Exhibit (17)(g)
FIRST PACIFIC MUTUAL FUND, INC.
HAWAII MUNICIPAL FUND SERIES
HAWAII INTERMEDIATE FUND SERIES
Investor Class
Institutional Class
STATEMENT OF ADDITIONAL INFORMATION
dated February 1, 2007
First Pacific Mutual Fund, Inc. ("Corporation") is a series investment
company organized as a Maryland corporation. In this Statement of Additional
Information ("SAI") all references to any series of the Corporation will be
called the "Fund" unless expressly noted otherwise. Hawaii Municipal Fund
("Municipal Fund") and Hawaii Intermediate Fund ("Intermediate Fund"), are
each a non-diversified, open-end management investment company whose investment
goal is to provide investors with as high a level of income exempt from federal
income taxes and Hawaii personal income taxes as is consistent with prudent
investment management and the preservation of shareholders' capital. Both
Funds offer two classes of shares: Investor Class and Institutional Class. As
of the date of this SAI, the Institutional Class is only offered for the
Municipal Fund. Both Funds are managed by Lee Financial Group Inc. (the
"Investment Manager").
This SAI is not a prospectus and should be read in conjunction with the
Corporation's Prospectuses. A copy of each Prospectus dated February 1, 2007
and shareholder reports may be obtained without charge by calling (808) 988-
8088 (collect) or (800) 354-9654 inter-island or visiting the Funds' website at
www.leehawaii.com.
The Prospectus and this SAI omit certain information contained in the
registration statement filed with the Securities and Exchange Commission
("Commission" or "SEC"). This omitted information may be obtained from the
Commission upon payment of the fee prescribed, or inspected at the SEC's office
at no charge.
The audited financial statements and the related report of Tait, Weller &
Baker LLP, Independent Registered Public Accounting Firm of the Funds, are
incorporated herein by reference in the section "Financial Statements." No
other portions of the Annual Report are incorporated by reference.
TABLE OF CONTENTS
Fund History .................................................................1
Investment Strategies and Risks................................................2
Description of Municipal Securities Ratings ..................................11
Tax Information...............................................................20
Management of the Fund........................................................21
Investment Management Agreement .............................................25
Portfolio Manager.............................................................28
Custodian ....................................................................29
Fund Accounting ..............................................................30
Independent Registered Public Accounting Firm ................................30
Portfolio Transactions .......................................................30
Purchasing and Redeeming Fund Shares..........................................31
The Distributor ..............................................................32
Transfer Agent................................................................34
FUND HISTORY
The Corporation was incorporated in Maryland on July 8, 1988 and has a
present authorized capitalization of 100,000,000 shares of $.01 par value
common stock, of which, 20,000,000 shares have been allocated to each class of
a Fund. The Corporation is an open-end, management investment company and each
Fund is not diversified. All shares have like rights and privileges. Each
full and fractional share, when issued and outstanding, has (1) equal voting
rights with respect to matters which affect the respective Fund or class of a
Fund, and (2) equal dividend, distribution and redemption rights to assets of
the respective Fund or class of a Fund. Shares when issued are fully paid and
nonassessable. The Corporation may create other series or classes of stock but
will not issue any senior securities.
Shares of all classes of a Fund will vote together as a single class
except when otherwise required by law or as determined by the members of the
Corporation's Board. If the Corporation is liquidated, the shareholders of the
Fund or any class thereof are entitled to receive the net assets belonging to
that Fund, or in the case of a class, belonging to that Fund and allocable to
that class. The Corporation will distribute its net assets to its shareholders
in proportion to the number of shares of that Fund or class thereof held by
them and recorded on the books of the Corporation. Shareholders do not have
pre-emptive or conversion rights. These shares have noncumulative voting
rights, which means that the holders of more than 50% of the shares voting for
the election of Directors can elect 100% of the Directors, if they choose to do
so, and in such event, the holders of the remaining less than 50% of the shares
voting will not be able to elect any Directors. The Corporation is not
required to hold a meeting of shareholders each year. The Corporation intends
to hold annual meetings when it is required to do so by the Maryland General
Corporate Law or the Investment Company Act of 1940, as amended ("1940 Act").
Shareholders have the right to call a meeting to consider the removal of one or
more of the Directors and will be assisted in shareholder communication in such
matter.
The Board has authorized two classes of shares for each Fund,
Institutional Class shares and Investor Class shares. The two classes
represent interests in the same assets of the Fund and, except as discussed
below, are identified in all respects. Institutional Class shares do not bear
any expenses for shareholder servicing and the distribution of such shares
pursuant to a 12b-1 plan. Investor Class shares bear certain expenses related
to shareholder servicing and the distribution of such shares and have exclusive
voting rights with respect to matters relating to such distribution
expenditures. Distribution and shareholder servicing fees reduce a class' net
income, dividends and NAV to the extent the Fund has undistributed net income.
Institutional Class shares do not have exchange privileges and higher
investment minimums. The Intermediate Fund does not currently offer
Institutional Class shares.
The Fund may use "First Pacific" in its name so long as Lee Financial
Group Inc. or an affiliate thereof, acts as its investment manager.
INVESTMENT STRATEGIES AND RISKS
The investment objective of each Fund is to provide a high level of
current income exempt from federal and Hawaii state income taxes, consistent
with preservation of capital and prudent investment management. The Municipal
Fund will attempt to achieve its objective by investing primarily in a varied
portfolio of investment grade obligations with maturities of up to 40 years and
the Fund has an average expected maturity of 10-25 years. The Intermediate
Fund will attempt to achieve its objective by investing primarily in a varied
portfolio of investment grade obligations with a dollar weighted average
portfolio maturity of more than three years but not more than ten years. Each
Fund will primarily invest its assets in obligations issued by or on behalf of
the State of Hawaii and its political subdivisions, agencies and certain
territories of the United States, the interest on which is exempt from federal
and Hawaii state income taxes in the opinion of counsel.
Fundamental investment restrictions, which limit the investments of each
Fund, provide that each Fund may not:
1. Issue senior securities.
2. Purchase any securities (other than obligations issued or guaranteed
by the United States Government or by its agencies or instrumentalities), if as
a result more than 5% of the Fund's total assets (taken at current value) would
then be invested in securities of a single issuer or if as a result the Fund
would hold more than 10% of the outstanding voting securities of any single
issuer, except that with respect to 50% of the Fund's total assets up to 25%
may be invested in one issuer.
3. Invest more than 25% of its assets in a single industry. The Fund
may from time to time invest more than 25% of its assets in a particular segment
(bonds financing similar projects such as utilities, hospitals or housing
finance agencies) of the municipal bond market; however, the Fund will not
invest more than 25% of its assets in industrial development bonds in a single
industry. Developments affecting a particular segment could have significant
effect on a Fund's performance. In such circumstances, economic, business,
political or other changes affecting one bond might also affect other bonds in
the same segment, thereby potentially increasing market risk with respect to
the bonds in such segment. Such changes could include, but are not limited to,
proposed or suggested legislation involving the financing of projects within
such segments, declining markets or needs for such projects and shortages or
price increases of materials needed for such projects. The Fund may be subject
to greater risk as compared to a fund that does not follow this practice.
4. Borrow money, except for temporary purposes from banks or in reverse
repurchase transactions as described in the SAI and then in amounts not in
excess of 5% of the total asset value of the Fund, or mortgage, pledge or
hypothecate any assets except in connection with a borrowing and in amounts not
in excess of 10% of the total asset value of the Fund. Borrowing (including
bank borrowing and reverse repurchase transactions) may not be made for
investment leverage, but only to enable the Fund to satisfy redemption requests
where liquidation of portfolio securities is considered disadvantageous or
inconvenient. In this connection, the Fund will not purchase portfolio
securities during any period that such borrowings exceed 5% of the total asset
value of the Fund. The Fund's investments may be diversified among fewer
issuers than if it were a diversified fund and, if so, the Fund's net asset
value may increase or decrease more rapidly than a diversified fund if these
securities change in value. Notwithstanding this investment restriction, the
Fund may enter into "when-issued" and "delayed delivery" transactions.
5. Make loans, except to the extent obligations in which the Fund may
invest in are considered to be loans.
6. Buy any securities "on margin." The deposit of initial or
maintenance margin in connection with municipal bond index and interest rate
futures contracts or related options transactions is not considered the purchase
of a security on margin.
7. Sell any securities "short," write, purchase or sell puts, calls or
combinations thereof, or purchase or sell interest rate or other financial
futures or index contracts or related options, except as described, from time
to time, under the heading "Investment Practices" in the Prospectus.
8. Act as an underwriter of securities, except to the extent the Fund
may be deemed to be an underwriter in connection with the sale of securities
held in its portfolio.
9. Purchase any illiquid assets, including any security which is
restricted as to disposition under federal securities laws or by contract
("restricted securities" or which is not readily marketable), if as a result of
such purchase more than 15% of the Fund's net assets would be so invested.
10. Make investments for the purpose of exercising control or
participation in management.
11. Invest in securities of other investment companies, except as part
of a merger, consolidation or other acquisition and except that the Fund may
temporarily invest up to 10% of the value of its assets in Hawaii tax exempt
money market funds for temporary defensive purposes, including when acceptable
investments are unavailable. Such tax exempt fund investments will be limited
in accordance with Section 12(d) of the 1940 Act.
12. Invest in equity, interests in oil, gas or other mineral exploration
or development programs.
13. Purchase or sell real estate, commodities or commodity
contracts, except to the extent the municipal securities the Fund may invest in
are considered to be interests in real estate, and except to the extent the
options and futures and index contracts the Fund may invest in are considered
to be commodities or commodities contracts.
14. Each Fund will invest, under normal circumstances, at least 80% of
its total net assets in investments in which the income is exempt from both
federal and State of Hawaii income tax. The total net assets subject to this
80% requirement may include securities that generate income subject to the
alternative minimum tax.
Each Fund may not change any of these investment restrictions without the
approval of the lesser of (i) more than 50% of the respective Fund's
outstanding shares or (ii) 67% of the respective Fund's shares present at a
meeting at which the holders of more than 50% of the outstanding shares are
present in person or by proxy. As long as the percentage restrictions
described above are satisfied at the time of the investment or borrowing, a
Fund will be considered to have abided by those restrictions even if, at a
later time, a change in values or net assets causes an increase or decrease in
percentage beyond that allowed.
Frequent portfolio turnover is not anticipated. Each Fund anticipates
that the annual portfolio turnover rate of the Fund will be less than 100%.
Each Fund will not seek capital gain or appreciation but may sell securities
held in its portfolio and, as a result, realize a capital gain or loss. Sales
of portfolio securities will be made for the following purposes: in order to
eliminate unsafe investments and investments not consistent with the
preservation of the capital or tax status of the respective Fund; honor
redemption orders, meet anticipated redemption requirements and negate gains
from discount purchases; reinvest the earnings from portfolio securities in
like securities; or defray normal administrative expenses.
Municipal Securities. Municipal securities include long-term obligations,
which are often called municipal bonds, as well as shorter term municipal
notes, municipal leases, and tax-exempt commercial papers. Municipal
securities are debt obligations issued by or on behalf of the government of
states, territories or possessions of the United States, the District of
Columbia and their political subdivisions, agencies and instrumentalities, the
interest on which is generally exempt from the regular Federal income tax.
Under normal market conditions, longer term municipal securities have greater
price fluctuation than shorter term municipal securities, and therefore the
Intermediate Fund generally expects to invest in obligations with a dollar
weighted average portfolio maturity of more than three years but not more than
ten years. The two principal classifications of municipal bonds are "general
obligation" and "revenue" or "special obligation" bonds, which include
"industrial revenue bonds." General obligation bonds are secured by the
issuer's pledge of its faith, credit, and taxing power for the payment of
principal and interest. Revenue or special obligation bonds are payable only
from the revenues derived from a particular facility or class of facilities or,
in some cases, from the proceeds of a special tax or other specific revenue
source such as from the user of the facility being financed. Municipal leases
are obligations issued by state and local governments or authorities to finance
the acquisition of equipment and facilities. They may take the form of a
lease, an installment purchase contract, a conditional sales contract, or a
participation certificate in any of the above. Some municipal leases and
participation certificates may not be considered readily marketable. The
"issuer" of municipal securities is generally deemed to be the governmental
agency, authority, instrumentality or other political subdivision, or the
nongovernmental user of a facility, the assets and revenues of which will be
used to meet the payment obligations, or the guarantee of such payment
obligations, of the municipal securities. Zero coupon bonds are debt
obligations which do not require the periodic payment of interest and are
issued at a significant discount from face value. The discount approximates
the total amount of interest the bonds will accrue and compound over the period
until maturity at a rate of interest reflecting the market rate of the security
at the time of issuance. Inverse floaters are types of derivative municipal
securities whose interest rates bear an inverse relationship to the interest
rate on another security or the value of an index. These securities usually
permit the investor to convert the floating rate to a fixed rate (normally
adjusted downward), and this optional conversion feature may provide a partial
hedge against rising interest rates if exercised at an opportune time. Pre-
refunded bonds are municipal bonds for which the issuer has previously provided
money and/or securities to pay the principal, any premium, and the interest on
the bonds to their maturity date or to a specific call date. The bonds are
payable from principal and interest on an escrow account invested in U.S.
government obligations, rather than from the usual tax base or revenue stream.
As a result, the bonds are rated AAA by the rating agencies.
