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AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON SEPTEMBER 20, 2007
FILE NO. 333-145624
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM N-14
REGISTRATION STATEMENT UNDER
THE SECURITIES ACT OF 1933
PRE-EFFECTIVE AMENDMENT NO. 1
VANGUARD MONTGOMERY FUNDS
(EXACT NAME OF REGISTRANT AS SPECIFIED IN DECLARATION OF TRUST)
P.O. BOX 2600, VALLEY FORGE, PA 19482
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)
REGISTRANT'S TELEPHONE NUMBER (610) 669-1000
HEIDI STAM, ESQUIRE
P.O. BOX 876
VALLEY FORGE, PA 19482
APPROXIMATE DATE OF PROPOSED PUBLIC OFFERING:
AS SOON AS PRACTICABLE AFTER THIS REGISTRATION STATEMENT BECOMES EFFECTIVE.
NO FILING FEE IS REQUIRED BECAUSE AN INDEFINITE NUMBER OF SHARES HAVE PREVIOUSLY
BEEN REGISTERED PURSUANT TO RULE 24F-2 UNDER THE INVESTMENT COMPANY ACT OF 1940.
LAUDUS ROSENBERG U.S. LARGE/MID CAPITALIZATION
LONG/SHORT EQUITY FUND
a series of LAUDUS TRUST
Dear Shareholder:
A Special Meeting of Shareholders of Laudus Rosenberg U.S. Large/Mid
Capitalization Long/Short Equity Fund (the "Laudus Fund"), a series of Laudus
Trust (the "Laudus Trust"), has been scheduled for 8:30 a.m. Pacific Time on
November 21, 2007. If you are a shareholder of record as of the close of
business on September 24, 2007, you are entitled to vote at the Meeting and at
any adjournment or postponement of the Meeting.
While you are, of course, welcome to join us at the Meeting, most
shareholders are likely to cast their votes by filling out and signing the
enclosed Proxy Card. Whether or not you plan to attend the Meeting, we need your
vote. Please mark, sign, and date the enclosed Proxy Card and return it promptly
in the enclosed, postage-paid envelope so that the maximum number of shares may
be voted. You may also vote by touch-tone telephone or through the Internet as
described on the enclosed proxy card.
The attached combined prospectus/proxy statement is designed to give you
information relating to the proposal upon which you will be asked to vote. The
Board of Trustees of Laudus Trust is recommending that you approve a
reorganization of the Laudus Fund with and into Vanguard(R) Market Neutral Fund
(the "Vanguard Fund"), a substantially similar fund created within The Vanguard
Group of Investment Companies just for this purpose. Assuming approval of the
reorganization, each shareholder of the Laudus Fund will receive an amount of
shares of the Vanguard Fund equal in value to the shares of the Laudus Fund
owned by such holder at the time of the closing of the reorganization. We
encourage you to support the Trustees' recommendation to approve the proposal.
The following two pages highlight key points about the proposed
reorganization. Before you vote, however, please read the full text of the
combined prospectus/proxy statement.
Your vote is important to us. Please do not hesitate to call 1-800-423-2107
if you have any questions. Thank you for taking the time to consider this
important proposal and for your investment in the Laudus Rosenberg U.S.
Large/Mid Capitalization Long/Short Equity Fund.
Sincerely,
-----------------------------
Randall W. Merk
President of the Laudus Funds
KEY POINTS ABOUT THE PROPOSED REORGANIZATION
Purpose of the Reorganization
The purpose of the reorganization (the "Reorganization") is to make Laudus
Rosenberg U.S. Large/Mid Capitalization Long/Short Equity Fund (the "Laudus
Fund") a part of The Vanguard Group of Investment Companies ("The Vanguard
Group"), the second largest mutual fund firm in the United States. Under this
proposal, all of the assets and liabilities of the Laudus Fund would be
transferred to Vanguard(R) Market Neutral Fund (the "Vanguard Fund"), a
substantially similar fund created just for this purpose. The Vanguard Fund will
seek to provide long-term capital appreciation while limiting exposure to
general stock market risk. The Vanguard Fund's investment objective is similar
to that of the Laudus Fund, which seeks to increase the value of a shareholder's
investment through bull markets and bear markets using strategies that are
designed to limit exposure to general equity market risk. AXA Rosenberg
Investment Management LLC ("AXA Rosenberg"), the current sub-adviser for the
Laudus Fund, would serve as an investment adviser for the Vanguard Fund,
carrying out an investment program for its allocated portion of the portfolio of
the Vanguard Fund that is substantially similar to the investment program of the
Laudus Fund. The Vanguard Group, Inc. ("Vanguard"), however, would replace
Charles Schwab Investment Management, Inc. ("CSIM") as overall manager of your
investment, subject to the direction of the Board of Trustees of the Vanguard
Fund. Vanguard, through its Quantitative Equity Group, would also serve as an
investment adviser of the Vanguard Fund under a multimanager arrangement. In
that capacity, Vanguard would manage a separate portion of the portfolio of the
Vanguard Fund. The Vanguard Board of Trustees will have the flexibility to make
advisory changes - including changes to the contract of an existing adviser or
the appointment of different or additional investment advisers - without
shareholder vote, pursuant to an exemption obtained from the U.S. Securities and
Exchange Commission by Vanguard. After the reorganization, the Vanguard Fund
would continue investing your portfolio, and the Laudus Fund, which will have no
remaining assets, would be dissolved. Your existing Board of Trustees believes
that the Reorganization is in shareholders' best interests for the following
reasons:
Lower Shareholder Costs
Because they jointly own their management company, the Vanguard funds operate on
an "at-cost" basis. This operating structure, combined with the efficiencies
inherent in Vanguard's size, will result in lower operating expenses for the
Vanguard Fund than for the Laudus Fund. The Vanguard Fund is expected to feature
a total expense ratio of approximately 0.75% for the Vanguard Fund's Investor
share class and 0.60% for the Vanguard Fund's Institutional share class
(excluding dividend expenses on securities sold short) for its first full year
of operations following the Reorganization - an annual cost to shareholders of
$75.00 for each $10,000 invested for the Investor share class and $60.00 for
each $10,000 invested for the Institutional share class. By contrast, the Laudus
Fund's total expense ratio for the fiscal year ended March 31, 2007 was 1.54%
for the Investor share class and 1.24% for the Institutional share class
(excluding dividend expenses on securities sold short and pursuant to
contractually imposed expense limitations and/or fee waivers in effect through
ii
June 30, 2009) --an annual cost to shareholders of the Investor share class of
$154.00 for each $10,000 invested and $124.00 for each $10,000 invested for the
Institutional share class. The Laudus Fund's total expense ratio for the fiscal
year ended March 31, 2007 would have been 2.98% on the Investor share class and
2.68% on Institutional share class (including dividend expenses on securities
sold short and without the expense limitations and/or fee waivers).
Future Growth of the Fund
Given the competitive nature of the mutual fund industry and a desire to
simplify the Laudus Trust's offerings of long/short funds, the Board of Trustees
of the Laudus Fund determined that it would be prudent to enter into an
arrangement with Vanguard. Joining The Vanguard Group should enable the Laudus
Fund (as reorganized into the Vanguard Fund) to grow assets due to Vanguard's
strong market penetration and reputation as a low-cost provider. Vanguard
expects (but cannot guarantee) that assets in the reorganized Laudus Fund will
grow considerably once it joins The Vanguard Group as the result of investments
by new shareholders, which would result in a larger, more stable asset base for
the reorganized Laudus Fund. As a result, expenses would be shared by a larger
group of shareholders and expenses for existing shareholders may be reduced.
Continuity of Investment Management
If shareholders approve the Reorganization, the Vanguard Fund will have an
investment objective and primary investment strategies that are substantially
similar to those of the Laudus Fund. In slight contrast to the Laudus Fund's
advisory arrangements, under which CSIM serves as investment adviser and AXA
Rosenberg serves as sub-adviser, the Vanguard Fund will use a multimanager
arrangement. If shareholders approve the Reorganization, AXA Rosenberg will
manage an allocated portion of the Vanguard Fund's investment portfolio pursuant
to an investment advisory agreement with the Vanguard Trust, while Vanguard's
Quantitative Equity Group will manage a separate portion of the Vanguard Fund
under the terms of the Fourth Amended and Restated Funds' Service Agreement that
provides for Vanguard's at-cost advisory services to funds in The Vanguard Group
("Funds' Service Agreement"). AXA Rosenberg will continue the same investment
program it used for the Laudus Fund while Vanguard will utilize its own security
selection process. As noted above, the Vanguard Board of Trustees will have the
flexibility to make advisory changes, including changes to the contract of an
existing investment adviser or the appointment of different or additional
investment advisers, without a shareholder vote.
Expanded Shareholder Services
Shareholders of the Vanguard Fund will have access to a wide range of
shareholder services, including 24-hour account access, the ability to transact
through Vanguard's website, exchange privileges with other Vanguard funds, and
access to Vanguard's comprehensive investor education programs.
iii
Tax-Free Nature of The Reorganization
The Reorganization is expected to be accomplished on a tax-free basis.
Accordingly, it is expected that shareholders will not realize any capital gains
when the Laudus Fund shares are exchanged for shares of the Vanguard Fund.
How The Reorganization Will Affect Your Account
If shareholders approve the Reorganization, your Laudus Fund shares will be
exchanged, on a tax-free basis, for an equivalent dollar amount of Vanguard Fund
shares. Your account registration and account options will remain the same
unless you change them. In addition, your aggregate tax basis in the account
will remain the same.
iv
LAUDUS TRUST
LAUDUS ROSENBERG U.S. LARGE/MID CAPITALIZATION
LONG/SHORT EQUITY FUND
--------------------
NOTICE OF SPECIAL MEETING OF SHAREHOLDERS
--------------------
OCTOBER 5, 2007
To the Shareholders:
This is to notify you that a Special Meeting of Shareholders of the Laudus
Rosenberg U.S. Large/Mid Capitalization Long/Short Equity Fund will be held on
November 21, 2007, at 8:30 a.m. Pacific Time. The Special Meeting will be held
at the offices of Charles Schwab & Co., Inc., 101 Montgomery Street, San
Francisco, California, 94104, for the following purposes:
1. To approve or disapprove a proposal to reorganize Laudus
Rosenberg U.S. Large/Mid Capitalization Long/Short Equity Fund
into Vanguard(R) Market Neutral Fund.
2. To transact such other business as may properly come before the
Special Meeting.
All shareholders are cordially invited to attend the Special Meeting.
However, if you are unable to attend the Meeting, you are requested to mark,
sign and date the enclosed Proxy Card and return it promptly in the enclosed,
postage-paid envelope so that the Special Meeting may be held and a maximum
number of shares may be voted or vote by touch-tone telephone. Please see the
enclosed materials for telephone and Internet voting instructions.
The Trustees have fixed the close of business on September 24, 2007 as the
record date for determination of shareholders entitled to notice of, and to vote
at, the Special Meeting or any adjournment or postponement thereof.
By Order of the Board of Trustees
Randall W. Merk,
President of the Laudus Funds
--------------------------------------------------------------------------------
YOUR VOTE IS IMPORTANT
WE URGE YOU TO MARK, SIGN, DATE AND MAIL THE ENCLOSED PROXY CARD IN THE
POSTAGE-PAID ENVELOPE PROVIDED OR VOTE BY TOUCH-TONE TELEPHONE OR INTERNET SO
THAT YOU WILL BE REPRESENTED AT THE SPECIAL MEETING.
--------------------------------------------------------------------------------
ACQUISITION OF THE ASSETS AND LIABILITIES OF
LAUDUS ROSENBERG U.S. LARGE/MID CAPITALIZATION
LONG/SHORT EQUITY FUND
A SERIES OF LAUDUS TRUST
P.O. BOX 8032
BOSTON, MASSACHUSETTS 02266
(888) 517-9900
IN EXCHANGE FOR SHARES OF
VANGUARD(R) MARKET NEUTRAL FUND
A SERIES OF VANGUARD MONTGOMERY FUNDS
P.O. BOX 2600
VALLEY FORGE, PA 19482
(610) 669-1000
COMBINED PROSPECTUS/PROXY STATEMENT DATED OCTOBER 5, 2007
INTRODUCTION
Proposal Summary. This combined prospectus/proxy statement describes a
proposal to reorganize Laudus Rosenberg U.S. Large/Mid Capitalization Long/Short
Equity Fund (the "Laudus Fund") into a substantially similar fund created by The
Vanguard Group, Inc. ("Vanguard"), called Vanguard(R) Market Neutral Fund (the
"Vanguard Fund"). The reorganization involves a few basic steps. The Laudus Fund
will transfer all of its assets and liabilities to the Vanguard Fund.
Simultaneously, the Vanguard Fund will open an account for each shareholder of
the Laudus Fund, crediting it with an amount of shares of the Vanguard Fund
equal in value to the shares of the Laudus Fund owned by such holder at the time
of the reorganization. Thereafter, the Laudus Fund will be dissolved.
Read and Keep these Documents. Please read this entire prospectus/proxy
statement. This prospectus/proxy statement sets forth concisely the information
about the Vanguard Fund that a prospective investor should know before
investing. A statement of additional information (the "Reorganization SAI")
dated October 5, 2007, relating to this prospectus/proxy statement is
incorporated by reference into this prospectus/proxy statement and is available
by calling Charles Schwab Investment Management, Inc. ("CSIM") at (866) 452-8387
(for Institutional Shares), (800) 447-3332 (for Investor Shares) or (866)
452-8387 (for Registered Investment Professionals). In addition, the Laudus
Fund's prospectus and statement of additional information, each dated July 31,
2007, are incorporated by reference into this prospectus/proxy statement and are
considered part of this prospectus/proxy statement. These documents are
important and should be kept for future reference.
Additional Information is Available. The Vanguard Fund has been organized
as a separate investment portfolio under Vanguard Montgomery Funds, which filed
a registration statement with the U.S. Securities and Exchange Commission (the
"SEC") on August 22, 2007, in order to create the new fund. The Vanguard Fund's
registration statement has not yet been declared effective by the SEC but is
available without charge at the SEC's website (www.sec.gov). The Laudus Fund's
prospectus and statement of additional information, each dated July 31, 2007,
and its most recent annual report to shareholders, are available without charge
by calling or writing the Laudus Trust at the number or address above or at the
SEC's website.
The Laudus Trust's Board of Trustees has fixed the close of business on
September 24, 2007 as the record date for the determination of shareholders
entitled to notice of, and to vote at, the Special Meeting. This combined
Prospectus/Proxy Statement is expected to be first sent to shareholders on or
about October 5, 2007.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION, NOR HAS THE SECURITIES AND EXCHANGE COMMISSION PASSED UPON
THE ACCURACY OF THIS COMBINED PROSPECTUS/PROXY STATEMENT. ANY REPRESENTATION TO
THE CONTRARY IS A CRIMINAL OFFENSE.
ii
TABLE OF CONTENTS
I. OVERVIEW..............................................................1
II. DETAILS OF REORGANIZATION PROPOSAL....................................2
III. INVESTMENT ADVISORY ARRANGEMENTS.....................................17
IV. ADDITIONAL INFORMATION ABOUT VANGUARD MARKET NEUTRAL FUND.. .........22
V. MANAGEMENT OF VANGUARD MARKET NEUTRAL FUND...........................44
VI. GENERAL INFORMATION..................................................49
APPENDIX A - FORM OF AGREEMENT AND PLAN OF REORGANIZATION................A-1
53
I. OVERVIEW
The Proposed Reorganization. The Board of Trustees of Laudus Trust (the
"Laudus Trust") approved an Agreement and Plan of Reorganization providing for
the reorganization of the Laudus Fund into the Vanguard Fund (the
"Reorganization"). The trustees of the Laudus Trust concluded that the proposed
Reorganization is in the best interests of the Laudus Fund and its shareholders.
The trustees also concluded that the proposed Reorganization would not dilute
the interests of the Laudus Fund's shareholders. If shareholders do not approve
the Reorganization, the Laudus Fund will continue in existence (unless the
Laudus Trust's Board of Trustees decides otherwise) and the Vanguard Fund will
not commence operations.
New Board of Trustees. Vanguard Montgomery Funds (the "Vanguard Trust")
has a different Board of Trustees than the Laudus Trust. A brief description of
the backgrounds and compensation of the individuals who serve as trustees of the
Vanguard Trust is set forth below in the section entitled, "Management of
Vanguard(R) Market Neutral Fund."
Investment Objectives, Strategies, and Policies of Each Fund. The Vanguard
Fund's investment objective is similar to that of the Laudus Fund. The Laudus
Fund seeks to increase the value of a shareholder's investment through bull
markets and bear markets using strategies that are designed to limit exposure to
general equity market risk. The Vanguard Fund will seek to provide long-term
capital appreciation while limiting exposure to general stock market risk after
the Reorganization. There is additional information below comparing the Laudus
Fund to the Vanguard Fund in the section entitled, "Details of the
Reorganization Proposal - How the Reorganization will Affect the Laudus Fund."
Investment Adviser. If shareholders approve the Reorganization, the
Vanguard Fund will use a multimanager approach. Each adviser of the Vanguard
Fund will be allocated a portion of the Vanguard Fund's assets and will
independently select and maintain a portfolio of securities for the Vanguard
Fund. The Vanguard Trust's Board of Trustees will designate the proportion of
the Vanguard Fund's assets to be managed by each adviser and may change the
proportions at any time. If shareholders of the Laudus Fund approve the
Reorganization, the Quantitative Equity Group of Vanguard will co-manage the
Vanguard Fund along with the Laudus Fund's current sub-adviser, AXA Rosenberg
Investment Management LLC ("AXA Rosenberg"). Vanguard and AXA Rosenberg are
hereinafter collectively referred to in this combined prospectus/proxy statement
as the "Advisers." Charles Schwab Investment Management, Inc. ("CSIM") will not,
however, serve as investment manager to the Vanguard Fund if shareholders
approve the Reorganization. Although there are no current plans to do so, one or
more new advisers could be added to the Vanguard Fund in the future, as either
additions to or replacements for AXA Rosenberg or Vanguard. The Board of
Trustees of the Vanguard Trust has the flexibility to make changes to the
investment advisers of the Vanguard Fund if it considers it to be in
shareholders' best interests, without a shareholder vote, under the terms of an
SEC exemption. Any significant change in the Vanguard Fund's advisory
arrangements will be communicated to shareholders in writing. Details of the
advisory arrangements for the Laudus Fund and the Vanguard Fund are provided
below in the section entitled, "Investment Advisory Arrangements."
Investment Advisory Fees. The Vanguard Fund will pay AXA Rosenberg an
investment advisory fee on a quarterly basis based on certain annual percentage
rates applied to average daily net assets managed by AXA Rosenberg for each
quarter. In addition, the quarterly fees paid to AXA Rosenberg are increased or
decreased based on AXA Rosenberg's performance in comparison with that of a
benchmark index. For these purposes, the cumulative total return of AXA
Rosenberg's portion of the Vanguard Fund over a trailing 36-month period is
compared with that of the Citigroup 3-Month Treasury Bill Index over the same
period. The Vanguard Fund will pay Vanguard on an at-cost basis for its
provision of investment advisory services. Additional information about the
Laudus Fund and Vanguard Fund fee schedules appears below in the section
entitled "Investment Advisory Arrangements - Comparing Investment Advisory
Agreements."
Tax-Free Reorganization. It is expected that the proposed Reorganization
will be accomplished on a tax-free basis, meaning that it is expected that you
won't realize any capital gains when your Laudus Fund shares are exchanged for
shares of the Vanguard Fund.
Independent Auditors. PricewaterhouseCoopers LLP is expected to serve as
independent registered public accountant to the Vanguard Fund, as they do for
all other Vanguard funds. PricewaterhouseCoopers LLP also serves as independent
registered public accountant to the Laudus Fund.
II. DETAILS OF REORGANIZATION PROPOSAL
At their meeting on August 7, 2007, the Board of Trustees of the Laudus
Trust discussed the Reorganization and subsequently approved the Agreement and
Plan of Reorganization via unanimous written consent. The Vanguard Fund is a
substantially similar fund that has been organized within The Vanguard Group.
Following are some important details regarding the Reorganization:
REASONS FOR THE REORGANIZATION
The Board of Trustees of the Laudus Trust approved the Reorganization for
the following reasons:
Lower Shareholder Costs. As discussed above, the funds within The Vanguard
Group operate on an "at-cost" basis. This operating structure, combined with the
efficiencies inherent in Vanguard's size, will result in lower operating
expenses for the Vanguard Fund than for the Laudus Fund. Joining The Vanguard
Group should enable the Laudus Fund (as reorganized into the Vanguard Fund) to
grow assets due to Vanguard's strong market penetration and reputation as a
low-cost provider. Vanguard expects (but cannot guarantee) that assets in the
reorganized Laudus Fund will grow considerably once it joins The Vanguard Group
as the result of investments by new shareholders after the Reorganization, which
would produce a larger, more stable asset base for the reorganized Laudus Fund.
As a result, expenses would be shared by a larger group of shareholders and
expenses for existing shareholders may be reduced.
2
Continuity of Investment Management. If shareholders approve the
Reorganization, the Vanguard Fund will have an investment objective and primary
investment strategies that are substantially similar to those of the Laudus
Fund. In slight contrast to the Laudus Fund's advisory arrangements, under which
CSIM serves as investment adviser and AXA Rosenberg serves as sub-adviser, the
Vanguard Fund will use a multimanager arrangement. Following the Reorganization,
AXA Rosenberg will manage an allocated portion of the Vanguard Fund, while
Vanguard's Quantitative Equity Group will manage a separate portion of the
Vanguard Fund under the terms of the Funds' Service Agreement. AXA Rosenberg
will continue the same investment program it used for the Laudus Fund while
Vanguard will utilize its own security selection process.
Similar Investment Program. The Board of Trustees of the Laudus Trust
considered that the investment objective and investment strategies and policies
of the Vanguard Fund are substantially similar to those of the Laudus Fund, and
that the Vanguard Fund will provide the Laudus Fund shareholders with an
investment program that is similar to the Laudus Fund.
Tax-Free Nature of the Reorganization. It is expected that the
Reorganization will be accomplished on a tax-free basis. Accordingly, it is
expected that shareholders will not realize any capital gains when Laudus Fund
shares are exchanged for shares of the Vanguard Fund.
Costs of the Reorganization. The Laudus Trust Board of Trustees considered
that the expense of the Reorganization would not be borne by Laudus Fund
shareholders.
Continued Viability. The Laudus Trust Board of Trustees also considered the
future prospects of the Laudus Fund if the Reorganization was not effected and
the Laudus Fund's continuing viability as a separate series of the Laudus Trust.
Vanguard management believes that the Laudus Fund will fit well within the
Vanguard Group. If the Reorganization is approved by Laudus Fund shareholders,
adoption of the Laudus Fund will expand the opportunities available to
institutional investors through The Vanguard Group.
Vanguard has entered into a Fund Sponsorship Agreement with CSIM and AXA
Rosenberg, which generally provides that CSIM and AXA Rosenberg will use
reasonable efforts to facilitate the proposed Reorganization. Vanguard, CSIM and
AXA Rosenberg have agreed to share certain costs and expenses relating to the
proxy solicitation process and the Reorganization, but neither CSIM nor AXA
Rosenberg is being compensated by Vanguard in consideration of the
Reorganization.
HOW THE REORGANIZATION WILL BE ACCOMPLISHED
Agreement and Plan of Reorganization. The Agreement and Plan of
Reorganization ("Agreement and Plan") sets out the terms and conditions that
will apply to the reorganization of the Laudus Fund into the Vanguard Fund
(assuming that shareholders approve this proposal). The allocation of costs and
expenses incurred in connection with the Reorganization is set out in the
Agreement and Plan. For a complete description of the terms and conditions that
will apply to the Reorganization, please see the Form of Agreement and Plan of
Reorganization attached as Appendix A to this prospectus/proxy statement.
3
Three steps to reorganize. If approved by shareholders, the Reorganization
will be accomplished in a three-step process. First, the Laudus Fund will
transfer all of its assets and liabilities to the Vanguard Fund. Second, and
simultaneously with step one, the Vanguard Fund will open an account for each
shareholder, crediting it with an amount of shares of the Vanguard Fund equal in
value to the shares of the Laudus Fund owned by such holder at the time of the
Reorganization. Third, the Laudus Fund will be liquidated promptly and
terminated as a series of Laudus Trust.
Effective as soon as practicable. If approved by shareholders, the
Reorganization will take place as soon as practicable after all necessary
regulatory approvals and legal opinions are received. It is currently
anticipated that the Reorganization will be accomplished by the end of November
2007.
The Reorganization is Conditioned on Tax-Free Treatment at the Federal
Level. It is anticipated that the Reorganization will have no federal income tax
consequences for the Laudus Fund or its shareholders. The Reorganization will
not proceed until this point is confirmed by an opinion of counsel. Following
the Reorganization, from a tax standpoint, the aggregate tax basis of the
Vanguard Fund shares received by a shareholder will be the same as the aggregate
tax basis of the Laudus Fund shares that the shareholder exchanged. Shareholders
are not expected to incur any personal state or local taxes as a result of the
Reorganization, but you should consult your own tax adviser regarding those
manners. There is additional information about the federal income tax
consequences of the Reorganization in the Form of Agreement and Plan of
Reorganization.
HOW THE REORGANIZATION WILL AFFECT THE LAUDUS FUND
Comparing Investment Objectives, Strategies, and Policies. The Laudus
Fund's investment objective is to increase the value of a shareholder's
investment through bull and bear markets using strategies that are designed to
limit exposure to general equity market risk. The Vanguard Fund's investment
objective is to seek to provide long-term capital appreciation while limiting
exposure to general stock market risk.
Unlike the Laudus Fund, the Vanguard Fund will not be required to invest at
least 80% of its net assets in U.S. large- and mid-capitalization equity
securities.
The Laudus Fund - Primary Investment Strategies and AXA Rosenberg's
Security Selection Process
The Laudus Fund attempts to achieve its investment objective by taking long
positions in large and mid capitalization stocks principally traded in the
markets of the United States that AXA Rosenberg has identified as undervalued
and short positions in such stocks that it has identified as overvalued. Under
normal circumstances, the Laudus Fund will invest at least 80% of its net assets
(including, for this purpose, any borrowings for investment purposes) in U.S.
large- and mid-capitalization equity securities. When AXA Rosenberg believes
that a security is undervalued relative to its peers, it may buy the security
for the Laudus Fund's long portfolio. When AXA Rosenberg believes that a
security is overvalued relative to its peers, it may sell the security short by
4
borrowing it from a third party and selling it at the then-current market price.
AXA Rosenberg's investment strategy is designed to maintain approximately equal
dollar amounts invested in long and short positions on a continual basis. By
taking long and short positions in different stocks that are approximately equal
in value, the Laudus Fund attempts to limit the effect of general stock market
movements on its performance.
The Laudus Fund may achieve a positive return if the securities in its long
portfolio increase in value more than the securities underlying its short
positions, each taken as a whole. Conversely, it is expected that the Laudus
Fund will incur losses if the securities underlying its short positions increase
in value more than the securities in its long portfolio. AXA Rosenberg will
determine the size of each long or short position by analyzing the tradeoff
between the attractiveness of each position and its impact on the risk
characteristics of the overall portfolio. It is currently expected that the long
and short positions of the Laudus Fund will be invested primarily in the 500
largest capitalization stocks principally traded in the markets of the United
States.
Under normal circumstances, AXA Rosenberg's security selection models will
result in the Laudus Fund's long and short positions being overweighted in
different business sectors (as well as different industries within sectors). In
other words, the Laudus Fund may take long positions in a sector of the market
that are not offset by short positions in that sector, and vice versa.
Consequently, the Laudus Fund may have net exposures to different industries and
sectors of the market, thereby increasing risk and the opportunity for loss
should the securities in a particular industry or sector not perform as
predicted by AXA Rosenberg's security selection models. AXA Rosenberg selects
sectors to overweight or underweight based on a bottom-up evaluation of the
securities within a sector. If the security selection models find most
securities within a sector to be attractive, then AXA Rosenberg would tend to
overweight that sector If the security selection models find most securities
within a sector to be unattractive, then AXA Rosenberg would tend to engage in
more short sales with respect to issuers in that sector. AXA Rosenberg's model
optimizer then weighs the potential gain of a position against the risk in
having overweighted/underweighted industry exposures (in addition to other risk
measures) and suggests trades to improve the return and risk characteristics of
the portfolio.
AXA Rosenberg uses the return that an investor could achieve through an
investment in 3-month U.S. Treasury Bills as a benchmark against which to
measure the Laudus Fund's performance. AXA Rosenberg attempts to achieve returns
for the Laudus Fund's shareholders that exceed the benchmark. An investment in
the Laudus Fund is different from an investment in 3-month U.S. Treasury Bills
because, among other differences, U.S. Treasury Bills are backed by the full
faith and credit of the U.S. Government, U.S. Treasury Bills have a fixed rate
of return, investors in U.S. Treasury Bills do not risk losing their investment,
and an investment in the Laudus Fund is more volatile than an investment in U.S.
Treasury Bills.
AXA Rosenberg employs a bottom-up approach to investing by evaluating the
financial characteristics of individual securities rather than forecasting the
trends in markets, investment styles or sectors. AXA Rosenberg seeks to identify
mispriced securities across industries, through rigorous analysis of a company's
fundamental data. AXA Rosenberg's stock selection process is driven by
proprietary technology known as "expert systems," which are designed to analyze
the fundamentals of the more than 20,000 securities currently in AXA Rosenberg's
global universe. AXA Rosenberg uses two stock selection models to evaluate the
5
relative attractiveness of the stocks in its universe: (1) its Valuation Model
estimates the fair value for each company in its database by assessing various
fundamental data such as company financial statistics, and (2) its Earnings
Forecast Model estimates year-ahead earnings by analyzing fundamental data and
investor sentiment data such as analysts' earnings estimates and broker buy/sell
recommendations. AXA Rosenberg compares companies operating in similar
businesses to identify those believed to be undervalued in relation to their
peers, putting together the valuation and earnings forecast views to gain an
overall perspective on the attractiveness of each stock.
AXA Rosenberg attempts to moderate the effects on the Laudus Fund's
performance of value and growth style swings in the broad market by applying a
quantitative risk-control and portfolio optimization process. Of course, other
factors, such as the Laudus Fund's industry weightings and the risks associated
with specific individual stock selections, also affect the Laudus Fund's
performance.
The Laudus Fund may engage in active and frequent trading of the securities
in its portfolio (e.g., greater than 100% turnover), which would increase
transaction costs incurred by the Laudus Fund. In addition, when a fund engages
in active and frequent trading, a larger portion of the distributions investors
receive from such fund may reflect short-term capital gains, which are taxed
like ordinary income, rather than long-term capital gain distributions.
For temporary defensive purposes during unusual economic or market
conditions or for liquidity purposes, the Laudus Fund may invest up to 100% of
its assets in cash, money market instruments, repurchase agreements and other
short-term obligations. When the Laudus Fund engages in such activities, it may
not achieve its investment objective.
The Vanguard Fund - Primary Investment Strategies and the Advisers'
Security Selection Processes
The Vanguard Fund uses multiple investment advisers, each of which
independently selects and maintains a diversified portfolio of securities for
the Vanguard Fund. Each Adviser buys securities it considers to be undervalued
and sells short an approximately equal dollar amount of securities the Adviser
considers to be overvalued. By taking long and short positions in different
securities that are approximately equal in value, the Vanguard Fund attempts to
limit the effect of market movements on portfolio performance to the extent
consistent with each Adviser's individual investment decisions. Each Adviser
uses an independent security selection process and may emphasize specific
industries, styles (growth/value), capitalization ranges, or other factors.
The overall profitability of the Vanguard Fund depends on the net
performance of its long and short positions, and it is possible for the Vanguard
Fund to experience a net loss across all positions. If the Vanguard Fund's
investment strategy is successful, however, the net performance of its long and
short positions will produce long-term capital appreciation that reflects the
quality of the Advisers' security selections, with limited exposure to general
stock market risk.
6
The Vanguard Fund's long/short market neutral investment strategy is an
absolute return investment approach seeking performance that exceeds the returns
of 3-month U.S. Treasury bills. An investment in the Vanguard Fund, however, is
different from an investment in 3-month U.S. Treasury bills because, among other
things, Treasury bills are backed by the full faith and credit of the U.S.
Government, Treasury bills have a fixed rate of return, investors in Treasury
bills do not risk losing their investment, and an investment in the Vanguard
Fund is expected to be substantially more volatile than an investment in
Treasury bills.
In managing its portion of the Vanguard Fund, AXA Rosenberg will employ the
same security selection process that it employs for the Laudus Fund, which is
described above under the heading "The Laudus Fund - Primary Investment
Strategies and AXA Rosenberg's Security Selection Process."
In managing its portion of the Vanguard Fund, Vanguard's Quantitative
Equity Group will seek to invest on a market neutral basis in a diversified
portfolio of securities selected primarily from the Russell 1000 Index
("Index")--an index that is made up of the stocks of large- and
mid-capitalization U.S. companies--based on Vanguard's assessment of the
relative return potential of the individual securities that are evaluated.
Vanguard will attempt to fully implement the results of its security selection
process by holding positions both long and short in approximately equal
aggregate dollar amounts while maintaining near-neutral exposure within the long
and short positions to industry group and market capitalization risk factors.
Vanguard will implement its security selection process through the use of
proprietary computer programs that rank securities based on the adviser's
assessment of the relative return potential of the individual securities.
High-ranking securities offer a balance between reasonable valuations and
attractive growth prospects relative to their peers, while low-ranking
securities have unattractive valuations or low/slowing growth prospects.
Securities ranked most attractive are "bought long" and securities considered
least attractive are "sold short." If Vanguard is successful, the net
performance of its long and short positions will produce long-term capital
appreciation that reflects the quality of Vanguard's security selection process,
with limited exposure to general stock market risk.
The market value of the long and short positions in the Vanguard Fund will
not always be equal because of continuous changes in the prices of securities.
The Vanguard Fund expects that its advisers will need to frequently rebalance
their long and short positions. Each Adviser is also expected to change the long
and short positions in its portion of the Vanguard Fund to reflect changes in
the universe of securities the Adviser considers undervalued or overvalued. As a
result, the Vanguard Fund's portfolio turnover rate may significantly exceed
100%. Higher portfolio turnover increases brokerage commissions and other
transaction costs that reduce performance. Higher portfolio turnover may lead to
the realization and distribution of capital gains to shareholders, potentially
increasing their tax liability.
The Vanguard Fund may temporarily depart from its normal investment
policies--for instance, by allocating substantial assets to cash investments--in
response to extraordinary market, economic, political, or other conditions, or
for liquidity purposes. In doing so, the Vanguard Fund may succeed in avoiding
losses, but may otherwise fail to achieve its investment objective.
7
Comparing Risk Factors. The Vanguard Fund is subject to substantially
similar primary risk factors as the Laudus Fund because it has substantially
similar investment strategies and policies and invests principally in the same
types of securities. An investment in the Vanguard Fund could lose money over
short or even long periods, and the entire amount invested could be lost. There
can be no assurance that the Vanguard Fund's investment objective or strategies
will be achieved, and results may vary substantially over time. The Vanguard
Fund's performance could be hurt by:
o Strategy risk, which is the chance that the Vanguard Fund's
investment strategy will not succeed. There is no guarantee that
the Vanguard Fund will be able to limit exposure to general stock
market risk or produce returns that exceed the returns of 3-month
Treasury bills. Each Adviser uses an independent security
selection process and may emphasize specific industries, styles
(growth/value), capitalization ranges, or other factors. An
Adviser's security selection process, whether deliberately or
unintentionally, may not eliminate all stock market risk factors
associated with the long and short positions it establishes for
the Vanguard Fund. The Vanguard Fund could lose money at any time
and may underperform the markets in which it invests during any
given period that such markets rise or perform strongly.
o Short selling risk, which is the chance that the Vanguard Fund
will lose money in connection with its short sales of securities.
Short selling allows an investor to profit from declines in the
price of securities. The Vanguard Fund's use of short sales in
combination with its long positions in an attempt to improve
performance or to reduce overall portfolio risk may not be
successful and may result in greater losses or lower positive
returns than if the Vanguard Fund held only long positions. It is
possible that the stocks the Vanguard Fund holds long will
decline in value at the same time that the stocks it holds short
increase in value, thereby increasing potential losses to the
Vanguard Fund. The Vanguard Fund may not always be able (or find
it economically attractive) to sell short a security the Adviser
believes to be particularly overvalued. In that case, the
Vanguard Fund may establish a short position in a different
security, and that short position may be less profitable for the
Vanguard Fund than if the Vanguard Fund had shorted the security
the Adviser believed was more overvalued. Also, the Vanguard Fund
may be unable to close out a short position at an acceptable
price, and may have to sell related long positions at
disadvantageous times to produce cash to unwind a short position.
The Vanguard Fund's loss on a short sale is potentially unlimited
because there is no upward limit on the price a borrowed security
could attain. Short selling involves high transaction costs. The
Advisers could have different opinions on the valuation of a
particular security, which could affect their investment
decisions. For example, one Adviser takes a "short" position in a
security at the same time that the other Adviser has taken a
"long" position in the same security. In that event, any gain
from the short position may be partially or totally offset by a
decline in the long position, or vice versa.
8
o Manager risk, which is the chance that poor security selection
will cause the Vanguard Fund to underperform relevant benchmarks
or other funds with a similar investment objective.
o Capitalization risk, which is the chance that returns from
small-, mid- and large-capitalization stocks (to the extent that
the Vanguard Fund's assets are invested in such stocks) will
trail returns from the overall stock market. Specific types of
stocks tend to go through cycles of doing better--or worse--than
the stock market in general. These periods have, in the past,
lasted for as long as several years.
o Style risk, which is the chance that returns from value stocks
will trail returns from the overall stock market. The security
selection processes used by the Advisers are likely to cause the
Vanguard Fund's portfolio to exhibit sensitivity to the
value-growth cycle within the U.S. equity markets, meaning that
the Vanguard Fund's performance will be more likely to decline
during periods when growth stocks outperform value stocks than
during periods when value stocks outperform growth stocks.
Although the Vanguard Fund may invest in ETFs, the Vanguard Fund is not subject
to the following primary risk factor that applies to the Laudus Fund:
o Investments in Exchange-Traded Funds. The Laudus Fund may
purchase shares of exchange-traded funds ("ETFs") to gain
exposure to a particular portion of the market while awaiting an
opportunity to purchase securities directly. When the Laudus Fund
invests in an ETF, in addition to directly bearing the expenses
associated with its own operations, it will bear a pro rata
portion of the ETF's expenses. Therefore, it may be more costly
to own an ETF than to own the underlying securities directly. In
addition, while the risks of owning shares of an ETF generally
reflect the risks of owning the underlying securities the ETF is
designed to track, lack of liquidity in an ETF can result in its
value being more volatile than the underlying portfolio of
securities.
Comparing Shareholder Fees and Fund Expenses. The following tables sets
forth the fees and expenses that you pay if you buy and hold Laudus Fund shares
and what you may pay if you buy and hold Vanguard Fund shares:
9
Shareholder Fees (fees paid directly from your investment)
--------------------- ---------------------- --------------------- --------------- --------------
Current Fees and Current Fees and Estimated Estimated
Expenses Expenses Fees and Fees and
Laudus Rosenberg Laudus Rosenberg Expenses Expenses
U.S. Large/Mid U.S. Large/Mid Vanguard(R) Vanguard(R)
Capitalization Capitalization Market Market
Long/Short Equity Long/Short Equity Neutral Fund Neutral Fund
Fund - Institutional Fund - Investor - - Investor
Class Class Institutional Class
Class
--------------------- ---------------------- --------------------- --------------- --------------
--------------------- ---------------------- --------------------- --------------- --------------
N/A N/A N/A N/A
Sales Charge (Load)
Imposed on Purchases
--------------------- ---------------------- --------------------- --------------- --------------
--------------------- ---------------------- --------------------- --------------- --------------
2%(1) 2%(1) 1%(2) 1%(2)
Redemption Fee
--------------------- ---------------------- --------------------- --------------- --------------
--------------------- ---------------------- --------------------- --------------- --------------
Exchange Fee N/A N/A N/A N/A
--------------------- ---------------------- --------------------- --------------- --------------
--------------------- ---------------------- --------------------- --------------- --------------
Account N/A N/A $20(3) $20(3)
Service Fee
--------------------- ---------------------- --------------------- --------------- --------------
(1) The 2% fee applies to shares redeemed or exchanged within 30 days of
purchase.
(2) The 1% fee applies to shares redeemed within one year of purchase by
selling or by exchanging to another Vanguard fund, or if your shares are
redeemed because your Vanguard Fund account balance falls below the minimum
initial investment for any reason, including market fluctuation. The fee is
withheld from redemption proceeds and retained by the Vanguard Fund. Shares
held for one year or more are not subject to the 1% fee.
(3) If applicable, the account service fee will be assessed by redeeming fund
shares in the amount of $20.
The table set forth below compares the expenses the Laudus Fund expects to
incur in its current fiscal year and the estimated expenses of the Vanguard Fund
for the first full year after the Reorganization is consummated (assuming
current asset levels of the Laudus Fund remain the same).
10
--------------------------------------------------------------------------------
Laudus Rosenberg
U.S. Large/Mid Pro forma Fees
Capitalization and Expenses
Long/Short Equity Vanguard Market as of the
Fund Neutral Fund Reorganization
Date
--------------------------------------------------------------------------------
Management Fees
Investor 1.00% 0.72% 0.72%
Institutional 1.00% 0.57% 0.57%
--------------------------------------------------------------------------------
Distribution and
Shareholder Service Fee
(12b-1 Fees)
Investor 0.25% N/A N/A
Institutional N/A N/A N/A
--------------------------------------------------------------------------------
Other Expenses
Investor N/A 0.03% 0.03%
Institutional N/A 0.03% 0.03%
--------------------------------------------------------------------------------
Dividend Expenses
on Securities Sold
Short(2)
Investor 1.44% 1.50% 0.72%
Institutional 1.44% 1.50% 0.57%
--------------------------------------------------------------------------------
Remainder of Other
Expenses
Investor 0.77% N/A 0.72%
Institutional 0.66% N/A 0.57%
--------------------------------------------------------------------------------
Total of Other Expenses
Investor 2.21% 1.50% 1.50%
Institutional 2.10% 1.50% 1.50%
--------------------------------------------------------------------------------
Total Annual Operating
Expenses(3)
Investor 3.46% 2.47% 2.25%
Institutional 3.10% 2.32% 2.10%
--------------------------------------------------------------------------------
Less Fee Waiver and/or
Expense Reimbursement
Investor (0.48%)1 N/A N/A
Institutional (0.42%)1 N/A N/A
--------------------------------------------------------------------------------
Net Expenses
Investor 2.98% 2.47% 2.25%
Institutional 2.68% 2.32% 2.10%
--------------------------------------------------------------------------------
(1) The fee waiver and/or expense reimbursement is made pursuant to CSIM's
contractual undertaking (the "Expense Limitation Agreement") to waive its
management fee and bear certain expenses for the Institutional and Investor
classes when the operating expenses reach 1.24% and 1.54%, respectively
(exclusive of nonrecurring account fees, fees on securities transactions
such as exchange fees, dividends and interest on securities sold short,
service fees, interest, taxes, brokerage commissions, other expenditures
which are capitalized in accordance with generally accepted accounting
principles, and other extraordinary expenses not incurred in the ordinary
course of the Laudus Fund's business). The Expense Limitation Agreement
will be in place until at least July 30, 2009. CSIM may, but is not
required to, extend the Agreement for additional years. Any amounts waived
or reimbursed in a particular fiscal year will be subject to reimbursement
by the Laudus Fund to CSIM during the next two fiscal years to the extent
that the repayment will not cause the Laudus Fund's Net Expenses to exceed
the current limit (as stated in the Expense Limitation Agreement) during
the respective year. The Expense Limitation Agreement will not apply to the
Vanguard Fund, which will be managed by Vanguard, not CSIM.
