EXHIBIT 17(v)
[BB&T FUNDS LOGO]
SUPPLEMENT DATED MARCH 14, 2006
TO THE
STATEMENT OF ADDITIONAL IFORMATION
DATED FEBRUARY 1, 2006
THIS SUPPLEMENT PROVIDES THE FOLLOWING AMENDED AND SUPPLEMENTAL INFORMATION
AND SUPERSEDES ANY INFORMATION TO THE CONTRARY IN THE STATEMENT OF ADDITIONAL
INFORMATION DATED FEBRUARY 1, 2006:
Effective immediately, the disclosure under the heading "FOREIGN CURRENCY
TRANSACTIONS" on page 7 of the statement of additional information is replaced
in its entirety with the following:
FOREIGN CURRENCY TRANSACTIONS. The International Equity Fund may use
forward currency exchange contracts. Forward currency exchange contracts
involve an obligation to exchange a specified currency for another at a
future date at a rate set at the time of the contract. Forward currency
exchange contracts do not eliminate fluctuations in the values of portfolio
securities but rather allow a Fund to establish a rate of exchange for a
future point in time.
Currency exposure is managed actively and separately from the
underlying assets in the Fund based upon the sub-Adviser's overall market
and currency management strategy. The sub-Adviser may alter the Fund's
currency exposure whenever the sub-Adviser perceives opportunities to
enhance the return or reduce the risk of the Fund. The sub-Adviser is
permitted to shift the currency exposure resulting from the underlying
assets from the original currency to another currency within the Fund's
benchmark, the Morgan Stanley Capital International EAFE Index, (or to the
U.S. dollar) and may enter into a net long position with respect to any
currency within the benchmark (or to the U.S. dollar), provided that the
aggregate currency positions created by forward currency exchange contracts
do not exceed 100 % of the Fund's total net assets. Net short positions are
not permitted.
To the extent the Fund invests in an emerging market, the resulting
emerging market currency exposure will generally be maintained. With
respect to any forward currency exchange contract, it will not generally be
possible to match precisely the amount covered by the contract and the
value of the securities involved due to the changes in the values of such
securities resulting from market movements between the date the forward
currency exchange contract is entered into and the date it matures. In
addition, while forward currency exchange contracts may offer protection
from losses resulting from declines in the value of a particular foreign
currency, they also may result in losses and moreover will limit potential
gains which might result from increases in the value of such currency. The
Fund will also incur costs in connection with forward currency exchange
contracts and conversions of foreign currencies and U.S. dollars.
A separate account of a Fund consisting of liquid assets equal to the
amount of the Fund's assets that could be required to consummate forward
currency exchange contracts will be established with the Fund's custodian.
For the purpose of determining the adequacy of the securities in the
account, the deposited securities will be valued at market or fair value.
If the
market or fair value of such securities declines, additional cash or
securities will be placed in the account daily so that the value of the
account will be equal the amount of such commitments by the Fund.
Effective immediately, the first paragraph under the heading "FUTURES
CONTRACTS AND RELATED OPTIONS" on page 16 of the statement of additional
information is replaced in its entirety with the following:
Each Fund of BB&T Funds (other than the U.S. Treasury Money Market
Fund and the Prime Money Market Fund) may invest in futures contracts and
options thereon (interest rate futures contracts or index futures
contracts, as applicable). The value of a Fund's contracts may approach,
but will not exceed, 100% of the Fund's total net assets.
SHAREHOLDERS SHOULD RETAIN THIS SUPPLEMENT
WITH THE STATEMENT OF ADDITIONAL INFORMATION
FOR FUTURE REFERENCE.
