brokerage charges
on the sale of any securities received in payment of redemptions.
The Trust reserves the right to delay settlement for redemptions received in
good order for up to seven days. The Trust may suspend the right of redemption
and may postpone payment for a reasonable period when the NYSE is closed for
other than weekends or holidays, or if permitted by the rules of the Securities
and Exchange Commission ("SEC"), during periods when trading on the NYSE is
restricted or during an emergency declared by the SEC which makes it
impracticable for the Funds to dispose of their securities or to determine the
value of their net assets fairly, or during any other period permitted by the
SEC for the protection of investors.
Due to local restrictions certain emerging markets may not permit in-kind
transactions.
EXCHANGING AND CONVERTING SHARES
As noted above in the "Purchasing Shares" section, if you deal directly with an
Intermediary, you should contact your Intermediary for more information about
how to exchange or convert Fund shares. Upon request, and subject to certain
limitations, shares of a Fund, including any class of shares, may be exchanged
or converted into shares of any other Fund of the Trust, or class of shares. In
order to convert your shares to another class of shares, you must satisfy the
minimum requirements for the new class of shares. If you deal directly with an
Intermediary, please contact your Intermediary to learn more about conversion
limitations that may apply. All other investors should contact the Trust at
1-800-447-3332. Although the Trust has no current intention of terminating or
modifying either the exchange or conversion privileges, it reserves the right to
do so at any time. An exchange of your shares for shares of another Laudus Fund
is taxable as a sale of a security on which a gain or loss may be recognized. A
conversion between classes within a Fund is not generally reported as a taxable
event. Shareholders should receive written confirmation of an exchange or
conversion within a few days of the completion of the transaction. A new account
opened by exchange or conversion must be established with the same name(s),
address(es) and social security number(s) as the existing account. All exchanges
and conversions will be made based on the respective net asset values next
determined following receipt of the request by the Funds containing the
information indicated below.
Shareholders of the Funds will not be permitted to exchange any shares for
shares of the Laudus Rosenberg International Small Capitalization Fund.
Shareholders of the Funds will not be permitted to exchange any of their shares
for shares of the Laudus Rosenberg U.S. Discovery Fund or the Laudus Rosenberg
U.S. Small Capitalization Fund unless such shareholders are also existing
shareholders of the Laudus Rosenberg U.S. Discovery Fund or the Laudus Rosenberg
U.S. Small Capitalization Fund. These Funds of the Trust are offered by a
separate prospectus. Shareholders should obtain and read the prospectus for the
Fund into which you are exchanging prior to placing your order.
EXCHANGE AND CONVERSION BY MAIL
To exchange or convert Fund shares by mail, shareholders should simply send a
letter of instruction to the Trust. The letter of instruction must include: (a)
the investor's account number; (b) the class of shares to be exchanged or
converted; (c) the Fund from and the Fund into which the exchange or conversion
is to be made; (d) the dollar or share amount to be exchanged or converted; and
(e) the signatures of all registered owners or authorized parties.
EXCHANGE AND CONVERSION BY TELEPHONE
To exchange or convert Fund shares by telephone, to ask questions about the
exchange or conversion privileges or to learn about what conditions and
limitations may apply to the exchange and conversion privileges, shareholders
may call the Trust at 1-800-447-3332. If you wish to exchange or convert shares,
please be prepared to give the telephone representative the following
information: (a) the account number, social security number and account
registration; (b) the class of shares to be exchanged or converted; (c) the name
of the Fund from which and the Fund into which the exchange or conversion is to
be made; and (d) the dollar or share amount to be exchanged or converted.
Telephone exchanges or conversions are available only if the shareholder so
indicates by checking the "yes" box on the Account Application. The Trust
employs procedures, including recording telephone calls,
22
testing a caller's identity, and written confirmation of telephone transactions,
designed to give reasonable assurance that instructions communicated by
telephone are genuine, and to discourage fraud. To the extent that a Fund does
not follow such procedures, it may be liable for losses due to unauthorized or
fraudulent telephone instructions. A Fund will not be liable for acting upon
instructions communicated by telephone that it reasonably believes to be
genuine.
The Trust reserves the right to suspend or terminate the privilege of exchanging
or converting shares of the Fund by mail or by telephone at any time.
HOW THE TRUST PRICES SHARES OF THE FUNDS
The Funds are open for business each day that the NYSE is open. The Funds
calculate their share price each business day as of the close of the NYSE
(generally 4:00 p.m. Eastern time). A Fund's share price is its net asset value
per share, or NAV, which is the Fund's net assets divided by the number of its
outstanding shares. Purchases and redemptions will be effected at the NAV next
determined after a Fund receives a purchase or redemption request in good order.
In valuing its securities, the Trust uses the current market value if one is
readily available. Securities held by a Fund for which market prices are not
readily available or for which the Adviser deems the market price to be
unreliable are valued in accordance with fair value procedures established by
the Board of Trustees. Some of the more common reasons that may necessitate that
a security be valued using fair value procedures include: the security's trading
has been halted or suspended; the security has been de-listed from a national
exchange; the security's primary trading market is temporarily closed at a time
when under normal conditions it would be open; or the security's primary pricing
source is not able or willing to provide a price. A Fund's determination of a
security's fair value price often involves the consideration of a number of
subjective factors, and is therefore subject to the unavoidable risk that the
value that the Fund assigns to a security may be higher or lower than the
security's value would be if a reliable market quotation for the security was
readily available. Shareholders should be aware that because foreign markets are
often open on weekends and other days when the Funds are closed, the value of
the Funds' portfolios may change on days when it is not possible to buy or sell
shares of the Funds.
When valuing fixed income securities with remaining maturities of more than 60
days, the funds use the value of the security provided by pricing services. The
pricing services may value fixed income securities at an evaluated price by
employing methodologies that utilize actual market transactions, broker-supplied
valuations, or other methodologies designed to identify the market value for
such securities. When valuing fixed income securities with remaining maturities
of 60 days or less, a fund may use the security's amortized cost, which
approximates the security's market value.
DISTRIBUTIONS
Each Fund intends to pay out as dividends substantially all of its net income
and net short-term and long-term capital gains (after reduction by any available
capital loss carry-forwards). The Funds' policy is to declare and pay
distributions of its dividends and interest annually although it may do so more
frequently as determined by the Trustees of the Trust. Each Fund's policy is to
distribute net short-term capital gains and net long-term gains annually,
although it may do so more frequently as determined by the Trustees of the Trust
to the extent permitted by applicable regulations. The amount of any
distribution will change and there is no guarantee the Funds will declare and
pay dividend income or distribute a capital gain.
All dividends and/or distributions will be paid out in the form of additional
shares of the relevant Fund to which the dividends and/or distributions relate
at net asset value unless the shareholder elects to receive cash. Shareholders
may make this election by marking the appropriate box on the Account Application
or by writing to the Trust.
If you elect to receive distributions in cash and checks are returned and marked
as "undeliverable" or remain uncashed for six months, your cash election will be
changed automatically and your future dividend and capital gains distributions
will be reinvested in that Fund at the per share net asset value determined as
of the date of payment of the distribution. In addition, any undeliverable
checks or checks that remain uncashed for six months will be canceled and will
be reinvested in that Fund at the per share net asset value determined as of the
date of cancellation.
TAXES
PLEASE CONSULT YOUR TAX ADVISOR REGARDING YOUR SPECIFIC QUESTIONS ABOUT FEDERAL,
STATE, AND LOCAL INCOME TAXES.
Each Fund intends to qualify each year as a regulated investment company under
Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code") and
to meet all requirements necessary to avoid paying any federal income or excise
taxes. For federal income tax purposes, distributions of investment income are
generally taxable as ordinary income. Taxes on distributions of capital gains
are determined by how long the Fund owned the investments that generated them,
rather than how long a shareholder has owned his or her shares. Distributions of
net capital gains from the sale of investments that the Fund owned for more than
one
23
year and that are properly designated by the Fund as capital gain dividends will
be taxable as long-term capital gains. Distributions of gains from the sale of
investments that the Fund owned for one year or less will be taxable as ordinary
income. For taxable years beginning on or before December 31, 2010,
distributions of investment income designated by the Fund as derived from
"qualified dividend income" will be taxed in the hands of individuals at the
rates applicable to long-term capital gain, provided holding period and other
requirements are met at both the shareholder and Fund level. Each Fund will
notify its shareholders as to what portion of Fund distributions are designated
as qualified dividend income.
Distributions are taxable to shareholders even if they are paid from income or
gains earned by the Fund before a shareholder's investment (and thus were
included in the price the shareholder paid). Distributions are taxable whether
shareholders receive them in cash or in the form of additional shares of the
Fund to which the distribution relates. Any gain resulting from the sale or
exchange of Fund shares generally will be taxable as capital gains. For tax
purposes, an exchange of your Fund shares for shares of a different Fund is the
same as a sale. The gain or loss generally will be treated as short term if you
held the shares for 12 months or less, long term if you held the shares for
longer.
Long-term capital gain rates applicable to individuals have been temporarily
reduced--in general, to 15% with lower rates applying to taxpayers in the 10%
and 15% rate brackets--for taxable years beginning on or before December 31,
2010.
Each Fund will provide federal tax information annually, including information
about dividends and distributions paid during the preceding year.
A Fund's investments in foreign securities may be subject to foreign withholding
taxes. In that case, a Fund's return on those securities would be decreased. In
addition, a Fund's investments in foreign securities or foreign currencies may
increase or accelerate a Fund's recognition of ordinary income and may affect
the timing or amount of a Fund's distributions. If more than 50% of a Fund's
assets at fiscal year-end is represented by debt and equity securities of
foreign corporations, the Funds intend to elect to permit shareholders who are
U.S. citizens, resident aliens or U.S. corporations to claim a foreign tax
credit or deduction (but not both) on their U.S. income tax returns for their
pro rata portion of qualified taxes paid by a Fund to foreign countries in
respect of foreign securities the Fund has held for at least the minimum period
specified in the Code. For the purposes of the foreign tax credit, each such
shareholder would include in gross income from foreign sources its pro rata
share of such taxes. Certain limitations imposed by the Code may prevent
shareholders from receiving a full foreign tax credit or deduction for their
allocable amount of such taxes.
To the extent such investments are permissible for a Fund, the Fund's
transactions in options, futures contracts, hedging transactions, forward
contracts, equity swap contracts and straddles will be subject to special tax
rules (including mark-to-market, constructive sale, straddle, and wash sale
rules), the effect of which may be to accelerate income to the Fund, defer
losses to the Fund, cause adjustments in the holding periods of the Fund's
securities, convert long-term capital gains into short-term gains or convert
short-term capital losses into long-term capital losses. These rules could
therefore affect the amount, timing and character of distributions to
shareholders. A Fund's use of such transactions may result in the Fund realizing
more short-term capital gains (subject to tax at ordinary income tax rates) and
ordinary income subject to tax at ordinary income tax rates than it would if it
did not engage in such transactions.
The foregoing is a general summary of the federal income tax consequences of
investing in a Fund to shareholders who are U.S. citizens or U.S. corporations.
Shareholders should consult their own tax advisers about the tax consequences of
an investment in a Fund in light of each shareholder's particular tax situation.
Shareholders should also consult their own tax advisers about consequences under
foreign, state, local or other applicable tax laws.
DISCLOSURE OF PORTFOLIO SECURITIES INFORMATION
The Funds may make various types of portfolio securities information available
to shareholders. Information regarding the Funds' policy and procedures on the
disclosure of portfolio securities information is available in the SAI. In
addition, shareholders can learn more about the availability of portfolio
securities information by calling the Funds at 1-800-447-3332.
24
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(LAUDUS FUNDS LOGO)
COMMAND PERFORMANCE(TM)
FOR MORE INFORMATION ABOUT THE FUNDS:
STATEMENT OF ADDITIONAL INFORMATION (SAI):
The SAI provides additional information about the Funds. It is incorporated by
reference into this Prospectus and is legally considered a part of this
Prospectus.
ANNUAL AND SEMI-ANNUAL REPORTS:
Additional information about the Funds' investments is available in the Funds'
Annual and Semi-Annual Reports to shareholders. In the Funds' Annual Report, you
will find a discussion of market conditions and investment strategies that
significantly affected the Funds' performance during the last fiscal year.
You may review and copy, for a fee, the Trust's Annual and Semi-Annual Reports
and the SAI in person at, or by writing to, the Public Reference Section of the
Commission, Washington D.C. 20549-0102, or by electronic request via e-mail at
the following address: publicinfo@sec.gov. Information on the operation of the
Commission's Public Reference Room can be obtained by calling 1-202-551-8090.
You may obtain reports and other information about the Funds for free from the
EDGAR database on the Commission's website at http://www.sec.gov.
You may also obtain free copies of the SAI and the Annual and Semi-Annual
Reports on the Funds' website at www.laudus.com. To request that a copy of the
SAI and the Annual and Semi-Annual Reports be mailed to you, free of charge, or
to request other information about the Funds or make shareholder inquiries, you
may contact the Funds at:
Laudus Trust
P.O. Box 8032
Boston, Massachusetts 02266
1.866.452.8387 Institutional Shares
1.866.452.8387 Registered Investment Professionals
1.800.447.3332 Investor Shares and Select Shares
Laudus Trust
Investment Company Act File No. 811-5547
REG41500 FLT-00 (6/2008)
LAUDUS TRUST
STATEMENT OF ADDITIONAL INFORMATION
LAUDUS MONDRIAN INTERNATIONAL EQUITY FUND
LAUDUS MONDRIAN GLOBAL EQUITY FUND
JUNE 15, 2008
The Statement of Additional Information (SAI) is not a prospectus. It should be
read in conjunction with the Funds' prospectus dated ___________, 2008. To
obtain a free copy of the prospectus, please contact Laudus Trust at P.O. Box
8032, Boston, Massachusetts 02266.
THE INFORMATION IN THIS STATEMENT OF ADDITIONAL INFORMATION IS NOT COMPLETE AND
MAY BE CHANGED. WE MAY NOT SELL THESE SECURITIES UNTIL THE REGISTRATION
STATEMENT FILED WITH THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS
STATEMENT OF ADDITIONAL INFORMATION IS NOT AN OFFER TO SELL THESE SECURITIES AND
IS NOT SOLICITING AN OFFER TO BUY THESE SECURITIES IN ANY STATE WHERE THE OFFER
OR SALE IS NOT PERMITTED.
Each funds are a series of the Laudus Trust (the "Trust").
TABLE OF CONTENTS
Page
INVESTMENT OBJECTIVES, SECURITIES, STRATEGIES,
RISKS AND LIMITATIONS........................................... 2
MANAGEMENT OF THE FUNDS.............................................. 35
INVESTMENT ADVISORY AND OTHER SERVICES .............................. 41
DESCRIPTION OF THE TRUST AND OWNERSHIP OF SHARES..................... 51
OWNERS OF 5% OR MORE OF A FUND'S SHARES.............................. 53
DETERMINATION OF NET ASSET VALUE..................................... 54
PURCHASE AND REDEMPTION OF SHARES.................................... 55
APPENDIX A -- DESCRIPTION OF PROXY VOTING POLICY AND PROCEDURES...... 56
APPENDIX B -- RATINGS OF INVESTMENT SECURITIES....................... 78
REG38790 - 01
INVESTMENT OBJECTIVES, SECURITIES, STRATEGIES, RISKS AND LIMITATIONS
Notice on Shareholder Approval. Unless otherwise indicated in the Prospectus or
this Statement of Additional Information, the investment objective and policies
of each of the funds may be changed without shareholder approval.
INVESTMENT OBJECTIVES
LAUDUS MONDRIAN INTERNATIONAL EQUITY FUND seeks long-term capital appreciation.
LAUDUS MONDRIAN GLOBAL EQUITY FUND seeks long-term capital appreciation.
The following investment policies, securities, strategies, risks and limitations
supplement those set forth in the prospectus and may be changed without
shareholder approval unless otherwise noted. Also, policies and limitations that
state a maximum percentage of assets that may be invested in a security or other
asset, or that set forth a quality standard, shall be measured immediately after
and as a result of a fund's acquisition of such security or asset unless
otherwise noted. Thus, any subsequent change in values, net assets or other
circumstances does not require a fund to sell an investment if it could not then
make the same investment. There is no guarantee the funds will achieve their
objectives.
FUND INVESTMENT POLICIES
It is the Laudus Mondrian International Equity Fund's policy that, under normal
circumstances, it will invest in equity securities of non-U.S. large
capitalization issuers, including the securities of emerging market companies,
that in the Subadviser's opinion, are undervalued at the time of purchase based
on fundamental value analysis employed by the Subadviser. Under normal
circumstances, the fund will invest at least 80% of its net assets (including,
for this purpose, any borrowings for investment purposes) in equity securities.
The fund will notify its shareholders at least 60 days before changing this
policy. The fund considers an "emerging country" to be any country except the
United States, Canada, and those in the Morgan Stanley Capital International
EAFE Index.
It is the Laudus Mondrian Global Equity Fund's policy that, under normal
circumstances, it will invest at least 80% of its net assets in equity
securities. The fund will notify its shareholders at least 60 days before
changing this policy. For purposes of this policy, net assets mean net assets
plus the amount of any borrowings for investment purposes. The fund pursues its
investment objective primarily by investing in equity securities of both U.S.
and non-U.S. issuers, including the securities of emerging market companies,
that, in the Subadviser's opinion, are undervalued at the time of purchase
based on fundamental value analysis employed by the Subadviser.
The Fund considers an "emerging country" to be any country, except the United
States, Canada, and those in EAFE or the Morgan Stanley Capital International
Index.
Each fund seeks to qualify as a "diversified" investment company under
provisions of Subchapter M of the Internal Revenue Code, as amended, however,
the Laudus Mondrian International Equity Fund will not be diversified under the
Investment Company Act of 1940, as amended. A non-diversified portfolio is
believed to be subject to greater risk and volatility because adverse effects
on the portfolio's security holdings may affect a larger portion of the overall
assets.
INVESTMENT SECURITIES, STRATEGIES AND RISKS
The different types of investments that the funds typically may invest in, the
investment techniques they may use and the risks normally associated with these
investments are discussed below. Not all securities or techniques discussed
below are eligible investments for each fund. A fund will make investments that
are intended to help achieve its investment objective.
BANKERS' ACCEPTANCES or notes are credit instruments evidencing a bank's
obligation to pay a draft drawn on it by a customer. These instruments reflect
the obligation both of the bank and of the drawer to pay the full amount of the
instrument upon maturity. A fund will invest only in bankers' acceptances of
banks that have capital, surplus and undivided profits in excess of $100
million.
BOND SUBSTITUTION is a strategy whereby a fund may, from time to time,
substitute one type of investment-grade bond for another. This means that, as an
example, a fund may have a higher weighting in corporate bonds and a lower
weighting in U.S. Treasury securities than its index in order to increase
income. This particular substitution -- a corporate bond substitution -- may
increase a fund's credit risk, although this may be mitigated through increased
diversification in the corporate sector of the bond market.
BORROWING. A fund may borrow for temporary or emergency purposes; for example, a
fund may borrow at times to
2
meet redemption requests rather than sell portfolio securities to raise the
necessary cash. A fund's borrowings will be subject to interest costs. Borrowing
can also involve leveraging when securities are purchased with the borrowed
money. Leveraging creates interest expenses that can exceed the income from the
assets purchased with the borrowed money. In addition, leveraging may magnify
changes in the net asset value of a fund's shares and in its portfolio yield. A
fund will earmark or segregate assets to cover such borrowings in accordance
with positions of the Securities and Exchange Commission ("SEC"). If assets used
to secure a borrowing decrease in value, a fund may be required to pledge
additional collateral to avoid liquidation of those assets.
Each fund may establish lines-of-credit ("lines") with certain banks by which it
may borrow funds for temporary or emergency purposes. A borrowing is presumed to
be for temporary or emergency purposes if it is repaid by a fund within 60 days
and is not extended or renewed. Each fund may use the lines to meet large or
unexpected redemptions that would otherwise force a fund to liquidate securities
under circumstances which are unfavorable to the fund's remaining shareholders.
Each fund will pay a fee to the bank for using the lines.
BRADY BONDS. The funds may invest in Brady Bonds. Brady Bonds are debt
securities issued under the framework of the Brady Plan, an initiative announced
by the U.S. Treasury Secretary, Nicholas F. Brady in 1989, as a mechanism for
debtor nations to restructure their outstanding external indebtedness
(generally, commercial bank debt). Brady Bonds tend to be lower quality and more
speculative than securities of developed country issuers.
Each fund may invest in Brady Bonds. Brady Bonds are securities created through
the exchange of existing commercial bank loans to sovereign entities for new
obligations in connection with debt restructurings under a debt restructuring
plan introduced by former U.S. Secretary of the Treasury, Nicholas F. Brady (the
"Brady Plan"). Brady Plan debt restructurings have been implemented in a number
of countries, including: Argentina, Bolivia, Brazil, Bulgaria, Costa Rica, the
Dominican Republic, Ecuador, Jordan, Mexico, Niger, Nigeria, Panama, Peru, the
Philippines, Poland, Uruguay, and Venezuela. Brady Bonds may be collateralized
or uncollateralized, are issued in various currencies (primarily the U.S.
dollar) and are actively traded in the over-the-counter secondary market. Brady
Bonds are not considered to be U.S. Government securities. U.S.
dollar-denominated, collateralized Brady Bonds, which may be fixed rate par
bonds or floating rate discount bonds, are generally collateralized in full as
to principal by U.S. Treasury zero coupon bonds having the same maturity as the
Brady Bonds. Interest payments on these Brady Bonds generally are collateralized
on a one-year or longer rolling-forward basis by cash or securities in an amount
that, in the case of fixed rate bonds, is equal to at least one year of interest
payments or, in the case of floating rate bonds, initially is equal to at least
one year's interest payments based on the applicable interest rate at that time
and is adjusted at regular intervals thereafter. Certain Brady Bonds are
entitled to "value recovery payments" in certain circumstances, which in effect
constitute supplemental interest payments but generally are not collateralized.
Brady Bonds are often viewed as having three or four valuation components: (i)
the collateralized repayment of principal at final maturity; (ii) the
collateralized interest payments; (iii) the uncollateralized interest payments;
and (iv) any uncollateralized repayment of principal at maturity (these
uncollateralized amounts constitute the "residual risk"). Most Mexican Brady
Bonds issued to date have principal repayments at final maturity fully
collateralized by U.S. Treasury zero coupon bonds (or comparable collateral
denominated in other currencies) and interest coupon payments collateralized on
an 18-month rolling-forward basis by funds held in escrow by an agent for the
bondholders. A significant portion of the Venezuelan Brady Bonds and the
Argentine Brady Bonds issued to date have principal repayments at final maturity
collateralized by U.S. Treasury zero coupon bonds (or comparable collateral
denominated in other currencies) and/or interest coupon payments collateralized
on a 14-month (for Venezuela) or 12-month (for Argentina) rolling-forward basis
by securities held by the Federal Reserve Bank of New York as collateral agent.
Brady Bonds involve various risk factors including residual risk and the history
of defaults with respect to commercial bank loans by public and private entities
of countries issuing Brady Bonds. There can be no assurance that Brady Bonds in
which a fund may invest will not be subject to restructuring arrangements or to
requests for new credit, which may cause the fund to suffer a loss of interest
or principal on any of its holdings.
CAPITAL SECURITIES are certain subordinated bank securities. They are bank
obligations that fall below senior unsecured debt and deposits in liquidation. A
bank's capital comprises share capital reserves and a series of hybrid
instruments also know as capital securities. These securities are used to
augment equity Tier 1 and are usually in the form of subordinated debt. A
capital security has to adhere to supervisory guidelines concerning its
characteristics such as amount, maturity, subordination and deferral language in
order to count as capital. Regulators across the world tend to look toward the
Bank for International Settlements ("BIS") for guidance in setting the capital
adequacy framework for banks. Regulators use these guidelines to place limits on
the proportions and type of capital (including capital securities) allowed to
make up the capital base. Capital adequacy requires not just a certain quantity
of capital but certain types in relationship to the nature of a bank's assets.
Capital securities may be denominated in U.S. or local currency.
CERTIFICATES OF DEPOSIT or time deposits are issued against funds deposited in a
banking institution for a specified period of time at a specified interest rate.
A fund will invest only in certificates of deposit of banks that have capital,
surplus and undivided profits in excess of $100 million.
COMMERCIAL PAPER consists of short term, promissory notes issued by banks,
corporations and other institutions to finance short term credit needs. These
securities generally are discounted but sometimes may be interest bearing.
Commercial paper, which also may be unsecured, is subject to credit risk.
CONCENTRATION means that substantial amounts of assets are invested in a
particular industry or group of industries. Concentration increases investment
exposure to industry risk. For example, the automobile industry may have a
greater exposure to a single factor, such as an increase in the price of oil,
which may adversely affect the sale of automobiles and, as a result, the value
of the industry's securities. Each fund will not concentrate its investments in
a particular industry or group of industries.
CREDIT DEFAULT SWAPS may be entered into for investment purposes. As the seller
in a credit default swap contract, a fund would be required to pay the par (or
other agreed-upon) value of a referenced debt obligation to the counterparty in
the event of a default by a third party, such as a U.S. or foreign corporate
issuer, on the debt obligation. In return, the fund would receive from the
counterparty a periodic stream of payments over the term of the contract
provided that no event of default has occurred. If no default occurs, the fund
would keep the stream of payments and would have no payment obligations. As the
seller, the fund would be subject to investment exposure on the notional amount
of the swap.
A fund may also purchase credit default swap contracts in order to hedge against
the risk of default of debt securities held in its portfolio, in which case the
fund would function as the counterparty referenced in the preceding paragraph.
This would involve the risk that the investment may expire worthless and would
only generate income in the event of an actual default by the issuer of the
underlying obligation (as opposed to a credit downgrade or other indication of
financial instability). It would also involve credit risk -- that the seller may
fail to satisfy its payment obligations to the fund in the event of a default.
CREDIT AND LIQUIDITY supports may be employed by issuers to reduce the credit
risk of their securities. Credit supports include letters of credit, insurance,
total return and credit swap agreements and guarantees provided by foreign and
domestic entities. Liquidity supports include puts, and demand features. Most of
these arrangements move the credit risk of an investment from the issuer of the
security to the support provider. Changes in the credit quality of a support
provider could cause losses to a fund, and affect its share price.
DEBT SECURITIES are obligations issued by domestic and foreign entities,
including governments and corporations, in order to raise money. They are
basically "IOUs," but are commonly referred to as bonds or money market
securities. These securities normally require the issuer to pay a fixed,
variable or floating rate of interest on the amount of money borrowed
("principal") until it is paid back upon maturity.
Debt securities experience price changes when interest rates change. For
example, when interest rates fall, the prices of debt securities generally rise.
Also, issuers tend to pre-pay their outstanding debts and issue new ones paying
lower interest rates. This is especially true for bonds with sinking fund
provisions, which commit the issuer to set aside a certain amount of money to
cover timely repayment of principal and typically allow the issuer to annually
repurchase certain of its outstanding bonds from the open market or at a pre-set
call price.
Conversely, in a rising interest rate environment, prepayment on outstanding
debt securities generally will not occur. This is known as extension risk and
may cause the value of debt securities to depreciate as a result of the higher
market interest rates. Typically, longer-maturity securities react to interest
rate changes more severely than shorter-term securities (all things being
equal), but generally offer greater rates of interest.
Debt securities also are subject to the risk that the issuers will not make
timely interest and/or principal payments or fail to make them at all. This is
called credit risk. Corporate debt securities ("bonds") tend to have higher
credit risk generally than U.S. government debt securities. Debt instruments
also may be subject to price volatility due to market perception of future
interest rates, the creditworthiness of the issuer and general market liquidity
(market risk). Investment-grade debt securities are considered medium- or/and
high-quality securities, although some still possess varying degrees of
speculative characteristics and risks. Debt securities rated below
investment-grade are riskier, but may offer higher yields. These securities are
sometimes referred to as high yield securities or "junk bonds."
The market for these securities has historically been less liquid than
investment grade securities.
DELAYED-DELIVERY TRANSACTIONS include purchasing and selling securities on a
delayed-delivery or when-issued basis. These transactions involve a commitment
to buy or sell specific securities at a predetermined price or yield, with
payment and delivery taking place after the customary settlement period for that
type of security. When purchasing securities on a delayed-delivery basis, a fund
assumes the rights and risks of ownership, including the risk of price and yield
fluctuations. Typically, no interest will accrue to the purchaser until the
security is delivered. A fund will earmark or segregate appropriate liquid
assets to cover its delayed-delivery purchase obligations. When a fund sells a
security on a delayed-delivery basis, it does not participate in further gains
or losses with respect to that security. If the other party to a
delayed-delivery transaction fails to deliver or pay for the securities, a fund
could suffer losses.
DEPOSITARY RECEIPTS include American Depositary Receipts (ADRs) as well as other
"hybrid" forms of ADRs, including European Depositary Receipts (EDRs) and Global
Depositary Receipts (GDRs), are certificates evidencing ownership of shares of a
foreign issuer. Depositary receipts may be sponsored or unsponsored. These
certificates are issued by depository banks and generally trade on an
established market in the United States or elsewhere. The underlying shares are
held in trust by a custodian bank or similar financial institution in the
issuer's home country. The depository bank may not have physical custody of the
underlying securities at all times and may charge fees for various services,
including forwarding dividends and interest and corporate actions. ADRs are
alternatives to directly purchasing the underlying foreign securities in their
national markets and currencies. However, ADRs continue to be subject to many of
the risks associated with investing directly in foreign securities.
Investments in the securities of foreign issuers may subject the funds to
investment risks that differ in some respects from those related to investments
in securities of U.S. issuers. Such risks include future adverse political and
economic developments, withholding taxes on income or possible imposition of
withholding taxes on income, possible seizure, nationalization or expropriation
of foreign deposits, possible establishment of exchange controls or taxation at
the source or greater fluctuation in value due to changes in exchange rates.
Foreign issuers of securities often engage in business practices different from
those of domestic issuers of similar securities, and there may be less
information publicly available about foreign issuers. In addition, foreign
issuers are, generally speaking, subject to less government supervision and
regulation and different accounting treatment than are those in the United
States.
Although the two types of depositary receipt facilities (unsponsored or
sponsored) are similar, there are differences regarding a holder's rights and
obligations and the practices of market participants. A depository may establish
an
3
unsponsored facility without participation by (or acquiescence of) the
underlying issuer; typically, however, the depository requests a letter of
non-objection from the underlying issuer prior to establishing the facility.
Holders of unsponsored depositary receipts generally bear all the costs of the
facility. The depository usually charges fees upon the deposit and withdrawal of
the underlying securities, the conversion of dividends into U.S. dollars or
other currency, the disposition of non-cash distributions, and the performance
of other services. The depository of an unsponsored facility frequently is under
no obligation to distribute shareholder communications received from the
underlying issuer or to pass through voting rights to depositary receipt holders
with respect to the underlying securities.
Sponsored depositary receipt facilities are created in generally the same manner
as unsponsored facilities, except that sponsored depositary receipts are
established jointly by a depository and the underlying issuer through a deposit
agreement. The deposit agreement sets out the rights and responsibilities of the
underlying issuer, the depository, and the depositary receipt holders. With
sponsored facilities, the underlying issuer typically bears some of the costs of
the depositary receipts (such as dividend payment fees of the depository),
although most sponsored depositary receipts holders may bear costs such as
deposit and withdrawal fees. Depositories of most sponsored depositary receipts
agree to distribute notices of shareholder meetings, voting instructions, and
other shareholder communications and information to the depositary receipt
holders at the underlying issuer's request.
DERIVATIVE INSTRUMENTS are commonly defined to include securities or contracts
whose values depend on (or "derive" from) the value of one or more other assets
such as securities, currencies or commodities. These "other assets" are commonly
referred to as "underlying assets."
A derivative instrument generally consists of, is based upon, or exhibits
characteristics similar to options or forward contracts. Options and forward
contracts are considered to be the basic "building blocks" of derivatives. For
example, forward-based derivatives include forward contracts, as well as
exchange-traded futures. Option-based derivatives include privately negotiated,
over-the-counter (OTC) options (including caps, floors, collars, and options on
forward and swap contracts) and exchange-traded options on futures. Diverse
types of derivatives may be created by combining options or forward contracts in
different ways, and applying these structures to a wide range of underlying
assets.
Risk management strategies include investment techniques designed to facilitate
the sale of portfolio securities, manage the average duration of the portfolio
or create or alter exposure to certain asset classes, such as equity, other debt
or foreign securities.
In addition to the derivative instruments and strategies described in this SAI,
the investment adviser or Subadviser expects to discover additional derivative
instruments and other hedging or risk management techniques. The investment
adviser or Subadviser may utilize these new derivative instruments and
techniques to the extent that they are consistent with a fund's investment
objective and permitted by a fund's investment limitations, operating policies,
and applicable regulatory authorities.
EMERGING OR DEVELOPING MARKETS exist in countries that are considered to be in
the initial stages of industrialization. The risks of investing in these markets
are similar to the risks of international investing in general, although the
risks are greater in emerging and developing markets. Countries with emerging or
developing securities markets tend to have economic structures that are less
stable than countries with developed securities markets. This is because their
economies may be based on only a few industries and their securities markets may
trade a small number of securities. Prices on these exchanges tend to be
volatile, and securities in these countries historically have offered greater
potential for gain (as well as loss) than securities of companies located in
developed countries. There are no strict definitions of what is emerging or
developing versus what is considered developed and certain countries are
considered emerging or developing in some indices yet developed in others.
EQUITY LINKED SECURITIES. The funds may invest a portion of their assets in
equity linked securities. Equity linked securities are privately issued
derivative securities which have a return component based on the performance of
a single security, a basket of securities, or an index. Equity linked securities
are primarily used by the funds as an alternative
4
means to more efficiently and effectively access the securities market of what
is generally an emerging country. To the extent that the funds invest in equity
linked securities whose return corresponds to the performance of a foreign
securities index or one or more of foreign stocks, investing in equity linked
securities will involve risks similar to the risks of investing in foreign
securities. See "Foreign Securities" below.
The funds deposit an amount of cash with its custodian (or broker, if legally
permitted) in an amount near or equal to the selling price of the underlying
security in exchange for an equity linked security. Upon sale, the fund receives
cash from the broker or custodian equal to the value of the underlying security.
Aside from the market risk associated with the underlying security, there is the
risk of default by the other party to the transaction. In the event of
insolvency of the other party, the fund might be unable to obtain its expected
benefit. In addition, while the fund will seek to enter into such transactions
only with parties which are capable of entering into closing transactions with
the fund, there can be no assurance that the fund will be able to close out such
a transaction with the other party or obtain an offsetting position with any
other party, at any time prior to the end of the term of the underlying
agreement. This may impair the fund's ability to enter into other transactions
at a time when doing so might be advantageous.
Equity linked securities are often used for many of the same purposes as, and
share many of the same risks with, derivative instruments such as options. See
"Options" below. Equity linked securities may be considered illiquid and thus
subject to a fund's restrictions on investments in illiquid securities. In some
instances, investments in equity linked securities may also be subject to a
fund's limitations on investing in investment companies; see "Investment Company
Securities" below.
EQUITY SECURITIES represent ownership interests in a company, and are commonly
called "stocks." Equity securities historically have outperformed most other
securities, although their prices can fluctuate based on changes in a company's
financial condition, market conditions and political, economic or even
company-specific news. When a stock's price declines, its market value is
lowered even though the intrinsic value of the company may not have changed.
Sometimes factors, such as economic conditions or political events, affect the
value of stocks of companies of the same or similar industry or group of
industries, and may affect the entire stock market.
Types of equity securities include common stocks, preferred stocks, convertible
securities, warrants, ADRs, EDRs, GDRs, and interests in real estate investment
trusts, (for more information on real estate investment trusts, "REITs", see
section entitled "Real Estate Investment Trusts").
Common stocks, which are probably the most recognized type of equity security,
represent an equity or ownership interest in an issuer and usually entitle the
owner to voting rights in the election of the corporation's directors and any
other matters submitted to the corporation's shareholders for voting, as well as
to receive dividends on such stock. The market value of common stock can
fluctuate widely, as it reflects increases and decreases in an issuer's
earnings. In the event an issuer is liquidated or declares bankruptcy, the
claims of bond owners, other debt holders and owners of preferred stock take
precedence over the claims of common stock owners.
Preferred stocks represent an equity or ownership interest in an issuer but do
not ordinarily carry voting rights, though they may carry limited voting rights.
Preferred stocks normally have preference over the corporation's assets and
earnings, however. For example, preferred stocks have preference over common
stock in the payment of dividends. Preferred stocks normally pay dividends at a
specified rate. However, preferred stock may be purchased where the issuer has
omitted, or is in danger of omitting, payment of its dividend. Such investments
would be made primarily for their capital appreciation potential. In the event
an issuer is liquidated or declares bankruptcy, the claims of bond owners take
precedence over the claims of preferred and common stock owners. Certain classes
of preferred stock are convertible into shares of common stock of the issuer. By
holding convertible preferred stock, a fund can receive a steady stream of
dividends and still have the option to convert the preferred stock to common
stock. Preferred stock is subject to many of the same risks as common stock and
debt securities.
Convertible securities are typically preferred stocks or bonds that are
exchangeable for a specific number of another form
5
of security (usually the issuer's common stock) at a specified price or ratio. A
convertible security generally entitles the holder to receive interest paid or
accrued on bonds or the dividend paid on preferred stock until the convertible
security matures or is redeemed, converted or exchanged. A company may issue a
convertible security that is subject to redemption after a specified date, and
usually under certain circumstances. A holder of a convertible security that is
called for redemption would be required to tender it for redemption to the
issuer, convert it to the underlying common stock or sell it to a third party.
The convertible structure allows the holder of the convertible bond to
participate in share price movements in the company's common stock. The actual
return on a convertible bond may exceed its stated yield if the company's common
stock appreciates in value and the option to convert to common stocks becomes
more valuable.
Convertible securities typically pay a lower interest rate than nonconvertible
bonds of the same quality and maturity because of the convertible feature.
