Restricted securities, as well as securities or other assets for which market quotations are not readily available, or are not valued by a pricing service approved by the Funds’ Board of Trustees (the “Board”), are valued at fair value in good faith by, or at the direction of, the Board.
The FBR Funds
Notes to Financial Statements (continued)
each Fund’s total operating expenses to 1.00% of each Fund’s average daily net assets. Under the terms of an agreement with MMA, the Funds pay a management fee at an annual rate of 0.375% on each Fund’s average daily net assets.
On October 25, 2005, the Board of Trustees of the Funds, including a majority of Independent Trustees, voted unanimously to assign the investment advisory agreement between the Fixed Income Funds and MMA, the Funds’ investment adviser since inception, to FBR Fund Advisers, Inc. (“Fund Advisers”). This assignment did not result in a change in control or in management. Both MMA and Fund Advisers are subsidiaries of Friedman, Billings, Ramsey Group, Inc. The assignment of the investment advisory agreement which was effective on November 1, 2005, will not affect the nature and quality of the advisory services rendered to the Funds. Additionally, the advisory fees will not change as a result of the change in advisers. Fund Advisers has agreed to maintain the 1.00% expense limitations with regard to each Fund through November 1, 2006.
Until October 26, 2005, MMA, on behalf of the Funds, retained Asset Management, Inc. (AMI), located at 5530 Wisconsin Avenue, Suite 1500, Chevy Chase, Maryland 20815, to serve as the investment sub-adviser to the Funds. The Sub-Advisory Agreement between MMA and AMI, by its terms, and in accordance with certain provisions of the 1940 Act, was terminated upon the assignment of the contract to the Estate of Arthur Adler Jr. as a result of the death of Mr. Arthur Adler Jr., President and controlling owner of AMI. Immediately following the termination of the agreement, MMA and AMI entered into an interim sub-advisory agreement (the “AMI Interim Sub-Advisory Agreement”). Under the AMI Interim Sub-Advisory Agreement, amounts payable to AMI for sub-advisory services to the Funds have been held in escrow in an interest-bearing escrow account with the Funds’ custodian. The escrow agent will release the money in this escrow account to AMI after the requisite amount of the Funds’ outstanding voting securities has approved payment of such fees. A meeting of the shareholders of each of the Funds is scheduled for February 24, 2006, in order to take action with respect to the escrowed fees.
Effective October 27, 2005, Chevy Chase Trust Company (CCTC), located at 7501 Wisconsin Avenue, Bethesda, Maryland 20814, purchased substantially all of the assets of AMI. Pursuant to the agreement, AMI is currently operating as a division of CCTC. The change of control of AMI terminated the Interim Sub-Advisory Agreement. The Board of Trustees of the Funds has approved an interim sub-advisory agreement with CCTC (the “CCTC Interim Sub-Advisory Agreement”) so that CCTC, as successor to the operations of AMI, could continue to render investment management services to the Funds. Under the CCTC Interim Sub-Advisory Agreement, amounts payable to CCTC for sub-advisory services to the Funds will be held in escrow in an interest-bearing escrow account with the Funds’ custodian. The escrow agent will release the money in this escrow account to CCTC after the requisite amount of the Funds’ outstanding voting securities approve payment of such fees. A meeting of shareholders of each of the Funds is scheduled for February 24, 2006, in order to take action with respect to the escrowed fees.
23
The FBR Funds
Notes to Financial Statements (continued)
Under the Second Interim Agreement, CCTC will continue to provide the Funds with the same level of investment advisory services as were provided by AMI.
Plan of Distribution — The Trust, on behalf of each Fund has adopted a Distribution Plan (the “Plan”) pursuant to Rule 12b-1 under the 1940 Act. Under the Plan, each Fund may pay FBR Investment Services, Inc. (the “Distributor”) a fee at an annual rate of up to 0.25% of each Fund’s average daily net assets. Fees paid to the Distributor under the Plan are payable without regard to actual expenses incurred.
Administrator, Transfer Agent and Custodian — Prior to November 1, 2005, FBR National (the “Administrator”) provided administrative, transfer agency and custodial services to the Funds and paid the operating expenses (not including extraordinary legal fees, marketing costs, outside of routine shareholder communications and interest costs) of the Funds. For these services, the Administrator received a fee at an annual rate based on each Fund’s average daily net assets as follows:
|
| | | | | Asset Level | | | | Annual Fee per Fund |
|
| FBR Maryland Tax-Free Portfolio | | | | <=$20MM | | | | $60,000 |
|
| FBR Virginia Tax-Free Portfolio | | | | >=$20MM <=$100MM | | | | 0.30% of Assets |
|
Effective November 1, 2005, FBR Fund Advisers, Inc. (the “Adviser”) provides day-to-day administrative services to The FBR Funds including monitoring portfolio compliance, determining compliance with provisions of the Internal Revenue Code, oversight of the service providers and preparing the Funds’ registration statements. Pursuant to the Agreement, the Adviser receives a fee of 0.06% of the first $2 billion of average daily net assets of the Funds, 0.05% of the next $1 billion of average daily net assets of the Funds and 0.035% of the Funds’ average daily net assets in excess of $3 billion. The Adviser also provides the Funds with office space, facilities and business equipment and generally administers the Funds’ business affairs and provides the services of executive and clerical personnel for administering the affairs of The FBR Funds. The Adviser compensates all personnel, Officers, and Trustees of the Funds if such persons are employees of the Adviser or Administrator. As of November 1, 2005, the Funds have contracted directly with a third party, Integrated Fund Services, Inc., for transfer agency and fund accounting services, and the Funds pay for all operating costs.