SP-SAI 2 0306
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BB&T FUNDS
STATEMENT OF ADDITIONAL INFORMATION
FEBRUARY 1, 2006
This Statement of Additional Information is not a Prospectus, but should be read
in conjunction with the Class A Shares, Class B Shares, and Class C Shares
Prospectus and Institutional Shares Prospectus of the BB&T Large Cap Value Fund,
the BB&T Large Cap Growth Fund, the BB&T Mid Cap Value Fund, the BB&T Mid Cap
Growth Fund, the BB&T Small Company Growth Fund, the BB&T Small Cap Fund, the
BB&T International Equity Fund, the BB&T Special Opportunities Equity Fund, the
BB&T Equity Income Fund, the BB&T Short U.S. Government Fund, the BB&T
Intermediate U.S. Government Fund, the BB&T Total Return Bond Fund, the BB&T
Kentucky Intermediate Tax-Free Fund, the BB&T Maryland Intermediate Tax-Free
Fund, the BB&T North Carolina Intermediate Tax-Free Fund, the BB&T South
Carolina Intermediate Tax-Free Fund, the BB&T Virginia Intermediate Tax-Free
Fund, the BB&T West Virginia Intermediate Tax-Free Fund, the BB&T Prime Money
Market Fund, the BB&T U.S. Treasury Money Market Fund, the BB&T Capital Manager
Conservative Growth Fund, the BB&T Capital Manager Moderate Growth Fund, the
BB&T Capital Manager Growth Fund, and the BB&T Capital Manager Equity Fund which
are dated February 1, 2006, the Prospectus of the BB&T U.S. Treasury Money
Market Fund and the BB&T Prime Money Market Fund, which is dated February 1,
2006, the Prospectus of the BB&T U.S. Treasury Money Market Fund (Class A
Shares) which is dated February 1, 2006, the Prospectus of the BB&T Prime Money
Market Fund (Class A Shares) which is dated February 1, 2006, the Prospectus of
the BB&T Small Company Growth Fund (Class A Shares, Class B Shares, and Class C
Shares) which is dated February 1, 2006, and the Prospectus of the BB&T Small
Company Growth Fund (Institutional Shares) which is dated February 1, 2006. This
Statement of Additional Information is incorporated by reference in its entirety
into the Prospectuses. Copies of the Prospectuses may be obtained by writing
BB&T Funds at 3435 Stelzer Road, Columbus, Ohio 43219, or by telephoning toll
free (800) 228-1872.
TABLE OF CONTENTS
PAGE
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BB&T FUNDS............................................................... 3
INVESTMENT OBJECTIVES AND POLICIES....................................... 4
Additional Information on Portfolio Instruments....................... 4
Investment Restrictions............................................... 19
Portfolio Turnover.................................................... 24
VALUATION................................................................ 26
Valuation of the Money Market Funds................................... 26
Valuation of the Bond Funds, the Stock Funds and the Funds of Funds... 26
Purchase of Class A, Class B, and Class C Shares...................... 27
Matters Affecting Redemption.......................................... 32
ADDITIONAL TAX INFORMATION............................................... 34
Additional Tax Information Concerning the International Equity Fund... 39
Additional Tax Information Concerning the Tax-Free Bond Funds......... 39
Additional Tax Information Concerning the Funds of Funds.............. 42
MANAGEMENT OF BB&T FUNDS................................................. 67
Sub-Advisers.......................................................... 74
Proxy Voting Policies and Procedures.................................. 80
Portfolio Transactions................................................ 80
Glass-Steagall Act.................................................... 82
Manager and Administrator............................................. 83
Distributor........................................................... 84
Securities Lending Agent.............................................. 87
Custodian............................................................. 88
Transfer Agent and Fund Accounting Services........................... 88
Independent Registered Public Accounting Firm......................... 88
Legal Counsel......................................................... 88
ADDITIONAL INFORMATION................................................... 88
Organization and Description of Shares................................ 88
Shareholder and Trustee Liability..................................... 89
Disclosure of Portfolio Holdings...................................... 89
Miscellaneous......................................................... 90
FINANCIAL STATEMENTS..................................................... 108
APPENDIX A............................................................... 108
APPENDIX B............................................................... 111
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STATEMENT OF ADDITIONAL INFORMATION
BB&T FUNDS
BB&T Funds is an open-end management investment company. BB&T Funds
consists of twenty-five series of units of beneficial interest ("Shares")
offered to the public, each representing interests in one of twenty-five
separate investment portfolios ("Funds"). Twenty-four of those series are
described in this Statement of Additional Information:
STOCK FUNDS
The BB&T Large Cap Value Fund (the "Large Cap Value Fund") (formerly the "Large
Company Value Fund")
The BB&T Large Cap Growth Fund (the "Large Cap Growth Fund") (formerly, the
"Large Company Growth Fund")