Convertible securities are also rated below investment grade ("high yield") or
are not rated, and are subject to credit risk.
Prior to conversion, convertible securities have characteristics and risks
similar to nonconvertible debt and equity securities. In addition, convertible
securities are often concentrated in economic sectors, which, like the stock
market in general, may experience unpredictable declines in value, as well as
periods of poor performance, which may last for several years. There may be a
small trading market for a particular convertible security at any given time,
which may adversely impact market price and a fund's ability to liquidate a
particular security or respond to an economic event, including deterioration of
an issuer's creditworthiness.
Convertible preferred stocks are nonvoting equity securities that pay a fixed
dividend. These securities have a convertible feature similar to convertible
bonds, but do not have a maturity date. Due to their fixed income features,
convertible securities provide higher income potential than the issuer's common
stock, but typically are more sensitive to interest rate changes than the
underlying common stock. In the event of a company's liquidation, bondholders
have claims on company assets senior to those of shareholders; preferred
shareholders have claims senior to those of common shareholders.
Convertible securities typically trade at prices above their conversion value,
which is the current market value of the common stock received upon conversion,
because of their higher yield potential than the underlying common stock. The
difference between the conversion value and the price of a convertible security
will vary depending on the value of the underlying common stock and interest
rates. When the underlying value of the common stocks declines, the price of the
issuer's convertible securities will tend not to fall as much because the
convertible security's income potential will act as a price support. While the
value of a convertible security also tends to rise when the underlying common
stock value rises, it will not rise as much because their conversion value is
more narrow. The value of convertible securities also is affected by changes in
interest rates. For example, when interest rates fall, the value of convertible
securities may rise because of their fixed income component.
Warrants are types of securities usually issued with bonds and preferred stock
that entitle the holder to purchase a proportionate amount of common stock at a
specified price for a specific period of time. The prices of warrants do not
necessarily move parallel to the prices of the underlying common stock. Warrants
have no voting rights, receive no dividends and have no rights with respect to
the assets of the issuer. If a warrant is not exercised within the specified
time period, it will become worthless and the fund will lose the purchase price
it paid for the warrant and the right to purchase the underlying security.
INITIAL PUBLIC OFFERING. The funds may purchase shares issued as part of, or a
short period after, a company's initial public offering ("IPOs"), and may at
times dispose of those shares shortly after their acquisition. A fund's purchase
of shares issued in IPOs exposes it to the risks associated with companies that
have little operating history as public companies, as well as to the risks
inherent in those sectors of the market where these new issuers operate. The
market for IPO issuers has been volatile, and share prices of newly-public
companies have fluctuated significantly over short periods of time.
6
MASTER LIMITED PARTNERSHIPS ("MLPS"). MLPs are limited partnerships in which the
common units are publicly traded. MLP common units are freely traded on a
securities exchange or in the over-the-counter market and are generally
registered with the SEC. MLPs often own several properties or businesses (or own
interests) that are related to real estate development and oil and gas
industries, but they also may finance motion pictures, research and development
and other projects. MLPs generally have two classes of owners, the general
partner and limited partners. The general partner is typically owned by a major
energy company, an investment fund, the direct management of the MLP or is an
entity owned by one or more of such parties. The general partner may be
structured as a private or publicly traded corporation or other entity. The
general partner typically controls the operations and management of the MLP
through an up to 2% equity interest in the MLP plus, in many cases, ownership of
common units and subordinated units. Limited partners own the remainder of the
partnership, through ownership of common units, and have a limited role, if any,
in the partnership's operations and management.
MLPs are typically structured such that common units and general partner
interests have first priority to receive quarterly cash distributions up to an
established minimum amount ("minimum quarterly distributions"). Common and
general partner interests also accrue arrearages in distributions to the extent
the minimum quarterly distribution is not paid. Once common and general partner
interests have been paid, subordinated units receive distributions of up to the
minimum quarterly distribution; however, subordinated units do not accrue
arrearages. Distributable cash in excess of the minimum quarterly distribution
paid to both common and subordinated units is distributed to both common and
subordinated units generally on a pro rata basis. The general partner is also
eligible to receive incentive distributions if the general partner operates the
business in a manner which results in distributions paid per common unit
surpassing specified target levels. As the general partner increases cash
distributions to the limited partners, the general partner receives an
increasingly higher percentage of the incremental cash distributions. A common
arrangement provides that the general partner can reach a tier where it receives
50% of every incremental dollar paid to common and subordinated unit holders.
These incentive distributions are intended to encourage the general partner to
streamline costs, increase capital expenditures and acquire assets in order to
increase the partnership's cash flow and raise the quarterly cash distribution
in order to reach higher tiers. Such results are intended to benefit all
security holders of the MLP, however, such incentive distribution payments give
rise to potential conflicts of interest between the common unit holders and the
general partner.
MLP common units represent a limited partnership interest in the MLP. Common
units are listed and traded on U.S. securities exchanges or over-the-counter,
with their value fluctuating predominantly based on prevailing market conditions
and the success of the MLP. The funds may purchase common units in market
transactions as well as directly from the MLP or other parties in private
placements. Unlike owners of common stock of a corporation, owners of common
units have limited voting rights and have no ability to annually elect
directors. MLPs generally distribute all available cash flow (cash flow from
operations less maintenance capital expenditures) in the form of quarterly
distributions. Common units along with general partner units, have first
priority to receive quarterly cash distributions up to the minimum quarterly
distribution and have arrearage rights. In the event of liquidation, common
units have preference over subordinated units, but not debt or preferred units,
to the remaining assets of the MLP.
MLP subordinated units are typically issued by MLPs to their original sponsors,
such as their founders, corporate general partners of MLPs, entities that sell
assets to the MLP, and investors. Subordinated units may be purchased directly
from these persons as well as newly-issued subordinated units from MLPs
themselves. Subordinated units have similar voting rights as common units and
are generally not publicly traded. Once the minimum quarterly distribution on
the common units, including any arrearages, has been paid, subordinated units
receive cash distributions up to the minimum quarterly distribution prior to any
incentive payments to the MLP's general partner. Unlike common units,
subordinated units do not have arrearage rights. In the event of liquidation,
common units and general partner interests have priority over subordinated
units. Subordinated units are typically converted into common units on a
one-to-one basis after certain time periods and/or performance targets have been
satisfied. The purchase or sale price of subordinated units is generally tied to
the common unit price less a discount. The size of the discount varies depending
on the likelihood of conversion, the length of time remaining to conversion, the
size of the block purchased relative to trading volumes, and other factors,
including smaller capitalization partnerships or companies potentially having
limited product lines, markets or financial resources, lacking management depth
or experience, and being more vulnerable to adverse general market or economic
7
development than larger more established companies.
General partner interests of MLPs are typically retained by an MLP's original
sponsors, such as its founders, corporate partners, entities that sell assets to
the MLP and investors. A holder of general partner interests can be liable under
certain circumstances for amounts greater than the amount of the holder's
investment in the general partner interest. General partner interests often
confer direct board participation rights and in many cases, operating control,
over the MLP. These interests themselves are not publicly traded, although they
may be owned by publicly traded entities. General partner interests receive cash
distributions, typically 2% of the MLP's aggregate cash distributions, which are
contractually defined in the partnership agreement. In addition, holders of
general partner interests typically hold incentive distribution rights, which
provide them with a larger share of the aggregate MLP cash distributions as the
distributions to limited partner unit holders are increased to prescribed
levels. General partner interests generally cannot be converted into common
units. The general partner interest can be redeemed by the MLP if the MLP
unitholders choose to remove the general partner, typically with a supermajority
vote by limited partner unitholders.
Additional risks involved with investing in a MLP are risks associated with the
specific industry or industries in which the partnership invests, such as the
risks of investing in real estate, or oil and gas industries.
Certain MLPs are dependent on their parent companies or sponsors for a majority
of their revenues. Any failure by a MLP's parents or sponsors to satisfy their
payments or obligations would impact the MLP's revenues and cash flows and
ability to make distributions.
EXCHANGE TRADED FUNDS ("ETFS") such as Standard and Poor's Depositary Receipts
("SPDRs") Trust, are investment companies that typically are registered under
the 1940 Act as open-end funds or unit investment trusts ("UITs"). ETFs are
actively traded on national securities exchanges and are generally based on
specific domestic and foreign market indices. Shares of an ETF may be bought and
sold throughout the day at market prices, which may be higher or lower than the
shares' net asset value. An "index-based ETF" seeks to track the performance of
an index holding in its portfolio either the contents of the index or a
representative sample of the securities in the index. Because ETFs are based on
an underlying basket of stocks or an index, they are subject to the same market
fluctuations as these types of securities in volatile market swings. ETFs, like
mutual funds, have expenses associated with their operation, including advisory
fees. When a fund invests in an ETF, in addition to directly bearing expenses
associated with its own operations, it will bear a pro rata portion of the ETF's
expenses. As with any exchange listed security, ETF shares purchased in the
secondary market are subject to customary brokerage charges.
Pursuant to an exemptive order issued by the Securities and Exchange Commission
to iShares and procedures approved by the funds' Board of Trustees, each fund
may invest in iShares not to exceed 25% of the fund's total assets, provided
that the fund has described exchange-traded fund investments in its prospectuses
and otherwise complies with the conditions of the exemptive order and other
applicable investment limitations.
EVENT-LINKED BONDS. Each fund may invest up to 5% of its net assets in
"event-linked bonds," which are fixed income securities for which the return of
principal and payment of interest is contingent on the non-occurrence of a
specific "trigger" event, such as a hurricane, earthquake, or other physical or
weather-related phenomenon. Some event-linked bonds are commonly referred to as
"catastrophe bonds." If a trigger event occurs, a fund may lose a portion or all
of its principal invested in the bond. Event-linked bonds often provide for an
extension of maturity to process and audit loss claims where a trigger event
has, or possibly has, occurred. An extension of maturity may increase
volatility. Event-linked bonds may also expose a fund to certain unanticipated
risks including credit risk, adverse regulatory or jurisdictional
interpretations, and adverse tax consequences. Event-linked bonds may also be
subject to liquidity risk.
FIXED RATE CAPITAL SECURITIES (FRCSs) are hybrid securities that combine the
features of both corporate bonds and preferred stock. FRCSs pay dividends
monthly or quarterly. FRCSs are listed on major exchanges and, also, trade on
the OTC markets. FRCSs are generally issued by large corporations and are rated
by a national rating service organizations ("NRSOs"). FRCSs bear the
creditworthiness of the corporate issuer, generally have a stated maturity (20
to 49 years), and, unlike preferred stock, are fully taxable. There are
currently three types of FRCSs offered in the marketplace: direct subordinate
FRCSs which are offered directly by a corporation and zero coupon partnership
preferred and trust preferred FRCS which are issued indirectly by a corporation
through a conduit financing vehicle. FRCSs generally rank senior to common stock
and preferred stock in a corporation's capital structure, but have a lower
security claim than the issuer's corporate bonds. FRCSs generally offer higher
yields than corporate bonds or agency securities, but they carry more risks than
the higher lien debt. In addition to risks commonly associated with other fixed
income securities, FRCSs are subject to certain additional risks. Many FRCs
include a "special event" redemption option, allowing the issuer to redeem the
securities at the liquidation value if a tax law change disallows the
deductibility of payments by the issuer's parent company, or subjects the issue
to taxation separate from the parent company. FRCs
8
permit the deferral of payments (without declaring default), if the issuer
experiences financial difficulties. Payments may be suspended for some
stipulated period, usually up to five years. If the issuer defers payments, the
deferred income continues to accrue for tax purposes, even though the investor
does not receive cash payments. Such deferrals can only occur if the parent
company stops all other stock dividend payments on both common and preferred
stock classes. The treatment of investment income from trust and debt securities
for federal tax purposes is uncertain and may vary depending on whether the
possibility of the issuer deferring payments is, or is not, considered a remote
contingency.
FIXED TIME DEPOSITS are bank obligations payable at a stated maturity date and
bearing interest at a fixed rate. Fixed time deposits may be withdrawn on demand
by the investor, but may be subject to early withdrawal penalties, which vary
depending upon market conditions and the remaining maturity of the obligation.
There are no contractual restrictions on the right to transfer a beneficial
interest in a fixed time deposit to a third party, although there is no market
for such deposits. A fund will not invest in fixed time deposits, which (1) are
not subject to prepayment or (2) provide for withdrawal penalties upon
prepayment (other than overnight deposits) if, in the aggregate, more than 15%
of its net assets would be invested in such deposits, repurchase agreements
maturing in more than seven days and other illiquid assets.
FOREIGN CURRENCY TRANSACTIONS. The funds that may invest in foreign
currency-denominated securities also may purchase and sell foreign currency
options and foreign currency futures contracts and related options and may
engage in foreign currency transactions either on a spot (cash) basis at the
rate prevailing in the currency exchange market at the time or through forward
currency contracts ("forwards") with terms generally of less than one year.
Funds may engage in these transactions in order to protect against uncertainty
in the level of future foreign exchange rates in the purchase and sale of
securities.
The funds may also use foreign currency options and foreign currency forward
contracts to increase exposure to a foreign currency or to shift exposure to
foreign currency fluctuations from one country to another (as in cross hedging,
see below). Each fund will earmark or segregate assets for any open positions in
forwards used for non-hedging purposes and mark to market daily as may be
required under the federal securities laws.
A forward involves an obligation to purchase or sell a specific currency at a
future date, which may be any fixed number of days from the date of the contract
agreed upon by the parties, at a price set at the time of the contract. These
contracts may be bought or sold to protect a fund against a possible loss
resulting from an adverse change in the relationship between foreign currencies
and the U.S. dollar or to increase exposure to a particular foreign currency.
Many foreign securities markets do not settle trades within a time frame that
would be considered customary in the U.S. stock market. Therefore, a fund may
engage in forward foreign currency exchange contracts in order to secure
exchange rates for fund securities purchased or sold, but awaiting settlement.
These transactions do not seek to eliminate any fluctuations in the underlying
prices of the securities involved. Instead, the transactions simply establish a
rate of exchange that can be expected when the fund settles its securities
transactions in the future. Forwards involve certain risks. For example, if the
counterparties to the contracts are unable to meet the terms of the contracts or
if the value of the foreign currency changes unfavorably, the fund could sustain
a loss.
Funds also may engage in forward foreign currency exchange contracts to protect
the value of specific portfolio positions, which is called "position hedging."
When engaging in position hedging, a fund may enter into forward foreign
currency exchange transactions to protect against a decline in the values of the
foreign currencies in which portfolio securities are denominated (or against an
increase in the value of currency for securities that the fund expects to
purchase).
Buying and selling foreign currency exchange contracts involves costs and may
result in losses. The ability of a fund to engage in these transactions may be
limited by tax considerations. Although these techniques tend to minimize the
risk of loss due to declines in the value of the hedged currency, they tend to
limit any potential gain that might result from an increase in the value of such
currency. Transactions in these contracts involve certain other risks.
Unanticipated fluctuations in currency prices may result in a poorer overall
performance for the funds than if they had not engaged in any such transactions.
Moreover, there may be imperfect correlation between the fund's holdings of
securities denominated in a particular currency and forward contracts into which
the fund enters. Such imperfect correlation may cause a fund to sustain losses,
which will prevent it from achieving a complete hedge or expose it to risk of
foreign exchange loss.
Suitable hedging transactions may not be available in all circumstances and
there can be no assurance that a fund will engage in such transactions at any
given time or from time to time. Also, such transactions may not be successful
and may eliminate any chance for a fund to benefit from favorable fluctuations
in relevant foreign currencies.
Forwards will be used primarily to adjust the foreign exchange exposure of each
fund with a view to protecting the
9
outlook, and the funds might be expected to enter into such contracts under the
following circumstances:
LOCK IN. When the investment adviser or Subadviser desires to lock in the U.S.
dollar price on the purchase or sale of a security denominated in a foreign
currency.
CROSS HEDGE. If a particular currency is expected to decrease against another
currency, a fund may sell the currency expected to decrease and purchase a
currency which is expected to increase against the currency sold in an amount
approximately equal to some or all of the fund's portfolio holdings denominated
in the currency sold.
DIRECT HEDGE. If the investment adviser or Subadviser wants to a eliminate
substantially all of the risk of owning a particular currency, and/or if the
investment adviser or Subadviser thinks that a fund can benefit from price
appreciation in a given country's bonds but does not want to hold the currency,
it may employ a direct hedge back into the U.S. dollar. In either case, a fund
would enter into a forward contract to sell the currency in which a portfolio
security is denominated and purchase U.S. dollars at an exchange rate
established at the time it initiated the contract. The cost of the direct hedge
transaction may offset most, if not all, of the yield advantage offered by the
foreign security, but a fund would benefit from an increase in value of the
bond.
PROXY HEDGE. The investment adviser or Subadviser might choose to use a proxy
hedge, which may be less costly than a direct hedge. In this case, a fund,
having purchased a security, will sell a currency whose value is believed to be
closely linked to the currency in which the security is denominated. Interest
rates prevailing in the country whose currency was sold would be expected to be
closer to those in the U.S. and lower than those of securities denominated in
the currency of the original holding. This type of hedging entails greater risk
than a direct hedge because it is dependent on a stable relationship between the
two currencies paired as proxies and the relationships can be very unstable at
times.
COSTS OF HEDGING. When a fund purchases a foreign bond with a higher interest
rate than is available on U.S. bonds of a similar maturity, the additional yield
on the foreign bond could be substantially reduced or lost if the fund were to
enter into a direct hedge by selling the foreign currency and purchasing the
U.S. dollar. This is what is known as the "cost" of hedging. Proxy hedging
attempts to reduce this cost through an indirect hedge back to the U.S. dollar.
It is important to note that hedging costs are treated as capital transactions
and are not, therefore, deducted from a fund's dividend distribution and are not
reflected in its yield. Instead such costs will, over time, be reflected in a
fund's net asset value per share.
TAX CONSEQUENCES OF HEDGING. Under applicable tax law, the funds may be required
to limit their gains from hedging in foreign currency forwards, futures, and
options. Although the funds are expected to comply with such limits, the extent
to which these limits apply is subject to tax regulations as yet unissued.
Hedging may also result in the application of the mark-to-market and straddle
provisions of the Internal Revenue Code. Those provisions could result in an
increase (or decrease) in the amount of taxable dividends paid by the funds and
could affect whether dividends paid by the funds are classified as capital gains
or ordinary income.
FOREIGN SECURITIES involve additional risks, including foreign currency exchange
rate risks, because they are issued by foreign entities, including foreign
governments, banks and corporations or because they are traded principally
overseas. Foreign securities in which the funds may invest include foreign
entities that are not subject to uniform accounting, auditing and financial
reporting standards, practices and requirements comparable to those applicable
to U.S. corporations. In addition, there may be less publicly available
information about foreign entities. Foreign economic, political and legal
developments, as well as fluctuating foreign currency exchange rates and
withholding taxes, could have more dramatic effects on the value of foreign
securities. For example, conditions within and around foreign countries, such as
the possibility of expropriation or confiscatory taxation, political or social
instability, diplomatic developments, change of government or war could affect
the value of foreign investments. Moreover, individual foreign economies may
differ favorably or unfavorably from the U.S. economy in such respects as growth
of gross national product, rate of inflation, capital reinvestment, resource
self-sufficiency and balance of payments position.
10
Foreign securities typically have less volume and are generally less liquid and
more volatile than securities of U.S. companies. Fixed commissions on foreign
securities exchanges are generally higher than negotiated commissions on U.S.
exchanges, although the funds will endeavor to achieve the most favorable
overall results on portfolio transactions. There is generally less government
supervision and regulation of foreign securities exchanges, brokers, dealers and
listed companies than in the United States, thus increasing the risk of delayed
settlements of portfolio transactions or loss of certificates for portfolio
securities. There may be difficulties in obtaining or enforcing judgments
against foreign issuers as well. Bankruptcy laws in some foreign countries are
sometimes biased to the borrowers and against the creditors. These factors and
others may increase the risks with respect to the liquidity of a fund, and its
ability to meet a large number of shareholder redemption requests.
Foreign markets also have different clearance and settlement procedures and, in
certain markets, there have been times when settlements have been unable to keep
pace with the volume of securities transactions, making it difficult to conduct
such transactions. Such delays in settlement could result in temporary periods
when a portion of the assets of a fund is uninvested and no return is earned
thereon. The inability to make intended security purchases due to settlement
problems could cause a fund to miss attractive investment opportunities. Losses
to a fund arising out of the inability to fulfill a contract to sell such
securities also could result in potential liability for a fund.
Investments in the securities of foreign issuers may be made and held in foreign
currencies. In addition, the funds may hold cash in foreign currencies. These
investments may be affected favorably or unfavorably by changes in currency
rates and in exchange control regulations, and may cause a fund to incur costs
in connection with conversions between various currencies. The rate of exchange
between the U.S. dollar and other currencies is determined by the forces of
supply and demand in the foreign exchange market as well as by political and
economic factors. Changes in the foreign currency exchange rates also may affect
the value of dividends and interest earned, gains and losses realized on the
sale of securities, and net investment income and gains, if any, to be
distributed to shareholders by a fund.
FORWARD CONTRACTS are sales contracts between a buyer (holding the "long"
position), and the seller (holding the "short" position) for an asset with
delivery deferred to a future date. The buyer agrees to pay a fixed price at the
agreed future date and the seller agrees to deliver the asset. The seller hopes
that the market price on the delivery date is less than the agreed upon price,
while the buyer hopes for the contrary. The change in value of a forward-based
derivative generally is roughly proportional to the change in value of the
underlying asset.
FUTURES CONTRACTS are instruments that represent an agreement between two
parties that obligates one party to buy, and the other party to sell, specific
instruments at an agreed-upon price on a stipulated future date. In the case of
futures contracts relating to an index or otherwise not calling for physical
delivery at the close of the transaction, the parties usually agree to deliver
the final cash settlement price of the contract. A fund may purchase and sell
futures contracts based on securities, securities indices and foreign
currencies, interest rates, or any other futures contracts traded on U.S.
exchanges or boards of trade that the Commodities Future Trading Commission
("CFTC") licenses and regulates on foreign exchanges. Consistent with CFTC
regulations, the trust has claimed an exclusion from the definition of the term
"commodity pool operator" under the Commodity Exchange Act and, therefore, is
not subject to registration or regulation as a pool operator under the Commodity
Exchange Act. Although positions are usually marked to market on a daily basis
with an intermediary (executing broker) there remains a credit risk with the
futures exchange.
Each fund must maintain a small portion of its assets in cash to process
shareholder transactions in and out of the fund and to pay its expenses. In
order to reduce the effect this otherwise uninvested cash would have on its
performance, a fund may purchase futures contracts. Such transactions allow the
fund's cash balance to produce a return similar to that of the underlying
security or index on which the futures contract is based. Also, a fund may
purchase or sell futures contracts on a specified foreign currency to "fix" the
price in U.S. dollars of the foreign security it has acquired or sold or expects
to acquire or sell. A fund may enter into futures contracts for other reasons as
well. For example, to efficiently change the duration stance of the fund by
buying and/or selling government bond futures.
When buying or selling futures contracts, a fund must place a deposit with its
broker equal to a fraction of the contract
11
amount. This amount is known as "initial margin" and must be in the form of
liquid debt instruments, including cash, cash-equivalents and U.S. government
securities. Subsequent payments to and from the broker, known as "variation
margin" may be made daily, if necessary, as the value of the futures contracts
fluctuate. This process is known as "marking-to-market." The margin amount will
be returned to the fund upon termination of the futures contracts assuming all
contractual obligations are satisfied. Because margin requirements are normally
only a fraction of the amount of the futures contracts in a given transaction,
futures trading can involve a great deal of leverage. In order to avoid this,
each fund will earmark or segregate assets for any outstanding futures contracts
as may be required under the federal securities laws.
While a fund intends to purchase and sell futures contracts in order to simulate
full investment, there are risks associated with these transactions. Adverse
market movements could cause a fund to experience substantial losses when buying
and selling futures contracts. Of course, barring significant market
distortions, similar results would have been expected if a fund had instead
transacted in the underlying securities directly. There also is the risk of
losing any margin payments held by a broker in the event of its bankruptcy.
Additionally, a fund incurs transaction costs (i.e. brokerage fees) when
engaging in futures trading. To the extent a fund also invests in futures in
order to simulate full investment, these same risks apply.
When interest rates are rising or securities prices are falling, a fund may
seek, through the sale of futures contracts, to offset a decline in the value of
their current portfolio securities. When rates are falling or prices are rising,
a fund, through the purchase of futures contracts, may attempt to secure better
rates or prices than might later be available in the market when they effect
anticipated purchases. Similarly, a fund may sell futures contracts on a
specified currency to protect against a decline in the value of that currency
and their portfolio securities that are denominated in that currency. A fund may
purchase futures contracts on a foreign currency to fix the price in U.S.
dollars of a security denominated in that currency that a fund have acquired or
expect to acquire.
Futures contracts normally require actual delivery or acquisition of an
underlying security or cash value of an index on the expiration date of the
contract. In most cases, however, the contractual obligation is fulfilled before
the date of the contract by buying or selling, as the case may be, identical
futures contracts. Such offsetting transactions terminate the original contracts
and cancel the obligation to take or make delivery of the underlying securities
or cash. There may not always be a liquid secondary market at the time a fund
seeks to close out a futures position. If a fund is unable to close out its
position and prices move adversely, the fund would have to continue to make
daily cash payments to maintain its margin requirements. If a fund had
insufficient cash to meet these requirements it may have to sell portfolio
securities at a disadvantageous time or incur extra costs by borrowing the cash.
Also, a fund may be required to make or take delivery and incur extra
transaction costs buying or selling the underlying securities. A fund seeks to
reduce the risks associated with futures transactions by buying and selling
futures contracts that are traded on national exchanges or for which there
appears to be a liquid secondary market.
HYBRID INSTRUMENTS are a type of potentially high-risk derivative that combines
a traditional stock, bond, or commodity with an option or forward contract.
Generally, the principal amount, amount payable upon maturity or redemption, or
interest rate of a hybrid is tied (positively or negatively) to the price of
some commodity, currency or securities index or another interest rate or some
other economic factor (each a "benchmark"). The interest rate or (unlike most
fixed income securities) the principal amount payable at maturity of a hybrid
security may be increased or decreased, depending on changes in the value of the
benchmark. An example of a hybrid could be a bond issued by an oil company that
pays a small base level of interest with additional interest that accrues in
correlation to the extent to which oil prices exceed a certain predetermined
level. Such a hybrid instrument would be a combination of a bond and a call
option on oil.
Hybrids can be used as an efficient means of pursuing a variety of investment
goals, including currency hedging, duration management, and increased total
return. Hybrids may not bear interest or pay dividends. The value of a hybrid or
its interest rate may be a multiple of a benchmark and, as a result, may be
leveraged and move (up or down) more steeply and rapidly than the benchmark.
These benchmarks may be sensitive to economic and political events, such as
commodity shortages and currency devaluations, which cannot be readily foreseen
by the purchaser of a hybrid. Under certain
12
conditions, the redemption value of a hybrid could be zero. Thus, an investment
in a hybrid may entail significant market risks that are not associated with a
similar investment in a traditional, U.S. dollar-denominated bond that has a
fixed principal amount and pays a fixed rate or floating rate of interest. The
purchase of hybrids also exposes a fund to the credit risk of the issuer of the
hybrids. These risks may cause significant fluctuations in the net asset value
of the fund. Each fund will not invest more than 5% of its total assets in
hybrid instruments.
Certain hybrid instruments may provide exposure to the commodities markets.
These are derivative securities with one or more commodity-linked components
that have payment features similar to commodity futures contracts, commodity
options, or similar instruments. Commodity-linked hybrid instruments may be
either equity or debt securities, and are considered hybrid instruments because
they have both security and commodity-like characteristics. A portion of the
value of these instruments may be derived from the value of a commodity, futures
contract, index or other economic variable. The funds will only invest in
commodity-linked hybrid instruments that qualify under applicable rules of the
CFTC for an exemption from the provisions of the CEA.
Certain issuers of structured products such as hybrid instruments may be deemed
to be investment companies as defined in the 1940 Act. As a result, the funds'
investments in these products may be subject to limits applicable to investments
in investment companies and may be subject to restrictions contained in the 1940
Act.
ILLIQUID SECURITIES generally are any securities that cannot be disposed of
promptly and in the ordinary course of business at approximately the amount at
which a fund has valued the instruments. The liquidity of a fund's investments
is monitored under the supervision and direction of the Board of Trustees.
Investments currently not considered liquid include repurchase agreements not
maturing within seven days and certain restricted securities. Any security may
become illiquid at times of market dislocation.
INTERNATIONAL BONDS are certain obligations or securities of foreign issuers,
including Eurodollar Bonds, which are U.S. dollar-denominated bonds issued by
foreign issuers payable in Eurodollars (U.S. dollars held in banks located
outside the United States, primarily Europe), Yankee Bonds, which are U.S.
dollar-denominated bonds issued in the U.S. by foreign banks and corporations,
and EuroBonds, which are bonds denominated in U.S. dollars and usually issued by
large underwriting groups composed of banks and issuing houses from many
countries. Investments in securities issued by foreign issuers, including
American Depositary Receipts and securities purchased on foreign securities
exchanges, may subject a fund to additional investment risks, such as adverse
political and economic developments, possible seizure, nationalization or
expropriation of foreign investments, less stringent disclosure requirements,
non-U.S. withholding taxes and the adoption of other foreign governmental
restrictions.
Additional risks include less publicly available information, the risk that
companies may not be subject to the accounting, auditing and financial reporting
standards and requirements of U.S. companies, the risk that foreign securities
markets may have less volume and therefore may be less liquid and their prices
more volatile than U.S. securities, and the risk that custodian and transaction
costs may be higher. Foreign issuers of securities or obligations are often
subject to accounting requirements and engage in business practices different
from those respecting domestic issuers of similar securities or obligations.
Foreign branches of U.S. banks and foreign banks may be subject to less
stringent reserve requirements than those applicable to domestic branches of
U.S. banks.
SOVEREIGN DEBT investment can involve a high degree of risk. The governmental
entity that controls the repayment of sovereign debt may not be able or willing
to repay the principal and/or interest when due in accordance with the terms of
the debt. A governmental entity's willingness or ability to repay principal and
interest due in a timely manner may be affected by, among other factors, its
cash flow situation, the extent of its foreign reserves, the availability of
sufficient foreign exchange on the date a payment is due, the relative size of
the debt service burden to the economy as a whole, the governmental entity's
policy toward the International Monetary Fund, and the political constraints to
which a governmental entity may be subject. Governmental entities also may
depend on expected disbursements from foreign governments, multilateral agencies
and others to reduce principal and interest arrearages on their debt. The
commitment on the part of these governments, agencies and others to make such
disbursements may be conditioned on a governmental entity's implementation of
economic reforms and/or economic performance and the timely service of such
debtor's obligations. Failure to implement such reforms, achieve such levels of
economic performance or repay principal or interest when due may result in the
cancellation of such third parties' commitments to lend funds to the
governmental entity, which may further impair such debtor's ability or
willingness to service its debts in a timely manner. Consequently, governmental
entities may default on their sovereign debt. Holders of sovereign debt
(including the funds) may be requested to participate in the rescheduling of
such debt and to extend further loans to governmental entities. There is no
bankruptcy proceeding by which sovereign debt on which governmental entities
have defaulted may be collected in whole or in part.
A fund's investments in foreign currency denominated debt obligations and
hedging activities will likely produce a difference between its book income and
its taxable income. This difference may cause a portion of the fund's income
distributions to constitute returns of capital for tax purposes or require the
fund to make distributions exceeding book income to qualify as a regulated
investment company for federal tax purposes.
LOAN INTERESTS, and other direct debt instruments or interests therein, may be
acquired by a fund. A loan interest is typically originated, negotiated, and
structured by a U.S. or foreign commercial bank, insurance company, finance
company, or other financial institution ("Agent") for a lending syndicate of
financial institutions. The Agent typically administers and enforces the loan on
behalf of the other lenders in the syndicate. In addition, an institution
typically but not always the Agent ("Collateral Bank"), holds collateral (if
any) on behalf of the lenders. When a Collateral Bank holds collateral, such
collateral typically consists of one or more of the following asset types:
inventory, accounts receivable, property, plant and equipment, intangibles,
common stock of subsidiaries or other investments. These loan interests may take
the form of participation interests in, assignments of or novations of a loan
during its second distribution, or direct interests during a primary
distribution. Such loan interests may be acquired from U.S. or foreign banks,
insurance companies, finance companies, or other financial institutions who have
made loans or are members of a lending syndicate or from other holders of loan
interests. A fund may also acquire loan interests under which the fund derives
its rights directly from the borrower. Such loan interests are separately
enforceable by a fund against the borrower and all payments of interest and
principal are typically made directly to the fund from the borrower. In the
event that a fund and other lenders become entitled to take possession of shared
collateral, it is anticipated that such collateral would be held in the custody
of the Collateral Bank for their mutual benefit. A fund may not act as an Agent,
a Collateral Bank, a guarantor or sole negotiator or structurer with respect to
a loan.
The investment adviser or subadviser will analyze and evaluate the financial
condition of the borrower in connection with the acquisition of any Loan
Interest. Credit ratings are typically assigned to Loan Interests in the same
manner as with other fixed income debt securities, and the investment adviser
analyzes and evaluates these ratings, if any, in deciding whether to purchase a
Loan Interest. The investment adviser also analyzes and evaluates the financial
condition of the Agent and, in the case of Loan Interests in which the fund does
not have privity with the borrower, those institutions from or through whom the
fund derives its rights in a loan ("Intermediate Participants").
In a typical loan, the Agent administers the terms of the loan agreement. In
such cases, the Agent is normally responsible for the collection of principal
and interest payments from the borrower and the apportionment of these payments
to the credit of all the institutions which are parties to the loan agreement. A
fund will generally rely upon the Agent or Intermediate Participant to receive
and forward to the fund its portion of the principal and interest payments on
the loan. Furthermore, unless under the terms of a participation agreement a
fund has direct recourse against the borrower, the fund will rely on the Agent
and the other members of the lending syndicate to use appropriate credit
remedies against the borrower. The Agent is typically responsible for monitoring
compliance with covenants contained in the loan agreement based upon reports
prepared by the borrower. The seller of the Loan Interest usually does, but is
often not obligated to, notify holders of Loan Interests of any failures of
compliance. The Agent may monitor the value of the collateral and, if the value
of the collateral declines, may accelerate the loan, may give the borrower an
opportunity to provide additional collateral or may seek other protection for
the benefit of the participants in the loan. The Agent is compensated by the
borrower for providing these services under a loan agreement, and such
compensation may include special fees paid upon structuring and funding the loan
and other fees paid on a continuing basis. With respect to Loan Interests for
which the Agent does not perform such administrative and enforcement functions,
the fund will perform such tasks on its own behalf, although a Collateral Bank
will typically hold any collateral on behalf of the fund and the other holders
pursuant to the applicable loan agreement.
A financial institution's appointment as Agent may usually be terminated in the
event that it fails to observe the requisite standard of care or becomes
insolvent, enters Federal Deposit Insurance Corporation ("FDIC") receivership,
or, if not FDIC insured, enters into bankruptcy proceedings. A successor agent
generally would be appointed to replace the terminated Agent, and assets held by
the Agent under the loan agreement should remain available to holders of Loan
Interests. However, if assets held by the Agent for the benefit of a fund were
determined to be subject to the claims of the Agent's general creditors, the
fund might incur certain costs and delays in realizing payment on a Loan
Interest, or suffer a loss of principal and/or interest. In situations involving
Intermediate Participants, similar risks may arise.
Purchasers of Loan Interests depend primarily upon the creditworthiness of the
borrower for payment of principal and interest. If a fund does not receive a
scheduled interest or principal payment on such indebtedness, the fund's share
price and yield could be adversely affected. Loans that are fully secured offer
a fund more protections than an unsecured loan in the event of non-payment of
scheduled interest or principal. However, there is no assurance that the
liquidation of collateral from a secured loan would satisfy the borrower's
obligation, or that the collateral can be liquidated. Indebtedness of borrowers
whose creditworthiness is poor involves substantially greater risks, and may be
highly speculative. Borrowers that are in bankruptcy or restructuring may never
pay off their indebtedness, or may pay only a small fraction of the amount owed.
Direct indebtedness of developing countries also will involve a risk that the
governmental entities responsible for the repayment of the debt may be unable,
or unwilling, to pay interest and repay principal when due.
The Loan Interests market is in a developing phase with increased participation
among several investor types. The dealer community has become increasingly
involved in this secondary market. If, however, a particular Loan Interest is
deemed to be illiquid, it would be valued using procedures adopted by the Board
of Trustees. In such a situation, there is no guarantee that the fund will be
able to sell such Loan Interests, which could lead to a decline in the value of
the Loan Interests and the value of the fund's shares.
LOAN PARTICIPATIONS. A fund may purchase participations in commercial loans.
Such indebtedness may be secured or unsecured. Loan participations typically
represent direct participation in a loan to a corporate borrower, and generally
are offered by banks or other financial institutions or lending syndicates. A
fund may participate in such syndications, or can buy part of a loan, becoming a
part lender. When purchasing loan participations, the fund assumes the credit
risk associated with the corporate borrower and may assume the credit risk
associated with an interposed bank or other financial intermediary. The
participation interests in which the fund intends to invest may not be rated by
any nationally recognized rating service.
A loan is often administered by an agent bank acting as agent for all holders.
The agent bank administers the terms of the loan, as specified in the loan
agreement. In addition, the agent bank is normally responsible for the
collection of principal and interest payments from the corporate borrower and
the apportionment of these payments to the credit of all institutions which are
parties to the loan agreement. Unless, under the terms of the loan or other
indebtedness, a fund has direct recourse against the corporate borrower, the
fund may have to rely on the agent bank or other financial intermediary to apply
appropriate credit remedies against a corporate borrower.