FBR National serves as Custodian of the Funds’ investments. The Custodian acts as the Funds’ depository, safe keeps portfolio securities, collects all income and other payments with respect thereto, disburses funds at the Funds’ request and maintains records in connection with its duties. Pursuant to the Custody Agreement, FBR National receives a fee based on daily average net assets of 0.01% on the first $250 million, 0.009% on the next $500 million, 0.0085% on the next $750 million and 0.0075% on assets over $1.5 billion. FBR National also receives a per transaction based fee.
On November 21, 2005, FBR National entered into an agreement with Cardinal Bank, a Virginia-chartered bank (“Cardinal”), whereby Cardinal has agreed to acquire certain of FBR National’s fiduciary and other assets and assume FBR National’s deposit liabilities.
24
The FBR Funds
Notes to Financial Statements (continued)
Closing of the transaction, which is subject to the satisfactory completion of due diligence by Cardinal, the receipt of required regulatory approvals and third-party consents, and other customary closing conditions, is anticipated to occur in the first quarter 2006. Upon closing of the transaction, the Funds’ custodian services will be performed by Cardinal.
4. Investment Transactions
For the year ended October 31, 2005, purchases and sales of investment securities (excluding short-term securities and U.S. government obligations) for each Fund were as follows:
| | | | Purchases | | | Sales | |
| | | |
| | |
| |
| Maryland Tax-Free Portfolio | | | $2,098,984 | | | $4,004,525 | |
| Virginia Tax-Free Portfolio | | | 3,046,361 | | | 4,166,768 | |
5. Federal Income Taxes
It is each Fund’s policy to comply with the special provisions of the Internal Revenue Code of 1986, as amended, applicable to regulated investment companies. As provided therein, in any fiscal year in which a Fund so qualifies and distributes at least 90% of its taxable net income, the Fund (but not the shareholders) will be relieved of federal income tax on the income distributed. Accordingly, no provision for income taxes has been made.
In order to avoid imposition of the excise tax applicable to regulated investment companies, it is also each Fund’s intention to declare and pay as dividends in each calendar year at least 98% of its net investment income (earned during the calendar year) and 98% of its net realized capital gains (earned during the twelve months ending October 31) plus undistributed amounts from prior years.
The tax character of distributions paid for each Fund’s tax year was as follows:
| | | Ordinary Income | | Long-Term Capital Gains |
| | |
| |
|
| | | Dollar | | Per Share | | Dollar | | Per Share |
| | | Amount | | Amount | | Amount | | Amount |
| | |
| |
| |
| |
|
| Maryland Tax-Free Portfolio | | | | | | | | | | | | | | | | | | | | |
For the Year Ended October 31, 2005 | | | $ | 1,495,592 | * | | | $ | 0.4406 | | | | $ | 72,652 | | | | $ | 0.0209 | |
For the Year Ended October 31, 2004 | | | $ | 1,342,056 | | | | $ | 0.3706 | | | | $ | — | | | | $ | — | |
| Virginia Tax-Free Portfolio | | | | | | | | | | | | | | | | | | | | |
For the Year Ended October 31, 2005 | | | $ | 961,589 | ** | | | $ | 0.4214 | | | | $ | 356,915 | | | | $ | 0.1523 | |
For the Year Ended October 31, 2004 | | | $ | 906,314 | | | | $ | 0.3524 | | | | $ | — | | | | $ | — | |
|
| * | | Ordinary income of $1,495,592 includes taxable income of $3,330. |
| ** | | Ordinary income of $961,589 includes taxable income of $725. |
25
The FBR Funds
Notes to Financial Statements (continued)
The following information is computed on a tax basis for each item:
| | | As of October 31, 2005 |
| | |
|
| | | Maryland | | | Virginia | |
| | | Tax-Free | | | Tax-Free | |
| | | Portfolio | | | Portfolio | |
| | |
| | |
| |
| Cost of investment securities | | $33,966,205 | | | $23,789,249 | |
| | |
| | |
| |
| Gross unrealized appreciation | | 1,494,600 | | | 1,043,943 | |
| Gross unrealized depreciation | | (47,311 | ) | | (32,753 | ) |
| | |
| | |
| |
| Net unrealized appreciation (depreciation) | | 1,447,289 | | | 1,011,190 | |
| Undistributed ordinary income | | 3,330 | | | 725 | |
| Undistributed long-term capital gains | | 77,829 | | | 228,212 | |
| | |
| | |
| |
| Accumulated earnings | | $ 1,528,448 | | | $ 1,240,127 | |
| | |
| | |
| |
The following reclassifications, the result of permanent differences between financial statement and income tax reporting requirements, have been made to the components of capital. These reclassifications have no impact on the net assets or net asset value per share of the Funds.