The BB&T Mid Cap Value Fund (the "Mid Cap Value Fund")
The BB&T Mid Cap Growth Fund (the "Mid Cap Growth Fund")
The BB&T Small Cap Fund (the "Small Cap Fund") (formerly the "Small Company
Value Fund")
The BB&T Small Company Growth Fund (the "Small Company Growth Fund")
The BB&T International Equity Fund (the "International Equity Fund")
The BB&T Special Opportunities Equity Fund (the "Special Opportunities Fund")
The BB&T Equity Income Fund (the "Equity Income Fund")
BOND FUNDS TAXABLE BOND FUNDS
The BB&T Short U.S. Government Fund (the "Short Fund")
The BB&T Intermediate U.S. Government Fund (the "Intermediate U.S. Government
Fund")
The BB&T Total Return Bond Fund (the "Total Return Bond Fund") (formerly the
"Intermediate Corporate Bond Fund")
TAX-FREE BOND FUNDS
The BB&T Kentucky Intermediate Tax-Free Fund (the "Kentucky Fund")
The BB&T Maryland Intermediate Tax-Free Fund (the "Maryland Fund")
The BB&T North Carolina Intermediate Tax-Free Fund (the "North Carolina Fund")
The BB&T South Carolina Intermediate Tax-Free Fund (the "South Carolina Fund")
The BB&T Virginia Intermediate Tax-Free Fund (the "Virginia Fund")
The BB&T West Virginia Intermediate Tax-Free Fund (the "West Virginia Fund")
MONEY MARKET FUNDS
The BB&T Prime Money Market Fund (the "Prime Money Market Fund")
The BB&T U.S. Treasury Money Market Fund (the "U.S. Treasury Fund")
FUNDS OF FUNDS
The BB&T Capital Manager Conservative Growth Fund (the "Conservative Growth
Fund")
The BB&T Capital Manager Moderate Growth Fund (the "Moderate Growth Fund")
The BB&T Capital Manager Growth Fund (the "Growth Fund")
The BB&T Capital Manager Equity Fund (the "Capital Manager Equity Fund")
The Funds of Funds offer Shareholders a professionally-managed investment
program by purchasing shares of existing Funds of BB&T Funds (the "Underlying
Funds"). Each Fund may offer to the public four classes of Shares: Class A
Shares, Class B Shares, Class C Shares, and Institutional Shares. As of the date
of this Statement of Additional Information, Class B Shares and Class C Shares
of the Short Fund, and the Tax-Free Bond Funds were not yet being offered.
Shares of the Equity Index Fund are currently being offered in a separate
prospectus and statement of additional information. Much of the information
contained in this Statement of Additional Information expands on subjects
discussed in the Prospectuses. Capitalized terms not defined herein are defined
in the Prospectuses. No investment in Shares of a Fund should be made without
first reading the applicable Prospectuses.
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OVB MERGER. In July, 2001, certain Funds of BB&T Funds merged with the OVB Funds
of The Arbor Fund pursuant to an Agreement and Plan of Reorganization. Except
for the following Funds listed below, BB&T Funds are considered to be the
surviving funds for accounting purposes. The following list shows the name of
the former OVB Funds that are considered to be the surviving funds for
accounting purposes and the current name of such Funds (the "Former OVB Funds"):
NAME OF FORMER OVB FUND BB&T FUNDS' NAME
----------------------- ----------------
1. OVB Capital Appreciation Portfolio 1. BB&T Mid Cap Growth Fund
2. OVB Equity Income Portfolio 2. BB&T Mid Cap Value Fund
3. OVB West Virginia Tax-Exempt Income Portfolio 3. BB&T West Virginia Intermediate Tax-Free Fund
INVESTMENT OBJECTIVES AND POLICIES
ADDITIONAL INFORMATION ON PORTFOLIO INSTRUMENTS
The following policies supplement the information pertaining to portfolio
instruments of each Fund as set forth in the Prospectuses.
The Appendix to this Statement of Additional Information identifies
nationally recognized statistical ratings organizations ("NRSROs") that may be
used by BB&T Asset Management, Inc. ("BB&T Asset Management" or the "Adviser"),
Scott & Stringfellow, Inc. ("Scott & Stringfellow"), UBS Global Asset Management
(Americas) Inc. ("UBS Global AM"), Federated Investment Management Company
("FIMC"), and Sterling Capital Management LLC ("Sterling Capital") (Scott &
Stringfellow, UBS Global AM, FIMC, and Sterling Capital each a "Sub-Adviser")
with regard to portfolio investments for the Funds and provides a description of
relevant ratings assigned by each such NRSRO. A rating by an NRSRO may be used
only where the NRSRO is neither controlling, controlled by, nor under common
control with the issuer of, or any issuer, guarantor, or provider of credit
support for, the instrument.
EQUITY SECURITIES. Each of the Stock Funds and, to the extent consistent
with its investment objective and policies, the Total Return Bond Fund may
invest in equity securities. Equity securities include common stocks, preferred
stocks, convertible securities and warrants. Common stocks, which represent an
ownership interest in a company, are probably the most recognized type of equity
security. Equity securities have historically outperformed most other
securities, although their prices can be volatile in the short term. Market
conditions, political, economic and even company-specific news can cause
significant changes in the price of a stock. Smaller companies (as measured by
market capitalization), sometimes called small-cap companies or small-cap
stocks, may be especially sensitive to these factors. To the extent a Fund
invests in equity securities, that Fund's Shares will fluctuate in value, and
thus equity securities may be more suitable for long-term investors who can bear
the risk of short-term fluctuations.