A financial institution's employment as agent bank might be terminated in the
event that it fails to observe a requisite standard of care or becomes
insolvent. A successor agent bank would generally be appointed to replace the
terminated agent bank, and assets held by the agent bank under the loan
agreement should remain available to holders of such indebtedness. However, if
assets held by the agent bank for the benefit of the fund were determined to be
subject to the claims of the agent bank's general creditors, the fund might
incur certain costs and delays in realizing payment on a loan or loan
participation and could suffer a loss of principal and/or interest. In
situations involving other interposed financial institutions (e.g., an insurance
company or governmental agency) similar risks may arise.
Purchasers of loans and other forms of direct indebtedness depend primarily upon
the creditworthiness of the corporate borrower for payment of principal and
interest. If a fund does not receive scheduled interest or principal payments on
such indebtedness, the fund's share price and yield could be adversely affected.
Loans that are fully secured offer the fund more protection than an unsecured
loan in the event of non-payment of scheduled interest or principal. However,
there is no assurance that the liquidation of collateral from a secured loan
would satisfy the corporate borrower's obligation, or that the collateral can be
liquidated.
A fund may invest in loan participations with credit quality comparable to that
of issuers of its securities investments. Indebtedness of companies whose
creditworthiness is poor involves substantially greater risks, and may be highly
speculative. Some companies may never pay off their indebtedness, or may pay
only a small fraction of the amount owed. Consequently, when investing in
indebtedness of companies with poor credit, the fund bears a substantial risk of
losing the entire amount invested.
A fund limits the amount of its total assets that it will invest in any one
issuer or in issuers within the same industry. For purposes of these limits, the
fund generally will treat the corporate borrower as the "issuer" of indebtedness
held by the fund. In the case of loan participations where a bank or other
lending institution serves as a financial intermediary between the fund and the
corporate borrower, if the participation does not shift to a fund the direct
debtor-creditor relationship with the corporate borrower, SEC interpretations
require the fund to treat both the lending bank or other lending institution and
the corporate borrower as "issuers" for the purposes of determining whether the
fund has invested more than 5% of its assets in a single issuer. Treating a
financial intermediary as an issuer of indebtedness may restrict the fund's
ability to invest in indebtedness related to a single financial intermediary, or
a group of intermediaries engaged in the same industry, even if the underlying
borrowers represent many different companies and industries.
Loans and other types of direct indebtedness may not be readily marketable and
may be subject to restrictions on resale. In some cases, negotiations involved
in disposing of indebtedness may require weeks to complete. Consequently, some
indebtedness may be difficult or impossible to dispose of readily at what the
investment adviser believes to be a fair price. In addition, valuation of
illiquid indebtedness involves a greater degree of judgment in determining the
fund's net asset value than if that value were based on available market
quotations, and could result in significant variations in the fund's daily share
price. At the same time, some loan interests are traded among certain financial
institutions and accordingly may be deemed liquid. As the market for different
types of indebtedness develops, the liquidity of these instruments is expected
to improve. In addition, a fund currently intends to treat indebtedness for
which there is no readily available market as illiquid for purposes of the
fund's limitation on illiquid investments. Investments in loan participations
are considered to be debt obligations for purposes of the fund's investment
restriction relating to the lending of funds or assets by a fund.
Investments in loans through a direct assignment of the financial institution's
interests with respect to the loan may involve additional risks to the fund. For
example, if a loan is foreclosed, a fund could become part owner of any
collateral, and would bear the costs and liabilities associated with owning and
disposing of the collateral. In addition, it is conceivable that under emerging
legal theories of lender liability, the fund could be held liable as co-lender.
It is unclear whether loans and other forms of direct indebtedness offer
securities law protections against fraud and misrepresentation. In the absence
of definitive regulatory guidance, a fund relies on the investment adviser's
research in an attempt to avoid situations where fraud or misrepresentation
could adversely affect the fund.
MATURITY OF INVESTMENTS will generally be determined using the portfolio
securities' final maturity dates. However for certain securities, maturity will
be determined using the security's effective maturity date. The effective
maturity date for a security subject to a put or demand feature is the demand
date, unless the security is a variable- or floating-rate security. If it is a
variable-rate security, its effective maturity date is the earlier of its demand
date or next interest rate change date. For variable-rate securities not subject
to a put or demand feature and floating-rate securities, the effective maturity
date is the next interest rate change date. The effective maturity of
mortgage-backed and certain other asset-backed securities is determined on an
"expected life" basis by the investment adviser or Subadviser. For an interest
rate swap agreement, its effective maturity would be equal to the difference in
the effective maturity of the interest rates "swapped." Securities being hedged
with futures contracts may be deemed to have a longer maturity, in the case of
purchases of future contracts, and a shorter maturity, in the case of sales of
futures contracts, than they would otherwise be deemed to have. In addition, a
security that is subject to redemption at the option of the issuer on a
particular date ("call date"), which is prior to, or in lieu of, the security's
stated maturity, may be deemed to mature on the call date rather than on its
stated maturity date. The call date of a security will be used to calculate
average portfolio maturity when the investment adviser or Subadviser reasonably
anticipates, based upon information available to it, that the issuer will
exercise its right to redeem the security. The average portfolio maturity of a
fund is dollar-weighted based upon the market value of the fund's securities at
the time of the calculation. A fund may invest in securities with final or
effective maturities of any length.
MONEY MARKET SECURITIES are high-quality, short term debt securities that may be
issued by entities such as the U.S. government, corporations and financial
institutions (like banks). Money market securities include commercial paper,
certificates of deposit, banker's acceptances, notes and time deposits.
Certificates of deposit and time deposits are issued against funds deposited in
a banking institution for a specified period of time at a specified interest
rate. Banker's acceptances are credit instruments evidencing a bank's obligation
to pay a draft drawn on it by a customer. These instruments reflect the
obligation both of the bank and of the drawer to pay the full amount of the
instrument upon maturity. Commercial paper consists of short term, unsecured
promissory notes issued to finance short term credit needs.
Money market securities pay fixed, variable or floating rates of interest and
are generally subject to credit and interest rate risks. The maturity date or
price of and financial assets collateralizing a security may be structured in
order to make it qualify as or act like a money market security. These
securities may be subject to greater credit and interest rate risks than other
money market securities because of their structure. Money market securities may
be issued with puts or sold separately, sometimes called demand features or
guarantees, which are agreements that allow the buyer to sell a security at a
specified price and time to the seller or "put provider." When a fund buys a
put, losses could occur as a result of the costs of the put or if it exercises
its rights under the put and the put provider does not perform as agreed.
Standby commitments are types of puts.
Each fund may keep a portion of its assets in cash for business operations. In
order to reduce the effect this otherwise uninvested cash would have on its
performance, a fund may invest in money market securities. Each fund may also
invest in money market securities to the extent it is consistent with its
investment objective.
MORTGAGE-BACKED SECURITIES ("MBS") AND OTHER ASSET-BACKED SECURITIES ("ABS") may
be purchased by a fund. MBS represent participations in mortgage loans, and
include pass-through securities, adjustable rate mortgages, collateralized
mortgage obligations and stripped mortgage-backed securities. MBS may be issued
or guaranteed by U.S. government agencies or instrumentalities, such as the
Government National Mortgage Association (GNMA or Ginnie Mae) and Fannie Mae or
Freddie Mac, or by private issuers, generally originators and investors in
mortgage loans, including savings associations, mortgage banks, commercial
banks, and special purpose entities (collectively, "private lenders"). MBS are
based on different types of mortgages including those on commercial real estate
and residential property. MBS issued by private lenders may be supported by
pools of mortgage loans or other MBS that are guaranteed, directly or
indirectly, by the U.S. government or one of its agencies or instrumentalities,
or they may be issued without any governmental guarantee of the underlying
mortgage assets but with some form of credit enhancement.
ABS have structural characteristics similar to MBS. ABS represent direct or
indirect participation in assets such as automobile loans, credit card
receivables, trade receivables, home equity loans (which sometimes are
categorized as MBS) or other financial assets. Therefore, repayment depends
largely on the cash flows generated by the assets backing the securities. The
credit quality of most ABS depends primarily on the credit quality of the assets
underlying such securities, how well the entity issuing the security is
insulated from the credit risk of the originator or any other affiliated
entities, and the amount and quality of any credit enhancement of the
securities. Payments or distributions of principal and interest on ABS may be
supported by credit enhancements including letters of credit, an insurance
guarantee, reserve funds and overcollateralization. In the case of
privately-issued mortgage-related and asset-backed securities, the Portfolios
take the position that such instruments do not represent interests in any
particular industry or group of industries.
COMMERCIAL MORTGAGE-BACKED SECURITIES include securities that reflect an
interest in, and are secured by, mortgage loans on commercial real property. The
market for commercial mortgage-backed securities developed more recently and in
terms of total outstanding principal amount of issues is relatively small
compared to the market for residential single-family MBS. Many of the risks of
investing in commercial MBS reflect the risks of investing in the real estate
securing the underlying mortgage loans. These risks reflect the effects of local
and other economic conditions on real estate markets, the ability of tenants to
make loan payments, and the ability of a property to attract and retain tenants.
Commercial MBS may be less liquid and exhibit greater price volatility than
other types of mortgage- or asset-backed securities.
COLLATERALIZED DEBT OBLIGATIONS. The funds may invest in collateralized debt
obligations ("CDOs"), which includes collateralized bond obligations ("CBOs"),
collateralized loan obligations ("CLOs") and other similarly structured
securities such as credit derivatives or even derivatives of credit derivatives.
CBOs and CLOs are types of asset-backed securities. A CBO is a trust which is
backed by a diversified pool of high risk, below investment grade fixed income
securities. A CLO is a trust typically collateralized by a pool of loans, which
may include, among others, domestic and foreign senior secured loans, senior
unsecured loans, and subordinate corporate loans, including loans that may be
rated below investment grade or equivalent unrated loans.
For both CBOs and CLOs, the cashflows from the trust are split into two or more
portions, called tranches, varying in risk and yield. The riskiest portion is
the "equity" tranche which bears the bulk of defaults from the bonds or loans in
the trust and serves to protect the other, more senior tranches from default in
all but the most severe circumstances. Since it is partially protected from
defaults, a senior tranche from a CBO trust or CLO trust typically have higher
ratings and lower yields than their underlying securities, and can be rated
investment grade. Despite the protection from the equity tranche, CBO or CLO
tranches can experience substantial losses due to actual defaults, increased
sensitivity to defaults due to collateral default and disappearance of
protecting tranches, market anticipation of defaults, as well as aversion to CBO
or CLO securities as a class.
The risks of an investment in a CDO depend largely on the type of the collateral
securities and the class of the CDO in which a fund invests. Normally, CBOs,
CLOs and other CDOs are privately offered and sold, and thus, are not registered
under the securities laws. As a result, investments in CDOs may be characterized
by the funds as illiquid securities, however an active dealer market may exist
for CDOs allowing a CDO to qualify for Rule 144A transactions. In addition to
the normal risks associated with fixed income securities discussed elsewhere in
this SAI and the funds' prospectuses (e.g., interest rate risk and default
risk), CDOs carry additional risks including, but are not limited to: (i) the
possibility that distributions from collateral securities will not be adequate
to make interest or other payments; (ii) the quality of the collateral may
decline in value or default; (iii) the funds may invest in CDOs that are
subordinate to other classes; (iv) the complex structure of the security may not
be fully understood at the time of investment and may produce disputes with the
issuer or unexpected investment results and (v) credit ratings by major credit
rating agencies may be no indication of the credit worthiness of the security.
COLLATERALIZED MORTGAGE OBLIGATION ("CMO") is a hybrid between a mortgage-backed
bond and a mortgage pass-through security. Similar to a bond, interest and
prepaid principal is paid, in most cases, on a monthly basis. CMOs may be
collateralized by whole mortgage loans, but are more typically collateralized by
portfolios of mortgage pass-through securities guaranteed by Ginnie Mae, Freddie
Mac, Fannie Mae, and their income streams.
CMOs are structured into multiple classes, each bearing a different stated
maturity. Actual maturity and average life will depend upon the prepayment
experience of the collateral. CMOs provide for a modified form of call
protection through a de facto breakdown of the underlying pool of mortgages
according to how quickly the loans are repaid. Monthly payment of principal
received from the pool of underlying mortgages, including prepayments, is first
returned to investors holding the shortest maturity class. Investors holding the
longer maturity classes receive principal only after the first class has been
retired. An investor is partially guarded against a sooner than desired return
of principal because of the sequential payments.
In a typical CMO transaction, a corporation ("issuer") issues multiple series
(e.g., A, B, C, Z) of CMO bonds ("Bonds"). Proceeds of the Bond offering are
used to purchase mortgages or mortgage pass-through certificates ("Collateral").
The Collateral is pledged to a third party trustee as security for the Bonds.
Principal and interest payments from the Collateral are used to pay principal on
the Bonds in the order A, B, C, Z. The Series A, B, and C Bonds all bear current
interest. Interest on the Series Z Bond is accrued and added to principal and a
like amount is paid as principal on the Series A, B, or C Bond currently being
paid off. When the Series A, B, and C Bonds are paid in full, interest and
principal on the Series Z Bond begins to be paid currently. With some CMOs, the
issuer serves as a conduit to allow loan originators (primarily builders or
savings and loan associations) to borrow against their loan portfolios.
The rate of principal payment on MBS and ABS generally depends on the rate of
principal payments received on the underlying assets which in turn may be
affected by a variety of economic and other factors. As a result, the price and
yield on any MBS or ABS is difficult to predict with precision and price and
yield to maturity may be more or less than the anticipated yield to maturity. If
a fund purchases these securities at a premium, a prepayment rate that is faster
than expected will reduce yield to maturity, while a prepayment rate that is
slower than expected will have the opposite effect of increasing the yield to
maturity. Conversely, if a fund purchases these securities at a discount, a
prepayment rate that is faster than expected will increase yield to maturity,
while a prepayment rate that is slower than expected will reduce yield to
maturity. Amounts available for reinvestment by a fund are likely to be greater
during a period of declining interest rates and, as a result, are likely to be
reinvested at lower interest rates than during a period of rising interest
rates.
While many MBS and ABS are issued with only one class of security, many are
issued in more than one class, each with different payment terms. Multiple class
MBS and ABS are issued as a method of providing credit support, typically
through creation of one or more classes whose right to payments on the security
is made subordinate to the right to such payments of the remaining class or
classes. In addition, multiple classes may permit the issuance of securities
with payment terms, interest rates, or other characteristics differing both from
those of each other and from those of the underlying assets. Examples include
stripped securities, which are MBS and ABS entitling the holder to
disproportionate interest or principal compared with the assets backing the
security, and securities with classes having characteristics different from the
assets backing the securities, such as a security with floating interest rates
with assets backing the securities having fixed interest rates. The market value
of such securities and CMO's generally is more or less sensitive to changes in
prepayment and interest rates than is the case with traditional MBS and ABS, and
in some cases such market value may be extremely volatile.
CMO RESIDUALS are mortgage securities issued by agencies or instrumentalities of
the U.S. Government or by private originators of, or investors in, mortgage
loans, including savings and loan associations, homebuilders, mortgage banks,
commercial banks, investment banks and special purpose entities of the
foregoing.
The cash flow generated by the mortgage assets underlying a series of CMOs is
applied first to make required payments of principal and interest on the CMOs
and second to pay the related administrative expenses of the issuer. The
residual in a CMO structure generally represents the interest in any excess cash
flow remaining after making the foregoing payments. Each payment of such excess
cash flow to a holder of the related CMO residual represents income and/or a
return of capital. The amount of residual cash flow resulting from a CMO will
depend on, among other things, the characteristics of the mortgage assets, the
coupon rate of each class of CMO, prevailing interest rates, the amount of
administrative expenses and the prepayment experience on the mortgage assets. In
particular, the yield to maturity on CMO residuals is extremely sensitive to
prepayments on the related underlying mortgage assets, in the same manner as an
interest-only ("IO") class of stripped mortgage-backed securities. See "Stripped
Mortgage-Backed Securities." In addition, if a series of a CMO includes a class
that bears interest at an adjustable rate, the yield to maturity on the related
CMO residual will also be extremely sensitive to changes in the level of the
index upon which interest rate adjustments are based. As described below with
respect to stripped mortgage-backed securities, in certain circumstances a fund
may fail to recoup fully its initial investment in a CMO residual.
CMO residuals are generally purchased and sold by institutional investors
through several investment banking firms acting as brokers or dealers. The CMO
residual market has only very recently developed and CMO residuals currently may
not have the liquidity of other more established securities trading in other
markets. Transactions in CMO residuals are generally completed only after
careful review of the characteristics of the securities in question. In
addition, CMO residuals may, or pursuant to an exemption therefrom, may not have
been registered under the Securities Act of 1933, as amended (the "1933 Act").
CMO residuals, whether or not registered under the 1933 Act, may be subject to
certain restrictions on transferability, and may be deemed "illiquid" and
subject to a fund's limitations on investment in illiquid securities.
STRIPPED MORTGAGE-BACKED SECURITIES("SMBS") are derivative multi-class mortgage
securities. SMBS may be issued by agencies or instrumentalities of the U.S.
Government, or by private originators of, or investors in, mortgage loans,
including savings and loan associations, mortgage banks, commercial banks,
investment banks and special purpose entities of the foregoing.
SMBS are usually structured with two classes that receive different proportions
of the interest and principal distributions on a pool of mortgage assets. A
common type of SMBS will have one class receiving some of the interest and most
of the principal from the mortgage assets, while the other class will receive
most of the interest and the remainder of the principal. In the most extreme
case, one class will receive all of the interest (the "IO" class), while the
other class will receive all of the principal (the principal-only or "PO"
class). The yield to maturity on an IO class is extremely sensitive to the rate
of principal payments (including prepayments) on the related underlying mortgage
assets, and a rapid rate of principal payments may have a material adverse
effect on a fund's yield to maturity from these securities. If the underlying
mortgage assets experience greater than anticipated prepayments of principal, a
fund may fail to recoup some or all of its initial investment in these
securities even if the security is in one of the highest rating categories.
Under certain circumstances these securities may be deemed "illiquid" and
subject to a fund's limitations on investment in illiquid securities.
NON-PUBLICLY TRADED SECURITIES AND PRIVATE PLACEMENTS. A fund may invest in
securities that are neither listed on a stock exchange nor traded
over-the-counter, including privately placed securities. Such unlisted
securities may involve a higher degree of business and financial risk that can
result in substantial losses. As a result of the absence of a public trading
market for these securities, they may be less liquid than publicly traded
securities. Although these securities may be resold in privately negotiated
transactions, the prices realized from these sales could be less than those
originally paid by the fund or less than what may be considered the fair value
of such securities. Furthermore,
13
companies whose securities are not publicly traded may not be subject to the
disclosure and other investor protection requirements which might be applicable
if their securities were publicly traded. If such securities are required to be
registered under the securities laws of one or more jurisdictions before being
sold, a fund may be required to bear the expenses of registration.
NON-TRADITIONAL EQUITY SECURITIES. The funds may invest in convertible preferred
stocks that offer enhanced yield features, such as Preferred Equity Redemption
Cumulative Stock ("PERCS"), which provide an investor, such as the funds, with
the opportunity to earn higher dividend income than is available on a company's
common stock. A PERCS is a preferred stock which generally features a mandatory
conversion date, as well as a capital appreciation limit which is usually
expressed in terms of a stated price. Upon the conversion date, most PERCS
convert into common stock of the issuer (PERCS are generally not convertible
into cash at maturity). Under a typical arrangement, if after a predetermined
number of years the issuer's common stock is trading at a price below that set
by the capital appreciation limit, each PERCS would convert to one share of
common stock. If, however, the issuer's common stock is trading at a price above
that set by the capital appreciation limit, the holder of the PERCS would
receive less than one full share of common stock. The amount of that fractional
share of common stock received by the PERCS holder is determined by dividing the
price set by the capital appreciation limit of the PERCS by the market price of
the issuer's common stock. PERCS can be called at any time prior to maturity,
and hence do not provide call protection. However, if called early, the issuer
may pay a call premium over the market price to the investor. This call premium
declines at a preset rate daily, up to the maturity date of the PERCS.
The funds may also invest in other enhanced convertible securities. These
include but are not limited to ACES (Automatically Convertible Equity
Securities), PEPS (Participating Equity Preferred Stock), PRIDES (Preferred
Redeemable Increased Dividend Equity Securities), SAILS (Stock Appreciation
Income Linked Securities), TECONS (Term Convertible Notes), QICS (Quarterly
Income Cumulative Securities), and DECS (Dividend Enhanced Convertible
Securities). ACES, PEPS, PRIDES, SAILS, TECONS, QICS, and DECS all have the
following features: they are company-issued convertible preferred stock; unlike
PERCS, they do not have capital appreciation limits; they seek to provide the
investor with high current income, with some prospect of future capital
appreciation; they are typically issued with three- to four-year maturities;
they typically have some built-in call protection for the first two to three
years; investors have the right to convert them into shares of common stock at a
preset conversion ratio or hold them until maturity; and upon maturity, they
will automatically convert to either cash or a specified number of shares of
common stock.
OPTIONS CONTRACTS generally provide the right to buy or sell a security,
commodity, futures contract or foreign currency in exchange for an agreed upon
price. If the right is not exercised after a specified period, the option
expires and the option buyer forfeits the money paid to the option seller.
A call option gives the buyer the right to buy a specified number of shares of a
security at a fixed price on or before a specified date in the future. For this
right, the call option buyer pays the call option seller, commonly called the
call option writer, a fee called a premium. Call option buyers are usually
anticipating that the price of the underlying security will rise above the price
fixed with the call writer, thereby allowing them to profit. If the price of the
underlying security does not rise, the call option buyer's losses are limited to
the premium paid to the call option writer. For call option writers, a rise in
the price of the underlying security will be offset in part by the premium
received from the call option buyer. If the call option writer does not own the
underlying security, however, the losses that may ensue if the price rises could
be potentially unlimited. If the call option writer owns the underlying security
or commodity, this is called writing a covered call. All call and put options
written by a fund will be covered, which means that a fund will own the
securities subject to the option so long as the option is outstanding or the
fund will earmark or segregate assets for any outstanding option contracts.
A put option is the opposite of a call option. It gives the buyer the right to
sell a specified number of shares of a security at a fixed price on or before a
specified date in the future. Put option buyers are usually anticipating a
decline in the price of the underlying security, and wish to offset those losses
when selling the security at a later date. All put options the funds
14
write will be covered, which means that a fund will earmark or segregate cash,
U.S. government securities or other liquid securities with a value at least
equal to the exercise price of the put option. The purpose of writing such
options is to generate additional income for the funds. However, in return for
the option premium, the funds accept the risk that they may be required to
purchase the underlying securities at a price in excess of the securities'
market value at the time of purchase.
A fund may purchase and write put and call options on any securities in which
they may invest or any securities index or basket of securities based on
securities in which they may invest. In addition, the funds may purchase and
sell foreign currency options and foreign currency futures contracts and related
options. The funds may purchase and write such options on securities that are
listed on domestic or foreign securities exchanges or traded in the
over-the-counter market. Like futures contracts, option contracts are rarely
exercised. Option buyers usually sell the option before it expires. Option
writers may terminate their obligations under a written call or put option by
purchasing an option identical to the one it has written. Such purchases are
referred to as "closing purchase transactions." A fund may enter into closing
sale transactions in order to realize gains or minimize losses on options they
have purchased or wrote.
An exchange-traded currency option position may be closed out only on an options
exchange that provides a secondary market for an option of the same series.
Although the funds generally will purchase or write only those options for which
there appears to be an active secondary market, there is no assurance that a
liquid secondary market will exist for any particular option or at any
particular time. If a fund is unable to effect a closing purchase transaction
with respect to options it has written, it will not be able to sell the
underlying securities or dispose of assets earmarked or held in a segregated
account until the options expire or are exercised. Similarly, if a fund is
unable to effect a closing sale transaction with respect to options it has
purchased, it would have to exercise the options in order to realize any profit
and will incur transaction costs upon the purchase or sale of underlying
securities.
Reasons for the absence of a liquid secondary market on an exchange include the
following: (1) there may be insufficient trading interest in certain options;
(2) an exchange may impose restrictions on opening transactions or closing
transactions or both; (3) trading halts, suspensions or other restrictions may
be imposed with respect to particular classes or series of options; (4) unusual
or unforeseen circumstances may interrupt normal operations on an exchange; (5)
the facilities of an exchange or the Options Clearing Corporation ("OCC") may
not at all times be adequate to handle current trading volume; or (6) one or
more exchanges could, for economic or other reasons, decide or be compelled at
some future date to discontinue the trading of options (or a particular class or
series of options), although outstanding options on that exchange that had been
issued by the OCC as a result of trades on that exchange would continue to be
exercisable in accordance with their terms.
The ability to terminate over-the-counter options is more limited than with
exchange-traded options and may involve the risk that broker-dealers
participating in such transactions will not fulfill their obligations. Until
such time as the staff of the SEC changes its position, the funds will treat
purchased over-the-counter options and all assets used to cover written
over-the-counter options as illiquid securities, except that with respect to
options written with primary dealers in U.S. government securities pursuant to
an agreement requiring a closing purchase transaction at a formula price, the
amount of illiquid securities may be calculated with reference to a formula the
staff of the SEC approves.
Additional risks are involved with options trading because of the low margin
deposits required and the extremely high degree of leverage that may be involved
in options trading. There may be imperfect correlation between the change in
market value of the securities held by a fund and the prices of the options,
possible lack of a liquid secondary market, and the resulting inability to close
such positions prior to their maturity dates.
A fund may write or purchase an option only when the market value of that
option, when aggregated with the market value of all other options transactions
made on behalf of the fund, does not exceed 5% of its net assets.
An option contract may be implicitly entered into by purchasing certain
securities with built in options. An example of such would be a reverse floating
rate note where the buyer is also selling one or more caps on short dated
interest rates.
15
PAY-IN-KIND ('PIK') are instruments that give the issuer an option (during an
initial period) either to make coupon payments in cash or in the form of
additional bonds.
PROMISSORY NOTES are written agreements committing the maker or issuer to pay
the payee a specified amount either on demand or at a fixed date in the future,
with or without interest. These are sometimes called negotiable notes or
instruments and are subject to credit risk. Bank notes are notes used to
represent obligations issued by banks in large denominations.
REAL ESTATE INVESTMENT TRUSTS (REITS) are pooled investment vehicles, which
invest primarily in income producing real estate or real estate related loans or
interests and, in some cases, manage real estate. REITs are sometimes referred
to as equity REITs, mortgage REITs or hybrid REITs. An equity REIT invests
primarily in properties and generates income from rental and lease properties
and, in some cases, from the management of real estate. Equity REITs also offer
the potential for growth as a result of property appreciation and from the sale
of appreciated property. Mortgage REITs invest primarily in real estate
mortgages, which may secure construction, development or long term loans, and
derive income for the collection of interest payments. Hybrid REITs may combine
the features of equity REITs and mortgage REITs. REITs are generally organized
as corporations or business trusts, but are not taxed as a corporation if they
meet certain requirements of Subchapter M of the Code. To qualify, a REIT must,
among other things, invest substantially all of its assets in interests in real
estate (including other REITs), cash and government securities, distribute at
least 95% of its taxable income to its shareholders and receive at least 75% of
that income from rents, mortgages and sales of property.
Like any investment in real estate, a REIT's performance depends on many
factors, such as its ability to find tenants for its properties, to renew
leases, and to finance property purchases and renovations. In general, REITs may
be affected by changes in underlying real estate values, which may have an
exaggerated effect to the extent a REIT concentrates its investment in certain
regions or property types. For example, rental income could decline because of
extended vacancies, increased competition from nearby properties, tenants'
failure to pay rent, or incompetent management. Property values could decrease
because of overbuilding, environmental liabilities, uninsured damages caused by
natural disasters, a general decline in the neighborhood, losses due to casualty
or condemnation, increases in property taxes, or changes in zoning laws.
Ultimately, a REIT's performance depends on the types of properties it owns and
how well the REIT manages its properties.
In general, during periods of rising interest rates, REITs may lose some of
their appeal for investors who may be able to obtain higher yields from other
income-producing investments, such as long term bonds. Higher interest rates
also mean that financing for property purchases and improvements is more costly
and difficult to obtain. During periods of declining interest rates, certain
mortgage REITs may hold mortgages that mortgagors elect to prepay, which can
reduce the yield on securities issued by mortgage REITs. Mortgage REITs may be
affected by the ability of borrowers to repay debts to the REIT when due and
equity REITs may be affected by the ability of tenants to pay rent.
Like small-cap stocks in general, certain REITs have relatively small market
capitalizations and their securities can be more volatile than--and at times
will perform differently from--large-cap stocks. In addition, because small-cap
stocks are typically less liquid than large-cap stocks, REIT stocks may
sometimes experience greater share-price fluctuations than the stocks of larger
companies. Further, REITs are dependent upon specialized management skills, have
limited diversification, and are therefore subject to risks inherent in
operating and financing a limited number of projects. By investing in REITs
indirectly through a fund, a shareholder will bear indirectly a proportionate
share of the REIT's expenses in addition to their proportionate share of a
fund's expenses. Finally, REITs could possibly fail to qualify for tax-free
pass-through of income under the Code or to maintain their exemptions from
registration under the Investment Company Act of 1940 ("1940 Act").
REPURCHASE AGREEMENTS are instruments under which a buyer acquires ownership of
certain securities (usually U.S. government securities) from a seller who agrees
to repurchase the securities at a mutually agreed-upon time and price, thereby
determining the yield during the buyer's holding period. Any repurchase
agreements a fund enters into will involve the fund as the buyer and banks or
broker-dealers as sellers. The period of repurchase agreements is usually short
- from overnight to one week, although the securities collateralizing a
repurchase agreement may have longer maturity dates. Default by the seller might
cause a fund to experience a loss or delay in the liquidation of the collateral
securing the repurchase agreement. A fund also may incur disposition costs in
liquidating the collateral. In the event of a bankruptcy or other default of a
repurchase agreement's seller, the fund might incur expenses in enforcing its
rights, and could experience losses, including a decline in the value of the
underlying securities and loss of income. A fund will make payment under a
repurchase agreement only upon physical delivery or evidence of book entry
transfer of the collateral to
16
the account of its custodian bank.
RESTRICTED SECURITIES are securities that are subject to legal restrictions on
their sale. Restricted securities may be considered to be liquid if an
institutional or other market exists for these securities. In making this
determination, a fund, under the direction and supervision of the Board of
Trustees will take into account various factors, including: (1) the frequency of
trades and quotes for the security; (2) the number of dealers willing to
purchase or sell the security and the number of potential purchasers; (3) dealer
undertakings to make a market in the security; and (4) the nature of the
security and marketplace trades (e.g., the time needed to dispose of the
security, the method of soliciting offers and the mechanics of transfer). To the
extent a fund invests in restricted securities that are deemed liquid, its
general level of illiquidity may be increased if qualified institutional buyers
become uninterested in purchasing these securities.
REVERSE REPURCHASE AGREEMENTS AND MORTGAGE DOLLAR ROLLS may be used by a fund. A
fund may engage in reverse repurchase agreements to facilitate portfolio
liquidity, a practice common in the mutual fund industry, or for arbitrage
transactions as discussed below. In a reverse repurchase agreement, a fund would
sell a security and enter into an agreement to repurchase the security at a
specified future date and price. A fund generally retains the right to interest
and principal payments on the security. If a fund uses the cash it obtains to
invest in other securities, this may be considered a form of leverage and may
expose the fund to a greater risk. Leverage tends to magnify the effect of any
decrease or increase in the value on a fund's portfolio's securities. Because a
fund receives cash upon entering into a reverse repurchase agreement, it may be
considered a borrowing. When required by guidelines of the SEC, a fund will set
aside permissible liquid assets earmarked or in a segregated account to secure
its obligations to repurchase the security.
A fund also may enter into mortgage dollar rolls, in which a fund would sell MBS
for delivery in the current month and simultaneously contract to purchase
substantially similar securities on a specified future date. While a fund would
forego principal and interest paid on the MBS during the roll period, a fund
would be compensated by the difference between the current sales price and the
lower price for the future purchase as well as by any interest earned on the
proceeds of the initial sale. A fund also could be compensated through the
receipt of fee income equivalent to a lower forward price. At the time a fund
would enter into a mortgage dollar roll, it would set aside permissible liquid
assets earmarked or in a segregated account to secure its obligation for the
forward commitment to buy MBS. Mortgage dollar roll transactions may be
considered a borrowing by a fund.
The mortgage dollar rolls and reverse repurchase agreements entered into by a
fund may be used as arbitrage transactions in which a fund will maintain an
offsetting position in short duration investment-grade debt obligations. Since a
fund will receive interest on the securities or repurchase agreements in which
it invests the transaction proceeds, such transactions may involve leverage.
However, since such securities or repurchase agreements will be high quality and
short duration, the investment adviser believes that such arbitrage transactions
present lower risks to a fund than those associated with other types of
leverage. There can be no assurance that a fund's use of the cash it receives
from a mortgage dollar roll will provide a positive return.
SECURITIES LENDING of portfolio securities is a common practice in the
securities industry. A fund will engage in security lending arrangements. For
example, a fund may receive cash collateral, and it may invest it in short term,
interest-bearing obligations, but will do so only to the extent that it will not
lose the tax treatment available to regulated investment companies. Lending
portfolio securities involves risks that the borrower may fail to return the
securities or provide additional collateral. Also, voting rights with respect to
the loaned securities may pass with the lending of the securities.
A fund may loan portfolio securities to qualified broker-dealers or other
institutional investors provided: (1) the loan is secured continuously by
collateral consisting of U.S. government securities, letters of credit, cash or
cash equivalents or other appropriate instruments maintained on a daily
marked-to-market basis in an amount at least equal to the current market value
of the securities loaned; (2) the fund may at any time call the loan and obtain
the return of the securities loaned; (3) the fund will receive any interest or
dividends paid on the loaned securities; and (4) the aggregate market value of
securities loaned will not at any time exceed one-third of the total assets of
the fund, including collateral received from the loan (at market value computed
at the time of the loan).
Although voting rights with respect to loaned securities pass to the borrower,
the lender retains the right to recall a security (or terminate a loan) for the
purpose of exercising the security's voting rights. Efforts to recall such
securities promptly may be unsuccessful, especially for foreign securities or
thinly traded securities such as small-cap stocks. In addition, because
recalling a security may involve expenses to a fund, it is expected that a fund
will do so only where the items being voted upon are, in the judgment of the
investment adviser, either material to the economic value of the security or
threaten to materially impact the issuer's corporate governance policies or
structure.
SECURITIES OF OTHER INVESTMENT COMPANIES may be purchased and sold by a fund and
those issued by foreign investment companies. Mutual funds are registered
investment companies, which may issue and redeem their shares on a continuous
basis (open-end mutual funds) or may offer a fixed number of shares usually
listed on an exchange (closed-end mutual funds). Mutual funds generally offer
investors the advantages of diversification and professional investment
management, by combining shareholders' money and investing it in various types
of securities, such as stocks, bonds and money market securities. Mutual funds
also make various investments and use certain techniques in order to enhance
their performance. These may include entering into delayed-delivery and
when-issued securities transactions or swap agreements; buying and selling
futures contracts, illiquid and restricted securities and repurchase agreements
and borrowing or lending money and/or portfolio securities. The risks of
investing in mutual funds generally reflect the risks of the securities in which
the mutual funds invest and the investment techniques they may employ. Also,
mutual funds charge fees and incur operating expenses.
If a fund decides to purchase securities of other investment companies, a fund
intends to purchase shares of mutual funds in compliance with the requirements
of federal law or any applicable exemptive relief received from the SEC. Mutual
fund investments for a fund are currently restricted under federal regulations,
and therefore, the extent to which a fund may invest in another mutual fund may
be limited.
Funds in which a fund also may invest include unregistered or privately-placed
funds, such as hedge funds and offshore
17
funds. Hedge funds and offshore funds are not registered with the SEC, and
therefore are largely exempt from the regulatory requirements that apply to
registered investment companies (mutual funds). As a result, these types of
funds have greater ability to make investments or use investment techniques,
such as leveraging, that can increase investment return but also may
substantially increase the risk of losses. Investments in these funds also may
be more difficult to sell, which could cause losses to a fund. For example,
hedge funds typically require investors to keep their investment in a hedge fund
for some period of time, such as 1 year or more. This means investors would not
be able to sell their shares of a hedge fund until such time had past, and the
investment may be deemed to be illiquid. In addition, because hedge funds may
not value their portfolio holdings on a frequent basis, investments in those
hedge funds may be difficult to price.
SHORT SALES may be used by a fund as part of its overall portfolio management
strategies or to offset (hedge) a potential decline in the value of a security.
A fund may engage in short sales that are either "against the box" or
"uncovered." A short sale is "against the box" if at all times during which the
short position is open, a fund owns at least an equal amount of the securities
or securities convertible into, or has the right to acquire, at no added cost,
the securities of the same issue as the securities that are sold short. A short
sale against the box is a taxable transaction to a fund with respect to the
securities that are sold short. "Uncovered" short sales are transactions under
which a fund sells a security it does not own. To complete such transaction, a
fund may borrow the security through a broker to make delivery to the buyer and,
in doing so, the fund becomes obligated to replace the security borrowed by
purchasing the security at the market price at the time of the replacement. A
fund also may have to pay a fee to borrow particular securities, which would
increase the cost of the security. In addition, a fund is often obligated to pay
any accrued interest and dividends on the securities until they are replaced.
The proceeds of the short sale position will be retained by the broker until a
fund replaces the borrowed securities.
A fund will incur a loss if the price of the security sold short increases
between the time of the short sale and the time the fund replaces the borrowed
security and, conversely, the fund will realize a gain if the price declines.
Any gain will be decreased, and any loss increased, by the transaction costs
described above. A short sale creates the risk of an unlimited loss, as the
price of the underlying securities could theoretically increase without limit,
thus increasing the cost of buying those securities to cover the short position.
If a fund sells securities short "against the box," it may protect unrealized
gains, but will lose the opportunity to profit on such securities if the price
rises. The successful use of short selling as a hedging strategy may be
adversely affected by imperfect correlation between movements in the price of
the security sold short and the securities being hedged.