Each Fund may purchase floating and variable rate demand notes, which are
municipal securities normally having a stated maturity payment in excess of one
year, but which permit the holder to demand payment of principal at any time,
or at specified intervals. The issuer of such notes normally has a
corresponding right, after a given period, to prepay at its discretion upon
notice to the note holders, the outstanding principal amount of the notes plus
accrued interest. The interest rate on a floating rate demand note is based on
a known lending rate, such as a bank's prime rate, and is adjusted
automatically each time such rate is adjusted. The interest rate on a variable
rate demand note is adjusted automatically at specified intervals. There
generally is no secondary market for these notes, although they are redeemable
at face value. Each note purchased by a Fund will meet the criteria
established for the purchase of municipal securities.
Medium and Lower Grade Municipal Securities. Municipal securities which
are in the medium and lower grade categories generally offer a higher current
yield than that offered by municipal securities which are in the high grade
categories, but they also generally involve greater price volatility and
greater credit and market risk. Credit risk relates to the issuer's ability to
make timely payment of principal and interest when due. Market risk relates to
the changes in market value that occur as a result of variation in the level of
prevailing interest rates and yield relationships in the municipal securities
market. Generally, prices for longer maturity issues tend to fluctuate more
than for shorter maturity issues, accordingly the Intermediate Fund will invest
in obligations with a dollar weighted average portfolio maturity of more than
three years but not more than ten years. Additionally, the Funds will seek to
reduce risk through investing in multiple issuers, credit analysis, and
attention to current developments and trends in the economy and financial and
credit markets.
Many issuers of medium and lower grade municipal securities choose not to
have a rating assigned to their obligations by one of the rating agencies;
hence a Fund's portfolio may at times contain unrated securities. Unrated
securities may carry a greater risk and a higher yield than rated securities.
Although unrated securities are not necessarily lower quality, the market for
them may not be so broad as for rated securities. A Fund will purchase only
those unrated securities which the Investment Manager believes are comparable
to rated securities that qualify for purchase by the Fund.
Hawaii Bonds. Four types of Hawaii bonds have been authorized for
issuance (bonds, notes and other instruments of indebtedness). They are:
1. General Obligation bonds (all bonds for the payment of the principal
and interest of which the full faith and credit of the State or a political
subdivision are pledged and, unless otherwise indicated, including reimbursable
general obligation bonds);
2. Bonds issued under special improvements statutes;
3. Revenue bonds or bond anticipation notes (all bonds payable from
revenues, or user taxes, or any combination of both, of a public undertaking,
improvement, system or loan program); and
4. Special purpose revenue bonds (all bonds payable from rental or
other payments made or any issuer by a person pursuant to contract and security)
including anti-pollution revenue bonds. Such bonds shall only be authorized or
issued to finance manufacturing, processing or industrial enterprise
facilities, utilities serving general public, health care facilities provided
to the general public by not-for-profit corporations or low and moderate income
governmental housing programs.
All bonds other than special purpose revenue bonds may be authorized by a
majority vote of the members of each House of the State Legislature. Special
purpose revenue bonds may be authorized by two-thirds vote of the members of
each House of the State Legislature.
The Constitution provides that determinations of the total outstanding
indebtedness of the State and the exclusions therefrom shall be made annually
and certified by law or as prescribed by law. General obligation bonds may be
issued by the State provided that such bonds at the time of issuance would not
cause the total amount of principal and interest payable in the current or any
future fiscal year, whichever is higher, on such bonds and on all outstanding
general obligation bonds in the current or any future fiscal year, whichever is
higher, to exceed a sum equal to 18.5% of the average of the General Fund
revenues of the State in the three fiscal years immediately preceding such
issuance. For the purposes of such determination, General Fund revenues of the
State do not include monies received as grants from the federal government and
receipts in reimbursement of any reimbursable general obligation bonds which
are excluded in computing the total indebtedness of the State.
Because a Fund will ordinarily invest 80% or more of its net assets in
Hawaii obligations, it is more susceptible to factors affecting Hawaii issuers
than is a comparable municipal bond fund not concentrated in the obligations of
issuers located in a single state.
According to the State of Hawaii Department of Business, Economic
Development and Tourism's ("DBEDT"), "[i]ndicators of the state economy in the
third quarter continued to reflect the strong economic position in 2006, but
the growth rates in many areas are somewhat lower than in the previous two
years." The data below has been gathered from DBEDT's Quarterly Statistical
Economic Report, Executive Summary 4th Quarter 2006.
Hawaii's civilian labor force totaled 655,000 an increase of 2.6% in the
third quarter of 2006. Hawaii's civilian labor force grew 2.8% year-to-date as
compared to the same period 2005, the highest rate of growth since 1990. The
unemployment rate was 2.9% in the third quarter of 2006, compared to 3.0% in
the third quarter of 2005. According to the U.S. Bureau of Labor Statistics,
Hawaii had the lowest unemployment rate in the nation in October, 2006.
Non-Agricultural wage and salary jobs were up 2.4% in the third quarter
of 2006. Contributing to the increase during this period were the
Transportation, Warehousing and Utilities; Natural Resources, Mining
Construction; Professional and Business Services; and Information job sectors,
which amounted to increases of 5.9%, 5.8%, 4.5%, and 3.3% respectively.
According to the U.S. Bureau of Economic Analysis, Hawaii's nominal
personal income rose 6.8% in the second quarter of 2006 from the second quarter
of 2005. In addition, most industries saw year-to-year quarterly increases in
earnings with the exception of Management of Companies and Enterprises;
Forestry and Fishing; and Utilities.
General fund tax revenue decreased by 2.1% in the third quarter of 2006
compared to the third quarter of 2005. For the third quarter of 2006, net
corporate income tax collections had a sharp decline of 66%, net individual
income tax collections were flat, and general excise and use tax and transient
accommodations tax had moderate increases.
In the third quarter of 2006, the number of visitor arrivals by air
decreased by 1.1%, in the same period, domestic arrivals were up 1.9% while
international arrivals decreased 9.1%. Hotel occupancy rates remain near
record territory with statewide hotel occupancy averaging 82.8% in the third
quarter of 2006.
On balance, construction activity was mixed for the third quarter of 2006.
Construction jobs - one of the major contributors to job growth in Hawaii -
increased, housing prices appeared to have stabilized while housing sales
decreased from the third quarter of 2005. Private building authorizations was
nearly flat, yet in the third quarter of 2006, the natural resources mining and
construction sector added 2,000 jobs, up 5.8%.
In addition, in the second quarter of 2006, total bankruptcy filings
decreased by more than 70%, for the second quarter in a row.
DBEDT forecasts are based on "the latest trends of growth for Hawaii's
economy, as well as those for the U.S. and Japanese economies, the two
economies most influencing Hawaii." According to the Blue Chip Economic
Consensus Forecast, an average of about 50 major U.S. forecasts, economic
growth is expected to remain strong in 2006 for both the U.S. and Japanese
economies. U.S. real GDP is projected to rise 3.3% in 2006 and 2.5% in 2007.
Japan real GDP is projected to rise 2.7% in 2006 and 2.2% in 2007.
DBEDT reaffirmed a positive outlook for Hawaii's economy for the
remainder of 2006 and into 2007. DBEDT believes that "[D]espite a lowered
forecast of visitor arrival growth from the previous quarter, the strong growth
of construction and other jobs is expected to maintain solid growth of the
overall economy." These economic forecasts assumed that no new catastrophic
event will occur to impact the Hawaii economy.
U.S. Government Securities. Government Securities include (1) U.S.
Treasury obligations, which differ only in their interest rates, maturities and
times of issuance: U.S. Treasury bills (maturity of one year or less), U.S.
Treasury notes (maturities of one to 10 years), and U.S. Treasury bonds
(generally maturities of greater than 10 years), and separated or divided U.S.
Treasury securities (stripped by the U.S. Treasury) whose payments of principal
and interest are all backed by the full faith and credit of the United States;
and (2) obligations issued or guaranteed by U.S. Government agencies or
instrumentalities, some of which are backed by the full faith and credit of the
U.S. Treasury, e.g., direct pass-through certificates of the Government
National Mortgage Association (generally referred to as "GNMA"); some of which
are supported by the right of the issuer to borrow from the U.S. Government,
e.g., obligations of Federal Home Loan Banks; and some of which are backed only
by the credit of the issuer itself, e.g., obligations of the Federal Home Loan
Mortgage Corporation.
Investments in taxable securities will be substantially in securities
issued or guaranteed by the United States Government (such as bills, notes and
bonds), its agencies, instrumentalities or authorities, highly-rated corporate
debt securities (rated AA, or better, by Standard & Poor's Ratings Service
("S&P" or "Standard & Poor's") or Aa3, or better, by Moody's Investors Service
("Moody's"); prime commercial paper (rated A-1 + or A-2 by S&P or P-1 or P-2
by Moody's) and certificates of deposit of the 100 largest domestic banks in
terms of assets which are subject to regulatory supervision by the U.S.
Government or state governments and the 50 largest foreign banks in terms of
assets with branches or agencies in the United States. Investments in
certificates of deposit of foreign banks and foreign branches of U.S. banks may
involve certain risks, including different regulation, use of different
accounting procedures, political or other economic developments, exchange
controls, withholding income taxes at the source, or possible seizure or
nationalization of foreign deposits. When the Investment Manager determines
that there is a period of adverse market conditions, including when Hawaiian
tax-exempt securities are unavailable, each Fund may invest up to 20% of the
value of its net assets for temporary defensive purposes in money market
instruments the interest on which may be subject to federal, state or local
income tax. When a Fund takes a temporary defensive position, the Fund will
not be pursuing policies designed to achieve its investment objective.
Investment Practices of The Fund.
Hedging. Hedging is a means of offsetting, or neutralizing, the price
movement of an investment by making another investment, the price of which
should tend to move in the opposite direction from that of the original
investment. If the Investment Manager deems it appropriate to hedge partially
or fully a Fund's portfolio against market value changes, the Fund may buy or
sell financial futures contracts and options thereon, such as municipal bond
index future contracts and the related put or call options contracts on such
index futures.
Both parties entering into a financial futures contract are required by
the contract marketplace to post a good faith deposit, known as "initial
margin." Thereafter, the parties must make additional deposits equal to any net
losses due to unfavorable price movements of the contract, and are credited with
an amount equal to any net gains due to favorable price movements. These
additional deposits or credits are calculated and required daily and are known
as "maintenance margin." In situations in which a Fund is required to deposit
additional maintenance margin, and if the Fund has insufficient cash, it may
have to sell portfolio securities to meet such maintenance margin requirements
at a time when it may be disadvantageous to do so. When a Fund engages in the
purchase or sale of futures contracts or the sale of options thereon, it will
deposit the initial margin required for such contracts in a segregated account
maintained with the Fund's custodian, in the name of the futures commission
merchant with whom the Fund maintains the related account. Thereafter, if the
Fund is required to make maintenance margin payments with respect to the
futures contracts, or mark-to-market payments with respect to such option sale
positions, the Fund will make such payments directly to such futures commission
merchant. The SEC currently requires mutual funds to demand promptly the
return of any excess maintenance margin or mark-to-market credits in its
account with futures commission merchants. Each Fund will comply with SEC
requirements concerning such excess margin.
Each Fund may also purchase and sell put and call options on financial
futures, including options on municipal bond index futures. An option on a
financial future gives the holder the right to receive, upon exercise of the
option, a position in the underlying futures contract. When a Fund purchases
an option on a financial futures contract, it receives in exchange for the
payment of a cash premium the right, but not the obligation, to enter into the
underlying futures contract at a price (the "strike price") determined at the
time the option was purchased, regardless of the comparative market value of
such futures position at the time the option is exercised. The holder of a
call option has the right to receive a long (or buyer's) position in the
underlying futures and the holder of a put option has the right to receive a
short (or seller's) position in the underlying futures.
When a Fund sells an option on a financial futures contract, it receives a
cash premium which can be used in whatever way is deemed most advantageous to
the Fund. In exchange for such premium, a Fund grants to the option purchaser
the right to receive from the Fund, at the strike price, a long position in the
underlying futures contract, in the case of a call option, or a short position
in such futures contract, in the case of a put option, even though the strike
price upon exercise of the option is less (in the case of a call option) or
greater (in the case of a put option) than the value of the futures position
received by such holder. If the value of the underlying futures position is
not such that the exercise of the option would be profitable to the option
holder, the option will generally expire without being exercised. A Fund has
no obligation to return premiums paid to it whether or not the option is
exercised. It will generally be the policy of a Fund, in order to avoid the
exercise of an option sold by it, to cancel its obligation under the option by
entering into a closing purchase transaction, if available, unless it is
determined to be in the Fund's interest to deliver the underlying futures
position. A closing purchase transaction consists of the purchase by a Fund of
an option having the same term as the option sold by the Fund, and has the
effect of canceling the Fund's position as a seller. The premium which a Fund
will pay in executing a closing purchase transaction may be higher than the
premium received when the option was sold, depending in large part upon the
relative price of the underlying futures position at the time of each
transaction. The SEC requires that the obligations of mutual funds, such as
the Funds, under option sale positions must be "covered."
Each Fund does not intend to engage in transactions in futures contracts
or related options for speculative purposes but only as a hedge against changes
in the values of securities in their portfolios resulting from market
conditions, such as fluctuations in interest rates. In addition, a Fund will
not enter into futures contracts or related options (except in closing
transactions) if, immediately thereafter, the sum of the amount of its initial
margin deposits and premiums paid for its open futures and options positions,
less the amount by which any such options are "in-the-money," would exceed 5% of
the Fund's total assets (taken at current value).