The Stock Funds may also invest in a company's securities at the time of a
company's initial public offering ("IPO"). Companies involved in IPOs are often
smaller and have a limited operating history, which involves a greater risk that
the value of their securities will be impaired following the IPO. In addition,
market psychology prevailing at the time of an IPO can have a substantial and
unpredictable effect on the price of an IPO security, causing the price of a
company's securities to be particularly volatile at the time of its IPO and for
a period thereafter. As a result, a Fund's Adviser or Sub-Adviser might decide
to sell an IPO security more quickly than it would otherwise, which may result
in significant gains or losses to the Fund.
CREDIT ENHANCEMENT. The Prime Money Market Fund may purchase securities
subject to credit enhancements. Credit enhancement consists of an arrangement in
which a company agrees to pay amounts due on a fixed income security if the
issuer defaults. In some cases the company providing credit enhancement makes
all payments directly to the security holders and receives reimbursement from
the issuer. Normally, the credit enhancer has greater financial resources and
liquidity than the issuer. For this reason, the Sub-Adviser usually evaluates
the credit risk of a fixed income security based solely upon its credit
enhancement.
ZERO COUPON SECURITIES. The Prime Money Market Fund may purchase zero
coupon securities. Zero coupon securities do not pay interest or principal until
final maturity unlike debt securities that provide periodic payments of interest
(referred to as a coupon payment). Investors buy zero coupon securities at a
price below the amount payable at maturity. The difference between the purchase
price and the amount paid at maturity represents interest on the zero coupon
security. Investors must wait until maturity to receive interest and principal,
which increases the interest rate and credit risks of a zero coupon security.
Even though such securities do not pay current interest in cash, a Fund
nonetheless is required to accrue interest income on these investments and to
distribute the interest income on a current basis. Thus, a Fund could be
required at times to liquidate other investments in order to satisfy its
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distribution requirements. The Taxable Bond Funds, the U. S. Treasury Fund, and
the Stock Funds may invest in "zero coupon" U.S. Government Securities.
INSURANCE CONTRACTS. The Prime Money Market Fund may purchase insurance
contracts. Insurance contracts include guaranteed investment contracts, funding
agreements and annuities. The Prime Money Market Fund treats these contracts as
fixed income securities.
The Prime Money Market Fund may make limited investments in funding
agreements issued by highly rated U.S. insurance companies. Under these
agreements, the Fund makes cash contributions to a deposit fund of the insurance
company's general account. The insurance company then credits interest to the
Fund on a monthly or quarterly basis, which is based on an index (such as
LIBOR).
BANKERS' ACCEPTANCES AND CERTIFICATES OF DEPOSIT. All of the Funds, except
the U.S. Treasury Fund, may invest in bankers' acceptances, certificates of
deposit, and demand and time deposits. The Prime Money Market Fund may also make
interest-bearing savings deposits in commercial and savings banks in amounts not
in excess of 5% of its total assets. Bankers' acceptances are negotiable drafts
or bills of exchange typically drawn by an importer or exporter to pay for
specific merchandise, which are "accepted" by a bank, meaning, in effect, that
the bank unconditionally agrees to pay the face value of the instrument on
maturity. Certificates of deposit are negotiable certificates issued against
funds deposited in a commercial bank or a savings and loan association for a
definite period of time and earning a specified return.
Bankers' acceptances will be those guaranteed by domestic and foreign
banks, if at the time of investment such banks have capital, surplus, and
undivided profits in excess of $100,000,000 (as of the date of their most
recently published financial statements). Certificates of deposit and demand and
time deposits will be those of domestic and foreign banks and savings and loan
associations, if (a) at the time of investment they have capital, surplus, and
undivided profits in excess of $100,000,000 (as of the date of their most
recently published financial statements) or (b) the principal amount of the
instrument is insured in full by the Federal Deposit Insurance Corporation.
COMMERCIAL PAPER. Each Fund, except for the U.S. Treasury Fund, may invest
in commercial paper. Commercial paper consists of unsecured promissory notes
issued by corporations. Issues of commercial paper normally have maturities of
less than nine months and fixed rates of return.
Commercial paper purchasable by each Fund, except for the U.S. Treasury
Fund, includes "Section 4(2) paper," a term that includes debt obligations
issued in reliance on the "private placement" exemption from registration
afforded by Section 4(2) of the Securities Act of 1933. Section 4(2) paper is
restricted as to disposition under the Federal securities laws, and is
frequently sold (and resold) to institutional investors such as the Fund through
or with the assistance of investment dealers who make a market in the Section
4(2) paper, thereby providing liquidity. Certain transactions in Section 4(2)
paper may qualify for the registration exemption provided in Rule 144A under the
Securities Act of 1933 (the "1933 Act").