(2) When a cash dividend is declared on a stock a fund has sold short, the fund
is required to pay an amount equal to that dividend to the party from whom
the fund borrowed the stock. The SEC requires every mutual fund that sells
securities short to disclose the related dividend expenses as an "other
expense" in the prospectus disclosure of annual fund operating expenses.
(3) If the SEC did not require Dividend Expenses on Securities Sold Short to be
included in this table, Total Annual Operating Expenses would have been
1.66% and 2.02% (without reflecting fee waiver and/or expense
reimbursement) for the Laudus Fund's Institutional and Investor Share
classes, respectively, and will be 0.60% and 0.75% for the Vanguard Fund's
Institutional and Investor Share classes, respectively.
11
Example
The following Example is intended to help you compare the cost of investing
in the Laudus Fund and the Vanguard Fund with the cost of investing in other
mutual funds. The Example assumes that you invest $10,000 in each Fund for the
time periods indicated and that you redeem your shares at the end of each
period. The Example also assumes that each year your investment has a 5% return,
that each Fund's operating expenses remain the same and that all dividends and
distributions are reinvested. Although your actual costs and returns might be
different based on these assumptions, your costs would be:
---------------------------------- ---------------------- ---------------------- ----------------------- ------------------
1 Year 3 years 5 Years 10 Years
---------------------------------- ---------------------- ---------------------- ----------------------- ------------------
---------------------------------- ---------------------- ---------------------- ----------------------- ------------------
Laudus Rosenberg U.S. Large/Mid $271(1) $876 $1,550 $3,351
Capitalization Long/Short Equity
Fund - Institutional Class
---------------------------------- ---------------------- ---------------------- ----------------------- ------------------
---------------------------------- ---------------------- ---------------------- ----------------------- ------------------
Laudus Rosenberg U.S. Large/Mid $301(1) $971 $1,714 $3,673
Capitalization Long/Short Equity
Fund - Investor Class
---------------------------------- ---------------------- ---------------------- ----------------------- ------------------
---------------------------------- ---------------------- ---------------------- ----------------------- ------------------
Vanguard(R) Market Neutral Fund - $238 $733 $1,255 $2,686
Institutional Class
---------------------------------- ---------------------- ---------------------- ----------------------- ------------------
---------------------------------- ---------------------- ---------------------- ----------------------- ------------------
Vanguard(R) Market Neutral Fund - $253 $779 $1,331 $2,836
Investor Class
---------------------------------- ---------------------- ---------------------- ----------------------- ------------------
(1) The fee waiver and/or expense reimbursement is made pursuant to CSIM's
contractual undertaking (the "Expense Limitation Agreement") to waive its
management fee and bear certain expenses for the Institutional and Investor
classes when the operating expenses reach 1.24% and 1.54%, respectively
(exclusive of nonrecurring account fees, fees on securities transactions
such as exchange fees, dividends and interest on securities sold short,
service fees, interest, taxes, brokerage commissions, other expenditures
which are capitalized in accordance with generally accepted accounting
principles, and other extraordinary expenses not incurred in the ordinary
course of the Laudus Fund's business). The Expense Limitation Agreement
will be in place until at least July 30, 2009. CSIM may, but is not
required to, extend the Agreement for additional years. Any amounts waived
or reimbursed in a particular fiscal year will be subject to reimbursement
by the Laudus Fund to CSIM during the next two fiscal years to the extent
that the repayment will not cause the Laudus Fund's Net Expenses to exceed
the current limit (as stated in the Expense Limitation Agreement) during
the respective year. The Expense Limitation Agreement will not apply to the
Vanguard Fund, which will be managed by Vanguard, not CSIM.
THIS EXAMPLE SHOULD NOT BE CONSIDERED TO REPRESENT ACTUAL EXPENSES OR
PERFORMANCE FROM THE PAST OR FOR THE FUTURE. ACTUAL FUTURE EXPENSES MAY BE
HIGHER OR LOWER THAN THOSE SHOWN.
The Reorganization will have no impact on the net asset value per share
("NAV") of the Laudus Fund. As indicated below, the Reorganization will not
cause the Laudus Fund's share price to go up or down, and each shareholder will
own an amount of shares of the Vanguard Fund equal in value to the shares of the
Laudus Fund owned by such holder at the time of the Reorganization. Any declared
but undistributed dividends or capital gains will carry over in the
Reorganization.
12
The following table shows the capitalization of the Laudus Fund and the
Vanguard Fund as of September 18, 2007 and the capitalization of the Vanguard
Fund on a pro-forma basis as of that date after giving effect to the
Reorganization. The following are examples of the number of Institutional and
Investor shares of the Laudus Fund that would be exchanged for the Institutional
and Investor shares of the Vanguard Fund if the Reorganization shown had been
consummated on September 18, 2007, and do not reflect the number of such shares
or the value of such shares that would actually be received if the
Reorganization occurs. Amounts in the tables are in thousands, except for net
asset value per share.
CAPITALIZATION TABLE
(UNAUDITED)
----------------------------------------------------------------------------------------------------------------------
Laudus Rosenberg Vanguard Pro forma Fees
U.S. Large/Mid Market Capitalization as of the
Capitalization Long/ Neutral Record Date
Short Equity Fund Fund
----------------------------------------------------------------------------------------------------------------------
Total Net Assets
Investor $10,238 N/A
Institutional $ 6,384 N/A
----------------------------------------------------------------------------------------------------------------------
Total Number of Shares Outstanding
Investor 815 N/A
Institutional 510 N/A
----------------------------------------------------------------------------------------------------------------------
NAV
Investor $12.56 N/A
Institutional $12.53 N/A
-----------------------------------------------------------------------------------------------------------------------
Comparing Trustees. As previously discussed, the Laudus Fund will be
reorganized into an investment portfolio of the Vanguard Trust if shareholders
approve the Reorganization. Information on the trustees of the Vanguard Trust
appears below in the section entitled "Management of Vanguard(R) Market Neutral
Fund." Following the Reorganization, the Board of Trustees of the Laudus Trust
will have no oversight over, or other involvement with, the Vanguard Fund.
Comparing Independent Auditors. PricewaterhouseCoopers LLP, the independent
registered public accounting firm for the Laudus Fund, is expected to serve as
the independent registered public accounting firm for the Vanguard Fund, and
currently serves in that capacity for all other Vanguard funds. In this role,
13
PricewaterhouseCoopers LLP audits and certifies the financial statements of all
Vanguard funds. PricewaterhouseCoopers LLP also reviews the Annual Reports to
Shareholders of the Vanguard funds and their filings with the SEC. Neither
PricewaterhouseCoopers LLP nor any of its partners have any direct or material
indirect financial interest in the Vanguard funds. The Vanguard Fund will keep
the same March 31st fiscal year end as the Laudus Fund and make distributions on
an annual basis.
Organization. The Vanguard Fund is a series of a trust organized as a Delaware
statutory trust. The Laudus Fund is a series of a trust organized as a
Massachusetts business trust. There are two material differences between the
provisions of the Amended and Restated Agreement and Declaration of Trust of the
Vanguard Trust ("Vanguard Declaration of Trust") and the Second Amended and
Restated Agreement and Declaration of Trust of the Laudus Trust ("Laudus
Declaration of Trust"). First, the Vanguard Declaration of Trust provides that
twenty-five (25%) of the shares entitled to vote constitutes a quorum for a
shareholder meeting, while the Laudus Declaration of Trust mandates that forty
percent (40%) of the shares entitled to vote constitutes a quorum. Under
Massachusetts law, shareholders of a Massachusetts business trust could, under
certain circumstances, be held personally liable for the acts or obligations of
a fund. The Laudus Declaration of Trust, however, disclaims shareholder
liability for acts or obligations of the Laudus Trust and requires that notice
of such disclaimer be given in each agreement, obligation, or instrument entered
into or executed by the Laudus Trust or its Trustees. The Laudus Declaration of
Trust provides for indemnification out of all the property of the Laudus Fund
for all loss and expense of any shareholder of the Laudus Fund held personally
liable for the obligations of the Trust. Thus, the risk of a shareholder
incurring financial loss on account of shareholder liability is considered
remote since it is limited to circumstances in which the disclaimer is
inoperative and the Laudus Fund would be unable to meet its obligations. The
Vanguard Declaration of Trust does not provide for such indemnity. Under
Delaware law, however, shareholders of a Delaware statutory trust are not held
personally liable for the acts or obligations of a fund, other than to the
extent of the shareholder's investment in the fund.
Description of Securities to be Issued. Full and fractional shares of the
Vanguard Fund will be issued to Laudus Fund shareholders in accordance with the
procedures set forth in the Agreement and Plan of Reorganization. If the Laudus
Fund shareholders approve the Reorganization, holders of shares of the
Institutional Class of the Laudus Fund will receive shares of the Institutional
Class of the Vanguard Fund, while holders of shares of the Investor Class of the
Laudus Fund will receive shares of the Investor Class of the Vanguard Fund.
Purchase, Redemption, and Exchange Information.
After the Reorganization, the Laudus Fund (as reorganized into the Vanguard
Fund) will continue to be sold to individuals and institutional investors. The
chart below highlights the purchase, redemption and exchange features of the
Laudus Fund as compared to such features of the Vanguard Fund.
Laudus Fund shareholders on the date of the Reorganization will be exempt
from the minimum initial purchase and maintenance amounts for Investor and
Institutional Shares of the Vanguard Fund.
Currently, the Laudus Fund shareholders approve the Reorganization, Laudus
Fund shareholders will continue to be subject to a redemption fee. Currently,
the Laudus Fund imposes a 2% fee if a shareholder redeems or exchanges its
shares within 30 days of purchase. After the Reorganization, the Vanguard Fund
will charge a 1% fee on shares redeemed within one year of purchase by selling
or by exchanging to another Vanguard fund, or when Vanguard applies the
low-balance account-closure policy. In both cases, this fee is designed to
ensure that short-term investors pay their share of each fund's transactions
costs and that long-term investors do not subsidize the activities of short-term
shareholders. Vanguard will waive the application of the 1% redemption fee for
Laudus Fund shareholders on the date of the Reorganization with respect to their
shareholdings as of the date of the Reorganization. Purchases of additional
shares by Laudus Fund shareholders after the date of the Reorganization will be
subject to the Vanguard Fund redemption fee.
14
With respect to the Laudus Fund, CSIM may waive the application of the
short-term redemption fee for 401(a), 401(k), 457 and 403(b) retirement plans,
as well as for certain wrap accounts. For the Vanguard Fund accounts, however,
redemption fees will not apply to the following (including participants in
employer-sponsored defined contribution plans that are serviced by Vanguard
Small Business Services): (i) redemptions of shares purchased with reinvested
dividend and capital gains distributions; (ii) share transfers, rollovers, or
re-registrations within the same fund; (iii) conversions of shares from one
share class to another in the same fund; (iv) redemptions of shares to pay fund
or account fees; (v) Section 529 college savings plans; (vi) for a one-year
period, shares rolled over to an IRA held at Vanguard from a retirement plan for
which Vanguard serves as recordkeeper (except for Vanguard Small Business
Services retirement plans); and (vii) distributions by shareholders age 70 1/2
or older from the following:
o Traditional IRAs;
o Inherited IRAs (traditional and Roth);
o Rollover IRAs;
o SEP-IRAs;
o SIMPLE IRAs;
o Section 403(b)(7) plans served by the Vanguard Small Business Services
Department; and
o Vanguard Retirement Plans for which Vanguard Fiduciary Trust Company serves
as trustee.
For participants in employer-sponsored defined contribution plans (other than
those serviced by the Vanguard Small Business Services Department), in addition
to the exclusions previously listed, redemption fees will not apply to the
following:
o Exchanges of shares purchased with participant payroll or employer
contributions;
o Distributions, loans, and in-service withdrawals from a plan;
o Redemptions or transfers of shares as part of a plan termination or at the
direction of the plan; and
Redemption fees will apply to Vanguard fund shares exchanged out of a fund
within the fund's redemption-fee period into which fund the shares had
previously been exchanged, rolled over, or transferred by a participant.
15
----------------------------------------------------------------------------------------------------------------------
Purchase, Redemption and Laudus Rosenberg U.S. Laudus Vanguard Market Vanguard Market
Exchange Features Large/Mid Capitalization Rosenberg U.S. Neutral Fund - Neutral Fund -
Long/Short Equity Fund - Large/Mid Institutional Investor Class
Institutional Class Capitalization Class
Long/Short
Equity Fund -
Investor Class
----------------------------------------------------------------------------------------------------------------------
Minimum initial $50,000/$0 $100/$0 $5 million/$50 $250,000/$50 by
purchase/additional investment by Automatic Automatic Investment
Investment Plan; Plan; $100 by check,
$100 by check, exchange, wire, or
exchange, wire, electronic bank
or electronic transfer (other
bank transfer than Automatic
(other than Investment Plan)
Automatic
Investment Plan)
----------------------------------------------------------------------------------------------------------------------
Purchases By intermediary, wire, By Through Through Vanguard's
mail, Laudus Funds intermediary, Vanguard's website, by
Automatic Investment wire, mail, or website, by telephone or mail
Program or investments Laudus Funds telephone or mail
in kind Automatic
Investment
----------------------------------------------------------------------------------------------------------------------
Redemptions By mail, phone (if By mail, phone Through Through Vanguard's
authorized), or (if Vanguard's website, by
systematic withdrawal authorized), or website, by telephone or mail
plan systematic telephone or mail
withdrawal plan
----------------------------------------------------------------------------------------------------------------------
Free Exchange Privileges By mail or phone(1) By mail or Yes, through Yes, through
phone(1) Vanguard's Vanguard's website,
website, by by telephone or mail
telephone or mail
----------------------------------------------------------------------------------------------------------------------
1. Shareholders of the Laudus Fund are not permitted to exchange any of their
shares for shares of the Laudus Rosenberg International Small
Capitalization Fund. Shareholders of the Laudus Fund are not permitted to
exchange any of their shares for shares of the Laudus Rosenberg U.S.
Discovery Fund or the Laudus Rosenberg U.S. Small Capitalization Fund
unless such shareholders are also existing shareholders of the Laudus
Rosenberg U.S. Discovery Fund or the Laudus Rosenberg U.S. Small
Capitalization Fund.
Calculating NAV. The Laudus Fund calculates its NAV once each business day
as of the close of the New York Stock Exchange (generally, 4:00 p.m. Eastern
time). Similarly, the Vanguard Fund calculates its NAV after the close of
regular trading on the New York Stock Exchange.
16
III. INVESTMENT ADVISORY ARRANGEMENTS
The Vanguard Fund uses a multimanager approach. Each of the Advisers
independently manages its assigned portion of the Vanguard Fund's assets,
subject to the supervision and oversight of Vanguard and the Vanguard Fund's
Board of Trustees. The Vanguard Fund's Board of Trustees designates the
proportion of the Vanguard Fund assets to be managed by each Adviser and may
change these proportions at any time. It is currently expected that AXA
Rosenberg and Vanguard Quantitative Equity Group will each manage approximately
50% of the assets of the Vanguard Fund.
Vanguard. Vanguard's Quantitative Equity Group will manage a portion of the
assets of the Vanguard Fund, if shareholders approve the Reorganization.
Vanguard began operations in 1975. Vanguard's address is P.O. Box 2600, Valley
Forge, Pennsylvania 19482. Vanguard will provide internalized investment
management services to the Vanguard Fund on an "at cost" basis pursuant to the
Funds' Service Agreement. Vanguard will, among other things, continuously
review, supervise and administer a portion of the investment program for the
Vanguard Fund. Vanguard is the nation's second-largest mutual fund firm and a
leading provider of company-sponsored retirement plan services.
George U. Sauter is Chief Investment Officer and Managing Director of
Vanguard. As Chief Investment Officer, he is responsible for the oversight of
Vanguard's Quantitative Equity and Fixed Income Groups. The investments managed
by these two groups include active quantitative equity funds, equity index
funds, active bond funds, index bond funds, stable value portfolios, and money
market funds. Since joining Vanguard in 1987, Mr. Sauter has been a key
contributor to the development of Vanguard's stock indexing and active
quantitative equity investment strategies. He received his A.B. in Economics
from Dartmouth College and an M.B.A. in Finance from the University of Chicago.
Joel M. Dickson, Ph.D., is head of Active Quantitative Equity Management
and Principal of Vanguard. He has direct oversight responsibility for all active
quantitative equity portfolios managed by Vanguard's Quantitative Equity Group.
He has been with Vanguard since 1996 and has managed investment portfolios since
2003. He received his A.B. in Economics from Washington University in St. Louis
and a Ph.D. in Economics from Stanford University.
James D. Troyer, CFA, is a Principal of Vanguard and will be the manager
primarily responsible for the day-to-day management of Vanguard's portion of the
Vanguard Fund, if the Reorganization is approved by shareholders. He has worked
in investment management since 1979 and has been with Vanguard since 1989. He
receive his A.B from Occidental College.
AXA Rosenberg Investment Management LLC. The Laudus Fund's sub-adviser, AXA
Rosenberg Investment Management LLC, will serve as co-Adviser to the Vanguard
Fund if shareholders approve the Reorganization. AXA Rosenberg's address is 4
Orinda Way, Building E, Orinda, California 94563. As of July 31, 2007, AXA
Rosenberg served as investment adviser for approximately $137 billion in assets.
17
Dr. William Ricks has been with AXA Rosenberg since 1989, where he has been
the Chief Executive Officer and Chief Investment Officer for the past five
years. He is responsible for overseeing the implementation of AXA Rosenberg
investment strategies, which are primarily driven by stock selection and
portfolio construction models. To that end, he has overall responsibility for
the implementation of AXA Rosenberg investment strategies and the various
aspects of AXA Rosenberg's investment process, including trading, operations,
portfolio engineering and portfolio construction. Dr. Ricks has managed the
Laudus Fund since its inception in 1998. If the Reorganization is approved by
shareholders, Dr. Ricks will be the manager primarily responsible for the
day-to-day management of AXA Rosenberg's portion of the Vanguard Fund. He
received his B.S. from the University of New Orleans, and a Ph.D from the
University of California, Berkley.
Comparing Investment Advisory Agreements. The investment advisory
agreements for the Laudus Fund consist of a management agreement between the
Laudus Fund and CSIM and a sub-advisory agreement among the Laudus Fund, CSIM
and AXA Rosenberg. The Vanguard Fund will have an investment advisory agreement
with AXA Rosenberg and an advisory arrangement with Vanguard. A description of
the terms of the current agreements for the Laudus Fund and the arrangement for
the Vanguard Fund is set forth below.
1. Current Management Agreement between the Laudus Fund and CSIM ("CSIM
Agreement")
Investment Advisory Fees
The CSIM Agreement provides that the Laudus Fund will pay, as compensation
to CSIM for its investment advisory services to the Laudus Fund, a monthly fee
of 1.00% of the Laudus Fund's average daily net assets up to $500 million and
0.95% of the Laudus Fund's average daily net assets over $500 million, each as
of the last business day of the month.
Delegation of Duties to a Sub-adviser
The CSIM Agreement provides that CSIM may, subject to its supervision,
delegate some or all of its duties under the CSIM Agreement to a sub-adviser.
Duration
Initially, the CSIM Agreement continued in effect for two years.
Subsequently, the CSIM Agreement continues in successive annual periods,
provided that such annual periods are approved annually by (1) a majority of the
outstanding shares of the Laudus Fund or by the Laudus Trust's Board of Trustees
and (2) a majority of the independent Trustees of the Laudus Trust, or (3) as
otherwise permitted by the Investment Company Act of 1940 ("1940 Act") or the
rules and regulations promulgated thereunder.
Termination
The CSIM Agreement may be terminated at any time by (1) a majority of the
outstanding shares of the Laudus Fund, (2) a majority of the entire Laudus Trust
18
Board of Trustees on 60 days' written notice to CSIM, or (3) CSIM on 60 days'
written notice to the Laudus Trust.
Liability of CSIM
The CSIM Agreement provides that, in the absence of willful misfeasance,
bad faith or gross negligence, CSIM is not liable to the Laudus Trust, the
Laudus Fund or any of their shareholders, officers, directors or trustees for an
act or omission in the course of providing investment advisory services pursuant
to the CSIM Agreement.
Selection of Brokers
The CSIM Agreement provides that CSIM will place on behalf of the Laudus
Fund all orders for the purchase and sale of the Laudus Fund's securities.
2. Current Sub-Advisory Agreement among CSIM, AXA Rosenberg, and the Laudus
Trust ("Current AXA Rosenberg Agreement")
Investment Advisory Fees
The Current AXA Rosenberg Agreement provides that CSIM will pay AXA
Rosenberg as compensation for its sub-advisory services to the Laudus Fund a
quarterly fee equal to (1) a sub-advisory base fee, plus or minus (2) a
performance adjustment.
Duration
Initially, the Current AXA Rosenberg Agreement continued in effect for two
years. Subsequently, the Current AXA Rosenberg Agreement continues in successive
annual periods, provided that such annual periods are approved annually by (1) a
majority of the outstanding shares of the Laudus Fund or by Laudus Trust's Board
of Trustees and (2) a majority of the independent Trustees of the Laudus Trust,
or (3) as otherwise permitted by the 1940 Act or the rules and regulations
promulgated thereunder.
Termination
The Current AXA Rosenberg Agreement may be terminated at any time by (1) a
majority of the outstanding shares of the Laudus Fund, (2) a majority of the
entire Laudus Trust Board of Trustees on 60 days' written notice to AXA
Rosenberg or (3) AXA Rosenberg on 60 days' written notice to the Trust.
Liability of AXA Rosenberg
The Current AXA Rosenberg Agreement provides that, in the absence of
willful misfeasance, bad faith or gross negligence, or reckless disregard of its
obligations and duties, AXA Rosenberg is not liable to CSIM, the Laudus Trust,
the Laudus Fund or any of their shareholders, officers, directors or trustees
for an act or omission in the course of providing investment advisory services
pursuant to the Current AXA Rosenberg Agreement.
19
Selection of Brokers
Under the Current AXA Rosenberg Agreement, AXA Rosenberg has the authority
to select brokers and/or place orders for the purchase and sale of the Laudus
Fund's securities.
3. Proposed Advisory Arrangement with Vanguard ("Proposed Vanguard
Arrangement")
Investment Advisory Fees
Under the Proposed Vanguard Arrangement, the Vanguard Fund would pay its
share of the actual cost of Vanguard's expenses for corporate, management,
administrative, and distribution services, including the actual cost of
investment advisory services provided by Vanguard's Quantitative Equity Group.
Delegation of Duties to a Sub-adviser
Vanguard may establish wholly-owned subsidiaries, and supervise the
management and operations of such subsidiaries, as are necessary or appropriate
to carry on or support the business activities of the Vanguard Fund. In
addition, Vanguard may authorize such subsidiaries to perform such other
functions for the Vanguard Fund as Vanguard's Board of Directors may determine.
Duration and Termination
The Proposed Vanguard Arrangement will continue in effect until terminated
or amended by mutual agreement of the Vanguard Fund and Vanguard.
Selection of Brokers
Under the Proposed Vanguard Arrangement, Vanguard's Quantitative Equity
Group has the authority to select brokers and/or place orders for the purchase
and sale of securities in its portion of the Vanguard Fund's assets.
4. Proposed Investment Advisory Agreement with AXA Rosenberg ("Proposed AXA
Rosenberg Agreement")
Delegation of Duties to a Sub-adviser
The Proposed AXA Rosenberg Agreement does not have a provision which would
permit AXA Rosenberg to delegate its duties under the Proposed AXA Rosenberg
Agreement.
20
Duration
Initially, the Proposed AXA Rosenberg Agreement will continue in effect for
two years. Subsequently, the Proposed AXA Rosenberg Agreement will continue in
successive annual periods, provided that the Proposed AXA Rosenberg Agreement is
approved annually by (1) the Board of Trustees of the Vanguard Fund, including a
majority of the independent Trustees or (2) a majority of outstanding voting
securities of the Vanguard Fund.
Termination
The Proposed AXA Rosenberg Agreement may be terminated at any time by (1)
a vote of the entire Board of Trustees of the Vanguard Trust or (2) by a
majority of the outstanding voting securities of the Vanguard Fund, both (1) and
(2) on 30 days' written notice to AXA Rosenberg, or (3) AXA Rosenberg on 90
days' written notice to the Vanguard Trust.
Liability of AXA Rosenberg
The Proposed AXA Rosenberg Agreement provides that AXA Rosenberg will be
liable to the Vanguard Fund or its shareholders because of willful misfeasance,
bad faith, or negligence in the performance of its duties pursuant to the
Proposed AXA Rosenberg Agreement or the reckless disregard of its obligations
pursuant to the Proposed AXA Rosenberg Agreement.
Selection of Brokers
The Proposed AXA Rosenberg Agreement provides that AXA Rosenberg may select
the brokers or dealers that will execute purchases and sales of securities of
the portion of the assets of the Vanguard Fund that the Vanguard Trust's Board
Trustees determines in its sole discretion to assign to Vanguard ("AXA Rosenberg
Portfolio").
Investment Advisory Fees
The Proposed AXA Rosenberg Agreement contemplates compensating AXA
Rosenberg for its investment advisory services a base fee ("Base Fee") plus a
performance adjustment ("Performance Adjustment"), payable quarterly in arrears.
The Base Fee and Performance Adjustment together is called the "Adjusted Fee."
21
The Base Fee for each fiscal quarter of the Vanguard Fund is calculated by
multiplying an annual percentage rate to the average daily net assets of the AXA
Rosenberg Portfolio during such fiscal quarter, and dividing the result by four.
The end of June, September, December, and March constitute the conclusion of the
Vanguard Fund's fiscal quarters. The Base Fee will be increased or decreased by
applying a Performance Adjustment based on the investment performance of the AXA
Rosenberg Portfolio relative to the investment performance of the Citigroup
3-Month Treasury Bill Index. The investment performance will be based on the
cumulative total return of the Portfolio over a trailing 36-month period ending
with the applicable quarter, compared with the cumulative total return of the
Index for the same period.
Based on the Laudus Fund's current size, the maximum possible fee payable
by the Vanguard Fund to AXA Rosenberg under the advisory agreement during the
first year the performance-based fee is fully in effect would be 0.45% of the
Vanguard Fund's average daily net assets. This compares favorably with the
contractual fee payable by the Laudus Fund, which is 1.00% of the Laudus Fund's
average daily net assets up to $500 million and 0.95% of the Laudus Fund's
average daily net assets over $500 million.
The following table shows on a comparative basis for the fiscal year ended March
31, 2007, the investment advisory fees payable under the Laudus Fund fee
schedule and the investment advisory fees (presented on a pro forma basis) that
would have been paid to AXA Rosenberg had the Vanguard Fund fee schedule been in
place for the same period.
------------------------------------------------------- -----------------------------------------------------
Gross Investment Advisory Fee for Fiscal Year Ended Pro forma Investment Advisory Fees for Fiscal Year
March 31, 2007 Ended March 31, 2007**
------------------------------------------------------- -----------------------------------------------------
------------------------------------------------------- -----------------------------------------------------
$283,832* $113,239
------------------------------------------------------- -----------------------------------------------------
* Pursuant to the Expense Limitation Agreement, CSIM waived $120,745 in
advisory fees, resulting in net advisory fees of $163,087 owed by the
Laudus Fund during the period.
** Pro forma fees shown do not include calculation of a performance fee.
Pursuant to the Proposed AXA Rosenberg Agreement, no performance
adjustment will apply to the calculation of the Base Fee during the
initial 36-month performance period. Thereafter, the quarterly fee paid
to AXA Rosenberg will be increased or decreased based on AXA
Rosenberg's performance in comparison with a benchmark index. See
"Overview - Investment Advisory Fees."
Future Changes to Vanguard Fund's Advisory Arrangements. Under the terms of
an SEC exemption, the Vanguard Fund's Board of Trustees may, without prior
approval from shareholders, change the terms of an advisory agreement or hire a
new investment adviser--either as a replacement for an existing adviser or as an
additional adviser. Any significant change in the Vanguard Fund's advisory
arrangements will be communicated to shareholders in writing. In addition, as
the Vanguard Fund's sponsor and overall manager, The Vanguard Group may provide
investment advisory services to the Vanguard Fund, on an at-cost basis, at any
time. Vanguard may also recommend to the board of trustees that an adviser be
hired, terminated, or replaced, or that the terms of an existing advisory
agreement be revised.
22
IV. ADDITIONAL INFORMATION ABOUT VANGUARD(R) MARKET NEUTRAL FUND
This section sets forth additional information about the Vanguard Fund,
including information regarding its investment program and expected advisory
arrangements, considerations regarding dividends, capital gains, and taxes, the
determination of its share price, and account related options. References to
"us," "we" or "our" refer to Vanguard or the Vanguard Fund, as applicable.
Reference to "you" or "your" refer to shareholders of the Vanguard Fund.
Performance/Risk Information
The Vanguard Fund has not commenced operations, so performance information
(including annual total returns and average annual total returns) for a full
calendar year is not yet available.
Primary Investment Strategies and Policies
The following sections further explain the primary investment strategies
and policies that the Vanguard Fund intends to use in pursuit of its investment
objective. You will also find information on other important features of the
Vanguard Fund.
The Vanguard Fund uses multiple investment advisers, each of which
independently selects and maintains a diversified portfolio of common stocks for
the Vanguard Fund. The Advisers employ active investment management methods,
which means that securities are bought and sold according to the Advisers'
evaluations of companies and their financial prospects, the prices of the
securities, and the stock market and the economy in general. Each Adviser buys
securities it considers to be undervalued and sells short an approximately equal
dollar amount of securities the Adviser considers to be overvalued. By taking
long and short positions in different securities that are approximately equal in
value, the Vanguard Fund attempts to limit the effect of market movements on
portfolio performance to the extent consistent with the Advisers' individual
investment decisions. Each Adviser uses an independent security selection
process and may emphasize specific industries, styles (growth/value),
capitalization ranges, or other factors. The overall profitability of the
Vanguard Fund depends on the net performance of its long and short positions,
and it is possible for the Vanguard Fund to experience a net loss across all
positions. If the Vanguard Fund's investment strategy is successful, however,
the net performance of its long and short positions will produce long-term
capital appreciation that reflects the quality of the Advisers' security
selections, with limited exposure to general stock market risk.
The market value of the long and short positions in the Vanguard Fund will
not always be equal because of continuous changes in the prices of securities.
The Vanguard Fund expects that its Advisers will need to frequently rebalance
their long and short positions. Each Adviser is also expected to change the long
and short positions in its portion of the Vanguard Fund to reflect changes in
the universe of securities the Adviser considers undervalued or overvalued. As a
result, the Vanguard Fund's portfolio turnover rate may significantly exceed
100%. Higher portfolio turnover increases brokerage commissions and other
transaction costs that reduce Vanguard Fund performance. Higher portfolio
turnover may lead to the realization and distribution of capital gains to
shareholders, potentially increasing their tax liability.
The Vanguard Fund is generally managed without regard to tax ramifications.
23
Other Investment Policies and Risks. Besides investing on a long and short
basis in publicly-traded stocks, the Vanguard Fund may make other kinds of
investments to achieve its objective.
Investments in Derivatives.
THE VANGUARD FUND MAY INVEST IN DERIVATIVES. IN GENERAL, DERIVATIVES MAY INVOLVE
RISKS DIFFERENT FROM, AND POSSIBLY GREATER THAN, THOSE OF THE VANGUARD FUND'S
OTHER INVESTMENTS.
Generally speaking, a derivative is a financial contract whose value is
based on the value of a financial asset (such as a stock, bond, or currency), a
physical asset (such as gold), or a market index (such as the S&P 500 Index).
The Vanguard Fund may invest in derivatives only if the expected risks and
rewards of the derivatives are consistent with the investment objective,
policies, strategies, and risks of the Vanguard Fund as disclosed in this
prospectus. An Adviser will not use derivatives to change the risks of the
Vanguard Fund as a whole as such risks are disclosed in this prospectus. In
particular, derivatives will be used only when an Adviser believes such use will
allow the Vanguard Fund to:
o Invest in eligible asset classes with greater efficiency and lower cost
than is possible through direct investment; or
o Add value when these instruments are attractively priced.
The Vanguard Fund's derivative investments may include futures contracts
and options thereon, options on stocks or stock indexes, warrants, swap
agreements, or other derivatives. Losses (or gains) involving futures contracts
can sometimes be substantial-in part because a relatively small price movement
in a futures contract may result in an immediate and substantial loss (or gain).
Similar risks exist for other types of derivatives. In general, investments in
derivatives have the potential to subject the Vanguard Fund to risks different
from, and possibly greater than, those of the underlying securities, assets, or
market indexes.
An Adviser may invest a small portion of the Vanguard Fund's assets in
shares of exchange-traded funds (ETFs), including exchange-traded shares issued
by Vanguard stock index funds. ETFs provide returns similar to those of common
stocks. The Vanguard Fund may purchase ETFs in order to invest in eligible asset
classes with greater efficiency and lower cost than is possible through direct
investment, or add value when ETFs are attractively priced. When investing in
ETFs, including Vanguard ETFs, the Vanguard Fund bears its proportionate share
of the expenses of the ETF in which it invests.
Investments in Vanguard CMT Funds. Vanguard may invest the Vanguard Fund's
daily cash balance in one or more Vanguard CMT Funds, which are very low-cost
money market funds. When investing in a CMT Fund, the Vanguard Fund bears its
proportionate share of the at-cost expenses of the Vanguard CMT Fund in which it
invests.
24
Temporary Investments. The Vanguard Fund may temporarily depart from its
normal investment policies--for instance, by allocating substantial assets to
cash investments, in response to extraordinary market, economic, political, or
other conditions, or for liquidity. In doing so, the Vanguard Fund may succeed
in avoiding losses, but may otherwise fail to achieve its investment objective.
FREQUENT TRADING OR MARKET-TIMING
Background. Some investors try to profit from strategies involving frequent
trading of mutual fund shares, such as market-timing. For Vanguard funds holding
foreign securities, investors may try to take advantage of an anticipated
difference between the price of the fund's shares and price movements in
overseas markets, a practice also known as time-zone arbitrage. Investors also
may try to engage in frequent trading of funds holding investments such as
small-cap stocks and high-yield bonds. As money is shifted into and out of a
fund by a shareholder engaging in frequent trading, a fund incurs costs for
buying and selling securities, resulting in increased brokerage and
administrative costs. These costs are borne by all Vanguard fund shareholders,
including the long-term investors who do not generate the costs. In addition,
frequent trading may interfere with an adviser's ability to efficiently manage
the Vanguard Fund.
Policies to Address Frequent Trading. The Vanguard funds (other than money
market funds, short-term bond funds, and Vanguard ETF(TM) Shares) do not
knowingly accommodate frequent trading. The board of trustees of each Vanguard
fund has adopted policies and procedures reasonably designed to detect and
discourage frequent trading and, in some cases, to compensate the fund for the
costs associated with it. Although there is no assurance that Vanguard will be
able to detect or prevent frequent trading or market-timing in all
circumstances, the following policies have been adopted to address these issues:
o Each Vanguard fund reserves the right to reject any purchase
request--including exchanges from other Vanguard funds--without notice and
regardless of size. For example, a purchase request could be rejected if
Vanguard determines that such purchase may negatively affect a fund's
operation or performance or because of a history of frequent trading by the
investor.
o Each Vanguard fund (other than money market funds, short-term bond funds,
and Vanguard ETF(TM) Shares) generally prohibits, except as otherwise noted
in the section entitled, "Investing With Vanguard", an investor's purchases
or exchanges into a fund account for 60 calendar days after the investor
has redeemed or exchanged out of that fund account.
o Certain Vanguard funds charge shareholders purchase and/or redemption fees
on transactions.
See the section below entitled "Investing with Vanguard" for further
details on Vanguard's transaction policies.
25
Each Vanguard fund (other than money market funds), in determining its net asset
value, will use fair value pricing as described in the section entitled "Share
Price." Fair-value pricing may reduce or eliminate the profitability of certain
frequent-trading strategies.
DO NOT INVEST WITH VANGUARD IF YOU ARE A MARKET-TIMER.
Turnover Rate
Although the Vanguard Fund normally seeks to invest for the long term, it
may sell securities regardless of how long they have been held.
The Vanguard Fund and Vanguard
The Vanguard Fund is a member of The Vanguard Group. Vanguard manages more
that $1.23 trillion in U.S. mutual fund assets, including more than $325 billion
in employer-sponsored retirement plans. Vanguard offers more than 140 funds to
U.S. investors and more than 40 additional funds in foreign markets. All of the
Vanguard funds share in the expenses associated with Vanguard's business
operations, such as personnel, office space, equipment, and advertising.
Vanguard provides marketing services to the Vanguard funds through Vanguard
Marketing Corporation, its wholly owned subsidiary. Although shareholders do not
pay sales commissions or 12b-1 distribution fees, each fund or each share class
of a fund with multiple share classes (including the Vanguard funds) pays its
allocated share of Vanguard's marketing costs.
Brokerage
The Advisers will be authorized to choose broker-dealers to handle the
purchase and sale of the Vanguard Fund's portfolio securities, and to obtain the
best available price and most favorable execution for all transactions. Subject
to applicable legal requirements, an Adviser may select a broker-dealer based
partly on brokerage or research services provided to the Adviser and its
clients, including the Vanguard Fund. The Adviser may cause the Vanguard Fund to
pay a higher commission than other broker-dealers would charge if the Adviser
determines in good faith that the amount of the commission is reasonable in
relation to the value of services provided. An Adviser also may receive
brokerage or research services from broker-dealers that are provided at no
charge in recognition of the volume of trades directed to the broker-dealer.
Dividends, Capital Gains, and Taxes
Vanguard Fund Distributions. The Vanguard Fund will distribute to
shareholders virtually all of its net income (interest and dividends, less
expenses), as well as any capital gains realized from the sale of its holdings.
Distributions generally occur in December. You can receive distributions of
income or capital gains in cash, or you can have them automatically reinvested
in more shares of the Vanguard Fund.
26
Basic Tax Points. Vanguard will send you a statement each year showing
the tax status of all your distributions. In addition, taxable investors should
be aware of the following basic tax points:
o Distributions are taxable to you for federal income tax purposes
whether or not you reinvest these amounts in additional Vanguard
Fund shares.
o Distributions declared in December - if paid to you by the end of
January - are taxable for federal income tax purposes as if
received in December.
o Distributions of any dividends, interest and short-term capital
gains that you receive are taxable to you as ordinary income for
federal income tax purposes, except that for taxable years
beginning on or before December 31, 2010, certain designated
distributions of dividend income will be taxed to you at
long-term capital gain rates, provided you and the Vanguard Fund
meet certain holding period and other requirements.
o Any distributions of net long-term capital gains are taxable to
you as long-term capital gains for federal income tax purposes,
no matter how long you've owned shares in the Vanguard Fund.
o Capital gains distributions may vary considerably from year to
year as a result of the Vanguard Fund's normal investment
activities and cash flows.
o A sale or exchange of Vanguard Fund shares is a taxable event.
This means that you may have a capital gain to report as income,
or a capital loss to report as a deduction, when you complete
your federal income tax return.
o Dividend and capital gains distributions that you receive, as
well as your gains or losses from any sale or exchange of the
Vanguard Fund shares, may be subject to state and local income
taxes.
o Any conversion between classes of shares of the same fund is a
non-taxable event. By contrast, an exchange between classes of
shares of different funds is a taxable event.
General Information
Backup withholding. By law, Vanguard must withhold 28% of any taxable
distributions or redemptions from your account if you do not:
o Provide us with your correct taxpayer identification number;
o Certify that the taxpayer identification number is correct; and
o Confirm that you are not subject to backup withholding.
27
(Please note that backup withholding will not apply to your account if you
previously satisfied these requirements for the Laudus Fund.)
Similarly, Vanguard must withhold taxes from your account if the Internal
Revenue Service instructs us to do so.
Foreign Investors. Vanguard funds generally are not sold outside the United
States, except to certain qualifying investors. If you reside outside the United
States, please consult our website at www.Vanguard.com and review "Non-U.S.
Investors." Foreign investors should be aware that U.S. withholding and estate
taxes may apply to any investments in Vanguard funds.
Invalid Addresses. If a dividend or capital gains distribution check mailed
to your address of record is returned as undeliverable, Vanguard will
automatically reinvest all future distributions until you provide us with a
valid mailing address.
Tax Consequences. The Vanguard Fund's short sales will be subject to tax
rules that may affect the amount, timing and character of distributions to
shareholders. This prospectus/proxy statement provides general tax information
only. If you are investing through a tax-deferred retirement account, such as an
IRA, special tax rules apply. Please consult your tax adviser for detailed
information about the Vanguard Fund's tax consequences for you, including
potential consequences for you of the Vanguard Fund simultaneously holding long
and short positions with respect to the same security.
Share Classes. The Vanguard Fund offers two separate classes of shares:
Investor shares and Institutional shares. Institutional shares are for investors
who generally do not require special employee benefit-plan services and who
invest a minimum of $5 million.
Share Price.
The Vanguard Fund's share price, called its net asset value, or NAV, is
calculated each business day after the close of regular trading on the New York
Stock Exchange, generally 4 p.m., Eastern time. NAV per share is computed by
dividing the net assets allocated to each share class by the number of Vanguard
Fund shares outstanding. On holidays or other days when the Exchange is closed,
the NAV is not calculated, and the Vanguard Fund does not transact purchase or
redemption requests. However, on those days the value of the Vanguard Fund's
assets may be affected to the extent that the Vanguard Fund holds foreign
securities that trade on foreign markets that are open.
Stocks held by the Vanguard Fund are valued at their market value when
reliable market quotations are readily available. Certain short-term debt
instruments used to manage the Vanguard Fund's cash are valued on the basis of
amortized cost. The values of any foreign securities held by the Vanguard Fund
are converted into U.S. dollars using an exchange rate obtained from an
independent third party. The values of any mutual fund shares held by the
Vanguard Fund are based on the NAVs of the underlying mutual funds (in the case
of conventional share classes) or the market value of the shares (in the case of
ETFs, such as ETF Shares).