Investments in financial futures and related options entail certain risks.
Among these are the possibility that the cost of hedging could have an adverse
effect on the performance of a Fund if the Investment Manager's predictions as
to interest rate trends are incorrect or due to the imperfect correlation
between movement in the price of the futures contracts and the price of the
Fund's actual portfolio of municipal securities. Although the contemplated use
of these contracts should tend to minimize the risk of loss due to a decline in
the value of the securities in a portfolio, at the same time hedging
transactions tend to limit any potential gains which might result in an
increase in the value of such securities. In addition, futures and options
markets may not be liquid in all circumstances due to, among other things,
daily price movement limits which may be imposed under the rules of the
contract marketplace, which could limit a Fund's ability to enter into
positions or close out existing positions, at a favorable price. If a Fund is
unable to close out a futures position in connection with adverse market
movements, the Fund would be required to make daily payments on maintenance
margin until such position is closed out. Also, the daily maintenance margin
requirement in futures and option sales transactions creates greater potential
financial exposure than do option purchase transactions, where a Fund's
exposure is limited to the initial cost of the option.
Income earned or deemed to be earned, if any, by a Fund from its hedging
activities will be distributed to its shareholders in taxable distributions.
Each Fund's hedging activities are subject to special provisions of the
Internal Revenue Code of 1986, as amended ("Internal Revenue Code"). These
provisions may, among other things, limit the use of losses of a Fund and
affect the holding period of the securities held by the Fund and the nature of
the income realized by the Fund. These provisions may also require a Fund to
mark-to-market some of the positions in its portfolio (i.e., treat them as if
they were closed out), which may cause the Fund to recognize income without the
cash to distribute such income and to incur tax at the Fund level. A Fund and
its shareholders may recognize taxable income as a result of the Fund's hedging
activities. Each Fund will monitor its transactions and may make certain tax
elections in order to mitigate the effect of these rules and prevent
disqualification of the Fund as a regulated investment company.
If the Investment Manager deems it appropriate to seek to hedge a Fund's
portfolio against market value changes, the Fund may buy or sell financial
futures contracts and related options, such as municipal bond index futures
contracts and the related put or call options contracts on such index futures.
A tax exempt bond index fluctuates with changes in the market values of the tax
exempt bonds included in the index. An index future is an agreement pursuant
to which two parties agree to receive or deliver at settlement an amount of
cash equal to a specified dollar amount multiplied by the difference between
the value of the index at the close of the last trading day of the contract and
the price at which the future was originally written. A financial future is an
agreement between two parties to buy and sell a security for a set price on a
future date. An index future has similar characteristics to a financial future
except that settlement is made through delivery of cash rather than the
underlying securities.
"When-issued" and "delayed delivery" transactions. Each Fund may engage
in "when-issued" and "delayed delivery" transactions and utilize futures
contracts and options thereon for hedging purposes. No income accrues to a Fund
on municipal securities in connection with such transactions prior to the date
the Fund actually takes delivery of and makes payment for such securities.
These transactions are subject to market fluctuation, the value of the
municipal securities at delivery may be more or less than their purchase price,
and yields generally available on municipal securities when delivery occurs may
be higher or lower than yields on the municipal securities obtained pursuant to
such transactions. Because a Fund relies on the buyer or seller, as the case
may be, to consummate the transaction, failure by the other party to complete
the transaction may result in the Fund missing the opportunity of obtaining a
price or yield considered to be advantageous. The SEC generally requires that
when mutual funds, such as the Funds, effect transactions of the foregoing
nature, such funds must either segregate cash or readily marketable portfolio
securities with its custodian in an amount of its obligations under the
foregoing transactions, or cover such obligations by maintaining positions in
portfolio securities, futures contracts or options that would serve to satisfy
or offset the risk of such obligations. When effecting transactions of the
foregoing nature, a Fund will comply with such segregation or cover
requirements. Each Fund will make commitments to purchase municipal securities
on such basis only with the intention of actually acquiring these securities,
but the Fund may sell such securities prior to the settlement date if such sale
is considered advisable. To the extent a Fund engages in "when-issued" and
"delayed delivery" transactions, it will do so for the purpose of acquiring
securities for its portfolio consistent with its investment objectives and
policies and not for the purpose of investment leverage.
Reverse Repurchase Agreements. Each Fund may enter into reverse
repurchase agreements with selected commercial banks or broker-dealers, under
which the Fund sells securities and agrees to repurchase them at an agreed upon
time and at an agreed upon price. The difference between the amount a Fund
receives for the securities and the amount it pays on repurchase is deemed to be
a payment of interest by the Fund. Each Fund will maintain in a segregated
account having an aggregate value with its custodian, cash, treasury bills, or
other U.S. Government securities having an aggregate value equal to the amount
of such commitment to repurchase, including accrued interest, until payment is
made. Reverse repurchase agreements are treated as a borrowing by the Funds
and will be used as a source of funds on a short-term basis, in an amount not
exceeding 5% of the net assets of the Fund (which 5% includes bank borrowings)
at the time of entering into any such agreement. A Fund will enter into
reverse repurchase agreements only with commercial banks whose deposits are
insured by the Federal Deposit Insurance Corporation and whose assets exceed
$500 million or broker-dealers who are registered with the SEC. In determining
whether to enter into a reverse repurchase agreement with a bank or broker-
dealer, the Fund will take into account the credit worthiness of such party and
will monitor such credit worthiness on an ongoing basis.
DESCRIPTION OF MUNICIPAL SECURITIES RATINGS
Short-Term Credit Ratings
A Standard & Poor's short-term issue credit rating is a current opinion
of the creditworthiness of an obligor with respect to a specific financial
obligation having an original maturity of no more than 365 days. The following
summarizes the rating categories used by Standard & Poor's for short-term
issues:
"A-1" - Obligations are rated in the highest category and indicate that
the obligor's capacity to meet its financial commitment on the obligation is
strong. Within this category, certain obligations are designated with a plus
sign (+). This indicates that the obligor's capacity to meet its financial
commitment on these obligations is extremely strong.
"A-2" - The obligor's capacity to meet its financial commitment on the
obligation is satisfactory. Obligations are somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions than
obligations in the higher rating categories.
"A-3" - Obligor has adequate protection parameters. However, adverse
economic conditions or changing circumstances are more likely to lead to a
weakened capacity of the obligor to meet its financial commitment on the
obligation.
"B" - An obligation is regarded as having significant speculative
characteristics. The obligor currently has the capacity to meet its financial
commitment on the obligation; however, it faces major ongoing uncertainties
which could lead to the obligor's inadequate capacity to meet its financial
commitment on the obligation. Ratings of "B1", "B-2" and "B-3" may be assigned
to indicate finer distinction within the "B" category.
"C" - Obligations are currently vulnerable to nonpayment and are
dependent upon favorable business, financial, and economic conditions for the
obligor to meet its financial commitment on the obligation.
"D" - Obligations are in payment default. This rating category is used
when payments on an obligation are not made on the date due even if the
applicable grace period has not expired, unless Standard & Poor's believes that
such payments will be made during such grace period. The "D" rating also will
be used upon the filing of a bankruptcy petition or the taking of a similar
action if payments on an obligation are jeopardized.
Local Currency and Foreign Currency Risks - Country risk considerations
are a standard part of Standard & Poor's analysis for credit ratings on any
issuer or issue. Currency of repayment is a key factor in this analysis. An
obligor's capacity to repay foreign currency obligations may be lower than its
capacity to repay obligations in its local currency due to the sovereign
government's own relatively lower capacity to repay external versus domestic
debt. These sovereign risk considerations are incorporated in the debt ratings
assigned to specific issues. Foreign Currency issuer ratings are also
distinguished from local currency issuer ratings to identify those instances
where sovereign risks make them different for the same issuer.
Moody's Investors Service ("Moody's") short-term ratings are opinions of
the ability of issuers to honor short-term financial obligations. Ratings may
be assigned to issuers, short-term programs or to individual short-term debt
instruments. Such obligations generally have an original maturity not
exceeding thirteen months, unless explicitly noted.
Moody's employs the following designations to indicate the relative
repayment ability of rated issuers:
"P-1" - Issuers (or supporting institutions) rated Prime-1 have a
superior ability to repay short-term debt obligations.
"P-2" - Issuers (or supporting institutions) rated Prime-2 have a strong
ability to repay short-term debt obligations.
"P-3" - Issuers (or supporting institutions) rated Prime-3 have an
acceptable ability to repay short-term obligations.
"NP" - Issuers (or supporting institutions) rated Not Prime do not fall
within any of the Prime rating categories.
Fitch, Inc. / Fitch Ratings Ltd. ("Fitch") short-term ratings scale
applies to foreign currency and local currency ratings. A short-term rating
has a time horizon of less than 13 months for most obligations, or up to three
years for U.S. public finance, in line with industry standards, to reflect
unique risk characteristics of bond, tax, and revenue anticipation notes that
are commonly issued with terms up to three years. Short-term ratings thus
place greater emphasis on the liquidity necessary to meet financial
commitments in a timely manner. The following summarizes the rating categories
used by Fitch for short-term obligations:
"F1" - Securities possess the highest credit quality. This designation
indicates the strongest capacity for timely payment of financial commitments;
may have an added "+" to denote any exceptionally strong credit feature.
"F2" - Securities possess good credit quality. This designation
indicates a satisfactory capacity for timely payment of financial commitments,
but the margin of safety is not as great as in the case of the higher ratings.
"F3" - Securities possess fair credit quality. This designation
indicates that the capacity for timely payment of financial commitments is
adequate; however, near term adverse changes could result in a reduction to non
investment grade.
"B" - Securities possess speculative credit quality. This designation
indicates minimal capacity for timely payment of financial commitments, plus
vulnerability to near term adverse changes in financial and economic
conditions.
"C" - Securities possess high default risk. Default is a real
possibility. This designation indicates a capacity for meeting financial
commitments which is solely reliant upon a sustained, favorable business and
economic environment.
"D" - Indicates an entity or sovereign that has defaulted on all of its
financial obligations.
"NR" - This designation indicates that Fitch does not publicly rate the
associated issuer or issue.
"WD" - This designation indicates that the rating has been withdrawn and
is no longer maintained by Fitch.
The following summarizes the ratings used by Dominion Bond Rating Service
Limited ("DBRS") for commercial paper and short-term debt:
"R-1 (high)" - Short-term debt rated "R-1 (high)" is of the highest
credit quality, and indicates an entity possessing 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 that 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
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 by only a small degree. Given the extremely tough definition
DBRS has established for the "R-1 (high)" category, entities rated "R-1
(middle)" are also considered strong credits, and typically exemplify above
average strength in key areas of consideration for the timely repayment of
short-term liabilities.
"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 are not normally as favorable as with higher rating
categories, but these considerations are still respectable. Any qualifying
negative factors that exist are considered manageable, and the entity is
normally of sufficient size to have some influence in its industry.
"R-2 (high)" - Short-term debt rated "R-2 (high)" is considered to be at
the upper end of adequate credit quality. The ability to repay obligations as
they mature remains acceptable, although the overall strength and outlook for
key liquidity, debt, and profitability ratios is not as strong as credits rated
in the "R-1 (low)" category. Relative to the latter category, other
shortcomings often include areas such as stability, financial flexibility, and
the relative size and market position of the entity within its industry.
"R-2 (middle)" - Short-term debt rated "R-2 (middle)" is considered to be
of adequate credit quality. Relative to the "R-2 (high)" category, entities
rated "R-2 (middle)" typically have some combination of higher volatility,
weaker debt or liquidity positions, lower future cash flow capabilities, or are
negatively impacted by a weaker industry. Ratings in this category would be
more vulnerable to adverse changes in financial and economic conditions.
"R-2 (low)" - Short-term debt rated "R-2 (low)" is considered to be at
the lower end of adequate credit quality, typically having some combination of
challenges that are not acceptable for an "R-2 (middle)" credit. However, "R-2
(low)" ratings still display a level of credit strength that allows for a
higher rating than the "R-3" category, with this distinction often reflecting
the issuer's liquidity profile.
"R-3" - Short-term debt rated "R-3" is considered to be at the lowest end
of adequate credit quality, one step up from being speculative. While not yet
defined as speculative, the R-3 category signifies that although repayment is
still expected, the certainty of repayment could be impacted by a variety of
possible adverse developments, many of which would be outside the issuer's
control. Entities in this area often have limited access to capital markets
and may also have limitations in securing alternative sources of liquidity,
particularly during periods of weak economic conditions.
"R-4" - Short-term debt rated R-4 is speculative. R-4 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-4 ratings would
normally have very limited access to alternative sources of liquidity.
Earnings and cash flow 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.
"R-5" - Short-tern debt rated R-5 is highly speculative. There is a
reasonably high level of uncertainty as to the ability of the entity to repay
the obligations on a continuing basis in the future, especially in periods of
economic recession or industry adversity. In some cases, short term debt rated
R-5 may have challenges that if not corrected, could lead to default.
"D" - A security rated "D" implies the issuer has either not met a
scheduled payment or the issuer has made it clear that it will be missing such
a payment in the near future. In some cases, DBRS may not assign a "D" rating
under a bankruptcy announcement scenario, as allowances for grace periods may
exist in the underlying legal documentation. Once assigned, the "D" rating
will continue as long as the missed payment continues to be in arrears, and
until such time as the rating is suspended, discontinued, or reinstated by
DBRS.