VARIABLE AMOUNT MASTER DEMAND NOTES. Variable amount master demand notes,
in which each Fund, except for the U.S. Treasury Fund, may invest, are unsecured
demand notes that permit the indebtedness thereunder to vary and provide for
periodic adjustments in the interest rate according to the terms of the
instrument. They are also referred to as variable rate demand notes. Because
these notes are direct lending arrangements between the Fund and the issuer,
they are not normally traded. Although there may be no secondary market in the
notes, the Fund may demand payment of principal and accrued interest at any time
or during specified periods not exceeding one year, depending upon the
instrument involved, and may resell the note at any time to a third party. The
absence of such an active secondary market, however, could make it difficult for
a Fund to dispose of a variable amount master demand note if the issuer
defaulted on its payment obligations or during periods when the Fund is not
entitled to exercise their demand rights, and a Fund could, for this or other
reasons, suffer a loss to the extent of the default. While the notes are not
typically rated by credit rating agencies, issuers of variable amount master
demand notes must satisfy the criteria for commercial paper. BB&T or the
Sub-Adviser will consider the earning power, cash flow, and other liquidity
ratios of the issuers of such notes and will continuously monitor their
financial status and ability to meet payment on demand. Where necessary to
ensure that a note is of "high quality," a Fund will require that the issuer's
obligation to pay the principal of the note be backed by an unconditional bank
letter or line of credit, guarantee or commitment to lend. In determining
dollar-weighted average portfolio maturity, a variable amount master demand note
will be deemed to have a maturity equal to the period of time remaining until
the principal amount can be recovered from the issuer through demand or, if
longer, the period of time remaining until the next adjustment of the interest
rate.
FOREIGN INVESTMENT. The Prime Money Market Fund, the Total Return Bond
Fund, the Stock Funds and the Funds of Funds may invest in certain obligations
or securities of foreign issuers. Permissible investments include Eurodollar
Certificates of Deposit ("ECDs") which are U.S. dollar denominated certificates
of deposit issued by branches of foreign and domestic banks located outside the
United States, Yankee Certificates of Deposit ("Yankee CDs") which are
certificates of deposit issued by a U.S. branch of a
5
foreign bank, denominated in U.S. dollars and held in the United States,
Eurodollar Time Deposits ("ETD's") which are U.S. dollar denominated deposits in
a foreign branch of a U.S. bank or a foreign bank, and Canadian Time Deposits
("CTD's") which are U.S. dollar denominated certificates of deposit issued by
Canadian offices of major Canadian Banks, Canadian Commercial Paper, which is
commercial paper issued by a Canadian corporation or a Canadian counterpart of a
U.S. corporation, and European commercial paper, which is U.S. dollar
denominated commercial paper of an issuer located in Europe. The Funds may
invest in foreign commercial paper, including Canadian and European commercial
paper as described above. The Total Return Bond Fund may also invest in debt
obligations of foreign issuers denominated in foreign currencies.
The Total Return Bond Fund, the Stock Funds, and the Funds of Funds may
invest in securities issued by foreign branches of U.S. banks, foreign banks, or
other foreign issuers, including American Depositary Receipts ("ADRs") and
securities purchased on foreign securities exchanges. Such securities may
subject a Fund to investment risks that differ in some respects from those
related to investment in obligations of U.S. domestic issuers or in U.S.
securities markets. Such risks include future adverse political and economic
developments, possible seizure, currency blockage, nationalization or
expropriation of foreign investments, less stringent disclosure requirements,
the possible establishment of exchange controls or taxation at the source, and
the adoption of other foreign governmental restrictions.
ADRs typically are issued by an American bank or trust company and evidence
ownership of underlying securities issued by a foreign corporation. EDRs, which
are sometimes referred to as Continental Depositary Receipts, are receipts
issued in Europe, typically by foreign banks and trust companies, that evidence
ownership of either foreign or domestic underlying securities. GDRs are
depository receipts structured like global debt issues to facilitate trading on
an international basis. Unsponsored ADR, EDR and GDR programs are organized
independently and without the cooperation of the issuer of the underlying
securities. As a result, available information concerning the issuers may not be
as current as for sponsored ADRs, EDRs and GDRs, and the prices of unsponsored
ADRs, EDRs and GDRs may be more volatile than if such instruments were sponsored
by the issuer.