A fund's obligation to replace the securities borrowed in connection with a
short sale will be secured by collateral deposited with the broker that consists
of cash or other liquid securities. In addition, a fund will earmark cash or
liquid assets or place in a segregated account an amount of cash or other liquid
assets equal to the difference, if any, between (1) the market value of the
securities sold short, marked-to-market daily, and (2) any cash or other liquid
securities deposited as collateral with the broker in connection with the short
sale.
SPREAD TRANSACTIONS may be used for hedging or managing risk. A fund may
purchase covered spread options from securities dealers. Such covered spread
options are not presently exchange-listed or exchange-traded. The purchase of a
spread option gives a fund the right to put, or sell, a security that it owns at
a fixed dollar spread or fixed yield spread in relation to another security that
a fund does not own, but which is used as a benchmark. The risk to a fund in
purchasing covered spread options is the cost of the premium paid for the spread
option and any transaction costs. In addition, there is no assurance that
closing transactions will be available. The purchase of spread options will be
used to protect a fund against adverse changes in prevailing credit quality
spreads, i.e., the yield spread between high quality and lower quality
securities. Such protection is only provided during the life of the spread
option.
STRIPPED SECURITIES are securities whose income and principal components are
detached and sold separately. While risks associated with stripped securities
are similar to other fixed income securities, stripped securities are typically
subject to greater changes in value. U.S. Treasury securities that have been
stripped by the Federal Reserve Bank are obligations of the U.S. Treasury.
SWAP AGREEMENTS are privately negotiated over-the-counter derivative products in
which two parties agree to exchange payment streams calculated in relation to a
rate, index, instrument or certain securities (referred to as the "underlying")
and a predetermined amount (referred to as the "notional amount"). The
underlying for a swap may be an interest rate (fixed or floating), a currency
exchange rate, a commodity price index, a credit derivative contract (single
name or multiname or index), a security, group of securities or a securities
index, a combination of any of these, or
18
various other rates, assets or indices. Swap agreements generally do not involve
the delivery of the underlying or principal, and a party's obligations generally
are equal to only the net amount to be paid or received under the agreement
based on the relative values of the positions held by each party to the swap
agreement.
Swap agreements can be structured to increase or decrease a fund's exposure to
long or short term interest rates, corporate borrowing rates and other
conditions, such as changing security prices and inflation rates. They also can
be structured to increase or decrease a fund's exposure to specific issuers or
specific sectors of the bond market such as mortgage securities. For example, if
a fund agreed to pay a longer-term fixed rate in exchange for a shorter-term
floating rate while holding longer-term fixed rate bonds, the swap would tend to
decrease a fund's exposure to longer-term interest rates. Swap agreements tend
to increase or decrease the overall volatility of a fund's investments and its
share price and yield. Changes in interest rates, or other factors determining
the amount of payments due to and from a fund, can be the most significant
factors in the performance of a swap agreement. If a swap agreement calls for
payments from a fund, a fund must be prepared to make such payments when they
are due. In order to help minimize risks, a fund will earmark or segregate
appropriate assets for any accrued but unpaid net amounts owed under the terms
of a swap agreement entered into on a net basis. All other swap agreements will
require a fund to earmark or segregate assets in the amount of the accrued
amounts owed under the swap. A fund could sustain losses if a counterparty does
not perform as agreed under the terms of the swap. A fund will enter into swap
agreements with counterparties deemed creditworthy by the investment adviser.
In addition, the funds may invest in swaptions, which are privately-negotiated
option-based derivative products. Swaptions give the holder the right to enter
into a swap. A fund may use a swaption in addition to or in lieu of a swap
involving a similar rate or index.
For purposes of applying the funds' investment policies and restrictions (as
stated in the prospectus and this SAI) swap agreements are generally valued by
the funds at market value. In the case of a credit default swap sold by a fund
(i.e., where the fund is selling credit default protection), however, the fund
will generally value the swap at its notional amount. The manner in which
certain securities or other instruments are valued by the funds for purposes of
applying investment policies and restrictions may differ from the manner in
which those investments are valued by other types of investors.
TEMPORARY DEFENSIVE STRATEGIES are strategies the funds may take for temporary
or defensive purposes. The investment strategies for the funds are those that
the funds use during normal circumstances. During unusual economic or market
conditions or for temporary defensive or liquidity purposes, each fund may
invest up to 100% of its assets in cash, money market instruments, repurchase
agreements and other short term obligations that would not ordinarily be
consistent with the funds' objectives. A fund will do so only if the investment
adviser or Subadviser believes that the risk of loss outweighs the opportunity
for capital gains or higher income. When a fund engages in such activities, it
may not achieve its investment objective.
U.S. GOVERNMENT SECURITIES are issued by the U.S. Treasury or issued or
guaranteed by the U.S. government or any of its agencies or instrumentalities.
Not all U.S. government securities are backed by the full faith and credit of
the United States. Some U.S. government securities, such as those issued by
Fannie Mae, Freddie Mac, the Student Loan Marketing Association (SLMA or Sallie
Mae), and the Federal Home Loan Banks (FHLB), are supported by a line of credit
the issuing entity has with the U.S. Treasury. Others are supported solely by
the credit of the issuing agency or instrumentality such as obligations issued
by the Federal Farm Credit Banks Funding Corporation (FFCB). There can be no
assurance that the U.S. government will provide financial support to U.S.
government securities of its agencies and instrumentalities if it is not
obligated to do so under law. Of course U.S. government securities, including
U.S. Treasury securities, are among the safest securities, however, not unlike
other debt securities, they are still sensitive to interest rate changes, which
will cause their yields and prices to fluctuate.
ZERO-COUPON SECURITIES are debt obligations that do not entitle the holder to
any periodic payments of interest before maturity or a specific date when the
securities begin paying current interest. Therefore, they are issued and traded
at a discount from their face amounts or par value. The market prices of
zero-coupon securities are generally more volatile than the market prices of
securities that pay interest periodically and are likely to respond to changes
in interest rates to a greater degree than do non-zero-coupon securities having
similar maturities and credit quality. Current federal income tax law requires
that a holder of a taxable zero-coupon security report as income each year the
portion of the original issue discount of such security that accrues that year,
even though the holder receives no cash payments of interest during the year.
The fund has qualified as a regulated investment company under the Code.
Accordingly, during periods when a fund receives no interest payments on its
zero-coupon securities, it will be required, in order to maintain its desired
tax treatment, to distribute cash approximating the income attributable to such
securities.
Such distribution may require the sale of portfolio securities to meet the
distribution requirements and such sales may be subject to the risk factor
discussed above.
INVESTMENT LIMITATIONS
THE FOLLOWING INVESTMENT LIMITATIONS MAY BE CHANGED ONLY BY VOTE OF A MAJORITY
OF EACH FUND'S OUTSTANDING SHARES.
THE LAUDUS MONDRIAN INTERNATIONAL EQUITY FUND AND THE LAUDUS MONDRIAN GLOBAL
EQUITY FUND MAY NOT:
1) Concentrate investments in a particular industry or group of industries,
as concentration is defined under the 1940 Act, the rules or regulations
thereunder or any exemption therefrom, as such statute, rules or
regulations may be amended or interpreted from time to time.
2) Purchase or sell commodities or real estate, except to the extent
permitted (or not prohibited) under the 1940 Act, the rules or regulations
thereunder or any exemption therefrom, as such statute, rules or
regulations may be amended or interpreted from time to time.
19
3) Make loans to other persons, except to the extent permitted (or not
prohibited) under the 1940 Act, the rules or regulations thereunder or any
exemption therefrom, as such statute, rules or regulations may be amended
or interpreted from time to time.
4) Borrow money, except to the extent permitted (or not prohibited) under the
1940 Act, the rules or regulations thereunder or any exemption therefrom,
as such statute, rules or regulations may be amended or interpreted from
time to time.
5) Issue senior securities, except to the extent permitted (or not
prohibited) under the 1940 Act, the rules or regulations thereunder or any
exemption therefrom, as such statute, rules or regulations may be amended
or interpreted from time to time.
6) Underwrite securities issued by other persons, except to the extent
permitted (or not prohibited) under the 1940 Act, the rules or regulations
thereunder or any exemption therefrom, as such statute, rules or
regulations may be amended or interpreted from time to time.
The following descriptions of the 1940 Act may assist investors in understanding
the above policies and restrictions.
BORROWING. The 1940 Act restricts an investment company from borrowing
(including pledging, mortgaging or hypothecating assets) in excess of 33 1/3% of
its total assets (not including temporary borrowings not in excess of 5% of its
total assets). Transactions that are fully collateralized in a manner that does
not involve the prohibited issuance of a "senior security" within the meaning of
Section 18(f) of the 1940 Act, shall not be regarded as borrowings for the
purposes of a fund's investment restriction.
CONCENTRATION. The SEC has defined concentration as investing 25% or more of an
investment company's total assets in an industry or group of industries, with
certain exceptions. For purposes of each fund's concentration policy, (i)
financial service companies will be classified according to the types of
services; for example, insurance, commercial banks, mortgages, and diversified
finance will each be considered a separate industry; (ii) energy and natural
resources companies will be classified according to the types of products and
services; for example, crude oil, petroleum, natural gas, precious metals and
mining will each be considered a separate industry.
LENDING. Under the 1940 Act, an investment company may only make loans if
expressly permitted by its investment policies.
REAL ESTATE. The 1940 Act does not directly restrict an investment company's
ability to invest in real estate, but does require that every investment company
have a fundamental investment policy governing such investments. Each fund has
adopted a fundamental policy that would permit direct investment in real estate.
However, each fund has a non-fundamental investment limitation that prohibits it
from investing directly in real estate. This non-fundamental policy may be
changed only by vote of a fund's Board of Trustees.
SENIOR SECURITIES. Senior securities may include any obligation or instrument
issued by an investment company evidencing indebtedness. The 1940 Act generally
prohibits each fund from issuing senior securities, although it provides
allowances for certain borrowings and certain other investments, such as short
sales, reverse repurchase agreements, firm commitment agreements and standby
commitments, when such investments are "covered" or with appropriate earmarking
or segregation of assets to cover such obligations.
UNDERWRITING. Under the 1940 Act, underwriting securities involves an investment
company purchasing securities directly from an issuer for the purpose of selling
(distributing) them or participating in any such activity either directly or
indirectly.
THE FOLLOWING ARE NON-FUNDAMENTAL INVESTMENT POLICIES AND RESTRICTIONS, AND MAY
BE CHANGED BY THE BOARD OF
20
TRUSTEES.
EACH FUND MAY NOT:
1) Invest more than 15% of its net assets in illiquid securities as defined
at time of purchase.
2) Purchase securities of other investment companies, except as permitted by
the 1940 Act, the rules or regulations thereunder or any exemption
therefrom, as such statute, rules or regulations may be amended or
interpreted from time to time.
3) Sell securities short unless it owns the security or the right to obtain
the security or equivalent securities, or unless it covers such short sale
as required by current SEC rules and interpretations (transactions in
futures contracts, options and other derivative instruments are not
considered selling securities short).
4) Purchase securities on margin, except such short term credits as may be
necessary for the clearance of purchases and sales of securities and
provided that margin deposits in connection with futures contracts,
options on futures or other derivative instruments shall not constitute
purchasing securities on margin.
5) Borrow money except that the fund may (i) borrow money from banks or
through an interfund lending facility, if any, only for temporary or
emergency purposes (and not for leveraging) and (ii) engage in reverse
repurchase agreements with any party; provided that (i) and (ii) in
combination do not exceed 33 1/3% of its total assets (any borrowings that
come to exceed this amount will be reduced to the extent necessary to
comply with the limitation within three business days).
6) Lend any security or make any other loan if, as a result, more than 33
1/3% of its total assets would be lent to other parties (this restriction
does not apply to purchases of debt securities or repurchase agreements).
7) Purchase or sell commodities, commodity contracts or real estate,
including interests in real estate limited partnerships, provided that the
fund may (i) purchase securities of companies that deal in real estate or
interests therein (including REITs), (ii) purchase or sell futures
contracts, options contracts, equity index participations and index
participation contracts, and (iii) purchase securities of companies that
deal in precious metals or interests therein.
Policies and investment limitations that state a maximum percentage of assets
that may be invested in a security or other asset, or that set forth a quality
standard shall be measured immediately after and as a result of the fund's
acquisition of such security or asset, unless otherwise noted. Except with
respect to limitations on borrowing and futures and option contracts, any
subsequent change in net assets or other circumstances does not require a fund
to sell an investment if it could not then make the same investment. With
respect to the limitation on illiquid securities, in the event that a subsequent
change in net assets or other circumstances cause a fund to exceed its
limitation, the fund will take steps to bring the aggregate amount of illiquid
instruments back within the limitations as soon as reasonably practicable.
The phrase "shareholder approval" as used in the Prospectus and herein, and the
phrase "vote of a majority of the outstanding voting securities," as used
herein, means the affirmative vote of the lesser of (1) more than 50% of the
outstanding shares of a fund or the Trust, as the case may be, or (2) 67% or
more of the shares of a fund or the Trust, as the case may be, present at a
meeting if more than 50% of the outstanding shares are represented at the
meeting in person or by proxy.
PORTFOLIO TURNOVER
A change in securities held by a fund is known as "portfolio turnover" and
almost always involves the payment by a fund of brokerage commissions or dealer
markup and other transaction costs on the sale of securities as well as on the
21
reinvestment of the proceeds in other securities. Portfolio turnover is not a
limiting factor with respect to investment decisions.
As disclosed in the Prospectus, high portfolio turnover involves
correspondingly greater brokerage commissions and other transaction costs, which
will be borne directly by the funds, and could involve realization of capital
gains that would be taxable when distributed to shareholders of a fund. To the
extent that portfolio turnover results in the realization of net short-term
capital gains, such gains are ordinarily taxed to shareholders at ordinary
income tax rates.
INCOME, DIVIDENDS, DISTRIBUTIONS AND TAX STATUS
This discussion of federal income tax consequences is based on Subchapter M
of the Internal Revenue Code of 1986, as amended (the "Code") and the
regulations issued thereunder as in effect on the date of this Statement of
Additional Information. New legislation, as well as administrative changes or
court decisions, may significantly change the conclusions expressed herein, and
may have a retroactive effect with respect to the transaction contemplated
herein.
The tax status of the funds and the distributions which they may make are
summarized in the Prospectus under the headings "Distributions" and "Taxes."
Each fund intends to qualify each year as a regulated investment company ("RIC")
under the Code. In order to qualify as a RIC and to qualify for the special tax
treatment accorded RICs and their shareholders, each fund must, among other
things: (a) derive at least 90% of its gross income from dividends, interest,
payments with respect to certain securities loans, gains from the sale or other
disposition of stock, securities or foreign currencies, or other income
(including but not limited to gains from options, futures or forward contracts)
derived with respect to its business of investing in such stock, securities or
currencies and net income derived from an interest in a qualified publicly
traded partnership; (b) diversify its holdings so that, at the close of each
quarter of its taxable year, (i) at least 50% of the value of its total assets
consists of cash, cash items, U.S. Government securities, securities of other
RICs or other securities limited generally with respect to any one issuer to a
value not more than 5% of the value of the total assets of such fund and not
more than 10% of the outstanding voting securities of such issuer, and (ii) not
more than 25% of the value of its total assets is invested in the securities
(other than U.S. Government securities or securities of other RICs) of any one
issuer, of two or more issuers of which the fund owns at least 20% of the voting
power of each issuer and that are engaged in the same, similar, or related
businesses, or the securities of one or more qualified publicly traded
partnerships; and (c) distribute with respect to each taxable year at least 90%
of the sum of its taxable net investment income, its net tax-exempt income (if
any), and the excess, if any, of net short-term capital gains over net long-term
capital losses for such year. To the extent a fund qualifies for treatment as a
RIC, the fund will not be subject to federal income tax on income paid to its
shareholders in the form of dividends or capital gain distributions.
If a fund fails to qualify as a RIC accorded special tax treatment in any
taxable year, the fund will be subject to tax on its taxable income at corporate
rates, and all distributions from earnings and profits, including any
distributions of net tax-exempt income and net long-term capital gains, will be
taxable to shareholders as ordinary income. Subject to certain limitations, such
distributions should qualify for the dividends received deduction for corporate
shareholders and for the lower tax rates applicable to qualified dividend income
for individual shareholders. In addition, the fund could be required to
recognize unrealized gains, pay substantial taxes and interest and make
substantial distributions before requalifying as a RIC that is accorded special
tax treatment.
In order to avoid an excise tax imposed on certain underdistributed
amounts, a fund must distribute prior to each calendar year end without regard
to the fund's fiscal year end (i) 98% of the fund's ordinary income, (ii) 98% of
the fund's capital gain net income, if any, realized in the one-year period
ending on March 31 (or later if the fund is permitted and so elects), and (iii)
100% of any undistributed income from prior years. A dividend paid to
shareholders by a fund in January of a year is generally deemed to have been
paid by the fund on December 31 of the preceding year, if the dividend was
declared and payable to shareholders of record on a date in October, November or
December of that preceding year.
Each the funds may be subject to foreign withholding taxes on income and
gains derived from foreign investments.
22
Such taxes would reduce the yield on such funds' investments, but, as discussed
in such funds' Prospectus, may in some situations be taken as either a deduction
or a credit by U.S. shareholders. Investment by each fund in certain "passive
foreign investment companies" could subject the fund to a U.S. federal income
tax or other charge on distributions received from, or on the sale of its
investment in, such a company. Such a tax cannot be eliminated by making
distributions to fund shareholders. A fund may avoid this tax by making an
election to mark certain of such securities to the market annually.
Alternatively, where it is in a position to do so, a fund may elect to treat a
passive foreign investment company as a "qualified electing fund," in which case
different rules will apply, although the funds generally do not expect to be in
the position to make such elections.
For federal income tax purposes, distributions of investment income are
generally taxable as ordinary income. Taxes on distributions of capital gains
are determined by how long the fund owned the investments that generated them,
rather than how long a shareholder has owned his or her shares. Distributions of
net capital gains from the sale of investments that the fund owned for more than
one year and that are properly designated by the fund as capital gain dividends
will be taxable as long-term capital gains. Distributions of gains from the sale
of investments that the fund owned for one year or less will be taxable as
ordinary income. The dividends-received deduction for corporations will
generally be available to corporate shareholders with respect to their receipt
of a fund's dividends from investment income to the extent derived from
dividends received by the fund from domestic corporations, provided the fund and
the shareholder each meet the relevant holding period requirements.
For taxable years beginning on or before December 31, 2010, distributions
of investment income designated by the fund as derived from "qualified dividend
income" will be taxed in the hands of individuals at the rates applicable to
long-term capital gain. In order for some portion of the dividends received by a
fund shareholder to be qualified dividend income, the fund must meet holding
period and other requirements with respect to some portion of the dividend
paying stocks in its portfolio and the shareholder must meet holding period and
other requirements with respect to the fund's shares. A dividend will not be
treated as qualified dividend income (1) if the dividend is received with
respect to any share of stock held for fewer than 61 days during the 121-day
period beginning on the date which is 60 days before the date on which such
share becomes ex-dividend with respect to such dividend (or, in the case of
certain preferred stock, 91 days during the 181-day period beginning 90 days
before such date), (2) to the extent that the recipient is under an obligation
(whether pursuant to a short sale or otherwise) to make related payments with
respect to positions in substantially similar or related property, (3) if the
recipient elects to have the dividend income treated as investment income for
purposes of the limitation on deductibility of investment interest, or (4) if
the dividend is received from a foreign corporation that is (a) not eligible for
the benefits of a comprehensive income tax treaty with the United States (with
the exception of dividends paid on stock of such a foreign corporation readily
tradable on an established securities market in the United States), or (b)
treated as a foreign personal holding company, foreign investment company, or
passive foreign investment company.
If the aggregate qualified dividends received by the fund during any
taxable year are 95% or more of its gross income, then 100% of the fund's
dividends (other than properly designated capital gain dividends) will be
eligible to be treated as qualified dividend income. For this purpose, the only
gain included in the term "gross income" is the excess of net short-term capital
gain over net long-term capital loss. In general, distributions of investment
income designated by the fund as derived from qualified dividend income will be
treated as qualified dividend income by a shareholder taxed as an individual
provided the shareholder meets the holding period and other requirements
described above with respect to the fund's shares.
Distributions are taxable to shareholders even if they are paid from income
or gains earned by the fund before a shareholder's investment (and thus were
included in the price the shareholder paid). Distributions are taxable whether
shareholders receive them in cash or in the form of additional shares of the
fund to which the distribution relates. Any gain resulting from the sale or
exchange of fund shares generally will be taxable as capital gains.
Long-term capital gain rates applicable to individuals have been
temporarily reduced--in general, to 15% with lower rates applying to taxpayers
in the 10% and 15% rate brackets--for taxable years beginning on or before
December 31, 2010.
23
Dividends and distributions on a fund's shares are generally subject to
federal income tax as described herein, even though such dividends and
distributions may economically represent a return of a particular shareholder's
investment. Such distributions are likely to occur in respect of shares
purchased at a time when a fund's net asset value reflects gains that are either
unrealized, or realized but not distributed.
Certain tax-exempt organizations or entities may not be subject to federal
income tax on dividends or distributions from a fund. Each organization or
entity should review its own circumstances and the federal tax treatment of its
income.
Under current law, each fund is generally required to withhold and remit to
the U.S. Treasury a percentage of the taxable dividends and other distributions
paid to and proceeds of share sales, exchanges or redemptions made by any
individual shareholder who fails to furnish the fund with a correct taxpayer
identification number, who has underreported income in the past or fails to
provide certain certifications. However, the general backup withholding rules
set forth above will not apply to a shareholder so long as the shareholder
furnishes a fund with the appropriate certification required by the Internal
Revenue Service. The backup withholding tax rate is 28% for amounts paid through
2010. The backup withholding rate reductions will be 31% for amounts paid after
December 31, 2010.
In order for a foreign investor to qualify for exemption from (or reduced
rates for) back up withholding tax under income tax treaties, the foreign
investor must comply with special certification and filing requirements. Foreign
investors in a fund should consult their tax advisers in this regard.
To the extent such investments are permissible for a particular fund, the
fund's transactions in options, futures contracts, hedging transactions, forward
contracts, straddles and certain foreign currencies will be subject to special
tax rules (including mark-to-market, constructive sale, straddle, wash sale and
short sale rules), the effect of which may be to accelerate income to the fund,
defer losses to the fund, cause adjustments in the holding periods of the fund's
securities, convert long-term capital gains into short-term capital gains and
convert short-term capital losses into long-term capital losses. These rules
could therefore affect the amount, timing and character of distributions to
shareholders.
Certain transactions effectively insulating a fund from substantially all
risk of loss and all opportunity for gain in an appreciated financial position
are treated as constructive sales of those positions for federal income tax
purposes. Short sales, swap contracts, and forward or futures contracts to sell
the appreciated position, or one or more other transactions that have
substantially the same effect as those transactions as determined under
regulations, are treated as "constructive sales" for this purpose. A fund that
owns an appreciated financial position that enters into such a transaction
generally recognizes gain for tax purposes prior to the generation of cash by
such activities, which may require the fund to sell assets to meet its
distribution requirement.
THE TAX DISCUSSION SET FORTH ABOVE IS A SUMMARY INCLUDED FOR GENERAL
INFORMATION PURPOSES ONLY. EACH SHAREHOLDER IS ADVISED TO CONSULT HIS OR HER OWN
TAX ADVISER WITH RESPECT TO THE SPECIFIC TAX CONSEQUENCES TO HIM OR HER OF AN
INVESTMENT IN ANY OF THE FUNDS, INCLUDING THE EFFECT AND APPLICABILITY OF STATE,
LOCAL, FOREIGN, AND OTHER TAX LAWS AND THE POSSIBLE EFFECTS OF CHANGES IN
FEDERAL OR OTHER TAX LAWS. THIS DISCUSSION IS NOT INTENDED, AND SHOULD NOT BE
CONSIDERED, TO BE A SUBSTITUTE FOR CAREFUL TAX PLANNING.
MANAGEMENT OF THE FUNDS
Laudus Trust. The Trustees oversee the general conduct of the funds'
business. Certain information concerning the Trustees is set forth below.
REVISED TABLE TO COME
------------
24
-- The Trust has a standing Audit and Compliance Committee (formerly the
Audit Committee). The members of the Audit & Compliance Committee are
identified above. The function of the Audit & Compliance Committee is to
provide oversight responsibility for the integrity of the Trust's
financial reporting processes and compliance policies, procedures and
processes, and for the Laudus Funds Complex's overall system of internal
controls. The charter directs that the Audit and Compliance Committee must
meet four times annually, with additional meetings as the Audit and
Compliance Committee deems appropriate. The current Audit and Compliance
Committee and its predecessor met X times during the fiscal year ended
March 31, 2008.
-- The Trust also has a Nominating Committee (formerly a function of the
Governance Committee, which included the Nominating Committee for the
period from September 2006 to September 2007) that is composed of all the
Independent Trustees, which meets as often as deemed appropriate by the
Nominating Committee for the primary purpose of selecting and nominating
candidates to serve as members of the Board of Trustees. There are no
specific procedures in place to consider nominees recommended by
shareholders, but such nominees would be considered if such nominations
were submitted in accordance with Rule 14a-8 of the Securities Exchange
Act of 1934 in conjunction with a shareholder meeting to consider the
election of Trustees. The charter directs that the Nominating Committee
meets at such times and with such frequency as is deemed necessary or
appropriate by the Nominating Committee. The Nominating Committee did not
meet during the fiscal year ended March 31, 2008.
-- From September 2006 to September 2007, the Trust also had a Governance
Committee, an Investment Oversight Committee, and a Marketing,
Distribution and Shareholder Servicing Committee. The Governance
Committee, which included the Nominating Committee during that time, met
three times during the fiscal year ended March 31, 2007. The Investment
Oversight Committee met three times, two of which meetings were held
jointly with the Marketing, Distribution and Shareholder Servicing
Committee, during the Trust's fiscal year ended March 31, 2007. The
Marketing, Distribution and Shareholder Servicing Committee met X
times, two of which meetings were held jointly with the Investment
Oversight Committee, during the Trust's fiscal year ended March 31, 2008.
The following table provides each Trustee's equity ownership of the funds and
ownership of all registered investment companies overseen by each Trustee in the
Family of Investment Companies as of December 31, 2007.
AGGREGATE DOLLAR RANGE OF EQUITY
SECURITIES IN THE FAMILY OF
INVESTMENT COMPANIES 7
NAME OF TRUSTEE DOLLAR RANGE OF SECURITIES IN A FUND AS OF DECEMBER 31, 2007
INTERNATIONAL EQUITY
INDEPENDENT TRUSTEES: FUND GLOBAL EQUITY FUND
Mariann Byerwalter $0 $0 $0
William A. Hasler $0 $0 $0
Nils H. Hakansson $0 $0 $10,001 - $50,000
INTERESTED TRUSTEE:
Randall W. Merk $0 $0 $50,001 - $100,000
------------
7 As of December 31, 2007 the Family of Investment Companies consisted of 74
operational series of the Trusts.
Certain information concerning the Trust's officers is set forth below:
REVISED TABLE TO COME
25
----------
8 The mailing address of each of the officers is c/o Laudus Trust, 101
Montgomery Street, San Francisco, CA 94104.
9 There is no stated term of office for the officers of the Trust.
Mmes. MacGregor and Sabo, and Messrs. Merk, Pereira, Mortimer, Fillmore,
Kern, Thomas and Haydel, each being an employee of Charles Schwab Investment
Management, Inc. or its affiliates, will each benefit indirectly from the
management fees paid by the Trust to Charles Schwab Investment Management, Inc.,
but receive no compensation from the Trust.
Trustee Compensation. Interested Trustees and officers of the Trust do not
receive compensation from the Trust. The Trust pays each Independent Trustee
aggregate compensation of $55,000 per year. This sum includes a quarterly
retainer fee of $8,788 and an additional $3,790 for each regular meeting
attended.
In addition, a retirement plan has been instituted for all of the
Independent Trustees of the Trust and Trustees of the Laudus Institutional Trust
(the "Retirement Plan"). Under the terms of the Retirement Plan, upon retirement
or other termination from service from the Trust and Laudus Institutional Trust
(other than termination for cause), a retiring Independent Trustee who has
served as Independent Trustee for at least five years shall be paid a lump sum
cash payment (the "Retirement Payment"). The Retirement Payment shall be equal
to $10,000 for each year that the Trustee has served as an Independent Trustee
of the Trust and the Laudus Institutional Trust, including years of service
prior to the adoption of the Retirement Plan. However, each Independent Trustee
is permitted to make a one-time election to have the $10,000 attributable to
service for the coming year adjusted up or down at the end of each subsequent
year based on the unweighted average performance of Institutional Shares of each
fund of the Trust and the sole series of the Laudus Institutional Trust that is
in operation for all of such year. Each Independent Trustee also was given the
opportunity to make a one-time election to have previously accrued benefits
fluctuate beginning April 1, 2005 based on performance of the funds as described
in the previous sentence. As a result, the amount of the Retirement Payment
payable to any Independent Trustee may increase or decrease based upon
performance of the funds. The portion of the total Retirement Payment owed to an
Independent Trustee upon his or her retirement that is payable by any fund will
be determined based on the relative net assets of the funds of the Trust in
operation on the date of the Independent Trustee's retirement.
Effective June 28, 2006, the Retirement Plan terminated with respect to new
Participants, including Independent Trustees of the Trust first elected by
shareholder vote on June 26, 2006. With respect to Participants prior to June
26, 2006 (a "Current Participant"), the Account Balance of each Current
Participant under the Plan was frozen at the value determined as of September
29, 2006, except that each Account Balance was credited with an amount equal to
one-half of the amount that would be credited to such Account Balance as of the
last day of the Plan Year ending March 31, 2007. The terms of the Plan,
including without limitation provisions relating to vesting and payment upon
termination of service, remain in full force and effect.
The total compensation accrued and payable to, as well as the benefits
accrued under the Retirement Plan by, the Independent Trustees by the Trust and
by the fund complex for the fiscal year ended March 31, 2007, is shown in the
table below.
26
TOTAL
COMPENSATION
PENSION OR FROM
RETIREMENT ESTIMATED REGISTRANT
AGGREGATE BENEFITS ANNUAL AND FUND
COMPENSATION ACCRUED AS BENEFITS COMPLEX 10
FROM PART OF FUND UPON PAID
NAME OF PERSON REGISTRANT EXPENSES RETIREMENT TO DIRECTORS
TRUSTEES:
------------------------------------------------------------------------------------------------------------
Mariann Byerwalter $32,425 $6,814 $0 $304,586 11
William A. Hasler $33,236 $6,814 $0 $304,586 11
Nils H. Hakansson $32,311 $20,404 $0 $102,811 11
Rodman L. Drake 12 $24,860 N/A N/A $141,283
Morrill Melton Hall, Jr. 12 $19,533 N/A N/A $115,033
Roger M. Lynch 13 $4,108 N/A N/A $41,666
Jonathan Piel 12 $19,533 N/A N/A $116,283
John D. Collins 12 $22,197 N/A N/A $126,283
----------
10 As of June 30, 2007, the fund complex consisted of 72 funds, which
included the 11 operational series of the Laudus Trust and 61 Schwab
Funds.
11 Total compensation amounts include payments relating to the Excelsior
Funds, formerly an affiliated fund group included in the fund complex and
on whose Board of Directors Ms. Byerwalter and Messrs. Hasler and
Hakansson served on prior to July 1, 2007. Prior to July 1, 2007, the fund
complex consisted of 99 funds, which included 11 operational series of the
Trust, 61 Schwab Funds, and 27 Excelsior Funds.
12 Resigned from the Board effective July 1, 2007.
13 Resigned from the Board effective August 26, 2006.
INVESTMENT ADVISORY AND OTHER SERVICES
ADVISORY AGREEMENTS
After its initial two year term, the continuation of each fund's
advisory agreements must be specifically approved at least annually (1) by the
vote of the Trustees or by a vote of the shareholders of the fund, and (2) by
the vote of a majority of the Trustees who are not parties to the investment
advisory agreement or "interested persons" of any party (the "Independent
Trustees"), cast in person at a meeting called for the purpose of voting on such
approval.
After its initial two year term, each year, the Board of Trustees
will call and hold one or more meetings to decide whether to renew the advisory
agreements between Laudus Trust (the "Trust") and CSIM, and the sub-advisory
agreement CSIM and Mondrian Investment Partners Limited (the "Subadviser" or
"Mondrian") with respect to the funds. In preparation for the meetings, the
Board requests and reviews a wide variety of materials provided by CSIM and
Mondrian as well as extensive data provided by third parties and the Independent
Trustees receive advice from counsel to the Independent Trustees.
Mondrian serves as a subadviser to the funds. Mondrian was
established as a limited company organized under the laws of England and Wales
in 1990 under the name Delaware International Advisers Limited, an indirect,
wholly owned subsidiary of Delaware Holdings, Inc. In 2004, a senior management
team, together with private equity funds sponsored by Hellman & Friedman LLC,
acquired Delaware International Advisers Limited and changed its name to
Mondrian Investment Partners Limited. Mondrian is currently 57% owned by its
senior employees, including the majority of investment professionals, senior
client service officers, and senior operations personnel, and 43% owned by
private equity funds affiliated with Hellman & Friedman, LLC. Mondrian's
principal office is located at Fifth Floor 10 Gresham Street London EC2V 7JD.
Hellman & Friedman's principal office is located at One Maritime Plaza, 12th
Floor, San Francisco, CA 94111.
CSIM oversees the advisory services provided to the funds. Pursuant
to separate sub-advisory agreement, and under the supervision of the investment
adviser and the funds' Board of Trustees, Mondrian is responsible for the
day-to-day investment management of each fund's assets. Mondrian also is
responsible for managing their employees who provide services to the funds.
INVESTMENT ADVISORY CONTRACTS
27
ABOUT CSIM
CSIM is a wholly-owned subsidiary of The Charles Schwab Corporation.
Both CSIM and The Charles Schwab Corporation are located at 101 Montgomery
Street, San Francisco, CA 94104.
As of December 31, 2007, CSIM managed 72 mutual funds and approximately
$235.20 billion in assets.
Principal Executive Officer and Directors - Listed below are the
directors and principal executive officer of CSIM. The principal business
address of each director and the principal executive officer, as it relates to
their duties at CSIM, is the same as above.
NAME POSITION
---------------------------------- ---------------------------------------
Randall W. Merk................... Director, President and Chief Executive
Officer
NAME POSITION
---------------------------------- ---------------------------------------
Charles R. Schwab................. Chairman and Director
As disclosed in the Prospectus under the heading "Management of the
Funds" under management contracts (each a "Management Contract") between the
Trust, on behalf of each fund, and CSIM, subject to the supervision of the
Trustees of the Trust and such policies as the Trustees may determine, CSIM
furnishes office space and equipment, provides certain bookkeeping and clerical
services and pays all salaries, fees and expenses of officers and Trustees of
the Trust who are affiliated with CSIM. In addition, pursuant to a sub-advisory
agreement between CSIM and Mondrian, Mondrian will continuously furnish an
investment program for each fund and will make investment decisions on behalf of
each fund and place all orders for the purchase and sale of portfolio
securities.
Each of the funds has agreed to pay CSIM a monthly management fee at the
annual percentage rate of the relevant fund's average daily net assets. The
table below shows the advisory fee payable to CSIM by each fund.
AGREEMENT
FUND RATE*
------------------------------------------------ --------------------------
First $1 billion -- x.xx%
Laudus Mondrian International Equity Fund....... Over $1 billion -- x.xx%
Laudus Mondrian Global Equity Fund............. x.xx%
* The advisory fee payable to CSIM varies based on fund assets.
CSIM has agreed with the Trust that it will waive some or all of its
management fees under the Management Contract and, if necessary, will bear
certain expenses of each fund until July 30, 2010 (unless the waiver is
extended, modified or terminated by mutual agreement of the Trust and CSIM) so
that each fund's total annual operating expenses (exclusive of nonrecurring
account fees, fees on securities transactions such as exchange fees, service
fees, interest, taxes, brokerage commissions, other expenditures which are
capitalized in accordance with generally accepted accounting principles, other
extraordinary expenses not incurred in the ordinary course of the funds'
business) applicable to each class will not exceed the limit stated in the
Prospectus. In addition, CSIM's compensation under each Management Contract is
subject to reduction to the extent that in any year the expenses of a fund
(including investment advisory fees but excluding taxes, portfolio brokerage
commissions and any distribution and shareholder service expenses paid by a
class of shares of a fund pursuant to a distribution and shareholder service
plan or otherwise) exceed the limits on investment company expenses imposed by
any statute or regulatory authority of any jurisdiction in which shares of the
fund are qualified for offer and sale.
Each Management Contract provides that CSIM shall not be subject to any
liability to the Trust or to any shareholder
28
of the Trust in connection with the performance of its services thereunder in
the absence of willful misfeasance, bad faith, gross negligence or reckless
disregard of its obligations and duties thereunder.
Each Management Contract will continue in effect for a period no more than
two years from the date of its execution, and renewals thereof must be approved
by (i) vote, cast in person at a meeting called for that purpose, of a majority
of those Trustees who are not "interested persons" of CSIM or the Trust, and by
(ii) the majority vote of either the full Board of Trustees or the vote of a
majority of the outstanding shares of the relevant fund. Each Management
Contract automatically terminates on assignment and is terminable on not more
than 60 days' notice by the Trust to CSIM or by CSIM to the Trust.
SUBADVISORY AGREEMENT
The Trust and CSIM have entered into an agreement on behalf of each fund
with Mondrian by which it acts as subadviser to the funds (the "Subadviser
Agreement"). Under the Subadviser Agreement, Mondrian, at its expense,
continuously furnishes an investment management program for the particular fund
and makes investment decisions on behalf of such fund and places all orders for
the purchase and sale of portfolio securities and all other investments, subject
to the supervision of CSIM and the Trustees.
SUBADVISORY FEE
This section describes the subadvisory fee payable by CSIM to Mondrian.