Long-Term Credit Ratings
The following summarizes the ratings used by Standard & Poor's for long-
term issues:
"AAA" - An obligation rated "AAA" has the highest rating assigned by
Standard & Poor's. The obligor's capacity to meet its financial commitment on
the obligation is extremely strong.
"AA" - An obligation rated "AA" differs from the highest-rated
obligations only to a small degree. The obligor's capacity to meet its
financial commitment on the obligation is very strong.
"A" - An obligation rated "A" is somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than obligations in
higher-rated categories. However, the obligor's capacity to meet its financial
commitment on the obligation is still strong.
"BBB" - An obligation rated "BBB" exhibits adequate protection
parameters. However, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity of the obligor to meet its financial
commitment on the obligation.
Obligations rated "BB," "B," "CCC," "CC" and "C" are regarded as having
significant speculative characteristics. "BB" indicates the least degree of
speculation and "C" the highest. While such obligations will likely have some
quality and protective characteristics, these may be outweighed by large
uncertainties or major exposures to adverse conditions.
"BB" - An obligation rated "BB" is less vulnerable to nonpayment than
other speculative issues. However, it faces major ongoing uncertainties or
exposure to adverse business, financial, or economic conditions which could
lead to the obligor's inadequate capacity to meet its financial commitment on
the obligation.
"B" - An obligation rated "B" is more vulnerable to nonpayment than
obligations rated "BB," but the obligor currently has the capacity to meet its
financial commitment on the obligation. Adverse business, financial, or
economic conditions will likely impair the obligor's capacity or willingness to
meet its financial commitment on the obligation.
"CCC" - An obligation rated "CCC" is currently vulnerable to nonpayment,
and is dependent upon favorable business, financial and economic conditions for
the obligor to meet its financial commitment on the obligation. In the event
of adverse business, financial, or economic conditions, the obligor is not
likely to have the capacity to meet its financial commitment on the obligation.
"CC" - An obligation rated "CC" is currently highly vulnerable to
nonpayment.
"C" - A subordinated debt or preferred stock obligation rated "C" is
currently highly vulnerable to nonpayment. The "C" rating may be used to cover
a situation where a bankruptcy petition has been filed or similar action taken,
but payments on this obligation are being continued. A "C" also will be
assigned to a preferred stock issue in arrears on dividends or sinking fund
payments, but that is currently paying.
"D" - An obligation rated "D" is in payment default. The "D" rating
category is used when payments on an obligation are not made on the date due
even if the applicable grace period has not expired, unless Standard & Poor's
believes that such payments will be made during such grace period. The "D"
rating also will be used upon the filing of a bankruptcy petition or the taking
of a similar action if payments on an obligation are jeopardized.
Plus (+) or minus (-) - The ratings from "AA" to "CCC" may be modified by
the addition of a plus (+) or minus (-) sign to show relative standing within
the major rating categories.
"NR" - This indicates that no rating has been requested, that there is
insufficient information on which to base a rating, or that Standard & Poor's
does not rate a particular obligation as a matter of policy.
Local Currency and Foreign Currency Risks - Country risk considerations
are a standard part of Standard & Poor's analysis for credit ratings on any
issuer or issue. Currency of repayment is a key factor in this analysis. An
obligor's capacity to repay foreign currency obligations may be lower than its
capacity to repay obligations in its local currency due to the sovereign
government's own relatively lower capacity to repay external versus domestic
debt. These sovereign risk considerations are incorporated in the debt ratings
assigned to specific issues. Foreign currency issuer ratings are also
distinguished from local currency issuer ratings to identify those instances
where sovereign risks make them different for the same issuer.
The following summarizes the ratings used by Moody's for long-term debt:
"Aaa" - Obligations rated "Aaa" are judged to be of the highest quality,
with minimal credit risk.
"Aa" - Obligations rated "Aa" are judged to be of high quality and are
subject to very low credit risk.
"A" - Obligations rated "A" are considered upper-medium grade and are
subject to low credit risk.
"Baa" - Obligations rated "Baa" are subject to moderate credit risk.
They are considered medium-grade and as such may possess certain speculative
characteristics.
"Ba" - Obligations rated "Ba" are judged to have speculative elements and
are subject to substantial credit risk.
"B" - Obligations rated "B" are considered speculative and are subject to
high credit risk.
"Caa" - Obligations rated "Caa" are judged to be of poor standing and are
subject to very high credit risk.
"Ca" - Obligations rated "Ca" are highly speculative and are likely in,
or very near, default, with some prospect of recovery of principal and
interest.
"C" - Obligations rated "C" are the lowest rated class of bonds and are
typically in default, with little prospect for recovery of principal or
interest.
Note: Moody's appends numerical modifiers 1, 2, and 3 to each generic
rating classification from "Aa" through "Caa." The modifier 1 indicates that
the obligation ranks in the higher end of its generic rating category; the
modifier 2 indicates a mid-range ranking; and the modifier 3 indicates a
ranking in the lower end of that generic rating category.
The following summarizes long-term ratings used by Fitch:
"AAA" - Securities considered to be of the highest credit quality. "AAA"
ratings denote the lowest expectation of credit risk. They are assigned only
in case of exceptionally strong capacity for payment of financial commitments.
This capacity is highly unlikely to be adversely affected by foreseeable
events.
"AA" - Securities considered to be of very high credit quality. "AA"
ratings denote expectations of very low credit risk. They indicate very strong
capacity for timely payment of financial commitments. This capacity is not
significantly vulnerable to foreseeable events.
"A" - Securities considered to be of high credit quality. "A" ratings
denote expectations of low credit risk. The capacity for payment of financial
commitments is considered strong. This capacity may, nevertheless, be more
vulnerable to changes in circumstances or in economic conditions than is the
case for higher ratings.
"BBB" - Securities considered to be of good credit quality. "BBB"
ratings indicate that there is currently expectations of low credit risk. The
capacity for payment of financial commitments is considered adequate but
adverse changes in circumstances and economic conditions are more likely to
impair this capacity. This is the lowest investment grade category.
"BB" - Securities considered to be speculative. "BB" ratings indicate
that there is a possibility of credit risk developing, particularly as the
result of adverse economic change over time; however, business or financial
alternatives may be available to allow financial commitments to be met.
Securities rated in this category are not investment grade.
"B" - Securities considered to be highly speculative. "B" ratings
indicate that significant credit risk is present, but a limited margin of
safety remains. Financial commitments are currently being met; however,
capacity for continued payment is contingent upon a sustained, favorable
business and economic environment.
"CCC," "CC" and "C" - Securities have high default risk. Default is a
real possibility, and capacity for meeting financial commitments is solely
reliant upon sustained, favorable business or economic developments. A "CC"
rating indicates that default of some kind appears probable. "C" ratings
signal imminent default.
"RD" - Indicates an entity has failed to make due payments (within the
applicable grace period) on some but not all material financial obligations,
but continues to honor other classes of obligations.
"D" - Indicates an entity or sovereign that has defaulted on all of its
financial obligations.
Plus (+) or minus (-) may be appended to a rating to denote relative
status within major rating categories. Such suffixes are not added to the
"AAA" category or to categories below "CCC".
"NR" indicates that Fitch does not publicly rate the associated issue or
issuer.
The following summarizes the ratings used by DBRS for long-term debt:
"AAA" - Long-term debt rated "AAA" is 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 high standard which DBRS has set for
this category, few entities are able to achieve a "AAA" rating.
"AA" - Long-term debt rated "AA" is of superior credit quality, and
protection of interest and principal is considered high. In many cases they
differ from long-term debt rated "AAA" only to a small degree. Given the
extremely restrictive definition DBRS has for the "AAA" category, entities
rated "AA" are also considered to be strong credits, typically exemplifying
above-average strength in key areas of consideration and unlikely to be
significantly affected by reasonably foreseeable events.
"A" - Long-term debt rated "A" is of satisfactory credit quality.
Protection of interest and principal is still substantial, but the degree of
strength is less than that of "AA" rated entities. While "A" is a respectable
rating, entities in this category are considered to be more susceptible to
adverse economic conditions and have greater cyclical tendencies than higher-
rated securities.
"BBB" - Long-term debt rated "BBB" is of adequate credit quality.
Protection of interest and principal is considered acceptable, but the entity
is fairly susceptible to adverse changes in financial and economic conditions,
or there may be other adverse conditions present which reduce the strength of
the entity and its rated securities.
"BB" - Long-term debt rated "BB" is defined to be speculative and non-
investment grade, where the degree of protection afforded interest and
principal is uncertain, particularly during periods of economic recession.
Entities in the "BB" range typically have limited access to capital markets and
additional liquidity support. In many cases, deficiencies in critical mass,
diversification, and competitive strength are additional negative
considerations.
"B" - Long-term debt rated "B" is highly speculative and there is a
reasonably high level of uncertainty as to the 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" and "C" -Long-term debt rated in any of these categories is
very highly speculative and is in danger of default of interest and principal.
The degree of adverse elements present is more severe than long-term debt rated
"B." Long-term debt rated below "B" often have features which, if not
remedied, may lead to default. In practice, there is little difference between
these three categories, with "CC" and "C" normally used for lower ranking debt
of companies for which the senior debt is rated in the "CCC" to "B" range.
"D" - A security rated "D" implies the issuer has either not met a
scheduled payment of interest or principal or that the issuer has made it clear
that it will miss such a payment in the near future. In some cases, DBRS may
not assign a "D" rating under a bankruptcy announcement scenario, as allowances
for grace periods may exist in the underlying legal documentation. Once
assigned, the "D" rating will continue as long as the missed payment continues
to be in arrears, and until such time as the rating is suspended, discontinued
or reinstated by DBRS.
("high", "low") - Each rating category is denoted by the subcategories
"high" and "low". The absence of either a "high" or "low" designation
indicates the rating is in the "middle" of the category. The "AAA" and "D"
categories do not utilize "high", "middle", and "low" as differential grades.
Municipal Note Ratings
A Standard & Poor's U.S. municipal note rating reflects the liquidity
factors and market access risks unique to notes. Notes due in three years or
less will likely receive a note rating. Notes maturing beyond three years will
most likely receive a long-term debt rating. The following criteria will be
used in making that assessment:
[Bullet] Amortization schedule-the larger the final maturity relative to
other maturities, the more likely it will be treated as a note; and
[Bullet] Source of payment-the more dependent the issue is on the market
for its refinancing, the more likely it will be treated as a note.
Note rating symbols are as follows:
"SP-1" - The issuers of these municipal notes exhibit a strong capacity
to pay principal and interest. Those issues determined to possess a very
strong capacity to pay debt service are given a plus (+) designation.
"SP-2" - The issuers of these municipal notes exhibit a satisfactory
capacity to pay principal and interest, with some vulnerability to adverse
financial and economic changes over the term of the notes.
"SP-3" - The issuers of these municipal notes exhibit speculative
capacity to pay principal and interest.
Moody's uses three rating categories for short-term municipal obligations
that are considered investment grade. These ratings are designated as
Municipal Investment Grade ("MIG") and are divided into three levels - "MIG-1"
through "MIG-3". In addition, those short-term obligations that are of
speculative quality are designated "SG", or speculative grade. MIG ratings
expire at the maturity of the obligation. The following summarizes the ratings
used by Moody's for these short-term obligations:
"MIG-1" - This designation denotes superior credit quality. Excellent
protection is afforded by established cash flows, highly reliable liquidity
support, or demonstrated broad-based access to the market for refinancing.
"MIG-2" - This designation denotes strong credit quality. Margins of
protection are ample, although not as large as in the preceding group.
"MIG-3" - This designation denotes acceptable credit quality. Liquidity
and cash-flow protection may be narrow, and market access for refinancing is
likely to be less well-established.
"SG" - This designation denotes speculative-grade credit quality. Debt
instruments in this category may lack sufficient margins of protection.
In the case of variable rate demand obligations ("VRDOs"), a two-
component rating is assigned; a long- or short-term debt rating and a demand
obligation rating. The first element represents Moody's evaluation of the
degree of risk associated with scheduled principal and interest payments. The
second element represents Moody's evaluation of the degree of risk associated
with the ability to receive purchase price upon demand ("demand feature"),
using a variation of the MIG rating scale, the Variable Municipal Investment
Grade or "VMIG" rating.
When either the long- or short-term aspect of a VRDO is not rated, that
piece is designated "NR", e.g., "Aaa/NR" or "NR/VMIG-1".
VMIG rating expirations are a function of each issue's specific
structural or credit features.
"VMIG-1" - This designation denotes superior credit quality. Excellent
protection is afforded by the superior short-term credit strength of the
liquidity provider and structural and legal protections that ensure the timely
payment of purchase price upon demand.
"VMIG-2" - This designation denotes strong credit quality. Good
protection is afforded by the strong short-term credit strength of the
liquidity provider and structural and legal protections that ensure the timely
payment of purchase price upon demand.
"VMIG-3" - This designation denotes acceptable credit quality. Adequate
protection is afforded by the satisfactory short-term credit strength of the
liquidity provider and structural and legal protections that ensure the timely
payment of purchase price upon demand.
"SG" - This designation denotes speculative-grade credit quality. Demand
features rated in this category may be supported by a liquidity provider that
does not have an investment grade short-term rating or may lack the structural
and/or legal protections necessary to ensure the timely payment of purchase
price upon demand.