| | | | | Accumulated | | |
| | | Undistributed | | Net Realized | | Paid-In |
| | | Income (Loss) | | Gain (Loss) | | Capital |
| | |
| |
| |
|
| Maryland Tax-Free Portfolio | | 3,330 | | — | | (3,330) |
| Virginia Tax-Free Portfolio | | 16,523 | | (15,798) | | (725) |
The difference between the cost of investment securities and financial statement cost the Funds is due to certain timing differences in the recognition of capital losses under income tax regulations and generally accepted accounting principles.
6. Commitments and Contingencies
In the normal course of business, the Funds enter into contracts that contain a variety of representations and warranties and which provide general indemnifications. The Funds’ maximum exposure under these arrangements is unknown, as this would involve future claims that may be made against the Funds that have not yet occurred. However, based on experience, the Funds expect the risk of loss to be remote.
7. Subsequent Events
The Board of Trustees of The FBR Funds, on behalf of the FBR Maryland Tax-Free Portfolio and FBR Virginia Tax-Free Portfolio (the “Funds”), has unanimously approved an Agreement and Plan of Reorganization (“Agreement”) for each of the Funds which will effect the following reorganizations:
|
| Acquired Funds | | Acquiring Funds |
|
| FBR Maryland Tax-Free Portfolio | | MTB Maryland Municipal Bond Fund |
|
| FBR Virginia Tax-Free Portfolio | | MTB Virginia Municipal Bond Fund |
|
26
The FBR Funds
Notes to Financial Statements (continued)
The reorganizations are expected to be effected on or about February 24, 2006 and will require approval by the requisite number of voting shares of each Fund. In addition, it is intended that the reorganizations will be accomplished without resulting in the imposition of federal income tax on the Acquired Funds or their shareholders.
A Special Meeting (the “Meeting”) of the Shareholders of the Funds is scheduled to be held on February 24, 2006, and approval of the Agreement will be voted on at that time. In connection with the Meeting, a combined proxy statement and prospectus describing the reorganizations has been filed with the Securities and Exchange Commission which the Funds will be delivering in January to its shareholders of record. Included with the materials sent to shareholders will be a Prospectus for the MTB Maryland Municipal Bond Fund and MTB Virginia Municipal Bond Fund.
Under the proposed terms of the Agreement, each Acquired Fund will transfer its assets to the corresponding Acquiring Fund in exchange for shares of the Acquiring Fund. After the transfer, each Acquired Fund will distribute the corresponding Acquiring Fund shares to its shareholders in a complete liquidation. As a result, each Acquired Fund shareholders will become shareholders of the corresponding Acquiring Fund. Each Acquired Fund and its corresponding Acquiring Fund have substantially the same investment objective and policies.
In anticipation of the completion of the reorganization, effective February 22, 2006, shares of the FBR Maryland Tax-Free Portfolio and FBR Virginia Tax-Free Portfolio will no longer be offered to the public for purchase.
27
The FBR Funds
Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Trustees of
The FBR Funds
Arlington, Virginia
We have audited the accompanying statements of assets and liabilities including the portfolio of investments, of the FBR Maryland Tax-Free Portfolio and FBR Virginia Tax-Free Portfolio, each a series of shares of The FBR Funds as of October 31, 2005, and the related statements of operations for the year then ended, the statement of changes in net assets for the year ended October 31, 2005 and the period January 1, 2004 through October 31, 2004, and the financial highlights for the year ended October 31, 2005 and the period January 1, 2004 through October 31, 2004. These financial statements and financial highlights are the responsibility of the Funds’ management. Our responsibility is to express an opinion on these financial statements and financial highlights based on our audits. The statements of changes in net assets for the year ended December 31, 2003 and the financial highlights for each of the four years in the period ended December 31, 2003 were audited by other auditors whose report dated February 4, 2004 expressed an unqualified opinion on such statements and financial highlights.