Investing in foreign securities involves considerations not typically
associated with investing in securities of companies organized and operated in
the United States. Because foreign securities generally are denominated and pay
dividends or interest in foreign currencies, the value of a Fund that invests in
foreign securities as measured in U.S. dollars will be affected favorably or
unfavorably by changes in exchange rates. A Fund's investments in foreign
securities may also be adversely affected by changes in foreign political or
social conditions, diplomatic relations, confiscatory taxation, expropriation,
limitation on the removal of funds or assets, or imposition of (or change in)
exchange control regulations. In addition, changes in government administrations
or economic or monetary policies in the U.S. or abroad could result in
appreciation or depreciation of portfolio securities and could favorably or
adversely affect a Fund's operations. Special tax considerations apply to
foreign securities.
Additional risks include currency exchange risks, less publicly available
information, the risk that companies may not be subject to the accounting,
auditing and financial reporting standards and requirements of U.S. companies,
the risk that foreign securities markets may have less volume and therefore many
securities traded in these markets may be less liquid and their prices more
volatile than U.S. securities, and the risk that custodian and brokerage costs
may be higher. Foreign issuers of securities or obligations are often subject to
accounting treatment and engage in business practices different from those
respecting domestic issuers of similar securities or obligations. Foreign
branches of U.S. banks and foreign banks may be subject to less stringent
reserve requirements than those applicable to domestic branches of U.S. banks.
The Total Return Bond Fund, the Stock Funds, and the Funds of Funds will acquire
such securities only when BB&T Asset Management or the Sub-Adviser believes the
benefits associated with such investments outweigh the risks. The Prime Money
Market Fund will acquire such securities only when BB&T Asset Management or the
Sub-Adviser believes that the risks associated with such investments are
minimal.
The International Equity Fund and the Total Return Bond Fund may invest its
assets in countries with emerging economies or securities markets. These
countries may include Argentina, Brazil, Bulgaria, Chile, China, Colombia, The
Czech Republic, Ecuador, Egypt, Greece, Hungary, India, Indonesia, Israel,
Lebanon, Malaysia, Mexico, Morocco, Pakistan, Peru, The Philippines, Poland,
Romania, Russia, South Africa, South Korea, Taiwan, Thailand, Tunisia, Turkey,
Venezuela and Vietnam. Political and economic structures in many of these
countries may be undergoing significant evolution and rapid development, and
these countries may lack the social, political and economic stability
characteristics of more developed countries. Some of these countries may have in
the past failed to recognize private property rights and have at times
nationalized or expropriated the assets of private companies. As a result, the
risks described above, including the risks of nationalization or expropriation
of assets, may be heightened. In addition, unanticipated political or social
developments may affect the value of investments in these countries and the
availability to the Fund of additional investments in emerging market countries.
The small size and inexperience of the securities markets in certain of these
countries and the limited volume of trading in securities in these countries may
make investments in the countries less liquid and more volatile than investments
in Japan or most Western European countries. There may be little financial or
accounting information
6
available with respect to issuers located in certain emerging market countries,
and it may be difficult as a result to access the value or prospects of an
investment in such issuers.
The expense ratio of the International Equity Fund is expected to be higher
than that of other Funds of BB&T Funds investing primarily in domestic
securities. The costs attributable to investing abroad are usually higher for
several reasons, such as the higher cost of investment research, higher cost of
custody of foreign securities, higher commissions paid on comparable
transactions on foreign markets, foreign income taxes withheld at the source and
additional costs arising from delays in settlements of transactions involving
foreign securities.
FOREIGN CURRENCY TRANSACTIONS. The International Equity Fund may use
forward foreign currency exchange contracts ("forward contracts"). Forward
foreign currency exchange contracts involve an obligation to purchase or sell a
specified currency at a future date at a price set at the time of the contract.
Forward foreign currency exchange contracts do not eliminate fluctuations in the
values of portfolio securities but rather allow a Fund to establish a rate of
exchange for a future point in time. The Fund may enter into forward foreign
currency exchange contracts when deemed advisable by its Sub-Adviser under two
circumstances. First, when entering into a contract for the purchase or sale of
a security, the Fund may enter into a forward foreign currency exchange contract
for the amount of the purchase or sale price to protect against variations,
between the date the security is purchased or sold and the date on which payment
is made or received, in the value of the foreign currency relative to the U.S.
dollar or other foreign currency.
Second, the Fund may (but is not required to) buy and sell forward foreign
currency contracts for the purpose of maintaining the currency exposure of the
Fund as close in line with that of the benchmark as practicable. In the event
the Fund invests a lower percentage of Fund assets in a particular market than
the percentage that market comprises of the benchmark (an underweight), the Fund
may enter into a long position with respect to the currency of that market in
order to maintain the Fund's currency exposure neutral relative to the
benchmark. Similarly, in the event that the Fund invests a higher percentage of
Fund assets in a particular market than the percentage that market comprises of
the benchmark (an overweight), the Fund may enter into a short position with
respect to the currency of that market in order to maintain the Fund's currency
exposure neutral relative to the benchmark. To the extent the Fund invests in an
emerging market whose currency is not readily able to be hedged back to a
benchmark currency, such emerging market currency exposure will remain unhedged.