Fitch uses the same ratings for municipal securities as described above
for other short-term credit ratings.
About Credit Ratings
A Standard & Poor's issue credit rating is a current opinion of the
creditworthiness of an obligor with respect to a specific financial obligation,
a specific class of financial obligations, or a specific financial program
(including ratings on medium-term note programs and commercial paper programs).
It takes into consideration the creditworthiness of guarantors, insurers, or
other forms of credit enhancement on the obligation and takes into account the
currency in which the obligation is denominated. The issue credit rating is
not a recommendation to purchase, sell, or hold a financial obligation,
inasmuch as it does not comment as to market price or suitability for a
particular investor.
Moody's credit ratings must be construed solely as statements of opinion and
not as statements of fact or recommendations to purchase, sell or hold any
securities.
Fitch's credit ratings provide an opinion on the relative ability of an entity
to meet financial commitments, such as interest, preferred dividends, repayment
of principal, insurance claims or counterparty obligations. Fitch credit
ratings are used by investors as indications of the likelihood of receiving
their money back in accordance with the terms on which they invested. Fitch's
credit ratings cover the global spectrum of corporate, sovereign (including
supranational and sub-national), financial, bank, insurance, municipal and
other public finance entities and the securities or other obligations they
issue, as well as structured finance securities backed by receivables or other
financial assets.
DBRS credit ratings are not buy, hold or sell recommendations, but rather the
result of qualitative and quantitative analysis focusing solely on the credit
quality of the issuer and its underlying obligations.
TAX INFORMATION
The following summarizes certain additional tax considerations generally
affecting the Funds and their shareholders that are not described in the
Prospectuses. No attempt is made to present a detailed explanation of the tax
treatment of the Funds or their shareholders, and the discussions here and in
the Prospectuses are not intended as a substitute for careful tax planning.
Potential investors should consult their tax advisers with specific reference
to their own tax situations.
The discussions of the federal tax consequences in the Prospectuses and
this SAI are based on the Internal Revenue Code (the "Code") and the laws and
regulations issued thereunder as in effect on the date of this SAI. Future
legislative or administrative changes or court decisions may significantly
change the statements included herein, and any such changes or decisions may
have a retroactive effect with respect to the transactions contemplated herein.
Each Fund qualified during its last taxable year and intends to qualify as
a regulated investment company under Subchapter M of Subtitle A, Chapter 1, of
the Internal Revenue Code, and to invest all, or substantially all, of its
income each year, so that the Fund itself generally will be relieved of federal
income and excise taxes. If a Fund were to fail to so qualify: (1) the Fund
would be taxed on its taxable income at regular corporate rates on its net
taxable investment income without any deduction for distributions to
shareholders; and (2) shareholders would recognize dividend income on
distributions attributable to the Fund's earnings. Moreover, if a Fund were to
fail to make sufficient distributions in a year, the Fund would be subject to
corporate income taxes and/or excise taxes in respect of the shortfall or, if
the shortfall is large enough, the Fund could be disqualified as a regulated
investment company.
A 4% non-deductible excise tax is imposed on regulated investment
companies that fail to distribute with respect to each calendar year at least
98% of their ordinary taxable income for the calendar year and capital gain net
income (excess of capital gains over capital losses) for the one year period
ending October 31 of such calendar year and 100% of any such amounts that were
not distributed in the prior year. Each Fund intends to make sufficient
distributions or deemed distributions of its ordinary taxable income and any
capital gain net income prior to the end of each calendar year to avoid
liability for this excise tax.
For a Fund to pay tax-exempt dividends for any taxable year, at least 50%
of the aggregate value of the Fund's assets at the close of each quarter of the
Fund's taxable year must consist of exempt-interest obligations. An exempt-
interest dividend is any dividend or part thereof (other than a capital gain
dividend) paid by a Fund and designated as an exempt-interest dividend in a
written notice mailed to shareholders not later than 60 days after the close of
the Fund's taxable year. However, the aggregate amount of dividends so
designated by the Funds cannot exceed the excess of the amount of interest
exempt from tax under section 103 of the Code received by the Funds during the
taxable year over any amounts disallowed as deductions under sections 265 and
171(a)(2) of the Code. The percentage of total dividends paid by the Funds
with respect to any taxable year which qualifies as federal exempt-interest
dividends will be the same for all shareholders receiving dividends from the
Funds with respect to such year.
An investment in a tax-exempt fund is not intended to constitute a
balanced investment program. Shares of the Funds would not be suitable for tax-
exempt institutions and may not be suitable for retirement plans qualified under
Section 401 of the Code, H.R. 10 plans and individual retirement accounts
because such plans and accounts are generally tax-exempt and, therefore, not
only would the shareholder not gain any additional benefit from the Funds'
dividends being tax-exempt, but such dividends would be ultimately taxable to
the beneficiaries when distributed. In addition, the Funds may not be an
appropriate investment for entities that are "substantial users" of facilities
financed by "private activity bonds" or "related persons" thereof.
"Substantial user" is defined under U.S. Treasury Regulations to include a non-
exempt person who (i) regularly uses a part of such facilities in his or her
trade or business and whose gross revenues derived with respect to the
facilities financed by the issuance of bonds are more than 5% of the total
revenues derived by all users of such facilities, (ii) occupies more than 5% of
the usable area of such facilities or (iii) are persons for whom such
facilities or a part thereof were specifically constructed, reconstructed or
acquired. "Related persons" include certain related natural persons,
affiliated corporations, a partnership and its partners and an S corporation
and its shareholders.
For federal income tax purposes, each Fund is generally permitted to carry
forward a net capital loss in any year to offset its own capital gains, if any,
during the eight years following the year of the loss. These amounts are
available to be carried forward to offset future capital gains to the extent
permitted by the Code and applicable tax regulations. As of September 30,
2006, the Municipal Fund did not have any capital loss carryforwards. The
Intermediate Fund had an unused capital loss carryforward of $2,052.
MANAGEMENT OF THE FUND
The Officers and Directors of the Corporation, their principal occupations
for the last five years and their affiliation, if any, with the Investment
Manager, or the Corporation's Distributor, are shown below. Interested persons
of the Corporation as defined in the 1940 Act are indicated by an asterisk (*)
in the table below. The Officers of the Corporation manage its day-to-day
operations. The Corporation's Investment Manager and its Officers are subject
to the supervision and control of the Directors under the laws of the state of
Maryland.
Number of
Portfolios
Position Term of in Fund
And Office and Complex
Office with Length of Principal Occupation Overseen
Name Age the Time During the Past by
and Address Corporation Served Five Years Director
DISINTERESTED DIRECTORS
Clayton W.H. Chow (54) Director Unlimited Term Office Technology Specialist, 2
896 Puuikena Dr. 18 years Xerox Corporation
Honolulu, HI 96821 Account Executive,
Roadway Express
Lynden M. Keala (52) Director Unlimited Term Account, Executive, Workflow 2
47-532 Hui Iwa St. 17 years One (formerly The Relizon
Kaneohe, HI 96744 Company)
Account Executive, Xpedx
(Distribution Division of
International Paper)
Stuart S. Marlowe (66) Director Unlimited Term Owner, Surfside Sales and 2
PO Box 630507 18 years Marketing (Sales and marketing of
Lanai City, HI 96763 music for the State of Hawaii)
Director
Karen T. Nakamura (62) Director Unlimited Term Executive Vice President & CEO, 2
1727 Dillingham Boulevard 9 years Building Industry of Hawaii
Honolulu, HI 96819 Vice President, Wallpaper
Hawaii, Ltd.
Kim F. Scoggins (59) Director Unlimited Term Commercial Real Estate, 2
220 S. King Street, #1800 9 years Colliers Monroe Friedlander, Inc.
Honolulu, HI 96813 Real Estate, 1250 Oceanside
Partners
INTERESTED DIRECTORS
*Terrence K.H. Lee (49)Director Unlimited Term Director, President and 2
593 Moaniala Street President 18 years CEO, Lee Financial Group, Inc.,
Honolulu, HI 96821 and First Pacific Securities, Inc.,
CEO First Pacific Recordkeeping, Inc.
OFFICERS
Nora B. Simpson (46) Treasurer, Chief Vice President, CCO, CFO and
503 Blackbird Drive Compliance Officer, Treasurer, Lee Financial Group,
Hockessin, DE 19707 Assistant Secretary Inc., First Pacific Securities,
Inc., and First Pacific
Recordkeeping, Inc.
Charlotte A. Meyer (53)Assistant Treasurer Director, Assistant Treasurer and
64-5251 Puu Nani Drive Vice President, Lee Financial
PO Box 2834 Group, Inc., First Pacific
Kamuela, HI 96743 Securities, Inc., and First
Pacific Recordkeeping, Inc.
Jean Chun Lee (50) Secretary Director, Secretary and Vice
2756 Woodlawn Drive, #6-201 President, Lee Financial Group,
Honolulu, HI 96822 Inc., First Pacific Securities,
Inc., and First Pacific
Recordkeeping, Inc.
There are no other Directorships held by any of the Directors.
Terrence K.H. Lee and Jean Chun Lee are husband and wife.
Terrence K.H. Lee is an interested person of First Pacific Mutual Fund, Inc. by
virtue of his relationship as President of the investment adviser, principal
underwriter and transfer agent and has had a material and professional
relationship with the Corporation for the last two completed calendar years.
Audit Committee
The Audit Committee of the Fund ("Committee") oversees the Fund's
financial reporting process and internal controls and monitors the Fund's
internal audit plans. With the assistance of the independent accountants of
the Fund, the Committee ensures the adequacy of Fund reporting, internal
controls and personnel, information systems, quality of the Fund's accounting
principles, clarity of the Fund's financial disclosures and degree of
aggressiveness or conservatism of accounting principles.
The Committee provides assistance to the Fund's Directors in fulfilling
their responsibilities to the Fund relating to fund accounting, reporting
practices of the Fund, and the quality and integrity of the financial reports
of the Fund. In so doing, it is the responsibility of the Committee to
maintain a free and open means of communication among the Directors, the
independent accountants and the Fund's officers.
Each non-interested Director serves as a member of the Committee.
The Audit Committee held one meeting during the fiscal year ended
September 30, 2006.
Nominating Committee
The Nominating Committee's mission is to promote the effective
participation of qualified individuals on the Board of Directors and Committees
of the Board.
Each non-interested Director serves as a member of the Nominating
Committee.
The Nominating Committee held one meeting during the fiscal year ended
September 30, 2006.
The Nominating Committee will not consider nominees recommended by
security holders.
Set forth below is the dollar range of securities of the Funds or the
Corporation beneficially owned by the Director as of December 31, 2006:
Aggregate Dollar Range of Securities
in all Registered Investment
Dollar Range of Companies overseen by Director in
Name of Director Securities In the Funds Family of Investment Companies
Disinterested Directors
Clayton W.H. Chow Municipal Fund $1 - $10,000 $1 - $10,000
Lynden M. Keala Municipal Fund $1 - $10,000 $1 - $10,000
Stuart S. Marlowe Municipal Fund $1 - $10,000 $1 - $10,000
Intermediate Fund $1 - $10,000
Karen T. Nakamura Municipal Fund over $100,000 over $100,000
Intermediate Fund over $100,000
Kim F. Scoggins Municipal Fund $1 - $10,000 $1 - $10,000
Interested Directors
Terrence K.H. Lee Municipal Fund $1 - $10,000 $1 - $10,000
The compensation of the Officers, other than the Corporation's Chief
Compliance Officer, who are interested persons (as defined in the 1940 Act) of
the Investment Manager is paid by the Investment Manager. The Corporation pays
the compensation of all other Directors of the Corporation who are not
interested persons of the Investment Manager for services or expenses incurred
in connection with attending meetings of the Board of Directors and pays the
compensation of the Chief Compliance Officer. The Directors and Officers as a
group own less than 1% of each Fund's shares. Set forth below is the Directors
and Chief Compliance Officer's compensation for the most recent fiscal year:
Aggregate Pension or Estimated Total
Compensation Retirement Benefits Annual Compensation
Name of Person From Accrued As Part of Benefits Upon From
Position Corporation Corporation Expenses Retirement Corporation
Disinterested Directors
Clayton W.H. Chow $1,200.00 0 0 $1,200.00
Director
Lynden M. Keala $1,200.00 0 0 $1,200.00
Director
Stuart S. Marlowe $1,200.00 0 0 $1,200.00
Director
Karen T. Nakamura $1,000.00 0 0 $1,000.00
Director
Kim F. Scoggins $1,200.00 0 0 $1,200.00
Director
Chief Compliance Officer
Nora B. Simpson $30,212 0 0 $30,212
Interested Directors
Terrence K.H. Lee 0 0 0 0
Director, President
Code of Ethics
The Corporation has adopted a Code of Ethics under Rule 17j-1 of the 1940
Act that permits personnel to purchase and sell securities for their personal
accounts, including securities that may be purchased or held by a Fund. The
Distributor and Investment Manager have adopted a joint Code of Ethics under
Rule 17j-1 of the 1940 Act and Rule 204A-1 of the Advisers Act of 1940, as
amended, that permits personnel to purchase and sell securities for their
personal accounts, including securities that may be purchased or held by a
Fund.