Please remember, however, that the following fees described are paid by CSIM to
Mondrian; they do not affect how much you pay or your fund pays.
FUND SUBADVISORY FEE
----------------------------------------- ---------------
Laudus Mondrian International Equity Fund
Laudus Mondrian Global Equity Fund
ADMINISTRATIVE SERVICES. The Trust has entered into a fund Administration
Agreement with State Street Bank and Trust Company (in such capacity, the
"Administrator") pursuant to which the Administrator provides certain management
and administrative services necessary for the funds' operations including: (i)
regulatory compliance, including the compilation of information for documents
such as reports to, and filings with, the SEC and state securities commissions,
and preparation of proxy statements and shareholder reports for the funds; (ii)
general supervision relative to the compilation of data required for the
preparation of periodic reports distributed to the funds' officers and Board of
Trustees; and (iii) furnishing office space and certain facilities required for
conducting the business of the funds. For these services, the Administrator is
entitled to receive $1,000 per fund per annum, as well as a fee based on the
average daily net assets of the Trust (the "Administrator's Asset-Based Fee").
In calculating the Administrator's Asset Based-Fee payable by the Trust, the
assets of the Trust are aggregated with the average daily net assets of each of
the other portfolios for which CSIM serves as investment adviser and State
Street Bank and Trust Company serves as administrator 1. The Administrator's
Asset-Based Fee will be calculated as follows:
29
AVERAGE DAILY NET ASSETS FEE
-------------------------------------------------------------------- -------
First $100 billion 0.11 bp
Next $60 billion 0.07 bp
Thereafter 0.05 bp
1 In addition to the trust, CSIM currently serves as investment adviser for
each of the portfolios of the Laudus Institutional Trust, Schwab Investments,
The Charles Schwab Family of Funds, Schwab Annuity Portfolios, and Schwab
Capital Trust.
The Trust also has entered into a Fund Accounting Agreement with State
Street Bank and Trust Company (in such capacity, the "Fund Accountant") pursuant
to which the Fund Accountant provides certain accounting services necessary for
the funds' operations. For these services, the Fund Accountant is entitled to
receive a base fee of $29,000 per annum for each of the funds. The Fund
Accountant is also entitled to a fee based on the average daily net assets of
the Trust (the "Fund Accountant's Asset-Based Fee"). In calculating the Fund
Accountant's Asset-Based Fee payable by the Trust, the assets of the Trust are
aggregated with the average daily net assets of each of the portfolios for which
CSIM serves as investment adviser and State Street Bank and Trust Company serves
as fund accountant (see footnote 1 below). The Fund Accountant's Asset-Based Fee
will be calculated as follows:
AVERAGE DAILY NET ASSETS FEE
-------------------------------------------------------------------- -------
First $100 billion 0.25 bp
Next $60 billion 0.18 bp
Thereafter 0.13 bp
In addition, the Fund Accountant is entitled to a per security pricing
fee based on the monthly holdings of each Fund equal to $2 for equity securities
and $8 for fixed income securities. For certain of the Funds this fee could be
quite substantial. Lastly, for each Fund, the Fund Accountant is entitled to a
fair valuation fee of $4,000 per annum.
Distributor and Distribution and Shareholder Service Plans. As stated in
the Prospectus under the heading "Management of the Funds -- Distributor,"
Institutional Shares, Select Shares and Investor Shares of each Fund are sold on
a continuous basis by the Trust's distributor, ALPS Distributors, Inc. (the
"Distributor"). The Trust reserves the right at any time to modify the
restrictions set forth above, including the suspension of all sales of all
shares or the lifting of restrictions on different classes of investors and/or
transactions. The Distributor's principal offices are located at 1625 Broadway,
Suite 2200, Denver, Colorado, 80202. Under the Distributor's Contract between
the Trust and the Distributor (the "Distributor's Contract"), the Distributor is
not obligated to sell any specific amount of shares of the Trust and will
purchase shares for resale only against orders for shares.
Pursuant to the Distribution and Shareholder Service Plans described in
the Prospectus (each a "Plan"), in connection with the distribution of Investor
Shares of the Trust and/or in connection with the provision of direct client
service, personal services, maintenance of shareholder accounts and reporting
services to holders of such shares, the Distributor receives certain
distribution and shareholder service fees from the Trust. The distribution and
shareholder service fees will not be retained by the Distributor but will
instead be reallowed to the financial intermediaries who provide these services.
Any amount not reallowed to financial intermediaries will be waived or
reimbursed to the fund. The Distributor may pay all or a portion of the
distribution and shareholder service fees it receives from the Trust to
intermediaries. The funds pay no fees in connection with the distribution of
Select Shares or Institutional Shares.
Each Plan may be terminated by a vote of the majority of the Trustees of
the Trust who are not interested persons of the Trust and who have no direct or
indirect financial interest in the operation of the Plan or the Distributor's
Contract (the "Independent Trustees"), or by a vote of a majority of the
outstanding voting securities of the relevant class. Any change in a Plan that
would materially increase the cost to Investor Shares requires approval by
holders of the relevant class of shares. The Trustees of the Trust review a
quarterly written report of such costs and the purposes for which such costs
have been incurred. Except as described above, the Plans may be amended by vote
of the Trustees of the Trust,
30
including a majority of the Independent Trustees, cast in person at a meeting
called for that purpose. For so long as the plans are in effect, selection and
nomination of those Trustees of the Trust who are not interested persons of the
Trust shall be committed to the discretion of such disinterested persons.
The Distributor's Contract may be terminated with respect to any fund or
Investor Shares thereof at any time on 60 days' written notice without penalty
either by the Distributor, by the fund or class, or by the Trust and will
terminate automatically in the event of its assignment.
The Plans and the Distributor's Contract will continue in effect with
respect to each class of shares to which they relate for two years and
thereafter for successive one-year periods, provided that each such continuance
is specifically approved (i) by the Trust's Board of Trustees or (ii) by the
vote of a majority of the outstanding shares of a class, provided that in either
event the continuance is also approved by a majority of the Independent Trustees
by vote cast in person at a meeting called for that purpose.
If any Plan or the Distributor's Contract is terminated (or not renewed
with respect to one or more classes), it may continue in effect with respect to
any class of any fund as to which it has not been terminated (or has not been
renewed).
The Trustees believe that the Plan will benefit the funds and their
shareholders. Based on the experience of the funds under the Plan, and the
relative success that this method of distribution has had for the funds, the
Trustees believe that the Plan will likely result in higher fund asset levels.
Higher fund asset levels can be expected to reduce fund expense ratios and
increase the ability of the Adviser to seek out more investment opportunities
for the funds in order to obtain greater portfolio diversification.
The Plans are "compensation" plans. This means that the fees are payable to
compensate the Distributor or another intermediary for services rendered even if
the amount paid exceeds the Distributor's or intermediary's expenses. Because
these fees are paid out of the funds' assets on an ongoing basis, over time
these fees will increase the cost of your investment and may cost you more than
paying other types of sales charges.
Custodial Arrangements. The Trust's custodian is State Street Bank and Trust
Company, Boston MA 02103. As such, the Custodian holds in safekeeping
certificated securities and cash belonging to the Trust and, in such capacity,
is the registered owner of securities in book-entry form belonging to each
relevant fund. Upon instruction, the Custodian receives and delivers cash and
securities of the relevant fund in connection with fund transactions and
collects all dividends and other distributions made with respect to fund
portfolio securities.
Independent Registered Public Accounting Firm. The Trust's independent
registered public accounting firm is PricewaterhouseCoopers LLP, 3 Embarcadero
Center, San Francisco, California 94111. The firm conducts an annual audit of
the financial statements, assists in the preparation of the Trust's federal and
state income tax returns and filings with the SEC, and consults with the Trust
as to matters of accounting and federal and state income taxation.
Codes Of Ethics. Each of the Trust (on behalf of each fund), CSIM, Mondrian
and the Distributor (as the funds' principal underwriter) have adopted codes of
ethics (each a "Code") pursuant to Rule 17j-1 of the 1940 Act. Each permits
personnel subject thereto to invest in securities subject to certain conditions
or restrictions. CSIM's Code permits personnel to buy or sell, directly or
indirectly, securities for their own accounts. This includes securities that may
be purchased or held by the funds CSIM manages. Securities transactions by some
of these individuals are subject to prior approval of CSIM's Chief Compliance
Officer or designee and are subject to certain restrictions. Covered securities
transactions are subject to quarterly and annual reporting and review
requirements. Mondrian's Code permits personnel to buy or sell securities for
their own accounts and accounts for which they are the beneficial owner so long
as the investment does not lead to an actual or potential conflict of interest.
This includes securities that may be purchased or held by the funds Mondrian
advises or subadvises. Securities transactions may be subject to prior approval
of Mondrian's Chief Compliance Officer or his or her alternate. Most securities
transactions are subject to quarterly reporting and review requirements. The
Distributor's Code permits personnel subject thereto to invest in securities,
including securities that the
31
fund may purchase or hold, so long as the individual, in the ordinary course of
fulfilling his or her duties, does not have knowledge of a pending buy or sell
order by the funds. In such cases where such knowledge may exist, the individual
is prohibited from engaging in such transactions while the buy or sell order is
pending.
The investment adviser and Schwab also have adopted a Code of Ethics ("Ethics
Code") as required under the 1940 Act. Subject to certain conditions or
restrictions, the Ethics Code permits the trustees, directors, officers or
advisory representatives of the funds or the investment adviser or the directors
or officers of Schwab to buy or sell directly or indirectly securities for their
own accounts. This includes securities that may be purchased or held by the
funds. Securities transactions by some of these individuals may be subject to
prior approval of the investment adviser's Chief Compliance Officer or
alternate. Most securities transactions are subject to quarterly reporting and
review requirements.
Mondrian has adopted a Code of Ethics and, subject to certain conditions or
restrictions, its Code of Ethics permits directors or officers of Mondrian to
buy or sell securities for their own account, including securities that may be
purchased or held by the funds. Securities transactions by some of these
individuals may be subject to prior approval of senior Mondrian personnel. Most
securities transactions are subject to quarterly reporting and review
requirements.
MONDRIAN INVESTMENT PARTNERS LIMITED ("MONDRIAN") SUB-ADVISES EACH OF THE FUNDS.
OWNERSHIP OF FUND SHARES. Because the funds have not commenced operations prior
to the date of this SAI, no information regarding the Portfolio Managers'
"beneficial ownership" of shares of the funds has been included. This
information will appear in a future version of the SAI.
OTHER ACCOUNTS. In addition to the funds, the portfolio manager is responsible
for the day-to-day management of certain other accounts, as listed below, as of
January 2, 2008, there are no accounts with respect to which the advisory fee is
based on the performance of the account.
Table to Come
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CONFLICTS OF INTEREST. Mondrian does not foresee any material conflicts of
interest that may arise in the management of the funds and any other accounts
managed with similar investment guidelines. Mondrian acts solely as an
investment manager and does not engage in any other business activities. The
following is a list of some potential conflicts of interest that can arise in
the course of normal investment management business activities together with a
summary of Mondrian's policy in that area:
ALLOCATION OF AGGREGATED TRADES
Mondrian may from time to time aggregate trades for a number of its clients.
Mondrian's policy requires that all allocations of aggregated trades must be
fair between clients. Transactions involving commingled orders are allocated in
a manner deemed equitable to each account. When a combined order is executed in
a series of transactions, at different prices, each account participating in the
order may be allocated an average price obtained from the broker/dealer. When a
trade can be allocated in a cost efficient manner to our clients, it will be
prorated across all participating accounts. Mondrian may randomly allocate
purchases or sales among participating accounts when the amounts involved are
too small to be evenly proportioned in a cost efficient manner. In performing
random allocations, Mondrian will consider consistency of strategy
implementation among participating accounts.
ALLOCATION OF INVESTMENT OPPORTUNITIES
Mondrian is an investment manager of multiple client portfolios. As such, it has
to ensure that investment opportunities are allocated fairly between clients.
There is a potential risk that Mondrian may favor one client over another client
in making allocations of investment opportunities.
Mondrian makes security selection decisions at committee level. Those securities
identified as investment opportunities are added to a list of approved
securities; portfolios will hold only such approved securities.
All portfolios governed by the same or a similar mandate will be structured
similarly (that is, will hold the same or comparable stocks), and will exhibit
similar characteristics. Sale and purchase opportunities identified at regular
investment meetings will be applied to portfolios across the board, subject to
the requirements of individual client mandates.
See also "Side-by-side management of hedge funds" below.
ALLOCATION OF IPO OPPORTUNITIES
Initial Public Offerings ("IPO's") present a potential conflict of interest when
they are priced at a discount to the anticipated secondary market price and the
issuer has restricted or scaled back its allocation due to market demand. In
such instances, the IPO allocation could be divided among a small select group
of clients with others not receiving the allocation they would otherwise be
entitled to.
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Mondrian clients with relevant mandates are given an equal opportunity,
proportionate to the size of their portfolio, to participate in IPO trades. All
IPO purchases are allocated on a strict pro-rata basis.
DEALING IN INVESTMENTS AS PRINCIPAL IN CONNECTIONS WITH THE PROVISION OF SEED
CAPITAL
A conflict of interest exists when a portfolio management firm manages its own
money alongside client money.
Mondrian generally does not trade for its own account. However, Mondrian
affiliates have provided the seed capital to certain investment vehicles that
have been established by Mondrian group entities. Mondrian serves as the
investment manager to these investment vehicles.
Mondrian operates dealing policies designed to ensure the fair and equal
treatment of all clients e.g. the allocation of aggregated trades among clients.
These policies ensure that any portfolios in which Mondrian has an investment
interest do not receive favorable treatment relative to other client portfolios.
DIRECTORSHIPS AND EXTERNAL ARRANGEMENTS
Certain Mondrian staff may hold positions in external organizations. There is a
potential risk that Mondrian personnel may place their own interests (resulting
from outside employment / directorships) ahead of the interests of Mondrian
clients.
Before accepting an executive or non-executive directorship or any other
appointment in another company, employees, including executive directors, must
obtain the prior approval of the Chief Executive Officer. The Chief Compliance
Officer must also be informed of all such appointments and changes.
The CEO and CCO will only permit appointments that would not present a conflict
of interest with the individual's responsibilities to Mondrian clients.
DUAL AGENCY
Dual Agency (also known as Cross Trading) concerns those transactions where
Mondrian may act as agent for both the buyer and seller. In such circumstances
there is a potential conflict of interest as it may be possible to favor one
client over another when establishing the execution price and/or commission
rate.
Although it rarely does so, Mondrian may act as agent for both buying and
selling parties with respect to transactions in investments. If Mondrian
proposes to act in such capacity, the Portfolio Manager will first obtain
approval from the Chief Compliance Officer. The CCO has an obligation to ensure
that both parties are treated fairly in any such trade.
EMPLOYEE PERSONAL ACCOUNT DEALING
There are a number of potential conflicts when staff of an investment firm
engage in buying and selling securities for their personal account.
Mondrian has arrangements in place to ensure that none of its directors,
officers or employees (or persons connected to them by way of a business or
domestic relationship) effects any transaction on their own account which
conflicts with client interests.
Mondrian's rules which govern personal account dealing and general ethical
standards are set out in the Mondrian Investment Partners Code of Ethics.
GIFTS AND ENTERTAINMENT (RECEIVED)
In the normal course of business Mondrian employees may receive gifts and
entertainment from third parties e.g. brokers and other service providers. This
results in a potential conflict of interest when selecting third parties to
provide services to Mondrian and its clients.
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Mondrian has a policy which requires that gifts and entertainment received are
reported to the Chief Compliance Officer (any items in excess of Pound
Sterling 100 require pre-approval).
All gifts and entertainment are reviewed to ensure that they are not
inappropriate and that staff have not been unduly influenced by them.
GIFTS AND ENTERTAINMENT (GIVEN)
In the normal course of business, Mondrian employees may provide gifts and
entertainment to third parties. Excessively lavish gifts and entertainment would
be inappropriate.
Mondrian has a policy which requires that any gifts and entertainment provided
are reported to the Chief Compliance Officer (any items in excess of Pound
Sterling 200 require pre-approval).
All gifts and entertainment are reviewed to ensure that they are not
inappropriate and that staff have not attempted to obtain undue influence from
them.
PERFORMANCE FEES
Where an investment firm has clients with a performance fee arrangement there is
a risk that those clients could be favored over clients without performance
fees.
Mondrian charges fees as a proportion of assets under management. In a very
limited number of situations, in addition to this fee basis, certain accounts
also include a performance fee basis.
The potential conflict of interest arising from these fee arrangements is
addressed by Mondrian's procedures for the allocation of aggregated trades among
clients. Investment opportunities are allocated totally independently of fee
arrangements.
SIDE-BY-SIDE MANAGEMENT OF HEDGE FUNDS (MONDRIAN ALPHA FUNDS)
Where an investment manager has responsibility for managing long only portfolios
alongside portfolios that can take short positions there is potential for a
conflict of interest to arise between the two types of portfolio.
Mondrian acts as investment manager for two Fixed Income Alpha and one Equity
Alpha fund. The Alpha Funds are permitted to take short positions and are also
permitted to invest in some or all of the same securities that Mondrian manages
for other clients.
Mondrian is satisfied that the investment styles of these different products
significantly reduce the likelihood of a conflict of interest arising. However,
Mondrian has a number of policies and procedures in place that are designed to
ensure that any potential conflicts are correctly managed and monitored so that
all clients are treated fairly.
SOFT DOLLAR ARRANGEMENTS
Where an investment manager has soft dollar arrangements in place with a
broker/dealer there is a potential conflict of interest as trading volumes
through that broker/dealer are usually important in ensuring that soft dollar
targets are met.
As is typical in the investment management industry, Mondrian client funds are
used to pay brokerage commissions for the execution of transactions in the
client's portfolio. As part of that execution service, brokers generally provide
proprietary research to their clients as to the value of securities, the
advisability of investing in, purchasing or selling securities, and the
availability of securities or purchasers or sellers of securities; furnishing of
analyses and reports concerning issuers, securities or industries; and providing
information on economic factors and trends.
35
Proprietary research may be used by Mondrian in connection with its investment
decision-making process with respect to one or more accounts managed by it, and
it may or may not be used, or used exclusively, with respect to the account
generating the brokerage.
With the exception of the receipt of proprietary research, Mondrian has no other
soft dollar or commission sharing arrangements in place with brokers.
COMPENSATION. Mondrian's compensation arrangements are designed to attract and
retain high caliber staff. The compensation structure does not provide
incentives for any member staff to favor any client (or group of clients).
Incentives (bonus and equity programs) focus on the key areas of research
quality, long-term and short-term performance, teamwork, client service and
marketing.
Competitive Salary -- All investment professionals are remunerated with a
competitive base salary that periodically changes over time.
Profit Sharing Bonus Pool -- All Mondrian staff, including portfolio managers
and senior officers, qualify for participation in an annual profit sharing pool
determined by the company's profitability (approximately 30% of profits).
Equity Ownership -- Mondrian is majority management-owned. A high proportion of
senior Mondrian staff (investment professionals and other support functions) are
shareholders in the business.
Incentives (Bonus and Equity Programs) focus on the key areas of research
quality, long-term and short-term performance, teamwork, client service and
marketing. As an individual's ability to influence these factors depends on that
individual's position and seniority within the firm, so the allocation of
participation in these programs will reflect this.
At Mondrian, the investment management of particular portfolios is not "star
manager" based but uses a team system. This means that Mondrian's investment
professionals are primarily assessed on their contribution to the team's effort
and results, though with an important element of their assessment being focused
on the quality of their individual research contribution.
Compensation Committee. In determining the amount of bonuses and equity awarded,
Mondrian's Board of Directors consults with the company's Compensation
Committee, which makes recommendations based on a number of factors including
investment research, organization management, team work, client servicing and
marketing.
Defined Contribution Pension Plan. All portfolio managers are members of the
Mondrian defined contribution pension plan where Mondrian pays a regular monthly
contribution and the member may pay additional voluntary contributions if they
wish. The plan is governed by trustees who have responsibility for the trust
fund and payments of benefits to members. In addition, the plan provides death
benefits for death in service and a spouse's or dependant's pension may also be
payable.
No element of portfolio manager compensation is based on the performance of
individual client accounts.
PORTFOLIO TRANSACTIONS
Investment Decisions. The purchase and sale of portfolio securities for the
funds and for the other investment advisory clients of Mondrian are made by it
with a view to achieving each client's investment objective. For example, a
particular security may be purchased or sold on behalf of certain clients of
Mondrian even though it could also have been purchased or sold for other clients
at the same time.
Likewise, a particular security may be purchased on behalf of one or more
clients when Mondrian is selling the same security on behalf of one or more
other clients. In some instances, therefore, Mondrian, acting for one client may
sell a
36
particular security to another client indirectly. It also happens that two or
more clients may simultaneously buy or sell the same security, in which event
purchases or sales are effected pro rata on the basis of cash available or
another equitable basis so as to avoid any one account being preferred over any
other account.
Brokerage and Research Services. It is Mondrian's policy to select brokers
for fund trades on the basis of "best execution." As a fiduciary to its advisory
clients, Mondrian endeavors to seek best execution for client transactions by
executing securities transactions for its clients in such a manner that the
client's net costs or proceeds in each transaction are the most favorable under
the circumstances, i.e., by seeking to obtain not necessarily the lowest
commission cost, but the best overall qualitative execution.
In determining which broker offers best execution for a particular
transaction, Mondrian maintains a list of approved brokers and Mondrian's
traders consider a number of factors, including: (i) the broker's effectiveness
in executing trades; (ii) the reliability, integrity, confidentiality,
promptness, reputation and financial condition of the broker (including the
trader's past execution history with the broker); (iii) the size of the trade,
its relative difficulty and the security's trading characteristics and
liquidity; (iv) the quality and breadth of products offered by the broker; and
(v) the broker's willingness to accept Mondrian's standardized commission rates.
Mondrian may aggregate client orders for the purpose of purchasing or
selling particular securities. The aggregation of orders may provide an overall
benefit to Mondrian's clients by achieving, in aggregate, a relatively better
purchase or sale price, lower commission expenses, lower market impact,
beneficial timing of transactions, or a combination of such factors. Aggregated
trades are allocated automatically among various clients by Mondrian's
investment model which includes "fairness rules" designed to allocate the
aggregated trades across individual client accounts in a way that is intended to
ensure fair and equitable treatment on average over time for all clients.
Mondrian may cause a fund to pay a higher commission than otherwise
obtainable from other brokers or dealers in return for brokerage or research
services if Mondrian believes that such commission is reasonable in relation to
the services provided. In addition to agency transactions, Mondrian may receive
brokerage and research services in connection with certain riskless principal
transactions, in accordance with applicable SEC and other regulatory guidelines.
In both instances, these services may include: economic, industry, or company
research reports or investment recommendations. Mondrian may use research
services furnished by brokers or dealers in servicing all fund accounts, and not
all services may necessarily be used in connection with the account that paid
commissions or spreads to the broker or dealer providing such services.
Performance Comparisons. Investors may judge the performance of the funds by
comparing them to the performance of other mutual fund portfolios with
comparable investment objectives and policies through various mutual fund or
market indices such as those prepared by Dow Jones & Co., Inc. and Standard &
Poor's and to data prepared by Lipper, Inc., a widely recognized independent
service which monitors the performance of mutual funds. Comparisons may also be
made to indices or data published in Money Magazine, Forbes, Barron's, The Wall
Street Journal, Morningstar, Inc., Ibbotson Associates, CDA/Weisenberger, The
New York Times, Business Week, U.S.A. Today, Institutional Investor and other
periodicals. In addition to performance information, general information about
the funds that appears in publications such as those mentioned above may be
included in advertisements, sales literature and reports to shareholders. The
funds may also include in advertisements and reports to shareholders information
discussing the performance of Mondrian in comparison to other investment
advisers and to other institutions.
From time to time, the Trust may include the following types of information
in advertisements, supplemental sales literature and reports to shareholders:
(1) discussions of general economic or financial principles (such as the effects
of inflation, the power of compounding and the benefits of dollar cost
averaging); (2) discussions of general economic trends; (3) presentations of
statistical data to supplement such discussions; (4) descriptions of past or
anticipated portfolio holdings for the funds; (5) descriptions of investment
strategies for the funds; (6) descriptions or comparisons of various investment
products, which may or may not include the funds; (7) comparisons of investment
products (including the funds) with relevant market or industry indices or other
appropriate benchmarks; (8) discussions of fund rankings or
37
ratings by recognized rating organizations; and (9) testimonials describing the
experience of persons that have invested in a fund. The Trust may also include
calculations, such as hypothetical compounding examples, which describe
hypothetical investment results in such communications. Such performance
examples will be based on an express set of assumptions and are not indicative
of the performance of a fund.
DESCRIPTION OF THE TRUST AND OWNERSHIP OF SHARES
The Trust is an open-end series investment company organized as a
Massachusetts business trust. A copy of the Third Amended and Restated Agreement
and Declaration of Trust of the Trust, as amended (the "Declaration of Trust"),
is on file with the Secretary of the Commonwealth of Massachusetts. The fiscal
year of the Trust ends on March 31. The Trust changed its name to "Barr
Rosenberg Series Trust" from "Rosenberg Series Trust" on August 5, 1996.
Effective March 30, 2004, the Trust changed its name to the "Laudus Trust."
Interests in the Trust's portfolios are currently represented by shares of
thirteen series, the Laudus Rosenberg U.S. Small Capitalization Fund, Laudus
Rosenberg U.S. Discovery Fund, Laudus Rosenberg U.S. Large Capitalization Fund,
Laudus Rosenberg U.S. Large Capitalization Growth Fund, Laudus Rosenberg U.S.
Large Capitalization Value Fund, Laudus Rosenberg International Equity Fund,
Laudus Rosenberg International Small Capitalization Fund, Laudus Rosenberg
International Discovery Fund, Laudus Rosenberg Value Long/Short Equity Fund,
Laudus Mondrian Emerging Markets Fund, Laudus Mondrian International Fixed
Income Fund, Laudus Mondrian International Equity Fund and Laudus Mondrian
Global Equity Fund issued pursuant to the Declaration of Trust. The rights of
shareholders and powers of the Trustees of the Trust with respect to such shares
are described in their respective Prospectuses.
Each of the Laudus Mondrian Emerging Markets Fund, Laudus Mondrian Fixed
Income Fund, Laudus Mondrian International Equity Fund and Laudus Mondrian
Global Equity Fund is divided into three classes of shares:
Institutional Shares, Select Shares and Investor Shares.
Each class of shares of each fund represents interests in the assets of such
fund and has identical dividend, liquidation and other rights and the same terms
and conditions, except that expenses, if any, related to the distribution and
shareholder servicing of a particular class are borne solely by such class, and
each class may, at the discretion of the Trustees of the Trust, also pay a
different share of other expenses, not including advisory or custodial fees or
other expenses related to the management of the Trust's assets, if these
expenses are actually incurred in a different amount by that class, or if the
class receives services of a different kind or to a different degree than the
other classes. All other expenses are allocated to each class on the basis of
the net asset value of that class in relation to the net asset value of the
particular fund.
The Declaration of Trust provides for the perpetual existence of the Trust.
The Trust may, however, be terminated at any time by vote of at least two-thirds
of the outstanding shares of each series of the Trust or by the vote of the
Trustees.
VOTING RIGHTS
Shareholders are entitled to one vote for each full share held (with
fractional votes for fractional shares held) and will vote (to the extent
provided herein) in the election of Trustees and the termination of the Trust
and on other matters submitted to the vote of shareholders. Shareholders will
vote by individual series on all matters except (i) when required by the 1940
Act, shares shall be voted in the aggregate and not by individual series and
(ii) when the Trustees have determined that the matter affects only the
interests of one or more series, then only shareholders of such series shall be
entitled to vote thereon. Shareholders of one series shall not be entitled to
vote on matters exclusively affecting another series, such matters including,
without limitation, the adoption of or change in any fundamental policies or
restrictions of the other series and the approval of the investment advisory
contracts of the other series.
Each class of shares of each fund has identical voting rights except that
each class has exclusive voting rights on any matter submitted to shareholders
that relates solely to that class, and has separate voting rights on any matter
submitted to shareholders in which the interests of one class differ from the
interests of any other class. Each class of shares has
38
exclusive voting rights with respect to matters pertaining to any distribution
and shareholder service plan applicable to that class. All classes of shares of
a fund will vote together, except with respect to any distribution and
shareholder service plan applicable to a class or when a class vote is required
as specified above or otherwise by the 1940 Act.
There will normally be no meetings of shareholders for the purpose of
electing Trustees, except that in accordance with the 1940 Act (i) the Trust
will hold a shareholders' meeting for the election of Trustees at such time as
less than a majority of the Trustees holding office have been elected by
shareholders, and (ii) if, as a result of a vacancy in the Board of Trustees,
less than two-thirds of the Independent Trustees holding office have been
elected by the shareholders, that vacancy may only be filled by a vote of the
shareholders. In addition, Trustees may be removed from office by a written
consent signed by the holders of two-thirds of the outstanding shares and filed
with the Trust's custodian or by a vote of the holders of two-thirds of the
outstanding shares at a meeting duly called for the purpose, which meeting shall
be held upon the written request of the holders of not less than 10% of the
outstanding shares. Upon written request by the holders of at least 1% of the
outstanding shares stating that such shareholders wish to communicate with the
other shareholders for the purpose of obtaining the signatures necessary to
demand a meeting to consider removal of a Trustee, the Trust has undertaken to
provide a list of shareholders or to disseminate appropriate materials (at the
expense of the requesting shareholders). Except as set forth above, the Trustees
shall continue to hold office and may appoint successor Trustees. Voting rights
are not cumulative.
No amendment may be made to the Declaration of Trust without the affirmative
vote of a majority of the outstanding shares of the Trust except (i) to change
the Trust's name or to cure technical problems in the Declaration of Trust and
(ii) to establish, designate or modify new and existing series, sub-series or
classes of shares of any series of Trust shares or other provisions relating to
Trust shares in response to applicable laws or regulations. Trustees may,
without approval of the relevant shareholders, amend the Declaration of Trust to
combine one or more series or classes of the Trust into a single series or class
on such terms and conditions as the Trustees shall determine.
Shareholders wishing to submit proposals for inclusion in a proxy statement
for a future shareholder meeting should send their written submissions to the
Trust at P. O. Box 8032, Boston, Massachusetts 02266. Proposals must be received
a reasonable time in advance of a proxy solicitation to be included. Submission
of a proposal does not guarantee inclusion in a proxy statement because
proposals must comply with certain federal securities regulations.
PROXY VOTING
The Trust's proxy voting policy is attached as Appendix A to this Statement
of Additional Information. Information regarding how the funds voted proxies
related to portfolio securities during the most recent 12-month period ended
June 30 is available, without charge, on the funds' website at www.laudus.com.
It is also available in the funds' Form N-PX which can be obtained on the SEC's
website at www.sec.gov.
SHAREHOLDER AND TRUSTEE LIABILITY
Under Massachusetts law, shareholders could, under certain circumstances, be
held personally liable for the obligations of the Trust. However, the
Declaration of Trust disclaims shareholder liability for acts or obligations of
the Trust and requires that notice of such disclaimer be given in each
agreement, obligation, or instrument entered into or executed by the Trust or
the Trustees. The Declaration of Trust provides for indemnification out of all
the property of the relevant series for all loss and expense of any shareholder
of that series held personally liable for the obligations of the Trust. Thus,
the risk of a shareholder incurring financial loss on account of shareholder
liability is considered remote since it is limited to circumstances in which the
disclaimer is inoperative and the series of which he is or was a shareholder
would be unable to meet its obligations.
The Declaration of Trust further provides that the Trustees will not be
liable for errors of judgment or mistakes of fact or law. However, nothing in
the Declaration of Trust protects a Trustee against any liability to which the
Trustee would otherwise be subject by reason of willful misfeasance, bad faith,
gross negligence, or reckless disregard of the duties
39
involved in the conduct of his office. The Declaration of Trust also provides
for indemnification by the Trust of the Trustees and the officers of the Trust
against liabilities and expenses reasonably incurred in connection with
litigation in which they may be involved because of their offices with the
Trust, except if it is determined in the manner specified in the Declaration of
Trust that such Trustees are liable to the Trust or its shareholders by reason
of willful misfeasance, bad faith, gross negligence or reckless disregard of his
or her duties. In addition, CSIM has agreed to indemnify each Trustee who is not
"an interested person" of the Trust to the maximum extent permitted by the 1940
Act against any liabilities arising by reason of such Trustee's status as a
Trustee of the Trust.
OWNERS OF 5% OR MORE OF A FUND'S SHARES
As of ___________, 2008, the officers and trustees of the Trust, as a group,
owned of record, directly or beneficially, none of the outstanding voting
securities of the funds.
As of ___________, 2008, the following persons or entities owned, of record or
beneficially, more than 5% of the outstanding voting securities of a fund:
40
DISCLOSURE OF PORTFOLIO SECURITIES INFORMATION
Information regarding the availability of the funds' portfolio securities
can be obtained by calling 1.800.447.3332.
The disclosure of portfolio securities information to shareholders and other
parties, prior to regular public filings, may be authorized only by the Trust's
President upon prior consultation with the funds' Subadviser and the funds'
Chief Legal Officer. Prior to authorizing the disclosure of portfolio
securities, the Trust's President must determine that: (i) such disclosure is in
the best interests of the funds' shareholders; and (ii) that no conflict exists
between the interests of the funds' shareholders and those of the funds'
Adviser, Subadviser or principal underwriter.
Portfolio securities information also may be made available on a selective
basis to service providers, ratings agencies, consultants and other qualified
financial professionals when the President upon prior consultation with the
funds'
41
Subadviser and the funds' Chief Legal Officer, determines such disclosure meets
the requirements for non-selective disclosure and serves a legitimate business
purpose. Agreements entered into with a service provider to whom the funds
selectively disclose portfolio securities information will generally include the
confidentiality provisions customary in such agreements. Although certain of the
service providers are not under formal confidentiality obligations in connection
with disclosure of portfolio securities information, a fund would not continue
to conduct business with a person who the fund believes was misusing the
disclosed information. Any third-party who is not a service provider to the
funds to whom the funds selectively disclose portfolio securities information
will, prior to that disclosure, be required to sign an agreement describing the
permitted use of portfolio securities information and providing that: (i) the
portfolio securities information will be kept confidential; (ii) the person will
not trade on the basis of any material non-public information; and (iii) the
information will be used only for the purpose described in the agreement. As
part of its ongoing review of fund operations, the Board of Trustees will
periodically review any agreements that the Trust has entered into to
selectively disclose portfolio securities information.
A complete list of each fund's portfolio holdings is published on the Laudus
website at www.laudus.com, under "Prospectuses and Reports", typically 60-80
days after the end of each fund's fiscal quarter. The portfolio holdings
information available on the funds' website is the same that is filed with the
Securities and Exchange Commission on Form N-Q or Form N-CSR. The funds provide
on the website quarterly information regarding certain attributes of a fund's
portfolio, such as a fund's sector weightings, composition, credit quality and
duration and maturity, as applicable. The information on the website is publicly
available to all categories of persons.
Each fund may disclose portfolio holdings information to certain persons and
entities prior to and more frequently than the public disclosure of such
information ("early disclosure"). The president may authorize early disclosure
of portfolio holdings information to such parties at differing times and/or with
different lag times provided that (a) the president of the funds determines that
the disclosure is in the best interests of the funds and that there are no
conflicts of interest between the fund's shareholders and fund's adviser,
Subadviser and distributor; and (b) the recipient is, either by contractual
agreement or otherwise by law, required to maintain the confidentiality of the
information.
The funds' service providers, including, without limitation, the Adviser,
Subadviser, distributor, transfer agent, auditor, proxy voting service provider,
pricing information vendors, publisher, printer and mailing agent may receive
early disclosure of portfolio securities information as frequently as daily in
connection with the services they perform for the funds. The names of those
persons to whom the funds selectively disclose portfolio securities information
will be disclosed in this Statement of Additional Information. Institutional
Shareholder Services and State Street Bank and Trust Company, as service
providers to the funds, are currently receiving this information on a daily
basis. RR Donnelley, as a service provider to the funds, is currently receiving
this information on a quarterly basis. Service providers will be subject to a
duty of confidentiality with respect to any portfolio securities information
whether imposed by the provisions of the service provider's contract with the
Trust or by the nature of the service provider's relationship with the Trust. In
accordance with the exemptive order issued by the SEC to iShares and procedures
approved by the Trust's Board of Trustees, the Trust will promptly notify
iShares Funds in writing of any purchase or acquisition of shares of an iShares
Fund that causes a fund to hold (i) 5% or more of such iShares Fund's total
outstanding voting securities, and (ii) 10% or more of such iShares Fund's total
outstanding voting securities. In addition, the adviser or Subadviser will, upon
causing a fund to acquire more than 3% of an open-end iShares Fund's outstanding
shares, notify the open-end iShares Fund of the investment.
The funds may disclose non-material information including commentary and
aggregate information about the characteristics of a fund in connection with or
relating to a fund or its portfolio securities to any person if such disclosure
is for a legitimate business purpose, such disclosure does not effectively
result in the disclosure of the complete portfolio securities of any fund (which
can only be disclosed in accordance with the above requirements), and such
information does not constitute material non-public information. Such disclosure
does not fall within the portfolio securities disclosure requirements outlined
above.
Whether the information constitutes material non-public information will be
made on a good faith determination,
42
which involves an assessment of the particular facts and circumstances. In most
cases commentary or analysis would be immaterial and would not convey any
advantage to a recipient in making a decision concerning a fund. Commentary and
analysis includes, but is not limited to, the allocation of a fund's portfolio
securities and other investments among various asset classes, sectors,
industries, and countries, the characteristics of the stock components and other
investments of a fund, the attribution of fund returns by asset class, sector,
industry and country, and the volatility characteristics of a fund.
Neither the funds nor the funds' Adviser or Subadviser may receive
compensation or other consideration in connection with the disclosure of
information about portfolio securities.