With respect to any forward foreign currency exchange contract, it will not
generally be possible to match precisely the amount covered by the contract and
the value of the securities involved due to the changes in the values of such
securities resulting from market movements between the date the forward contract
is entered into and the date it matures. In addition, while forward contracts
may offer protection from losses resulting from declines in the value of a
particular foreign currency, they also limit potential gains which might result
from increases in the value of such currency. The Fund will also incur costs in
connection with forward foreign currency exchange contracts and conversions of
foreign currencies and U.S. dollars.
A separate account of a Fund consisting of liquid assets equal to the
amount of the Fund's assets that could be required to consummate forward
contracts entered into under the second circumstance, as set forth above, will
be established with the Fund's custodian. For the purpose of determining the
adequacy of the securities in the account, the deposited securities will be
valued at market or fair value. If the market or fair value of such securities
declines, additional cash or securities will be placed in the account daily so
that the value of the account will be equal the amount of such commitments by
the Fund.
REPURCHASE AGREEMENTS. Securities held by each of the Funds may be subject
to repurchase agreements. Under the terms of a repurchase agreement, a Fund
would acquire securities from member banks of the Federal Deposit Insurance
Corporation with capital, surplus, and undivided profits of not less than
$100,000,000 (as of the date of their most recently published financial
statements) and from registered broker-dealers which BB&T Asset Management or
the Sub-Adviser deems creditworthy under guidelines approved by the Board of
Trustees, subject to the seller's agreement to repurchase such securities at a
mutually agreed-upon date and price. The repurchase price would generally equal
the price paid by the Fund plus interest negotiated on the basis of current
short-term rates, which may be more or less than the rate on the underlying
portfolio securities. The seller under a repurchase agreement will be required
to maintain the value of collateral held pursuant to the agreement at not less
than the repurchase price (including accrued interest) and BB&T Asset Management
or the Sub-Adviser will monitor the collateral's value to ensure that it equals
or exceeds the repurchase price (including accrued interest). In addition,
securities subject to repurchase agreements will be held in a segregated
account.
If the seller were to default on its repurchase obligation or become
insolvent, a Fund holding such obligation would suffer a loss to the extent that
the proceeds from a sale of the underlying portfolio securities were less than
the repurchase price under the agreement, or to the extent that the disposition
of such securities held by the Fund were delayed pending court action.
Additionally, if the seller should be involved in bankruptcy or insolvency
proceedings, a Fund may incur delay and costs in selling the underlying security
or may suffer a loss of principal and interest if the Fund is treated as an
unsecured creditor and required to return the underlying security
7
to the seller's estate. Securities subject to repurchase agreements will be held
by BB&T Funds' custodian or another qualified custodian or in the Federal
Reserve/Treasury book-entry system. Repurchase agreements are considered to be
loans by a Fund under the Investment Company Act of 1940 (the "1940 Act").
REVERSE REPURCHASE AGREEMENTS AND DOLLAR ROLL AGREEMENTS. The Funds may
also enter into reverse repurchase agreements and dollar roll agreements in
accordance with applicable investment restrictions. Pursuant to such reverse
repurchase agreements, a Fund would sell certain of its securities to financial
institutions such as banks and broker-dealers, and agree to repurchase them, or
substantially similar securities in the case of a dollar roll agreement, at a
mutually agreed-upon date and price. A dollar roll agreement is analogous to a
reverse repurchase agreement, with a Fund selling mortgage-backed securities for
delivery in the current month and simultaneously contracting to repurchase
substantially similar (same type, coupon and maturity) securities on a specified
future date. At the time a Fund enters into a reverse repurchase agreement or
dollar roll agreement, it will place in a segregated custodial account assets
such as U.S. Government securities or other liquid securities consistent with
its investment restrictions having a value equal to the repurchase price
(including accrued interest), and will subsequently continually monitor the
account to ensure that such equivalent value is maintained at all times. Reverse
repurchase agreements and dollar roll agreements involve the risk that the
market value of securities to be purchased by a Fund may decline below the price
at which it is obligated to repurchase the securities, or that the other party
may default on its obligation, so that a Fund is delayed or prevented from
completing the transaction. Reverse repurchase agreements are considered to be
borrowings by a Fund under the 1940 Act.