Proxy Voting Policies
The Proxy Voting Procedures ("Procedures") of the Corporation are
attached as Exhibit A to this SAI. The purpose of these Procedures is to set
forth the process by which a Fund will vote proxies related to the assets in
its investment portfolio. Under normal circumstances, a Fund does not hold any
voting securities in its investment portfolio. However, under limited
circumstances, a Fund may hold money market mutual fund shares. The Procedures
have been approved by the Board and may be amended only by the Board.
The Board has delegated its voting responsibilities and duties with
respect to proxy votes for portfolio securities to Lee Financial Group Inc.,
provided that voting determinations are made in accordance with proxy voting
procedures and guidelines that have been approved by the Board.
Information regarding how a Fund voted proxies relating to portfolio
securities for the most recent 12-month period ended June 30 is available,
without charge, upon request, by contacting the Investment Manager at (800)
354-9654 or by visiting the Funds' website at www. leehawaii.com or the SEC's
website at www.sec.gov.
Disclosure of Portfolio Holdings Policies
The Policies and Procedures Relating to Selective Disclosure of Portfolio
Holdings ("Procedures") of the Corporation are attached as Exhibit C to this
SAI.
The Funds' disclosure of portfolio holdings is currently limited to its
primary service providers, including its independent auditors, custodian,
administrator and legal counsel, in connection with the on-going operations of
the Fund.
INVESTMENT MANAGEMENT AGREEMENT
Subject to the authority of the Directors and under the laws of the State
of Maryland, the Investment Manager and the Corporation's Officers will
supervise and implement each Fund's investment activities. The Investment
Manager implements the investment program of each Fund and the composition of
its portfolio on a day-to-day basis.
The Investment Management Agreement between the Investment Manager and the
Corporation provides that the Investment Manager will provide portfolio
management services to a Fund including the selection of securities for the
Fund to purchase, hold or sell, supply investment research to the Fund and the
selection of brokers through whom the Fund's portfolio transactions are
executed. The Investment Manager is responsible for evaluating the portfolio
and overseeing its performance.
The Investment Manager also administers the business affairs of the
Corporation, furnishes offices, necessary facilities and equipment, provides
administrative services, and permits its Officers and employees to serve
without compensation as Directors and Officers of the Corporation, other than
as the Corporation's Chief Compliance Officer, if duly elected to such
positions. The Investment Manager provides or pays the cost of certain
management, supervisory and administrative services required in the normal
operation of the Corporation. This includes investment management and
supervision, remuneration of Directors, Officers, other than the Corporation's
Chief Compliance Officer, and other personnel, rent, and such other items that
arise in daily corporate administration. Daily corporate administration
includes the coordination and monitoring of any third parties furnishing
services to the Corporation, providing the necessary office space, equipment
and personnel for Fund business and assisting in the maintenance of each Fund's
federal registration statement and other documents required to comply with
federal and state law. Not considered normal operating expenses, and therefore
payable by the Corporation, are organizational expenses, custodian fees,
shareholder services and transfer agency fees, taxes, interest, governmental
charges and fees, including registration of a Fund and its shares with the SEC
and the Securities Departments of the various States, brokerage costs, dues and
all extraordinary costs and expenses including but not limited to legal and
accounting fees incurred in anticipation of or arising out of litigation or
administrative proceedings to which the Corporation, its Directors or Officers
may be subject or a party thereto. As compensation for the services provided
by the Investment Manager, each Fund pays the Investment Manager a fee at the
annual rate of 0.50 of one percent (0.50%) of its average daily net assets.
Fees paid by the Municipal Fund for the three most recent fiscal years:
Investment Management Management
Agreement Fees Waived
2006* $771,191 $0
2005* $746,186 $0
2004* $726,550 $0
*Includes fees paid by both the Institutional and Investor Classes. The
Institutional Class commenced operations on October 22, 2002.
Investment Management Fees paid by the Municipal Fund are allocated to the
proper class of shares based on the assets in each class.
Fees paid by the Intermediate Fund Investor Class for the three most
recent fiscal years:
Investment Management Management
Agreement Fees Waived
2006 $47,836 $9,555
2005 $49,118 $9,862
2004 $42,370 $8,560
The Hawaii Intermediate Fund is contractually obligated to pay the
Investment Manager 0.50 of one percent (0.50%) of its average daily net assets
for the most recent fiscal year; however, the Investment Manager voluntarily
agreed to waive 0.10 of one percent (0.10%) of its average daily net assets.
This waiver can be modified or terminated at any time.
The Investment Management Agreement provides that the Investment Manager
shall not be liable for any error of judgment or of law, or for any loss
suffered by a Fund in connection with the matters to which the agreement
relates, except a loss resulting from willful misfeasance, bad faith or gross
negligence on the part of the Investment Manager in the performance of its
obligations and duties, or by reason of its reckless disregard of its
obligations and duties under the Investment Management Agreement.
In the event the expenses of each Fund for any fiscal year exceed the
limit set by applicable regulation of state securities commissions, if any, the
compensation due to the Investment Manager hereunder will be reduced by the
amount of such excess.
The current Investment Management Agreement between the Municipal Fund and
the Investment Manager was initially approved on May 14, 1991 and the
Investment Management Agreement between the Intermediate Fund and the
Investment Manager was initially approved on July 7, 1994. The Investment
Management Agreements continue in effect for successive annual periods, so long
as such continuance is specifically approved at least annually by the Directors
or by a vote of the majority of the outstanding voting securities of the Fund,
and, provided also that such continuance is approved by a vote of the majority
of the Directors who are not parties to the Agreements or interested persons of
any such party at a meeting held in person and called specifically for the
purpose of evaluating and voting on such approval. The Investment Management
Agreements provide that either party may terminate by giving the other not more
than sixty days', nor less than thirty days', written notice. Each Investment
Management Agreement will terminate automatically if assigned by either party.
The Investment Manager's activities are subject to the review and
supervision of the Corporation's Board of Directors, to whom the Investment
Manager renders periodic reports of each Fund's investment activities.
The Investment Manager also serves as administrator for the Corporation
pursuant to an Administrative Agreement initially approved by the Directors on
October 14, 1999. The Administrative Agreement is subject to annual renewal by
the Directors, including the Directors who are not interested persons of the
Corporation. Administrative services shall include the compliance matters of
the Funds. Pursuant to the Administrative Agreement, the administrator will
receive a fee calculated at an annual rate of up to 0.05 of one percent (0.05%)
of each Fund's average daily net assets.
The Administrator shall furnish each Fund administrative services.
Administrative services shall include, but are not limited to, the following
compliance matters of each Fund: filings with the SEC, the National
Association of Securities Dealers, and state and other regulatory organizations
(updating, amending and filing prospectus, annual and semi-annual reports,
proxy material and blue sky requirements); establishing and maintaining written
supervisory procedures and compliance manuals; researching and communicating
changes in applicable rules and regulations; and preserving all books and
records.
Fees paid by the Municipal Fund for the three most recent fiscal years:
Administrative Administrative
Agreement Fees Waived
2006* $30,211 $0
2005* $29,262 $0
2004* $28,457 $0
*Includes fees paid by both the Institutional and Investor Classes. The
Institutional Class commenced operations on October 22, 2002.
Fees paid by the Intermediate Fund Investor Class for the three most
recent fiscal years:
Administrative Administrative
Agreement Fees Waived
2006 $1,914 $0
2005 $1,963 $0
2004 $1,690 $0
Certain Officers and Directors of the Corporation are also Officers or
Directors, or both, of Lee Financial Group Inc. Terrence K.H. Lee, President
of the Corporation and the Investment Manager, owns the majority of the stock
of, and controls, the Investment Manager. The stock of the Investment Manager,
owned by Mr. Lee and by other stockholders who are not controlling persons, is
subject to certain agreements providing for rights of first refusal as to such
stock.
As of January 22, 2007, the following persons held of record or
beneficially 5% or more of the outstanding shares of the Hawaii Municipal Fund
Investor Class: None.
As of January 22, 2007, the following persons held of record or
beneficially 5% or more of the outstanding shares of the Hawaii Municipal Fund
Institutional Class:
Circle Trust Company (CAMCO)
80 West Street, Suite #201
Rutland, VT 05701
81.78%
Alton K. Fujii TTEE
Alton K. Fujii Revocable Trust
900 Punahou Street, #201
Honolulu, HI 96826
9.44%
Sandra M. Fujii TTEE
Sandra M. Fujii Revocable Trust
900 Punahou Street, #201
Honolulu, HI 96826
9.44%
As of January 22, 2007 the following persons held of record or
beneficially 5% or more of the outstanding shares of the Hawaii Intermediate
Fund Investor Class: None.
PORTFOLIO MANAGER
Louis D'Avanzo serves as the Portfolio Manager of each Fund.
Other Accounts Managed: The following provides information regarding
other accounts, other than the Funds, managed by Mr. D'Avanzo as of September
30, 2006.
Number of
Accounts Total Assets
Managed with Managed With
Number of Performance Performance
Type of Accounts Total Assets Based Based
Accounts Managed Managed Advisory Fees Advisory Fees
Registered
Investment
Companies None $0 None $0
Other Pooled
Investment
Vehicles None $0 None $0
Other Accounts 159 $33,409,467 None $0
Ownership of Securities: Mr. D'Avanzo did not beneficially own any
shares of the Funds as of September 30, 2006.
Compensation: Mr. D'Avanzo's compensation is a fixed salary that is
set by industry standards. His salary is not based on Fund or account
performance. In addition, all employees meeting certain participant
requirements, including Mr. D'Avanzo, are eligible to participate in the
Investment Manager's 401k plan profit sharing plan, in which certain
employer contributions are based on the overall financial condition of the
Investment Manager.
Conflicts of Interest: Mr. D'Avanzo is responsible for managing the
Funds as well as other accounts. Mr. D'Avanzo may manage accounts which may
have materially higher or lower fee arrangements than the Funds. The side-
by-side management of these funds may raise potential conflicts of interest
relating to cross trading, the allocation of investment opportunities and
the aggregation and allocation of trades. In addition, it is possible that
due to varying investment restrictions among accounts or other reasons,
certain investments could be made for some accounts and not others, or
conflicting investment positions could be taken among accounts.
The Investment Manager has a fiduciary responsibility to manage all
client accounts in a fair and equitable manner. The firm seeks to provide
best execution of all securities transactions and may aggregate and then
allocate securities to client accounts. To this end, the Investment Manager
has developed policies and procedures designed to mitigate and manage the
potential conflicts of interest that may arise from side-by-side management.
In addition, the Investment Manager and the Funds have adopted policies
limiting the circumstances under which cross-trades may be effected by the
Investment Manager between a Fund and another client account. The
Investment Manager conducts periodic reviews of trades for consistency with
these policies.
CUSTODIAN
Union Bank of California, N.A., 475 Sansome Street, San Francisco,
California 94111, is the custodian for each Fund and has custody of all
securities and cash pursuant to the terms of a custodian agreement with the
Corporation. The custodian, among other things, attends to the collection of
principal and income, and payment for the collection of proceeds of securities
bought and sold by the Fund.
FUND ACCOUNTING
Ultimus Fund Solutions, LLC., 225 Pictoria Drive, Suite #450, Cincinnati,
Ohio 45246, provides fund accounting services for the Corporation. The monthly
accounting fee schedule for each Fund is as follows:
Calculated fee will be based upon prior month combined average net assets
for the Municipal Fund and Intermediate Fund:
Base fee per year of $60,000.00 plus:
First $500 million of average daily net assets, .010% (1 basis point)
In excess of $500 million, .005% (1/2 basis point)
The above base fee assumes two portfolios, each with a single class of
shares. For a portfolio with more than one class of shares, there is an
additional charge of $500.00 per month for each additional class of shares.
The forgoing fees include 100 portfolio trades per month (exclusive of
daily cash investments). For portfolios with more than 100 trades in a month,
there is a charge of $5.00 for each trade in excess of 100.
Additionally, each portfolio is charged $250.00 per month for performance
reporting.
Fees paid by the Municipal Fund for the three most recent fiscal years:
Fund Accounting Fund Accounting
Agreement Fees Waived
2006* $22,181 $88,794
2005* $79,860 $53,716
2004* $104,429 $0
*Includes fees paid by both the Institutional and Investor Classes. The
Institutional Class commenced operations on October 22, 2002.
Fees paid by the Intermediate Fund Investor Class for the three most
recent fiscal years:
Fund Accounting Fund Accounting
Agreement Fees Waived
2006 $0 $5,343
2005 $6,747 $2,827
2004 $5,598 $0
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The independent registered public accounting firm for the Corporation is
Tait, Weller & Baker LLP, 1818 Market Street, Suite #2400, Philadelphia,
Pennsylvania 19103-2108.
PORTFOLIO TRANSACTIONS
The Investment Manager will place orders for portfolio transactions for
the Funds with broker-dealer firms giving consideration to the quality, quantity
and nature of each firm's professional services. These services include
execution, clearance procedures, wire service quotations and statistical and
other research information provided to the Funds and the Investment Manager,
including quotations necessary to determine the value of the Funds' net assets.
Any research benefits derived are available for all clients of the Investment
Manager. Since statistical and other research information is only
supplementary to the research efforts of the Investment Manager and still must
be analyzed and reviewed by its staff, the receipt of research information is
not expected to materially reduce its expenses. In selecting among the firms
believed to meet the criteria for handling a particular transaction, a Fund or
the Investment Manager may (subject always to best price and execution) take
into consideration that certain firms provide market, statistical or other
research information to the Fund. Securities may be acquired through firms
that are affiliated with the Corporation, its Investment Manager, or its
Distributor and other principal underwriters acting as agent, and not as
principal. Transactions will only be placed with affiliated brokers if the
price to be paid by a Fund is at least as good as the price the Fund would pay
to acquire the security from other unaffiliated parties.