DETERMINATION OF NET ASSET VALUE
Each business day, each fund calculates its share price, or NAV, as of the
close of the New York Stock Exchange ("NYSE"). This means that NAVs are
calculated using the values of each fund's portfolio securities as of the close
of the NYSE. Such values are required to be determined in one of two ways:
securities for which market quotations are readily available are required to be
valued at current market value; and securities for which market quotations are
not readily available or the adviser deems them to be unreliable are required to
be valued at fair value using procedures approved by the Board of Trustees. Each
fund uses approved pricing services to provide values for its portfolio
securities. Current market values are generally determined by the approved
pricing services as follows: securities traded on stock exchanges are valued at
the last-quoted sales price on the exchange on which such securities are
primarily traded (closing values), or, lacking any sales, at the mean between
the bid and ask prices; securities traded in the over-the-counter market are
valued at the last sales price that day, or, if there are no sales that day, at
the mean between the bid and ask prices. In addition, securities that are
primarily traded on foreign exchanges are generally valued at the preceding
closing values of such securities on their respective exchanges with these
values then translated into U.S. dollars at the current exchange rate. Fixed
income securities normally are valued based on valuations provided by approved
pricing services. Securities may be fair valued pursuant to procedures approved
by the funds' Board of Trustees when approved pricing services do not provide a
value for a security, a furnished price appears manifestly incorrect or events
occur prior to the close of the NYSE that materially affect the furnished price.
The Board of Trustees regularly reviews fair value determinations made by the
funds pursuant to the procedures.
PURCHASE AND REDEMPTION OF SHARES
The procedures for purchasing shares of each of the funds and for
determining the offering price of such shares are described in the Prospectus.
The Trust has elected to be governed by Rule 18f-1 under the 1940 Act pursuant
to which the Trust is obligated to redeem shares solely in cash for any
shareholder during any 90-day period up to the lesser of (i) $250,000 or (ii) 1%
of the total net asset value of the Trust at the beginning of such period. The
procedures for redeeming shares of each of the funds are described in the
Prospectus.
As described in the Prospectus, the Trust reserves the right, in its sole
discretion, to reject purchase orders for shares of a fund. As a general matter,
the Trust expects that it will not accept purchase orders when the purchase
price is to be paid by cash (in the form of actual currency), third party
checks, checks payable in foreign currency, credit card convenience checks or
traveler's checks.
The funds have authorized one or more brokers to accept on their behalf
purchase and redemption orders. Such brokers have also been authorized to
designate other intermediaries to accept purchase and redemption orders on the
funds' behalf. The funds will be deemed to have received a purchase or
redemption order when an authorized broker or, if applicable, a broker's
authorized designee, receives such order. Such orders will be priced at the
respective fund's net asset value per share next determined after such orders
are received by an authorized broker or the broker's authorized designee.
43
APPENDIX A - DESCRIPTION OF PROXY VOTING POLICY AND PROCEDURES
Charles Schwab Investment Management ("CSIM"), as an investment adviser, is
generally responsible for voting proxies with respect to the securities held in
accounts of investment companies and other clients for which it provides
discretionary investment management services. CSIM 's Proxy Committee exercises
and documents CSIM's responsibility with regard to voting of client proxies (the
"Proxy Committee"). The Proxy Committee is composed of representatives of CSIM's
Fund Administration, Legal, and Portfolio Management Departments, and chaired by
CSIM's Vice President-Portfolio Operations & Analytics. The Chairman of the
Committee may appoint the remaining members of the Committee. The Proxy
Committee reviews and, as necessary, may amend periodically these Procedures to
address new or revised proxy voting policies or procedures. The policies stated
in these Proxy Voting Policy and Procedures (the "CSIM Proxy Procedures")
pertain to all of CSIM's clients.
The Boards of Trustees (the "Trustees") of The Laudus Trust, and Laudus
Institutional Trust (collectively, the "Funds" or "Laudus Funds") has delegated
the responsibility for voting proxies to CSIM through their respective
Investment Advisory and Administration Agreements. The Trustees have adopted
these Proxy Procedures with respect to proxies voted on behalf of the various
Laudus Funds portfolios. CSIM will present amendments to the Trustees for
approval. However, there may be circumstances where the Proxy Committee deems it
advisable to amend the Proxy Procedures between regular Laudus Funds Board
meetings. In such cases, the Trustees will be asked to ratify any changes at the
next regular meeting of the Board.
To assist CSIM in its responsibility for voting proxies and the overall proxy
voting process, CSIM has retained Institutional Shareholder Services ("ISS") as
an expert in the proxy voting and corporate governance area. ISS is an
independent company that specializes in providing a variety of proxy-related
services to institutional investment managers, plan sponsors, custodians,
consultants, and other institutional investors. The services provided by ISS
include in-depth research, global issuer analysis, and voting recommendations as
well as vote execution, reporting and record keeping. CSIM has also retained
Glass Lewis & Co. ("Glass Lewis"), as an additional expert in proxy voting, to
assist CSIM in voting proxies of limited partnerships. Glass Lewis is an
independent provider of global proxy research and voting recommendations.
PROXY VOTING POLICY
For investment companies and other clients for which CSIM exercises its
responsibility for voting proxies, it is CSIM's policy to vote proxies in the
manner that CSIM and the Proxy Committee determine will maximize the economic
benefit to CSIM's clients. In furtherance of this policy, the Proxy Committee
has received and reviewed ISS's written proxy voting policies and procedures
("ISS's Proxy Procedures") and has determined that ISS's Proxy Procedures are
consistent with the CSIM Proxy Procedures and CSIM's fiduciary duty with respect
to its clients. The Proxy Committee will review any material amendments to ISS's
Proxy Procedures to determine whether such procedures continue to be consistent
with the CSIM Proxy Voting Procedures, and CSIM's fiduciary duty with respect to
its clients.
Except under each of the circumstances described below, the Proxy
Committee will delegate to ISS responsibility for voting proxies, including
timely submission of votes, on behalf of CSIM's clients in accordance with ISS's
Proxy Procedures.
ISS's Proxy Procedures are not intended to cover proxies of limited
partnerships ("LP Proxies"), and accordingly ISS does not provide analysis or
voting recommendations for LP Proxies. To assist in its responsibility for
voting LP Proxies, the Proxy Committee has received and reviewed Glass Lewis's
written proxy policy guidelines ("Glass Lewis's Proxy Procedures") and has
determined that Glass Lewis's Proxy Procedures are consistent with CSIM Proxy
Procedures and CSIM's fiduciary duty with respect to its clients. The Proxy
Committee will review any material amendments to Glass Lewis's Proxy Procedures
to determine whether such procedures continue to be consistent with the CSIM
Proxy Voting Procedures, and CSIM's fiduciary duty with respect to its clients.
In general, the Proxy Committee or its designee
44
will instruct ISS to vote an LP Proxy consistent with the recommendation
provided by Glass Lewis in accordance with Glass Lewis's Proxy Procedures.
For proxy issues, including LP Proxy issues, that are determined by the
Proxy Committee or the applicable portfolio manager or other relevant portfolio
management staff to raise significant concerns with respect to the accounts of
CSIM clients, the Proxy Committee will review the analysis and recommendation of
ISS or Glass Lewis, as applicable. Examples of factors that could cause a matter
to raise significant concerns include, but are not limited to: issues whose
outcome has the potential to materially affect the company's industry, or
regional or national economy, and matters which involve broad public policy
developments which may similarly materially affect the environment in which the
company operates. The Proxy Committee also will solicit input from the assigned
portfolio manager and other relevant portfolio management staff for the
particular portfolio security. After evaluating all such recommendations, the
Proxy Committee will decide how to vote the shares and will instruct ISS to vote
consistent with its decision. The Proxy Committee has the ultimate
responsibility for making the determination of how to vote the shares in order
to maximize the value of that particular holding.
With respect to proxies of an affiliated mutual fund, the Proxy
Committee will vote such proxies in the same proportion as the vote of all other
shareholders of the fund (i.e., "echo vote"), unless otherwise required by law.
When required by law, the Proxy Committee will also "echo vote" proxies of an
unaffiliated mutual fund. For example, certain exemptive orders issued to the
Laudus Funds by the Securities and Exchange Commission and Section 12(d)(1)(F)
of the Investment Company Act of 1940, as amended, require the Laudus Funds,
under certain circumstances, to "echo vote" proxies of registered investment
companies that serve as underlying investments of the Laudus Funds. When not
required to "echo vote," the Proxy Committee will delegate to ISS responsibility
for voting proxies of an unaffiliated mutual fund in accordance with ISS's Proxy
Procedures.
In addition to ISS not providing analyses or recommendations for LP
Proxies, there may be other circumstances in which ISS does not provide an
analysis or recommendation for voting a security's proxy. In that event, and
when the following criteria are met, two members of the Proxy Committee,
including at least one representative from equity Portfolio Management, may
decide how to vote such proxy in order to maximize the value of that particular
holding. The following criteria must be met: (1) For each Fund that holds the
security in its portfolio, the value of the security must represent less than
one tenth of one cent in the Fund's NAV, and (2) the security's value must equal
less than $50,000 in the aggregate across all of the Funds and separate accounts
that hold this security. Any voting decision made under these circumstances will
be reported to the Proxy Committee at its next scheduled meeting.
CONFLICTS OF INTEREST. EXCEPT AS DESCRIBED ABOVE FOR PROXIES OF MUTUAL
FUNDS, WHERE PROXY ISSUES PRESENT MATERIAL CONFLICTS OF INTEREST BETWEEN CSIM,
AND/OR ANY OF ITS AFFILIATES, AND CSIM'S CLIENTS, CSIM WILL DELEGATE TO ISS
RESPONSIBILITY FOR VOTING SUCH PROXIES IN ACCORDANCE WITH ISS'S PROXY
PROCEDURES, OR, IN THE CASE OF LP PROXIES, IN ACCORDANCE WITH GLASS LEWIS'S
RECOMMENDATIONS AS PROVIDED TO ISS. THE CSIM LEGAL DEPARTMENT IS RESPONSIBLE FOR
DEVELOPING PROCEDURES TO IDENTIFY MATERIAL CONFLICTS OF INTEREST.
Voting Foreign Proxies. CSIM has arrangements with ISS for voting
proxies. However, voting proxies with respect to shares of foreign securities
may involve significantly greater effort and corresponding cost than voting
proxies with respect to domestic securities, due to the variety of regulatory
schemes and corporate practices in foreign countries with respect to proxy
voting. Problems voting foreign proxies may include the following:
o proxy statements and ballots written in a foreign language;
o untimely and/or inadequate notice of shareholder meetings;
o restrictions of foreigner's ability to exercise votes;
o requirements to vote proxies in person;
o requirements to provide local agents with power of attorney to facilitate
CSIM's voting instructions.
45
In consideration of the foregoing issues, ISS uses its best-efforts to vote
foreign proxies. As part of its ongoing oversight, the Proxy Committee will
monitor the voting of foreign proxies to determine whether all reasonable steps
are taken to vote foreign proxies. If the Proxy Committee determines that the
cost associated with the attempt to vote outweighs the potential benefits
clients may derive from voting, the Proxy Committee may decide not to attempt to
vote. In addition, certain foreign countries impose restrictions on the sale of
securities for a period of time in proximity to the shareholder meeting. To
avoid these trading restrictions, the Proxy Committee instructs ISS not to vote
such foreign proxies.
Securities Lending Programs. Certain of the Funds enter into securities
lending arrangements with lending agents to generate additional revenue for
their portfolios. In securities lending arrangements, any voting rights that
accompany the loaned securities generally pass to the borrower of the
securities, but the lender retains the right to recall a security and may then
exercise the security's voting rights. In order to vote the proxies of
securities out on loan, the securities must be recalled prior to the established
record date. CSIM will use its best efforts to recall a Fund's securities on
loan and vote such securities' proxies if (a) the proxy relates to a special
meeting of shareholders of the issuer (as opposed to the issuer's annual meeting
of shareholders), or (b) the Fund owns more than 5% of the outstanding shares of
the issuer. Further, it is CSIM's policy to use its best efforts to recall
securities on loan and vote such securities' proxies if CSIM determines that the
proxies involve a material event affecting the loaned securities. CSIM may
utilize third-party service providers to assist it in identifying and evaluating
whether an event is material.
Sub-Advisory Relationships. For investment companies or other clients
that CSIM has delegated day-to-day investment management responsibilities to an
investment adviser, CSIM may delegate its responsibility to vote proxies with
respect to such investment companies' or other clients' securities. Each
Sub-adviser to whom proxy voting responsibility has been delegated will be
required to review all proxy solicitation material and to exercise the voting
rights associated with the securities as it has been allocated in the best
interest of each investment company and its shareholders, or other client. Prior
to delegating the proxy voting responsibility, CSIM will review each
sub-adviser's proxy voting policy to ensure that each Sub-adviser's proxy voting
policy is generally consistent with the maximization of economic benefits to the
investment company or other client.
REPORTING AND RECORD RETENTION
CSIM will maintain, or cause ISS to maintain, records which identify the manner
in which proxies have been voted (or not voted) on behalf of CSIM clients. CSIM
will comply with all applicable rules and regulations regarding disclosure of
its or its clients proxy voting records and procedures.
CSIM will retain all proxy voting materials and supporting documentation as
required under the Investment Advisers Act of 1940 and the rules and regulations
thereunder.
PROXY COMMITTEE QUORUM
At scheduled meetings of the Proxy Committee, attendance by four members (or
their respective designates) constitutes a quorum. Two members of the Committee
may make voting decisions under the limited circumstances described above.
CONCISE SUMMARY OF ISS 2008 PROXY VOTING GUIDELINES:
Effective for Meetings on or after Feb. 1, 2008
Updated Dec. 21, 2007
1. AUDITORS
AUDITOR RATIFICATION
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Vote FOR proposals to ratify auditors, unless any of the following apply:
- An auditor has a financial interest in or association with the
company, and is therefore not independent;
- There is reason to believe that the independent auditor has rendered
an opinion which is neither accurate nor indicative of the company's
financial position;
- Poor accounting practices are identified that rise to a serious level
of concern, such as: fraud; misapplication of GAAP; and material
weaknesses identified in Section 404 disclosures; or
- Fees for non-audit services ("other" fees) are excessive.
Vote CASE-BY-CASE on shareholder proposals asking for audit firm rotation,
taking into account:
- The tenure of the audit firm;
- The length of rotation specified in the proposal;
- Any significant audit-related issues at the company;
- The number of audit committee meetings held each year;
- The number of financial experts serving on the committee; and
- Whether the company has a periodic renewal process where the auditor
is evaluated for both audit quality and competitive price.
2. BOARD OF DIRECTORS
VOTING ON DIRECTOR NOMINEES IN UNCONTESTED ELECTIONS
Vote AGAINST or WITHHOLD from individual directors who:
- Attend less than 75 percent of the board and committee meetings
without a valid excuse;
- Sit on more than six public company boards;
- Are CEOs of public companies who sit on the boards of more than two
public companies besides their own--withhold only at their outside
boards.
Vote AGAINST or WITHHOLD from all nominees of the board of directors, (except
from new nominees, who should be considered on a CASE-BY-CASE basis) if:
- The company's proxy indicates that not all directors attended 75
percent of the aggregate of their board and committee meetings, but
fails to provide the required disclosure of the names of the
directors involved. If this information cannot be obtained, vote
against/withhold from all incumbent directors;
- The company's poison pill has a dead-hand or modified dead-hand
feature. Vote against/withhold every year until this feature is
removed;
- The board adopts or renews a poison pill without shareholder
approval, does not commit to putting it to shareholder vote within 12
months of adoption (or in the case of an newly public company, does
not commit to put the pill to a shareholder vote within 12 months
following the IPO), or reneges on a commitment to put the pill to a
vote, and has not yet received a withhold/against recommendation for
this issue;
- The board failed to act on a shareholder proposal that received
approval by a majority of the shares outstanding the previous year (a
management proposal with other than a FOR recommendation by
management will not be considered as sufficient action taken);
- The board failed to act on a shareholder proposal that received
approval of the majority of shares cast for the previous two
consecutive years (a management proposal with other than a FOR
recommendation by management will not be considered as sufficient
action taken);
- The board failed to act on takeover offers where the majority of the
shareholders tendered their shares;
- At the previous board election, any director received more than 50
percent withhold/against votes of the shares cast and the company has
failed to address the underlying issue(s) that caused the high
withhold/against vote;
- The company is a Russell 3000 company that underperformed its
industry group (GICS group) under ISS' "Performance Test for
Directors" policy;
- The board is classified, and a continuing director responsible for a
problematic governance issue at the board/committee level that would
warrant a withhold/against vote recommendation is not up for
election--any or all appropriate nominees (except new) may be held
accountable.
47
Vote AGAINST or WITHHOLD from inside directors and affiliated outside directors
when:
- The inside or affiliated outside director serves on any of the three
key committees: audit, compensation, or nominating;
- The company lacks an audit, compensation, or nominating committee so
that the full board functions as that committee;
- The company lacks a formal nominating committee, even if board
attests that the independent directors fulfill the functions of such
a committee;
- The full board is less than majority independent.
Vote AGAINST or WITHHOLD from the members of the audit committee if:
- The non-audit fees paid to the auditor are excessive (see discussion
under "Auditor Ratification");
- Poor accounting practices are identified which rise to a level of
serious concern, such as: fraud; misapplication of GAAP; and material
weaknesses identified in Section 404 disclosures; or
- There is persuasive evidence that the audit committee entered into an
inappropriate indemnification agreement with its auditor that limits
the ability of the company, or its shareholders, to pursue legitimate
legal recourse against the audit firm.
Vote AGAINST or WITHHOLD from the members of the compensation committee if:
- There is a negative correlation between the chief executive's pay and
company performance;
- The company reprices underwater options for stock, cash or other
consideration without prior shareholder approval, even if allowed in
their equity plan;
- The company fails to submit one-time transfers of stock options to a
shareholder vote;
- The company fails to fulfill the terms of a burn-rate commitment made
to shareholders;
- The company has backdated options (see "Options Backdating" policy);
- The company has poor compensation practices (see "Poor Pay Practices"
policy). Poor pay practices may warrant withholding votes from the
CEO and potentially the entire board as well.
Vote AGAINST or WITHHOLD from directors, individually or the entire board, for
egregious actions or failure to replace management as appropriate.
CLASSIFICATION/DECLASSIFICATION OF THE BOARD
Vote AGAINST proposals to classify the board. Vote FOR proposals to repeal
classified boards and to elect all directors annually.
CUMULATIVE VOTING
Generally vote AGAINST proposals to eliminate cumulative voting. Generally vote
FOR proposals to restore or provide for cumulative voting unless:
- The company has proxy access or a similar structure to allow
shareholders to nominate directors to the company's ballot; and
- The company has adopted a majority vote standard, with a carve-out
for plurality voting in situations where there are more nominees than
seats, and a director resignation policy to address failed elections.
Vote FOR proposals for cumulative voting at controlled companies (insider voting
power > 50 percent).
INDEPENDENT CHAIR (SEPARATE CHAIR/CEO)
Generally vote FOR shareholder proposals requiring that the chairman's position
be filled by an independent director, unless there are compelling reasons to
recommend against the proposal, such as a counterbalancing governance structure.
This should include all the following:
- Designated lead director, elected by and from the independent board
members with clearly delineated and comprehensive duties. (The role
may alternatively reside with a presiding director, vice chairman, or
48
rotating lead director; however the director must serve a minimum of
one year in order to qualify as a lead director.) The duties should
include, but are not limited to, the following:
- presides at all meetings of the board at which the
chairman is not present, including executive sessions
of the independent directors;
- serves as liaison between the chairman and the
independent directors;
- approves information sent to the board;
- approves meeting agendas for the board;
- approves meeting schedules to assure that there is
sufficient time for discussion of all agenda items;
- has the authority to call meetings of the independent
directors;
- if requested by major shareholders, ensures that he is
available for consultation and direct communication;
- The company publicly discloses a comparison of the duties of its
independent lead director and its chairman;
- The company publicly discloses a sufficient explanation of why it
chooses not to give the position of chairman to the independent lead
director, and instead combine the chairman and CEO positions;
- Two-thirds independent board;
- All independent key committees;
- Established governance guidelines;
- The company should not have underperformed both its peers and index
on the basis of both one-year and three-year total shareholder
returns*, unless there has been a change in the Chairman/CEO position
within that time; and
- The company does not have any problematic governance issues.
Vote FOR the proposal if the company does not provide disclosure with respect to
any or all of the bullet points above. If disclosure is provided, evaluate on a
CASE-BY-CASE basis.
* The industry peer group used for this evaluation is the average of the 12
companies in the same six-digit GICS group that are closest in revenue to the
company. To fail, the company must underperform its index and industry group on
all four measures (one- and three-year on industry peers and index).
MAJORITY VOTE SHAREHOLDER PROPOSALS
Generally vote FOR precatory and binding resolutions requesting that the board
change the company's bylaws to stipulate that directors need to be elected with
an affirmative majority of votes cast, provided it does not conflict with the
state law where the company is incorporated. Binding resolutions need to allow
for a carve-out for a plurality vote standard when there are more nominees than
board seats. Companies are strongly encouraged to also adopt a post-election
policy (also known as a director resignation policy) that will provide
guidelines so that the company will promptly address the situation of a holdover
director.
OPEN ACCESS
Vote shareholder proposals asking for open or proxy access on a CASE-BY-CASE
basis, taking into account:
- The ownership threshold proposed in the resolution;
- The proponent's rationale for the proposal at the targeted company in
terms of board and director conduct.
3. PROXY CONTESTS
VOTING FOR DIRECTOR NOMINEES IN CONTESTED ELECTIONS
Vote CASE-BY-CASE on the election of directors in contested elections,
considering the following factors:
- Long-term financial performance of the target company relative to its
industry;
- Management's track record;
- Background to the proxy contest;
- Qualifications of director nominees (both slates);
49
- Strategic plan of dissident slate and quality of critique against
management;
- Likelihood that the proposed goals and objectives can be achieved
(both slates);
- Stock ownership positions.
REIMBURSING PROXY SOLICITATION EXPENSES
Vote CASE-BY-CASE on proposals to reimburse proxy solicitation expenses. When
voting in conjunction with support of a dissident slate, vote FOR the
reimbursement of all appropriate proxy solicitation expenses associated with the
election.
Generally vote FOR shareholder proposals calling for the reimbursement of
reasonable costs incurred in connection with nominating one or more candidates
in a contested election where the following apply:
- The election of fewer than 50 percent of the directors to be elected
is contested in the election;
- One or more of the dissident's candidates is elected;
- Shareholders are not permitted to cumulate their votes for directors;
and
- The election occurred, and the expenses were incurred, after the
adoption of this bylaw.
4. TAKEOVER DEFENSES
POISON PILLS
Vote FOR shareholder proposals requesting that the company submit its poison
pill to a shareholder vote or redeem it UNLESS the company has: (1) A
shareholder approved poison pill in place; or (2) The company has adopted a
policy concerning the adoption of a pill in the future specifying that the board
will only adopt a shareholder rights plan if either:
- Shareholders have approved the adoption of the plan; or
- The board, in its exercise of its fiduciary responsibilities,
determines that it is in the best interest of shareholders under the
circumstances to adopt a pill without the delay that would result from
seeking stockholder approval (i.e., the "fiduciary out" provision). A
poison pill adopted under this fiduciary out will be put to a
shareholder ratification vote within 12 months of adoption or expire.
If the pill is not approved by a majority of the votes cast on this
issue, the plan will immediately terminate.
Vote FOR shareholder proposals calling for poison pills to be put to a vote
within a year after adoption. If the company has no non-shareholder approved
poison pill in place and has adopted a policy with the provisions outlined
above, vote AGAINST the proposal. If these conditions are not met, vote FOR the
proposal, but with the caveat that a vote within 12 months would be considered
sufficient.
Vote CASE-by-CASE on management proposals on poison pill ratification, focusing
on the features of the shareholder rights plan. Rights plans should contain the
following attributes:
- No lower than a 20 percent trigger, flip-in or flip-over;
- A term of no more than three years;
- No dead-hand, slow-hand, no-hand, or similar feature that limits the
ability of a future board to redeem the pill;
- Shareholder redemption feature (qualifying offer clause); if the board
refuses to redeem the pill 90 days after a qualifying offer is
announced, 10 percent of the shares may call a special meeting, or
seek a written consent to vote on rescinding the pill.
SHAREHOLDER ABILITY TO CALL SPECIAL MEETINGS
Vote AGAINST proposals to restrict or prohibit shareholder ability to call
special meetings. Vote FOR proposals that remove restrictions on the right of
shareholders to act independently of management.
SUPERMAJORITY VOTE REQUIREMENTS
Vote AGAINST proposals to require a supermajority shareholder vote. Vote FOR
proposals to lower supermajority vote requirements.
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5. MERGERS AND CORPORATE RESTRUCTURINGS
For mergers and acquisitions, review and evaluate the merits and drawbacks of
the proposed transaction, balancing various and sometimes countervailing factors
including:
- Valuation - Is the value to be received by the target shareholders (or
paid by the acquirer) reasonable? While the fairness opinion may
provide an initial starting point for assessing valuation
reasonableness, emphasis is placed on the offer premium, market
reaction and strategic rationale.
- Market reaction - How has the market responded to the proposed deal? A
negative market reaction should cause closer scrutiny of a deal.
- Strategic rationale - Does the deal make sense strategically? From
where is the value derived? Cost and revenue synergies should not be
overly aggressive or optimistic, but reasonably achievable. Management
should also have a favorable track record of successful integration of
historical acquisitions.
- Negotiations and process - Were the terms of the transaction
negotiated at arm's-length? Was the process fair and equitable? A fair
process helps to ensure the best price for shareholders. Significant
negotiation "wins" can also signify the deal makers' competency. The
comprehensiveness of the sales process (e.g., full auction, partial
auction, no auction) can also affect shareholder value.
- Conflicts of interest - Are insiders benefiting from the
transaction disproportionately and inappropriately as compared to
non-insider shareholders? As the result of potential conflicts,
the directors and officers of the company may be more likely to
vote to approve a merger than if they did not hold these
interests. Consider whether these interests may have influenced
these directors and officers to support or recommend the merger.
The aggregate CIC figure may be a misleading indicator of the
true value transfer from shareholders to insiders. Where such
figure appears to be excessive, analyze the underlying
assumptions to determine whether a potential conflict exists.
- Governance - Will the combined company have a better or worse
governance profile than the current governance profiles of the
respective parties to the transaction? If the governance profile
is to change for the worse, the burden is on the company to prove
that other issues (such as valuation) outweigh any deterioration
in governance.
6. STATE OF INCORPORATION
REINCORPORATION PROPOSALS
Vote CASE-BY-CASE on proposals to change a company's state of incorporation,
taking into consideration both financial and corporate governance concerns,
including:
- The reasons for reincorporating;
- A comparison of the governance provisions;
- Comparative economic benefits; and
- A comparison of the jurisdictional laws.
7. CAPITAL STRUCTURE
COMMON STOCK AUTHORIZATION
Vote CASE-BY-CASE on proposals to increase the number of shares of common stock
authorized for issuance using a model developed by ISS. Vote FOR proposals to
approve increases beyond the allowable increase when a company's shares are in
danger of being delisted or if a company's ability to continue to operate as a
going concern is uncertain.
In addition, for capital requests less than or equal to 300 percent of the
current authorized shares that marginally fail the calculated allowable cap
(i.e., exceed the allowable cap by no more than 5 percent), on a CASE-BY-CASE
basis, vote FOR the increase based on the company's performance and whether the
company's ongoing use of shares has shown prudence. Factors should include, at a
minimum, the following:
- Rationale;
- Good performance with respect to peers and index on a
five-year total shareholder return basis;
51
- Absence of non-shareholder approved poison pill;
- Reasonable equity compensation burn rate;
- No non-shareholder approved pay plans; and
- Absence of egregious equity compensation practices.
DUAL-CLASS STOCK
Vote AGAINST proposals to create a new class of common stock with superior
voting rights. Vote AGAINST proposals at companies with dual-class capital
structures to increase the number of authorized shares of the class of stock
that has superior voting rights. Vote FOR proposals to create a new class of
nonvoting or sub-voting common stock if:
- It is intended for financing purposes with minimal or no
dilution to current shareholders;
- It is not designed to preserve the voting power of an
insider or significant shareholder.
ISSUE STOCK FOR USE WITH RIGHTS PLAN
Vote AGAINST proposals that increase authorized common stock for the explicit
purpose of implementing a non-shareholder approved shareholder rights plan
(poison pill).
PREFERRED STOCK
Vote AGAINST proposals authorizing the creation of new classes of preferred
stock with unspecified voting, conversion, dividend distribution, and other
rights ("blank check" preferred stock), and AGAINST proposals to increase the
number of blank check preferred stock authorized for issuance when no shares
have been issued or reserved for a specific purpose. Vote FOR proposals to
create "declawed" blank check preferred stock (stock that cannot be used as a
takeover defense), and FOR proposals to authorize preferred stock in cases where
the company specifies the voting, dividend, conversion, and other rights of such
stock and the terms of the preferred stock appear reasonable. Vote CASE-BY-CASE
on proposals to increase the number of blank check preferred shares after
analyzing the number of preferred shares available for issue given a company's
industry and performance in terms of shareholder returns.
8. Executive and Director Compensation
EQUITY COMPENSATION PLANS
Vote CASE-BY-CASE on equity-based compensation plans. Vote AGAINST the equity
plan if any of the following factors apply:
- The total cost of the company's equity plans is
unreasonable;
- The plan expressly permits the repricing of stock options
without prior shareholder approval;
- There is a disconnect between CEO pay and the company's
performance;
- The company's three year burn rate exceeds the greater of 2%
and the mean plus one standard deviation of its industry
group; or
- The plan is a vehicle for poor pay practices.
POOR PAY PRACTICES
Vote AGAINST or WITHHOLD from compensation committee members, the CEO, and
potentially the entire board, if the company has poor compensation practices.
Vote AGAINST equity plans if the plan is a vehicle for poor compensation
practices. The following practices, while not exhaustive, are examples of poor
compensation practices:
- Egregious employment contracts (e.g., multi-year guarantees for salary
increases, bonuses, and equity compensation);
- Excessive perks (overly generous cost and/or reimbursement of taxes
for personal use of corporate aircraft, personal security systems
maintenance and/or installation, car allowances, and/or other
excessive arrangements relative to base salary);
- Abnormally large bonus payouts without justifiable performance linkage
or proper disclosure (e.g., performance metrics that are changed,
canceled, or replaced during the performance period without adequate
explanation of the action and the link to performance);
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- Egregious pension/SERP (supplemental executive retirement plan)
payouts (inclusion of additional years of service not worked that
result in significant payouts, or inclusion of performance-based
equity awards in the pension calculation;
- New CEO with overly generous new hire package (e.g., excessive "make
whole" provisions);
- Excessive severance and/or change-in-control provisions: Inclusion of
excessive change-in-control or severance payments, especially those
with a multiple in excess of 3X cash pay;
- Severance paid for a "performance termination," (i.e.,
due to the executive's failure to perform job functions
at the appropriate level);
- Change-in-control payouts without loss of job or
substantial diminution of job duties
(single-triggered);
- Perquisites for former executives such as car
allowances, personal use of corporate aircraft, or
other inappropriate arrangements;
- Poor disclosure practices, (unclear explanation of how the CEO is
involved in the pay setting process, retrospective performance targets
and methodology not discussed, or methodology for benchmarking
practices and/or peer group not disclosed and explained);
- Internal pay disparity (e.g., excessive differential between CEO total
pay and that of next highest-paid named executive officer);
- Other excessive compensation payouts or poor pay practices at the
company.
DIRECTOR COMPENSATION
Vote CASE-BY-CASE on compensation plans for non-employee directors, based on the
cost of the plans against the company's allowable cap.
On occasion, director stock plans that set aside a relatively small number of
shares when combined with employee or executive stock compensation plans will
exceed the allowable cap. Vote for the plan if ALL of the following qualitative
factors in the board's compensation are met and disclosed in the proxy
statement:
- Director stock ownership guidelines with a minimum of three times the
annual cash retainer.
- Vesting schedule or mandatory holding/deferral period:
- A minimum vesting of three years for stock options or
restricted stock; or --
- Deferred stock payable at the end of a three-year deferral
period.
- Mix between cash and equity:
- A balanced mix of cash and equity, for example 40 percent
cash/60 percent equity or 50 percent cash/50 percent equity;
or
- If the mix is heavier on the equity component, the vesting
schedule or deferral period should be more stringent, with
the lesser of five years or the term of directorship.
- No retirement/benefits and perquisites provided to non-employee
directors; and
- Detailed disclosure provided on cash and equity compensation delivered
to each non-employee director for the most recent fiscal year in a
table. The column headers for the table may include the following:
name of each non-employee director, annual retainer, board meeting
fees, committee retainer, committee-meeting fees, and equity grants.
EMPLOYEE STOCK PURCHASE PLANS--QUALIFIED PLANS
Vote CASE-BY-CASE on qualified employee stock purchase plans. Vote FOR employee
stock purchase plans where all of the following apply:
- Purchase price is at least 85 percent of fair market value;
- Offering period is 27 months or less; and
- The number of shares allocated to the plan is 10 percent or less of
the outstanding shares.
Vote AGAINST qualified employee stock purchase plans where any of the following
apply:
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- Purchase price is less than 85 percent of fair market value; or
- Offering period is greater than 27 months; or
- The number of shares allocated to the plan is more than 10 percent of the
outstanding shares.
EMPLOYEE STOCK PURCHASE PLANS--NON-QUALIFIED PLANS
Vote CASE-by-CASE on nonqualified employee stock purchase plans. Vote FOR
nonqualified employee stock purchase plans with all the following features:
- Broad-based participation (i.e., all employees of the company with the
exclusion of individuals with 5 percent or more of beneficial
ownership of the company);
- Limits on employee contribution, which may be a fixed dollar amount or
expressed as a percent of base salary;
- Company matching contribution up to 25 percent of employee's
contribution, which is effectively a discount of 20 percent from
market value;
- No discount on the stock price on the date of purchase since there is
a company matching contribution.
Vote AGAINST nonqualified employee stock purchase plans when any of the plan
features do not meet the above criteria. If the company matching contribution
exceeds 25 percent of employee's contribution, evaluate the cost of the plan
against its allowable cap.
OPTIONS BACKDATING
In cases where a company has practiced options backdating, vote AGAINST or
WITHHOLD on a CASE-BY-CASE basis from the members of the compensation committee,
depending on the severity of the practices and the subsequent corrective actions
on the part of the board. Vote AGAINST or WITHHOLD from the compensation
committee members who oversaw the questionable options practices or from current
compensation committee members who fail to respond to the issue proactively,
depending on several factors, including, but not limited to:
- Reason and motive for the options backdating issue (inadvertent vs.
deliberate grant date changes);
- Length of time of options backdating;
- Size of restatement due to options backdating;
- Corrective actions taken by the board or compensation committee, such
as canceling or repricing backdated options, or recoupment of option
gains on backdated grants;
- Adoption of a grant policy that prohibits backdating, and creation of
a fixed grant schedule or window period for equity grants going
forward.
OPTION EXCHANGE PROGRAMS/REPRICING OPTIONS
Vote CASE-by-CASE on management proposals seeking approval to exchange/reprice
options, considering:
- Historic trading patterns--the stock price should not be so volatile
that the options are likely to be back "in-the-money" over the near
term;
- Rationale for the re-pricing--was the stock price decline beyond
management's control?
- Is this a value-for-value exchange?
- Are surrendered stock options added back to the plan reserve?
- Option vesting--does the new option vest immediately or is there a
black-out period?
- Term of the option--the term should remain the same as that of the
replaced option; - Exercise price--should be set at fair market or a
premium to market;
- Participants--executive officers and directors should be excluded.
If the surrendered options are added back to the equity plans for re-issuance,
then also take into consideration the company's three-year average burn rate. In
addition to the above considerations, evaluate the intent, rationale, and timing
of the repricing proposal. The proposal should clearly articulate why the board
is choosing to conduct an exchange program at this point in time. Repricing
underwater options after a recent precipitous drop in the company's stock price
demonstrates poor timing. Repricing after a recent decline in stock price
triggers additional scrutiny and a potential AGAINST vote on the proposal. At a
minimum, the decline should not have happened within the past year. Also,
consider the terms of the surrendered options, such as the grant date, exercise
price and vesting schedule. Grant dates of surrendered options should be far
enough back (two to three years) so as not to suggest that repricings are being
done to
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take advantage of short-term downward price movements. Similarly, the exercise
price of surrendered options should be above the 52-week high for the stock
price.
Vote FOR shareholder proposals to put option repricings to a shareholder vote.
STOCK PLANS IN LIEU OF CASH
Vote CASE-by-CASE on plans that provide participants with the option of taking
all or a portion of their cash compensation in the form of stock, and on plans
that do not provide a dollar-for-dollar cash for stock exchange. In cases where
the exchange is not dollar-for-dollar, the request for new or additional shares
for such equity program will be considered using the binomial option pricing
model. In an effort to capture the total cost of total compensation, ISS will
not make any adjustments to carve out the in-lieu-of cash compensation. Vote FOR
non-employee director-only equity plans that provide a dollar-for-dollar
cash-for-stock exchange.
TRANSFER PROGRAMS OF STOCK OPTIONS
Vote AGAINST or WITHHOLD from compensation committee members if they fail to
submit one-time transfers to shareholders for approval.
Vote CASE-BY-CASE on one-time transfers. Vote FOR if:
- Executive officers and non-employee directors are excluded from
participating;
- Stock options are purchased by third-party financial institutions at a
discount to their fair value using option pricing models such as
Black-Scholes or a Binomial Option Valuation or other appropriate
financial models;
- There is a two-year minimum holding period for sale proceeds (cash or
stock) for all participants.
Additionally, management should provide a clear explanation of why options are
being transferred and whether the events leading up to the decline in stock
price were beyond management's control. A review of the company's historic stock
price volatility should indicate if the options are likely to be back
"in-the-money" over the near term.