We conducted our audits in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of material misstatement. We were not engaged to perform an audit of the Funds’ internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Funds’ internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our procedures included confirmation of securities owned as of October 31, 2005, by correspondence with the custodian. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred to above present fairly, in all material respects, the financial position of the FBR Maryland Tax-Free Portfolio and FBR Virginia Tax-Free Portfolio as of October 31, 2005, the results of their operations for the year then ended, the changes in their net assets for the year ended October 31, 2005 and the period January 1, 2004 through October 31, 2004, and their financial highlights for the year ended October 31, 2005 and the period January 1, 2004 through October 31, 2004, in conformity with accounting principles generally accepted in the United States of America.
TAIT, WELLER & BAKER LLP
Philadelphia, Pennsylvania
December 2, 2005
28
The FBR Funds
Important Supplemental Information (unaudited)
Proxy Voting Guidelines
FBR Fund Advisers, Inc. (the “Adviser”) is responsible for exercising the voting rights associated with the securities purchased and held by the Funds. A description of the policies and procedures the Adviser uses in fulfilling this responsibility is included in the Funds’ Statement of Additional Information and is available without charge, upon request, by calling 888.888.0025. The policies and procedures are also available on the Securities and Exchange Commission’s website at http://www.sec.gov. Ordinarily, the securities in which the Funds invest will be non-voting securities. In the event that the Funds do receive aproxy statement related to a portfolio security, information on how the Funds voted such proxies during the most recent 12-month period ended June 30 is available without charge, upon request, by calling 888.888.0025 and is also available on the SEC’s website at http://www.sec.gov.
Portfolio Holdings
The Funds file their complete schedule of holdings with the SEC for the first and third quarters of each fiscal year on Form N-Q. The Funds’ Form N-Q is available on the SEC’s website, beginning with the July 31, 2004 report, at http://www.sec.gov. You may review and make copies at the SEC’s Public Reference Room in Washington, D.C. You may also obtain copies after paying a duplicating fee by writing the SEC’s Public Reference Section, Washington, D.C. 20549-0102 or by electronic request to publicinfo@sec.gov. A copy of the quarterly holdings report is available, without charge, upon request, by calling 888.888.0025.
Approval of the Investment Advisory Agreements
In accordance with the 1940 Act, the Board of Trustees is required, on an annual basis at an in-person meeting of the Board called for such purpose, to consider the approval of the Investment Advisory Agreement and any applicable Sub-Advisory Agreement intended for use in connection with the Funds (collectively, the “Advisory Agreements”). The relevant provisions of the 1940 Act specifically provide that it is the duty of the Board to request and evaluate such information as the Board determines is necessary to allow them to properly consider the approval of the Advisory Agreements, and it is the duty of each of the Advisers to furnish the Trustees with such information that is responsive to the Board’s request.
Accordingly, at an in-person meeting held on October 25, 2005, the Board considered: (i) the renewal of the Investment Advisory Agreement with MMA and (ii) the adoption of an Interim Sub-Advisory Agreement with CCTC, as the successor in interest to AMI, to be effective upon the acquisition of AMI by CCTC on October 27, 2005 (the “CCTC Interim Sub-Advisory Agreement”). In determining whether to approve the continuation of the Advisory Agreement with MMA and the adoption of the CCTC Interim Sub-Advisory Agreement, the Board requested, and the Advisers provided, information and data relevant to the Board’s consideration. This included information regarding the investment performance of the Funds and information regarding the fees and expenses of the Funds,
29
The FBR Funds
Important Supplemental Information (unaudited) (continued)
as compared to other similar mutual funds. The Board was also provided with extensive information about CCTC and its investment advisory capabilities in connection with its acquisition of AMI.
As part of its deliberations, the Board also considered and relied upon the information about the Funds and the Advisers that had been provided to them throughout the year in connection with their regular Board meetings at which they engage in the ongoing oversight of the Funds and their operations. The Independent Trustees were counseled during this process by independent legal counsel, as such term is defined in the rules under the 1940 Act, who reviewed with them their duties and responsibilities with respect to their consideration of the approval of the Advisory Agreements.
The Board first reviewed matters relating to the fact that AMI, the firm that had been providing subadvisory services to the Funds pursuant to an Interim Sub-Advisory Agreement with MMA (the “AMI Interim Sub-Advisory Agreement”), had entered into an agreement with CCTC pursuant to which CCTC intended to acquire substantially all of the assets of AMI effective as of October 27, 2005. The Board was informed that each of the portfolio managers of the Funds were being retained by CCTC and that the portfolio managers would therefore continue to serve as the portfolio managers to the Funds as employees of CCTC.