If it is believed to be in the best interests of a Fund, the Investment
Manager may place portfolio transactions with unaffiliated brokers or dealers
who provide the types of service (other than sales) described above, even if it
means the Fund will have to pay a higher commission (or, if the dealer's profit
is part of the cost of the security, will have to pay a higher price for the
security) than would be the case if no weight were given to the broker's or
dealer's furnishing of those services. This will be done, however, only if, in
the opinion of the Investment Manager, the amount of additional commission or
increased cost is reasonable in relation to the value of the services.
If purchases or sales of securities of the Funds and of one or more other
clients advised by the Investment Manager are considered at or about the same
time, transactions in such securities will be allocated among the several
clients in a manner deemed equitable to all by the Investment Manager, taking
into account the respective sizes of each Fund and the amount of securities to
be purchased or sold. Although it is possible that in some cases this
procedure could have a detrimental effect on the price or volume of the
security as far as the Fund is concerned, it is also possible that the ability
to participate in volume transactions and to negotiate lower brokerage
commissions generally will be beneficial to the Fund.
The Directors have adopted certain policies incorporating the standards of
Rule 17e-1 under the 1940 Act issued by the SEC which requires that the
commission paid to the Distributor and other affiliates of the Corporation must
be reasonable and fair compared to the commissions, fees or other remuneration
received or to be received by other brokers in connection with comparable
transactions involving similar securities during a comparable period of time.
The rule and procedures also contain review requirements and require the
Distributor to furnish reports to the Directors and to maintain records in
connection with such reviews.
Commissions, fees or other remuneration paid to the Distributor for
portfolio transactions for the Municipal Fund and Intermediate Fund for the
three most recent fiscal years: 2006-none, 2005-none, 2004-none.
PURCHASING AND REDEEMING FUND SHARES
Shares of a Fund may be purchased and redeemed by customers of broker-
dealers or other financial intermediaries ("Service Agents") which have
established a shareholder servicing relationship with their customers. These
Service Agents are authorized to designate other intermediaries to accept
purchase and redemption orders on a Fund's behalf. A Fund will be deemed to
have received a purchase or redemption order when an authorized Service Agent,
or authorized designee, accepts the order. Customer orders will be priced at
the Fund's net asset value next computed after they are accepted by a Service
Agent or authorized designee. Service Agents may impose additional or
different conditions on purchases or redemptions of Fund shares and may charge
transaction or other account fees. The Service Agent is responsible for
transmitting to its customers a schedule of any such fees and information
regarding additional or different purchase or redemption conditions.
Shareholders who are customers of Service Agents should consult their Service
Agent for information regarding these fees and conditions. Amounts paid to
Service Agents may include transaction fees and/or service fees, which would
not be imposed if shares of a Fund were purchased directly from the
Distributor. Service Agents may provide shareholder services to their
customers that are not available to a shareholder dealing directly with the
distributor.
Service Agents may enter confirmed purchase and redemption orders on
behalf of their customers. If shares of a Fund are purchased in this manner,
the Service Agent must receive your investment order before the close of the New
York Stock Exchange, and transmit it to the Fund's Transfer Agent prior to a
designated time contracted with the Transfer Agent, but not later than 8:00 pm
EST, to receive that day's share price. Proper payment for the order must be
received by the Transfer Agent within three (3) business days following the
trade date. Service Agents are responsible to their customers and the Funds
for timely transmission of all subscription and redemption requests, investment
information, documentation and money.
The Investment Manager and its affiliates provide additional cash payments
out of their own resources to financial intermediaries that sell shares of the
Funds or provide other services. Such payments are in addition to any sales
charges, 12b-1 fees and/or shareholder services fees paid by the Fund. Cash
compensation also may be paid to intermediaries for inclusion of the Funds on a
sales list or in sales programs. These payments may create an incentive for a
financial intermediary or its employees to recommend or sell shares of the
Funds to you.
The issuance of shares is recorded on the books of the Funds in full and
fractional shares carried to the third decimal place. To avoid additional
operating costs and for investor convenience, share certificates will no longer
be issued.
Under certain circumstances, an investor may purchase Fund shares by
delivering to a Fund securities eligible for the Fund's portfolio. All in-kind
purchases are subject to prior approval by the Investment Manager. Prior to
sending securities to a Fund with a purchase order, investors must contact the
Investment Manager at (808) 988-8088 for verbal approval on the in-kind
purchase. Acceptance of such securities will be at the discretion of the
Investment Manager based on its judgment as to whether, in each case,
acceptance of the securities will allow a Fund to acquire the securities at no
more than the cost of acquiring them through normal channels. Fund shares
purchased in exchange for securities are issued at the net asset value next
determined after receipt of securities and the purchase order. Securities
accepted for in-kind purchases will be valued in the same manner as portfolio
securities at the value next determined after receipt of the purchase order.
Approval of the Investment Manager of in-kind purchases will not delay
valuation of the securities accepted for in-kind purchases or Fund shares
issued in exchange for such securities. The in-kind exchange, for tax
purposes, constitutes the sale of one security and the purchase of another.
The sale may involve either a capital gain or loss to the shareholder for
federal income tax purposes.
The minimum initial investment for Investor Class shares is $10,000.00
and the minimum subsequent purchase amount is $100.00. This requirement may be
waived under certain circumstances. The minimum initial investment for
Institutional Class shares is $1,000,000.00 and the minimum subsequent purchase
amount is $1,000.00.
THE DISTRIBUTOR
Shares of the Funds are offered on a continuous basis through First
Pacific Securities, Inc. 2756 Woodlawn Drive, #6-201, Honolulu, Hawaii 96822
(the "Distributor"), a wholly-owned subsidiary of the Investment Manager.
Pursuant to a Distribution Agreement, the Distributor will purchase shares of
the Funds for resale to the public, either directly or through securities
dealers and brokers, and is obligated to purchase only those shares for which it
has received purchase orders. A discussion of how to purchase and redeem Fund
shares and how Fund shares are priced is contained in the Prospectus.
Mr. Lee, Director, President and Chief Executive Officer of the
Distributor, Ms. Meyer, Director, Vice President and Assistant Treasurer of the
Distributor, Ms. Lee, Director, Vice President and Secretary of the Distributor,
Ms. Simpson, Vice President, Chief Compliance Officer, Chief Financial Officer
and Treasurer of the Distributor and Mr. D'Avanzo, Vice President of the
Distributor, are affiliated with both the Corporation and the Distributor.
Under the Distribution Agreement between the Corporation and the Distributor,
the Distributor pays the expenses of distribution of Fund shares, including
preparation and distribution of literature relating to the Funds and their
investment performance and advertising and public relations material. The
Corporation bears the expenses of registration of its shares with the SEC and
of sending prospectuses to existing shareholders. The Distributor pays the
cost of qualifying and maintaining qualification of the shares for sale under
the securities laws of the various states and permits its Officers and
employees to serve without compensation as Directors and Officers of the
Corporation if duly elected to such positions.
The Distribution Agreement continues in effect from year to year if
specifically approved at least annually by the shareholders or Directors of the
Corporation and by the Corporation's disinterested Directors in compliance with
the 1940 Act. The Agreement may be terminated without penalty upon thirty days
written notice by either party and will automatically terminate if it is
assigned.
Investor Class shares are subject to a Distribution Plan. The amounts
payable to the Distributor under the Distribution Plan may not fully reimburse
the Distributor for its actual distribution related expenses. Distribution
Plan payments are subject to limits under the rules of the National Association
of Securities Dealers. There is no Distribution Plan for Institutional Class
shares.
Under the Distribution Plan, a Fund will pay the Distributor for
expenditures which are primarily intended to result in the sale of the
respective Funds' Investor Class shares such as advertising, marketing and
distributing the Funds' Investor Class shares and servicing a Fund's Investor
Class investors, including payments for reimbursement of and/or compensation to
brokers, dealers, certain financial institutions, (which may include banks) and
other intermediaries for administrative and accounting services for Investor
Class investors who are also their clients. Such third party institutions will
receive fees based on the average daily value of a Fund's Investor Class shares
owned by investors for whom the institution performs administrative and
accounting services.
The Distribution Plan provides that it will continue in full force and
effect if ratified at the first meeting of a Fund's shareholders and thereafter
from year to year so long as such continuance is specifically approved by a
vote of the Directors and also by a vote of the disinterested Directors, cast
in person at a meeting called for the purpose of voting on the Distribution
Plan. The Distribution Plan for each Fund was approved by each Fund's initial
shareholder(s). The Distribution Plan may not be amended to increase
materially the amount to be spent for the services described therein without
approval by a vote of a majority of the outstanding voting shares of the
respective Fund's Investor Class, and all material amendments of a Distribution
Plan must be approved by the Directors and also by the disinterested Directors.
The Plan may be terminated at any time by a vote of a majority of the
disinterested Directors or by a vote of a majority of the outstanding voting
shares of the respective Fund's Investor Class. While the Distribution Plan is
in effect, selection of the nominees for disinterested Directors is committed
to the discretion of the disinterested Directors.
The Distribution Plan provides that the Investor Class of a Fund may incur
certain expenses which may not exceed a maximum amount equal to 0.25% of the
average daily net assets of the Investor Class of a Fund. Under the
Distribution Plan, the Distributor is entitled to receive from the Investor
Class of a Fund a distribution fee, which is accrued daily and paid monthly, of
up to 0.25% of the average daily net assets of the Investor Class of a Fund.
The Distribution Plan obligates the Investor Class of a Fund, during the period
it is in effect, to accrue and pay to the Distributor on behalf of the Investor
Class of the Fund the fee agreed to under the Distribution Plan. Payments
under the Distribution Plan are tied exclusively to marketing and distribution
expenses actually incurred by the Distributor, and the payments may not exceed
distribution expenses actually incurred. Institutional Class shares will not
incur any distribution expenses.
The Plan provides that the Distributor must submit quarterly reports to
the Directors setting forth all amounts paid under the Distribution Plan and the
purposes for which such expenditures were made, together with such other
information as from time to time is reasonably requested by the Directors.
Distribution Plan payments by the Municipal Fund Investor Class, by
category, for the most recent fiscal year were as follows: Advertising $0;
Seminars and Meetings $0; Printing $0; Rent $14,178; Utilities $4,964; Salaries
and Wages $198,845; Employee Benefits $8,616; Miscellaneous $0; Total $226,603.
Distribution Plan payments by the Intermediate Fund Investor Class, by
category, for the most recent fiscal year were as follows: None.
TRANSFER AGENT
First Pacific Recordkeeping, Inc., 2756 Woodlawn Drive, #6-201, Honolulu,
Hawaii 96822, a wholly-owned subsidiary of the Investment Manager, serves as
transfer agent, dividend disbursing agent and redemption agent pursuant to a
Transfer and Dividend Disbursing Agent Agreement initially approved by the
Directors on March 15, 1994. The Transfer and Dividend Disbursing Agent
Agreement is subject to annual renewal by the Directors, including the
Directors who are not interested persons of the Corporation or of the Transfer
Agent. Pursuant to the Transfer and Dividend Disbursing Agent Agreement, the
Transfer Agent will receive a fee calculated at an annual rate of 0.06 of one
percent (0.06%) of each Fund's average daily net assets and will be reimbursed
out-of-pocket expenses incurred on the Fund's behalf.
The Transfer Agent acts as paying agent for all Fund expenses and provides
all the necessary facilities, equipment and personnel to perform the usual or
ordinary services of the Transfer and Dividend Disbursing Agent, including:
receiving and processing orders and payments for purchases of shares, opening
stockholder accounts, preparing annual stockholder meeting lists, mailing proxy
material, receiving and tabulating proxies, mailing stockholder reports and
prospectuses, withholding certain taxes on nonresident alien accounts,
disbursing income dividends and capital distributions, preparing and filing
U.S. Treasury Department Form 1099 (or equivalent) for all stockholders,
preparing and mailing confirmation forms to stockholders for all purchases and
redemptions of a Fund's shares and all other confirmable transactions in
stockholders' accounts, recording reinvestment of dividends and distributions
of each Fund's shares and causing redemption of shares for and disbursements of
proceeds to stockholders.
The Shareholder Services Agreement does not duplicate services provided
under the Transfer Agent Agreement. Clerical services provided by the Transfer
Agent on behalf of the Municipal Fund Investor Class under the Shareholder
Services Agreement include personnel as needed, equipment and supplies to
respond to and process the shareholder inquiries. Bookkeeping services
provided by the Transfer Agent on behalf of the Municipal Fund Investor Class
pursuant to the Shareholder Services Agreement, are generally limited to
records of transactions and expenditures originating with the Transfer Agent in
connection with providing supplemental shareholder services and maintaining
shareholder relations and communications. As compensation for its clerical,
bookkeeping and shareholder services, the Transfer Agent receives a fee
computed daily and payable monthly, at an annualized rate of up to 0.10% of the
average daily net assets of the Municipal Fund Investor Class. As of January
21, 1998, the Intermediate Fund no longer charges shareholder service fees.
The Municipal Fund Institutional Class does not pay fees under the Shareholder
Services Agreement.