28
When reliable market quotations are not readily available, securities are
priced at their fair value (the amount that the owner might reasonably expect to
receive upon the current sale of a security). The Vanguard Fund also will use
fair-value pricing if the value of a security it holds has been materially
affected by events occurring before the Vanguard Fund's pricing time but after
the close of the primary markets or exchanges on which the security is traded.
This most commonly occurs with foreign securities, which may trade on foreign
exchanges that close many hours before the Vanguard Fund's pricing time.
Intervening events might be company-specific (e.g., earnings report, merger
announcement); country-specific (e.g., natural disaster, economic or political
news, act of terrorism, interest rate change); or global. Intervening events
include price movements in U.S. markets that are deemed to affect the value of
foreign securities. Although rare, fair-value pricing also may be used for
domestic securities - for example, if (1) trading in a security is halted and
does not resume before the Vanguard Fund's pricing time or if a security does
not trade in the course of a day, and (2) the Vanguard Fund holds enough of the
security that its price could affect the Vanguard Fund's NAV.
Fair-value prices are determined by Vanguard according to procedures
adopted by Vanguard Trust's Board of Trustees. When fair-value pricing is
employed, the prices of securities used by a Vanguard fund to calculate its NAV
may differ from quoted or published prices for the same securities.
Vanguard fund share prices can be found daily in the mutual fund listings
of most major newspapers under various "Vanguard" headings.
Financial Highlights
The Vanguard Fund has not commenced operations, so financial highlights
are not yet available.
PURCHASING SHARES
Account Minimums
To open and maintain an account. $250,000 (Investor Shares); $5 million
(Institutional Shares). Laudus Fund shareholders on the date of the
Reorganization will not be subject to these account minimums.
To add to an existing account. $50 by Automatic Investment Plan; $100 by
check, exchange, wire, or electronic bank transfer (other than Automatic
Investment Plan).
Vanguard reserves the right, without prior notice, to increase or decrease
the minimum amount required to open, convert shares to, or maintain a fund
account, or to add to an existing fund account.
Investment minimums may differ for certain categories of investors.
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How To Purchase Shares
Be sure to check Exchanging Shares, Frequent-Trading Limits, and Other
Rules You Should Know before initiating your request.
Online transactions. You may open certain types of accounts, request an
electronic bank transfer, and make an exchange (the purchase of shares in an
open fund with the proceeds of a redemption from another fund) through our
website at www.vanguard.com.
By telephone. You may call Vanguard to request a purchase of shares by
wire, by electronic bank transfer, or by an exchange. You may also begin the
account registration process or request that the forms be sent to you. See
Contacting Vanguard.
By mail. You may send your check and account registration form to open a
new fund account at Vanguard. To add to an existing fund account, you may send
your check with an Invest-by-Mail form (from your account statement) or with a
deposit slip (available online). You may also send a written request to Vanguard
to add to a fund account or to make an exchange. The request must be in good
order. See How to Make a Purchase Request: By check. For a list of Vanguard
addresses, see Contacting Vanguard.
How To Make A Purchase Request
By electronic bank transfer. To establish the electronic bank transfer
option, you must designate a bank account online, complete a special form, or
fill out the appropriate section of your account registration form. You can then
purchase shares by electronic bank transfer on a regular schedule (Automatic
Investment Plan) or whenever you wish. Your transaction can be initiated online,
by telephone, or by mail if your request is in good order.
By wire. Because wiring instructions vary for different types of purchases,
please call Vanguard for instructions and policies on purchasing shares by wire.
See Contacting Vanguard.
By check. You may send a check to make initial or additional purchases to
your fund account. Also see How to Purchase Shares: By mail. Make your check
payable to: Vanguard--Fund # 634 (Investor) or 734 (Institutional). See
Contacting Vanguard.
Trade Dates
You buy shares at a fund's next-determined NAV after Vanguard receives your
purchase request in good order, including any special required documentation.
For example, if your request is received by Vanguard before the close of regular
trading on the New York Stock Exchange (generally 4 p.m., Eastern time), your
shares are purchased at that day's NAV. This is known as your trade date.
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For check and wire purchases into all funds other than money market funds,
and for exchanges into all funds: A purchase request received by Vanguard before
the close of regular trading on the New York Stock Exchange (generally 4 p.m.,
Eastern time) will have a trade date of the same day, and a purchase request
received after that time will have a trade date of the first business day
following the date of receipt.
For check purchases of money market funds only: A request received by
Vanguard before the close of regular trading on the New York Stock Exchange
(generally 4 p.m., Eastern time) will have a trade date of the first business
day following the date of receipt. For a request received after that time, the
trade date will be the second business day following the date of receipt.
Because money market instruments must be purchased with federal funds and it
takes a money market mutual fund one business day to convert check proceeds into
federal funds, the trade date will always be one business day later than for
other funds.
For an electronic bank transfer by Automatic Withdrawal Plan: Your trade
date will be one business day before the date you designated for withdrawal from
your bank account.
For an electronic bank transfer (other than an Automatic Investment Plan
purchase): A purchase request received by Vanguard on a business day before 10
p.m., Eastern time, will have a trade date of the following business day.
For further information about purchase transactions, consult our website at
www.vanguard.com or see Contacting Vanguard.
Good order. The required information on your purchase request must be
accurate and complete. See Other Rules You Should Know--Good Order. The
requirements vary among types of accounts and transactions.
Other Purchase Rules You Should Know
Check purchases. All purchase checks must be written in U.S. dollars and
drawn on a U.S. bank. Vanguard does not accept cash, traveler's checks, or money
orders. In addition, to protect the funds from fraud, Vanguard may refuse
"starter checks" and checks that are not made payable to Vanguard.
New accounts. We are required by law to obtain from you certain personal
information that we will use to verify your identity. If you do not provide the
information, we may not be able to open your account. If we are unable to verify
your identity, Vanguard reserves the right, without prior notice, to close your
account or take such other steps as we deem reasonable.
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Purchase requests. Vanguard reserves the right to stop selling shares or to
reject any purchase request at any time and without prior notice, including, but
not limited to, purchases requested by exchange from another Vanguard fund. This
also includes the right to reject any purchase request because of a history of
frequent trading by the investor or because the purchase may negatively affect a
fund's operation or performance.
Large purchases. Please call Vanguard before attempting to invest a large
dollar amount.
No cancellations. Place your transaction requests carefully. Vanguard will
not cancel any transaction request received by telephone or through Vanguard.com
once it has been confirmed. In the case of written, wire, check, or automatic
transaction requests, Vanguard will not cancel any transaction once it has been
processed.
CONVERTING SHARES
A conversion between share classes of the same fund is a nontaxable event.
A conversion request (other than a request to convert to Vanguard ETF(TM)
Shares) received in good order by Vanguard before the close of regular trading
on the New York Stock Exchange (generally 4 p.m., Eastern time) will have a
trade date of the same day, and a conversion request received after that time
will have a trade date of the first business day following the date of receipt.
See the section entitled, "Other Rules You Should Know." (Please contact
Vanguard for information on conversions into Vanguard ETF(TM) Shares.)
Pricing of Share Class Conversions
If you convert from one class of the Vanguard Fund's shares to another, the
transaction will be based on the respective net asset values of the separate
classes on the trade date for the conversion. Consequently, a conversion may
provide you with fewer shares or more shares than you originally owned,
depending on that day's net asset values. At the time of conversion, the total
dollar value of your "old" shares will equal the total dollar value of your
"new" shares. However, subsequent share price fluctuations may decrease or
increase the total dollar value of your "new" shares compared with that of your
"old" shares.
Conversions Into Institutional Shares
You are eligible for a self-directed conversion from Investor Shares into
Institutional Shares of the same Vanguard fund (if available), provided that
your account balance in the fund is at least $5 million. Registered users of
Vanguard's website, www.vanguard.com, may request a conversion online, or you
may contact Vanguard by telephone or by mail to request this transaction.
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Mandatory Conversions Into Investor Shares
If an investor no longer meets the requirements for Institutional Shares,
the Vanguard Fund may automatically convert the investor's shares into Investor
Shares. A decline in the investor's account balance because of market movement
may result in such a conversion. The Vanguard Fund will notify the investor in
writing before any mandatory, conversion occurs.
REDEEMING SHARES
The Vanguard Fund charges a 1% fee on shares that are redeemed before they
have been held for one year. Shares held by Laudus Fund shareholders on the date
of the Reorganization will not be subject to the redemption fee. The fee applies
when shares are redeemed by selling or by exchanging to another Vanguard fund,
or when Vanguard applies the low-balance account-closure policy. Shares you have
held the longest will be redeemed first.
Unlike a sales charge or a load paid to a broker or a fund management
company, the redemption fee is paid directly to the Vanguard Fund to offset the
costs of buying and selling securities. The fee is designed to ensure that
short-term investors pay their share of the Vanguard Fund's transaction costs
and that long-term investors do not subsidize the activities of short-term
traders. See the section below entitled "Investing with Vanguard" for further
details on Vanguard's redemption fees.
How To Redeem Shares
Be sure to check Exchanging Shares, Frequent-Trading Limits, and Other
Rules You Should Know before initiating your request.
Online transactions. You may redeem shares, request an electronic bank
transfer, and make an exchange (the purchase of shares with the proceeds of a
redemption from another fund) through our website at www.vanguard.com.
By telephone. You may call Vanguard to request a redemption of shares by
wire, by electronic bank transfer, by check, or by an exchange. See Contacting
Vanguard.
By mail. You may send a written request to Vanguard to redeem from a fund
account or to make an exchange. The request must be in good order. See
Contacting Vanguard.
How To Receive Redemption Proceeds
By electronic bank transfer. To establish the electronic bank transfer
option, you must designate a bank account online, complete a special form or
fill out the appropriate section of your account registration form. You can then
redeem shares by electronic bank transfer on a regular schedule (Automatic
Withdrawal Plan--$50 minimum) or whenever you wish ($100 minimum). Your
transaction can be initiated online, by telephone, or by mail if your request is
in good order.
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By wire. When redeeming from a money market fund or a bond fund, you may
instruct Vanguard to wire your redemption proceeds ($1,000 minimum) to a
previously designated bank account. Wire redemptions generally are not available
for Vanguard's balanced or stock funds. The wire redemption option is not
automatic; you must designate a bank account online, complete a special form, or
fill out the appropriate section of your account registration form. Vanguard
charges a $5 fee for wire redemptions under $5,000.
By check. Vanguard will normally mail you a redemption check within two
business days of your trade date.
Trade Dates
You redeem shares at a fund's next-determined NAV after Vanguard receives
your redemption request in good order, including any special required
documentation. For example, if your request is received by Vanguard before the
close of regular trading on the New York Stock Exchange (generally 4 p.m.,
Eastern time), your shares are redeemed at that day's NAV. This is known as your
trade date.
For check redemptions and exchanges from all funds: A request received by
Vanguard before the close of regular trading on the New York Stock Exchange
(generally 4 p.m., Eastern time) will have a trade date of the same day, and a
request received after that time will have a trade date of the first business
day following the date of receipt.
For money market fund redemptions by wire: For telephone requests received
by Vanguard before 10:45 a.m., Eastern time (2 p.m., Eastern time, for Vanguard
Prime Money Market Fund), the redemption proceeds will leave Vanguard by the
close of business that same day. For other requests received before 4 p.m.,
Eastern time, the redemption proceeds will leave Vanguard by the close of
business on the following business day.
For bond fund redemptions by wire: For requests received by Vanguard before
4 p.m., Eastern time, the redemption proceeds will leave Vanguard by the close
of business on the following business day.
For an electronic bank transfer by Automatic Withdrawal Plan: Proceeds of
redeemed shares will be credited to your bank account two business days after
your trade date. (The trade date is two business days prior to the date you
designated for the proceeds to be in your bank account.)
For an electronic bank transfer (other than an Automatic Withdrawal Plan
redemption): A redemption request received by Vanguard before the close of
regular trading on the New York Stock Exchange (generally 4 p.m., Eastern time)
will have a trade date of the same day, and a redemption request received after
that time will have a trade date of the first business day following the date of
receipt.
For further information about redemption transactions, consult our website
at www.vanguard.com or see Contacting Vanguard.
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Good order. The required information on your redemption request must be
accurate and complete. See Other Rules You Should Know--Good Order. The
requirements vary among types of accounts and transactions.
Redemption Fees
The Vanguard Fund charges a 1% fee on shares redeemed within one year of
purchase by selling or by exchanging to another fund, or when Vanguard applies
the low-balance account-closure policy. The fee is withheld from redemption
proceeds and is paid directly to the Vanguard Fund. Shares held for one year or
more are not subject to the 1% fee. After redeeming shares that are exempt from
redemption fees, shares you have held the longest will be redeemed first.
For Vanguard fund accounts (including participants in employer-sponsored
defined contribution plans that are serviced by Vanguard Small Business
Services), redemption fees will not apply to the following:
o Redemptions of shares purchased with reinvested dividend and capital gains
distributions.
o Share transfers, rollovers, or re-registrations within the same fund.
o Conversions of shares from one share class to another in the same fund.
o Redemptions of shares to pay fund or account fees.
o Section 529 college savings plans.
o For a one-year period, shares rolled over to an IRA held at Vanguard from a
retirement plan for which Vanguard serves as recordkeeper (except for
Vanguard Small Business Services retirement plans).
o Distributions by shareholders age 70 1/2 or older from the following:
o Traditional IRAs.
o Inherited IRAs (traditional and Roth).
o Rollover IRAs.
o SEP-IRAs.
o SIMPLE IRAs.
o Section 403(b)(7) plans served by the Vanguard Small Business Services
Department.
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o Vanguard Retirement Plans for which Vanguard Fiduciary Trust Company
serves as trustee.
For participants in employer-sponsored defined contribution plans (other
than those serviced by the Vanguard Small Business Services Department), in
addition to the exclusions previously listed, redemption fees will not apply to
the following:
o Exchanges of shares purchased with participant payroll or employer
contributions.
o Distributions, loans, and in-service withdrawals from a plan.
o Redemptions or transfers of shares as part of a plan termination or at the
direction of the plan.
o Direct rollovers into IRAs.
Redemption fees will apply to shares exchanged out of a fund within the
fund's redemption-fee period into which fund the shares had previously been
exchanged, rolled over, or transferred by a participant. If Vanguard does not
serve as record keeper for your plan, redemption fees may be applied
differently. Please read your recordkeeper's plan materials carefully to learn
of any other rules or fees that may apply. Also see "Frequent-Trading Limits--
Accounts Held by Intermediaries" for information about the assessment of
redemption fees by intermediaries.
Other Redemption Rules You Should Know
Documentation for certain accounts. Special documentation may be required
to redeem from certain types of accounts, such as trust, corporate, nonprofit,
or retirement accounts. Please call us before attempting to redeem from these
types of accounts.
Potentially disruptive redemptions. Vanguard reserves the right to pay all
or part of a redemption in kind--that is, in the form of securities - if we
reasonably believe that a cash redemption would negatively affect the fund's
operation or performance or that the shareholder may be engaged in frequent
trading. Under these circumstances, Vanguard also reserves the right to delay
payment of the redemption proceeds for up to seven calendar days. By calling us
before you attempt to redeem a large dollar amount, you may avoid in-kind or
delayed payment of your redemption. Please see Frequent-Trading Limits for
information about Vanguard's policies to limit frequent trading.
Recently purchased shares. Although you can redeem shares at any time,
proceeds may not be made available to you until the fund collects payment for
your purchase. This may take up to ten calendar days for shares purchased by
check or by electronic bank transfer. If you have written a check on a fund with
checkwriting privileges, that check may be rejected if your fund account does
not have a sufficient available balance.
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Address change. If you change your address online or by telephone, there
may be a 15-day hold on online and telephone redemptions. Address-change
confirmations are sent to both the old and new addresses.
Payment to a different person or address. At your request, we can make your
redemption check payable to a different person or send it to a different
address. However, this requires the written consent of all registered account
owners and may require a signature guarantee. You can obtain a signature
guarantee from most commercial and savings banks, credit unions, trust
companies, or member firms of a U.S. stock exchange. A notary public cannot
provide a signature guarantee.
No cancellations. Place your transaction requests carefully. Vanguard will
not cancel any transaction request received by telephone or through Vanguard.com
once it has been confirmed. In the case of written or automatic transaction
requests, Vanguard will not cancel any transaction once it has been processed.
Emergency circumstances. Vanguard funds can postpone payment of redemption
proceeds for up to seven calendar days. In addition, Vanguard funds can suspend
redemptions and/or postpone payments of redemption proceeds beyond seven
calendar days at times when the New York Stock Exchange is closed or during
emergency circumstances, as determined by the SEC.
EXCHANGING SHARES
An exchange occurs when the assets redeemed from one Vanguard fund are used
to purchase shares in an open Vanguard fund. You can make exchange requests
online (through your account registered with Vanguard.com), by telephone, or by
mail.
Please note that Vanguard reserves the right, without prior notice, to
revise or terminate the exchange privilege, limit the amount of any exchange, or
reject an exchange, at any time, for any reason.
FREQUENT-TRADING LIMITS
Because excessive transactions can disrupt management of a fund and
increase the fund's costs for all shareholders, Vanguard places certain limits
on frequent trading in the Vanguard funds. Each Vanguard fund (other than money
market funds, short-term bond funds, and ETF Shares) limits an investor's
purchases or exchanges into a fund account for 60 calendar days after the
investor has redeemed or exchanged out of that fund account.
For Vanguard Retirement Investment Program pooled plans, the policy applies
to exchanges made by participants online or by phone.
The policy does not apply to the following:
o Purchases of shares with reinvested dividend or capital gains
distributions.
37
o Transactions through Vanguard's Automatic Investment Plan, Automatic
Exchange Service, Direct Deposit Service, Automatic Withdrawal Plan,
Required Minimum Distribution Service, and Vanguard Small Business
Online(R).
o Redemptions of shares to pay fund or account fees.
o Transaction requests submitted by mail to Vanguard from shareholders
who hold their accounts directly with Vanguard. (Transactions
submitted by fax or wire are not mail transactions and are subject to
the policy.)
o Transfers and re-registrations of shares within the same fund.
o Purchases of shares by asset transfer or direct rollover.
o Conversions of shares from one share class to another in the same
fund.
o Checkwriting redemptions.
o Section 529 college savings plans.
o Certain approved institutional portfolios and asset allocation
programs, as well as trades made by Vanguard funds that invest in
other Vanguard funds. (Please note that shareholders of Vanguard's
funds of funds are subject to the policy.)
For participants in employer-sponsored defined contribution plans that are
not serviced by Vanguard Small Business Services, the frequent-trading policy
does not apply to:
o Purchases of shares with participant payroll or employer contributions
or loan repayments.
o Purchases of shares with reinvested dividend or capital gains
distributions.
o Distributions, loans, and in-service withdrawals from a plan.
o Redemptions of shares as part of a plan termination or at the
direction of the plan.
o Automated transactions executed during the first six months of a
participant's enrollment in the Vanguard Managed Account Program.
o Redemptions of shares to pay fund or account fees.
o Share or asset transfers or rollovers.
o Re-registrations of shares.
o Conversions of shares from one share class to another in the same
fund.
ACCOUNTS HELD BY INSTITUTIONS (OTHER THAN DEFINED CONTRIBUTION PLANS)
Vanguard will systematically monitor for frequent trading in institutional
clients' accounts. If we detect suspicious trading activity, we will investigate
and take appropriate action, which may include applying to a client's accounts
the 60-day policy previously described, prohibiting a client's purchases of fund
shares, and/or eliminating the client's exchange privilege.
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ACCOUNTS HELD BY INTERMEDIARIES
When intermediaries establish accounts in Vanguard funds for their clients,
we cannot always monitor the trading activity of individual clients. However, we
review trading activity at the omnibus level, and if we detect suspicious
activity, we will seek to investigate and take appropriate action. If necessary,
Vanguard may prohibit additional purchases of fund shares by an intermediary or
by certain of the intermediary's clients. Intermediaries may also monitor their
clients' trading activities in the Vanguard funds.
For those Vanguard funds that charge purchase or redemption fees,
intermediaries will be asked to assess purchase and redemption fees on
shareholder and participant accounts and remit these fees to the funds. The
application of purchase and redemption fees and frequent-trading policies may
vary among intermediaries. There are no assurances that Vanguard will
successfully identify all intermediaries or that intermediaries will properly
assess purchase and redemption fees or administer frequent-trading policies. If
you invest with Vanguard through an intermediary, please read that firm's
materials carefully to learn of any other rules or fees that may apply.
OTHER RULES YOU SHOULD KNOW
Vanguard.com(R)Registration. If you are a registered user of Vanguard.com,
you can use your personal computer to review your account holdings; to buy,
sell, or exchange shares of most Vanguard funds; and to perform most other
transactions. You must register for this service online.
Electronic delivery. Vanguard can deliver your account statements,
transaction confirmations, and fund financial reports electronically. If you are
a registered user of Vanguard.com, you can consent to the electronic delivery of
these documents by logging on and changing your mailing preference under "My
Profile." You can revoke your electronic consent at any time, and we will begin
to send paper copies of these documents within 30 days of receiving your notice.
Telephone Transactions
Automatic. When we set up your account, we'll automatically enable you to
do business with us by telephone, unless you instruct us otherwise in writing.
Tele-account(R). To conduct account transactions through Vanguard's
automated telephone service, you must first obtain a Personal Identification
Number (PIN). Call Tele-Account at 800-662-6273 to obtain a PIN, and allow seven
days after requesting the PIN before using this service.
Proof of a caller's authority. We reserve the right to refuse a telephone
request if the caller is unable to provide the requested information or if we
reasonably believe that the caller is not an individual authorized to act on the
account. Before we allow a caller to act on an account, we may request the
following information:
39
o Authorization to act on the account (as the account owner or by legal
documentation or other means).
o Account registration and address.
o Social Security or employer identification number.
o Fund name and account number, if applicable.
o Other information relating to the caller, the account holder, or the
account.
Subject to revision. We reserve the right, at any time without prior
notice, to revise, suspend, or terminate the ability for any or all shareholders
to transact or communicate with Vanguard by telephone.
Good Order
We reserve the right to reject any transaction instructions that are not in
"good order." Good order generally means that your instructions include:
o The fund name and account number.
o The amount of the transaction (stated in dollars, shares, or
percentage).
Written instructions also must include:
o Signatures of all registered owners.
o Signature guarantees, if required for the type of transaction.*
o Any supporting legal documentation that may be required.
The requirements vary among types of accounts and transactions.
*Call Vanguard for specific signature-guarantee requirements.
Vanguard reserves the right, without prior notice, to revise the requirements
for good order.
Future Trade-Date Requests
Vanguard does not accept requests to hold a purchase, conversion,
redemption, or exchange transaction for a future date. All such requests will
receive trade dates as previously described in Buying Shares and Redeeming
Shares. Vanguard reserves the right to return future-dated checks.
Accounts With More Than One Owner
If an account has more than one owner or authorized person, Vanguard will
accept telephone or online instructions from any one owner or authorized person.
Responsibility For Fraud
Vanguard will not be responsible for any account losses because of fraud if
we reasonably believe that the person transacting business on an account is
authorized to do so. Please take precautions to protect yourself from fraud.
40
Keep your account information private, and immediately review any account
statements that we send to you. It is important that you contact Vanguard
immediately about any transactions you believe to be unauthorized.
Uncashed Checks
Please cash your distribution or redemption checks promptly. Vanguard will
not pay interest on uncashed checks.
Unusual Circumstances
If you experience difficulty contacting Vanguard online, by telephone, or
by Tele-Account, you can send us your transaction request by regular or express
mail. See Contacting Vanguard for addresses.
Investing With Vanguard Through Other Firms
You may purchase or sell shares of most Vanguard funds through a financial
intermediary, such as a bank, broker, or investment adviser.
Please see Frequent-Trading Limits--Accounts Held by Intermediaries for
information about the assessment of redemption fees and monitoring of frequent
trading for accounts held by intermediaries.
Account Service Fee
For most shareholders, Vanguard deducts a $20 account service fee from all
fund accounts that have a balance below $10,000 for any reason, including market
fluctuations. The account service fee applies to both retirement and
nonretirement fund accounts. The fee will be assessed on fund accounts in all
Vanguard funds, regardless of a fund's minimum investment amount. The account
service fee, which will be assessed by redeeming fund shares in the amount of
$20, will be deducted from a fund account only once per calendar year.
If you register on Vanguard.com and elect electronic delivery of
statements, reports, and other materials for all of your fund accounts, the
account service fee will not be charged for balances below $10,000.
The account service fee also does not apply to the following:
o Money market sweep accounts held through Vanguard Brokerage Services.
o Accounts held through intermediaries.
o Accounts registered under your taxpayer identification number and
having aggregate Vanguard mutual fund assets greater than $100,000
(including IRAs, employer-sponsored retirement plans, brokerage
accounts, annuities, and non-IRA accounts).
o Participant accounts in employer-sponsored defined contribution plans
(other than those served by the Vanguard Small Business Services
Department, which are subject to various fee structures. Please
consult your account registration paperwork for the rules that apply
to your account).
o Section 529 college savings plans.
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Low-Balance Accounts
All Vanguard funds reserve the right, without prior notice, to liquidate
any investment-only retirement-plan fund account or any nonretirement fund
account whose balance falls below the minimum initial investment for any reason,
including market fluctuation. Shares redeemed in accordance with this policy
will be subject to applicable redemption fees.
Right To Change Policies
In addition to the rights expressly stated elsewhere in this prospectus,
Vanguard reserves the right to (1) alter, add, or discontinue any conditions of
purchase (including eligibility requirements), redemption, exchange, service, or
privilege at any time without prior notice; (2) accept initial purchases by
telephone; conversion, (3) freeze any account and/or suspend account services
when Vanguard has received reasonable notice of a dispute regarding the assets
in an account, including notice of a dispute between the registered or
beneficial account owners or when we reasonably believe a fraudulent transaction
may occur or has occurred; (4) alter, impose, discontinue, or waive any
redemption fee, account service fee, low-balance account fee, account
maintenance fee, or other fees charged to a group of shareholders; and (5)
redeem an account, without the owner's permission to do so, in cases of
threatening conduct or suspicious, fraudulent, or illegal activity. Changes may
affect any or all investors. These actions will be taken when, at the sole
discretion of Vanguard management, we reasonably believe they are deemed to be
in the best interest of a fund.
Share Classes
Vanguard reserves the right, without prior notice, to change the
eligibility requirements of its share classes, including the types of clients
who are eligible to purchase each share class.
FUND AND ACCOUNT UPDATES
Confirmation Statements
We will send (or provide online, whichever you prefer) a confirmation
statement confirming your trade date and the amount of your transaction when you
buy, sell, or exchange shares. However, we will not send confirmation statements
reflecting only checkwriting redemptions or the reinvestment of dividends or
capital gains distributions. For any month in which you had a checkwriting
redemption, a Checkwriting Activity Statement will be sent to you itemizing the
checkwriting redemptions for that month. Promptly review each confirmation
statement that we send to you. It is important that you contact Vanguard
immediately with any questions you may have about any transaction reflected on
the confirmation statement.
Portfolio Summaries
We will send (or provide online, whichever you prefer) quarterly portfolio
summaries to help you keep track of your accounts throughout the year. Each
summary shows the market value of your account at the close of the statement
period, as well as all distributions, purchases, redemptions, exchanges,
transfers, and conversions for the current calendar year. Promptly review each
summary that we send to you. It is important that you contact Vanguard
immediately with any questions you may have about any transaction reflected on
the summary.
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Tax Statements
For most taxable accounts, we will send annual tax statements to assist you
in preparing your income tax returns. These statements, which are generally
mailed in January, will report the previous year's dividend and capital gains
distributions, proceeds from the sale of shares, and distributions from IRAs and
other retirement plans. These statements can be viewed online.
Average-Cost Review Statements
For most taxable accounts, average-cost review statements will accompany
annual 1099B tax statements. These statements show the average cost of shares
that you redeemed during the previous calendar year, using the average-cost
single-category method, which is one of the methods established by the Internal
Revenue Service.
Annual and Semiannual Reports
We will send (or provide online, whichever you prefer) financial reports
about the Vanguard Fund twice a year, in May and November. These comprehensive
reports include overviews of the financial markets and provide the following
specific Vanguard Fund information:
o Performance assessments and comparisons with industry benchmarks.
o Reports from the adviser.
o Financial statements with detailed listings of the Vanguard Fund's
holdings.
Vanguard attempts to eliminate the unnecessary expense of duplicate
mailings by sending just one report when two or more shareholders have the same
last name and address. You may request individual reports by contacting our
Client Services Department in writing, by telephone, or by e-mail.
Portfolio Holdings
We generally post on our website at www.vanguard.com, in the Holdings
section of the Vanguard Fund's Profile page, a detailed list of the securities
held by the Vanguard Fund (under Portfolio Holdings), as of the most recent
calendar-quarter-end. This list is generally updated within 30 days after the
end of each calendar quarter. Vanguard may exclude any portion of these
portfolio holdings from publication when deemed in the best interest of the
Vanguard Fund. We also generally post the ten largest stock portfolio holdings
of the Vanguard Fund and the percentage of the Vanguard Fund's total assets that
each of these holdings represents, as of the most recent calendar-quarter-end.
This list is generally updated within 15 calendar days after the end of each
calendar quarter. These postings generally remain until replaced by new postings
as previously described. Please consult the Vanguard Fund's Statement of
Additional Information or our website for a description of the policies and
procedures that govern disclosure of the Vanguard Fund's portfolio holdings.
43
Contacting Vanguard
-------------------------------------------------- -------------------------------------------------------------------
Web
-------------------------------------------------- -------------------------------------------------------------------
-------------------------------------------------- -------------------------------------------------------------------
Vanguard.com For the most complete source of Vanguard news
24 hours a day, 7 days a week For fund, account, and service information
For most account transactions
For literature requests
-------------------------------------------------- -------------------------------------------------------------------
-------------------------------------------------- -------------------------------------------------------------------
Phone
-------------------------------------------------- -------------------------------------------------------------------
-------------------------------------------------- -------------------------------------------------------------------
Vanguard Tele-Account(R) For automated fund and account information
800-662-6273 (ON-BOARD) For exchange transactions (subject to limitations)
Toll-free, 24 hours a day, 7 days a week
-------------------------------------------------- -------------------------------------------------------------------
-------------------------------------------------- -------------------------------------------------------------------
Investor Information For fund and service information
800-662-7447 (SHIP) For literature requests
(Text telephone for people with hearing Business hours only: Monday-Friday, 8 a.m. to 10 p.m.,
impairment: 800-952-3335) Eastern time; Saturday, 9 a.m. to 4 p.m., Eastern time
-------------------------------------------------- -------------------------------------------------------------------
-------------------------------------------------- -------------------------------------------------------------------
Client Services For account information
800-662-2739 (CREW) For most account transactions
(Text telephone for people with hearing Business hours only: Monday-Friday, 8 a.m. to 10 p.m., Eastern
impairment: 800-749-7273) time; Saturday, 9 a.m. to 4 p.m., Eastern time
-------------------------------------------------- -------------------------------------------------------------------
-------------------------------------------------- -------------------------------------------------------------------
Institutional Division For information and services for large institutional investors
888-809-8102 Business hours only: Monday-Friday, 8:30 a.m. to 9 p.m., Eastern
time
-------------------------------------------------- -------------------------------------------------------------------
-------------------------------------------------- -------------------------------------------------------------------
Intermediary Sales Support For information and services for financial intermediaries
800-997-2798 including broker-dealers, trust institutions, insurance
companies, and financial advisers
Business hours only: Monday-Friday, 8:30 a.m. to 8 p.m., Eastern
time
-------------------------------------------------- -------------------------------------------------------------------
44
Vanguard Addresses
Please be sure to use the correct address, depending on your method of delivery.
Use of an incorrect address could delay the processing of your transaction.
-------------------------------------------------- -------------------------------------------------------------------
Regular Mail (Individuals) The Vanguard Group
P.O. Box 1110 Valley Forge,
PA 19482-1110
-------------------------------------------------- -------------------------------------------------------------------
-------------------------------------------------- -------------------------------------------------------------------
Regular Mail (Institutions) The Vanguard Group
P.O. Box 2900 Valley Forge,
PA 19482-2900
-------------------------------------------------- -------------------------------------------------------------------
-------------------------------------------------- -------------------------------------------------------------------
Registered, Express, or Overnight The Vanguard Group
455 Devon Park Drive
Wayne, PA 19087-1815
-------------------------------------------------- -------------------------------------------------------------------
Fund Number
Please use the specific fund number when contacting us:
--------------------------------------------------------------------------------
Investor Shares Institutional Shares
--------------------------------------------------------------------------------
Vanguard Market Neutral Fund 634 734
--------------------------------------------------------------------------------
45
V. MANAGEMENT OF VANGUARD(R) MARKET NEUTRAL FUND
Officers and Trustees. The officers of the Vanguard Fund and the other
Vanguard funds manage their day-to-day operations under the direction of a Board
of Trustees. The trustees set broad policies for, and choose the officers of,
the Vanguard funds. Each trustee serves the relevant Vanguard fund until its
termination; until the trustee's retirement, resignation, death; or otherwise as
specified in the relevant organizational documents. Each trustee also serves as
a director of Vanguard.
The following chart shows information for each trustee and executive
officer of the Vanguard Fund. The mailing address of the trustees and officers
is P.O. Box 876, Valley Forge, PA 19482.
NUMBER OF
VANGUARD PRINCIPAL OCCUPATION(S) AND OUTSIDE VANGUARD FUNDS
POSITION(S) FUNDS' TRUSTEE/ DIRECTORSHIPS OVERSEEN BY
NAME, YEAR OF BIRTH HELD WITH FUNDS OFFICER SINCE DURING THE PAST FIVE YEARS TRUSTEE/OFFICER
------------------- --------------- -------------- -------------------------- ----------------
INTERESTED TRUSTEE
John J. Brennan/1/ Chairman of the May 1987 Chairman of the Board, Chief 147
(1954) Board, Chief Executive Officer, and Director
Executive Officer, (Trustee) of Vanguard, and of each of the
and Trustee investment companies served by Vanguard.
-----------------------------------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------------------------------
INDEPENDENT TRUSTEES
Charles D. Ellis Trustee January 2001 Applecore Partners (pro bono ventures in 147
(1937) education); Senior Advisor to Greenwich
Associates (international business strategy
consulting); Successor Trustee of Yale
University; Overseer of the Stern School of
Business at New York University; Trustee of
the Whitehead Institute for Biomedical Research.
Rajiv L. Gupta Trustee December 2001 Chairman, President and Chief Executive Officer of Rohm 147
(1945) and Haas Co. (chemicals); Board Member of
American Chemistry Council; Director of Tyco
International, Ltd. (diversified manufacturing and
services) since 2005; Trustee of Drexel University
and the Chemical Heritage Foundation.
46
NUMBER OF
VANGUARD PRINCIPAL OCCUPATION(S) AND OUTSIDE VANGUARD FUNDS
POSITION(S) FUNDS' TRUSTEE/ DIRECTORSHIPS OVERSEEN BY
NAME, YEAR OF BIRTH HELD WITH FUNDS OFFICER SINCE DURING THE PAST FIVE YEARS TRUSTEE/OFFICER
------------------- --------------- -------------- -------------------------- ----------------
Amy Gutmann Trustee June 2006 President of the University of Pennsylvania 147
(1949) since 2004; Professor in the School of Arts
and Sciences, Annenberg School for Communi-
cation, and Graduate School of Education of
the University of Pennsylvania since 2004;
Provost (2001 - 2004) and Laurance S.
Rockefeller Professor of Politics and the
University Center for Human Values (1990 -
2004), Princeton University; Director of
Carnegie Corporation of New York since 2005,
and of Schuylkill River Development
Corporation and Greater Philadelphia
Chamber of Commerce since 2004.
JoAnn Heffernan Heisen Trustee July 1998 Corporate Vice President and Chief Global 147
(1950) Diversity Officer since 2006, Vice President
and Chief Information Officer (1997 - 2005),
and Member of the Executive Committee of
Johnson & Johnson (pharmaceuticals/consumer
products); Director of the University Medical
Center at Princeton and Women's Research and
Education Institute.
Andre F. Perold Trustee December 2004 George Gund Professor of Finance and Banking, 147
(1952) Harvard Business School; Senior Associate Dean,
Director of Faculty Recruiting, and Chair of Finance
Faculty, Harvard Business School; Director and
Chairman of UNX, Inc. (equities trading firm) since
2003; Chair of the Investment Committee of HighVista
Strategies LLC (private investment firm) since 2005.
47
NUMBER OF
VANGUARD PRINCIPAL OCCUPATION(S) AND OUTSIDE VANGUARD FUNDS
POSITION(S) FUNDS' TRUSTEE/ DIRECTORSHIPS OVERSEEN BY
NAME, YEAR OF BIRTH HELD WITH FUNDS OFFICER SINCE DURING THE PAST FIVE YEARS TRUSTEE/OFFICER
------------------- --------------- -------------- -------------------------- ----------------
Alfred M. Rankin, Jr. Trustee January 1993 Chairman, President, Chief Executive Officer, and 147
(1941) Director of NACCO Industries, Inc.(forklift trucks/
housewares/lignite); Director of Goodrich Corporation
(industrial products/aircraft systems and services).
J. Lawrence Wilson Trustee April 1985 Retired Chairman, Chief Executive Officer, and 147
(1936) President of Rohm and Haas Co. (chemicals);
Director of Cummins Inc.
(diesel engines), and AmerisourceBergen Corp.
(pharmaceutical distribution); Trustee of Vanderbilt
University and Culver Educational Foundation.
EXECUTIVE OFFICERS
Heidi Stam/1/ Secretary July 2005 Managing Director of Vanguard since 2006; General 147
(1956) Counsel of Vanguard since 2005; Secretary of
Vanguard, and of each of the investment companies
served by Vanguard, since 2005; Principal of Vanguard
(1997-2006).
Thomas J. Higgins/1/ Treasurer July 1998 Principal of Vanguard; Treasurer of each of the 147
(1957) investment companies served by Vanguard.
(1) Officers of the Vanguard Fund are "interested persons" as defined in the
Investment Company Act of 1940 Act.
Mr. Ellis is a Senior Advisor to Greenwich Associates, a firm that consults
on business strategy to professional financial services organizations in markets
around the world. A large number of financial service providers, including
Vanguard, subscribe to programs of research-based consulting. During 2005 and
2006, Vanguard paid Greenwich subscription fees amounting to less than $400,000.
Vanguard's subscription rates are similar to those of other subscribers.
48
Trustees' Ownership of Vanguard Fund Shares. All trustees allocate their
investments among the various Vanguard funds based on their own investment
needs. The following table shows each trustee's ownership of shares of the
Vanguard Fund and of all Vanguard funds served by the trustee as of July 31,
2007. As a group, the Vanguard funds' trustees and officers own no shares of the
Vanguard Fund at the time of the Reorganization.
--------------------------------------------------------------------------------
Dollar Range of
Vanguard Fund Aggregate Dollar Range
Shares Owned of Shares of the Vanguard funds
Name of Trustee by Trustee* Owned by Trustee
--------------------------------------------------------------------------------
John J. Brennan None Over $100,000
--------------------------------------------------------------------------------
Charles D. Ellis None Over $100,000
--------------------------------------------------------------------------------
Rajiv L. Gupta None Over $100,000
--------------------------------------------------------------------------------
Amy Gutman None Over $100,000
--------------------------------------------------------------------------------
JoAnn Heffernan Heisen None Over $100,000
--------------------------------------------------------------------------------
Andre F. Perold None Over $100,000
--------------------------------------------------------------------------------
Alfred M. Rankin, Jr. None Over $100,000
--------------------------------------------------------------------------------
J. Lawrence Wilson None Over $100,000
--------------------------------------------------------------------------------
* The Vanguard Fund has not yet commenced operations.
As of July 31 2007, the trustees and executive officers of the Vanguard
Fund owned, in the aggregate, less than 1% of the Vanguard Fund's shares.
Trustee Compensation. The same individuals serve as trustees of all
Vanguard funds, and each fund pays a proportionate share of the trustees'
compensation. The Vanguard funds employ their officers on a shared basis, as
well. However, officers are compensated by Vanguard, not the Vanguard funds.
Independent Trustees. The Vanguard funds compensate their independent
trustees-that is, the ones who are not also officers of the Vanguard funds-in
three ways:
o The independent trustees receive an annual fee for their service to the
Vanguard funds, which is subject to reduction based on absences from
scheduled board meetings.
o The independent trustees are reimbursed for the travel and other expenses
that they incur in attending board meetings.
o Upon retirement (after attaining age 65 and completing five years of
service), the independent trustees who began their service prior to January
1, 2001, receive a retirement benefit under a separate account arrangement.
As of January 1, 2001, the opening balance of each eligible trustee's
separate account was generally equal to the net present value of the
benefits he or she had accrued under the trustees' former retirement plan.
Each eligible trustee's separate account will be credited annually with
49
interest at a rate of 7.5% until the trustee receives his or her final
distribution. Those independent trustees who began their service on or
after January 1, 2001, are not eligible to participate in the plan.
"Interested" Trustees. Mr. Brennan serves as a trustee, but is not paid in
this capacity. He is, however, paid in his role as officer of Vanguard.
Compensation Table. The following table provides compensation details for
each of the trustees. The amounts paid as compensation and accrued as retirement
benefits by the Vanguard funds for each trustee are listed. In addition, the
table shows the total amount of benefits that the Vanguard Trust expects each
trustee to receive from all Vanguard funds upon retirement, and the total amount
of compensation paid to each trustee by all Vanguard funds.
VANGUARD MONTGOMERY FUNDS
COMPENSATION TABLE
--------------------------------------------------------------------------------------------------------------------
Names of Trustee Aggregate Pension or Retirement Estimated Annual Total Compensation
Compensation from Benefits Accrued as Part Benefits Upon from All
Vanguard(R) Market of Vanguard(R) Market Retirement(2) Vanguard funds
Neutral Fund (1) Neutral Fund's Expenses(1) Paid to Trustees(3)
--------------------------------------------------------------------------------------------------------------------
John J. Brennan - - - -
Charles D. Ellis $2.80 - - $140,000
Rajiv L. Gupta $2.72 - - $136,000
Amy Gutmann(4) $1.44 - - $72,000
JoAnn Heffernan Heisen $2.80 $0.05 $2,365 $140,000
Andre F. Perold $2.80 - - $140,000
Alfred M. Rankin, Jr. $3.04 $0.09 $4,634 $152,000
J. Lawrence Wilson $2.90 $0.13 $6,735 $144,750
(1) The amounts shown in this column are based on estimated amounts for
the Vanguard Fund's current fiscal year.