Vote AGAINST equity plan proposals if the details of ongoing Transfer of Stock
Options programs are not provided to shareholders. Since TSOs will be one of the
award types under a stock plan, the ongoing TSO program, structure and mechanics
must be disclosed to shareholders. The specific criteria to be considered in
evaluating these proposals include, but not limited, to the following:
- Eligibility;
- Vesting;
- Bid-price;
- Term of options;
- Transfer value to third-party financial institution, employees and the
company.
Amendments to existing plans that allow for introduction of transferability of
stock options should make clear that only options granted post-amendment shall
be transferable.
Shareholder Proposals on Compensation
ADVISORY VOTE ON EXECUTIVE COMPENSATION (SAY-ON-PAY)
Generally, vote FOR shareholder proposals that call for non-binding shareholder
ratification of the compensation of the named executive officers and the
accompanying narrative disclosure of material factors provided to understand the
Summary Compensation Table.
COMPENSATION CONSULTANTS--DISCLOSURE OF BOARD OR COMPANY'S UTILIZATION
Generally vote FOR shareholder proposals seeking disclosure regarding the
company, board, or compensation committee's use of compensation consultants,
such as company name, business relationship(s) and fees paid.
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DISCLOSURE/SETTING LEVELS OR TYPES OF COMPENSATION FOR EXECUTIVES AND DIRECTORS
Generally, vote FOR shareholder proposals seeking additional disclosure of
executive and director pay information, provided the information requested is
relevant to shareholders' needs, would not put the company at a competitive
disadvantage relative to its industry, and is not unduly burdensome to the
company. Vote AGAINST shareholder proposals seeking to set absolute levels on
compensation or otherwise dictate the amount or form of compensation. Vote
AGAINST shareholder proposals requiring director fees be paid in stock only.
Vote CASE-BY-CASE on all other shareholder proposals regarding executive and
director pay, taking into account company performance, pay level versus peers,
pay level versus industry, and long-term corporate outlook.
PAY FOR SUPERIOR PERFORMANCE
Generally vote FOR shareholder proposals based on a case-by-case analysis that
requests the board establish a pay-for-superior performance standard in the
company's compensation plan for senior executives. The proposal should have the
following principles:
- Sets compensation targets for the plan's annual and long-term
incentive pay components at or below the peer group median;
- Delivers a majority of the plan's target long-term compensation
through performance-vested, not simply time-vested, equity awards;
- Provides the strategic rationale and relative weightings of the
financial and non-financial performance metrics or criteria used in
the annual and performance-vested long-term incentive components of
the plan;
- Establishes performance targets for each plan financial metric
relative to the performance of the company's peer companies;
- Limits payment under the annual and performance-vested long-term
incentive components of the plan to when the company's performance on
its selected financial performance metrics exceeds peer group median
performance.
- Consider the following factors in evaluating this proposal:
- What aspects of the company's annual and long-term equity incentive
programs are performance-driven?
- If the annual and long-term equity incentive programs are performance
driven, are the performance criteria and hurdle rates disclosed to
shareholders or are they benchmarked against a disclosed peer group?
- Can shareholders assess the correlation between pay and performance
based on the current disclosure?
- What type of industry and stage of business cycle does the company
belong to?
PERFORMANCE-BASED AWARDS
Vote CASE-BY-CASE on shareholder proposal requesting that a significant amount
of future long-term incentive compensation awarded to senior executives shall be
performance-based and requesting that the board adopt and disclose challenging
performance metrics to shareholders, based on the following analytical steps:
- First, vote FOR shareholder proposals advocating the use of
performance-based equity awards, such as performance contingent
options or restricted stock, indexed options or premium-priced
options, unless the proposal is overly restrictive or if the company
has demonstrated that it is using a "substantial" portion of
performance-based awards for its top executives. Standard stock
options and performance-accelerated awards do not meet the criteria to
be considered as performance-based awards. Further, premium-priced
options should have a premium of at least 25 percent and higher to be
considered performance-based awards.
- Second, assess the rigor of the company's performance-based equity
program. If the bar set for the performance-based program is too low
based on the company's historical or peer group comparison, generally
vote FOR the proposal. Furthermore, if target performance results in
an above target payout, vote FOR the shareholder proposal due to
program's poor design. If the company does not disclose the
performance metric of the performance-based equity program, vote FOR
the shareholder proposal regardless of the outcome of the first step
to the test.
In general, vote FOR the shareholder proposal if the company does not meet both
of these two requirements.
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PRE-ARRANGED TRADING PLANS (10B5-1 PLANS)
Generally vote FOR shareholder proposals calling for certain principles
regarding the use of prearranged trading plans (10b5-1 plans) for executives.
These principles include: - Adoption, amendment, or termination of a 10b5-1 plan
must be disclosed within two business days in a Form 8-K;
- Amendment or early termination of a 10b5-1 plan is allowed only under
extraordinary circumstances, as determined by the board;
- Ninety days must elapse between adoption or amendment of a 10b5-1 plan
and initial trading under the plan;
- Reports on Form 4 must identify transactions made pursuant to a 10b5-1
plan;
- An executive may not trade in company stock outside the 10b5-1 Plan.
- Trades under a 10b5-1 plan must be handled by a broker who does not
handle other securities transactions for the executive.
RECOUP BONUSES
Vote on a CASE-BY-CASE on proposals to recoup unearned incentive bonuses or
other incentive payments made to senior executives if it is later determined
that fraud, misconduct, or negligence significantly contributed to a restatement
of financial results that led to the awarding of unearned incentive
compensation, taking into consideration:
- If the company has adopted a formal recoupment bonus policy; or
- If the company has chronic restatement history or material financial
problems.
SEVERANCE AGREEMENTS FOR EXECUTIVES/GOLDEN PARACHUTES
Vote FOR shareholder proposals requiring that golden parachutes or executive
severance agreements be submitted for shareholder ratification, unless the
proposal requires shareholder approval prior to entering into employment
contracts. Vote on a CASE-BY-CASE basis on proposals to ratify or cancel golden
parachutes. An acceptable parachute should include, but is not limited to, the
following:
- The triggering mechanism should be beyond the control of management;
- The amount should not exceed three times base amount (defined as the
average annual taxable W-2 compensation during the five years prior to
the change of control);
- Change-in-control payments should be double-triggered, i.e., (1) after
a change in control has taken place, and (2) termination of the
executive as a result of the change in control. Change in control is
defined as a change in the company ownership structure.
SUPPLEMENTAL EXECUTIVE RETIREMENT PLANS (SERPS)
Generally vote FOR shareholder proposals requesting to put extraordinary
benefits contained in SERP agreements to a shareholder vote unless the company's
executive pension plans do not contain excessive benefits beyond what is offered
under employee-wide plans. Generally vote FOR shareholder proposals requesting
to limit the executive benefits provided under the company's supplemental
executive retirement plan (SERP) by limiting covered compensation to a senior
executive's annual salary and excluding of all incentive or bonus pay from the
plan's definition of covered compensation used to establish such benefits.
9. CORPORATE SOCIAL RESPONSIBILITY (CSR) ISSUES
CONSUMER LENDING
Vote CASE-BY CASE on requests for reports on the company's lending guidelines
and procedures, including the establishment of a board committee for oversight,
taking into account:
- Whether the company has adequately disclosed mechanisms to prevent
abusive lending practices;
- Whether the company has adequately disclosed the financial risks of
the lending products in question;
- Whether the company has been subject to violations of lending laws or
serious lending controversies;
- Peer companies' policies to prevent abusive lending practices.
PHARMACEUTICAL PRICING
Generally vote AGAINST proposals requesting that companies implement specific
price restraints on pharmaceutical products unless the company fails to adhere
to legislative guidelines or industry norms in its product pricing.
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Vote CASE-BY-CASE on proposals requesting that the company evaluate their
product pricing considering:
- The existing level of disclosure on pricing
policies; - Deviation from established industry pricing norms;
- The
company's existing initiatives to provide its products to needy consumers;
- Whether the proposal focuses on specific products or geographic regions.
PRODUCT SAFETY AND TOXIC MATERIALS
Generally vote FOR proposals requesting the company to report on its policies,
initiatives/procedures, and oversight mechanisms related to toxic materials
and/or product safety in its supply chain, unless:
- The company already discloses similar information through existing
reports or policies such as a supplier code of conduct and/or a
sustainability report;
- The company has formally committed to the implementation of a toxic
materials and/or product safety and supply chain reporting and
monitoring program based on industry norms or similar standards within
a specified time frame; and
- The company has not been recently involved in relevant significant
controversies or violations.
Vote CASE-BY-CASE on resolutions requesting that companies develop a feasibility
assessment to phaseout of certain toxic chemicals and/or evaluate and disclose
the financial and legal risks associated with utilizing certain chemicals,
considering:
- Current regulations in the markets in which the company operates;
- Recent significant controversy, litigation, or fines stemming from
toxic chemicals or ingredients at the company; and
- The current level of disclosure on this topic.
CLIMATE CHANGE
In general, vote FOR resolutions requesting that a company disclose information
on the impact of climate change on the company's operations unless:
- The company already provides current, publicly available information
on the perceived impact that climate change may have on the company as
well as associated policies and procedures to address such risks
and/or opportunities;
- The company's level of disclosure is comparable to or better than
information provided by industry peers; and
- There are no significant fines, penalties, or litigation associated
with the company's environmental performance.
GREENHOUSE GAS EMISSIONS
Generally vote FOR proposals requesting a report on greenhouse gas emissions
from company operations and/or products unless this information is already
publicly disclosed or such factors are not integral to the company's line of
business. Generally vote AGAINST proposals that call for reduction in greenhouse
gas emissions by specified amounts or within a restrictive time frame unless the
company lags industry standards and has been the subject of recent, significant
fines, or litigation resulting from greenhouse gas emissions.
POLITICAL CONTRIBUTIONS AND TRADE ASSOCIATIONS SPENDING
Generally vote AGAINST proposals asking the company to affirm political
nonpartisanship in the workplace so long as:
- The company is in compliance with laws governing corporate political
activities; and
- The company has procedures in place to ensure that employee
contributions to company-sponsored political action committees (PACs)
are strictly voluntary and not coercive.
Vote AGAINST proposals to publish in newspapers and public media the company's
political contributions as such publications could present significant cost to
the company without providing commensurate value to shareholders. Vote
CASE-BY-CASE on proposals to improve the disclosure of a company's political
contributions and trade association spending, considering:
- Recent significant controversy or litigation related to the company's
political contributions or governmental affairs; and
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- The public availability of a company policy on political contributions
and trade association spending including information on the types of
organizations supported, the business rationale for supporting these
organizations, and the oversight and compliance procedures related to
such expenditures.
Vote AGAINST proposals barring the company from making political contributions.
Businesses are affected by legislation at the federal, state, and local level
and barring contributions can put the company at a competitive disadvantage.
Vote AGAINST proposals asking for a list of company executives, directors,
consultants, legal counsels, lobbyists, or investment bankers that have prior
government service and whether such service had a bearing on the business of the
company. Such a list would be burdensome to prepare without providing any
meaningful information to shareholders.
SUSTAINABILITY REPORTING
Generally vote FOR proposals requesting the company to report on policies and
initiatives related to social, economic, and environmental sustainability,
unless:
- The company already discloses similar information through existing
reports or policies such as an environment, health, and safety (EHS)
report; a comprehensive code of corporate conduct; and/or a diversity
report; or
- The company has formally committed to the implementation of a
reporting program based on Global Reporting Initiative (GRI)
guidelines or a similar standard within a specified time frame.
GLASS LEWIS SUMMARY DOMESTIC PROXY PAPER POLICY GUIDELINES:
I. ELECTION OF DIRECTORS
Board of Directors
Boards are put in place to represent shareholders and protect their interests.
Glass Lewis seeks boards with a proven record of protecting shareholders and
delivering value over the medium- and long-term. In our view, boards working to
protect and enhance the best interests of shareholders typically consist of at
least two-thirds independent directors, have a record of positive performance
and include directors with a breadth and depth of experience.
Board Composition
We look at each individual on the board and examine his or her relationships
with the company, the company's executives and with other board members. The
purpose of this inquiry is to determine whether pre-existing personal, familial
or financial relationships are likely to impact the decisions of that board
member.
We vote in favor of governance structures that will drive positive
performance and enhance shareholder value. The most crucial test of a board's
commitment to the company and to its shareholders is the performance of the
board and its members. The performance of directors in their capacity as board
members and as executives of the company, when applicable, and in their roles at
other companies where they serve is critical to this evaluation.
We believe a director is independent if he or she has no material financial,
familial or other current relationships with the company, its executives or
other board members except for service on the board and standard fees paid for
that service. Relationships that have existed within the five years prior to the
inquiry are usually considered to be "current" for purposes of this test.
In our view, a director is affiliated if he or she has a material financial,
familial or other relationship with the company or its executives, but is not an
employee of the company. This includes directors whose employers have a material
financial relationship with the Company. This also includes a director who owns
or controls 25% or more of the company's voting stock.
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We define an inside director as one who simultaneously serves as a director and
as an employee of the company. This category may include a chairman of the board
who acts as an employee of the company or is paid as an employee of the company.
Although we typically vote for the election of directors, we will withhold from
directors for the following reasons:
- A director who attends less than 75% of the board and applicable
committee meetings.
- A director who fails to file timely form(s) 4 or 5 (assessed on a
case-by-case basis).
- A director who is also the CEO of a company where a serious
restatement has occurred after the CEO certified the pre-restatement
financial statements.
- All board members who served at a time when a poison pill was adopted
without shareholder approval within the prior twelve months.
We also feel that the following conflicts of interest may hinder a director's
performance and will therefore withhold from a:
- CFO who presently sits on the board.
- Director who presently sits on an excessive number of boards
- Director, or a director whose immediate family member, provides
material professional services to the company at any time during the
past five years.
- Director, or a director whose immediate family member, engages in
airplane, real estate or other similar deals, including perquisite
type grants from the company.
- Director with an interlocking directorship.
Board Committee Composition
All key committees including audit, compensation, governance, and nominating
committees should be composed solely of independent directors and each committee
should be focused on fulfilling its specific duty to shareholders. We typically
recommend that shareholders withhold their votes for any affiliated or inside
director seeking appointment to an audit, compensation, nominating or governance
committee or who has served in that capacity in the past year.
Review of the Compensation Discussion and Analysis Report
We review the CD&A in our evaluation of the overall compensation practices of a
company, as overseen by the compensation committee. In our evaluation of the
CD&A, we examine, among other factors, the extent to which the company has used
performance goals in determining overall compensation, how well the company has
disclosed performance metrics and goals and the extent to which the performance
metrics, targets and goals are implemented to enhance company performance. We
would recommend voting against the chair of the compensation committee where the
CD&A provides insufficient or unclear information about performance metrics and
goals, where the CD&A indicates that pay is not tied to performance, or where
the compensation committee or management has excessive discretion to alter
performance terms or increase amounts of awards in contravention of previously
defined targets.
Separation of the roles of Chairman and CEO
Glass Lewis believes that separating the roles of corporate officers and the
chairman of the board is a better governance structure than a combined
executive/chairman position. The role of executives is to manage the business on
the basis of the course charted by the board. Executives should be in the
position of reporting and answering to the board for their performance in
achieving the goals set out by such board. This becomes much more complicated
when management actually sits on, or chairs, the board.
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We view an independent chairman as better able to oversee the executives of the
company and set a pro-shareholder agenda without the management conflicts that a
CEO and other executive insiders often face. This, in turn, leads to a more
proactive and effective board of directors that is looking out for the interests
of shareholders above all else.
We do not withhold votes from CEOs who serve on or chair the board. However, we
do support a separation between the roles of chairman of the board and CEO,
whenever that question is posed in a proxy.
In the absence of an independent chairman, we support the appointment of a
presiding or lead director with authority to set the agenda for the meetings and
to lead sessions outside the presence of the insider chairman.
Majority Voting for the Election of Directors
Glass Lewis will generally support proposals calling for the election of
directors by a majority vote in place of plurality voting. If a majority vote
standard were implemented, a nominee would have to receive the support of a
majority of the shares voted in order to assume the role of a director. Thus,
shareholders could collectively vote to reject a director they believe will not
pursue their best interests. We think that this minimal amount of protection for
shareholders is reasonable and will not upset the corporate structure nor reduce
the willingness of qualified shareholder-focused directors to serve in the
future.
Classified Boards
Glass Lewis favors the repeal of staggered boards in favor of the annual
election of directors. We believe that staggered boards are less accountable to
shareholders than annually elected boards. Furthermore, we feel that the annual
election of directors encourages board members to focus on protecting the
interests of shareholders.
Mutual Fund Boards
Mutual funds, or investment companies, are structured differently than regular
public companies (i.e., operating companies). Members of the fund's adviser are
typically on the board and management takes on a different role than that of
other public companies. As such, although many of our guidelines remain the
same, the following differences from the guidelines at operating companies apply
at mutual funds:
1. We believe three-fourths of the boards of investment companies should
be made up of independent directors, a stricter standard than the
two-thirds independence standard we employ at operating companies.
2. We recommend withholding votes from the chairman of the nominating
committee at an investment company if the chairman and CEO of a mutual
fund are the same person and the fund does not have an independent
lead or presiding director.
II. FINANCIAL REPORTING
Auditor Ratification
We believe that role of the auditor is crucial in protecting shareholder value.
In our view, shareholders should demand the services of objective and
well-qualified auditors at every company in which they hold an interest. Like
directors, auditors should be free from conflicts of interest and should
assiduously avoid situations that require them to make choices between their own
interests and the interests of the shareholders.
Glass Lewis generally supports management's recommendation regarding the
selection of an auditor. However, we recommend voting against the ratification
of auditors for the following reasons:
- When audit fees added to audit-related fees total less than one-third
of total fees.
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- When there have been any recent restatements or late filings by the
company where the auditor bears some responsibility for the
restatement or late filing (e.g., a restatement due to a reporting
error).
- When the company has aggressive accounting policies.
- When the company has poor disclosure or lack of transparency in
financial statements.
- When there are other relationships or issues of concern with the
auditor that might suggest a conflict between the interest of the
auditor and the interests of shareholders.
- When the company is changing auditors as a result of a disagreement
between the company and the auditor on a matter of accounting
principles or practices, financial statement disclosure or auditing
scope or procedures.
Auditor Rotation
We typically support audit related proposals regarding mandatory auditor
rotation when the proposal uses a reasonable period of time (usually not less
than 5-7 years).
Pension Accounting Issues
Proxy proposals sometimes raise the question as to whether pension accounting
should have an effect on the company's net income and therefore be reflected in
the performance of the business for purposes of calculating payments to
executives. It is our view that pension credits should not be included in
measuring income used to award performance-based compensation. Many of the
assumptions used in accounting for retirement plans are subject to the
discretion of a company, and management would have an obvious conflict of
interest if pay were tied to pension income.
III. COMPENSATION
Equity Based Compensation Plans
Glass Lewis evaluates option and other equity-based compensation on a
case-by-case basis. We believe that equity compensation awards are a useful
tool, when not abused, for retaining and incentivizing employees to engage in
conduct that will improve the performance of the company.
We evaluate option plans based on ten overarching principles:
- Companies should seek additional shares only when needed.
- The number of shares requested should be small enough that companies
need shareholder approval every three to four years (or more
frequently).
- If a plan is relatively expensive, it should not be granting options
solely to senior executives and board members.
- Annual net share count and voting power dilution should be limited.
- Annual cost of the plan (especially if not shown on the income
statement) should be reasonable as a percentage of financial results
and in line with the peer group.
- The expected annual cost of the plan should be proportional to the
value of the business.
- The intrinsic value received by option grantees in the past should be
reasonable compared with the financial results of the business.
- Plans should deliver value on a per-employee basis when compared with
programs at peer companies.
- Plans should not permit re-pricing of stock options.
Option Exchanges
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Option exchanges are reviewed on a case-by-case basis, although they are
approached with great skepticism. Repricing is tantamount to a re-trade. We will
support a repricing only if the following conditions are true:
- Officers and board members do not participate in the program.
- The stock decline mirrors the market or industry price decline in
terms of timing and approximates the decline in magnitude.
- The exchange is value neutral or value creative to shareholders with
very conservative assumptions and a recognition of the adverse
selection problems inherent in voluntary programs.
- Management and the board make a cogent case for needing to incentivize
and retain existing employees, such as being in a competitive
employment market.
Performance Based Options
We generally recommend that shareholders vote in favor of performance-based
option requirements. We feel that executives should be compensated with equity
when their performance and that of the company warrants such rewards. We believe
that boards can develop a consistent, reliable approach, as boards of many
companies have, that would attract executives who believe in their ability to
guide the company to achieve its targets.
Linking Pay with Performance
Executive compensation should be linked directly with the performance of the
business the executive is charged with managing. Glass Lewis grades companies on
an A to F scale based on our analysis of executive compensation relative to
performance and that of the company's peers and will recommend withholding votes
for the election of compensation committee members at companies that receive a
grade of F.
Director Compensation Plans
Non-employee directors should receive compensation for the time and effort they
spend serving on the board and its committees. In particular, we support
compensation plans that include equity-based awards, which help to align the
interests of outside directors with those of shareholders. Director fees should
be competitive in order to retain and attract qualified individuals.
Options Expensing
We will always recommend a vote in favor of a proposal to expense stock options.
We believe that stock options are an important component of executive
compensation and that the expense of that compensation should be reflected in a
company's operational earnings. When companies do not to expense options, the
effect of options on the company's finances is obscured and accountability for
their use as a means of compensation is greatly diminished.
Limits on Executive Compensation
Proposals to limit executive compensation will be evaluated on a case-by-case
basis. As a general rule, we believe that executive compensation should be left
to the board's compensation committee. We view the election of directors, and
specifically those who sit on the compensation committee, as the appropriate
mechanism for shareholders to express their disapproval or support of board
policy on this issue.
Limits on Executive Stock Options
We favor the grant of options to executives. Options are a very important
component of compensation packages designed to attract and retain experienced
executives and other key employees. Tying a portion of an executive's
compensation to
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the performance of the company also provides an excellent incentive to maximize
share values by those in the best position to affect those values. Accordingly,
we typically vote against caps on executive stock options.
IV. GOVERNANCE STRUCTURE
Anti-Takeover Measures
Poison Pills (Shareholder Rights Plans)
Glass Lewis believes that poison pill plans generally are not in the best
interests of shareholders. Specifically, they can reduce management
accountability by substantially limiting opportunities for corporate takeovers.
Rights plans can thus prevent shareholders from receiving a buy-out premium for
their stock.
We believe that boards should be given wide latitude in directing the activities
of the company and charting the company's course. However, on an issue such as
this where the link between the financial interests of shareholders and their
right to consider and accept buyout offers is so substantial, we believe that
shareholders should be allowed to vote on whether or not they support such a
plan's implementation.
In certain limited circumstances, we will support a limited poison pill to
accomplish a particular objective, such as the closing of an important merger,
or a pill that contains what we believe to be a reasonable 'qualifying offer'
clause.
Right of Shareholders to Call a Special Meeting
We will vote in favor of proposals that allow shareholders to call special
meetings. In order to prevent abuse and waste of corporate resources by a very
small minority of shareholders, we believe that such rights should be limited to
a minimum threshold of at least 15% of the shareholders requesting such a
meeting.
Shareholder Action by Written Consent
We will vote in favor of proposals that allow shareholders to act by written
consent. In order to prevent abuse and waste of corporate resources by a very
small minority of shareholders, we believe that such rights should be limited to
a minimum threshold of at least 15% of the shareholders requesting action by
written consent.
Authorized Shares
Proposals to increase the number of authorized shares will be evaluated on a
case-by-case basis. Adequate capital stock is important to the operation of a
company. When analyzing a request for additional shares, we typically review
four common reasons why a company might need additional capital stock beyond
what is currently available:
1. Stock split
2. Shareholder defenses
3. Financing for acquisitions
4. Financing for operations
Unless we find that the company has not disclosed a detailed plan for use of the
proposed shares, or where the number of shares far exceeds those needed to
accomplish a detailed plan, we typically recommend in favor of the authorization
of additional shares.
Voting Structure
Cumulative Voting
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Glass Lewis will vote for proposals seeking to allow cumulative voting.
Cumulative voting is a voting process that maximizes the ability of minority
shareholders to ensure representation of their views on the board. Cumulative
voting generally operates as a safeguard for by ensuring that those who hold a
significant minority of shares are able to elect a candidate of their choosing
to the board.
Supermajority Vote Requirements
Glass Lewis favors a simple majority voting structure. Supermajority vote
requirements act as impediments to shareholder action on ballot items that are
critical to our interests. One key example is in the takeover context where
supermajority vote requirements can strongly limit shareholders' input in making
decisions on such crucial matters as selling the business.
Shareholder Proposals
Shareholder proposals are evaluated on a case-by-case basis. We generally favor
proposals that are likely to increase shareholder value and/or promote and
protect shareholder rights. We typically prefer to leave decisions regarding
day-to-day management of the business and policy decisions related to political,
social or environmental issues to management and the board except when we see a
clear and direct link between the proposal and some economic or financial issue
for the company.
65
APPENDIX B - RATINGS OF INVESTMENT SECURITIES
From time to time, the fund may report the percentage of its assets that fall
into the rating categories set forth below.
BONDS
MOODY'S INVESTORS SERVICE
Aaa Bonds which are rated Aaa are judged to be of the best quality. They carry
the smallest degree of investment risk and are generally referred to as "gilt
edged." Interest payments are protected by a large or by an exceptionally stable
margin and principal is secure. While the various protective elements are likely
to change, such changes as can be visualized are most unlikely to impair the
fundamentally strong position of such issues.
Aa Bonds which are rated Aa are judged to be of high quality by all standards.
Together with the Aaa group they comprise what are generally known as high-grade
bonds. They are rated lower than the best bonds because margins of protection
may not be as large as in Aaa securities or fluctuation of protective elements
may be of greater amplitude or there may be other elements present which make
the long term risk appear somewhat larger than the Aaa securities.
A Bonds which are rated A possess many favorable investment attributes and are
to be considered as upper-medium grade obligations. Factors giving security to
principal and interest are considered adequate, but elements may be present
which suggest a susceptibility to impairment some time in the future.
Baa Bonds which are rated Baa are considered as medium-grade obligations (i.e.,
they are neither highly protected nor poorly secured). Interest payments and
principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Ba Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well-assured. Often the protection of interest
and principal payments may be very moderate and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
B Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
STANDARD & POOR'S CORPORATION
INVESTMENT GRADE
AAA Debt rated 'AAA' has the highest rating assigned by S&P. Capacity to pay
interest and repay principal is extremely strong.
AA Debt rated 'AA' has a very strong capacity to pay interest and repay
principal and differs from the highest rated debt only in small degree.
A Debt rated 'A' has a strong capacity to pay interest and repay principal,
although it is somewhat more susceptible to adverse effects of changes in
circumstances and economic conditions than debt in higher-rated categories.
BBB Debt rated 'BBB' is regarded as having an adequate capacity to pay interest
and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
66
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher rated categories.
SPECULATIVE GRADE
Debt rated 'BB' and 'B' is regarded as having predominantly speculative
characteristics with respect to capacity to pay interest and repay principal.
While such debt will likely have some quality and protective characteristics,
these are outweighed by large uncertainties or major risk exposures to adverse
conditions.
BB Debt rated 'BB' has less near-term vulnerability to default than other
speculative grade debt. However, it faces major ongoing uncertainties or
exposure to adverse business, financial, or economic conditions that could lead
to inadequate capacity to meet timely interest and principal payments. The 'BB'
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied 'BBB-' rating.
B Debt rate 'B' has greater vulnerability to default but presently has the
capacity to meet interest payments and principal repayments. Adverse business,
financial, or economic conditions would likely impair capacity or willingness to
pay interest and repay principal. The 'B' rating category also is used for debt
subordinated to senior debt that is assigned an actual or implied 'BB' or 'BB-'
rating.
FITCH, INC.
INVESTMENT GRADE BOND
AAA Bonds considered to be investment grade and of the highest credit quality.
The obligor has an exceptionally strong ability to pay interest and repay
principal, which is unlikely to be affected by reasonably foreseeable
events.
AA Bonds considered to be investment grade and of very high credit quality.
The obligor's ability to pay interest and repay principal is very strong,
although not quite as strong as bonds rated 'AAA'. Because bonds rated in
the 'AAA' and 'AA' categories are not significantly vulnerable to
foreseeable future developments, short term debt of these issuers is
generally rated 'F1+'.
A Bonds considered to be investment grade and of high credit quality. The
obligor's ability to pay interest and repay principal is considered to be
strong, but may be more vulnerable to adverse changes in economic
conditions and circumstances than bonds with higher ratings.
BBB Bonds considered to be investment grade and of satisfactory credit
quality. The obligor's ability to pay interest and repay principal is
considered to be adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have adverse impact on these
bonds, and therefore impair timely payment. The likelihood that the
ratings of these bonds will fall below investment grade is higher than for
bonds with higher ratings.
SPECULATIVE GRADE BOND
BB Bonds are considered speculative. The obligor's ability to pay interest
and repay principal may be affected over time by adverse economic changes.
However, business and financial alternatives can be identified which could
assist the obligor in satisfying its debt service requirements.
B Bonds are considered highly speculative. While bonds in this class are
currently meeting debt service requirements, the probability of continued
timely payment of principal and interest reflects the obligor's limited
margin of safety and the need for reasonable business and economic
activity throughout the life of the issue.
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DOMINION BOND RATING SERVICE
BOND AND LONG TERM DEBT RATING SCALE
As is the case with all DBRS rating scales, long term debt ratings are meant to
give an indication of the risk that the borrower will not fulfill its full
obligations in a timely manner with respect to both interest and principal
commitments. DBRS ratings do not take factors such as pricing or market risk
into consideration and are expected to be used by purchasers as one part of
their investment process. Every DBRS rating is based on quantitative and
qualitative considerations that are relevant for the borrowing entity.
AAA: Highest Credit Quality
AA: Superior Credit Quality
A: Satisfactory Credit Quality
BBB: Adequate Credit Quality
BB: Speculative
B: Highly Speculative
CCC: Very Highly Speculative
CC: Very Highly Speculative
C: Very Highly Speculative
"AAA" Bonds rated "AAA" are of the highest credit quality, with exceptionally
strong protection for the timely repayment of principal and interest. Earnings
are considered stable, the structure of the industry in which the entity
operates is strong, and the outlook for future profitability is favorable. There
are few qualifying factors present which would detract from the performance of
the entity, the strength of liquidity and coverage ratios is unquestioned and
the entity has established a creditable track record of superior performance.
Given the extremely tough definition which DBRS has established for this
category, few entities are able to achieve a AAA rating.
"AA" Bonds rated "AA" are of superior credit quality, and protection of interest
and principal is considered high. In many cases, they differ from bonds rated
AAA only to a small degree. Given the extremely tough definition which DBRS has
for the AAA category (which few companies are able to achieve), entities rated
AA are also considered to be strong credits which typically exemplify
above-average strength in key areas of consideration and are unlikely to be
significantly affected by reasonably foreseeable events.
"A" Bonds rated "A" are of satisfactory credit quality. Protection of interest
and principal is still substantial, but the degree of strength is less than with
AA rated entities. While a respectable rating, entities in the "A" category are
considered to be more susceptible to adverse economic conditions and have
greater cyclical tendencies than higher rated companies.
"BBB" Bonds rated "BBB" are of adequate credit quality. Protection of interest
and principal is considered adequate, but the entity is more susceptible to
adverse changes in financial and economic conditions, or there may be other
adversities present which reduce the strength of the entity and its rated
securities.
"BB" Bonds rated "BB" are defined to be speculative, where the degree of
protection afforded interest and principal is uncertain, particularly during
periods of economic recession. Entities in the BB area typically have limited
access to capital markets and additional liquidity support and, in many cases,
small size or lack of competitive strength may be additional negative
considerations.
"B" Bonds rated "B" are highly speculative and there is a reasonably high level
of uncertainty which exists as to the
68
ability of the entity to pay interest and principal on a continuing basis in the
future, especially in periods of economic recession or industry adversity.
"CCC" / "CC" / "C" Bonds rated in any of these categories are very highly
speculative and are in danger of default of interest and principal. The degree
of adverse elements present is more severe than bonds rated "B". Bonds rated
below "B" often have characteristics which, if not remedied, may lead to
default. In practice, there is little difference between the "C" to "CCC"
categories, with "CC" and "C" normally used to lower ranking debt of companies
where the senior debt is rated in the "CCC" to "B" range.
"D" This category indicates Bonds in default of either interest or principal.
("HIGH", "LOW") grades are used to indicate the relative standing of a credit
within a particular rating category. The lack of one of these designations
indicates a rating which is essentially in the middle of the category. Note that
"high" and "low" grades are not used for the AAA category.
COMMERCIAL PAPER AND SHORT-TERM DEBT RATING SCALE
DOMINION BOND RATING SERVICE
As is the case with all DBRS rating scales, commercial paper ratings are meant
to give an indication of the risk that the borrower will not fulfill its
obligations in a timely manner. DBRS ratings do not take factors such as pricing
or market risk into consideration and are expected to be used by purchasers as
one part of their investment process. Every DBRS rating is based on quantitative
and qualitative considerations which are relevant for the borrowing entity.
R-1: Prime Credit Quality
R-2: Adequate Credit Quality
R-3: Speculative
All three DBRS rating categories for short term debt use "high", "middle" or
"low" as subset grades to designate the relative standing of the credit within a
particular rating category. The following comments provide separate definitions
for the three grades in the Prime Credit Quality area, as this is where ratings
for active borrowers in Canada continue to be heavily concentrated.
"R-1 (HIGH)" Short term debt rated "R-1 (high)" is of the highest credit
quality, and indicates an entity which possesses unquestioned ability to repay
current liabilities as they fall due. Entities rated in this category normally
maintain strong liquidity positions, conservative debt levels and profitability
which is both stable and above average. Companies achieving an "R-1 (high)"
rating are normally leaders in structurally sound industry segments with proven
track records, sustainable positive future results and no substantial qualifying
negative factors. Given the extremely tough definition which DBRS has
established for an "R-1 (high)", few entities are strong enough to achieve this
rating.
"R-1 (MIDDLE)" Short term debt rated "R-1 (middle)" is of superior credit
quality and, in most cases, ratings in this category differ from "R-1 (high)"
credits to only a small degree. Given the extremely tough definition which DBRS
has for the "R-1 (high)" category (which few companies are able to achieve),
entities rated "R-1 (middle)" are also considered strong credits which typically
exemplify above average strength in key areas of consideration for debt
protection.
"R-1 (LOW)" Short term debt rated "R-1 (low)" is of satisfactory credit quality.
The overall strength and outlook for key liquidity, debt and profitability
ratios is not normally as favorable as with higher rating categories, but these
considerations are still respectable. Any qualifying negative factors which
exist are considered manageable, and the entity is normally of sufficient size
to have some influence in its industry.
69
"R-2 (HIGH)", "R-2 (MIDDLE)", "R-2 (LOW)" Short term debt rated "R-2" is of
adequate credit quality and within the three subset grades, debt protection
ranges from having reasonable ability for timely repayment to a level which is
considered only just adequate. The liquidity and debt ratios of entities in the
"R-2" classification are not as strong as those in the "R-1" category, and the
past and future trend may suggest some risk of maintaining the strength of key
ratios in these areas. Alternative sources of liquidity support are considered
satisfactory; however, even the strongest liquidity support will not improve the
commercial paper rating of the issuer. The size of the entity may restrict its
flexibility, and its relative position in the industry is not typically as
strong as an "R-1 credit". Profitability trends, past and future, may be less
favorable, earnings not as stable, and there are often negative qualifying
factors present which could also make the entity more vulnerable to adverse
changes in financial and economic conditions.
"R-3 (HIGH)", "R-3 (MIDDLE)", "R-3 (LOW)" Short term debt rated "R-3" is
speculative, and within the three subset grades, the capacity for timely payment
ranges from mildly speculative to doubtful. "R-3" credits tend to have weak
liquidity and debt ratios, and the future trend of these ratios is also unclear.
Due to its speculative nature, companies with "R-3" ratings would normally have
very limited access to alternative sources of liquidity. Earnings would
typically be very unstable, and the level of overall profitability of the entity
is also likely to be low. The industry environment may be weak, and strong
negative qualifying factors are also likely to be present.
SHORT TERM NOTES AND VARIABLE RATE DEMAND OBLIGATIONS
MOODY'S INVESTORS SERVICE
Short term notes/variable rate demand obligations bearing the designations
MIG-1/VMIG-1 are considered to be of the best quality, enjoying strong
protection from established cash flows, superior liquidity support or
demonstrated broad-based access to the market for refinancing. Obligations rated
MIG-2/VMIG-3 are of high quality and enjoy ample margins of protection although
not as large as those of the top rated securities.
STANDARD & POOR'S CORPORATION
An S&P SP-1 rating indicates that the subject securities' issuer has a strong
capacity to pay principal and interest. Issues determined to possess very strong
safety characteristics are given a plus (+) designation. S&P's determination
that an issuer has a satisfactory capacity to pay principal and interest is
denoted by an SP-2 rating.
FITCH, INC.
Obligations supported by the highest capacity for timely repayment are rated
F1+. An F1 rating indicates that the obligation is supported by a very strong
capacity for timely repayment. Obligations rated F2 are supported by a good
capacity for timely repayment, although adverse changes in business, economic,
or financial conditions may affect this capacity.
COMMERCIAL PAPER
MOODY'S INVESTORS SERVICE
Prime-1 is the highest commercial paper rating assigned by Moody's. Issuers (or
related supporting institutions) of commercial paper with this rating are
considered to have a superior ability to repay short term promissory
obligations. Issuers (or related supporting institutions) of securities rated
Prime-2 are viewed as having a strong capacity to repay short term promissory
obligations. This capacity will normally be evidenced by many of the
characteristics of issuers whose commercial paper is rated Prime-1 but to a
lesser degree.
STANDARD & POOR'S CORPORATION
70
A Standard & Poor's Corporation ("S&P") A-1 commercial paper rating indicates a
strong degree of safety regarding timely payment of principal and interest.