The Board then reviewed the status of matters relating to AMI. The Board noted that AMI had continued to provide subadvisory services to the Funds pursuant to the AMI Interim Sub-Advisory Agreement following the sudden death of Arthur A. Adler, Jr., AMI’s President and controlling owner. The Board took note of the fact that in accordance with the terms of the AMI Interim Sub-Advisory Agreement and upon the direction of the Board, all subadvisory fees payable to AMI were continuing to be held in escrow pending a final resolution of Mr.Adler’s estate and pending approval by shareholders of the release of the fees from escrow. The Board members further noted that while shareholder approval of the AMI Interim Sub-Advisory Agreement had not been sought due to the need to await the completion of the administration of Mr.Adler’s personal estate, the Board had, in the meantime, directed that a reorganization transaction with respect to the Funds be sought. The Board considered that AMI had provided subadvisory services to the Funds under the terms of the AMI Sub-Advisory Agreement and that at all times during this period AMI had produced investment results that were comparable to the Funds’ applicable benchmark indices and other similar mutual funds. Notwithstanding the investment results achieved for the Funds by AMI, the Board had also determined that a tax-free reorganization transaction pursuant to which the Funds would be merged with another mutual fund organization would be in the best interests of the shareholders of the Funds in order to have the Funds become part of a larger mutual fund organization having more of an emphasis on tax-free investing.
The Board then reviewed matters relating to the proposed reorganization transaction pursuant to which each of the Funds would be reorganized into similar mutual funds that are part of the MTB Group of Funds (the “Acquiring Funds”). The Board considered the terms and conditions of the proposed reorganization transaction and the investment
30
The FBR Funds
Important Supplemental Information (unaudited) (continued)
capabilities of MTB Investment Advisors, Inc., the investment adviser to the MTB Group of Funds and a subsidiary of M&T Bank. The Board also reviewed the proposed fees and expenses of the Acquiring Funds, the expense limitation agreement applicable to the Acquiring Funds, and the potential benefits to shareholders of being part of the MTB Group of Funds. The Board noted that a meeting of the shareholders of the Funds had been scheduled for February 24, 2006, in order for shareholders to consider the approval of the reorganization transaction and to also consider the approval of the release of the escrowed fees to AMI.
The Board then reviewed matters relating to the fact that, as part of a restructuring arrangement, effective November 1, 2005, MMA intended to assign the Investment Advisory Agreement for the Funds to Fund Advisers and the Board took this fact into consideration during their review of the proposed approval of the continuation of the Investment Advisory Agreement for the Funds. The Board was informed that Fund Advisers had the requisite investment capabilities to manage the assets of the Funds and that the investment personnel from MMA primarily responsible for overseeing the portfolio management of the Funds would continue to be involved with the oversight of the management of the Funds for Fund Advisers.
During their meeting, the Board reviewed relevant information and data provided by the Advisers in response to written questions from the Independent Trustees and held extended discussions with independent legal counsel to the Independent Trustees concerning the same. The Board met with representatives of MMA and AMI and discussed with them their investment process, the investment results of the Funds, compensation arrangements for the portfolio managers, brokerage practices used for the Funds, and matters relating to the distribution and marketing of the Funds.
The Board then reviewed information and materials regarding the investment advisory fees for the Funds. The Board was also informed by representatives of MMA that MMA maintains an expense limitation agreement with respect to the Funds in order to limit the total annual operating expenses of each of the Funds, which Fund Advisers intends to maintain upon assignment of the Investment Advisory Agreement.
The Board then considered information regarding each of the Funds separately and reviewed with the representatives of MMA and AMI various performance and expense information for each of the Funds, changes in total assets for each of the Funds, the costs of providing services, the profitability of each of the Funds to the Advisers, and distribution arrangements for each of the Funds.
The Board then undertook a review of the proposed approval of the Advisory Agreements. Among the factors the Board considered was the overall performance of the Funds relative to the performance of other mutual funds in each Funds’ peer group on a long-term basis and over shorter time periods. The Board also took note of the long-term relationship between each of the Advisers and the Funds and the efforts that had been undertaken by the Advisers to support the continuing operation of the Funds since the inception of each of the Funds. In addition, the Board compared expenses of each Fund to the expenses of its peers, noting that the expenses for each of the Funds compare favorably with industry
31
The FBR Funds
Important Supplemental Information (unaudited) (continued)
averages for other funds of similar size. They noted the range of investment advisory and administrative services provided by the Advisers and their affiliates to the Funds and the level and quality of these services, and in particular, they noted the quality of the personnel providing these services. The Board also reviewed financial information concerning the Advisers and their affiliates relating to the operation of the Funds, noting the overall profitability of the relationship with the Funds to the Advisers and the financial soundness of the Advisers as demonstrated by the financial information provided. The Board further reviewed the Funds’ brokerage practices and best-execution procedures, and noted that these were reasonable and consistent with standard industry practice.