(2) Each trustee is eligible to receive retirement benefits only after
completing at least 5 years (60 consecutive months) of service as a
trustee for the Vanguard funds. The annual retirement benefit will be
paid in monthly installments, beginning with the month following the
trustee's retirement from service, and will cease after 10 years of
payments (120 monthly installments). Trustees who began their service
on or after January 1, 2001, are not eligible to
participate in the retirement benefit plan.
(3) The amounts reported in this column reflect the total compensation
paid to each trustee for his or her service as trustee of 145 Vanguard
funds for the 2006 calendar year.
(4) Dr. Gutmann became a member of the Vanguard Funds board effective June
2006.
50
The Vanguard Group. Vanguard Market Neutral Fund has been organized as a
member of The Vanguard Group of Investment Companies, which consists of more
than 140 mutual funds. The Vanguard Group, Inc., located at P.O. Box 2600,
Valley Forge, PA 19482-6200, which is a jointly owned subsidiary of the Vanguard
funds, provides corporate management, administrative and distribution services
to the Vanguard funds on an at-cost basis. Vanguard also provides investment
advisory services on an at-cost basis to many of the Vanguard funds.
Vanguard employs a supporting staff of management and administrative
personnel needed to provide the requisite services to the Vanguard funds and
also furnishes the funds with necessary office space, furnishings, and
equipment. Each among the funds under methods approved by the board of trustees
of each Vanguard Fund. In addition, each Vanguard Fund bears its own direct
expenses, such as legal, auditing and custodian fees.
Vanguard was established and operates under an Amended and Restated Funds'
Service Agreement that was approved by the shareholders of The Vanguard Group,
Inc. The amount that each Vanguard Fund has invested in Vanguard is adjusted
from time to time in order to maintain the proportionate relationship between
each fund's relative net assets and its contribution to Vanguard's capital.
Under the Amended and Restated Service Agreement, no fund can be called on to
invest more than 0.40% of its current assets in Vanguard.
VI. GENERAL INFORMATION
This section provides information on a number of topics relating to proxy
voting and the shareholder meeting.
Proxy Solicitation Methods. The Laudus Trust Board of Trustees is
furnishing this combined Prospectus/Proxy Statement in connection with the
solicitation of proxies. The Laudus Fund will solicit shareholder proxies in a
variety of ways. All shareholders that are entitled to vote will receive these
proxy materials by mail. In addition, employees and officers of Charles Schwab &
Co., Inc., or its affiliates may solicit shareholder proxies in person or by
telephone.
The Laudus Fund has retained D.F. King & Co., Inc. (the "Proxy Solicitor"),
48 Wall Street, 22nd Floor, New York, NY 10005 to aid in the solicitation of
proxies. The costs of retaining the Proxy Solicitor and other expenses incurred
in connection with the solicitation of proxies will be shared by Vanguard, CSIM
and AXA Rosenberg in accordance with the terms of the Fund Sponsorship
Agreement. The anticipated cost associated with the solicitation of proxies by
the Proxy Solicitor is $20,000 plus any reasonable out-of-pocket expenses
incurred by the Proxy Solicitor.
In addition to voting by mail or in person at the Meeting, you may give
your voting instructions over the telephone by calling 1-888-221-0697 or through
the Internet by going to www.proxyweb.com. A representative of the Proxy
Solicitor will answer your call. When receiving your instructions by telephone,
the Proxy Solicitor representative is required to ask you for your full name,
address, the last four digits of your social security number or employer
identification number, title (if the person giving the proxy is authorized to
act for an entity, such as a corporation), the number of shares of the Laudus
Fund, and to
51
confirm that you have received the proxy statement in the mail. If the
information you provided matches the information provided to the Proxy Solicitor
by CSIM, the Proxy Solicitor representative will explain the voting process. The
Proxy Solicitor is not permitted to recommend to you how to vote, other than to
read any recommendation included in the prospectus/proxy statement. The Proxy
Solicitor will record your instructions and transmit them to the official
tabulator and send you a letter or mailgram to confirm your vote. That letter
will also ask you to call the Proxy Solicitor immediately if the confirmation
does not reflect your instruction correctly. You may receive a call from a
representative of the Proxy Solicitor if CSIM has not yet received your vote.
The Proxy Solicitor may ask you for authority by telephone to permit the Proxy
Solicitor to sign a proxy on your behalf. The Proxy Solicitor will record all
instructions, in accordance with the procedures set forth above. The Laudus
Trust believes those procedures are reasonably designed to determine accurately
the shareholder's identity and voting instructions.
Proxy Solicitation Costs. Vanguard, CSIM and AXA Rosenberg will share 100%
of the costs of soliciting proxies in accordance with the terms and conditions
of the Fund Sponsorship Agreement, including costs related to the preparation,
printing, mailing and tabulation of proxies. The Laudus Fund will not bear any
of those costs. Voting immediately can help Vanguard, CSIM and AXA Rosenberg
avoid the considerable expense of a second solicitation.
Quorum. In order for the shareholder meeting to go forward, the Laudus Fund
must achieve a quorum. This means that at least forty percent (40.0%) of the
Laudus Fund's shares must be represented at the meeting - either in person or by
proxy. All returned proxies count towards a quorum regardless of how they are
voted ("For," "Against," or "Abstain"). As discussed more fully below in the
section entitled "Tabulation of Votes," broker non-votes are considered present
for purposes of determining the presence of a quorum.
Required Vote. Proceeding with the Reorganization requires the affirmative
vote of a "majority of the outstanding voting securities" of the Laudus Fund, as
defined in the 1940 Act. THE BOARD OF TRUSTEES OF THE LAUDUS TRUST RECOMMENDS
THAT SHAREHOLDERS APPROVE THE REORGANIZATION.
Revoking a Proxy. Shareholders may revoke a proxy at any time up until
voting results are announced at the Meeting. You can do this by writing to the
Laudus Fund's Secretary, P.O. Box 8032, Boston, Massachusetts 02266, or by
voting in person at the Meeting.
Adjournment. In the event that sufficient votes in favor of the
Reorganization are not received by the time scheduled for the Meeting, the
persons named as proxies may propose one or more adjournments or postponements
of the Meeting for a reasonable time after the date set for the original Meeting
to permit further solicitation of proxies. In addition, if, in the judgment of
the persons named as proxies, subsequent developments make it advisable to defer
action on the proposal, the persons named as proxies may propose one or more
adjournments or postponements of the Meeting for a reasonable time in order to
defer action on the proposal. Any such adjournments or postponements will
require the affirmative vote of a majority of the votes cast on the question in
person or by proxy, whether or not a quorum is present, at the session of the
Meeting to be adjourned, as required by the Laudus Trust's Second Amended and
Restated Agreement and Declaration of Trust and Bylaws. The persons named as
52
proxies will abstain from voting on adjournment all shares represented by
proxies that abstain from voting on such proposal. Any adjournment does not
require notice to shareholders. The Laudus Trust's Board of the Trustees may
postpone the Meeting prior to the Meeting with notice to the shareholders
entitled to vote at the Meeting. The costs of any additional solicitation of
proxies and of any adjourned or postponed session with regard to the proposal
will be borne by Vanguard, CSIM and AXA Rosenberg in accordance with the terms
of the Fund Sponsorship Agreement.
Tabulation of Votes. Abstentions and "broker non-votes" (i.e., proxies
received from brokers indicating that they have not received instructions from
the beneficial owner or other person entitled to vote shares) will be counted
for purposes of determining whether a quorum is present at the Special Meeting.
Abstentions and "broker non-votes" will have the same effect as a vote "Against"
the Proposal. Pursuant to certain rules promulgated by the New York Stock
Exchange, Inc. that govern the voting by such broker-dealers, a broker-dealer
holding shares of record for a beneficial owner may not exercise discretionary
voting power with respect to certain non-routine matters. It is anticipated that
such broker-dealers will not have discretionary authority to vote on the
Proposal. The absence of instructions from the beneficial owner will result in a
"broker non-vote" with respect to the Proposal.
Shareholder proposals. The Laudus Funds does not intend to hold meetings of
its shareholders except to the extent that such meetings are required under the
1940 Act or state law. Laudus Fund shareholders who wish to submit proposals for
inclusion in the proxy statement for a subsequent Laudus Fund shareholder
meeting should send their written proposals to the Clerk of the Laudus Trust,
c/o CSIM Legal, 101 Montgomery Street, San Francisco, California 94104 within a
reasonable time before such meeting. If the Reorganization is consummated there
will be no further meeting of shareholders of the Laudus Fund.
Principal Shareholders. As of September 24, 2007, the Laudus Fund had
approximately $[___] million in net assets and [___] outstanding shares. As of
the same date, the officers and trustees of the Laudus Trust, as a group, owned
less than 1% of the outstanding shares of the Investor Class and Institutional
Class of the Laudus Fund. As of the same date, each of the following persons was
known to be the record or beneficial owner of more than 5% of the outstanding
shares of the Laudus Fund:
53
Investor Class
--------------------------------------------------------------------------------
RECORD OR BENEFICIAL OWNER PERCENTAGE OF OUTSTANDING SHARES OWNED
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
Institutional Class
--------------------------------------------------------------------------------
RECORD OR BENEFICIAL OWNER PERCENTAGE OF OUTSTANDING SHARES OWNED
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
For purposes of the 1940 Act, any person who owns directly or through one
or more controlled companies more than 25% of the voting securities of a company
is presumed to "control" such company. Accordingly, to the extent that a
shareholder identified in the foregoing table is identified as the beneficial
holder of more than 25% of a class, or is identified as the holder of record of
more than 25% of a class and has voting and/or investment power, it may be
presumed to control such class. The Laudus Fund believes that most of the shares
referred to in the table above were held by the above persons in accounts for
their fiduciary, agency, or custodial customers.
The percentage of the Vanguard Fund that would be owned by the above
named shareholders upon consummation of the Reorganization is expected to be the
same.
Other Matters. The Laudus Trust Board of Trustees knows of no other
business to be brought before the Meeting. However, if additional matters do
arise, it is the Trustees' intention that proxies will be voted on such matters
in accordance with the judgment of the persons named on the enclosed proxy. If
you object to our voting other matters on your behalf, please tell us in writing
before the Meeting.
Obtaining Information from the SEC. The Vanguard Trust is subject to the
informational requirements of the Securities Exchange Act of 1934 and must file
certain reports and other information with the SEC.
The proxy materials, reports and other information filed by the Laudus
Trust and the Vanguard Trust can be inspected and copied at the public reference
facilities maintained by the SEC located at 100 F Street, N.E., Washington, DC
20549. Copies of such materials also can be obtained from the Public Reference
Branch, Securities and Exchange Commission, Washington, DC 20549 at prescribed
rates.
SHAREHOLDERS WHO DO NOT EXPECT TO BE PRESENT AT THE MEETING ARE REQUESTED TO
DATE AND SIGN THE ENCLOSED PROXY AND RETURN IT IN THE ENCLOSED ENVELOPE.
SHAREHOLDERS ARE ENCOURAGED TO VOTE BY TELEPHONE OR THROUGH THE INTERNET. NO
POSTAGE IS REQUIRED IF MAILED IN THE UNITED STATES. PLEASE FOLLOW THE ENCLOSED
INSTRUCTIONS TO UTILIZE THESE METHODS OF VOTING.
54
APPENDIX A
FORM OF
AGREEMENT AND PLAN OF REORGANIZATION
THIS AGREEMENT AND PLAN OF REORGANIZATION (the "Agreement") is made as of
this [__] day of [___], 2007, between Vanguard on Montgomery Funds, a statutory
trust formed under the laws of the State of Delaware with its principal place of
business at P.O. Box on 2600, Valley Forge, PA 19482 (the "Vanguard Trust"), on
behalf of Vanguard Market Neutral Fund, a series of the Vanguard Trust (the on
"Acquiring Fund"), and the Laudus Trust, a business trust formed under the laws
of the Commonwealth of Massachusetts with its on principal place of business at
P.O. Box 8032, Boston, Massachusetts 02266 (the "Laudus Trust"), on behalf of
Laudus Rosenberg U.S. on Large/Mid Capitalization Long/Short Equity Fund, a
series of the Laudus Trust (the "Selling Fund"); The Vanguard Group, Inc., a on
Pennsylvania corporation, with its principal place of business at P.O. Box 2600,
Valley Forge, PA 19482 ("The Vanguard Group") (with respect to the provisions of
Paragraphs 9.2 and 9.4 only); Charles Schwab Investment Management, Inc., a
Delaware corporation, with on its principal place of business at 101 Montgomery
Street, San Francisco, CA 94104 ("CSIM") (with respect to the provisions of on
Paragraphs 1.3, 9.2 and 9.3 only); and AXA Rosenberg Investment Management LLC,
a Delaware limited liability company, with its on principal place of business at
4 Orinda Way, Building E, Orinda, CA, 94563 ("AXA") (with respect to the
provisions of Paragraphs 9.2 and 9.3 only).
This Agreement is intended to be, and is adopted as, a plan of
reorganization and liquidation within the meaning of Section 368(a) of the
United States Internal Revenue Code of 1986, as amended (the "Code"). The
reorganization of the Selling Fund (the on "Reorganization") will consist of (i)
the transfer of all of the assets of the Selling Fund in exchange solely for
units of beneficial interest (the "Shares") of the Acquiring Fund (the
"Acquiring Fund Shares"), (ii) the assumption by the Acquiring Fund of all on
Liabilities (as defined below) of the Selling Fund; and (iii) the distribution,
after the Closing Date (as defined in paragraph 1.2 of this Agreement), of
Acquiring Fund Shares to the shareholders of the Selling Fund in liquidation of
the Selling Fund as provided in on this Agreement, all upon the terms and
conditions set out below.
WHEREAS, the Vanguard Trust and the Laudus Trust are each registered as an
open-end management investment company under the Investment Company Act of 1940,
as amended (the "1940 Act");
WHEREAS, the Selling Fund owns securities that generally are assets of the
character in which the Acquiring Fund is on permitted to invest;
WHEREAS, the Acquiring Fund and the Selling Fund are authorized to issue
shares of beneficial interest;
WHEREAS, the Board of Trustees, including a majority of the trustees who
are not "interested persons" (as defined in the on 1940 Act), of the Vanguard
Trust has determined with respect to the Acquiring Fund that the exchange of all
of the assets of the on Selling Fund for Acquiring Fund Shares is in the best
interests of the Acquiring Fund and its shareholders;
WHEREAS, the Board of Trustees, including a majority of the trustees who
are not "interested persons" (as defined under the 1940 Act), of the Laudus
Trust has determined with respect to the Selling Fund that the exchange of all
the assets of, and all on Liabilities (as defined below) of, the Selling Fund
for Acquiring Fund Shares is in the best interests of the Selling Fund and its
on shareholders; and
WHEREAS, the purpose and effect of the Reorganization is to change the form
of organization of the Selling Fund from a on series of the Laudus Trust to a
series of Vanguard Trust. It is anticipated that the Reorganization will provide
long-term benefits on to the Selling Fund and its shareholders.
NOW THEREFORE, in consideration of the mutual promises contained in this
Agreement, the parties hereto agree as follows:
ARTICLE I
Transfer of Assets of the Selling Fund in Exchange for Acquiring Fund Shares and
--------------------------------------------------------------------------------
Assumption of Selling Fund Liabilities; Liquidation of the Selling Fund
-----------------------------------------------------------------------
1.1 Subject to the terms and conditions set out in this Agreement and on
the basis of the representations and warranties contained in this Agreement, the
Laudus Trust agrees to transfer the Selling Fund's assets as set out in
paragraph 1.2 of this on Agreement to the Acquiring Fund, and the Vanguard Trust
agrees in exchange for such assets: (a) to deliver to the Selling Fund the on
number of Acquiring Fund Shares, including fractional Acquiring Fund Shares,
determined by dividing (i) the value of the Selling on Fund's assets, computed
in the manner and as of the time and date set out in paragraph 2.1 of this
Agreement, less the value of any on Liabilities (as defined in paragraph 1.3 of
this Agreement) to be assumed by Acquiring Fund, by (ii) the net asset value of
one on Acquiring Fund Share, computed in the manner and as of the time and date
set out in paragraph 2.2 of this Agreement; and (b) to on assume all Liabilities
(as defined below) of the Selling Fund, as set out in paragraph 1.3 of this
Agreement. Each of these on transactions will take place at the closing provided
for in paragraph 3.1 of this Agreement (the "Closing").
1.2 The assets of the Selling Fund to be acquired by the Acquiring Fund
will consist of all property of the Selling on Fund, free and clear of any Lien
(as defined below) including, without limitation, all cash, securities,
commodities and futures on interests, and dividend or interest receivables that
are owned by the Selling Fund and any deferred or prepaid expenses shown as an
on asset on the books of the Selling Fund on the closing date described in
paragraph 3.1 of this Agreement (the "Closing Date").
For purposes of the Agreement, a "Lien" means any security agreement,
financing statement (whether or not filed), on mortgage, lien (statutory or
otherwise), charge, pledge, hypothecation, conditional sales agreement, adverse
claim, title retention on agreement or other security interest, encumbrance,
restriction, deed of trust, indenture, option, limitation, exception to or other
on title defect in or on any interest or title of any vendor, lessor, lender or
other secured party to or of such Person (as defined on below) under any
condition sale, lease, consignment or
2
bailment given for security purposes, trust receipt or other title retention on
agreement with respect to any property or asset of such Person, whether direct,
indirect, accrued or contingent. A Lien does not on include contract rights,
swaps or short positions currently existing in the Selling Fund, of which the
Acquiring Fund has received on notice.
For purposes of the Agreement, a "Person" means any individual,
corporation, limited liability company, limited or general partnership, joint
venture, association, joint stock company, trust, unincorporated organization,
or government or any agency or political subdivision thereof.
The Laudus Trust, on behalf of the Selling Fund, shall have provided the
Vanguard Trust on or before the date hereof with (a) accurate, correct, and
complete financial statements of the Selling Fund as of and for its most
recently completed fiscal on year and for the semi-annual period, if any,
following its most recently completed fiscal year (the "Financial Statements")
and (b) a list of all of the Selling Fund's assets as of the date of execution
of this Agreement. The Laudus Trust, on behalf of the Selling on Fund,
represents that as of the date of the execution of this Agreement no material
changes have occurred in its financial position on as reflected in its Financial
Statements other than those occurring in the ordinary course of its business in
connection with the on purchase and sale of securities and the payment of its
normal operating expenses. The Laudus Trust, on behalf of the Selling Fund, on
reserves the right to sell or otherwise dispose of any of the Selling Fund's
assets but will not, without the prior written approval of the Vanguard Trust,
acquire any additional assets for the Selling Fund other than instruments of the
type in which the Laudus on Trust reasonably believes that the Acquiring Fund is
permitted to invest. The Laudus Trust, on behalf of the Selling Fund, will, on
within a reasonable time prior to the Closing Date, furnish the Vanguard Trust
with a list of the securities and other assets of the Selling Fund. In the event
that the Selling Fund holds any assets that the Acquiring Fund determines the
Acquiring Fund may not on hold, the Selling Fund will use its best efforts to
dispose of such assets prior to the Closing Date. Notwithstanding the foregoing,
nothing herein will require the Selling Fund to dispose of any investments or
securities if, in the reasonable judgment of the on Selling Fund, such
disposition would either violate the Selling Fund's fiduciary duty to its
shareholders or adversely affect the on tax-free nature of the Reorganization.
1.3 The Laudus Trust, on behalf of the Selling Fund, will discharge, or
make provision for the discharge of, all of the Selling Fund's known
Liabilities, and Liabilities that should have been known upon reasonable
investigation prior to the Closing Date, other than those Liabilities that would
otherwise be discharged at a later date in the ordinary course of the Selling
Fund's business (including accrued fees and expenses and payables for securities
transactions or for share redemptions that are reflected on the statement of
assets and liabilities of the Selling Fund referred to in the next paragraph).
The Acquiring Fund will assume all of the remaining Liabilities of the Selling
Fund. CSIM will indemnify Vanguard Trust, the Acquiring Fund and The Vanguard
Group for any Liabilities assumed by the Acquiring Fund that arise directly out
of CSIM's or any CSIM affiliate's negligence, fraud or reckless disregard of its
duties to the Selling Fund.
For purposes of the Agreement, "Liabilities" means all existing and future
liabilities and obligations of any nature, whether accrued, absolute, contingent
or otherwise of the Selling Fund including, but not limited to, those reflected
on an unaudited statement of assets
3
and liabilities of the Selling Fund prepared by the Treasurer as of the
Valuation Date in accordance with generally accepted accounting principles
consistently applied from the prior audited reporting period.
1.4 As provided in paragraph 3.4 of this Agreement, as soon as practicable
after the Closing Date (the "Liquidation on Date"), the Selling Fund will
distribute on a proportionate basis to the Selling Fund's shareholders of record
determined as of the on close of business on the Closing Date (the "Selling Fund
Shareholders"), the Acquiring Fund Shares it receives pursuant to paragraph 1.1
of this Agreement in liquidation of all Selling Fund Shares (defined below).
This distribution in liquidation of all Selling on Fund Shares (defined below)
will be accomplished by the transfer of the Acquiring Fund Shares then credited
to the account of the on Selling Fund on the books of the Acquiring Fund to open
accounts on the share records of the Acquiring Fund in the names of the on
Selling Fund Shareholders representing the respective proportionate number of
Acquiring Fund Shares due those shareholders. All on issued and outstanding
Shares of the Selling Fund ("Selling Fund Shares") will simultaneously be
canceled on the books of the Selling Fund and all certificates relating to the
Selling Fund Shares, if any, will be marked "Cancelled." The Acquiring Fund will
not issue certificates representing the Acquiring Fund's Shares in connection
with the exchange of Acquiring Fund Shares for shares of the on Selling Fund.
1.5. The Selling Fund shall pay or cause to be paid to the Acquiring Fund
any interest or proceeds it receives on or on after the Closing Date with
respect to its assets.
1.6 After the Reorganization, ownership of Acquiring Fund Shares will be
shown on the books of the Acquiring Fund's on transfer agent. Shares of the
Acquiring Fund will be issued in the manner described in the Acquiring Fund's
then-current prospectus on and statement of additional information.
1.7 After distribution of the Acquiring Fund Shares pursuant to paragraph
1.4 of this Agreement, the Selling Fund will be liquidated promptly and
terminated as a series of Laudus Trust ("Termination Date"). In addition, Laudus
Trust will as soon as on practicable after the Termination Date take all other
actions in connection with the termination of the Selling Fund as required by on
applicable law.
1.8 Any reporting responsibility of the Selling Fund to any public
authority is and will remain the responsibility of on the Selling Fund up to and
including the Closing Date and the Termination Date.
1.9 Each of the Acquiring Fund and the Selling Fund shall file any
instrument as may be required by any governmental on authority with respect to
its participation in the Reorganization, and shall cooperate with the other in
the filing of any such on instrument which is required to be filed jointly.
1.10 Any transfer taxes payable upon issuance of the Acquiring Fund Shares
in a name other than the registered holder of Selling Fund Shares on the books
of the Selling Fund as of that time will, as a condition of the issuance and
transfer, be paid by on the person to whom the Acquiring Fund Shares are to be
issued and transferred.
4
ARTICLE II
Valuation
---------
2.1 The value of the Selling Fund's assets and Liabilities to be acquired
under this Agreement will be the value on computed as of the close of regular
trading (generally 4:00 p.m., Eastern Time) on the New York Stock Exchange, Inc.
(the "NYSE") on the Closing Date (the time and date being referred to as the
"Valuation Date" for purposes of this Agreement), using the valuation on
procedures set out in the Selling Fund's then-current prospectus and/or
statement of additional information.
2.2 The net asset value of the Acquiring Fund Shares will be the net asset
value per share computed as of the Valuation Date, using the valuation
procedures set out in the Acquiring Fund's then-current prospectus and/or
statement of additional on information.
2.3 The number of Acquiring Fund Shares to be issued (including fractional
shares (to the third decimal place), if any) in exchange for the Selling Fund's
assets will be determined by dividing the value of the assets of the Selling
Fund determined using the same valuation procedures referred to in paragraph 2.1
of this Agreement by the net asset value per share of the Acquiring Fund on
determined in accordance with paragraph 2.2 of this Agreement.
ARTICLE III
Closing and Closing Date
------------------------
3.1 The Closing Date for the Reorganization will be ___ __, 2007, or such
other date agreed to in writing by the on Vanguard Trust and the Laudus Trust.
All acts taking place at the Closing will be deemed to take place simultaneously
as of the on close of business on the Closing Date unless otherwise provided.
The Closing will be held as of 4:00 p.m., Eastern Time, at the on offices of the
Vanguard Trust, 100 Vanguard Blvd., Malvern, PA 19355, or at such other time
and/or place agreed to by the Vanguard on Trust and the Laudus Trust.
3.2 The custodian for the Acquiring Fund (the "Custodian") will deliver at
the Closing a certificate of an authorized on officer stating that: (a) the
Selling Fund's portfolio securities, cash and any other assets have been
delivered in proper form to on the Acquiring Fund prior to or on the Closing
Date, and (b) all necessary taxes, including all applicable federal and state
stock transfer stamps, if any, have been paid, or provision for payment has been
made, in conjunction with the delivery of portfolio securities.
3.3 In the event that on the Valuation Date (a) the NYSE or another primary
trading market for portfolio securities of the Acquiring Fund or the Selling
Fund is closed to trading or trading on the market is restricted or (b) trading
or the reporting of trading on the NYSE or
5
elsewhere is disrupted so that accurate appraisal of the value of the net assets
of the Acquiring Fund or the Selling Fund is impracticable, the Closing Date
will be postponed until the first business day after the day when normal trading
has fully resumed and reporting has been restored.
3.4 The Laudus Trust, on behalf of the Selling Fund, will deliver at the
Closing a list of the names and addresses of the Selling Fund Shareholders and
the number of outstanding Selling Fund Shares owned by each such shareholder as
of the Valuation Date immediately prior to the Closing or provide evidence that
the information has been provided to the Acquiring Fund's transfer agent. The
Vanguard Trust, on behalf of the Acquiring Fund, will issue and deliver a
confirmation evidencing that the Acquiring Fund Shares have been credited to the
Selling Fund's account on the Closing Date to the Secretary of the Laudus Trust
or provide evidence satisfactory to the Laudus Trust that the Acquiring Fund
Shares have been credited to the Selling Fund's account on the books of the
Acquiring Fund. At the Closing, each party to this Agreement will deliver to the
other party such bills of sale, checks, assignments, share certificates, if any,
receipts or other documents as the other party or its counsel may reasonably
request.
ARTICLE IV
Representations and Warranties
------------------------------
4.1 The Laudus Trust, on behalf of the Selling Fund, represents and
warrants to the Vanguard Trust as follows:
(a) The Selling Fund is an investment series of the Laudus Trust, a
business trust duly organized, validly existing, and in good standing
under the laws of the Commonwealth of Massachusetts;
(b) The Laudus Trust is registered as an open-end management investment
company and its registration with the Securities and Exchange
Commission (the "Commission") as an investment company under the 1940
Act is in full force and effect;
(c) The Laudus Trust is not, and the execution, delivery, and performance
of this Agreement (subject to approval of the Selling Fund
Shareholders) will not result, in a violation of any provision of its
Declaration of Trust or any material agreement, indenture, instrument,
contract, lease or other undertaking to which the Laudus Trust on
behalf of itself or on behalf of the Selling Fund is a party or by
which its property is bound;
(d) The Laudus Trust will turn over all of the books and records relating
to the Selling Fund (including all books and records required to be
maintained under the 1940 Act and the Code and the rules and
regulations under the 1940 Act and the Code) or copies thereof to the
Vanguard Trust at the Closing. The books and records turned over by
the Laudus Trust to the Acquiring Fund pursuant to this subparagraph
(d) are
6
substantially true and correct and contain no material misstatements or
omissions with respect to the operations of the Selling Fund;
(e) The Laudus Trust has no material contracts or other commitments (other
than this Agreement) with respect to the Selling Fund that will be
terminated with liability to the Laudus Trust prior to the Closing
Date, except for liabilities, if any, to be discharged as provided for
in paragraph 1.3 hereof;
(f) Except as previously disclosed in writing to and accepted by the
Vanguard Trust, no litigation or administrative proceeding or
investigation of or before any court or governmental body is presently
pending, or to the Laudus Trust's knowledge, threatened against the
Laudus Trust in connection with the Selling Fund or any of its
properties or assets that, if adversely determined, would materially
and adversely affect the Laudus Trust's financial condition or the
conduct of its business. The Laudus Trust knows of no facts that might
form the basis for the institution of such proceedings and is not a
party to or subject to the provisions of any order, decree or judgment
of any court or governmental body that materially and adversely
affects its business or the business of the Selling Fund or the Laudus
Trust's ability to consummate the transactions contemplated by this
Agreement. The Laudus Trust, in connection with the Selling Fund, is
not charged with or, to its knowledge, threatened with any violation
or investigation of any possible violation, of any provisions of any
federal, state, local, or self-regulatory law or regulation or
administrative ruling relating to any aspect of the Selling Fund's
business that could reasonably be expected to have a material and
adverse affect on the Selling Fund's business;
(g) The statements of assets and liabilities of the Laudus Trust relating
to the Selling Fund for the fiscal year ended March 31, 2007 have been
audited by PricewaterhouseCoopers LLP ("PwC"), a --- certified public
accountant, are in accordance with generally accepted accounting
principles consistently applied, and those statements (copies of which
have been furnished to the Acquiring Fund) fairly reflect the
financial condition of the Selling Fund as of such date, and no known
contingent Liabilities of the Selling Fund exist as of such date that
are not disclosed in those statements;
(h) Since March 31, 2007, no material adverse change has occurred in the
Selling Fund's financial condition, assets, Liabilities or business
other than changes occurring in the ordinary course of business, or
any incurrence by the Selling Fund of indebtedness maturing more than
one year from the date that such indebtedness was incurred, except as
otherwise disclosed in writing to and accepted by the Vanguard Trust
prior to the Closing Date. For the purposes of this subparagraph (h),
a decline in net asset value per share or the total assets of the
Selling Fund in the ordinary course of business, the discharge of
Selling Fund Liabilities or the redemption of Selling Fund shares by
Selling Fund shareholders does not constitute a material adverse
change;
(i) At the Closing Date, all federal and other tax returns and other
reports or filings (together, "Tax Returns") with respect to the
Selling Fund required by law to have been filed by the Closing Date
will have been filed (including, without limitation, Tax
7
Returns for the Selling Fund's fiscal year ended March 31, 2007), and
all federal and other taxes will have been paid so far as due, or
provision will have been made for the payment of those taxes and, to
the best of the Laudus Trust's knowledge, no such Tax Return is
currently under audit and no assessment has been asserted with respect
to such a Tax Return;
(j) The Selling Fund is a "fund" as defined in Section 851(g)(2) of the
Code; for each of its prior fiscal years of operation and for each
subsequent quarter end of the current fiscal year, the Selling Fund
has met the requirements of Subchapter M of the Code for qualification
and treatment of the Selling Fund as a regulated investment company;
it has no earnings and profits accumulated in any taxable year in
which the provisions of Subchapter M did not apply to it and all of
the Selling Fund's issued and outstanding shares have been offered and
sold in compliance in all material respects with applicable federal
and state securities laws;
(k) The Selling Fund is not under the jurisdiction of a court in a "title
11 or similar case" (within the meaning of section 368(a)(3)(A) of the
Code);
(l) As of the Closing Date, not more than 25% of the value of the Selling
Fund's total assets (excluding cash, cash items and U.S. government
securities) is invested in the stock and securities of any one issuer,
and not more than 50% of the value of such assets is invested in the
stock and securities of five or fewer issuers;
(m) The Selling Fund will be terminated as soon as reasonably practicable
after the Reorganization;
(n) At the date of this Agreement, all issued and outstanding Selling Fund
Shares are, and at the Closing Date will be, duly and validly issued
and outstanding, fully paid and non-assessable. All of the issued and
outstanding Selling Fund Shares will, at the time of Closing, be held
by the persons and in the amounts set out in the records of the Laudus
Trust's transfer agent as provided in paragraph 3.4 of this Agreement.
The Laudus Trust does not have outstanding any options, warrants or
other rights to subscribe for or purchase any of the Selling Fund's
Shares, nor is any security convertible into any of the Selling Fund's
shares currently outstanding;
(o) At the Closing Date, the Laudus Trust will have good and marketable
title to the Selling Fund's assets, to be transferred to the Acquiring
Fund pursuant to paragraph 1.2 of this Agreement, and full right,
power and authority to sell, assign, transfer and deliver the assets
under the terms and conditions of this Agreement and, upon delivery
and payment for the assets, the Acquiring Fund will acquire good and
marketable title, free of all Liens except those Liens of which the
Acquiring Fund has received notice, to them, subject to no
restrictions on the full transfer of the assets, other than such
restrictions as might arise under the Securities Act of 1933, as
amended (the "1933 Act"), and other than as disclosed to the Vanguard
Trust, including by indication on the books of the Laudus Trust;
8
(p) The execution, delivery and performance of this Agreement has been
duly authorized by all necessary actions on the part of the Laudus
Trust's Board of Trustees and, subject to the approval of the Selling
Fund Shareholders, this Agreement will constitute a valid and binding
obligation of the Laudus Trust, enforceable in accordance with its
terms, subject to the effect of bankruptcy, insolvency, fraudulent
conveyance, reorganization, moratorium and other laws relating to or
affecting creditors' rights and to general equity principles;
(q) The information to be furnished by the Laudus Trust for use in
no-action letters, applications for exemptive orders, registration
statements, proxy materials and other documents that may be necessary
in connection with the transactions contemplated by this Agreement
will be accurate and complete in all material respects and will comply
in all material respects with federal securities and other laws and
regulations under those laws applicable to those transactions;
(r) The proxy statement of the Selling Fund (the "Proxy Statement") to be
included in the Registration Statement referred to in paragraph 5.7 of
this Agreement (insofar as it relates to the Selling Fund) will, on
the effective date of the Registration Statement and on the Closing
Date, not contain any untrue statement of a material fact or omit to
state a material fact required to be stated in the Proxy Statement or
necessary to make the statements in the Proxy Statement, in light of
the circumstances under which such statements were made, not
misleading; and
(s) The current prospectus and statement of additional information filed
with the Commission as part of the Laudus Trust's registration
statement on Form N-1A, insofar as they relate to the Selling Fund,
conform in all material respects to the applicable requirements of the
1933 Act and the 1940 Act and the rules and regulations under those
Acts and do not include any untrue statement of a material fact or
omit to state any material fact required to be stated in that
registration statement or necessary to make the statements in the
registration statement, in light of the circumstances under which they
were made, not misleading.
4.2 The Vanguard Trust, on behalf of the Acquiring Fund, represents and
warrants to the Laudus Trust as follows:
(a) The Acquiring Fund is an investment series of the Vanguard Trust, a
statutory trust duly organized, validly existing and in good standing under the
laws of the State of Delaware;
(b) The Vanguard Trust is a registered open-end management investment
company and its registration with the Commission as an investment company under
the 1940 Act is in full force and effect;
(c) The current prospectus and statement of additional information filed as
part of the Vanguard Trust's registration statement on Form N-1A, which will
become effective prior to the Closing Date, insofar as they relate to the
Acquiring Fund (the "Vanguard Trust
9
Registration Statement") conform in all material respects to the applicable
requirements of the 1933 Act and the 1940 Act and the rules and regulations of
the Commission thereunder and do not include any untrue statement of a material
fact or omit to state any material fact required to be stated in the Vanguard
Trust Registration Statement or necessary to make the statements therein, in
light of the circumstances under which they were made, not materially
misleading;
(d) The Vanguard Trust is not, and the execution, delivery and performance
of this Agreement will not result, in a violation of its Declaration of Trust or
any material agreement, indenture, instrument, contract, lease or other
undertaking to which the Vanguard Trust on behalf of itself or on behalf of the
Acquiring Fund is a party or by which its property is bound;
(e) Except as previously disclosed in writing to and accepted by the Laudus
Trust, no litigation or administrative proceeding or investigation of or before
any court or governmental body is presently pending or, to the Vanguard Trust's
knowledge, threatened, against the Vanguard Trust in connection with the
Acquiring Fund or any of its properties or assets that, if adversely determined,
would materially and adversely affect the Vanguard Trust's financial condition
or the conduct of its business. The Vanguard Trust knows of no facts that might
form the basis for the institution of such proceedings and is not a party to or
subject to the provisions of any order, decree or judgment of any court or
governmental body that materially and adversely affects its business or the
business of the Acquiring Fund or the Vanguard Trust's ability to consummate the
transactions contemplated in this Agreement. The Vanguard Trust, in connection
with the Acquiring Fund, is not charged with or, to its knowledge, threatened
with any violation or investigation of any possible violation, of any provisions
of any federal, state, local, or self-regulatory law or regulation or
administrative ruling relating to any aspect of the Selling Fund's business that
could reasonably be expected to have a material and adverse affect on the
Selling Fund's business;
(f) At the Closing Date, all federal and other Tax Returns with respect to
the Acquiring Fund required by law to have been filed by the Closing Date will
have been filed, and all federal and other taxes will have been paid so far as
due, or provision will have been made for the payment of those taxes and, to the
best of the Vanguard Trust's knowledge, no such Tax Return is currently under
audit and no assessment has been asserted with respect to such a Tax Return;
(g) The Acquiring Fund intends to meet the requirements of Subchapter M of
the Code for qualification and treatment of the Acquiring Fund as a regulated
investment company in the future, and from the date of this Agreement until the
Closing Date, shall not take any action inconsistent with such efforts to
qualify as a regulated investment company under the Code in the future;
(h) At the date of this Agreement, all issued and outstanding Acquiring
Fund Shares are, and at the Closing Date will be, duly and validly issued and
outstanding, fully paid and non-assessable, with no personal liability attaching
to the ownership of those shares. The Vanguard Trust does not have outstanding
any options, warrants or other rights to subscribe for
10
or purchase any Acquiring Fund Shares, nor is any security convertible into any
Acquiring Fund Shares currently outstanding;
(i) The execution, delivery and performance of this Agreement has been duly
authorized by all necessary actions, if any, of the Vanguard Trust's Board of
Trustees, and this Agreement will constitute a valid and binding obligation of
the Vanguard Trust enforceable in accordance with its terms, subject to the
effect of bankruptcy, insolvency, fraudulent conveyance, reorganization,
moratorium and other laws relating to or affecting creditors' rights and to
general equity principles;
(j) The Acquiring Fund Shares to be issued and delivered to the Selling
Fund, for the account of the Selling Fund Shareholders, under the terms of this
Agreement, will at the Closing Date have been duly authorized and, when so
issued and delivered, will be duly and validly issued Acquiring Fund Shares, and
will be fully paid and non-assessable with no personal liability attaching to
the ownership of those shares;
(k) The information to be furnished by the Vanguard Trust for use in
no-action letters, applications for exemptive orders, registration statements,
proxy materials and other documents that may be necessary in connection with the
transactions contemplated by this Agreement will be accurate and complete in all
material respects and will comply in all material respects with federal
securities and other laws and regulations under those laws applicable to those
transactions;
(l) The Registration Statement referred to in paragraph 5.7 of this
Agreement and the Proxy Statement to be included in the Registration Statement
(insofar as it relates to the Acquiring Fund) will, on the effective date of the
Registration Statement and on the Closing Date, not contain any untrue statement
of a material fact or omit to state a material fact required to be stated
therein or necessary to make the statements therein, in light of the
circumstances under which such statements were made, not misleading; and
(m) The Vanguard Trust agrees to use all reasonable efforts to obtain the
approvals and authorizations required by the 1933 Act, the 1940 Act and any
state Blue Sky or securities law as it may deem appropriate in order to continue
the operations of the Acquiring Fund after the Closing Date.
(n) There shall be no issued and outstanding Shares of the Acquiring Fund
prior to the Closing Date other than those as described in paragraph 6.2 of this
Agreement.
ARTICLE V
Covenants of the Acquiring Fund and the Selling Fund
----------------------------------------------------
5.1 The Vanguard Trust will operate the business of the Acquiring Fund, and
the Laudus Trust will operate the business of the Selling Fund, in the ordinary
course between the date of this Agreement and the Closing Date. The Vanguard
Trust and the Laudus Trust agree
11
for purposes of this Agreement that the declaration and payment of customary
dividends and distributions will be considered to have been paid in the ordinary
course of business.
5.2 The Laudus Trust, on behalf of the Selling Fund, will call a meeting of
its shareholders to consider and act upon this Agreement and to take all other
actions in coordination with the Vanguard Trust necessary to obtain approval of
the transactions contemplated by this Agreement.
5.3 The Laudus Trust, on behalf of the Selling Fund, covenants that the
Acquiring Fund Shares to be issued under this Agreement are not being acquired
for the purpose of making any distribution other than in accordance with the
terms of this Agreement.
5.4 The Laudus Trust, on behalf of the Selling Fund, will assist the
Vanguard Trust in obtaining all information on record with the Selling Fund's
transfer agent that the Vanguard Trust reasonably requests concerning the
beneficial ownership of the Selling Fund's Shares.
5.5 Subject to the provisions of this Agreement, the Vanguard Trust and the
Laudus Trust each will take, or cause to be taken, all action, and do, or cause
to be done, all actions, reasonably necessary, proper or advisable to consummate
and make effective the transactions contemplated by this Agreement, including
any actions required to be taken after the Closing Date.
5.6 Prior to the Closing Date, the Laudus Trust will furnish to the
Vanguard Trust copies of the tax returns for the Selling Fund which were filed
on its behalf for its immediately preceding five taxable years, together with
certification by the Selling Fund's Treasurer that, to the best of their
knowledge, they are correct and complete insofar as relevant to the
determination of earnings and profits of the Selling Fund for such time period.
5.7 The Laudus Trust, on behalf of the Selling Fund, will provide the
Vanguard Trust with information reasonably necessary for the preparation of a
prospectus (the "Prospectus") that will include the Proxy Statement referred to
in paragraphs 4.1(o) and 4.2(m) of this Agreement, all to be included in a
registration statement on Form N-14 of the Vanguard Trust (the "Registration
Statement"), in compliance with the 1933 Act, the Securities Exchange Act of
1934 (the "1934 Act") and the 1940 Act in connection with the meeting of the
Selling Fund's shareholders to consider approval of the transactions
contemplated by this Agreement.
5.8 On or as soon as practicable prior to the Closing Date, the Selling
Fund will declare and pay to its shareholders of record one or more dividends
and/or other distributions so that it will have distributed substantially all of
its investment company taxable income (computed without regard to any deduction
for dividends paid) and realized net capital gain, if any, for the current
taxable year through the Closing Date.
5.9 The Selling Fund will discharge all of its known Liabilities and
Liabilities that should have been known upon reasonable investigation prior to
the Closing Date other than those Liabilities that would otherwise be discharged
at a later date in the ordinary course of the Selling
12
Fund's business (including accrued fees and expenses and payables for securities
transactions or for share redemptions).