Fees paid by the Municipal Fund for the three most recent fiscal years:
Transfer Transfer Shareholder Shareholder
Agent Agent Services Services
Agreement Fees Waived Agreement Fees Waived
2006* $111,298 $0 $151,067 $0
2005* $104,480 $0 $146,321 $0
2004* $105,152 $0 $142,295 $0
*Includes fees paid by both the Institutional and Investor Classes. The
Institutional Class commenced operations on October 22, 2002.
Fees paid by the Intermediate Fund Investor Class for the three most
recent fiscal years:
Transfer Transfer Shareholder Shareholder
Agent Agent Services Services
Agreement Fees Waived Agreement Fees Waived
2006 $9,957 $0 $0 $0
2005 $8,242 $0 $0 $0
2004 $6,282 $0 $0 $0
Financial Statements
The Financial Statements of the Funds will be audited at least annually by
Tait, Weller & Baker LLP, Independent Registered Public Accounting Firm. The
Financial Statements for the fiscal year ended September 30, 2006, Financial
Highlights for the respective periods presented and the report of Tait, Weller
& Baker LLP are incorporated by reference into this SAI. However, no other
parts of the 2006 Annual Report to Shareholders are incorporated by reference
to this SAI. Shareholders may get copies of the Annual Report free of charge
by calling the Corporation at the telephone number on the front page of this
SAI or by visiting the Funds' website at www.leehawaii.com.
EXHIBIT A
FIRST PACIFIC MUTUAL FUND, INC.
PROXY VOTING PROCEDURES
I. INTRODUCTION
The following represents the Proxy Voting Procedures ("Procedures") of
First Pacific Mutual Fund and each series thereof ("Fund"). The purpose of
these Procedures is to set forth the process by which the Fund will vote
proxies related to the assets in its investment portfolio. Under normal
circumstances the Fund does not hold any voting securities in its investment
portfolio. The Fund may hold money market mutual fund shares under limited
circumstances. These Procedures have been approved by the Board of the Fund
and may be amended only by the Board.
II. DELEGATION OF VOTING RESPONSIBILITY
The Board hereby delegates its voting responsibilities and duties with
respect to proxy votes for portfolio securities to Lee Financial Group Inc.
("Adviser"), provided that voting determinations are made in accordance with
proxy voting procedures and guidelines that have been approved by the Board.
III. APPROVAL AND REVIEW OF PROCEDURES
The Adviser has adopted proxy voting procedures and guidelines in
connection with the voting of portfolio securities for its clients, as attached
hereto as an exhibit. The Board hereby approves such procedures and
guidelines.
LEE FINANCIAL GROUP INC.
PROXY VOTING POLICIES
I. INTRODUCTION
Lee Financial Group Inc. ("Adviser") is the investment adviser to First
Pacific Mutual Fund, Inc. ("Fund") and certain individuals ("Accounts" and
collectively with the Fund "Clients"). Under normal circumstances the Fund is
invested in tax-exempt and other permissible fixed income instruments. The
Fund may invest in tax-exempt money market instruments, including money market
mutual funds under limited circumstances. The Adviser has the authority to
vote proxies for the Fund. The Adviser does not have authority to vote proxies
for the Accounts. Therefore, under normal circumstances the Adviser does not
vote proxies for clients.
Proxies must be voted in the best interest of the Fund. The Guidelines
set forth below summarize the Adviser's position on various issues of concern
to investors, and give a general indication of how Fund portfolio securities,
specifically money market mutual funds, will be voted on proposals dealing with
particular issues. The Guidelines are not exhaustive and do not include all
potential voting issues.
In voting proxies, the Adviser is guided by general fiduciary principles.
The Adviser will act prudently, solely in the interest of the beneficial owners
of the Fund.
II. CONFLICTS OF INTERESTS
The Adviser may be subject to conflicts of interest in the voting of
proxies due to business or personal relationships it maintains with persons
having an interest in the outcome of certain votes. If the Adviser determines
that a particular proxy vote involves a material conflict of interest, it may
resolve the conflict of interest in several ways, including, without
limitation, voting pursuant to the direction of the Fund's Board or a committee
of the Board or abstaining. Conflicts may arise as to votes involving an
investment company's investment adviser, the underwriter, their affiliates or
affiliates of the investment company. In such cases, the Adviser will follow
the Guidelines described herein, including the process for handling conflicts.
III. PROXY ADMINISTRATION
The portfolio manager and the compliance officer are primarily
responsible for monitoring corporate actions, making voting decisions and
ensuring that proxies are submitted timely, consistent with this policy.
A report summarizing each corporate issue and corresponding proxy vote
will be available to clients upon request.
IV. GUIDELINES
Mutual Fund Proxies
Election of Directors
Vote the election of directors on a CASE-BY-CASE basis.
Converting Closed -end Fund to Open End Fund
Vote conversion proposals on a CASE-BY-CASE basis.
Proxy Contests
Vote proxy contests on a CASE-BY-CASE basis.
Investment Advisory Agreements
Vote investment advisory agreements on a CASE-BY-CASE basis.
Approving New Classes or Series of Shares
Generally, vote FOR the establishment of new classes or series of shares.
Preferred Stock Proposals
Vote the authorization for or increase in preferred shares on a CASE-BY-
CASE basis.
1940 Act Policies
Vote these proposals on a CASE-BY-CASE basis.
Changing a Fundamental Restriction to a Nonfundable Restriction
Vote these proposals on a CASE-BY-CASE basis.
Change Fundamental Investment Objective to Nonfundamental
Generally, vote AGAINST proposals to change a funds fundamental
investment objective to nonfundamental.
Name Rule Proposals
Vote these proposals on a CASE-BY-CASE basis.
Disposition of Assets/Termination/Liquidation
Vote these proposals on a CASE-BY-CASE basis.
Changes to the Charter Document
Vote changes to the charter document on a CASE-BY-CASE basis.
Changing the Domicile of a Fund
Vote reincorporations on a CASE-BY-CASE basis.
Change in Fund's Subclassification
Vote these proposals on a CASE-BY-CASE basis.
Authorizing the Board to Hire and Terminate Subadvisors Without
Shareholder Approval
Generally, vote FOR proposals.
Distribution Agreements
Vote these proposals on a CASE-BY-CASE basis.
Master-Feeder Structure
Generally, vote FOR the establishment of a master-feeder structure.
Changes to the Charter Document
Vote changes to the charter document on a CASE-BY-CASE basis.
Mergers
Vote merger proposals on a CASE-BY-CASE basis.
Establish Director Ownership Requirement
Generally, vote AGAINST shareholder proposals for the establishment of a
director ownership requirement.
Reimburse Shareholder for Expenses Incurred
Voting to reimburse proxy solicitation expenses should be analyzed on a
CASE-BY-CASE basis.
Terminate the Investment Advisor
Vote to terminate the investment advisor on a CASE-BY-CASE basis.
Exhibit B
FIRST PACIFIC MUTUAL FUND
(the "Fund")
Policies and Procedures Relating to Selective Disclosure of Portfolio Holdings
A. Background
Pursuant to the requirements of the Securities Act of 1933, as amended,
and the Investment Company Act of 1940, as amended (the "1940 Act"), the Fund
has filed a registration statement on Form N-1A with the Securities and
Exchange Commission (the "SEC"). Form N-1A requires the Fund to disclose in
its prospectuses and statements of additional information certain information
about its policies and procedures with respect to the disclosure of its
portfolio securities and any ongoing arrangements to make available information
about its portfolio securities. The following policies and procedures describe
the circumstances under which the Fund or its investment adviser, Lee Financial
Group ("LFG"), may disclose the Fund's portfolio securities. Notwithstanding
such policies and procedures, any disclosures of the Fund's portfolio
securities must be consistent with the antifraud provisions of the federal
securities laws and the Fund's or LFG's fiduciary duties.
B. Policies and Procedures
1. Disclosure of Portfolio Holdings. The Fund and LFG shall only disclose
information concerning securities held in the Fund's portfolios under the
following circumstances:
(i) Within 15 days following the end of each calendar month, LFG shall
post the securities held by each of the Fund's portfolios on any
website maintained for the Fund or otherwise in a manner available
to all shareholders, or shall disclose holdings only in publicly
available SEC filings; or
(ii) The Fund or LFG may disclose the Fund's portfolio securities
holdings to selected third parties when the Fund has a legitimate
business purpose for doing so; or
(a) Examples of instances in which selective disclosure of the
Fund's portfolio securities may be appropriate include
disclosure for due diligence purposes to an investment
adviser that is in merger or acquisition talks with LFG;
disclosure to a newly hired investment adviser or
sub-adviser prior to its commencing its duties; disclosure
to third party service providers of auditing, custody,
proxy voting and other services to the Fund; or disclosure
to a rating or ranking organization.
(iii) As required by the federal securities laws, including the 1940 Act,
the Fund shall disclose its portfolio holdings in its applicable
regulatory filings, including shareholder reports, reports on Form
N-CSR or such other filings, reports or disclosure documents as the
applicable regulatory authorities may require.
2. Confidentiality and Duty not to Trade. In the event that the Fund or LFG
discloses the Fund's portfolio securities holdings to a selected third party
for a legitimate business purpose, such third party shall be required to keep
the information confidential and shall not trade on such information.
3. Prohibition against Compensation. Neither the Fund, LFG nor any of their
affiliated persons (as that term is defined in the 1940 Act) shall receive
compensation in any form, whether in cash or otherwise, in connection with the
disclosure of information about the Fund's portfolio securities.
4. Persons Authorized to Disclose Information. With respect to the monthly
disclosure of portfolio holdings on any Fund website, LFG's president or the
Fund's Chief Compliance Officer is authorized to prepare and post to any Fund
website its portfolio holdings. With respect to any other disclosure of the
Fund's portfolio holdings, the Fund's President and Treasurer and LFG's
president shall be authorized to disclose such information.
5. Shareholders' Best Interests and Conflicts of Interest. In order to ensure
that the disclosure of the Fund's portfolio securities is in the best interests
of the Fund's shareholders and to avoid any potential or actual conflicts of
interest with LFG, the Fund's principal underwriter or any affiliated person
(as that term is defined in the 1940 Act) of such entities, the disclosure of
any of the Fund's portfolio securities for legitimate business purposes shall
be approved by the Fund's Board of Directors in advance of such disclosure.
This requirement shall not apply to the disclosure of the Fund's portfolio
securities to the Fund's existing service providers of auditing, custody, proxy
voting and other services to the Fund in connection with the provision of their
services to the Fund.
6. Board Oversight. The Board shall receive quarterly reports from LFG
stating whether disclosures were made concerning the Fund's portfolio holdings,
pursuant to these policies and procedures, during the previous quarter, and if
so, such report shall describe to whom and under what circumstance such
disclosures were made.
Exhibit C
FIRST PACIFIC MUTUAL FUND
(the "Fund")
Form of Policies and Procedures With Respect to
Frequent Purchases and Redemptions
Section 1. Policy
The Board of Directors (the "Board") of the Fund has determined that
market timing or frequent, short-term trading is not in the best interest of
the Fund or its shareholders. In order to deter such trading activity, the
Board has determined to limit shareholders in each Fund to six exchanges among
the Funds or equivalent purchase and redemption transactions, within a one-year
period, other than transactions associated with automatic purchases or
redemptions or transactions in omnibus accounts as described below. In order
to implement this policy, the Funds are directed to monitor trading activity in
the Funds and follow the procedures set forth in Section II. The Board
recognizes that the procedures set forth in Section II may differ from the
procedures used by various financial intermediaries for similar purposes and it
is also recognized that there is no guarantee that the Fund's administrator
("Administrator") will be able to identify individual shareholders who may be
making frequent, short-term trades or curtail their trading activity.
Section II. Procedures
On a bi-weekly basis (once every two weeks), the Administrator shall
determine which accounts have placed large exchanges among the Funds using a
specified threshold. Initially, the threshold shall be $25,000; however, the
threshold may be increased or decreased based upon the initial threshold
serving as an adequate basis for detection of excessive short-term trading.
The account history for every exchange transaction over such threshold shall be
reviewed.
If the Administrator determines that an account shows a pattern of
excessive trading and/or excessive exchanging among the Funds, the account
shall be flagged as a Potential Market Timer ("PMT") and shall undergo further
review. The Administrator may use an independent market timing system to
assist in the daily review of Fund accounts.
If after further review, it is determined that a PMT account has exceeded
the current trading policy limits or has otherwise engaged in market timing,
the Administrator shall take one of the following actions with respect to
accounts identified as belonging to the PMT:
Reject additional purchase or exchange orders;
Extend settlement of redemption transactions up to seven days;
Reject all trades in the current PMT account; or
Terminate the selling group agreement with the PMT.
It is understood that it may not be possible to monitor all accounts
belonging to the PMT, but reasonable efforts will be made to do so.
The administrator shall notify the Funds' transfer agent as well as the
PMT or, its related financial intermediary, that such action has been taken
using procedures adopted by the Administrator that are reasonably designed to
document the suspected market timing activity as well as keep the Funds and the
Board informed regarding implementation of the frequent trading policy.
For those accounts held in omnibus account arrangements with financial
intermediaries, including: broker-dealers; banks, investment advisers; record-
keepers; retirement plans; trusts; and fee-based program accounts, where such
omnibus accounts generally do not identify customers' trading activity on an
individual basis, the Fund shall seek assurances from the intermediary that it
has procedures adequate to monitor and address frequent, short-term trading.