The Board also took note of the fact that an affiliate of Fund Advisers and MMA, FBR Investment Services, Inc. (“FBRIS”), serves as the distributor of the shares of the Funds and receives distribution fees from the Funds for serving in that role. The Board considered and discussed the activities routinely engaged in by FBRIS in order to distribute and market the Funds. The Board reviewed the distribution arrangements maintained by FBRIS for the Funds, noting the sales arrangements for the Funds on various mutual fund supermarket platforms and the manner in which the distribution fees paid by the Funds are utilized in connection with these arrangements.
Then Board also considered and reviewed information regarding the administrative services fees proposed to be paid to Fund Advisers by the Funds for providing certain types of administrative services. The Board determined that these administrative fees were fair and reasonable in connection with the types of services to be provided by Fund Advisers to the Funds and that they were reasonable fees to be paid in addition to the investment advisory fees to be paid by the Funds to Fund Advisers given that the administrative services are separate and distinct services apart from the investment advisory services to be provided to the Funds by Fund Advisers effective November 1, 2005.
The Independent Trustees then met separately with the independent legal counsel to the Independent Trustees in order to consider the proposed approval of the Advisory Agreements. At the conclusion of their session, the Independent Trustees indicated that they had determined that they had received sufficient information in order to allow them to take action with respect to their consideration of the continuation of the Advisory Agreements.
In reaching their conclusion with respect to the approval of the Advisory Agreements, the Trustees did not identify any one single factor as being controlling, rather, the Board took note of a combination of factors that influenced their decision making process. The Board did, however, identify the overall favorable investment performance of the Funds, and the level of expenses of the Funds, as well as the continued use of expense limitation agreements in order to reduce the overall operating expenses of the Funds, as being important elements of their consideration. Based upon their review and consideration of these factors and other matters deemed relevant by the Board in reaching an informed business judgment, a majority of the Board of Trustees, including a majority of the Independent Trustees, concluded that the terms of the Investment Advisory Agreements
32
The FBR Funds
Important Supplemental Information (unaudited) (continued)
are fair and reasonable and the Board voted to approve the Agreements for a one-year period, subject to the applicable limitations on the total operating expenses of the Funds as considered and approved at the meeting. The Board took this action after also noting that the proposed reorganization transaction involving the Funds had been determined by the Board to be in the best interests of the Funds and their shareholders and the Board further noted that in the event that the shareholders of the Funds voted in favor of the reorganization transactions at the special meeting of shareholders scheduled for February 24, 2006, the Advisory Agreements would be terminated shortly thereafter in connection with the completion of the reorganization.
33
The FBR Funds
Supplemental Information (unaudited) (continued)
Information About Trustees and Officers
Information pertaining to the Trustees and Officers of the Trust is set forth below. The address for each Trustee and Officer is 1001 19th Street North, Arlington, VA 22209 unless otherwise stated. The statement of additional information (SAI) includes additional information about the Trustees and is available without charge upon request by calling 888.888.0025.
| | | Portfolios | | |
| | | Overseen in | | Other |
| | Position | the Trust | | Trusteeships/ |
| | Held* and | and Fund | Principal Occupation(s) | Directorships |
| Name, Age, Address, | Tenure** | Complex*** | during past 5 years | by Trustee |
F. David Fowler, 72 | Trustee Since May 1997; Chairman Since September 2003 | 9 | Retired, 1997. Dean, The George Washington University School of Business and Public Management, 1992-1997. | MicroStrategy, Inc. |
Charles O. Heller, 69 | Trustee Since September 2003 | 9 | Managing Director, Beacon Global Private Equity (venture capital firm), since 2003; Charles Heller Associates (management consulting), 1986 to present; Gabriel Venture Partners (venture capital firm), 2000-2003. | Walden University |