5.10 As promptly as practicable, but in any case within thirty days (30)
after the Closing Date, the Laudus Trust, on behalf of the Selling Fund, will
furnish the Vanguard Trust with a statement containing information required for
purposes of complying with Rule 24f-2 under the 1940 Act. A notice pursuant to
Rule 24f-2 will be filed by the Acquiring Fund offsetting redemptions by the
Selling Fund during the fiscal year ending on or after the Closing Date against
sales of the Acquiring Fund Shares; and the Laudus Trust agrees that it will not
net redemptions during that period by the Selling Fund against sales of shares
of any other series of the Laudus Trust.
5.11 As promptly as practicable, but in any case within the period required
by applicable law or regulation, the Laudus Trust, on behalf of the Selling
Fund, will file all federal and other tax returns and other reports or filings
with respect to the Selling Fund required by applicable law or regulation to be
filed.
5.12 It is the intention of the parties that the transaction will qualify
as a reorganization within the meaning of Section 368(a) of the Code. Neither
the Laudus Trust, the Vanguard Trust, the Selling Fund nor the Acquiring Fund
shall take any action or cause any action to be taken (including, without
limitation the filing of any tax return) that is inconsistent with such
treatment or results in the failure of the transaction to qualify as a
reorganization within the meaning of Section 368(a) of the Code. At or prior to
the Closing Date, the parties to this Agreement will take such reasonable
action, or cause such action to be taken, as is reasonably necessary to enable
Willkie Farr & Gallagher LLP to render the tax opinion contemplated in the
Agreement.
5.13 The Laudus Trust, on behalf of the Selling Fund, will (a) prepare the
semiannual shareholders report of the Selling Fund for the period ended
September 30, 2007 and (b) file (i) the semiannual shareholders report of the
Selling Fund for the period ended September 30, 2007 on Form N-CSRS and (ii) the
Form NSAR-A for such period, no later than the dates such Form N-CSRS and such
Form NSAR-A, respectively, are required to be filed pursuant to the 1940 Act and
the rules and regulations thereunder (the "Required Filing Dates"), in the case
of each of (a) and (b), irrespective of whether the Closing occurs before or
after such Required Filing Dates.
ARTICLE VI
Conditions Precedent to the Obligations of the Laudus Trust
-----------------------------------------------------------
The obligations of the Laudus Trust to consummate the transactions provided
for in this Agreement will be subject, at its election, to the performance by
the Vanguard Trust of all obligations to be performed by it under this Agreement
on or before the Closing Date and, in addition to those obligations to the
following specific conditions unless waived in writing:
13
6.1 All representations and warranties of the Vanguard Trust contained in
this Agreement will be true and correct in all material respects as of the date
of this Agreement and, except as they may be affected by the transactions
contemplated by this Agreement, as of the Closing Date with the same force and
effect as if made on and as of the Closing Date.
6.2 The Vanguard Trust will have delivered to the Laudus Trust a
certificate executed in its name by its Chief Executive Officer, President or
Vice President and its Secretary, Treasurer or Assistant Treasurer, in a form
reasonably satisfactory to the Laudus Trust and dated as of the Closing Date, to
the effect that the representations and warranties of the Vanguard Trust made in
this Agreement are true and correct at and as of the Closing Date, except as
they may be affected by the transactions contemplated by this Agreement, and as
to such other matters as the Laudus Trust may reasonably request.
6.3 The sole shareholder of the Acquiring Fund will have approved Vanguard
and AXA as advisers to the Acquiring Fund prior to the Closing Date.
6.4 The Laudus Trust will have received on the Closing Date a favorable
opinion from Willkie Farr & Gallagher LLP, counsel to the Vanguard Trust, dated
as of the Closing Date, in a form reasonably satisfactory to the Laudus Trust,
covering the following points:
(a) the Acquiring Fund is a separate series of the Vanguard Trust, a
statutory trust duly formed, validly existing and in good standing under the
laws of the State of Delaware and the Vanguard Trust has the requisite statutory
trust power to own all of the Acquiring Fund's properties and assets and to
carry on the Acquiring Fund's business as presently conducted;
(b) the Vanguard Trust is registered as an investment company under the
1940 Act, and, to such counsel's knowledge, the Vanguard Trust's registration
with the Commission as an investment company under the 1940 Act is in force and
effect with respect to the Acquiring Fund, and the Acquiring Fund's shares are
registered under the 1933 Act pursuant to an effective registration statement;
(c) this Agreement has been duly authorized, executed and delivered by the
Vanguard Trust on behalf of the Acquiring Fund and, assuming that the
Prospectus, Registration Statement and Proxy Statement comply with the 1933 Act,
the 1934 Act and the 1940 Act and the rules and regulations under those laws and
assuming due authorization, execution and delivery of the Agreement by the
Laudus Trust, is a valid and binding obligation of the Vanguard Trust
enforceable against the Vanguard Trust in accordance with its terms, subject to
the effect of bankruptcy, insolvency, fraudulent conveyance, reorganization,
moratorium and other laws relating to or affecting creditors' rights generally
and to general equity principles;
(d) the Acquiring Fund Shares to be issued to the Selling Fund's
shareholders as provided by this Agreement are duly authorized and upon delivery
will be validly issued, fully paid and non-assessable; the holders of the Shares
will be, subject to the terms of the Vanguard Trust's Declaration of Trust,
entitled to the same limitation of personal liability extended to stockholders
of private corporations for profit organized under the General Corporation Law
of the State of Delaware; provided, however, that such counsel need express no
opinion with
14
respect to the liability of any holder of such Shares who is, was or may become
a named trustee of the Trust; and under the Vanguard Trust's Declaration of
Trust and the Delaware Statutory Trust Act, 12 Del. C. ss.ss. 3801 et seq., no
shareholder of the Acquiring Fund has any preemptive rights to subscription or
purchase in respect of the Shares;
(e) the execution and delivery of this Agreement did not, and the
consummation of the transactions contemplated hereby will not, result in a
violation of the Vanguard Trust's Declaration of Trust or in a material
violation of any provision of any agreement relating to the Acquiring Fund
(known to such counsel) to which the Vanguard Trust is a party or by which it or
its properties are bound or, to the knowledge of such counsel, result in the
acceleration of any obligation or the imposition of any penalty, under any
agreement, judgment, or decree to which the Vanguard Trust is a party or by
which it or its properties are bound, except for such accelerations or penalties
as would not have a material adverse effect on the condition, financial or
otherwise, or in the earnings, business affairs or business prospects of the
Acquiring Fund;
(f) to the knowledge of such counsel, no consent, approval, authorization
or order of any court or governmental authority of the United States or State of
Delaware is required for the consummation by the Vanguard Trust of the actions
contemplated in this Agreement, except such as have been obtained under the 1933
Act, the 1934 Act and the 1940 Act or such as may be required under the
securities or blue sky laws of the various states, as to which counsel need
express no opinion;
(g) the descriptions in the Proxy Statement, insofar as they relate to the
Vanguard Trust, the Acquiring Fund, or the Vanguard Group, of statutes, legal
and governmental proceedings, investigations, orders, decrees or judgments of
any court or governmental body in the United States, and contracts and other
documents, if any, are accurate in all material respects and fairly present, in
all material respects, the information required to be shown;
(h) such counsel does not know of any legal, administrative or governmental
proceedings, investigation, order, decree or judgment of any court or
governmental body, only insofar as they relate to the Vanguard Trust or the
Acquiring Fund or their respective assets or properties, pending, threatened or
otherwise existing on or before the effective date of the Registration Statement
or the Closing Date, which are required to be described in the Registration
Statement or to be filed as exhibits to the Registration Statement that are not
described and filed as required; and
(i) each of he Vanguard Trust Registration Statement and the Registration
Statement is effective under the 1933 Act and the 1940 Act and no stop order
suspending its effectiveness or order pursuant to section 8(e) of the 1940 Act
has been issued.
Counsel also will state that they have participated in conferences with
officers and other representatives of the Vanguard Trust at which the contents
of the Proxy Statement, the Vanguard Trust Registration Statement and related
matters were discussed and, although they are not passing upon and do not assume
any responsibility for the accuracy, completeness or fairness of the statements
contained in the Proxy Statement and the Vanguard Trust Registration
15
Statement (except to the extent indicated in paragraph (g) of their above
opinion), on the basis of the foregoing information (relying as to materiality
upon the opinions of officers and other representatives of the Vanguard Trust),
they do not believe that the Proxy Statement and the Vanguard Trust Registration
Statement as of their respective dates, as of the date of the Selling Fund's
shareholders' meeting, and as of the Closing Date, contained an untrue statement
of a material fact or omitted to state a material fact required to be stated in
the Proxy Statement and the Vanguard Trust Registration Statement or necessary
to make the statements in the Proxy Statement and the Vanguard Trust
Registration Statement in the light of the circumstances under which they were
made not misleading.
The opinion may state that counsel does not express any opinion or belief
as to the Financial Statements or other financial or statistical data, or as to
the information relating to the Laudus Trust or the Selling Fund, contained in
the Proxy Statement, Registration Statement or the Vanguard Trust Registration
Statement, and that the opinion is solely for the benefit of the Laudus Trust
and its trustees and officers. Such counsel may rely as to matters governed by
the laws of the State of Delaware on an opinion of local counsel and/or
certificates of officers or trustees of the Acquiring Fund. The opinion also
will include such other matters incident to the transaction contemplated by this
Agreement as the Laudus Trust may reasonably request.
In this paragraph 6.3, references to the Proxy Statement, the Registration
Statement or the Vanguard Trust Registration Statement include and relate only
to the text of such Proxy Statement, Registration Statement or Vanguard Trust
Registration Statement and not, except as specifically stated above, to any
exhibits or attachments to the Proxy Statement, the Registration Statement or
the Vanguard Trust Registration Statement or to any documents incorporated by
reference in the Proxy Statement, the Registration Statement or the Vanguard
Trust Registration Statement.
ARTICLE VII
Conditions Precedent to the Obligations of the Vanguard Trust
-------------------------------------------------------------
The obligations of the Vanguard Trust to complete the transactions provided
for in this Agreement will be subject, at its election, to the performance by
the Laudus Trust of all the obligations to be performed by it under this
Agreement on or before the Closing Date and, in addition to those obligations,
the following conditions unless waived in writing:
7.1 All representations and warranties of the Laudus Trust contained in
this Agreement will be true and correct in all material respects as of the date
of this Agreement and, except as they may be affected by the transactions
contemplated by this Agreement, as of the Closing Date with the same force and
effect as if made on and as of the Closing Date;
7.2 The Laudus Trust will have delivered to the Vanguard Trust a statement
of the Selling Fund's assets and known Liabilities (including, without
limitation, those accrued fees and expenses and payables for securities
transactions or for share redemptions referred to in Paragraph 1.3), together
with a list of the Selling Fund's portfolio securities showing the tax costs
(and, if different from tax costs, book costs) of those securities by lot and
the holding
16
periods of the securities as of the Closing Date, certified by the Treasurer or
Assistant Treasurer of the Laudus Trust.
7.3 The Laudus Trust will have delivered to the Vanguard Trust on the
Closing Date a certificate executed in its name, and on behalf of the Selling
Fund, by its Chief Executive Officer, President or Vice President and its Clerk,
Treasurer or Assistant Treasurer, in form and substance reasonably satisfactory
to the Vanguard Trust and dated as of the Closing Date, to the effect that the
representations and warranties of the Laudus Trust made in this Agreement are
true and correct at and as of the Closing Date, except as they may be affected
by the transactions contemplated by this Agreement, and as to such other matters
as the Vanguard Trust shall reasonably request; and
7.4 The Vanguard Trust will have received on the Closing Date a favorable
opinion of Morgan, Lewis & Bockius LLP, counsel to the Laudus Trust, dated as of
the Closing Date, in a form reasonably satisfactory to the Vanguard Trust,
covering the following points:
(a) the Selling Fund is a separate investment series of the Laudus Trust, a
business trust that is duly organized and validly existing and under the laws of
the Commonwealth of Massachusetts and the Laudus Trust has the trust power to
own all of the Selling Fund's properties and assets and to carry on the Selling
Fund's business as presently conducted;
(b) the Laudus Trust is registered as an investment company under the 1940
Act and, to such counsel's knowledge, the Laudus Trust's registration with the
Commission as an investment company under the 1940 Act is in force and effect
with respect to the Selling Fund;
(c) this Agreement has been duly authorized, executed and delivered by the
Laudus Trust and, assuming that the Prospectus, the Registration Statement and
the Proxy Statement comply with the 1933 Act, the 1934 Act and the 1940 Act and
the rules and regulations under those laws and assuming due authorization,
execution and delivery of the Agreement by the Vanguard Trust, is a valid and
binding obligation of the Laudus Trust enforceable against the Laudus Trust in
accordance with its terms, subject to the effect of bankruptcy, insolvency,
fraudulent conveyance, reorganization, moratorium and other laws relating to or
affecting creditors, rights generally and to general equity principles;
(d) the execution and delivery of the Agreement did not, and the
consummation of the transactions contemplated by this Agreement will not, result
in a violation of the Laudus Trust's Declaration of Trust or in a material
violation of any provision of any agreement (known to such counsel) to which the
Laudus Trust is a party or by which it or its properties are bound or, to the
knowledge of such counsel, result in the acceleration of any obligation or the
imposition of any penalty, under any agreement, judgment or decree to which the
Laudus Trust is a party or by which it or its properties are bound (except for
such accelerations or penalties that would not have a material adverse effect on
the condition, financial or otherwise, or in the earnings, business affairs or
business prospects of the Selling Fund);
17
(e) to the knowledge of such counsel, no consent, approval, authorization
or order of any court or governmental authority of the United States or
Commonwealth of Massachusetts is required for the consummation by the Laudus
Trust of the transactions contemplated in this Agreement, except such as have
been obtained under the 1933 Act, the 1934 Act and the 1940 Act or such as may
be required under the securities or blue sky laws of the various states, as to
which counsel need express no opinion;
(f) to such counsel's actual knowledge, the descriptions in the Proxy
Statement, insofar as they relate to the Laudus Trust or the Selling Fund, of
statutes, legal and governmental proceedings, investigations, orders, decrees or
judgments of any court or governmental body in the United States, and contracts
and other documents, if any, are accurate in all material respects and fairly
present, in all material respects, the information required to be shown;
(g) counsel does not know of any legal, administrative or governmental
proceedings, investigation, order, decree or judgment of any court or
governmental body, only insofar as they relate to the Laudus Trust or the
Selling Fund, or its respective assets or properties, pending, threatened or
otherwise existing on or before the effective date of the Registration Statement
or the Closing Date, which are required to be described in the Registration
Statement or to be filed as exhibits to the Registration Statement that are not
described and filed as required.
Counsel also will state that they have participated in conferences with
officers and other representatives of the Laudus Trust at which the contents of
the Proxy Statement, the Vanguard Trust Registration Statement and related
matters were discussed and, although they are not passing upon and do not assume
any responsibility for the accuracy, completeness or fairness of the statements
contained in the Proxy Statement (except to the extent indicated in paragraph
(f) of their above opinion), on the basis of the foregoing information (relying
as to materiality upon the opinions or certificates of officers and other
representatives of the Laudus Trust), they do not believe that the Proxy
Statement as of its date, as of the date of the Selling Fund's shareholders'
meeting, and as of the Closing Date, contained an untrue statement of a material
fact or omitted to state a material fact required to be stated in the Proxy
Statement or necessary to make the statements in the Proxy Statement in the
light of the circumstances under which they were made not misleading.
The opinion may state that counsel does not express any opinion or belief
as to the Financial Statements or other financial or statistical data, or as to
the information relating to the Vanguard Trust or the Acquiring Fund, contained
in the Proxy Statement, Registration Statement or the Vanguard Trust
Registration Statement, and that the opinion is solely for the benefit of the
Vanguard Trust and its trustees and officers. Such counsel may rely as to
matters governed by the laws of the Commonwealth of Massachusetts on an opinion
of local counsel and/or certificates of officers or trustees of the Selling
Fund. The opinion also will include such other matters incident to the
transaction contemplated by this Agreement as the Vanguard Trust may reasonably
request.
18
In this paragraph 7.4, references to the Proxy Statement include and relate
only to the text of such Proxy Statement and not, except as specifically stated
above, to any exhibits or attachments to the Proxy Statement or to any documents
incorporated by reference in the Proxy Statement.
7.5 The Vanguard Trust will have received from PricewaterhouseCoopers LLP a
letter addressed to the Vanguard Trust dated as of the effective date of the
Registration Statement in form and substance satisfactory to the Vanguard Trust,
to the effect that:
(a) they are independent public accountants with respect to the Laudus
Trust within the meaning of the 1933 Act and the applicable regulations under
the 1933 Act;
(b) in their opinion, the Financial Statements and Financial Highlights of
the Selling Fund included or incorporated by reference in the Registration
Statement and reported on by them comply as to form in all material respects
with the applicable accounting requirements of the 1933 Act and the rules and
regulations under the 1933 Act; and
(c) on the basis of limited procedures agreed upon by the Vanguard Trust
and the Laudus Trust and described in the letter (but not an examination in
accordance with generally accepted auditing standards), the specified
information relating to the Selling Fund appearing in the Registration Statement
and the Proxy Statement has been obtained from the accounting records of the
Selling Fund or from schedules prepared by officers of the Laudus Trust having
responsibility for financial and reporting matters and the information is in
agreement with these records, schedules or computations made from those
documents.
7.6 The Laudus Trust will have delivered to the Vanguard Trust copies of
Financial Statements of the Selling Fund as of and for its most recently
completed fiscal year.
7.7 The Vanguard Trust shall have received from PricewaterhouseCoopers LLP
a letter addressed both to the Vanguard Trust and the Laudus Trust, dated as of
the Closing Date, stating that, as of a date no more than three (3) business
days prior to the Closing Date, PricewaterhouseCoopers LLP performed limited
procedures and that on the basis of those procedures it confirmed the matters
set forth in paragraph 7.5(c).
ARTICLE VIII
Further Conditions Precedent to Obligations of the Acquiring Fund
-----------------------------------------------------------------
and the Selling Fund
--------------------
If any of the conditions set forth below do not exist on or before the
Closing Date, each party to this Agreement shall, at its option, not be required
to consummate the transactions contemplated by this Agreement.
8.1 This Agreement and the transactions contemplated in this Agreement will
have been approved by the requisite vote of the holders of the outstanding
shares of the Selling Fund in accordance with the provisions of the Laudus
Trust's Declaration of Trust and applicable law
19
and certified copies of the votes evidencing the approval will have been
delivered to the Acquiring Fund.
8.2 On the Closing Date, no action, suit or other proceeding will be
pending or to each party's knowledge threatened before any court or governmental
agency in which it is sought to restrain or prohibit, or obtain damages or other
relief in connection with, this Agreement or the transactions contemplated by
this Agreement. On the Closing Date, the Commission will not have issued an
unfavorable report under Section 25(b) of the 1940 Act, nor instituted any
proceeding seeking to enjoin the consummation of the transactions contemplated
by this Agreement under Section 25(c) of the 1940 Act.
8.3 All consents of other parties and all other consents, orders and
permits of federal, state and local regulatory authorities (including those of
the Commission and of state blue sky and securities authorities, including
no-action positions of and exemptive orders from federal and state authorities)
deemed, in good faith, necessary by the Vanguard Trust or the Laudus Trust to
permit consummation, in all material respects, of the transactions contemplated
by this Agreement will have been obtained, except if the failure to obtain any
such consent, order or permit would not involve a risk of a material adverse
effect on the assets or properties of the Acquiring Fund or the Selling Fund,
provided that either the Vanguard Trust or the Laudus Trust may for itself waive
any of the conditions in this paragraph 8.3.
8.4 The Vanguard Trust Registration Statement and the Registration
Statement will each have become effective under the 1933 Act and no stop orders
suspending the effectiveness of the Vanguard Trust Registration Statement and
the Registration Statement will have been issued and, to the best knowledge of
the Vanguard Trust or the Laudus Trust, no investigation or proceeding for that
purpose will have been instituted or be pending, threatened or contemplated
under the 1933 Act.
8.5 The parties will have received a favorable opinion of Willkie Farr &
Gallagher LLP, addressed to, and in form and substance reasonably satisfactory
to, the Laudus Trust substantially to the effect that, provided the
Reorganization is carried out in accordance with this Agreement and based upon
the facts, representations and assumptions stated in such opinion and upon
customary certificates with respect to matters of fact from the officers of the
Laudus Trust and the Vanguard Trust, for federal income tax purposes:
(a) the transfer to the Acquiring Fund of all of the Selling Fund's assets
solely in exchange for Acquiring Fund Shares and the assumption by the Acquiring
Fund of the Liabilities, followed by the Selling Fund's distribution of those
Shares to the Selling Fund Shareholders in complete liquidation of the Selling
Fund, all pursuant to the Plan, will constitute a "reorganization" within the
meaning of Section 368(a) of the Code, and the Acquiring Fund and the Selling
Fund will each be a "party to a reorganization" within the meaning of Section
368(b) of the Code;
(b) no gain or loss will be recognized by the Acquiring Fund upon the
receipt of the assets of the Selling Fund solely in exchange for Acquiring Fund
Shares and the assumption by the Acquiring Fund of the Liabilities;
20
(c) no gain or loss will be recognized by the Selling Fund upon the
transfer of the Selling Fund's assets to the Acquiring Fund solely in exchange
for the Acquiring Fund Shares and the assumption by the Acquiring Fund of the
Liabilities or upon the subsequent distribution, whether actual or constructive,
of the Acquiring Fund Shares to the Selling Fund Shareholders in exchange for
their Selling Fund Shares;
(d) no gain or loss will be recognized by Selling Fund Shareholders upon
the exchange of their Selling Fund Shares for the Acquiring Fund Shares pursuant
to the Reorganization and upon the assumption by the Acquiring Fund of the
Liabilities of the Selling Fund;
(e) the aggregate tax basis for the Acquiring Fund Shares received by each
of the Selling Fund Shareholders pursuant to the Reorganization will be the same
as the aggregate tax basis of the Selling Fund Shares held by the shareholder
immediately prior to the Reorganization, and the holding period of the Acquiring
Fund Shares to be received by each Selling Fund Shareholder pursuant to the
Reorganization will include the period during which the Selling Fund Shares
exchanged for the Acquiring Fund Shares were held by the shareholder (provided
that the Selling Fund Shares were held as capital assets on the Closing Date);
(f) the tax basis of the Selling Fund's assets acquired by the Acquiring
Fund will be the same as the tax basis of the assets to the Selling Fund
immediately prior to the Reorganization, and the holding period of the assets of
the Selling Fund in the hands of the Acquiring Fund will include the period
during which those assets were held by the Selling Fund; and
(g) the Acquiring Fund will succeed to and take into account the items of
the Selling Fund described in Section 381(c) of the Code.
No opinion will be expressed as to the effect of the Reorganization with
respect to unrealized gain or loss required to be marked to market for Federal
tax purposes as a result of a termination of the Selling Fund's tax year, where
applicable.
Notwithstanding anything in this Agreement to the contrary, neither the
Vanguard Trust nor the Laudus Trust may waive the conditions set out in this
paragraph 8.5.
ARTICLE IX
Brokerage Fees and Expenses; Other Agreements
---------------------------------------------
9.1 The Vanguard Trust represents and warrants to the Laudus Trust, and the
Laudus Trust represents and warrants to the Vanguard Trust, that no brokers or
finders or other entities are entitled to receive any payments in connection
with the transactions provided for in this Agreement.
21
9.2 The Vanguard Group, CSIM and AXA shall each bear the fees, costs, and
expenses incurred in connection with the transactions contemplated by this
Agreement in the manner set forth in the Fund Sponsorship Agreement, dated July
31, 2007, to which The Vanguard Group, CSIM and AXA are parties provided that
any such expenses of the Selling Fund that are paid or assumed are solely and
directly related to the Reorganization in accordance with the guidance
established in Rev. Rul. 73-54, 1973-1 C.B. 187; provided, however, that the
fees, costs, and expenses of PricewaterhouseCoopers LLP in performing the
limited procedures and issuing the related letter pursuant to paragraphs 7.5 and
7.7 (the "Limited Procedures Expenses") shall be paid for by The Vanguard Group.
9.3 (a) CSIM and AXA will each indemnify and hold harmless the Vanguard
Trust, the Acquiring Fund, The Vanguard Group, their directors, officers,
employees, and affiliates (each, a "Vanguard Indemnified Party"), from and
against any and all damages, costs and expenses (including reasonable attorney's
fees and costs) incurred by any of them as a result of any breach or failure of
the Laudus Trust's representations or warranties under this Agreement, or as a
result of any willful misconduct or gross negligence by the Laudus Trust in the
performance (or failure to perform) of the Laudus Trust's obligations under this
Agreement.
(b) CSIM's and AXA's agreement to indemnify a Vanguard Indemnified Party
pursuant to this paragraph 9.3 is expressly conditioned upon CSIM's and AXA's
being promptly notified of any action or claim brought against any Vanguard
Indemnified Party after that party receives notice of the action. The failure of
a Vanguard Indemnified Party to notify CSIM or AXA will not relieve CSIM's or
AXA's from any liability that CSIM or AXA may have otherwise than on account of
this indemnification agreement.
(c) In case any action or claim is brought against any Vanguard Indemnified
Party and that party timely notifies CSIM and/or AXA of the commencement of the
action or claim, CSIM and/or AXA will be entitled to participate in and, to the
extent that it wishes to do so, to assume the defense of the action or claim
with counsel satisfactory to it. If CSIM and/or AXA decides to assume the
defense of the action, CSIM and/or AXA will not be liable to the Vanguard
Indemnified Party for any legal or other expenses subsequently incurred by the
Vanguard Indemnified Party in connection with the defense of the action or claim
other than: (i) reasonable costs of investigation or the furnishing of documents
or witnesses and (ii) all reasonable fees and expenses of separate counsel to
the Vanguard Indemnified Party if the Vanguard Indemnified Party has concluded
reasonably that representation of CSIM or AXA and the Vanguard Indemnified Party
would be inappropriate as a result of actual or potential differing interests
between them in the conduct of the defense of such action.
9.4 (a) The Vanguard Group will indemnify and hold harmless the Laudus
Trust, CSIM, AXA, the Selling Fund, their directors, officers, employees and
affiliates (each, a "Laudus Indemnified Party") from and against any and all
damages (including reasonable attorney's fees and costs) incurred by any of them
as a result of any breach or failure of the Vanguard Trust's representations or
warranties under this Agreement, or as a result of any willful misconduct or
gross negligence by the Vanguard Trust in the performance (or failure to
perform) of the Vanguard Trust's obligations under this Agreement.
22
(b) The Vanguard Group's agreement to indemnify a Laudus Indemnified Party
pursuant to this paragraph 9.4 is expressly conditioned upon The Vanguard
Group's being promptly notified of any action or claim brought against any
Laudus Indemnified Party after that party receives notice of the action. The
failure of a Laudus Indemnified Party to notify The Vanguard Group will not
relieve The Vanguard Group from any liability that The Vanguard Group may have
otherwise than on account of this indemnification agreement.
(c) In case any action or claim is brought against any Laudus Indemnified
Party and that party timely notifies The Vanguard Group of the commencement of
the action or claim, The Vanguard Group will be entitled to participate in and,
to the extent that it wishes to do so, to assume the defense of the action or
claim with counsel satisfactory to it. If The Vanguard Group decides to assume
the defense of the action, The Vanguard Group will not be liable to the Laudus
Indemnified Party for any legal or other expenses subsequently incurred by the
Laudus Indemnified Party in connection with the defense of the action or claim
other than: (i) reasonable costs of investigation or the furnishing of documents
or witnesses and (ii) all reasonable fees and expenses of separate counsel to
the Laudus Indemnified Party if the Laudus Indemnified Party has concluded
reasonably that representation of The Vanguard Group and the Laudus Indemnified
Party would be inappropriate as a result of actual or potential differing
interest between them in the conduct of the defense as a result of the action.
ARTICLE X
Entire Agreement; Survival of Representations, Warranties and Covenants
-----------------------------------------------------------------------
10.1 The Vanguard Trust and the Laudus Trust agree that neither of them has
made any representation, warranty or covenant with respect to the Reorganization
not set forth in this Agreement or the Fund Sponsorship Agreement and that those
Agreements represent the entire agreement among them with respect to the
Reorganization.
10.2 The representations, warranties and covenants contained in this
Agreement or in any document delivered in accordance with its terms will survive
the consummation of the transactions contemplated under this Agreement.
ARTICLE XI
Termination
-----------
11.1 This Agreement may be terminated at any time at or prior to the
Closing Date by: (i) mutual agreement of the Laudus Trust and the Vanguard
Trust; (ii) the Laudus Trust, in the event the Vanguard Trust has, or the
Vanguard Trust in the event the Laudus Trust has, materially breached any
representation, warranty or agreement contained in this Agreement to be
performed at or prior to the Closing Date; (iii) the Laudus Trust or the
Vanguard Trust in the event a condition included in this Agreement expressed to
be precedent to the obligations of the terminating party or parties has not been
met and it reasonably appears that it will not or cannot be met or (iv) the
Laudus Trust or the Vanguard Trust by written notice to the other party
23
following a determination by the terminating party's Board of Trustees that the
consummation of the Reorganization is not in the best interest of its
shareholders.
11.2 In the event of any such termination, in the absence of willful
default, the Vanguard Trust or the Laudus Trust or their respective trustees or
officers, will not be liable to the other party or parties.
ARTICLE XII
Amendments
----------
This Agreement may be amended, modified or supplemented in writing in such
manner as may be mutually agreed upon by the authorized officers of the Vanguard
Trust and the Laudus Trust; provided, however, that following the meeting of the
Selling Fund's shareholders called pursuant to paragraph 5.2 of this Agreement,
no amendment may have the effect of changing the provisions for determining the
number of the Acquiring Fund Shares to be issued to the Selling Fund's
Shareholders under this Agreement to the detriment of the shareholders without
their further approval.
ARTICLE XIII
Notices
-------
13.1 Any notice, report, statement or demand required or permitted by any
provisions of this Agreement will be in writing and given by prepaid telegraph,
telecopy, or certified mail as follows:
If to the Vanguard Trust, at:
Vanguard Montgomery Funds
P.O. Box 2600
Valley Forge, PA 19482
Attention: Joseph P. Brennan
Telephone: 610-503-2042
Facsimile: 610-503-5855
If to the Laudus Trust, at:
Laudus Trust
P.O. Box 8032
Boston, MA 02266
Attention: George Pereira
Telephone: 415-636-3300
Facsimile: 415-636-3800
With copies (which shall not constitute notice) to:
24
Morgan Lewis & Bockius LLP
1701 Market Street
Philadelphia, PA 19103
Attn: Timothy W. Levin, Esq.
Telephone: 215-963-5037
Facsimile: 215-963-5001
Email: tlevin@morganlewis.com
----------------------
ARTICLE XIV
Headings; Counterparts; Governing Law; Assignment; Limitation of Liability
--------------------------------------------------------------------------
14.1 The article and paragraph headings contained in this Agreement are for
reference purposes only and will not affect in any way the meaning or
interpretation of this Agreement.
14.2 This Agreement may be executed in any number of counterparts, each of
which will be deemed an original.
14.3 This Agreement shall be governed by and construed in accordance with
the laws (without giving effect to the conflicts-of-law principles thereof) of
the Commonwealth of Pennsylvania.
14.4 This Agreement will bind and inure to the benefit of the parties to
the Agreement and their respective successors and assigns, but no assignment or
transfer of the Agreement or of any rights or obligations under the Agreement
may be made by either party without the written consent of the other party.
Nothing expressed or implied in this Agreement is intended or may be construed
to confer upon or give any person, firm or corporation, other than the parties
to the Agreement and their respective successors and assigns, any rights or
remedies under or by reason of this Agreement.
14.5 The Laudus Trust is executing this Agreement solely on behalf of the
Selling Fund. References to the "Laudus Trust" shall be construed to refer
solely to the Laudus Trust acting on behalf of the Selling Fund, and no
liability shall accrue to the Laudus Trust generally or to any other fund in
respect of this Agreement or any of the obligations hereunder, and each of the
parties will look only to the assets of the Selling Fund for satisfaction of any
obligation or liability arising under or in respect of this Agreement.
Notice is hereby given that this instrument is executed on behalf of the
Trustees of the Laudus Trust as Trustees and not individually, and that the
obligations of or arising out of this instrument are not binding upon any of the
Trustees, officers, or shareholders individually but are binding only upon the
assets and property of the Selling Fund.
14.6 The Vanguard Trust is executing this Agreement solely on behalf of the
Acquiring Fund. References to the "Vanguard Trust" shall be construed to refer
solely to the Vanguard Trust acting on behalf of the Acquiring Fund, and no
liability shall accrue to the Vanguard Trust generally or to any other fund in
respect of this Agreement or any of the
25
obligations hereunder, and each of the parties will look only to the assets of
the Acquiring Fund for satisfaction of any obligation or liability arising under
or in respect of this Agreement.
Notice is hereby given that this instrument is executed on behalf of the
Trustees of the Vanguard Trust as Trustees and not individually, and that the
obligations of or arising out of this instrument are not binding upon any of the
Trustees, officers, or shareholders individually but are binding only upon the
assets and property of the Acquiring Fund.
26
* * * * *
IN WITNESS WHEREOF, the parties hereto have caused this Agreement and Plan
of Reorganization to be executed as of the date first set forth herein.
LAUDUS TRUST VANGUARD MONTGOMERY FUNDS
----------------------------------- ------------------------------------
Signature Date Signature Date
----------------------------------- ------------------------------------
Print Name Title Print Name Title
CHARLES SCHWAB INVESTMENT THE VANGUARD GROUP, INC.
MANAGEMENT, INC. (as to the provision of Paragraphs
(as to the provisions of Paragraphs 1.3, 9.2 and 9.4 only)
9.2 and 9.3 only)
----------------------------------- ------------------------------------
Signature Date Signature Date
----------------------------------- ------------------------------------
Print Name Title Print Name Title
AXA ROSENBERG INVESTMENT MANAGEMENT LLC
(as to the provisions of Paragraphs 9.2
and 9.3 only)
-----------------------------------
Signature Date
-----------------------------------
Print Name Title
27
LAUDUS TRUST
LAUDUS ROSENBERG U.S. LARGE/MID CAPITALIZATION LONG/SHORT EQUITY FUND
PROXY SOLICITED BY THE BOARD OF TRUSTEES
PROXY FOR MEETING OF SHAREHOLDERS ON NOVEMBER 21, 2007
The undersigned hereby appoints David Rosenberg and Catherine MacGregor and each
of them separately, proxies, with power of substitution to each, and hereby
authorizes each of them, to represent and to vote, as designated below, at the
Meeting of Shareholders (the "Meeting") of the Laudus Rosenberg U.S. Large/Mid
Capitalization Long/Short Equity Fund (the "Laudus Fund"), a series of Laudus
Trust (the "Laudus Trust"), to be held at the offices of Charles Schwab & Co.,
Inc., 101 Montgomery Street, San Francisco, CA 94104, on November 21, 2007 at
8:30 a.m., Pacific Time, and at any adjournments thereof, all of the shares of
the Laudus Fund which the undersigned would be entitled to vote if personally
present.
--------------------------------------------------------------------------------
TO VOTE BY MAIL, PLEASE VOTE, SIGN, DATE AND RETURN PROMPTLY IN THE ENCLOSED
ENVELOPE.
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
Note: PLEASE SIGN EXACTLY AS YOUR NAME APPEARS ON THIS PROXY CARD. All joint
owners should sign. When signing as executor, administrator, attorney, trustee
or guardian, or as custodian for a minor, please sign in full corporate name,
and indicate the signer's office. If a partner, sign in the partnership name.
--------------------------------------------------------------------------------
PROXY TABULATOR
P.O. BOX 9112
FARMINGDALE, NY 11735
------------------------------------------ -------------------------------------- --------------------------------------
To vote by Telephone To vote by Internet To vote by Mail
1) Read the Proxy Statement and have the 1) Read the Proxy Statement and have 1)Read the Proxy Statement.
Proxy card below at hand. the Proxy card below at hand.
2) Call 1-888-221-0697. 2) Go to www.proxyweb.com 2)Check the appropriate box on the
reverse side.
3) Follow the simple instructions. 3) Follow the simple instructions. 3)Sign, date and return the Proxy
card using the enclosed envelope.
------------------------------------------ -------------------------------------- --------------------------------------
IF YOU VOTE BY TELEPHONE OR INTERNET, PLEASE DO NOT RETURN YOUR PROXY CARD.
THIS PROXY IS SOLICITED ON BEHALF
OF THE BOARD OF TRUSTEES OF LAUDUS TRUST
SPECIAL MEETING OF SHAREHOLDERS--NOVEMBER 21, 2007
LAUDUS ROSENBERG U.S. LARGE/MID CAPITALIZATION
LONG/SHORT EQUITY FUND (THE "FUND")
The undersigned shareholder(s) of the Fund, revoking previous proxies, hereby
appoint(s) David Rosenberg and Catherine MacGregor, and each of them (with full
power of substitution), the proxies of the undersigned to attend the Special
Meeting of Shareholders to be held on November 21, 2007, at the offices of
Charles Schwab & Co., Inc., 101 Montgomery Street, San Francisco, California, at
8:30 a.m., Pacific time, and any adjournments thereof (the "Meeting"), and to
vote all of the shares of the Fund that the undersigned would be entitled to
vote at the Meeting upon the proposal set forth herein and upon any other matter
that may properly come before the Meeting.
This proxy, when properly executed, will be voted in the manner directed herein
by the undersigned.
IF YOU SIGN THE PROXY WITHOUT OTHERWISE INDICATING A VOTE ON THE PROPOSAL, THIS
PROXY WILL BE VOTED FOR THE PROPOSAL LISTED BELOW. AS TO ANY OTHER MATTER THAT
MAY PROPERLY COME BEFORE THE MEETING, THE SHARES WILL BE VOTED BY THE PROXIES IN
ACCORDANCE WITH THEIR JUDGMENT. The undersigned acknowledges receipt of the
Notice of the Meeting and the Proxy Statement.
----------------------------------
Date_____________, 2007
------------------------
------------------------
----------------------------------
Signature(s) (Joint Owners) (PLEASE SIGN WITHIN BOX)
Please print and sign exactly as your name(s) appear on this card to authorize
the voting of your shares. When signing as attorney or executor, administrator,
trustee or guardian, please give full title as such. If a corporation, please
sign in full corporate name by president or other authorized officer. If a
partnership, please sign in partnership name by authorized person. For joint
accounts, each joint owner must sign.
Please fill in circles as shown using black or blue ink or number 2 pencil.
X PLEASE DO NOT USE FINE POINT PENS.
This proxy is solicited on behalf of the Board of Trustees, which unanimously
recommends that shareholders vote "FOR" the proposal listed below.
Proposal: To approve the reorganization of the Laudus Rosenberg U.S. Large/Mid FOR AGAINST ABSTAIN
Capitalization Long/Short Equity Fund into the Vanguard Market Neutral
Fund.
O O O
PLEASE COMPLETE, SIGN, DATE, AND RETURN THIS PROXY PROMPTLY USING THE ENCLOSED
ENVELOPE. NO POSTAGE IS NECESSARY IF MAILED IN THE UNITED STATES.
PART B
STATEMENT OF ADDITIONAL INFORMATION
Relating to the Acquisition of the Assets and Liabilities of
LAUDUS ROSENBERG U.S. LARGE/MID CAPITALIZATION
LONG/SHORT EQUITY FUND
A Series of LAUDUS TRUST
P.O. Box 8032
Boston, Massachusetts 02266
(888) 517-9900
By and In Exchange for Shares of
Vanguard(R) Market Neutral Fund
A Series of VANGUARD MONTGOMERY FUNDS
P.O. Box 2600
Valley Forge, Pennsylvania 19482
(800) 662-7447
October 5, 2007
This Statement of Additional Information ("SAI"), dated October 5, 2007
relates to the proposed reorganization (the "Reorganization") of Laudus
Rosenberg U.S. Large/Mid Capitalization Long/Short Equity Fund (the "Laudus
Fund"), a series of Laudus Trust (the "Laudus Trust"), with and into Vanguard(R)
Market Neutral Fund (the "Vanguard Fund"), a series of Vanguard Montgomery Funds
(the "Vanguard Trust"). Assuming approval of the Reorganization, each
shareholder of the Laudus Fund will receive an amount of shares of the Vanguard
Fund equal in value to the shares of the Laudus Fund owned by such shareholder
at the time of the closing of the Reorganization.
This SAI, which is not a prospectus, supplements and should be read in
conjunction with the Prospectus/Proxy Statement dated October 5, 2007 (the
"Prospectus/Proxy Statement") relating specifically to the Special Meeting of
Shareholders of the Laudus Fund which is scheduled to be held on November 21,
2007.
This SAI and the Prospectus/Proxy Statement have been filed with the
Securities and Exchange Commission ("SEC").
A copy of the Prospectus/Proxy Statement relating to the Reorganization may
be obtained without charge by writing the Laudus Trust at P.O. Box 8032, Boston,
Massachusetts 02266, or by calling the Laudus Trust at (866) 452-8387 for
shareholders holding Institutional class shares and for registered investment
professionals, and (800) 447-3332 for shareholders holding Investor class
shares.
The following publicly available documents each accompany this SAI.
1. Statement of Additional Information of Laudus Trust, dated July 31,
2007.
2. Annual Report to Shareholders of Laudus Trust for the year ended March
31, 2007.
Incorporation of Documents by Reference into this SAI:
Further information about Institutional Shares and Investor Shares of the
Laudus Fund is contained in and incorporated herein by reference to the Laudus
Trust's Statement of Additional Information, dated July 31, 2007.
The audited financial statements and related Report of Independent
Registered Public Accounting Firm included in the Annual Report to Shareholders
for the fiscal year ended March 31, 2007 for the Laudus Fund are incorporated
herein by reference. No other parts of the Annual Report are incorporated herein
by reference.
Financial statements of the Vanguard Fund are not included herein because
the Vanguard Fund has not yet commenced operations.
Pro forma Financial Statements. No financial information relating to the
Vanguard Fund and no projected (pro forma) financial information is being
provided because the Vanguard Fund into which the Laudus Fund will be
reorganized is a newly formed shell fund, and has not conducted any business
other than matters incident to its organization and will not commence operations
until completion of the Reorganization.