Issues determined to possess overwhelming safety characteristics are denoted
A-1+. Capacity for timely payment on commercial paper rated A-2 is satisfactory,
but the relative degree of safety is not as high as for issues designated A-1.
FITCH, INC.
F1+ is the highest category, and indicates the strongest degree of assurance for
timely payment. Issues rated F1 reflect an assurance of timely payment only
slightly less than issues rated F1+. Issues assigned an F2 rating have a
satisfactory degree of assurance for timely payment, but the margin of safety is
not as great as for issues in the first two rating categories.
71
PART C OTHER INFORMATION
ITEM 23. EXHIBITS.
(a) (1) Second Amended and Restated Agreement and Declaration of Trust of
the Registrant -- incorporated by reference to Post-Effective
Amendment No. 45 to the Registration Statement filed on July 31,
2003;
(2) Amendment No. 1 to Second Amended and Restated Agreement and
Declaration of Trust of the Registrant -- incorporated by reference
to Post-Effective Amendment No. 45 to the Registration Statement
filed on July 31, 2003;
(3) Amendment No. 2 to Second Amended and Restated Agreement and
Declaration of Trust of the Registrant -- incorporated by reference
to Post-Effective Amendment No. 24 to the Registration Statement
filed on May 28, 1999;
(4) Amendment No. 3 to the Second Amended and Restated Agreement and
Declaration of Trust of the Registrant -- incorporated by reference
to Post-Effective Amendment No. 33 to the Registration Statement
filed on July 28, 2000;
(5) Amendment No. 4 to the Second Amended and Restated Agreement and
Declaration of Trust of the Registrant -- incorporated by reference
to Post-Effective Amendment No. 35 to the Registration Statement
filed on December 4, 2000;
(6) Amendment No. 5 to the Second Amended and Restated Agreement and
Declaration of Trust of the Registrant -- incorporated by reference
to Post-Effective Amendment No. 38 to the Registration Statement
filed on July 11, 2001;
(7) Amendment No. 6 to the Second Amended and Restated Agreement and
Declaration of Trust of the Registrant -- incorporated by reference
to Post-Effective Amendment No. 40 to the Registration Statement
filed on January 16, 2002;
(8) Amendment No. 7 to the Second Amended and Restated Agreement and
Declaration of Trust of the Registrant -- incorporated by reference
to Post-Effective Amendment No. 41 to the Registration Statement
filed on March 28, 2002;
(9) Amendment No. 8 to the Second Amended and Restated Agreement and
Declaration of Trust of the Registrant -- incorporated by reference
to Post-Effective Amendment No. 45 to the Registration Statement
filed on July 31, 2003;
(10) Amendment No. 9 to the Second Amended and Restated Agreement and
Declaration of Trust of the Registrant -- incorporated by reference
to Post-Effective Amendment No. 49 to the Registration Statement
filed on July 29, 2004;
(11) Amendment No. 10 to the Second Amended and Restated Agreement and
Declaration of Trust of the Registrant -- incorporated by reference
to Post-Effective Amendment No. 47 to the Registration Statement
filed on May 27, 2004;
(12) Amendment No. 11 to the Second Amended and Restated Agreement and
Declaration of Trust of the Registrant -- incorporated by reference
to Post-Effective Amendment No. 49 to the Registration Statement
filed on July 29, 2004;
(13) Amendment No. 12 to the Second Amended and Restated Agreement and
Declaration of Trust of the Registrant -- incorporated by reference
to Post-Effective Amendment No. 56 to the Registration Statement
filed on April 16, 2006;
(14) Third Amendment and Restated Agreement and Declaration of Trust of
the Registrant -- incorporated by reference to Post-Effective
Amendment No. 60 to the Registration Statement filed on October 23,
2007;
(b) (1) By-Laws of the Registrant -- incorporated by reference to
Post-Effective Amendment No. 45 to the Registration Statement filed
on July 31, 2003;
2
(2) Amended By-Laws of the Registrant -- incorporated by reference to
Post-Effective Amendment No. 61 to the Registration Statement filed
on December 17, 2007.
(c) Reference is made to Article 5 of the Second Amended and Restated
Agreement and Declaration of Trust of the Registrant;
(d) (1) Management Contract between the Registrant on behalf of its
Laudus Rosenberg U.S. Small Capitalization Fund and Charles Schwab
Investment Management, Inc. -- incorporated by reference to
Post-Effective Amendment No. 46 to the Registration Statement filed
on March 12, 2004;
(2) Management Contract between the Registrant on behalf of its Laudus
Rosenberg International Small Capitalization Fund and Charles Schwab
Investment Management, Inc. -- incorporated by reference to
Post-Effective Amendment No. 46 to the Registration Statement filed
on March 12, 2004;
(3) Management Contract between the Registrant on behalf of its Laudus
Rosenberg Value Long/Short Equity Fund and Charles Schwab Investment
Management, Inc. -- incorporated by reference to Post-Effective
Amendment No. 46 to the Registration Statement filed on March 12,
2004;
(4) Management Contract between the Registrant on behalf of its Laudus
Rosenberg U.S. Large/Mid Capitalization Long/Short Equity Fund and
Charles Schwab Investment Management, Inc. --incorporated by
reference to Post-Effective Amendment No. 46 to the Registration
Statement filed on March 12, 2004;
(5) Management Contract between the Registrant on behalf of its Laudus
Rosenberg U.S. Large Capitalization Growth Fund and Charles Schwab
Investment Management, Inc. -- incorporated by reference to
Post-Effective Amendment No. 46 to the Registration Statement filed
on March 12, 2004;
(6) Management Contract between the Registrant on behalf of its Laudus
Rosenberg International Equity Fund and Charles Schwab Investment
Management, Inc. -- incorporated by reference to Post-Effective
Amendment No. 46 to the Registration Statement filed on March 12,
2004;
(7) Management Contract between the Registrant on behalf of its Laudus
Rosenberg Global Long/Short Equity Fund and Charles Schwab
Investment Management, Inc. -- incorporated by reference to
Post-Effective Amendment No. 46 to the Registration Statement filed
on March 12, 2004;
(8) Management Contract between the Registrant on behalf of its Laudus
Rosenberg U. S. Discovery Fund and Charles Schwab Investment
Management, Inc. -- incorporated by reference to Post-Effective
Amendment No. 46 to the Registration Statement filed on March 12,
2004;
(9) Management Contract between the Registrant on behalf of its Laudus
Rosenberg U.S. Large Capitalization Fund and Charles Schwab
Investment Management, Inc. -- incorporated by reference to
Post-Effective Amendment No. 46 to the Registration Statement filed
on March 12, 2004;
(10) Management Contract between the Registrant on behalf of its Laudus
Rosenberg U.S. Long/Short Equity Fund and Charles Schwab Investment
Management, Inc. -- incorporated by reference to Post-Effective
Amendment No. 46 to the Registration Statement filed on March 12,
2004;
(11) Management Contract between the Registrant on behalf of its Laudus
Rosenberg U.S. Large Capitalization Value Fund and Charles Schwab
Investment Management, Inc. -- incorporated by reference to
Post-Effective Amendment No. 56 to the Registration Statement filed
on April 14, 2006;
(12) Management Contract between the Registrant on behalf of its Laudus
Rosenberg International Discovery Fund and Charles Schwab Investment
Management, Inc. -- incorporated by reference to Post-Effective
Amendment No. 57 to the Registration Statement filed on July 28,
2006;
3
(13) Management Contract between the Registrant on behalf of its Laudus
Mondrian Emerging Markets Fund and Charles Schwab Investment
Management, Inc. -- incorporated by reference to Post-Effective
Amendment No. 60 to the Registration Statement filed on October 23,
2007;
(14) Management Contract between the Registrant on behalf of its Laudus
Mondrian International Fixed Income Fund and Charles Schwab
Investment Management, Inc. -- incorporated by reference to
Post-Effective Amendment No. 60 to the Registration Statement filed
on October 23, 2007.
(15) Subadviser Agreement between the Registrant on behalf of its Laudus
Rosenberg U.S. Small Capitalization Fund, Charles Schwab Investment
Management, Inc. and AXA Rosenberg Investment Management LLC --
incorporated by reference to Post-Effective Amendment No. 46 to the
Registration Statement filed on March 12, 2004;
(16) Subadviser Agreement between the Registrant on behalf of its Laudus
Rosenberg International Small Capitalization Fund, Charles Schwab
Investment Management, Inc. and AXA Rosenberg Investment Management
LLC -- incorporated by reference to Post-Effective Amendment No. 46
to the Registration Statement filed on March 12, 2004;
(17) Subadviser Agreement between the Registrant on behalf of its Laudus
Rosenberg Value Long/Short Equity Fund, Charles Schwab Investment
Management, Inc. and AXA Rosenberg Investment Management LLC --
incorporated by reference to Post-Effective Amendment No. 46 to the
Registration Statement filed on March 12, 2004;
(18) Subadviser Agreement between the Registrant on behalf of its Laudus
Rosenberg U.S. Large/Mid Capitalization Long/Short Equity Fund,
Charles Schwab Investment Management, Inc. and AXA Rosenberg
Investment Management LLC -- incorporated by reference to
Post-Effective Amendment No. 46 to the Registration Statement filed
on March 12, 2004;
(19) Subadviser Agreement between the Registrant on behalf of its Laudus
Rosenberg U.S. Large Capitalization Growth Fund, Charles Schwab
Investment Management, Inc. and AXA Rosenberg Investment Management
LLC -- incorporated by reference to Post-Effective Amendment No. 46
to the Registration Statement filed on March 12, 2004;
(20) Subadviser Agreement between the Registrant on behalf of its Laudus
Rosenberg International Equity Fund, Charles Schwab Investment
Management, Inc. and AXA Rosenberg Investment Management LLC --
incorporated by reference to Post-Effective Amendment No. 46 to the
Registration Statement filed on March 12, 2004;
(21) Subadviser Agreement between the Registrant on behalf of its Laudus
Rosenberg Global Long/Short Equity Fund, Charles Schwab Investment
Management, Inc. and AXA Rosenberg Investment Management LLC --
incorporated by reference to Post-Effective Amendment No. 46 to the
Registration Statement filed on March 12, 2004;
(22) Subadviser Agreement between the Registrant on behalf of its Laudus
Rosenberg U. S. Discovery Fund, Charles Schwab Investment
Management, Inc. and AXA Rosenberg Investment Management LLC --
incorporated by reference to Post-Effective Amendment No. 46 to the
Registration Statement filed on March 12, 2004;
(23) Subadviser Agreement between the Registrant on behalf of its Laudus
Rosenberg U.S. Large Capitalization Fund, Charles Schwab Investment
Management, Inc. and AXA Rosenberg Investment Management LLC --
incorporated by reference to Post-Effective Amendment No. 46 to the
Registration Statement filed on March 12, 2004;
(24) Subadviser Agreement between the Registrant on behalf of its Laudus
Rosenberg U.S. Long/Short Equity Fund, Charles Schwab Investment
Management, Inc. and AXA Rosenberg Investment Management LLC --
incorporated by reference to Post-Effective Amendment No. 46 to the
Registration Statement filed on March 12, 2004;
(25) Subadviser Agreement between the Registrant on behalf of its Laudus
Rosenberg U.S. Large Capitalization Value Fund, Charles Schwab
Investment Management, Inc. and AXA Rosenberg Investment Management
LLC -- incorporated by reference to Post-Effective Amendment No. 53
to the Registration Statement filed on December 22, 2005;
4
(26) Subadviser Agreement between the Registrant on behalf of its Laudus
Rosenberg International Discovery Fund, Charles Schwab Investment
Management, Inc., AXA Rosenberg Investment Management LLC --
incorporated by reference to Post-Effective Amendment No. 57 to
Registrant's Registration Statement filed on July 28, 2007;
(27) Subadviser Agreement between the Registrant on behalf of its Laudus
Mondrian Emerging Markets Fund and Laudus Mondrian International
Fixed Income Fund, Charles Schwab Investment Management, Inc.,
Mondrian Investment Partners Limited -- incorporated by reference to
Post-Effective Amendment No. 60 to the Registration Statement filed
on October 23, 2007;
(e) Distribution Agreement by and among the Registrant, Laudus
Institutional Trust, Charles Schwab Investment Management, Inc. and
ALPS Distributors, Inc., -- incorporated by reference to
Post-Effective Amendment No. 56 to the Registration Statement filed
on April 14, 2006;
(f) None;
(g) Amended and Restated Master Custodian Agreement by and among the
Registrant and State Street Bank and Trust Company -- incorporated
by reference to Post-Effective Amendment No. 56 to the Registration
Statement filed on April 14, 2006;
(h) (1) Transfer Agency and Service Agreement between the Registrant and
Boston Financial Data Services, Inc. -- incorporated by reference to
Post-Effective Amendment No. 56 to the Registration Statement filed
on April 14, 2006;
(2) Amended and Restated Expense Limitation Agreement between Charles
Schwab Investment Management, Inc. and the Registrant --
incorporated by reference to Post-Effective Amendment No. 60 to the
Registration Statement filed on October 23, 2007;
(3) Administration Agreement by and between State Street Bank and Trust
Company and the Registrant -- incorporated by reference to
Post-Effective Amendment No. 56 to the Registration Statement filed
on April 14, 2006;
(4) Master Fund Accounting and Services Agreement between the Registrant
and State Street Bank and Trust Company -- incorporated by reference
to Post-Effective Amendment No. 56 to the Registration Statement
filed on July 28, 2007;
(i) Legal Opinion -- Not applicable.
(j) Independent Public Accountant's Consent -- Not applicable.
(k) None;
(l) Investment letter regarding initial capital -- incorporated by
reference to Post-Effective Amendment No. 45 to the Registration
Statement filed on July 31, 2003;
(m) Not applicable;
(n) Further Amended and Restated Multi-Class Plan -- incorporated by
reference to Post-Effective Amendment No. 52 to the Registration
Statement filed on July 29, 2005;
(o) (1) Power of Attorney of Nils H. Hakansson -- electronically filed
herein as Exhibit (o)(1);
(2) Power of Attorney of Mariann Byerwalter -- electronically filed
herein as Exhibit (o)(2);
(3) Power of Attorney of William A. Hasler -- electronically filed
herein as Exhibit (o)(3);
5
(4) Power of Attorney of Randall W. Merk -- electronically filed herein
as Exhibit (o)(4);
(5) Power of Attorney of George Pereira -- electronically filed herein
as Exhibit (o)(5);
(6) Power of Attorney of Jeffrey Mortimer -- electronically filed herein
as Exhibit (o)(6);
(p) (1) Code of Ethics of the Registrant and Charles Schwab Investment
Management, Inc., investment adviser to the Funds -- incorporated by
reference to Post-Effective Amendment No. 50 to the Registration
Statement filed on May 27, 2005;
(2) Code of Ethics of AXA Rosenberg Investment Management LLC,
investment subadviser to the Funds -- incorporated by reference to
Post-Effective Amendment No. 50 to the Registration Statement filed
on May 27, 2005;
(3) Code of Ethics of ALPS Distributors, Inc., principal underwriter to
the Fund -- incorporated by reference to Post-Effective Amendment
No. 56 to the Registration Statement filed on April 14, 2006;
(4) Code of Ethics of Mondrian Investment Partners LLP, investment
subadviser to the Laudus Mondrian Emerging Markets Fund and Laudus
International Fixed Income Fund -- incorporated by reference to
Post-Effective Amendment No. 60 to the Registration Statement filed
on October 23, 2007;
ITEM 24. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH REGISTRANT.
The Board of Trustees of the Registrant is identical to that of the Laudus
Institutional Trust and similar to the Board of Trustees of other Funds advised
by Charles Schwab Investment Management, Inc. However, the officers of the Fund
are different. That fact, together with the fact that the power residing in the
respective boards and officers arises as the result of an official position with
the Fund, leads the Registrant to take the position that it is not under common
control with these other Funds.
ITEM 25. INDEMNIFICATION.
(a) Indemnification
Article VIII of the Registrant's Second Amended and Restated Agreement and
Declaration of Trust reads as follows (referring to the Registrant as the
"Trust"):
ARTICLE VIII
Indemnification
SECTION 1. TRUSTEES, OFFICERS, ETC. The Trust shall indemnify each of its
Trustees and officers (including persons who serve at the Trust's request as
directors, officers or trustees of another organization in which the Trust has
any interest as a shareholder, creditor or otherwise) (hereinafter referred to
as a "Covered Person") against all liabilities and expenses, including but not
limited to amounts paid in satisfaction of judgments, in compromise or as fines
and penalties, and counsel fees reasonably incurred by any Covered Person in
connection with the defense or disposition of any action, suit or other
proceeding, whether civil or criminal, before any court or administrative or
legislative body, in which such Covered Person may be or may have been involved
as a party or otherwise or with which such Covered Person may be or may have
been threatened, while in office or thereafter, by reason of being or having
been such a Covered Person except with respect to any matter as to which such
Covered Person shall have been finally adjudicated in any such action, suit or
other proceeding to be liable to the Trust or its Shareholders by reason of
willful misfeasance, bad faith, gross negligence or reckless disregard of the
duties involved in the conduct of such Covered Person's office. Expenses,
including counsel fees so incurred by any such Covered Person (but excluding
amounts paid in satisfaction of judgments, in compromise or as fines or
penalties), shall be paid from time to time by the Trust in advance of the final
disposition of any such action, suit or proceeding upon receipt of an
undertaking by or on behalf of such Covered Person to repay amounts so paid to
the Trust if it is ultimately determined that indemnification of such expenses
is not authorized under this Article, provided, however, that either (a) such
Covered Person shall have provided appropriate security for such undertaking,
(b) the Trust shall be insured against losses arising from any such advance
payments or (c) either a majority of the disinterested Trustees acting on the
matter (provided that a majority of the disinterested Trustees then in office
act on the matter), or independent legal counsel in a written opinion, shall
have
6
determined, based upon a review of readily available facts (as opposed to a full
trial type inquiry) that there is reason to believe that such Covered Person
will be found entitled to indemnification under this Article.
SECTION 2. COMPROMISE PAYMENT. As to any matter disposed of (whether by a
compromise payment, pursuant to a consent decree or otherwise) without an
adjudication by a court, or by any other body before which the proceeding was
brought, that such Covered Person is liable to the Trust or its Shareholders by
reason of willful misfeasance, bad faith, gross negligence or reckless disregard
of the duties involved in the conduct of his or her office, indemnification
shall be provided if (a) approved, after notice that it involves such
indemnification, by at least a majority of the disinterested Trustees acting on
the matter (provided that a majority of the disinterested Trustees then in
office act on the matter) upon a determination, based upon a review of readily
available facts (as opposed to a full trial type inquiry) that such Covered
Person is not liable to the Trust or its Shareholders by reason of willful
misfeasance, bad faith, gross negligence or reckless disregard of the duties
involved in the conduct of his or her office, or (b) there has been obtained an
opinion in writing of independent legal counsel, based upon a review of readily
available facts (as opposed to a full trial type inquiry) to the effect that
such indemnification would not protect such Person against any liability to the
Trust to which he would otherwise be subject by reason of willful misfeasance,
bad faith, gross negligence or reckless disregard of the duties involved in the
conduct of his office. Any approval pursuant to this Section shall not prevent
the recovery from any Covered Person of any amount paid to such Covered Person
in accordance with this Section as indemnification if such Covered Person is
subsequently adjudicated by a court of competent jurisdiction to have been
liable to the Trust or its Shareholders by reason of willful misfeasance, bad
faith, gross negligence or reckless disregard of the duties involved in the
conduct of such Covered Person's office.
SECTION 3. INDEMNIFICATION NOT EXCLUSIVE. The right of indemnification
hereby provided shall not be exclusive of or affect any other rights to which
such Covered Person may be entitled. As used in this Article VIII, the term
"Covered Person" shall include such person's heirs, executors and administrators
and a "disinterested Trustee" is a Trustee who is not an "interested person" of
the Trust as defined in Section 2(a)(19) of the Investment Company Act of 1940,
as amended, (or who has been exempted from being an "interested person" by any
rule, regulation or order of the Commission) and against whom none of such
actions, suits or other proceedings or another action, suit or other proceeding
on the same or similar grounds is then or has been pending. Nothing contained in
this Article shall affect any rights to indemnification to which personnel of
the Trust, other than Trustees or officers, and other persons may be entitled by
contract or otherwise under law, nor the power of the Trust to purchase and
maintain liability insurance on behalf of any such person; provided, however,
that the Trust shall not purchase or maintain any such liability insurance in
contravention of applicable law, including without limitation the 1940 Act.
SECTION 4. SHAREHOLDERS. In case any Shareholder or former Shareholder shall
be held to be personally liable solely by reason of his or her being or having
been a Shareholder and not because of his or her acts or omissions or for some
other reason, the Shareholder or former Shareholder (or his or her heirs,
executors, administrators or other legal representatives or in the case of a
corporation or other entity, its corporate or other general successor) shall be
entitled to be held harmless from and indemnified against all loss and expense
arising from such liability, but only out of the assets of the particular series
of Shares of which he or she is or was a Shareholder."
(b) Summary of Indemnification Provisions
The Trust shall indemnify each of its Trustees and officers against all
liabilities, expenses and counsel fees reasonably incurred in the defense or
disposition of any action, suit or proceeding in which the Trustee or officer is
involved because of his or her role as a Trustee or officer unless, in the final
adjudication of that action, suit or proceeding, the Trustee or officer was
found to have acted with willful malfeasance, bad faith, gross negligence, or
reckless disregard of the duties involved in the conduct of his or her office.
This right of indemnification is not exclusive.
Any shareholder held personally liable solely by reason of having been a
shareholder shall be entitled to be held harmless from and indemnified against
all loss or expense arising from such liability.
(c) Insurance
The Trust maintains Professional Liability Insurance for each of its
directors and officers. The Trust's policy is carried by the American
International Specialty Lines Insurance Company and insures each director and
officer against professional liability for decisions made in connection with the
Trust, to the extent permitted by the 1940 Act, up to a maximum of $3,000,000.
7
ITEM 26. BUSINESS AND OTHER CONNECTIONS OF INVESTMENT ADVISER.
The Registrant's investment adviser, Charles Schwab Investment Management,
Inc., a Delaware corporation, organized in October 1989, also serves as the
investment manager to the Laudus Institutional Trust, Schwab Capital Trust, The
Charles Schwab Family of Funds, Schwab Investments, and Schwab Annuity
Portfolios, each an open-end, management investment company. The principal place
of business of the investment adviser is 101 Montgomery Street, San Francisco,
California 94104. The only business in which the investment adviser engages is
that of investment adviser and administrator to the Schwab Capital Trust, The
Charles Schwab Family of Funds, Schwab Investments, Schwab Annuity Portfolios
and any other investment companies that Schwab may sponsor in the future,
investment adviser to the Registrant and the Laudus Institutional Trust and an
investment adviser to certain non-investment company clients.
The business, profession, vocation or employment of a substantial nature
in which each director and/or senior or executive officer of the investment
adviser (CSIM) is or has been engaged during the past two fiscal years is listed
below. The name of any company for which any director and/or senior or executive
officer of the investment adviser serves as director, officer, employee, partner
or trustee is also listed below.
CONNECTION WITH
NAME AND POSITION WITH ADVISER NAME OF COMPANY OTHER COMPANY
Charles R. Schwab, Chairman Charles Schwab & Co., Inc. Chairman
The Charles Schwab Bank, N.A. Chairman, Director
The Charles Schwab Corporation Chairman; Chief Executive Officer
Schwab Holdings, Inc. Chief Executive Officer
Schwab International Holdings, Inc. Chairman and Chief Executive
Officer
Schwab (SIS) Holdings, Inc. Chairman and Chief Executive
Officer
Charles Schwab Holdings (UK) Chairman
United States Trust Company of New Chairman, Director
York
U.S. Trust Company Chairman, Director
U.S. Trust Corporation Chairman, Director
All Kinds of Minds Director
Charles and Helen Schwab Foundation Director
Stanford University Trustee
Schwab Funds Trustee and Chairman
Randall W. Merk Charles Schwab & Co., Inc. Executive Vice President and
President and Chief Executive Officer, President, Investment Management
Director Services.
Laudus Trust Trustee; President and Chief
Laudus Institutional Trust Executive Officer
Charles Schwab Worldwide Funds, PLC Director
Charles Schwab Asset Management Director
(Ireland) Limited
Excelsior Funds Inc. Trustee
Excelsior Tax-Exempt Funds, Inc.
Excelsior Funds Trust
Koji Felton Schwab Funds Secretary and Chief Legal Officer
8
CONNECTION WITH
NAME AND POSITION WITH ADVISER NAME OF COMPANY OTHER COMPANY
Senior Vice President, Chief Counsel
and Corporate Secretary
Charles Schwab & Co. Inc. Senior Vice President, Deputy
General Counsel
Excelsior Funds Inc. Chief Legal Officer
Excelsior Tax-Exempt Funds, Inc.
Excelsior Funds Trust
George Pereira Schwab Funds Treasurer and Principal Financial
Senior Vice President and Chief Officer
Financial Officer
Laudus Trust and Laudus Institutional Chief Financial Officer
Trust
Excelsior Funds Inc. Chief Financial Officer and Chief
Excelsior Tax-Exempt Funds, Inc. Accounting Officer
Excelsior Funds Trust
Mutual Fund Division, UST Advisers, Chief Financial Officer
Inc.
Charles Schwab Worldwide Funds, PLC Director
Charles Schwab Asset Management Director
(Ireland) Limited
Jeffrey M. Mortimer Laudus Trust and Laudus Institutional Vice President and Chief
Senior Vice President and Chief Trust Investment Officer
Investment Officer, Equities
Schwab Funds Senior Vice President and Chief
Investment Officer
Randall Fillmore Schwab Funds Chief Compliance Officer
Senior Vice President and Chief
Compliance Officer
Laudus Trust and Laudus Institutional Chief Compliance Officer
Trust
Charles Schwab & Co., Inc. Senior Vice President
Excelsior Funds Inc. Chief Compliance Officer
Excelsior Tax-Exempt Funds, Inc.
Excelsior Funds Trust
Kimon P. Daifotis Schwab Funds Senior Vice President and Chief
Senior Vice President and Chief Investment Officer
Investment Officer, Fixed Income
AXA Rosenberg Investment Management LLC (the "Subadviser") was
organized as a limited liability company under the laws of the State of Delaware
in 1998, and is registered as an investment adviser under the Investment
Advisers Act of 1940. The Subadviser provides investment advisory services to a
substantial number of institutional investors and to the Laudus Rosenberg
International Discovery Fund.
Set forth below are the substantial business engagements during at
least the past two fiscal years of each director or officer of the Subadviser:
9
NAME AND POSITION NAME OF CONNECTION WITH
WITH SUBADVISER OTHER COMPANY OTHER COMPANY
--------------- ------------- -------------
Kenneth Reid Barr Rosenberg Director
Global Chief Investment Officer Research Center
William Ricks -- --
Chief Executive Officer and Chief Investment
Officer, North America
Thomas Mead Barr Rosenberg Director; Deputy Director, 1999 to 2002
Global Research Director Research Center
ITEM 27. PRINCIPAL UNDERWRITERS:
(a) ALPS Distributors, Inc. (the "Distributor") is the principal underwriter
of the Trust's Institutional Class, Investor Class and Adviser Class
shares. The Distributor is also the principal underwriter for the Laudus
Institutional Trust.
(b) Information with respect to the Distributor's directors and officers is as
follows:
POSITIONS AND
POSITIONS AND OFFICES OFFICES
NAME WITH UNDERWRITER WITH REGISTRANT
---- ---------------- ---------------
Edmund J. Burke President None
Thomas A. Carter Managing Director -- Sales and Finance; Treasurer None
Managing Director -- Operations and Client
Jeremy O. May Service; Secretary None
Diana Adamas Vice President, Controller None
Tane Tyler Chief Legal Officer, Assistant Secretary None
Brad Swenson Chief Compliance Officer None
The principal business address of all directors and officers of the
Distributor is 1625 Broadway, Suite 2200, Denver, Colorado, 80202.
(c) None
10
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended
(the "1933 Act"), and the Investment Company Act of 1940, as amended, the
Registrant has duly caused this Post-Effective Amendment No. 63 to be signed on
its behalf by the undersigned, thereto duly authorized, in the City of
Philadelphia, Commonwealth of Pennsylvania, on this 1st day of April, 2008.
LAUDUS TRUST
By: Jeffrey Mortimer*
------------------------------
Jeffrey Mortimer
Chief Executive Officer, Chief
Investment Officer & President
Pursuant to the requirements of the 1933 Act, this Post-Effective
Amendment No. 63 to Registrant's Registration Statement on Form N-1A has been
signed below by the following persons in the capacities indicated this 1st day
of April, 2008.
Signature Title
--------- -----
Jeffrey Mortimer* Chief Executive Officer, Chief
------------------- Investment Officer & President
Jeffrey Mortimer
George Pereira* Treasurer and Chief Financial
------------------- Officer (Principal Financial and
George Pereira Accounting Officer)
Randall W. Merk* Trustee
-------------------
Randall W. Merk
Mariann Byerwalter* Trustee
-------------------
Mariann Byerwalter
Nils H. Hakansson* Trustee
-------------------
Nils H. Hakansson
William A. Hasler* Trustee
-------------------
William A. Hasler
*By: /s/ Timothy W. Levin
----------------------------------
Timothy W. Levin, Attorney-in-Fact
Pursuant to Power of Attorney
Exhibit Index
Exhibit (o)(1) Hakansson Power of Attorney
(o)(2) Byerwalter Power of Attorney
(o)(3) Hasler Power of Attorney
(o)(4) Merk Power of Attorney
(o)(5) Pereira Power of Attorney
(o)(6) Mortimer Power of Attorney
EX-99.(O)(1)
3
f39030exv99wxoyx1y.txt
EXHIBIT 99.(O)(1)
Exhibit (o)(1)
LAUDUS TRUST
POWER OF ATTORNEY
I, the undersigned trustee and/or officer of Laudus Trust, a Massachusetts
business trust, (the "Trust"), do hereby constitute and appoint Catherine
MacGregor, Shelley A. Harding Christine Pierangeli, Richard W. Grant, Tim Levin,
and Sean Graber, and each of them singly, my true and lawful attorneys, with
full power to them and each of them, to sign for me and in my name and the
capacity listed below, any and all amendments to the Registration Statement on
Form N1-A of the Trust, and to file the same with all exhibits thereto, and
other documents in connection thereunder, with the Securities and Exchange
Commission, granting unto my said attorneys, and each of them, acting alone,
full power and authority to do and perform each and every act and thing
requisite or necessary to be done in the premises, as fully as to all intents
and purposes as he or she might or could do in person, hereby ratifying and
confirming all that said attorneys or any of them may lawfully do or cause to be
done by virtue thereof.
WITNESS my hand on the date set forth below.
/s/ Nils H. Hakansson Date: March 31, 2008
---------------------------------------- --------------
Nils H. Hakansson
Trustee
EX-99.(O)(2)
4
f39030exv99wxoyx2y.txt
EXHIBIT 99.(O)(2)
Exhibit (o)(2)
LAUDUS TRUST
POWER OF ATTORNEY
I, the undersigned trustee and/or officer of Laudus Trust, a Massachusetts
business trust, (the "Trust"), do hereby constitute and appoint Catherine
MacGregor, Shelley A. Harding Christine Pierangeli, Richard W. Grant, Tim Levin,
and Sean Graber, and each of them singly, my true and lawful attorneys, with
full power to them and each of them, to sign for me and in my name and the
capacity listed below, any and all amendments to the Registration Statement on
Form N1-A of the Trust, and to file the same with all exhibits thereto, and
other documents in connection thereunder, with the Securities and Exchange
Commission, granting unto my said attorneys, and each of them, acting alone,
full power and authority to do and perform each and every act and thing
requisite or necessary to be done in the premises, as fully as to all intents
and purposes as he or she might or could do in person, hereby ratifying and
confirming all that said attorneys or any of them may lawfully do or cause to be
done by virtue thereof.
WITNESS my hand on the date set forth below.
/s/ Mariann Byerwalter Date: March 31, 2008
---------------------------------------- --------------
Mariann Byerwalter
Trustee
EX-99.(O)(3)
5
f39030exv99wxoyx3y.txt
EXHIBIT 99.(O)(3)
Exhibit (o)(3)
LAUDUS TRUST
POWER OF ATTORNEY
I, the undersigned trustee and/or officer of Laudus Trust, a Massachusetts
business trust, (the "Trust"), do hereby constitute and appoint Catherine
MacGregor, Shelley A. Harding Christine Pierangeli, Richard W. Grant, Tim Levin,
and Sean Graber, and each of them singly, my true and lawful attorneys, with
full power to them and each of them, to sign for me and in my name and the
capacity listed below, any and all amendments to the Registration Statement on
Form N1-A of the Trust, and to file the same with all exhibits thereto, and
other documents in connection thereunder, with the Securities and Exchange
Commission, granting unto my said attorneys, and each of them, acting alone,
full power and authority to do and perform each and every act and thing
requisite or necessary to be done in the premises, as fully as to all intents
and purposes as he or she might or could do in person, hereby ratifying and
confirming all that said attorneys or any of them may lawfully do or cause to be
done by virtue thereof.
WITNESS my hand on the date set forth below.
/s/ William A. Hasler Date: March 31, 2008
---------------------------------------- --------------
William A. Hasler
Trustee
EX-99.(O)(4)
6
f39030exv99wxoyx4y.txt
EXHIBIT 99.(O)(4)
Exhibit (o)(4)
LAUDUS TRUST
POWER OF ATTORNEY
I, the undersigned trustee and/or officer of Laudus Trust, a Massachusetts
business trust, (the "Trust"), do hereby constitute and appoint Catherine
MacGregor, Shelley A. Harding Christine Pierangeli, Richard W. Grant, Tim Levin,
and Sean Graber, and each of them singly, my true and lawful attorneys, with
full power to them and each of them, to sign for me and in my name and the
capacity listed below, any and all amendments to the Registration Statement on
Form N1-A of the Trust, and to file the same with all exhibits thereto, and
other documents in connection thereunder, with the Securities and Exchange
Commission, granting unto my said attorneys, and each of them, acting alone,
full power and authority to do and perform each and every act and thing
requisite or necessary to be done in the premises, as fully as to all intents
and purposes as he or she might or could do in person, hereby ratifying and
confirming all that said attorneys or any of them may lawfully do or cause to be
done by virtue thereof.
WITNESS my hand on the date set forth below.
/s/ Randall W. Merk Date: March 31, 2008
---------------------------------------- ---------------
Randall W. Merk
Trustee
EX-99.(O)(5)
7
f39030exv99wxoyx5y.txt
EXHIBIT 99.(O)(5)
Exhibit (o)(5)
LAUDUS TRUST
POWER OF ATTORNEY
I, the undersigned trustee and/or officer of Laudus Trust, a Massachusetts
business trust, (the "Trust"), do hereby constitute and appoint Catherine
MacGregor, Shelley A. Harding Christine Pierangeli, Richard W. Grant, Tim Levin,
and Sean Graber, and each of them singly, my true and lawful attorneys, with
full power to them and each of them, to sign for me and in my name and the
capacity listed below, any and all amendments to the Registration Statement on
Form N1-A of the Trust, and to file the same with all exhibits thereto, and
other documents in connection thereunder, with the Securities and Exchange
Commission, granting unto my said attorneys, and each of them, acting alone,
full power and authority to do and perform each and every act and thing
requisite or necessary to be done in the premises, as fully as to all intents
and purposes as he or she might or could do in person, hereby ratifying and
confirming all that said attorneys or any of them may lawfully do or cause to be
done by virtue thereof.
WITNESS my hand on the date set forth below.
/s/ George Pereira Date: March 31, 2008
---------------------------------------- --------------
George Pereira
Chief Financial Officer
EX-99.(O)(6)
8
f39030exv99wxoyx6y.txt
EXHIBIT 99.(O)(6)
Exhibit (o)(6)
LAUDUS TRUST
POWER OF ATTORNEY
I, the undersigned trustee and/or officer of Laudus Trust, a Massachusetts
business trust, (the "Trust"), do hereby constitute and appoint Catherine
MacGregor, Shelley A. Harding Christine Pierangeli, Richard W. Grant, Tim Levin,
and Sean Graber, and each of them singly, my true and lawful attorneys, with
full power to them and each of them, to sign for me and in my name and the
capacity listed below, any and all amendments to the Registration Statement on
Form N1-A of the Trust, and to file the same with all exhibits thereto, and
other documents in connection thereunder, with the Securities and Exchange
Commission, granting unto my said attorneys, and each of them, acting alone,
full power and authority to do and perform each and every act and thing
requisite or necessary to be done in the premises, as fully as to all intents
and purposes as he or she might or could do in person, hereby ratifying and
confirming all that said attorneys or any of them may lawfully do or cause to be
done by virtue thereof.
WITNESS my hand on the date set forth below.
/s/ Jeffrey Mortimer Date: March 31, 2008
---------------------------------------- --------------
Jeffrey Mortimer
CEO, CIO & President
COVER
9
filename9.txt
1701 Market Street Morgan, Lewis
Philadelphia, PA 19103-2921 & Bockius LLP
215-963-5000 Counselors at Law
Fax: 215-963-5001
April 1, 2008
VIA EDGAR
Securities and Exchange Commission
100 F Street, NE
Washington, D.C. 20549
Re: Laudus Trust - Post-Effective Amendment No. 63
File Nos. 033-21677 and 811-05547
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Ladies and Gentlemen:
Our client, Laudus Trust (the "Trust"), has enclosed, pursuant to Rule 485(a)
under the Securities Act of 1933, as amended, and the Investment Company Act of
1940, as amended, Post-Effective Amendment ("PEA") No. 63 to the Trust's
Registration Statement on Form N-1A, together with all exhibits thereto. The
purpose of PEA No. 63 is to introduce the Laudus Mondrian International Equity
Fund and Laudus Mondrian Global Equity Fund, each a new series of the Trust.
If you have any questions regarding PEA No. 63, please do not hesitate to
contact the undersigned at 215.963.5598.
Very truly yours,
/s/ Sean Graber
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Sean Graber