Larry R. Levitan, 64 | Trustee Since September 2003 | 9 | Retired; Oversight Board, Internal Revenue Service, September 2000 to present. | Choice Hotels International, Inc. |
Michael A. Willner, 49 | Trustee Since May 1997 | 9 | CEO AlphaGrip, Inc. January 2001 to present; President, New Traders, Inc. from September 1996 to December 2000. | AlphaGrip, Inc. |
David Ellison†, 47 100 Federal Street Boston, MA02110 | Trustee Since September 2003; President Since June 2001 | 9 | Director, CEO and President, FBR Fund Advisers, Inc., since December 1999; Portfolio Manager for Equity Funds since October 1996; and President Money Management Advisers, Inc., April 2001 – March 2002. | None |
Winsor H. Aylesworth, 58 100 Federal Street Boston, MA 02110 | Executive Vice President Since January 1999 | 9 | Portfolio Manager, FBR Fund Advisers, Inc. since September 1998; Vice President, Money Management Advisers, Inc., April 2001-March 2002. | None |
Bart Sanders, 41 | Executive Vice President Since December 1999 | 9 | Senior Vice President of Fund Operations, FBR Fund Advisers, Inc. since August 1999. Head Trader for FBR Fund Advisers, Inc., since January 1997; and Vice President, Money Management Advisers, Inc. April 2001-March 2002. | None |
Susan L. Silva, 38 | Treasurer Since July 2002 | 9 | Vice President, FBR National Trust Company since 2002; Employee of FBR National Trust Company since January 2000; Vice President and Treasurer of Money Management Advisers, Inc. since June 2000. | None |
Kimberly J. Ochterski, 31 | Secretary Since July 2003 | 9 | Assistant Vice President, FBR National Trust Company since 2003; Vice President and Secretary of Money Management Advisers, Inc. since October 2003; Employee of FBR National Trust Company since August 1998, serving in various capacities, including Fund Accounting Supervisor and Transfer Agent Operations Manager. | None |
William Vastardis,50
41 Madison Avenue
30th Floor
New York, NY 10010 | Chief Compliance Officer Since October 2004 | 9 | Co-Chief Executive Officer, Vastardis Compliance Services LLC (formerly, EOS Compliance Services LLC), since June 2004; President and founder, Vastardis Fund Services LLC (formerly, EOS Fund Services LLC), since August 2003; Managing Director of Investors Capital Services, Inc. (affiliate of Investors Bank & Trust Company) from May 1998 through July 2003. | None |
| * | | Trustees serve until their resignation, removal, or death, or until they reach the mandatory retirement age of 75 established by the Board. The Trust’s President, Treasurer, and Secretary serve until their successor is chosen and qualified. The other Officers of the Trust serve at the pleasure of the Trustees. |
| ** | | Length of time served is measured from the earliest date of service as a Trustee or Officer of any of the Funds or their predecessor funds. |
| *** | | The “Fund Complex” consists of all mutual funds advised by Friedman, Billings Ramsey Group, Inc. (“FBR Group”) and its affiliate advisers. |
| † | | Mr. Ellison is considered to be an “Interested Trustee” of the Trust due to his position with FBR Fund Advisers. |
34
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THE FBR FUNDS
888.888.0025
funds@fbr.com
www.fbrfunds.com
Investment Adviser and Administrator
FBR FUND ADVISERS, INC.
1001 NINETEENTH STREET NORTH
ARLINGTON, VIRGINIA 22209
Distributor
FBR INVESTMENT SERVICES, INC.
1001 NINETEENTH STREET NORTH
ARLINGTON, VIRGINIA 22209
Custodian
FBR NATIONAL TRUST COMPANY
4922 FAIRMONT AVENUE
BETHESDA, MARYLAND 20814
Transfer Agent
INTEGRATED FUND SERVICES, INC.
P.O. BOX 5354
CINCINNATI, OHIO 45201
Independent Public Accountants
TAIT, WELLER, AND BAKER LLP
1818 MARKET STREET
PHILADELPHIA, PENNSYLVANIA 19103
This report is not authorized
for distribution to prospective
investors unless it is preceded or
accompanied by a current prospectus.
ITEM 2. CODE OF ETHICS.
As of the end of the period covered by this report, Registrant had adopted a code of ethics (the “Code”) that applies to Registrant’s principal executive officer (“PEO”) and principal financial officer (“PFO”). There were no amendments to the Code during the period covered by the report. The Registrant did not grant any waivers, including implicit waivers, from any provisions of the Code to the PEO or PFO during the period covered by this report. The Registrant undertakes to provide a copy of such code to any person upon request, without charge, by calling 888.888.0025.
ITEM 3. AUDIT COMMITTEE FINANCIAL EXPERT.
The Board of Trustees determined at a meeting held September 29, 2003 that F. David Fowler qualifies as an Audit Committee Financial Expert and he is “independent” as defined under the relevant Securities and Exchange Commission rules and releases.