-2-
TABLE OF CONTENTS
DESCRIPTION OF TRUST 4
Organization 4
Service Providers 4
Characteristics of The Vanguard Fund's Shares 5
Tax Status of The Vanguard Fund 6
Investment Policies 7
INVESTMENT LIMITATIONS 24
SHARE PRICE 25
PURCHASE AND REDEMPTION OF SHARES 26
MANAGEMENT OF THE VANGUARD FUND 29
INVESTMENT ADVISOR SERVICES 38
PORTFOLIO TRANSACTIONS 42
PROXY VOTING GUIDELINES 43
-3-
DESCRIPTION OF THE VANGUARD TRUST
ORGANIZATION
The Vanguard Trust was organized as a Delaware statutory trust on July 18,
2007. The Vanguard Trust is registered with the SEC under the Investment Company
Act of 1940 (the "1940 Act") as an open-end, diversified management investment
company. The Vanguard Trust currently offers the following fund (and classes
thereof):
----------------------------------- ----------------------------------------
Fund Share Classes
----------------------------------- ----------------------------------------
----------------------------------- ----------------------------------------
Vanguard(R) Market Neutral Fund Investor and Institutional(1)
----------------------------------- ----------------------------------------
The Vanguard Trust has the ability to offer additional funds, which in turn
may issue classes of shares. There is no limit on the number of full and
fractional shares that may be issued for a single fund or class of shares.
The Vanguard Fund is a member fund. There are two types of Vanguard funds,
member funds and non-member funds. Member funds jointly own The Vanguard Group,
Inc. ("Vanguard"), contribute to Vanguard's capital, and receive services at
cost from Vanguard pursuant to the Amended and Restated Funds' Service Agreement
("Funds' Service Agreement"). Non-member funds do not contribute to Vanguard's
capital, but they do receive services pursuant to special services agreements.
See "Management of the Vanguard Fund" for more information.
SERVICE PROVIDERS
CUSTODIAN. Brown Brothers Harriman & Co., 40 Water Street, Boston, MA
02109, serves as the Vanguard Fund's custodian. The Vanguard Fund's custodian is
responsible for maintaining the Vanguard Fund's assets, keeping all necessary
accounts and records of Vanguard Fund assets, and appointing any foreign
sub-custodians or foreign securities depositories.
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM. PricewaterhouseCoopers LLP,
Two Commerce Square, Suite 1700, 2001 Market Street, Philadelphia, PA,
19103-7042, serves as the Vanguard Fund's independent registered public
accounting firm. The independent registered public accounting firm audits the
Vanguard Fund's annual financial statements and provides other related services.
TRANSFER AND DIVIDEND-PAYING AGENT. The Vanguard Fund's transfer agent and
dividend-paying agent is Vanguard, P.O. Box 2600, Valley Forge, PA 19482.
----------------------------
1 Individually, a class; collectively, the classes.
-4-
CHARACTERISTICS OF THE VANGUARD FUND'S SHARES
RESTRICTIONS ON HOLDING OR DISPOSING OF SHARES. There are no restrictions
on the right of shareholders to retain or dispose of the Vanguard Fund's shares,
other than those described in the Prospectus/Proxy Statement and elsewhere in
this Statement of Additional Information or the possible future termination of
the Vanguard Fund or a share class. The Vanguard Fund or class may be terminated
by reorganization into another mutual fund or class or by liquidation and
distribution of the assets of the Vanguard Fund or class. Unless terminated by
reorganization or liquidation, the Vanguard Fund and share class will continue
indefinitely.
SHAREHOLDER LIABILITY. The Vanguard Trust is organized under Delaware law,
which provides that shareholders of a statutory trust are entitled to the same
limitations of personal liability as shareholders of a corporation organized
under Delaware law. Effectively, this means that a shareholder of the Vanguard
Fund will not be personally liable for payment of the Vanguard Fund's debts
except by reason of his or her own conduct or acts. In addition, a shareholder
could incur a financial loss as a result of a Vanguard Fund obligation only if
the Vanguard Fund itself had no remaining assets with which to meet such
obligation. We believe that the possibility of such a situation arising is
extremely remote.
DIVIDEND RIGHTS. The shareholders of each class of the Vanguard Fund are
entitled to receive any dividends or other distributions declared by the
Vanguard Fund for each such class. No shares of the Vanguard Fund have priority
or preference over any other shares of the Vanguard Fund with respect to
distributions. Distributions will be made from the assets of the Vanguard Fund
and will be paid ratably to all shareholders of a particular class according to
the number of shares of the class held by shareholders on the record date. The
amount of dividends per share may vary between separate share classes of the
Vanguard Fund based upon differences in the net asset values of the different
classes and differences in the way that expenses are allocated between share
classes pursuant to a multiple class plan.
VOTING RIGHTS. Shareholders are entitled to vote on a matter if: (1) a
shareholder vote is required under the 1940 Act; (2) the matter concerns an
amendment to the Vanguard Trust's Declaration of Trust that would adversely
affect to a material degree the rights and preferences of the shares of the
Vanguard Fund or any class; (3) the trustees determine that it is necessary or
desirable to obtain a shareholder vote; or (4) a certain type of merger or
consolidation, share conversion, share exchange, or sale of assets is proposed.
The 1940 Act requires a shareholder vote under various circumstances, including
to elect or remove trustees upon the written request of shareholders
representing 10% or more of the Vanguard Fund's net assets and to change any
fundamental policy of the Vanguard Fund. Unless otherwise required by applicable
law, shareholders of the Vanguard Fund receive one vote for each dollar of net
asset value owned on the record date, and a fractional vote for each fractional
dollar of net asset value owned on the record date. However, only the shares of
the Vanguard Fund or class affected by a particular matter are entitled to vote
on that matter. In addition, each class has exclusive voting rights on any
-5-
matter submitted to shareholders that relates solely to that class, and each
class has separate voting rights on any matter submitted to shareholders in
which the interests of one class differ from the interests of another. Voting
rights are noncumulative and cannot be modified without a majority vote.
LIQUIDATION RIGHTS. In the event that the Vanguard Fund is liquidated,
shareholders will be entitled to receive a pro rata share of the Vanguard Fund's
net assets. In the event that a class of shares is liquidated, shareholders of
that class will be entitled to receive a pro rata share of the Vanguard Fund's
net assets that are allocated to that class. Shareholders may receive cash,
securities, or a combination of the two.
PREEMPTIVE RIGHTS. There are no preemptive rights associated with the
Vanguard Fund's shares.
CONVERSION RIGHTS. Shareholders of the Vanguard Fund may convert their
shares into another class of shares of the Vanguard Fund upon the satisfaction
of any then applicable eligibility requirements.
REDEMPTION PROVISIONS. The Vanguard Fund's redemption provisions are
described in Prospectus/Proxy Statement and elsewhere in this Statement of
Additional Information.
SINKING FUND PROVISIONS. The Vanguard Fund has no sinking fund provisions.
CALLS OR ASSESSMENT. The Vanguard Fund's shares, when issued, are fully
paid and non-assessable.
TAX STATUS OF THE VANGUARD FUND
The Vanguard Fund intends to qualify as a "regulated investment company"
under Subchapter M of the Internal Revenue Code of 1986, as amended (the "IRC").
This special tax status means that the Vanguard Fund will not be liable for
federal tax on income and capital gains distributed to shareholders. In order to
preserve its tax status, the Vanguard Fund must comply with certain
requirements. If the Vanguard Fund fails to meet these requirements in any
taxable year, it will be subject to tax on its taxable income at corporate
rates, and all distributions from earnings and profits, including any
distributions of net tax-exempt income and net long-term capital gains, will be
taxable to shareholders as ordinary income. In addition, the Vanguard Fund could
be required to recognize unrealized gains, pay substantial taxes and interest,
and make substantial distributions before regaining its tax status as a
regulated investment company.
Dividends received and distributed by the Vanguard Fund on shares of stock
of domestic corporations may be eligible for the dividends-received deduction
applicable to corporate shareholders. Corporations must satisfy certain
requirements in order to claim the deduction. Capital gains distributed by the
Vanguard Fund are not eligible for the dividends-received deduction.
The Vanguard Fund is generally managed without regard to tax ramifications.
Prospective investors should consult their own tax advisors about the U.S.
federal, state, local, and foreign tax aspects of an investment in a fund,
including taxes applicable to the acquisition, holding, and disposition of
shares. The tax discussion in this SAI is general in nature and is not intended
to be used, and cannot be used, for the purpose of avoiding any tax penalties.
-6-
INVESTMENT POLICIES
Some of the investment policies described below and in the Prospectus/Proxy
Statement set forth percentage limitations on the Vanguard Fund's investment in,
or holdings of, certain securities or other assets. Unless otherwise required by
law, compliance with these policies will be determined immediately after the
acquisition of such securities or assets. Subsequent changes in values, net
assets, or other circumstances will not be considered when determining whether
the investment complies with the Vanguard Fund's investment policies and
limitations.
The following policies and explanations supplement the Vanguard Fund's
investment objective and policies set forth in the Prospectus/Proxy Statement.
With respect to the different investments discussed below, the Vanguard Fund may
acquire such investments to the extent consistent with its investment objective
and policies.
BORROWING. The Vanguard Fund's ability to borrow money is limited by its
investment policies and limitations, by the 1940 Act, and by applicable
exemptions, no-action letters, interpretations, and other pronouncements issued
from time to time by the SEC and its staff or any other regulatory authority
with jurisdiction. Under the 1940 Act, a fund is required to maintain continuous
asset coverage (that is, total assets including borrowings, less liabilities
exclusive of borrowings) of 300% of the amount borrowed, with an exception for
borrowings not in excess of 5% of the fund's total assets made for temporary or
emergency purposes. Any borrowings for temporary purposes in excess of 5% of a
fund's total assets must maintain continuous asset coverage. If the 300% asset
coverage should decline as a result of market fluctuations or for other reasons,
a fund may be required to sell some of its portfolio holdings within three days
(excluding Sundays and holidays) to reduce the debt and restore the 300% asset
coverage, even though it may be disadvantageous from an investment standpoint to
sell securities at that time.
Borrowing will tend to exaggerate the effect on net asset value of any
increase or decrease in the market value of a fund's portfolio. Money borrowed
will be subject to interest costs that may or may not be recovered by earnings
on the securities purchased. A fund also may be required to maintain minimum
average balances in connection with a borrowing or to pay a commitment or other
fee to maintain a line of credit; either of these requirements would increase
the cost of borrowing over the stated interest rate.
The SEC takes the position that other transactions that have a leveraging
effect on the capital structure of a fund or are economically equivalent to
borrowing can be viewed as constituting a form of borrowing by a fund for
purposes of the 1940 Act. These transactions can include entering into reverse
repurchase agreements, engaging in mortgage-dollar-roll transactions, selling
securities short (other than short sales "against-the-box"), buying and selling
certain derivatives (such as futures contracts), selling (or writing) put and
call options, engaging in sale-buybacks, entering into firm-commitment and
standby-commitment agreements, engaging in when-issued, delayed-delivery, or
forward-commitment transactions, and other trading practices that have a
leveraging effect on the capital structure of a fund or are economically
equivalent to borrowing (additional discussion about a number of these
transactions can be found below). A borrowing transaction will not be considered
to constitute the issuance of a "senior security" by a fund, and therefore such
transaction will not be subject to the 300% asset coverage requirement otherwise
applicable to borrowings by a fund, if the fund (1) maintains an offsetting
financial position; (2) segregates liquid assets (with such liquidity determined
-7-
by the adviser in accordance with procedures established by the board of
trustees) equal (as determined on a daily mark-to-market basis) in value to the
fund's potential economic exposure under the borrowing transaction; or (3)
otherwise "covers" the transaction in accordance with applicable SEC guidance
(collectively, "covers" the transaction). A fund may have to buy or sell a
security at a disadvantageous time or price in order to cover a borrowing
transaction. In addition, segregated assets may not be available to satisfy
redemptions or for other purposes.
COMMON STOCK. Common stock represents an equity or ownership interest in an
issuer. Common stock typically entitles the owner to vote on the election of
directors and other important matters as well as to receive dividends on such
stock. In the event an issuer is liquidated or declares bankruptcy, the claims
of owners of bonds, other debt holders, and owners of preferred stock take
precedence over the claims of those who own common stock.
DEBT SECURITIES. A debt security, sometimes called a fixed income security,
is a security consisting of a certificate or other evidence of a debt (secured
or unsecured) on which the issuing company or governmental body promises to pay
the holder thereof a fixed, variable, or floating rate of interest for a
specified length of time, and to repay the debt on the specified maturity date.
Some debt securities, such as zero coupon bonds, do not make regular interest
payments but are issued at a discount to their principal or maturity value. Debt
securities include a variety of fixed income obligations, including, but not
limited to, corporate bonds, government securities, municipal securities,
convertible securities, mortgage-backed securities, and asset-backed securities.
Debt securities include investment-grade securities, noninvestment-grade
securities, and unrated securities. Debt securities are subject to a variety of
risks, such as interest rate risk, income risk, call/prepayment risk, inflation
risk, credit risk, and (in the case of foreign securities) country risk and
currency risk. The reorganization of an issuer under the federal bankruptcy laws
may result in the issuer's debt securities being cancelled without repayment,
repaid only in part, or repaid in part or in whole through an exchange thereof
for any combination of cash, debt securities, convertible securities, equity
securities, or other instruments or rights in respect of the same issuer or a
related entity.
DEPOSITARY RECEIPTS. Depositary receipts are securities that evidence
ownership interests in a security or a pool of securities that have been
deposited with a "depository." Depositary receipts may be sponsored or
unsponsored and include American Depositary Receipts (ADRs), European Depositary
Receipts (EDRs) and Global Depositary Receipts (GDRs). For ADRs, the depository
is typically a U.S. financial institution and the underlying securities are
issued by a foreign issuer. For other depositary receipts, the depository may be
a foreign or a U.S. entity, and the underlying securities may have a foreign or
a U.S. issuer. Depositary receipts will not necessarily be denominated in the
same currency as their underlying securities. Generally, ADRs are issued in
registered form, denominated in U.S. dollars, and designed for use in the U.S.
securities markets. Other depositary receipts, such as GDRs and EDRs, may be
issued in bearer form and denominated in other currencies, and are generally
designed for use in securities markets outside the U.S. Although the two types
of depositary receipt facilities (unsponsored or sponsored) are similar, there
are differences regarding a holder's rights and obligations and the practices of
market participants. A depository may establish an unsponsored facility without
participation by (or acquiescence of) the underlying issuer; typically, however,
-8-
the depository requests a letter of non-objection from the underlying issuer
prior to establishing the facility. Holders of unsponsored depositary receipts
generally bear all the costs of the facility. The depository usually charges
fees upon the deposit and withdrawal of the underlying securities, the
conversion of dividends into U.S. dollars or other currency, the disposition of
non-cash distributions, and the performance of other services. The depository of
an unsponsored facility frequently is under no obligation to distribute
shareholder communications received from the underlying issuer or to pass
through voting rights to depositary receipt holders with respect to the
underlying securities.
Sponsored depositary receipt facilities are created in generally the same
manner as unsponsored facilities, except that sponsored depositary receipts are
established jointly by a depository and the underlying issuer through a deposit
agreement. The deposit agreement sets out the rights and responsibilities of the
underlying issuer, the depository, and the depositary receipt holders. With
sponsored facilities, the underlying issuer typically bears some of the costs of
the depositary receipts (such as dividend payment fees of the depository),
although most sponsored depositary receipts holders may bear costs such as
deposit and withdrawal fees. Depositories of most sponsored depositary receipts
agree to distribute notices of shareholder meetings, voting instructions, and
other shareholder communications and information to the depositary receipt
holders at the underlying issuer's request. The depository of an unsponsored
facility frequently is under no obligation to distribute shareholder
communications received from the issuer of the deposited security or to pass
through, to the holders of the receipts, voting rights with respect to the
deposited securities.
For purposes of a fund's investment policies, investments in depositary
receipts will be deemed to be investments in the underlying securities. Thus, a
depositary receipt representing ownership of common stock will be treated as
common stock. Depositary receipts do not eliminate all of the risks associated
with directly investing in the securities of foreign issuers.
DERIVATIVES. A derivative is a financial instrument that has a value that
is based on--or "derived from"--the values of other assets, reference rates, or
indexes. Derivatives may relate to a wide variety of underlying references, such
as commodities, stocks, bonds, interest rates, currency exchange rates, and
related indexes. Derivatives include futures contracts and options on futures
contracts, forward-commitment transactions, options on securities, caps, floors,
collars, swap agreements, and other financial instruments. Some derivatives,
such as futures contracts and certain options, are traded on U.S. commodity and
securities exchanges, while other derivatives, such as swap agreements, are
privately negotiated and entered into in the over-the-counter (OTC) market. The
risks associated with the use of derivatives are different from, and possibly
greater than, the risks associated with investing directly in the securities,
assets, or market indexes on which the derivatives are based. Derivatives are
used by some investors for speculative purposes. Derivatives also may be used
for a variety of purposes that do not constitute speculation, such as hedging,
risk management, seeking to stay fully invested, seeking to reduce transaction
costs, seeking to simulate an investment in equity or debt securities or other
investments, seeking to add value by using derivatives to more efficiently
implement portfolio positions when derivatives are favorably priced relative to
equity or debt securities or other investments, and for other purposes. There is
no assurance that any derivatives strategy used by a fund's adviser will
succeed. The counterparties to a fund's derivatives will not be considered
-9-
the issuers thereof for purposes of certain provisions of the 1940 Act and the
IRC, although such derivatives may qualify as securities or investments under
such laws. A fund's advisors, however, will monitor the fund's credit risk
exposure to derivative counterparties to prevent excess concentration to any one
counterparty.
Derivative products are highly specialized instruments that require
investment techniques and risk analyses different from those associated with
stocks, bonds, and other traditional investments. The use of a derivative
requires an understanding not only of the underlying instrument but also of the
derivative itself, without the benefit of observing the performance of the
derivative under all possible market conditions.
The use of a derivative involves the risk that a loss may be sustained as a
result of the insolvency or bankruptcy of the other party to the contract
(usually referred to as a "counterparty") or the failure of the counterparty to
make required payments or otherwise comply with the terms of the contract.
Additionally, the use of credit derivatives can result in losses if a fund's
adviser does not correctly evaluate the creditworthiness of the issuer on which
the credit derivative is based.
Derivatives may be subject to liquidity risk, which exists when a
particular derivative is difficult to purchase or sell. If a derivative
transaction is particularly large or if the relevant market is illiquid (as is
the case with many OTC derivatives), it may not be possible to initiate a
transaction or liquidate a position at an advantageous time or price.
Derivatives may be subject to pricing or "basis" risk, which exists when a
particular derivative becomes extraordinarily expensive relative to historical
prices or the prices of corresponding cash market instruments. Under certain
market conditions, it may not be economically feasible to initiate a transaction
or liquidate a position in time to avoid a loss or take advantage of an
opportunity.
Because many derivatives have a leverage component, adverse changes in the
value or level of the underlying asset, reference rate, or index can result in a
loss substantially greater than the amount invested in the derivative itself.
Certain derivatives have the potential for unlimited loss, regardless of the
size of the initial investment. A derivative transaction will not be considered
to constitute the issuance of a "senior security" by a fund, and therefore such
transaction will not be subject to the 300% asset coverage requirement otherwise
applicable to borrowings by a fund, if the fund covers the transaction in
accordance with the requirements, and subject to the risks, described above
under the heading "Borrowing."
Like most other investments, derivative instruments are subject to the risk
that the market value of the instrument will change in a way detrimental to a
fund's interest. A fund bears the risk that its adviser will incorrectly
forecast future market trends or the values of assets, reference rates, indexes,
or other financial or economic factors in establishing derivative positions for
the fund. If the adviser attempts to use a derivative as a hedge against, or as
a substitute for, a portfolio investment, the fund will be exposed to the risk
that the derivative will have or will develop imperfect or no correlation with
the portfolio investment. This could cause substantial losses for the fund.
Although hedging strategies involving derivative instruments can reduce the risk
of loss, they can also reduce the opportunity for gain or even result in losses
by offsetting
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favorable price movements in other fund investments. Many derivatives, in
particular OTC derivatives, are complex and often valued subjectively. Improper
valuations can result in increased cash payment requirements to counterparties
or a loss of value to a fund.
EXCHANGE-TRADED FUNDS. A fund may purchase shares of exchange-traded funds
(ETFs), including ETF shares issued by other Vanguard funds. Typically, a fund
would purchase ETF shares for the same reason it would purchase (and as an
alternative to purchasing) futures contracts: to obtain exposure to all or a
portion of the stock or bond market. ETF shares enjoy several advantages over
futures. Depending on the market, the holding period, and other factors, ETF
shares can be less costly and more tax-efficient than futures. In addition, ETF
shares can be purchased for smaller sums, offer exposure to market sectors and
styles for which there is no suitable or liquid futures contract, and do not
involve leverage.
An investment in an ETF generally presents the same primary risks as an
investment in a conventional fund (i.e., one that is not exchange traded) that
has the same investment objective, strategies, and policies. The price of an ETF
can fluctuate within a wide range, and a fund could lose money investing in an
ETF if the prices of the securities owned by the ETF go down. In addition, ETFs
are subject to the following risks that do not apply to conventional funds: (1)
the market price of the ETF's shares may trade at a discount to its net asset
value; (2) an active trading market for an ETF's shares may not develop or be
maintained; or (3) trading of an ETF's shares may be halted if the listing
exchange's officials deem such action appropriate, the shares are de-listed from
the exchange, or the activation of market-wide "circuit breakers" (which are
tied to large decreases in stock prices) halts stock trading generally.
Most ETFs are investment companies. Therefore, the Vanguard Fund's
purchases of ETF shares generally are subject to the limitations on, and the
risks of, the Vanguard Fund's investments in other investment companies, which
are described below under the heading "Other Investment Companies."
Vanguard ETF(TM)* Shares are exchange-traded shares that represent an
interest in an investment portfolio held by Vanguard index funds. A fund's
investments in Vanguard ETF Shares are also generally subject to the
descriptions, limitations, and risks described under the heading "Other
Investment Companies," except as provided by an exemption granted by the SEC
that permits registered investment companies to invest in a Vanguard fund that
issues ETF Shares beyond the limits of Section 12(d)(1) of the 1940 Act, subject
to certain terms and conditions.
FOREIGN SECURITIES. Typically, foreign securities are considered to be
equity or debt securities issued by entities organized, domiciled, or with a
principal executive office outside the United States, such as foreign
corporations and governments. Securities issued by certain companies organized
outside the United States may not be deemed to be foreign securities if the
company's principal operations are conducted from the United States or when the
company's equity securities trade principally on a U.S. stock exchange. Foreign
securities may trade in U.S.
---------------------------
* U.S. Pat. No. 6,879,964 B2.
-11-
or foreign securities markets. A fund may make foreign investments either
directly by purchasing foreign securities or indirectly by purchasing depositary
receipts or depositary shares of similar instruments (depositary receipts) for
foreign securities. Depositary receipts are securities that are listed on
exchanges or quoted in OTC markets in one country but represent shares of
issuers domiciled in another country. Direct investments in foreign securities
may be made either on foreign securities exchanges or in the OTC markets.
Investing in foreign securities involves certain special risk considerations
that are not typically associated with investing in securities of U.S. companies
or governments.
Because foreign issuers are not generally subject to uniform accounting,
auditing, and financial reporting standards and practices comparable to those
applicable to U.S. issuers, there may be less publicly available information
about certain foreign issuers than about U.S. issuers. Evidence of securities
ownership may be uncertain in many foreign countries. As a result, there is a
risk that a fund's trade details could be incorrectly or fraudulently entered at
the time of the transaction, resulting in a loss to the fund. Securities of
foreign issuers are generally less liquid than securities of comparable U.S.
issuers. In certain countries, there is less government supervision and
regulation of stock exchanges, brokers, and listed companies than in the U.S. In
addition, with respect to certain foreign countries, there is the possibility of
expropriation or confiscatory taxation, political or social instability, war,
terrorism, nationalization, limitations on the removal of funds or other assets,
or diplomatic developments which could affect U.S. investments in those
countries. Although an adviser will endeavor to achieve most favorable execution
costs for a fund's portfolio transactions in foreign securities under the
circumstances, commissions (and other transaction costs) are generally higher
than those on U.S. securities. In addition, it is expected that the expenses for
custodian arrangements of a fund's foreign securities will be somewhat greater
than the expenses for a fund that invests primarily in domestic securities.
Certain foreign governments levy withholding taxes against dividend and interest
income from foreign securities. Although in some countries a portion of these
taxes is recoverable by a fund, the non-recovered portion of foreign withholding
taxes will reduce the income received from the companies making up a fund.
The value of the foreign securities held by a fund that are not U.S.
dollar-denominated may be significantly affected by changes in currency exchange
rates. The U.S. dollar value of a foreign security generally decreases when the
value of the U.S. dollar rises against the foreign currency in which the
security is denominated and tends to increase when the value of the U.S. dollar
falls against such currency (as discussed below, a fund may attempt to hedge its
currency risks). In addition, the value of fund assets may be affected by losses
and other expenses incurred in converting between various currencies in order to
purchase and sell foreign securities, and by currency restrictions, exchange
control regulation, currency devaluations, and political and economic
developments.
FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS-RISKS. Futures contracts
and options on futures contracts are derivatives. A futures contract is a
standardized agreement between two parties to buy or sell at a specific time in
the future a specific quantity of a commodity at a specific price. The commodity
may consist of an asset, a reference rate, or an index. A security futures
contract relates to the sale of a specific quantity of shares of a single equity
security or a narrow-based securities index. The value of a futures contract
tends to increase and decrease in tandem with the value of the underlying
commodity. The buyer of a
-12-
futures contract enters into an agreement to purchase the underlying commodity
on the settlement date and is said to be "long" the contract. The seller of a
futures contract enters into an agreement to sell the underlying commodity on
the settlement date and is said to be "short" the contract. The price at which a
futures contract is entered into is established either in the electronic
marketplace or by open outcry on the floor of an exchange between exchange
members acting as traders or brokers. Open futures contracts can be liquidated
or closed out by physical delivery of the underlying commodity or payment of the
cash settlement amount on the settlement date, depending on the terms of the
particular contract. Some financial futures contracts (such as security futures)
provide for physical settlement at maturity. Other financial futures contracts
(such as those relating to interest rates, foreign currencies, and broad-based
securities indexes) generally provide for cash settlement at maturity. In the
case of cash settled futures contracts, the cash settlement amount is equal to
the difference between the final settlement price on the last trading day of the
contract and the price at which the contract was entered into. Most futures
contracts, however, are not held until maturity but instead are "offset" before
the settlement date through the establishment of an opposite and equal futures
position.
The purchaser or seller of a futures contract is not required to deliver or
pay for the underlying commodity unless the contract is held until the
settlement date. However, both the purchaser and seller are required to deposit
"initial margin" with a futures commission merchant (FCM) when the futures
contract is entered into. Initial margin deposits are typically calculated as a
percentage of the contract's market value. If the value of either party's
position declines, that party will be required to make additional "variation
margin" payments to settle the change in value on a daily basis. This process is
known as "marking-to-market." A futures transaction will not be considered to
constitute the issuance of a "senior security" by a fund for purposes of the
1940 Act, and such transaction will not be subject to the 300% asset coverage
requirement otherwise applicable to borrowings by a fund, if the fund covers the
transaction in accordance with the requirements, and subject to the risks,
described above under the heading "Borrowing."
An option on a futures contract (or futures option) conveys the right, but
not the obligation, to purchase (in the case of a call option) or sell (in the
case of a put option) a specific futures contract at a specific price (called
the "exercise" or "strike" price) any time before the option expires. The seller
of an option is called an option writer. The purchase price of an option is
called the premium. The potential loss to an option buyer is limited to the
amount of the premium plus transaction costs. This will be the case, for
example, if the option is held and not exercised prior to its expiration date.
Generally, an option writer sells options with the goal of obtaining the premium
paid by the option buyer. If an option sold by an option writer expires without
being exercised, the writer retains the full amount of the premium. The option
writer, however, has unlimited economic risk because its potential loss, except
to the extent offset by the premium received when the option was written, is
equal to the amount the option is "in-the-money" at the expiration date. A call
option is in-the-money if the value of the underlying futures contract exceeds
the exercise price of the option. A put option is in-the-money if the exercise
price of the option exceeds the value of the underlying futures contract.
Generally, any profit realized by an option buyer represents a loss for the
option writer.
A fund that takes the position of a writer of a futures option is required
to deposit and maintain initial and variation margin with respect to the option,
as described above in the case of futures contracts. A futures option
transaction will not be considered to constitute the issuance
-13-
of a "senior security" by a fund for purposes of the 1940 Act, and such
transaction will not be subject to the 300% asset coverage requirement otherwise
applicable to borrowings by a fund, if the fund covers the transaction in
accordance with the requirements, and subject to the risks, described above
under the heading "Borrowing."
The Vanguard Fund intends to comply with Rule 4.5 of the Commodity Futures
Trading Commission, under which a mutual fund is conditionally excluded from the
definition of the term "commodity pool operator." The Vanguard Fund will only
enter into futures contracts and futures options that are standardized and
traded on a U.S. or foreign exchange, board of trade, or similar entity, or
quoted on an automated quotation system.
FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS -- RISKS. The risk of
loss in trading futures contracts and in writing futures options can be
substantial, because of the low margin deposits required, the extremely high
degree of leverage involved in futures and options pricing, and the potential
high volatility of the futures markets. As a result, a relatively small price
movement in a futures position may result in immediate and substantial loss (or
gain) to the investor. For example, if at the time of purchase, 10% of the value
of the futures contract is deposited as margin, a subsequent 10% decrease in the
value of the futures contract would result in a total loss of the margin
deposit, before any deduction for the transaction costs, if the account were
then closed out. A 15% decrease would result in a loss equal to 150% of the
original margin deposit if the contract were closed out. Thus, a purchase or
sale of a futures contract, and the writing of a futures option, may result in
losses in excess of the amount invested in the position. In the event of adverse
price movements, a fund would continue to be required to make daily cash
payments to maintain its required margin. In such situations, if a fund has
insufficient cash, it may have to sell portfolio securities to meet daily margin
requirements (and segregation requirements, if applicable) at a time when it may
be disadvantageous to do so. In addition, on the settlement date, a fund may be
required to make delivery of the instruments underlying the futures positions it
holds.
A fund could suffer losses if it is unable to close out a futures contract
or a futures option because of an illiquid secondary market. Futures contracts
and futures options may be closed out only on an exchange which provides a
secondary market for such products. However, there can be no assurance that a
liquid secondary market will exist for any particular futures product at any
specific time. Thus, it may not be possible to close a futures or option
position. Moreover, most futures exchanges limit the amount of fluctuation
permitted in futures contract prices during a single trading day. The daily
limit establishes the maximum amount that the price of a futures contract may
vary either up or down from the previous day's settlement price at the end of a
trading session. Once the daily limit has been reached in a particular type of
contract, no trades may be made on that day at a price beyond that limit. The
daily limit governs only price movement during a particular trading day and
therefore does not limit potential losses, because the limit may prevent the
liquidation of unfavorable positions. Futures contract prices have occasionally
moved to the daily limit for several consecutive trading days with little or no
trading, thereby preventing prompt liquidation of future positions and
subjecting some futures traders to substantial losses. The inability to close
futures and options positions also could have an adverse impact on the ability
to hedge a portfolio investment or to establish a substitute for a portfolio
investment. Treasury futures are generally not subject to such daily limits.
-14-
A fund bears the risk that its adviser will incorrectly predict future
market trends. If the adviser attempts to use a futures contract or a futures
option as a hedge against, or as a substitute for, a portfolio investment, the
fund will be exposed to the risk that the futures position will have or will
develop imperfect or no correlation with the portfolio investment. This could
cause substantial losses for the fund. While hedging strategies involving
futures products can reduce the risk of loss, they can also reduce the
opportunity for gain or even result in losses by offsetting favorable price
movements in other fund investments.
A fund could lose margin payments it has deposited with its FCM, if, for
example, the FCM breaches its agreement with the fund or becomes insolvent or
goes into bankruptcy. In that event, the fund may be entitled to return of
margin owed to it only in proportion to the amount received by the FCM's other
customers, potentially resulting in losses to the fund.
INTERFUND BORROWING AND LENDING. The SEC has granted an exemption
permitting the Vanguard funds to participate in Vanguard's interfund lending
program. This program allows the Vanguard funds to borrow money from and lend
money to each other for temporary or emergency purposes. The program is subject
to a number of conditions, including, among other things, the requirement that:
(1) no fund may borrow or lend money through the program unless it receives a
more favorable interest rate than is typically available from a bank for a
comparable transaction; (2) no equity, taxable bond, or money market fund may
loan funds if the loan would cause its aggregate outstanding loans through the
program to exceed 5%, 7.5%, or 10%, respectively, of its net assets at the time
of the loan; and (3) a fund's interfund loans to any one fund shall not exceed
5% of the lending fund's net assets. In addition, a Vanguard fund may
participate in the program only if and to the extent that such participation is
consistent with the fund's investment objective and other investment policies.
The boards of trustees of the Vanguard funds are responsible for overseeing the
interfund lending program. Any delay in repayment to a lending fund could result
in a lost investment opportunity or additional borrowing costs.
OPTIONS. An option is a derivative. An option on a security (or index) is a
contract that gives the holder of the option, in return for the payment of a
"premium," the right, but not the obligation, to buy from (in the case of a call
option) or sell to (in the case of a put option) the writer of the option the
security underlying the option (or the cash value of the index) at a specified
exercise price prior to the expiration date of the option. The writer of an
option on a security has the obligation upon exercise of the option (1) to
deliver the underlying security upon payment of the exercise price (in the case
of a call option) or (2) to pay the exercise price upon delivery of the
underlying security (in the case of a put option). The writer of an option on an
index has the obligation upon exercise of the option to pay an amount equal to
the cash value of the index minus the exercise price, multiplied by the
specified multiplier for the index option. The multiplier for an index option
determines the size of the investment position the option represents. Unlike
exchange-traded options, which are standardized with respect to the underlying
instrument, expiration date, contract size, and strike price, the terms of OTC
options (options not traded on exchanges) generally are established through
negotiation with the other party to the option contract. While this type of
arrangement allows the purchaser or writer greater flexibility to tailor an
option to its needs, OTC options generally involve greater credit risk than
exchange-traded options, which are guaranteed by the clearing organization of
the exchanges where they are traded.
-15-
The buyer (or holder) of an option is said to be "long" the option, while
the seller (or writer) of an option is said to be "short" the option. A call
option grants to the holder the right to buy (and obligates the writer to sell)
the underlying security at the strike price. A put option grants to the holder
the right to sell (and obligates the writer to buy) the underlying security at
the strike price. The purchase price of an option is called the "premium." The
potential loss to an option buyer is limited to the amount of the premium plus
transaction costs. This will be the case if the option is held and not exercised
prior to its expiration date. Generally, an option writer sells options with the
goal of obtaining the premium paid by the option buyer, but that person could
also seek to profit from an anticipated rise or decline in option prices. If an
option sold by an option writer expires without being exercised, the writer
retains the full amount of the premium. The option writer, however, has
unlimited economic risk because its potential loss, except to the extent offset
by the premium received when the option was written, is equal to the amount the
option is "in-the-money" at the expiration date. A call option is in-the-money
if the value of the underlying position exceeds the exercise price of the
option. A put option is in-the-money if the exercise price of the option exceeds
the value of the underlying position. Generally, any profit realized by an
option buyer represents a loss for the option writer. The writing of an option
will not be considered to constitute the issuance of a "senior security" by a
fund for purposes of the 1940 Act, and such transaction will not be subject to
the 300% asset coverage requirement otherwise applicable to borrowings by a
fund, if the fund covers the transaction in accordance with the requirements,
and subject to the risks, described above under the heading "Borrowing."
If a trading market in particular options were to become unavailable,
investors in those options (such as the funds) would be unable to close out
their positions until trading resumes, and they may be faced with substantial
losses if the value of the underlying interest moves adversely during that time.
Even if the market were to remain available, there may be times when options
prices will not maintain their customary or anticipated relationships to the
prices of the underlying interests and related interests. Lack of investor
interest, changes in volatility, or other factors or conditions might adversely
affect the liquidity, efficiency, continuity, or even the orderliness of the
market for particular options.
A fund bears the risk that its adviser will not accurately predict future
market trends. If the adviser attempts to use an option as a hedge against, or
as a substitute for, a portfolio investment, the fund will be exposed to the
risk that the option will have or will develop imperfect or no correlation with
the portfolio investment. This could cause substantial losses for the fund.
While hedging strategies involving options can reduce the risk of loss, they can
also reduce the opportunity for gain or even result in losses by offsetting
favorable price movements in other fund investments. Many options, in particular
OTC options, are complex and often valued based on subjective factors. Improper
valuations can result in increased cash payment requirements to counterparties
or a loss of value to a fund.
OTHER INVESTMENT COMPANIES. A fund may invest in other investment companies
to the extent permitted by applicable law or SEC exemption. Under Section
12(d)(1) of the 1940 Act, a fund generally may invest up to 10% of its assets in
shares of investment companies and up to 5% of its assets in any one investment
company, as long as no investment represents more than 3% of the voting stock of
an acquired investment company. The 1940 Act and related rules provide certain
exemptions from these restrictions. For example, Section 12(d)(1)(G) permits a
-16-
mutual fund to acquire an unlimited amount of shares of mutual funds that are
part of the same group of investment companies as the acquiring fund.
Furthermore, Rule 12d1-2 conditionally permits an affiliated fund of funds to
acquire securities of funds that are not part of the same group of investment
companies (subject to certain percentage limits) and permits the fund to invest
directly in stocks, bonds and other types of securities, as well as invest in
affiliated or unaffiliated money market funds. If a fund invests in other
investment companies, shareholders will bear not only their proportionate share
of the fund's expenses (including operating expenses and the fees of the
adviser), but also, indirectly, the similar expenses of the underlying
investment companies. Shareholders would also be exposed to the risks associated
not only to the investments of the fund but also to the portfolio investments of
the underlying investment companies. Certain types of investment companies, such
as closed-end investment companies, issue a fixed number of shares that
typically trade on a stock exchange or over-the-counter at a premium or discount
to their net asset value. Others are continuously offered at net asset value but
also may be traded on the secondary market.
PREFERRED STOCK. Preferred stock represents an equity or ownership interest
in an issuer. Preferred stock normally pays dividends at a specified rate and
has precedence over common stock in the event the issuer is liquidated or
declares bankruptcy. However, in the event an issuer is liquidated or declares
bankruptcy, the claims of owners of bonds take precedence over the claims of
those who own preferred and common stock. Preferred stock, unlike common stock,
often has a stated dividend rate payable from the corporation's earnings.
Preferred stock dividends may be cumulative or non-cumulative, participating, or
auction rate. "Cumulative" dividend provisions require all or a portion of prior
unpaid dividends to be paid before dividends can be paid to the issuer's common
stock. "Participating" preferred stock may be entitled to a dividend exceeding
the stated dividend in certain cases. If interest rates rise, the fixed dividend
on preferred stocks may be less attractive, causing the price of such stocks to
decline. Preferred stock may have mandatory sinking fund provisions, as well as
provisions allowing the stock to be called or redeemed, which can limit the
benefit of a decline in interest rates. Preferred stock is subject to many of
the risks to which common stock and debt securities are subject.
REPURCHASE AGREEMENTS. A repurchase agreement is an agreement under which a
fund acquires a fixed income security (generally a security issued by the U.S.
government or an agency thereof, a banker's acceptance, or a certificate of
deposit) from a commercial bank, broker, or dealer, and simultaneously agrees to
resell such security to the seller at an agreed upon price and date (normally,
the next business day). Because the security purchased constitutes collateral
for the repurchase obligation, a repurchase agreement may be considered a loan
that is collateralized by the security purchased. The resale price reflects an
agreed upon interest rate effective for the period the instrument is held by a
fund and is unrelated to the interest rate on the underlying instrument. In
these transactions, the securities acquired by a fund (including accrued
interest earned thereon) must have a total value in excess of the value of the
repurchase agreement and be held by a custodian bank until repurchased. In
addition, the investment adviser will monitor a fund's repurchase agreement
transactions generally and will evaluate the creditworthiness of any bank,
broker, or dealer party to a repurchase agreement relating to a fund. The
aggregate amount of any such agreements is not limited except to the extent
required by law.
-17-
The use of repurchase agreements involves certain risks. One risk is the
seller's ability to pay the agreed-upon repurchase price on the repurchase date.
If the seller defaults, the fund may incur costs in disposing of the collateral,
which would reduce the amount realized thereon. If the seller seeks relief under
the bankruptcy laws, the disposition of the collateral may be delayed or
limited. For example, if the other party to the agreement becomes insolvent and
subject to liquidation or reorganization under the bankruptcy or other laws, a
court may determine that the underlying security is collateral for a loan by the
fund not within its control and therefore the realization by the fund on such
collateral may be automatically stayed. Finally, it is possible that the fund
may not be able to substantiate its interest in the underlying security and may
be deemed an unsecured creditor of the other party to the agreement.
RESTRICTED AND ILLIQUID SECURITIES. Illiquid securities are securities that
cannot be sold or disposed of in the ordinary course of business within seven
business days at approximately the value at which they are being carried on a
fund's books. Illiquid securities may include a wide variety of investments,
such as: (1) repurchase agreements maturing in more than seven days; (2) OTC
options contracts and certain other derivatives (including certain swap
agreements); (3) fixed time deposits that are not subject to prepayment or do
not provide for withdrawal penalties upon prepayment (other than overnight
deposits); (4) participation interests in loans; (5) municipal lease
obligations; (6) commercial paper issued pursuant to Section 4(2) of the
Securities Act of 1933 (the "1933" Act); and (7) securities whose disposition is
restricted under the federal securities laws. Illiquid securities include
restricted, privately placed securities that, under the federal securities laws,
generally may be resold only to qualified institutional buyers. If a substantial
market develops for a restricted security (or other illiquid investment) held by
a fund, it may be treated as a liquid security, in accordance with procedures
and guidelines approved by the board of trustees. This generally includes
securities that are unregistered, that can be sold to qualified institutional
buyers in accordance with Rule 144A under the 1933 Act, or that are exempt from
registration under the 1933 Act, such as commercial paper. While a fund's
adviser monitors the liquidity of restricted securities on a daily basis, the
board of trustees oversees and retains ultimate responsibility for the adviser's
liquidity determinations. Several factors that the trustees consider in
monitoring these decisions include the valuation of a security, the availability
of qualified institutional buyers, brokers, and dealers that trade in the
security, and the availability of information about the security's issuer.
REVERSE REPURCHASE AGREEMENTS. In a reverse repurchase agreement, a fund
sells a security to another party, such as a bank or broker-dealer, in return
for cash and agrees to repurchase that security at an agreed-upon price and
time. Under a reverse repurchase agreement, the fund continues to receive any
principal and interest payments on the underlying security during the term of
the agreement. Reverse repurchase agreements involve the risk that the market
value of securities retained by the fund may decline below the repurchase price
of the securities sold by the fund which it is obligated to repurchase. A
reverse repurchase agreement may be considered a borrowing transaction for
purposes of the 1940 Act. A reverse repurchase agreement transaction will not be
considered to constitute the issuance of a "senior security" by a fund, and such
transaction will not be subject to the 300% asset coverage requirement otherwise
applicable to borrowings by a fund, if the fund covers the transaction in
accordance with the requirements, and subject to the risks, described above
under the heading "Borrowing." A fund will enter into reverse repurchase
agreements only with parties whose creditworthiness has been reviewed and found
satisfactory by the adviser.
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SECURITIES LENDING. A fund may lend its investment securities to qualified
institutional investors (typically brokers, dealers, banks, or other financial
institutions) who may need to borrow securities in order to complete certain
transactions, such as covering short sales, avoiding failures to deliver
securities, or completing arbitrage operations. By lending its investment
securities, a fund attempts to increase its net investment income through the
receipt of interest on the securities lent. Any gain or loss in the market price
of the securities lent that might occur during the term of the loan would be for
the account of the fund. If the borrower defaults on its obligation to return
the securities lent because of insolvency or other reasons, a fund could
experience delays and costs in recovering the securities lent or in gaining
access to the collateral. These delays and costs could be greater for foreign
securities. If a fund is not able to recover the securities lent, a fund may
sell the collateral and purchase a replacement investment in the market. The
value of the collateral could decrease below the value of the replacement
investment by the time the replacement investment is purchased. Cash received as
collateral through loan transactions may be invested in other eligible
securities. Investing this cash subjects that investment to market appreciation
or depreciation.
The 1940 Act, together with the rules and interpretations of the SEC
thereunder, limit the amount of securities a fund may lend to 33-1/3% of the
fund's total assets, and require that (1) the borrower pledge and maintain with
the fund collateral consisting of cash, an irrevocable letter of credit or
securities issued or guaranteed by the U.S. government having at all times not
less than 100% of the value of the securities lent; (2) the borrower add to such
collateral whenever the price of the securities lent rises (i.e., the borrower
"marks-to-market" on a daily basis); (3) the loan be made subject to termination
by the fund at any time; and (4) the fund receive reasonable interest on the
loan (which may include the fund's investing any cash collateral in interest
bearing short-term investments), any distribution on the lent securities, and
any increase in their market value. Loan arrangements made by each fund will
comply with all other applicable regulatory requirements, including the rules of
the New York Stock Exchange, which presently require the borrower, after notice,
to redeliver the securities within the normal settlement time of three business
days. The adviser will consider the creditworthiness of the borrower, among
other things, in making decisions with respect to the lending of securities,
subject to oversight by the board of trustees. At the present time, the SEC does
not object if an investment company pays reasonable negotiated fees in
connection with lent securities, so long as such fees are set forth in a written
contract and approved by the investment company's trustees. In addition, voting
rights pass with the lent securities, but if a fund has knowledge that a
material event will occur affecting securities on loan, and in respect of which
the holder of the securities will be entitled to vote or consent, the lender
must be entitled to call the loaned securities in time to vote or consent.
SHORT SALES. In a short sale of securities, a fund sells stock that it does
not own, making delivery with securities "borrowed" from a broker. The fund is
then obligated to replace the security borrowed by purchasing it at the market
price at the time of replacement. The price at such time may be more or less
than the price at which the security was sold by the fund. Until the security is
replaced, the fund is required to pay the lender any dividends or interest that
accrue during the period of the loan. To borrow the security, the fund may also
have to pay a premium which would increase the cost of the security sold.
Generally speaking, the proceeds of the short sale will be retained by the
broker, to the extent necessary to meet margin requirements, until the short
position is closed out. A fund will also incur transaction costs in effecting
short
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sales. A fund will incur a loss as a result of a short sale if the price of the
security increases between the date of the short sale and the date on which the
fund replaces the borrowed security. The fund will realize a gain if the
security declines in price between those two dates. The amount of any gain will
be decreased and the amount of any loss will be increased by the amount of the
premium, dividends, interest or expenses the fund may be required to pay in
connection with the short sale. A short sale creates the risk of an unlimited
loss, as the price of the underlying securities could theoretically increase
without limit, thus increasing the cost of buying those securities to cover the
short position. There can be no assurance that the security necessary to cover a
short position will be available for purchase. Purchasing securities to close
out the short position can itself cause the price of the securities to rise
further, thereby exacerbating the loss.
SWAP AGREEMENTS. A swap agreement is a derivative. A swap agreement is an
agreement between two parties (counterparties) to exchange payments at specified
dates (periodic payment dates) on the basis of a specified amount (notional
amount) with the payments calculated with reference to a specified asset,
reference rate, or index.
Examples of swap agreements include, but are not limited to, interest rate
swaps, credit default swaps, equity swaps, commodity swaps, foreign currency
swaps, index swaps, and total return swaps. Most swap agreements provide that
when the periodic payment dates for both parties are the same, payments are
netted, and only the net amount is paid to the counterparty entitled to receive
the net payment. Consequently, a fund's current obligations (or rights) under a
swap agreement will generally be equal only to the net amount to be paid or
received under the agreement, based on the relative values of the positions held
by each counterparty. Swap agreements allow for a wide variety of transactions.
For example, fixed rate payments may be exchanged for floating rate payments;
U.S. dollar-denominated payments may be exchanged for payments denominated in a
different currency; and payments tied to the price of one asset, reference rate,
or index may be exchanged for payments tied to the price of another asset,
reference rate, or index.
An option on a swap agreement, also called a "swaption," is an option that
gives the buyer the right, but not the obligation, to enter into a swap on a
future date in exchange for paying a market-based "premium." A receiver swaption
gives the owner the right to receive the total return of a specified asset,
reference rate, or index. A payer swaption gives the owner the right to pay the
total return of a specified asset, reference rate, or index. Swaptions also
include options that allow an existing swap to be terminated or extended by one
of the counterparties.
The use of swap agreements by a fund entails certain risks, which may be
different from, or possibly greater than, the risks associated with investing
directly in the securities and other investments that are the referenced asset
for the swap agreement. Swaps are highly specialized instruments that require
investment techniques, risk analyses, and tax planning different from those
associated with stocks, bonds, and other traditional investments. The use of a
swap requires an understanding not only of the referenced asset, reference rate,
or index but also of the swap itself, without the benefit of observing the
performance of the swap under all possible market conditions.
-20-
Swap agreements may be subject to liquidity risk, which exists when a
particular swap is difficult to purchase or sell. If a swap transaction is
particularly large or if the relevant market is illiquid (as is the case with
many OTC swaps), it may not be possible to initiate a transaction or liquidate a
position at an advantageous time or price, which may result in significant
losses. In addition, swap transactions may be subject to a fund's limitation on
investments in illiquid securities.
Swap agreements may be subject to pricing risk, which exists when a
particular swap becomes extraordinarily expensive (or cheap) relative to
historical prices or the prices of corresponding cash market instruments. Under
certain market conditions, it may not be economically feasible to initiate a
transaction or liquidate a position in time to avoid a loss or take advantage of
an opportunity or to realize the intrinsic value of the swap agreement.
Because some swap agreements have a leverage component, adverse changes in
the value or level of the underlying asset, reference rate, or index can result
in a loss substantially greater than the amount invested in the swap itself.
Certain swaps have the potential for unlimited loss, regardless of the size of
the initial investment. A leveraged swap transaction will not be considered to
constitute the issuance of a "senior security" by a fund, and such transaction
will not be subject to the 300% asset coverage requirement otherwise applicable
to borrowings by a fund, if the fund covers the transaction in accordance with
the requirements, and subject to the risks, described above under the heading
"Borrowing."
Like most other investments, swap agreements are subject to the risk that
the market value of the instrument will change in a way detrimental to a fund's
interest. A fund bears the risk that its adviser will not accurately forecast
future market trends or the values of assets, reference rates, indexes, or other
economic factors in establishing swap positions for the fund. If the adviser
attempts to use a swap as a hedge against, or as a substitute for, a portfolio
investment, the fund will be exposed to the risk that the swap will have or will
develop imperfect or no correlation with the portfolio investment. This could
cause substantial losses for the fund. While hedging strategies involving swap
instruments can reduce the risk of loss, they can also reduce the opportunity
for gain or even result in losses by offsetting favorable price movements in
other fund investments. Many swaps, in particular OTC swaps, are complex and
often valued subjectively. Improper valuations can result in increased cash
payment requirements to counterparties or a loss of value to a fund.
The use of a swap agreement also involves the risk that a loss may be
sustained as a result of the insolvency or bankruptcy of the counterparty or the
failure of the counterparty to make required payments or otherwise comply with
the terms of the agreement. Additionally, the use of credit default swaps can
result in losses if a fund's adviser does not correctly evaluate the
creditworthiness of the issuer on which the credit swap is based.
The swaps market is a relatively new market and is largely unregulated. It
is possible that developments in the swaps market, including potential
government regulation, could adversely affect a fund's ability to terminate
existing swap agreements or to realize amounts to be received under such
agreements.
-21-
Tax Matters -- Futures, Certain Options, and Short Sales. A fund must
generally recognize any net unrealized gains and losses on certain futures
contracts and certain options traded on U.S. exchanges as of the end of the
taxable year, as well as any gains and losses actually realized during the year.
A fund must treat such gains and losses as 60% long-term and 40% short-term,
regardless of how long it held the positions.
A fund's investments may be subject to federal income tax rules that may,
among other things, disallow, suspend, or otherwise limit the allowance of
certain losses or deductions, convert long-term capital gains into short-term
capital gains or ordinary income, convert an ordinary loss or a deduction into a
capital loss, or require the capitalization of certain expenses. For example, if
it holds both long and short positions in the same security, a fund may be
required to apply the straddle or constructive sales rules, which could affect
the character and timing of gains and losses a fund realized, as well as its
holding period for the securities involved.
Most, if not all, a fund's gains from short sales may be treated as
short-term capital gains.
In order for a fund to continue to qualify for federal income tax treatment
as a regulated investment company, at least 90% of its gross income for a
taxable year must be derived from qualifying income; i.e., dividends, interest,
income derived from loans of securities, gains from the sale of securities or of
foreign currencies, or other income derived with respect to the fund's business
of investing in securities or currencies. It is anticipated that any net gain
recognized on futures contracts, options, and short sales will be considered
qualifying income for purposes of the 90% requirement.
A fund will distribute to shareholders annually any net capital gains which
have been recognized for federal income tax purposes on futures, options, and
short sales transactions. Such distributions will be combined with distributions
of other capital gains or ordinary income, as appropriate, realized on the
fund's other investments, and shareholders will be advised on the tax character
of the distributions.
TAX MATTERS -- FEDERAL TAX TREATMENT OF NON-U.S. TRANSACTIONS. Special
rules govern the federal income tax treatment of certain transactions
denominated in a currency other than the U.S. dollar or determined by reference
to the value of one or more currencies other than the U.S. dollar. The types of
transactions covered by the special rules include the following: (1) the
acquisition of, or becoming the obligor under, a bond or other debt instrument
(including, to the extent provided in Treasury regulations, preferred stock);
(2) the accruing of certain trade receivables and payables; and (3) the entering
into or acquisition of any forward contract, futures contract, option, or
similar financial instrument if such instrument is not marked to market. The
disposition of a currency other than the U.S. dollar by a taxpayer whose
functional currency is the U.S. dollar is also treated as a transaction subject
to the special currency rules. However, foreign currency-related regulated
futures contracts and non-equity options are generally not subject to the
special currency rules if they are or would be treated as sold for their fair
market value at year-end under the marking-to-market rules applicable to other
futures contracts unless an election is made to have such currency rules apply.
With respect to transactions covered by the special rules, foreign currency gain
or loss is calculated separately from any gain or loss on the underlying
transaction and is normally taxable as ordinary income or loss. A taxpayer may
elect to treat as capital gain or loss foreign currency gain or loss arising
from certain identified forward contracts, futures contracts, and options that
are capital assets in the hands of the taxpayer and which are not part of a
straddle. The Treasury Department issued regulations under which certain
transactions subject to the special currency rules that are part of a "section
988
-22-
hedging transaction" (as defined in the IRC and the Treasury regulations) will
be integrated and treated as a single transaction or otherwise treated
consistently for purposes of the IRC. Any gain or loss attributable to the
foreign currency component of a transaction engaged in by a fund which is not
subject to the special currency rules (such as foreign equity investments other
than certain preferred stocks) will be treated as capital gain or loss and will
not be segregated from the gain or loss on the underlying transaction. It is
anticipated that some of the non-U.S. dollar-denominated investments and foreign
currency contracts a fund may make or enter into will be subject to the special
currency rules described above.
TAX MATTERS -- FOREIGN TAX CREDIT. Foreign governments may withhold taxes
on dividends and interest paid with respect to foreign securities held by a
fund. Foreign governments may also impose taxes on other payments or gains with
respect to foreign securities. If, at the close of its fiscal year, more than
50% of a fund's total assets are invested in securities of foreign issuers, the
fund may elect to pass through foreign taxes paid, and thereby allow
shareholders to take a deduction or, if they meet certain holding period
requirements, a tax credit on their tax returns. If shareholders do not meet the
holding period requirements, they may still be entitled to a deduction for
certain gains that were actually distributed by the fund, but will also show the
amount of the available offsetting credit or deduction.
TEMPORARY INVESTMENTS. The Vanguard Fund may take temporary defensive
measures that are inconsistent with the fund's normal fundamental or
non-fundamental investment policies and strategies in response to adverse
market, economic, political, or other conditions as determined by the advisor.
Such measures could include, but are not limited to, investments in (1) highly
liquid short-term fixed income securities issued by or on behalf of municipal or
corporate issuers, obligations of the U.S. government and its agencies,
commercial paper, and bank certificates of deposit; (2) shares of other
investment companies that have investment objectives consistent with those of
the fund; (3) repurchase agreements involving any such securities; and (4) other
money market instruments. There is no limit on the extent to which the Vanguard
Fund may take temporary defensive measures. In taking such measures, the
Vanguard Fund may fail to achieve its investment objective.
WARRANTS. Warrants are instruments that give the holder the right, but not
the obligation, to buy an equity security at a specific price for a specific
period of time. Changes in the value of a warrant do not necessarily correspond
to changes in the value of its underlying security. The price of a warrant may
be more volatile than the price of its underlying security, and a warrant may
offer greater potential for capital appreciation as well as capital loss.
Warrants do not entitle a holder to dividends or voting rights with respect to
the underlying security and do not represent any rights in the assets of the
issuing company. A warrant ceases to have value if it is not exercised prior to
its expiration date. These factors can make warrants more speculative than other
types of investments.
WHEN-ISSUED, DELAYED-DELIVERY, AND FORWARD-COMMITMENT TRANSACTIONS.
When-issued, delayed-delivery, and forward-commitment transactions involve a
commitment to purchase or sell specific securities at a predetermined price or
yield in which payment and delivery take place after the customary settlement
period for that type of security. Typically, no interest accrues to the
purchaser until the security is delivered. When purchasing securities pursuant
to one of these transactions, payment for the securities is not required until
the delivery date. However, the purchaser assumes the rights and risks of
ownership, including the risks of price and yield fluctuations and the risk that
the security will not be issued as anticipated. When
-23-
a fund has sold a security pursuant to one of these transactions, the fund does
not participate in further gains or losses with respect to the security. If the
other party to a delayed-delivery transaction fails to deliver or pay for the
securities, the fund could miss a favorable price or yield opportunity or suffer
a loss. A fund may renegotiate a when-issued or forward-commitment transaction
and may sell the underlying securities before delivery, which may result in
capital gains or losses for the fund. When-issued, delayed-delivery, and
forward-commitment transactions will not be considered to constitute the
issuance of a "senior security" by a fund, and such transaction will not be
subject to the 300% asset coverage requirement otherwise applicable to
borrowings by the fund, if the fund covers the transaction in accordance with
the requirements, and subject to the risks, described above under the heading
"Borrowing."
INVESTMENT LIMITATIONS
The Vanguard Fund is subject to the following fundamental investment
limitations, which cannot be changed in any material way without the approval of
the holders of a majority of the Vanguard Fund's shares. For these purposes, a
"majority" of shares means shares representing the lesser of: (1) 67% or more of
the Vanguard Fund's net assets voted, so long as shares representing more than
50% of the Vanguard Fund's net assets are present or represented by proxy; or
(2) more than 50% of the Vanguard Fund's net assets.
BORROWING AND ISSUING SENIOR SECURITIES. The Vanguard Fund may borrow money
or issue senior securities only as permitted under the 1940 Act.
COMMODITIES. The Vanguard Fund may not purchase or sell physical
commodities unless acquired as a result of ownership of securities or other
instruments. This limitation shall not prevent the Vanguard Fund from
purchasing, selling, or entering into securities or other instruments backed by
physical commodities, foreign currencies, foreign currency forward contracts,
foreign currency options, futures contracts, options on futures contracts, swap
agreements, or other derivative instruments, subject to compliance with
applicable provisions of the federal securities and commodities laws.
DIVERSIFICATION. The Vanguard Fund may not change its classification as a
"management company" or its subclassification as an "open-end company" and as a
"diversified company" as each such term is defined in the 1940 Act.
INDUSTRY CONCENTRATION. The Vanguard Fund may not concentrate its
investments in a particular industry or group of industries, within the meaning
of the 1940 Act. This limitation shall not be deemed to (1) limit the ability of
the Vanguard Fund to invest in securities issued by any company or group of
companies located in any country or group of countries or (2) limit the ability
of the Vanguard Fund to invest in obligations issued or guaranteed by any
government, or any agency or instrumentality of any government, of any country.
INVESTING FOR CONTROL. The Vanguard Fund may make loans only as permitted
under the 1940 Act.
LOANS. The Vanguard Fund may make loans only as permitted under the 1940
Act.
-24-
PLEDGING ASSETS. The Vanguard Fund may not pledge, mortgage, or hypothecate
more than 15% of its net assets.
REAL ESTATE. The Vanguard Fund may not purchase or sell real estate unless
acquired as a result of ownership of securities or other instruments. This
limitation shall not prevent the Vanguard Fund from investing in securities or
other instruments backed by real estate or securities issued by any company
engaged in the real estate business.
SENIOR SECURITIES. The Vanguard Fund may borrow money or issue senior
securities only as permitted under the 1940 Act.
UNDERWRITING. The Vanguard Fund may not act as an underwriter of another
issuer's securities, except to the extent that the Vanguard Fund may be deemed
to be an underwriter within the meaning of the 1933 Act, in connection with the
purchase and sale of portfolio securities.
The Vanguard Fund is subject to the following operational, non-fundamental
policies, which may be changed without a Shareholder vote.
ILLIQUID SECURITIES. The Vanguard Fund may not acquire any security if, as
a result, more than 15% of its net assets would be invested in securities that
are illiquid.
INVESTMENT COMPANIES. The Vanguard Fund may invest in an investment company
only as permitted under the 1940 Act.
LOANS. The Vanguard Fund may not lend money to any person except by
purchasing fixed income securities that are publicly distributed, by lending its
portfolio securities, or through Vanguard's interfund lending program.
Compliance with the investment limitations set forth above is generally
measured at the time the securities are purchased. All investment limitations
must comply with applicable regulatory requirements. If a percentage restriction
is adhered to at the time the investment is made, a later change in percentage
resulting from a change in the market value of assets will not constitute a
violation of such restriction.
None of these limitations prevents the Vanguard Fund from having an
ownership interest in Vanguard. As a part owner of Vanguard, the Vanguard Fund
may own securities issued by Vanguard, make loans to Vanguard, and contribute to
Vanguard's costs or other financial requirements. See "Management of the
Vanguard Fund" for more information.
SHARE PRICE
Multi-class funds do not have a share price. Rather, each class has a share
price, called its net asset value, or NAV, is calculated each business day as of
the close of regular trading on the New York Stock Exchange (the "Exchange"),
generally 4 p.m., Eastern time. NAV per share is computed by dividing the net
assets allocated to each share class by the number of Vanguard Fund's shares
outstanding for that class.
-25-
The Exchange typically observes the following holidays: New Year's Day,
Martin Luther King Jr. Day, Presidents' Day (Washington's Birthday), Good
Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day, and
Christmas Day. Although the Vanguard Fund expects the same holidays to be
observed in the future, the Exchange may modify its holiday schedule or hours of
operation at any time.
PURCHASE AND REDEMPTION OF SHARES
PURCHASE OF SHARES
The purchase price of shares of the Vanguard Fund is the NAV per share next
determined after the purchase request is received in good order, as defined in
the Prospectus/Proxy Statement. The NAV per share is calculated as of the close
of regular trading on the Exchange on each day the Exchange is open for
business. A purchase order received before the close of regular trading on the
Exchange will be executed at the NAV computed on the date of receipt; a purchase
order received after the close of regular trading on the Exchange will be
executed at the NAV computed on the first business day following the date of
receipt.
REDEMPTION OF SHARES
The redemption price of shares of the Vanguard Fund is the NAV next
determined after the redemption request is received in good order, as defined in
Prospectus/Proxy Statement. A redemption order received before the close of
regular trading on the Exchange will be executed at the NAV computed on the date
of receipt; a redemption order received after the close of regular trading on
the Exchange will be executed at the NAV computed on the next day that the
Exchange is open.
The Vanguard Fund may suspend redemption privileges or postpone the date of
payment for redeemed shares: (1) during any period that the Exchange is closed
or trading on the Exchange is restricted as determined by the SEC; (2) during
any period when an emergency exists, as defined by the SEC, as a result of which
it is not reasonably practicable for the Vanguard Fund to dispose of securities
it owns or to fairly determine the value of its assets; and (3) for such other
periods as the SEC may permit.
The Vanguard Fund has filed a notice of election with the SEC to pay in
cash all redemptions requested by any shareholder of record limited in amount
during any 90-day period to the lesser of $250,000 or 1% of the net assets of
the Vanguard Fund at the beginning of such period.
If Vanguard determines that it would be detrimental to the best interests
of the remaining shareholders of the Vanguard Fund to make payment wholly or
partly in cash, the Vanguard Fund may pay the redemption price in whole or in
part by a distribution in kind of readily marketable securities held by the
Vanguard Fund in lieu of cash in conformity with applicable rules of the SEC.
Investors may incur brokerage charges on the sale of such securities received in
payment of redemptions.
The Vanguard Fund charges a 1% fee on shares redeemed (either by selling or
by exchanging to another fund, or by application of the low-balance
-26-
account-closure policy) that were held less than one year. Shares redeemed may
be worth more or less than what was paid for them, depending on the market value
of the securities held by the Vanguard Fund.
After redeeming shares that are exempt from redemption fees, shares you
have held the longest will be redeemed first. Redemption fees do not apply to
the following:
o Redemptions of shares purchased with reinvested dividend and capital
gains distributions.
o Share transfers, rollovers, or re-registrations within the same fund.
Conversions of shares from one share class to another in the same
fund.
o Redemptions of shares by Vanguard to pay fund or account fees. Section
529 college savings plans.
o Distributions by shareholders age 70 1/2 or older from the following:
o Traditional IRAs.
o Inherited IRAs (traditional and Roth).
o Rollover IRAs.
o SEP-IRAs.
o Section 403(b)(7) plans served by the Vanguard Small Business
Services Department.
o SIMPLE IRAs.
o Vanguard Retirement Plans for which Vanguard Fiduciary Trust
Company serves as trustee.
o For a one year period, shares rolled over to an IRA held at
Vanguard from a retirement plan for which Vanguard serves as
recordkeeper (except for Vanguard Small Business Services
retirement plans).
For participants in employer-sponsored defined contribution plans (other
than those served by the Vanguard Small Business Services Department),
redemption fees will apply to shares exchanged out of a fund into which they had
been exchanged, rolled over, or transferred by a participant within the Vanguard
Fund's redemption-fee period.
In addition to the exclusions previously listed, redemption fees will not
apply to:
o Exchanges of shares purchased with participant payroll or employer
contributions.
o Distributions, loans, and in-service withdrawals from a plan.
-27-
o Direct rollovers into IRAs.
o Redemptions or transfers of shares as part of a plan termination or at the
direction of the plan. If Vanguard does not serve as recordkeeper for a
plan, redemption fees may be applied differently.
RIGHT TO CHANGE POLICIES
Vanguard reserves the right to (1) alter, add, or discontinue any
conditions of purchase (including eligibility requirements), redemption,
exchange, conversion, service, or privilege at any time without prior notice;
(2) accept initial purchases by telephone; (3) freeze any account and/or suspend
account services when Vanguard has received reasonable notice of a dispute
regarding the assets in an account, including notice of a dispute between the
registered or beneficial account owners or when we reasonably believe a
fraudulent transaction may occur or has occurred; (4) alter, impose,
discontinue, or waive any redemption fee, low-balance account fee, account
maintenance fee, or other fees charged to a group of shareholders; and (5)
redeem an account, without the owner's permission to do so, in cases of
threatening conduct or suspicious, fraudulent, or illegal activity. Changes may
affect any or all investors. These actions will be taken when, at the sole
discretion of Vanguard management, we reasonably believe they are deemed to be
in the best interest of the Vanguard Fund.
INVESTING WITH VANGUARD THROUGH OTHER FIRMS
The Vanguard Fund has authorized certain agents to accept on its behalf
purchase and redemption orders, and those agents are authorized to designate
other intermediaries to accept purchase and redemption orders on the Vanguard
Fund's behalf (collectively, "Authorized Agents"). The Vanguard Fund will be
deemed to have received a purchase or redemption order when an Authorized Agent
accepts the order in accordance with the Vanguard Fund's instructions. In most
instances, a customer order that is properly transmitted to an Authorized Agent
will be priced at the Vanguard Fund's NAV next determined after the order is
received by the Authorized Agent.
When intermediaries establish accounts in Vanguard funds for their clients,
we cannot always monitor the trading activity of individual clients. However, we
review trading activity at the omnibus level, and if we detect suspicious
activity, we will seek to investigate and take appropriate action. If necessary,
Vanguard may prohibit additional purchases of fund shares by an intermediary or
by certain of the intermediary's clients. Intermediaries may also monitor their
clients' trading activities in the Vanguard funds.
For those Vanguard funds that charge purchase or redemption fees,
intermediaries will be asked to assess purchase and redemption fees on
shareholder and participant accounts and remit these fees to the funds. The
application of purchase and redemption fees and frequent-trading policies may
vary among intermediaries. There are no assurances that Vanguard will
successfully identify all intermediaries or that intermediaries will properly
assess purchase and redemption fees or administer frequent-trading policies. If
you invest with Vanguard through an intermediary, please read that firm's
materials carefully to learn of any other rules or fees that may apply.
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MANAGEMENT OF THE VANGUARD FUND
Vanguard
The Vanguard Fund is part of the Vanguard group of investment companies,
which consists of more than 140 funds. Through their jointly-owned subsidiary,
Vanguard, the funds obtain at cost virtually all of their corporate management,
administrative, and distribution services. Vanguard also provides investment
advisory services on an at-cost basis to several of the Vanguard funds.
Vanguard employs a supporting staff of management and administrative
personnel needed to provide the requisite services to the funds and also
furnishes the funds with necessary office space, furnishings, and equipment.
Each fund pays its share of Vanguard's total expenses, which are allocated among
the funds under methods approved by the board of trustees of each fund. In
addition, each fund bears its own direct expenses, such as legal, auditing, and
custodian fees.
The funds' officers are also officers and employees of Vanguard.
Vanguard, Vanguard Marketing Corporation, the funds' advisers, and the
funds have adopted Codes of Ethics designed to prevent employees who may have
access to nonpublic information about the trading activities of the funds
(access persons) from profiting from that information. The Codes permit access
persons to invest in securities for their own accounts, including securities
that may be held by a fund, but place substantive and procedural restrictions on
the trading activities of access persons. For example, the Codes require that
access persons receive advance approval for most securities trades to ensure
that there is no conflict with the trading activities of the funds. The Codes
also limit the ability of Vanguard employees to engage in short-term trading of
Vanguard funds.
Vanguard was established and operates under the Funds' Service Agreement.
The Funds' Service Agreement provides as follows: (1) each Vanguard fund may be
called upon to invest up to 0.40% of its current net assets in Vanguard, and (2)
there is no other limitation on the dollar amount that each Vanguard fund may
contribute to Vanguard's capitalization. The amounts that each fund has invested
are adjusted from time to time in order to maintain the proportionate
relationship between each fund's relative net assets and its contribution to
Vanguard's capital.
MANAGEMENT. Corporate management and administrative services include: (1)
executive staff; (2) accounting and financial; (3) legal and regulatory; (4)
shareholder account maintenance; (5) monitoring and control of custodian
relationships; (6) shareholder reporting; and (7) review and evaluation of
advisory and other services provided to the funds by third parties.
DISTRIBUTION. Vanguard Marketing Corporation ("VMC"), a wholly-owned
subsidiary of Vanguard, is the principal underwriter for the funds and in that
capacity performs and finances marketing, promotional, and distribution
activities (collectively, marketing and distribution activities) that are
primarily intended to result in the sale of the funds' shares. VMC performs
marketing and distribution activities at cost in accordance with the terms and
-29-
conditions of a 1981 SEC exemptive order that permits the Vanguard funds to
internalize and jointly finance the marketing, promotion, and distribution of
their shares. Under the terms of the SEC order, the funds' trustees review and
approve the marketing and distribution expenses incurred on their behalf,
including the nature and cost of the activities and the desirability of each
fund's continued participation in the joint arrangement.
To ensure that each fund's participation in the joint arrangement falls
within a reasonable range of fairness, each fund contributes to VMC's marketing
and distribution expenses in accordance with an SEC-approved formula. Under that
formula, one half of the marketing and distribution expenses are allocated among
the funds based upon their relative net assets. The remaining half of those
expenses is allocated among the funds based upon each fund's sales for the
preceding 24 months relative to the total sales of the funds as a group;
provided, however, that no fund's aggregate quarterly rate of contribution for
marketing and distribution expenses shall exceed 125% of the average marketing
and distribution expense rate for Vanguard, and that no fund shall incur annual
marketing and distribution expenses in excess of 0.20 of 1% of its average
month-end net assets. As of December 31, 2006, none of the Vanguard funds'
allocated share of VMC's marketing and distribution expenses was greater than
0.03% of the fund's average month-end net assets. Each fund's contribution to
these marketing and distribution expenses helps to maintain and enhance the
attractiveness and viability of the Vanguard complex as a whole, which benefits
all of the funds and their shareholders.
VMC's principal marketing and distribution expenses are for advertising,
promotional materials, and marketing personnel. Other marketing and distribution
activities that VMC undertakes on behalf of the funds may include, but are not
limited to:
o Conducting or publishing Vanguard-generated research and analysis
concerning the funds, other investments, the financial markets, or the
economy;
o Providing views, opinions, advice, or commentary concerning the funds,
other investments, the financial markets, or the economy;
o Providing analytical, statistical, performance, or other information
concerning the funds, other investments, the financial markets, or the
economy;
o Providing administrative services in connection with investments in the
funds or other investments, including, but not limited to, shareholder
services, recordkeeping services, and educational services;
o Providing products or services that assist investors or financial service
providers (as defined below) in the investment decision-making process;
o Providing promotional discounts, commission-free trading, fee waivers, and
other benefits to clients of Vanguard Brokerage Services(R) who maintain
qualifying investments in the funds; and
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o Sponsoring, jointly sponsoring, financially supporting, or participating in
conferences, programs, seminars, presentations, meetings, or other events
involving fund shareholders, financial service providers, or others
concerning the funds, other investments, the financial markets, or the
economy, such as industry conferences, prospecting trips, due diligence
visits, training or education meetings, and sales presentations.
VMC performs most marketing and distribution activities itself. Some
activities may be conducted by third parties pursuant to shared marketing
arrangements under which VMC agrees to share the costs and performance of
marketing and distribution activities in concert with a financial service
provider. Financial service providers include, but are not limited to,
investment advisors, broker-dealers, financial planners, financial consultants,
banks, and insurance companies. Under these cost- and performance-sharing
arrangements, VMC may pay or reimburse a financial service provider (or a third
party it retains) for marketing and distribution activities that VMC would
otherwise perform. VMC's cost- and performance-sharing arrangements may be
established in connection with Vanguard investment products or services offered
or provided to or through the financial service providers. VMC's arrangements
for shared marketing and distribution activities may vary among financial
service providers, and its payments or reimbursements to financial service
providers in connection with shared marketing and distribution activities may be
significant. VMC does not participate in the offshore arrangement Vanguard has
established for qualifying Vanguard funds to be distributed in certain foreign
countries on a private-placement basis to government-sponsored and other
institutional investors through a third-party "asesor de inversiones"
(investment adviser), which includes incentive-based remuneration.
In connection with its marketing and distribution activities, VMC may give
financial service providers (or their representatives): (1) promotional items of
nominal value that display Vanguard's logo, such as golf balls, shirts, towels,
pens, and mouse pads; (2) gifts that do not exceed $100 per person annually and
are not preconditioned on achievement of a sales target; (3) an occasional meal,
a ticket to a sporting event or the theater, or comparable entertainment which
is neither so frequent nor so extensive as to raise any question of propriety
and is not preconditioned on achievement of a sales target; and (4) reasonable
travel and lodging accommodations to facilitate participation in marketing and
distribution activities.
VMC, as a matter of policy, does not pay asset-based fees, sales-based
fees, or account-based fees to financial service providers in connection with
its marketing and distribution activities for the Vanguard funds. VMC policy
also prohibits marketing and distribution activities that are intended,
designed, or likely to compromise suitability determinations by, or the
fulfillment of any fiduciary duties or other obligations that apply to,
financial service providers. Nonetheless, VMC's marketing and distribution
activities are primarily intended to result in the sale of the funds' shares,
and as such its activities, including shared marketing and distribution
activities, may influence participating financial service providers (or their
representatives) to recommend, promote, include, or invest in a Vanguard fund or
share class. In addition, Vanguard or any of its subsidiaries may retain a
financial service provider to provide consulting or other services, and that
financial service provider also may provide services to investors. Investors
should consider the possibility that any of these activities or relationships
may influence a financial service provider's (or its representatives') decision
to recommend,
-31-
promote, include, or invest in a Vanguard fund or share class. Each financial
service provider should consider its suitability determinations, fiduciary
duties, and other legal obligations (or those of its representatives) in
connection with any decision to consider, recommend, promote, include, or invest
in a Vanguard fund or share class.
OFFICERS AND TRUSTEES
The Vanguard Fund is governed by the board of trustees to the Vanguard
Trust and a single set of officers. The officers manage the day-to-day
operations of the Vanguard Fund under the direction of the Vanguard Fund's board
of trustees. The trustees set broad policies for the Vanguard Fund; select
investment advisors; monitor fund operations, performance, and costs; nominate
and select new trustees; and elect fund officers. Each trustee serves the
Vanguard Fund until its termination; until the trustee's retirement,
resignation, or death; or as otherwise specified in the Vanguard Trust's
organizational documents. Any trustee may be removed at a meeting of
shareholders by a vote representing two-thirds of the total net asset value of
all shares of the Vanguard Fund. Each trustee also serves as a director of
Vanguard.
Vanguard's Board of Trustees has the following committees:
o Audit Committee: This committee oversees the accounting and financial
reporting policies, the systems of internal controls, and the
independent audits of each fund and Vanguard. All independent trustees
serve as members of the committee.
o Compensation Committee: This committee oversees the compensation
programs established by each fund and Vanguard for the benefit of
their employees, officers, and trustees/directors. All independent
trustees serve as members of the committee.
o Nominating Committee: This committee nominates candidates for election
to Vanguard's board of directors and the board of trustees of each
fund (collectively, the Vanguard boards). The committee also has the
authority to recommend the removal of any director or trustee from the
Vanguard boards. All independent trustees serve as members of the
committee.
The Nominating Committee will consider shareholder recommendations for
trustee nominees. Shareholders may send recommendations to Alfred M. Rankin,
Jr., Chairman of the Committee.
PORTFOLIO HOLDINGS DISCLOSURE POLICIES AND PROCEDURES
INTRODUCTION
Vanguard and the Boards of Trustees of the Vanguard funds ("Boards")
have adopted Portfolio Holdings Disclosure Policies and Procedures ("Policies
and Procedures") to govern the disclosure of the portfolio holdings of each
Vanguard fund. Vanguard and the Boards considered each of the circumstances
under which Vanguard fund portfolio holdings may be
-32-
disclosed to different categories of persons under the Policies and Procedures.
Vanguard and the Boards also considered actual and potential material conflicts
that could arise in such circumstances between the interests of Vanguard fund
shareholders, on the one hand, and those of the fund's investment adviser,
distributor, or any affiliated person of the fund, its investment adviser, or
its distributor, on the other. After giving due consideration to such matters
and after the exercise of their fiduciary duties and reasonable business
judgment, Vanguard and the Boards determined that the Vanguard funds have a
legitimate business purpose for disclosing portfolio holdings to the persons
described in each of the circumstances set forth in the Policies and Procedures
and that the Policies and Procedures are reasonably designed to ensure that
disclosure of portfolio holdings and information about portfolio holdings is in
the best interests of fund shareholders and appropriately addresses the
potential for material conflicts of interest.
The Boards exercise continuing oversight of the disclosure of Vanguard fund
portfolio holdings by (1) overseeing the implementation and enforcement of the
Policies and Procedures, the Code of Ethics, and the Policies and Procedures
Designed to Prevent the Misuse of Inside Information (collectively, the
portfolio holdings governing policies) by the Chief Compliance Officer of
Vanguard and the Vanguard funds; (2) considering reports and recommendations by
the Chief Compliance Officer concerning any material compliance matters (as
defined in Rule 38a-1 under the 1940 Act and Rule 206(4)-7 under the Investment
Advisers Act of 1940) that may arise in connection with any portfolio holdings
governing policies; and (3) considering whether to approve or ratify any
amendment to any portfolio holdings governing policies. Vanguard and the Boards
reserve the right to amend the Policies and Procedures at any time and from time
to time without prior notice in their sole discretion. For purposes of the
Policies and Procedures, the term "portfolio holdings" means the equity and debt
securities (e.g., stocks and bonds) held by a Vanguard fund and does not mean
the cash investments, derivatives, and other investment positions (collectively,
other investment positions) held by the fund.
ONLINE DISCLOSURE OF TEN LARGEST STOCK HOLDINGS
Each of the Vanguard equity funds and Vanguard balanced funds generally
will seek to disclose the fund's ten largest stock portfolio holdings and the
percentages that each of these ten largest stock portfolio holdings represent of
the fund's total assets as of the most recent calendar-quarter-end (quarter-end
ten largest stock holdings) online at www.vanguard.com in the "Holdings" section
of the fund's Profile page, 15 calendar days after the end of the calendar
quarter. In addition, those funds generally will seek to disclose the fund's ten
largest stock portfolio holdings as of the most recent month-end (month-end ten
largest stock holdings, and together with quarter-end ten largest stock
holdings, ten largest stock holdings) online at www.vanguard.com in the
"Holdings" section of the fund's Profile page, 10 business days after the end of
the month. Online disclosure of the ten largest stock holdings is made to all
categories of persons, including individual investors, institutional investors,
intermediaries, third-party service providers, rating and ranking organizations,
affiliated persons of a Vanguard fund, and all other persons.
-33-
ONLINE DISCLOSURE OF COMPLETE PORTFOLIO HOLDINGS
Each of the Vanguard funds, excluding Vanguard money market funds,
generally will seek to disclose the fund's complete portfolio holdings (complete
portfolio holdings) as of the most recent calendar-quarter-end online at
www.vanguard.com in the "Holdings" section of the fund's Profile page, 30
calendar days after the end of the calendar quarter. Online disclosure of
complete portfolio holdings is made to all categories of persons, including
individual investors, institutional investors, intermediaries, third-party
service providers, rating and ranking organizations, affiliated persons of a
Vanguard fund, and all other persons. Vanguard's Portfolio Review Department
will review complete portfolio holdings before online disclosure is made as
described above and, after consultation with a Vanguard fund's investment
adviser, may withhold any portion of the fund's complete portfolio holdings from
online disclosure as described above when deemed to be in the best interests of
the fund.
DISCLOSURE OF COMPLETE PORTFOLIO HOLDINGS TO SERVICE PROVIDERS SUBJECT TO
CONFIDENTIALITY AND TRADING RESTRICTIONS
Vanguard, for legitimate business purposes, may disclose Vanguard fund
complete portfolio holdings at times it deems necessary and appropriate to
rating and ranking organizations, financial printers, proxy voting service
providers, pricing information vendors, third-parties that deliver analytical,
statistical, or consulting services, and other third parties that provide
services (collectively, "Service Providers") to Vanguard, Vanguard subsidiaries,
and/or the Vanguard funds. Disclosure of complete portfolio holdings to a
Service Provider is conditioned on the Service Provider being subject to a
written agreement imposing a duty of confidentiality, including a duty not to
trade on the basis of any material nonpublic information.
The frequency with which complete portfolio holdings may be disclosed to a
Service Provider, and the length of the lag, if any, between the date of the
information and the date on which the information is disclosed to the Service
Provider, is determined based on the facts and circumstances, including, without
limitation, the nature of the portfolio holdings information to be disclosed,
the risk of harm to the funds and their shareholders, and the legitimate
business purposes served by such disclosure. The frequency of disclosure to a
Service Provider varies and may be as frequent as daily, with no lag. Disclosure
of Vanguard fund complete portfolio holdings by Vanguard to a Service Provider
must be authorized by a Vanguard fund officer or a Principal in Vanguard's
Portfolio Review or Legal Department. Any disclosure of Vanguard fund complete
portfolio holdings to a Service Provider as previously described may also
include a list of the other investment positions that make up the fund, such as
cash investments and derivatives.
As of March 31, 2007, Vanguard fund complete portfolio holdings are
disclosed to the following Service Providers as part of ongoing arrangements
that serve legitimate business purposes: Abel/Noser Corporation, Advisor
Software, Inc., Alcom Printing Group Inc., Apple Press, L.C., Automatic Data
Processing, Inc., Brown Brothers Harriman & Co., FactSet Research Systems Inc.,
Intelligencer Printing Company, Investment Technology Group, Inc., Lipper, Inc.,
McMunn Associates Inc., Moore Wallace Inc., Pitney Bowes Management Services,
Reuters America Inc., State Street Investment Manager Solutions, Triune Color
Corporation, and Tursack Printing Inc.
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DISCLOSURE OF COMPLETE PORTFOLIO HOLDINGS TO VANGUARD AFFILIATES AND CERTAIN
FIDUCIARIES SUBJECT TO CONFIDENTIALITY AND TRADING RESTRICTIONS
Vanguard fund complete portfolio holdings may be disclosed between and
among the following persons (collectively, "Affiliates and Fiduciaries") for
legitimate business purposes within the scope of their official duties and
responsibilities, subject to such persons' continuing legal duty of
confidentiality and legal duty not to trade on the basis of any material
nonpublic information, as such duties are imposed under the Code of Ethics, the
Policies and Procedures Designed to Prevent the Misuse of Inside Information, by
agreement, or under applicable laws, rules, and regulations: (1) persons who are
subject to the Code of Ethics or the Policies and Procedures Designed to Prevent
the Misuse of Inside Information; (2) an investment adviser, distributor,
administrator, transfer agent, or custodian to a Vanguard fund; (3) an
accounting firm, an auditing firm or outside legal counsel retained by Vanguard,
a Vanguard subsidiary, or a Vanguard fund; (4) an investment adviser to whom
complete portfolio holdings are disclosed for due diligence purposes when the
adviser is in merger or acquisition talks with a Vanguard fund's current
adviser; and (5) a newly hired investment adviser or sub-adviser to whom
complete portfolio holdings are disclosed prior to the time it commences its
duties.