| ITEM 4. PRINCIPAL ACCOUNTANT FEES AND SERVICES. |
| (a) | | Audit Fees – The aggregate fees billed for the professional services rendered by Tait, Weller & Baker, Registrant’s principal accountant for the audit of the Registrant’s annual financial statements, were $105,500 and $99,500 for all series of the Registrant for the fiscal year ended October 31, 2005 and 2004 respectively. |
| (b) | | Audit Related Fees – The aggregate fees billed for assurance and related services rendered by Tait, Weller & Baker, Registrant’s principal accountant that are reasonably related to the performance of the audit of the Registrant’s financial statements and are not reported under paragraph (a) were $13,500 for all series of the Registrant for each of the fiscal years ended October 31, 2005 and 2004. The Audit Related Fees pertain to services performed in connection with Rule 17f-2 of the Investment Company Act of 1940. In compliance with this rule the principal accountant performed three examinations during the year. |
| (c) | | Tax Fees – The aggregate fees billed by Tait, Weller & Baker, Registrant’s principal accountant for tax compliance, tax advice and tax planning for completing federal and excise tax returns, were $23,400 in 2005 and $22,500 in 2004 for all series of the Registrant for the fiscal year ended October 31. |
| (d) | | All Other Fees – There were no additional fees paid for audit and non-audit services other than those disclosed in (a) through (c) above. |
| (e) | | (1) Pursuant to the Registrant’s Audit Committee Charter (“Charter”), the Audit Committee is responsible for approving in advance the firm to be employed as the Registrant’s independent auditor. In addition, the Charter provides that the Audit Committee is responsible for approving any and all proposals by the Registrant, its investment adviser or their affiliated persons or an entity controlling, controlled by, or under common control with the adviser that provides services to the Registrant to employ the independent auditor to render permissible non-audit services to such entity, provided those permissible non-audit services relate directly to the operations and financial reporting of the Registrant. In determining whether to approve non-audit services, the Audit Committee considers whether such services are consistent with the independent auditor’s independence. |
| | | (2) None of the services described in (b) through (d) above were approved by the audit committee pursuant to paragraph (c)(7)(i)(C) of Rule 2-01 of Regulation S-X. |
| (f) | | Less than fifty percent of the hours expended on the principal accountant’s engagement to audit the Registrant’s financial statements for the most recent fiscal year were attributed to work performed by persons other than the principal accountant’s full-time, permanent employees. |
| (g) | | There were no non-audit services fees billed by the Registrant’s accountant to the Registrant other than those described above. There were no non-audit services fees billed by the Registrant’s accountant to the Registrant’s investment adviser or to any entity controlling, controlled by, or under common control with the adviser that provides ongoing services to the Registrant over the past two years. |
| (h) | | Not applicable as no non-audit services were provided to the Registrant’s investment adviser nor any entity controlling, controlled by, or under common control with the investment adviser that provides ongoing services to the Registrant that were not pre-approved pursuant to Rule 2-01(c)(7)(ii) of Regulation S-X. |
ITEMS 5. AUDIT COMMITTEE OF LISTED REGISTRANTS
Not applicable.
ITEM 6. SCHEDULE OF INVESTMENTS
Contained in Item 1.
ITEM 7. DISCLOSURE OF PROXY VOTING POLICIES AND PROCEDURES FOR CLOSED-END MANAGEMENT INVESTMENT COMPANIES.
Not applicable.
ITEM 8. PORTFOLIO MANAGERS OF CLOSED-END MANAGEMENT INVESTMENT COMPANIES.
Not applicable.
ITEM 9. PURCHASES OF EQUITY SECURITIES BY CLOSED-END MANAGEMENT INVESTMENT COMPANY AND AFFLIIATED PURCHASERS.
Not applicable.
ITEM 10. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The Board of Trustees has not adopted procedures by which shareholders may recommend nominees to the Board.
| ITEM 11. CONTROLS AND PROCEDURES. |
| (a) | | Based upon their evaluation of the Registrant’s disclosure controls and procedures as conducted within 90 days of the filing date of this Form N-CSR, the Registrant’s PFO and PEO have concluded that those disclosure controls and procedures provide reasonable assurance that the material information required to be disclosed by the Registrant in this Form N-CSR has been recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. |
| (b) | | There were no changes in the Registrant’s internal controls over financial reporting as defined in Rule 30a-3(d) under the Act (17 CFR 270.30a-3(d)) that occurred during the second fiscal half-year of the period covered by this report that has materially affected, or is reasonably likely to materially affect, the Registrant’s internal control over financial reporting. |
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| ITEM 12. EXHIBITS. |
| File the exhibits listed below as part of this Form. Letter or number the exhibits in the sequence indicated. |
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| (a) | | (1) Not applicable. |
| | | (2) A separate certification for each principal executive officer and principal financial officer of the Registrant as required by Rule 30a-2(a) under the Act (17 CFR 270.30a-2): Attached herewith. |
| | | (3) Not applicable. |
| (b) | | (1) The certifications required by Rule 30a-2(b) of the Investment Company Act of 1940 and Section 906 of the Sarbanes-Oxley Act of 2002: Attached herewith. |
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| SIGNATURES | | | | | | |
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| Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. |
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| (Registrant) | The FBR Funds |
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| By (Signature and Title)* | | /s/ Susan L. Silva | | 1/3/2006 |
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| | | Susan L. Silva | | Date |
| | | Treasurer and Principal Financial Officer | | |
| | | The FBR Funds | | |
Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
| By (Signature and Title) | | /s/ David H. Ellison | | 1/3/2006 |
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| | | David H. Ellison | | Date |
| | | President and Principal Executive Officer | | |
| | | The FBR Funds | | |
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| By (Signature and Title) | | /s/ Susan L. Silva | | 1/3/2006 |
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| | | Susan L. Silva | | Date |
| | | Treasurer and Principal Financial Officer | | |
| | | The FBR Funds | | |