The frequency with which complete portfolio holdings may be disclosed
between and among Affiliates and Fiduciaries, and the length of the lag, if any,
between the date of the information and the date on which the information is
disclosed between and among the Affiliates and Fiduciaries, is determined by
such Affiliates and Fiduciaries based on the facts and circumstances, including,
without limitation, the nature of the portfolio holdings information to be
disclosed, the risk of harm to the funds and their shareholders, and the
legitimate business purposes served by such disclosure. The frequency of
disclosure between and among Affiliates and Fiduciaries varies and may be as
frequent as daily, with no lag. Any disclosure of Vanguard fund complete
portfolio holdings to any Affiliates and Fiduciaries as previously described may
also include a list of the other investment positions that make up the fund,
such as cash investments and derivatives. Disclosure of Vanguard fund complete
portfolio holdings or other investment positions by Vanguard, Vanguard Marketing
Corporation, or a Vanguard fund to Affiliates and Fiduciaries must be authorized
by a Vanguard fund officer or a Principal of Vanguard.
As of December 31, 2006, Vanguard fund complete portfolio holdings are
disclosed to the following Affiliates and Fiduciaries as part of ongoing
arrangements that serve legitimate business purposes: Vanguard and each
investment adviser, custodian, and independent registered public accounting firm
identified in this Statement of Additional Information.
DISCLOSURE OF PORTFOLIO HOLDINGS TO BROKER-DEALERS IN THE NORMAL COURSE OF
MANAGING THE VANGUARD FUND'S ASSETS
An investment adviser, administrator, or custodian for a Vanguard fund may,
for legitimate business purposes within the scope of its official duties and
responsibilities, disclose portfolio holdings (whether partial portfolio
holdings or complete portfolio holdings) and other investment positions that
make up the fund to one or more broker-dealers during the course of, or in
connection with, normal day-to-day securities and derivatives transactions with
or through such broker-dealers subject to the broker-dealer's legal obligation
not to use or disclose material
-35-
nonpublic information concerning the fund's portfolio holdings, other investment
positions, securities transactions, or derivatives transactions without the
consent of the fund or its agents. The Vanguard funds have not given their
consent to any such use or disclosure and no person or agent of Vanguard is
authorized to give such consent except as approved in writing by the Boards of
the Vanguard funds. Disclosure of portfolio holdings or other investment
positions by Vanguard to broker-dealers must be authorized by a Vanguard fund
officer or a Principal of Vanguard.
DISCLOSURE OF NON-MATERIAL INFORMATION
The Policies and Procedures permit Vanguard fund officers, Vanguard fund
portfolio managers, and other Vanguard representatives (collectively, "Approved
Vanguard Representatives") to disclose any views, opinions, judgments, advice,
or commentary, or any analytical, statistical, performance, or other
information, in connection with or relating to a Vanguard fund or its portfolio
holdings and/or other investment positions (collectively, commentary and
analysis) or any changes in the portfolio holdings of a Vanguard fund that
occurred after the most recent calendar-quarter end (recent portfolio changes)
to any person if (1) such disclosure serves a legitimate business purpose, (2)
such disclosure does not effectively result in the disclosure of the complete
portfolio holdings of any Vanguard fund (which can be disclosed only in
accordance with the Policies and Procedures), and (3) such information does not
constitute material nonpublic information. Disclosure of commentary and analysis
or recent portfolio changes by Vanguard, Vanguard Marketing Corporation, or a
Vanguard fund must be authorized by a Vanguard fund officer or a Principal of
Vanguard.
An Approved Vanguard Representative must make a good faith determination
whether the information constitutes material nonpublic information, which
involves an assessment of the particular facts and circumstances. Vanguard
believes that in most cases recent portfolio changes that involve a few or even
several securities in a diversified portfolio or commentary and analysis would
be immaterial and would not convey any advantage to a recipient in making an
investment decision concerning a Vanguard fund. Nonexclusive examples of
commentary and analysis about a Vanguard fund include (1) the allocation of the
fund's portfolio holdings and other investment positions among various asset
classes, sectors, industries, and countries; (2) the characteristics of the
stock and bond components of the fund's portfolio holdings and other investment
positions; (3) the attribution of fund returns by asset class, sector, industry,
and country; and (4) the volatility characteristics of the fund. An Approved
Vanguard Representative may in its sole discretion determine whether to deny any
request for information made by any person, and may do so for any reason or for
no reason. "Approved Vanguard Representatives" include, for purposes of the
Policies and Procedures, persons employed by or associated with Vanguard or a
subsidiary of Vanguard who have been authorized by Vanguard's Portfolio Review
Department to disclose recent portfolio changes and/or commentary and analysis
in accordance with the Policies and Procedures.
As of December 31, 2006, Vanguard non-material portfolio holdings
information is disclosed to KPMG, LLP, and R.V. Kuhns & Associates.
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DISCLOSURE OF PORTFOLIO HOLDINGS RELATED INFORMATION TO THE ISSUER OF A SECURITY
FOR LEGITIMATE BUSINESS PURPOSES
Vanguard, in its sole discretion, may disclose portfolio holdings
information concerning a security held by one or more Vanguard funds to the
issuer of such security if the issuer presents, to the satisfaction of Fund
Financial Services, convincing evidence that the issuer has a legitimate
business purpose for such information. Disclosure of this information to an
issuer is conditioned on the issuer being subject to a written agreement
imposing a duty of confidentiality, including a duty not to trade on the basis
of any material nonpublic information. The frequency with which portfolio
holdings information concerning a security may be disclosed to the issuer of
such security, and the length of the lag, if any, between the date of the
information and the date on which the information is disclosed to the issuer, is
determined based on the facts and circumstances, including, without limitation,
the nature of the portfolio holdings information to be disclosed, the risk of
harm to the funds and their shareholders, and the legitimate business purposes
served by such disclosure. The frequency of disclosure to an issuer cannot be
determined in advance of a specific request and will vary based upon the
particular facts and circumstances and the legitimate business purposes, but in
unusual situations could be as frequent as daily, with no lag. Disclosure of
portfolio holdings information concerning a security held by one or more
Vanguard funds to the issuer of such security must be authorized by a Vanguard
fund officer or a Principal in Vanguard's Portfolio Review or Legal Department.
DISCLOSURE OF PORTFOLIO HOLDINGS AS REQUIRED BY APPLICABLE LAW
Vanguard fund portfolio holdings (whether partial portfolio holdings or
complete portfolio holdings) and other investment positions that make up a fund
shall be disclosed to any person as required by applicable laws, rules, and
regulations. Examples of such required disclosure include, but are not limited
to, disclosure of Vanguard fund portfolio holdings (1) in a filing or submission
with the SEC or another regulatory body, (2) in connection with seeking recovery
on defaulted bonds in a federal bankruptcy case, (3) in connection with a
lawsuit, or (4) as required by court order. Disclosure of portfolio holdings or
other investment positions by Vanguard, Vanguard Marketing Corporation, or a
Vanguard fund as required by applicable laws, rules, and regulations must be
authorized by a Vanguard fund officer or a Principal of Vanguard.
PROHIBITIONS ON DISCLOSURE OF PORTFOLIO HOLDINGS
No person is authorized to disclose Vanguard fund portfolio holdings or
other investment positions (whether online at www.vanguard.com, in writing, by
fax, by e-mail, orally, or by other means) except in accordance with the
Policies and Procedures. In addition, no person is authorized to make disclosure
pursuant to the Policies and Procedures if such disclosure is otherwise unlawful
under the antifraud provisions of the federal securities laws (as defined in
Rule 38a-1 under the 1940 Act). Furthermore, Vanguard's management, in its sole
discretion, may determine not to disclose portfolio holdings or other investment
positions that make up a Vanguard fund to any person who would otherwise be
eligible to receive such information under the Policies and Procedures, or may
determine to make such disclosures publicly as provided by the Policies and
Procedures.
-37-
PROHIBITIONS ON RECEIPT OF COMPENSATION OR OTHER CONSIDERATION
The Policies and Procedures prohibit a Vanguard fund, its investment
adviser, and any other person to pay or receive any compensation or other
consideration of any type for the purpose of obtaining disclosure of Vanguard
fund portfolio holdings or other investment positions. "Consideration" includes
any agreement to maintain assets in the fund or in other investment companies or
accounts managed by the investment adviser or by any affiliated person of the
investment adviser.
INVESTMENT ADVISORY SERVICES
The Vanguard Fund currently uses two investment advisors:
o AXA Rosenberg Investment Management LLC ("AXA Rosenberg"), founded in 1985,
provides investment advisory services to a portion of the assets of the
Fund.
o Vanguard, 100 Vanguard Boulevard, Malvern, PA 19355, which began operations
in 1975, provides investment advisory services to a portion of the assets
of the Vanguard Fund.
For funds that are advised by independent third-party advisory firms
unaffiliated with Vanguard, Vanguard hires investment advisory firms, not
individual portfolio managers, to provide investment advisory services to such
funds. Vanguard negotiates each advisory agreement, which contains advisory fee
arrangements, on an arms-length basis with the advisory firm. Each advisory
agreement is reviewed annually by each fund's board of trustees, taking into
account numerous factors, which include, without limitation, the nature, extent,
and quality of the services provided, investment performance, and fair market
value of services provided. Each advisory agreement is between the fund and the
advisory firm, not between the fund and the portfolio manager. The structure of
the advisory fee paid to each unaffiliated investment advisory firm is described
in the following sections. In addition, each firm has established policies and
procedures designed to address the potential for conflicts of interest. Each
firm's compensation structure and management of potential conflicts of interest
is summarized by the advisory firm in the following sections.
The Vanguard Fund uses a multimanager approach. The Vanguard Fund has
entered into an investment advisory agreement with AXA Rosenberg to manage the
investment and reinvestment of the portion of the Vanguard Fund's assets that
the Vanguard Fund's board of trustees determines to assign to the adviser
(hereafter referred to as the "AXA Rosenber" Portfolio). In this capacity, AXA
Rosenberg continuously reviews, supervises, and administers the AXA Rosenberg
Portfolio's investment program. AXA Rosenberg discharges its responsibilities
subject to the supervision and oversight of Vanguard's Portfolio Review Group
and the officers and trustees of the Vanguard Fund. Vanguard's Portfolio Review
Group is responsible for recommending changes in a fund's advisory arrangements
to the fund's board of trustees, including changes in the amount of assets
allocated to each adviser, and whether to hire, terminate, or replace an
adviser.
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The Vanguard Fund pays AXA Rosenberg a basic advisory fee at the end of
each of the Vanguard Fund's fiscal quarters, calculated by applying a quarterly
rate, based on certain annual percentage rates, to the average daily net assets
of the adviser's Portfolio for the quarter. The basic fee will be increased or
decreased by applying a performance fee adjustment based on the investment
performance of the Portfolio relative to the investment performance of the
Citigroup 3-Month Treasury Bill Index (the "Index"). The investment performance
will be based on the cumulative total return of the Portfolio over a trailing
36-month period ending with the applicable quarter, compared with the cumulative
total return of the Index for the same period. Vanguard provides advisory
services to a portion of the Vanguard Fund on an at-cost basis.
AXA ROSENBERG INVESTMENT MANAGEMENT LLC
AXA Rosenberg is an independently operated, 75%-owned subsidiary of AXA
Investment Managers; the remaining 25% is owned by the firm's founding partners.
OTHER ACCOUNTS MANAGED
William E. Ricks, Ph.D., manages a portion of the Vanguard Fund. As of
March 31, 2007, the Laudus Fund held assets of $19.323 million. As of March 31,
2007, Dr. Ricks also managed 28 other registered investment companies with total
assets of over $7.255 billion, (including 20 with total assets of approximately
$15.470 billion for which the advisory fee was based on account performance); 14
other pooled investment vehicles with total assets of over $2.671 billion
(including 14 with assets of approximately $13.428 million for which the
advisory fee was based on account performance); and 168 other accounts with
total assets of approximately $30.884 billion (including 33 with total assets of
$8.481 billion for which the advisory fee was based on account performance).
MATERIAL CONFLICTS OF INTEREST
AXA Rosenberg recognizes that conflicts of interest are inherent in its
business and accordingly has developed policies, procedures, and disclosures
that it believes are reasonably designed to detect, manage, and mitigate the
effects of potential conflicts of interest in the areas of employee personal
trading; managing multiple accounts for multiple clients, including funds; and
allocating investment opportunities. Employees are subject to these policies,
and oversight is designed to ensure that all clients are treated fairly.
Actual or potential conflicts of interest may arise when a portfolio
manager has management responsibilities for more than one fund or account
(including the Vanguard Fund), such as devotion of unequal time and attention to
the management of the accounts, inability to allocate limited investment
opportunities across a broad band of accounts, and incentive to allocate
opportunities to an account where there is a greater financial incentive, such
as a performance fee account. AXA Rosenberg believes it has adopted policies and
procedures that are reasonably designed to address these types of conflicts and
to ensure that the company operates in a manner that is fair and equitable among
its clients, including the Vanguard Fund.
-39-
Dr. Ricks' management of other accounts may give rise to potential
conflicts of interest in connection with his management of the Vanguard Fund's
investments, on the one hand, and the investments of the other accounts, on the
other. The other accounts might have investment objectives similar to the
Vanguard Fund's, or hold, purchase, or sell securities that are eligible to be
held, purchased, or sold by the Vanguard Fund. AXA Rosenberg believes that its
quantitative investment process and pro rata allocation of investment
opportunities diminish the possibility of any conflict of interest resulting in
unfair or inequitable allocation of investment opportunities among accounts. AXA
Rosenberg also believes that it has adopted policies and procedures designed to
manage those conflicts in an appropriate way.
DESCRIPTION OF COMPENSATION
Compensation is paid by AXA Rosenberg. The components include base salary
and bonus, both of which are discretionary, and not derived formulaically from
performance of any individual accounts, including mutual funds like the Vanguard
Fund.
OWNERSHIP OF SECURITIES
As of July 31, 2007, Dr. Ricks owned no shares of the Vanguard Fund.
VANGUARD
Vanguard, through its Quantitative Equity Group, provides investment
advisory services on an at-cost basis with respect to a portion of the Vanguard
Fund's assets. The investment management staff is supervised by the senior
officers of the Vanguard Fund. The senior officers are directly responsible to
the board of trustees of the Vanguard Fund.
OTHER ACCOUNTS MANAGED
James D. Troyer manages a portion of the Vanguard Fund. As of July 31,2007,
Mr. Troyer also managed all or a portion of six other registered investment
companies with total assets of $ 84.8 billion and two other pooled investment
vehicles with total assets of $93.3 million.
MATERIAL CONFLICTS OF INTEREST
At Vanguard, individual portfolio managers may manage multiple accounts for
multiple clients. In addition to mutual funds, these other accounts may include
separate accounts, collective trusts, or offshore funds. Managing multiple
accounts may give rise to potential conflicts of interest including for example,
conflicts among investment strategies and conflicts in the allocation of
investment opportunities. Vanguard manages potential conflicts between funds or
with other types of accounts through allocation policies and procedures,
internal review processes and oversight by directors and independent third
parties. Vanguard has developed trade allocation procedures and controls to
ensure that no one client, regardless of type, is intentionally favored at the
expense of another. Allocation policies are designed to address potential
conflicts in situations where two or more funds or accounts participate in
investment decisions involving the same securities.
DESCRIPTION OF COMPENSATION
-40-
Vanguard's portion of the management of the Vanguard Fund's portfolio are
managed by portfolio managers who are Vanguard employees. This section describes
the compensation of the Vanguard employees who manage Vanguard mutual funds. As
of July 31, 2007, a Vanguard portfolio manager's compensation generally consists
of base salary, bonus, and payments under Vanguard's long-term incentive
compensation program. In addition, portfolio managers are eligible for the
standard retirement benefits and health and welfare benefits available to all
Vanguard employees. Also, certain portfolio managers may be eligible for
additional retirement benefits under several supplemental retirement plans that
Vanguard adopted in the 1980's to restore dollar-for-dollar the benefits of
management employees that had been cut back solely as a result of tax law
changes. These plans are structured to provide the same retirement benefits as
the standard retirement benefits.
In the case of portfolio managers responsible for managing multiple
Vanguard funds or accounts, the method used to determine their compensation is
the same for all funds and investment accounts.
A portfolio manager's base salary is determined by the manager's experience
and performance in the role, taking into account the ongoing compensation
benchmark analyses performed by the Vanguard Human Resources Department. A
portfolio manager's base salary is generally a fixed amount that may change as a
result of an annual review, upon assumption of new duties, or when a market
adjustment of the position occurs.
A portfolio manager's bonus is determined by a number of factors. One
factor is gross, pre-tax performance of the fund relative to expectations for
how the fund should have performed, given the fund's investment objective,
policies, strategies, and limitations, and the market environment during the
measurement period. The performance factor is not based on the value of assets
held in the fund's portfolio. For the Vanguard Fund, the performance factor
dependS on how successfully the portfolio manager outperforms the Citigroup
3-Month Treasury Bill Index and maintains the risk parameters of the Vanguard
Fund over a three-year period. Additional factors include the portfolio
manager's contributions to the investment management functions within the
sub-asset class, contributions to the development of other investment
professionals and supporting staff, and overall contributions to strategic
planning and decisions for the investment group. The target bonus is expressed
as a percentage of base salary. The actual bonus paid may be more or less than
the target bonus, based on how well the manager satisfies the objectives stated
above. The bonus is paid on an annual basis.
Under the long-term incentive compensation program, all full-time employees
receive a payment from Vanguard's long term incentive compensation plan based on
their years of service, job level and, if applicable, management
responsibilities. Each year, Vanguard's independent directors determine the
amount of the long-term incentive compensation award for that year based on the
investment performance of the Vanguard funds relative to competitors and
Vanguard's operating efficiencies in providing services to the Vanguard funds.
OWNERSHIP OF SECURITIES
Vanguard employees, including portfolio managers, allocate their
investments among the various Vanguard funds based on their own individual
investment needs and goals. Vanguard
-41-
employees as a group invest a sizeable portion of their personal assets in
Vanguard funds. As of July 31, 2007, Vanguard employees collectively invested
$2.1 billion in Vanguard funds. John J. Brennan, Chairman and Chief Executive
Officer of Vanguard and the Vanguard funds, and George U. Sauter, Managing
Director and Chief Investment Officer, invest substantially all of their
personal financial assets in Vanguard funds. As of July 31, 2007, Mr. Troyer
owned no shares of the Vanguard Fund.
DURATION AND TERMINATION OF INVESTMENT ADVISORY ARRANGEMENTS
The Funds' Service Agreement, which governs the at-cost investment advisory
services provided to the Vanguard funds, including the Vanguard Fund, will
continue in full force and effect until terminated or amended by mutual
agreement of the Vanguard funds and Vanguard.
The investment advisory agreement between the Vanguard Fund and AXA
Rosenberg will continue in effect for a period of two years and will continue in
effect for successive twelve-month periods thereafter, only so long as this
agreement is approved at least annually by Vanguard's Board of Trustees,
including a majority of trustees who are not parties to such agreement or
interested persons of any such party.
PORTFOLIO TRANSACTIONS
Each adviser decides which securities to buy and sell on behalf of the
Vanguard Fund for that portion of the Vanguard Fund's portfolio which it advises
and then selects the brokers or dealers that will execute the trades on an
agency basis or the dealers with whom the trades will be effected on a principal
basis. For each trade, the adviser must select a broker-dealer that it believes
will provide "best execution." Best execution does not necessarily mean paying
the lowest spread or commission rate available. In seeking best execution, the
SEC has said that an adviser should consider the full range of a broker-dealer's
services. The factors considered by the adviser in seeking best execution
include, but are not limited to, the broker-dealer's execution capability,
clearance and settlement services, commission rate, trading expertise,
willingness and ability to commit capital, ability to provide anonymity,
financial responsibility, reputation and integrity, responsiveness, access to
underwritten offerings and secondary markets, and access to company management,
as well as the value of any research provided by the broker-dealer. In assessing
which broker-dealer can provide best execution for a particular trade, the
adviser also may consider the timing and size of the order and available
liquidity and current market conditions. Subject to applicable legal
requirements, the adviser may select a broker based partly on brokerage or
research services provided to the adviser and its clients, including the
Vanguard Fund. The adviser may cause the Vanguard Fund to pay a higher
commission than other brokers would charge if the adviser determines in good
faith that the amount of the commission is reasonable in relation to the value
of services provided. An adviser also may receive brokerage or research services
from broker-dealers that are provided at no charge in recognition of the volume
of trades directed to the broker. To the extent research services or products
may be a factor in selecting brokers, services and products may include written
research reports analyzing performance or securities, discussions with research
analysts, meetings with corporate executives to obtain oral reports on company
performance, and market data.
Some securities that are considered for investment by the Vanguard Fund may
also be appropriate for other Vanguard funds or for other clients served by the
adviser. If such securities
-42-
are compatible with the investment policies of the Vanguard Fund and one or more
of the adviser's other clients, and are considered for purchase or sale at or
about the same time, then transactions in such securities will be aggregated by
the adviser and the purchased securities or sale proceeds will be allocated
among the participating Vanguard funds and the other participating clients of
the adviser in a manner deemed equitable by the adviser. Although there may be
no specified formula for allocating such transactions, the allocation methods
used, and the results of such allocations, will be subject to periodic review by
the Vanguard Fund's board of trustees.
PROXY VOTING GUIDELINES
The Board of Trustees (the "Board") of each Vanguard fund that invests in
stocks has adopted proxy voting procedures and guidelines to govern proxy voting
by the fund. The Board has delegated oversight of proxy voting to the Proxy
Oversight Committee (the "Committee"), composed of senior officers of Vanguard,
a majority of whom are also officers of each Vanguard fund, and subject to the
operating procedures and guidelines described below. The Committee reports
directly to the Board. Vanguard is subject to these guidelines to the extent the
guidelines call for Vanguard to administer the voting process and implement the
resulting voting decisions, and for these purposes have been approved by the
Board of Directors of Vanguard.
The overarching objective in voting is simple: to support proposals and
director nominees that maximize the value of a fund's investments--and those of
fund shareholders--over the long term. While the goal is simple, the proposals
the funds receive are varied and frequently complex. As such, the guidelines
adopted by the Board provide a rigorous framework for assessing each proposal.
Under the guidelines, each proposal must be evaluated on its merits, based on
the particular facts and circumstances as presented.
For ease of reference, the procedures and guidelines often refer to all
funds, however, our processes and practices seek to ensure that proxy voting
decisions are suitable for individual funds. For most proxy proposals,
particularly those involving corporate governance, the evaluation will result in
the same position being taken across all of the funds and the funds voting as a
block. In some cases, however, a fund may vote differently, depending upon the
nature and objective of the fund, the composition of its portfolio and other
factors.
The guidelines do not permit the Board to delegate voting responsibility to
a third party that does not serve as a fiduciary for the funds. Because many
factors bear on each decision, the guidelines incorporate factors the Committee
should consider in each voting decision. A fund may refrain from voting if that
would be in the fund's and its shareholders' best interests. These circumstances
may arise, for example, when the expected cost of voting exceeds the expected
benefits of voting, or exercising the vote results in the imposition of trading
or other restrictions.
In evaluating proxy proposals, we consider information from many sources,
including but not limited to the investment adviser for the fund, management or
shareholders of a company presenting a proposal, and independent proxy research
services. We will give substantial weight to the recommendations of the
company's board, absent guidelines or other specific facts that would support a
vote against management. In all cases, however, the ultimate decision rests with
the members of the Proxy Oversight Committee, who are accountable to the fund's
Board.
-43-
While serving as a framework, the following guidelines cannot contemplate
all possible proposals with which a fund may be presented. In the absence of a
specific guideline for a particular proposal (e.g., in the case of a
transactional issue or contested proxy), the Committee will evaluate the issue
and cast the fund's vote in a manner that, in the Committee's view, will
maximize the value of the fund's investment, subject to the individual
circumstances of the fund.
THE BOARD OF DIRECTORS
ELECTION OF DIRECTORS
Good governance starts with a majority-independent board, whose key
committees are composed entirely of independent directors. As such, companies
should attest to the independence of directors who serve on the Compensation,
Nominating, and Audit committees. In any instance in which a director is not
categorically independent, the basis for the independence determination should
be clearly explained in the proxy statement.
While the funds will generally support the board's nominees, the following
factors will be taken into account in determining each fund's vote:
FACTORS FOR APPROVAL FACTORS AGAINST APPROVAL
-------------------- ------------------------
Nominated slate results in board made up of a Nominated slate results in board made up of a majority of non-
majority of independent directors. independent directors.
All members of Audit, Nominating, and Compensation Audit, Nominating, and/or Compensation committees include non-
committees are independent of management. independent members.
Incumbent board member failed to attend at least 75% of meetings in the
previous year.
Actions of committee(s) on which nominee serves are inconsistent with
other guidelines (e.g., excessive option grants, substantial non-audit fees,
lack of board independence).
CONTESTED DIRECTOR ELECTIONS
In the case of contested board elections, we will evaluate the nominees'
qualifications, the performance of the incumbent board, as well as the rationale
behind the dissidents' campaign, to determine the outcome that we believe will
maximize shareholder value.
CLASSIFIED BOARDS
The funds will generally support proposals to declassify existing boards
(whether proposed by management or shareholders), and will block efforts by
companies to adopt classified board structures, in which only part of the board
is elected each year.
APPROVAL OF INDEPENDENT AUDITORS
The relationship between the company and its auditors should be limited
primarily to the audit, although it may include certain closely related
activities that do not, in the aggregate, raise any appearance of impaired
independence. The funds will generally support management's recommendation for
the ratification of the auditor, except in instances where audit and
audit-related
-44-
fees make up less than 50% of the total fees paid by the company to the audit
firm. We will evaluate on a case-by-case basis instances in which the audit firm
has a substantial non-audit relationship with the company (regardless of its
size relative to the audit fee) to determine whether independence has been
compromised.
COMPENSATION ISSUES
STOCK-BASED COMPENSATION PLANS
Appropriately designed stock-based compensation plans, administered by an
independent committee of the board and approved by shareholders, can be an
effective way to align the interests of long-term shareholders and the interests
of management, employees, and directors. Conversely, the funds oppose plans that
substantially dilute their ownership interest in the company, provide
participants with excessive awards, or have inherently objectionable structural
features.
An independent compensation committee should have significant latitude to
deliver varied compensation to motivate the company's employees. However, we
will evaluate compensation proposals in the context of several factors (a
company's industry, market capitalization, competitors for talent, etc.) to
determine whether a particular plan or proposal balances the perspectives of
employees and the company's other shareholders. We will evaluate each proposal
on a case-by-case basis, taking all material facts and circumstances into
account.
The following factors will be among those considered in evaluating these
proposals.
FACTORS FOR APPROVAL FACTORS AGAINST APPROVAL
-------------------- ------------------------
Company requires senior executives to hold a minimum amount Total potential dilution (including all stock-based plans)
of company stock (frequently expressed as a multiple of salary). exceeds 15% of shares outstanding.
Company requires stock acquired through option exercise Annual option grants have exceeded 2% of shares outstanding.
to be held for a certain period of time.
Compensation program includes performance-vesting Plan permits repricing or replacement of options without
awards, indexed options, or other performance-linked grants. shareholder approval.
Concentration of option grants to senior executives is Plan provides for the issuance of reload options.
limited (indicating that the plan is very broad-based).
Stock-based compensation is clearly used as a Plan contains automatic share replenishment (evergreen) feature.
substitute for cash in delivering market-competitive total pay.
BONUS PLANS
Bonus plans, which must be periodically submitted for shareholder approval
to qualify for deductibility under Section 162(m) of the IRC, should have
clearly defined performance criteria and maximum awards expressed in dollars.
Bonus plans with awards that are excessive, in both absolute terms and relative
to a comparative group, generally will not be supported.
-45-
EMPLOYEE STOCK PURCHASE PLANS
The funds will generally support the use of employee stock purchase plans
to increase company stock ownership by employees, provided that shares purchased
under the plan are acquired for no less than 85% of their market value and that
shares reserved under the plan make up less than 5% of the outstanding shares.
EXECUTIVE SEVERANCE AGREEMENTS (GOLDEN PARACHUTES)
While executives' incentives for continued employment should be more
significant than severance benefits, there are instances--particularly in the
event of a change in control--in which severance arrangements may be
appropriate. Severance benefits triggered by a change in control that do not
exceed three times an executive's salary and bonus may generally be approved by
the compensation committee of the board without submission to shareholders. Any
such arrangement under which the beneficiary receives more than three times
salary and bonus--or where severance is guaranteed absent a change in
control--should be submitted for shareholder approval.
CORPORATE STRUCTURE AND SHAREHOLDER RIGHTS
The exercise of shareholder rights, in proportion to economic ownership, is
a fundamental privilege of stock ownership that should not be unnecessarily
limited. Such limits may be placed on shareholders' ability to act by corporate
charter or by-law provisions, or by the adoption of certain takeover provisions.
In general, the market for corporate control should be allowed to function
without undue interference from these artificial barriers.
The funds' positions on a number of the most commonly presented issues in
this area are as follows:
SHAREHOLDER RIGHTS PLANS (POISON PILLS)
A company's adoption of a so-called poison pill effectively limits a
potential acquirer's ability to buy a controlling interest without the approval
of the target's board of directors. Such a plan, in conjunction with other
takeover defenses, may serve to entrench incumbent management and directors.
However, in other cases, a poison pill may force a suitor to negotiate with the
board and result in the payment of a higher acquisition premium.
In general, shareholders should be afforded the opportunity to approve
shareholder rights plans within a year of their adoption. This provides the
board with the ability to put a poison pill in place for legitimate defensive
purposes, subject to subsequent approval by shareholders. In evaluating the
approval of proposed shareholder rights plans, we will consider the following
factors:
-46-
FACTORS FOR APPROVAL FACTORS AGAINST APPROVAL
-------------------- ------------------------
Plan is relatively short-term (3-5 years). Plan is long term (>5 years).
Plan requires shareholder approval Renewal of plan is automatic or does not require shareholder approval.
for renewal.
Plan incorporates review by a committee Ownership trigger is less than 15%.
of independent directors at least
every three years (so-called TIDE
provisions).
Plan includes permitted bid/qualified offer Classified board.
feature (chewable pill) that mandates
shareholder vote in certain situations.
Ownership trigger is reasonable (15-20%). Board with limited independence.
Highly independent, non-classified board.
CUMULATIVE VOTING
The funds are generally opposed to cumulative voting under the premise that
it allows shareholders a voice in director elections that is disproportionate to
their economic investment in the corporation.
SUPERMAJORITY VOTE REQUIREMENTS
The funds support shareholders' ability to approve or reject matters
presented for a vote based on a simple majority. Accordingly, the funds will
support proposals to remove supermajority requirements and oppose proposals to
impose them.
RIGHT TO CALL MEETINGS AND ACT BY WRITTEN CONSENT
The funds support shareholders' right to call special meetings of the board
(for good cause and with ample representation) and to act by written consent.
The funds will generally vote for proposals to grant these rights to
shareholders and against proposals to abridge them.
CONFIDENTIAL VOTING
The integrity of the voting process is enhanced substantially when
shareholders (both institutions and individuals) can vote without fear of
coercion or retribution based on their votes. As such, the funds support
proposals to provide confidential voting.
DUAL CLASSES OF STOCK
We are opposed to dual class capitalization structures that provide
disparate voting rights to different groups of shareholders with similar
economic investments. We will oppose the creation of separate classes with
different voting rights and will support the dissolution of such classes.
CORPORATE AND SOCIAL POLICY ISSUES
Proposals in this category, initiated primarily by shareholders, typically
request that the company disclose or amend certain business practices. The Board
generally believes that these are "ordinary business matters" that are primarily
the responsibility of management and should be evaluated and approved solely by
the corporation's board of directors. Often, proposals may
-47-
address concerns with which the Board philosophically agrees, but absent a
compelling economic impact on shareholder value (e.g., proposals to require
expensing of stock options), the funds will typically abstain from voting on
these proposals. This reflects the belief that regardless of our philosophical
perspective on the issue, these decisions should be the province of company
management unless they have a significant, tangible impact on the value of a
fund's investment and management is not responsive to the matter.
VOTING IN FOREIGN MARKETS
Corporate governance standards, disclosure requirements, and voting
mechanics vary greatly among the markets outside the United States in which the
funds may invest. Each fund's votes will be used, where applicable, to advocate
for improvements in governance and disclosure by each fund's portfolio
companies. We will evaluate issues presented to shareholders for each fund's
foreign holdings in the context with the guidelines described above, as well as
local market standards and best practices. The funds will cast their votes in a
manner believed to be philosophically consistent with these guidelines, while
taking into account differing practices by market. In addition, there may be
instances in which the funds elect not to vote, as described below.
Many foreign markets require that securities be "blocked" or reregistered
to vote at a company's meeting. Absent an issue of compelling economic
importance, we will generally not subject the fund to the loss of liquidity
imposed by these requirements.
The costs of voting (e.g., custodian fees, vote agency fees) in foreign
markets may be substantially higher than for U.S. holdings. As such, the fund
may limit its voting on foreign holdings in instances where the issues presented
are unlikely to have a material impact on shareholder value.
VOTING ON THE VANGUARD FUND'S HOLDINGS OF OTHER VANGUARD FUNDS
Certain Vanguard funds (owner funds) may, from time to time, own shares of
other Vanguard funds (underlying funds). If an underlying fund submits a matter
to a vote of its shareholders, votes for and against such matters on behalf of
the owner funds will be cast in the same proportion as the votes of the other
shareholders in the underlying fund.
THE PROXY VOTING GROUP
The Board has delegated the day-to-day operations of the funds' proxy
voting process to the Proxy Voting Group, which the Committee oversees. While
most votes will be determined, subject to the individual circumstances of each
fund, by reference to the guidelines as separately adopted by each of the funds,
there may be circumstances when the Proxy Voting Group will refer proxy issues
to the Committee for consideration. In addition, at any time, the Board has the
authority to vote proxies, when, in the Board's or the Committee's discretion,
such action is warranted.
The Proxy Voting Group performs the following functions: (1) managing proxy
voting vendors; (2) reconciling share positions; (3) analyzing proxy proposals
using factors described in the guidelines; (4) determining and addressing
potential or actual conflicts of interest that may be
-48-
presented by a particular proxy; and (5) voting proxies. The Proxy Voting Group
also prepares periodic and special reports to the Board, and any proposed
amendments to the procedures and guidelines.
THE PROXY OVERSIGHT COMMITTEE
The Board, including a majority of the independent trustees, appoints the
members of the Committee who are senior officers of Vanguard, a majority of whom
are also officers of each Vanguard fund.
The Committee does not include anyone whose primary duties include external
client relationship management or sales. This clear separation between the proxy
voting and client relationship functions is intended to eliminate any potential
conflict of interest in the proxy voting process. In the unlikely event that a
member of the Committee believes he or she might have a conflict of interest
regarding a proxy vote, that member must recuse him or herself from the
committee meeting at which the matter is addressed, and not participate in the
voting decision.
The Committee works with the Proxy Voting Group to provide reports and
other guidance to the Board regarding proxy voting by the funds. The Committee
has an obligation to conduct its meetings and exercise its decision-making
authority subject to the fiduciary standards of good faith, fairness and
Vanguard's Code of Ethics. The Committee shall authorize proxy votes that the
Committee determines, in its sole discretion, to be in the best interests of
each fund's shareholders. In determining how to apply the guidelines to a
particular factual situation, the Committee may not take into account any
interest that would conflict with the interest of fund shareholders in
maximizing the value of their investments.
The Board may review these procedures and guidelines and modify them from
time to time. The procedures and guidelines are available on Vanguard's website
at www.vanguard.com.
You may obtain a free copy of a report that details how the funds voted the
proxies relating to the portfolio securities held by the funds for the prior
12-month period ended June 30 by logging on to Vanguard's internet site, at
www.vanguard.com, or the SEC's website at www.sec.gov.
-49-
VANGUARD MONTGOMERY FUNDS
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
FORM N-14
PART C
OTHER INFORMATION
ITEM 15. INDEMNIFICATION.
The Registrant's organizational documents contain provisions indemnifying
Trustees and Officers against liability incurred in their official capacity.
Article VII, Section 2 of the Declaration of Trust provides that the Registrant
may indemnify and hold harmless each and every Trustee and Officer from and
against any and all claims, demands, costs, losses, expenses, and damages
whatsoever arising out of or related to the performance of his or her duties as
a Trustee or Officer. However, this provision does not cover any liability to
which a Trustee or Officer would otherwise be subject by reason of willful
misfeasance, bad faith, gross negligence or reckless disregard of the duties
involved in the conduct of his or her office. Article VI of the By-Laws
generally provides that the Registrant shall indemnify its Trustees and Officers
from any liability arising out of their past or present service in that
capacity. Among other things, this provision excludes any liability arising by
reason of willful misfeasance, bad faith, gross negligence, or the reckless
disregard of the duties involved in the conduct of the Trustee's or Officer's
office with the Registrant.
ITEM 16. EXHIBITS.
(1) Declaration of Trust of Vanguard Montgomery Funds is
incorporated by reference to Registrant's Registration
Statement on Form N-1A filed on August 22, 2007.
(2) By-Laws of Vanguard Montgomery Funds are incorporated
by reference to Registrant's Registration Statement on
Form N-1A filed on August 22, 2007.
(3) Not Applicable.
(4) Form of Agreement and Plan of Reorganization is filed
herewith as Appendix A to the Combined Prospectus/Proxy
Statement.
(5) Not Applicable.
(6) Form of Investment Advisory Agreement between Vanguard
Montgomery Funds and AXA Rosenberg Investment
Management LLC, is incorporated by reference to
Registrant's Registration Statement on Form N-14 filed
on August 22, 2007.
(7) Amended and Restated Funds' Service Agreement is
incorporated by reference to Registrant's Registration
Statement on Form N-1A filed on August 22, 2007.
(8) Not Applicable.
(9) Form of Custodian Agreement is incorporated by
reference to Registrant's Registration Statement on
Form N-1A filed on August 22, 2007.
(10) Not Applicable.
(11) (a) Opinion and Consent of Willkie Farr & Gallagher LLP
that shares will be validly issued, fully paid and
non-assessable is incorporated by reference to
Registrant's Registration Statement on Form N-14 filed
on August 22, 2007.
(11) (b) Opinion and Consent of Morris, Nichols, Arsht &
Tunnell LLP that shares will be validly issued, fully
paid and non-assessable is incorporated by reference to
Registrant's Registration Statement on Form N-14 filed
on August 22, 2007.
(12) Form of Opinion of Willkie Farr & Gallagher LLP as to
certain tax matters and consequences is incorporated by
reference to Registrant's Registration Statement on
Form N-14 filed on August 22, 2007.
(13) Not Applicable.
(14) Consent of PricewaterhouseCoopers LLP is filed
herewith.
(15) Not applicable.
(16) Power of Attorney for Heidi Stam is incorporated by
reference to Registrant's Registration Statement on
Form N-14 filed on August 22, 2007.
(17) (a) Prospectus for Laudus Rosenberg U.S. Large/Mid
Capitalization Long/Short Equity Fund dated July 31,
2007, is incorporated by reference to Registrant's
Registration Statement on Form N-14 filed on August 22,
2007.
(17) (b) Statement of Additional Information for Laudus
Rosenberg U.S. Large/Mid Capitalization Long/Short
Equity Fund dated July 31, 2007, is incorporated by
reference to Registrant's Registration Statement on
Form N-14 filed on August 22, 2007.
(17) (c) Annual Report to Shareholders including the Audited
Financial Statements dated March 31, 2007 for the
Laudus Rosenberg U.S. Large/Mid Capitalization
Long/Short Equity Fund, is incorporated by reference to
Registrant's Registration Statement on Form N-14 filed
on August 22, 2007.
-2-
ITEM 17. UNDERTAKINGS
(1) The undersigned Registrant agrees that prior to any public reoffering of the
securities registered through the use of a prospectus which is a part of this
Registration Statement by any person or party who is deemed to be an underwriter
within the meaning of Rule 145(c) of the Securities Act of 1933, the reoffering
prospectus will contain the information called for by the applicable
registration form for reofferings by persons who may be deemed underwriters, in
addition to the information called for by the other items of the applicable
form.
(2) The undersigned Registrant agrees that every prospectus that is filed under
paragraph (1) above will be filed as a part of an amendment to the Registration
Statement and will not be used until the amendment is effective, and that, in
determining any liability under the Securities Act of 1933, each post-effective
amendment shall be deemed to be a new registration statement for the securities
offered therein, and the offering of the securities at that time shall be deemed
to be the initial bona fide offering of them.
(3) The tax opinion will be filed as a post-effective amendment pursuant to Rule
486(b) because filing pursuant to Rule 497 only relates to information that is
being supplemented into the prospectus and SAI, not for exhibits.
-3-
SIGNATURES
As required by the Securities Act of 1933, this Registration Statement has
been signed on behalf of the Registrant in Malvern on the 20th day of September,
2007.
Pursuant to the requirements of the Securities Act of 1933, this Amendment
has been signed below by the following persons in the capacity on the date
indicated.
VANGUARD MONTGOMERY FUNDS
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SIGNATURE TITLE DATE
By: ----------------------------President, Chairman, September 20, 2007
/S/ JOHN J. BRENNAN Chief Executive Officer,
(Heidi Stam) and Trustee
John J. Brennan*
By: ----------------------------Trustee September 20, 2007
/S/ CHARLES D. ELLIS
(Heidi Stam)
Charles D. Ellis*
By: ----------------------------Trustee September 20, 2007
/S/ RAJIV L. GUPTA
(Heidi Stam)
Rajiv L. Gupta*
By: ----------------------------Trustee September 20, 2007
/S/ AMY GUTMANN
(Heidi Stam)
Amy Gutmann*
By: ----------------------------Trustee September 20, 2007
/S/ JOANN HEFFERNAN HEISEN
(Heidi Stam)
JoAnn Heffernan Heisen*
By: ----------------------------Trustee September 20, 2007
/S/ ANDRE F. PEROLD
(Heidi Stam)
Andre F. Perold*
By: ----------------------------Trustee September 20, 2007
/S/ ALFRED M. RANKIN, JR.
(Heidi Stam)
Alfred M. Rankin, Jr.*
By: ----------------------------Trustee September 20, 2007
/S/ J. LAWRENCE WILSON
(Heidi Stam)
J. Lawrence Wilson*
By: ----------------------------Treasurer and Principal September 20, 2007
/S/ THOMAS J. HIGGINS Financial and Principal
(Heidi Stam) Accounting Officer
Thomas J. Higgins*
* By Power of Attorney, filed on August 22, 2007, incorporated by reference.