U.S. GOVERNMENT SECURITIES. The U.S. Treasury Fund will invest exclusively
in bills, notes and bonds issued or guaranteed by the U.S. Treasury. Such
obligations are supported by the full faith and credit of the U.S. Government.
Each of the other Funds may invest in such securities and in other securities
issued or guaranteed by the U.S. Government, its agencies and instrumentalities.
These securities will constitute the primary investment of the Short Fund and
the Intermediate U.S. Government Fund. Such securities may include those which
are supported by the full faith and credit of the U.S. Government; others which
are supported by the right of the issuer to borrow from the Treasury; others
which are supported by the discretionary authority of the U.S. Government to
purchase the agency's securities; and still others which are supported only by
the credit of the instrumentality. No assurance can be given that the U.S.
Government would provide financial support to U.S. Government-sponsored agencies
and instrumentalities if it is not obligated to do so by law. A Fund will invest
in the obligations of such agencies and instrumentalities only when BB&T Asset
Management or the Sub-Adviser believes that the credit risk with respect thereto
is minimal.
Obligations of certain agencies and instrumentalities of the U.S.
Government, such as the Government National Mortgage Association and the
Export-Import Bank of the United States, are supported by the full faith and
credit of the U.S. Treasury; others, such as those of the Federal National
Mortgage Association, are supported by the right of the issuer to borrow from
the Treasury; others are supported by the discretionary authority of the U.S.
Government to purchase the agency's obligations; still others, such as those of
the Federal Farm Credit Banks, or the Federal Home Loan Mortgage Corporation,
are supported only by the credit of the instrumentality. No assurance can be
given that the U.S. Government would provide financial support to U.S.
Government-sponsored agencies or instrumentalities if it is not obligated to do
so by law.
U.S. Government Securities may include mortgage-backed pass-through
securities. Interest and principal payments (including prepayments) on the
mortgages underlying such securities are passed through to the holders of the
security. Prepayments occur when the borrower under an individual mortgage
prepays the remaining principal before the mortgage's scheduled maturity date.
As a result of the pass-through of prepayments of principal on the underlying
securities, mortgage-backed pass-through securities are often subject to more
rapid prepayments of principal than their stated maturity would indicate.
Because the prepayment characteristics of the underlying mortgages vary, it is
not possible to predict accurately the realized yield or average life of a
particular issue of pass-through certificates. Prepayments are important because
of their effect on the yield and price of the securities. During periods of
declining interest rates, such prepayments can be expected to accelerate, and
the Funds would be required to reinvest the proceeds at the lower interest rates
then available. In addition, prepayments of mortgages which underlie securities
purchased at a premium may not have been fully amortized at the time the
obligation is repaid. As a result of these principal prepayment features,
mortgage-backed pass-through securities are generally more volatile investments
than other U.S. Government Securities. Although under normal market conditions,
the Prime Money Market Fund does not expect to do so, except in connection with
repurchase agreements, it may invest in such mortgage-backed pass-through
securities.
The Taxable Bond Funds and the Stock Funds may also invest in "zero coupon"
U.S. Government Securities. These securities tend to be more volatile than other
types of U.S. Government Securities. Zero coupon securities are debt instruments
that do not pay current interest and are typically sold at prices greatly
discounted from par value. The return on a zero coupon obligation, when held to
maturity, equals the difference between the par value and the original purchase
price. Even though such securities do not pay current
8
interest in cash, a Fund nonetheless is required to accrue interest income on
these investments and to distribute the interest income on a current basis.
Thus, a Fund could be required at times to liquidate other investments in order
to satisfy its distribution requirements.
The Tax-Free Bond Funds may invest in U.S. Government Securities in
connection with the purchase of taxable obligations (as described below).
SUPRANATIONAL ORGANIZATIONAL OBLIGATIONS. The Stock Funds, the Taxable Bond
Funds and the Prime Money Market Fund may purchase debt securities of
supranational organizations such as the European Coal and Steel Community, the
European Economic Community and the World Bank, which are chartered to promote
economic development.
INVESTMENT GRADE DEBT OBLIGATIONS. The Total Return Bond Fund, the Tax-Free
Bond Funds, and the Stock Funds may invest in "investment grade securities,"
which are securities rated in the four highest rating categories of an NRSRO.
The Short Fund and the Intermediate U.S. Government Fund may only invest in
those investment grade securities rated in the three highest rating categories
of an NRSRO. It should be noted that debt obligations rated in the lowest of the
top four ratings (i.e., "Baa" by Moody's Investors Services, Inc. ("Moody's") or
"BBB" by Standard & Poor's Corporation ("S&P"), are considered to have some
speculative characteristics and are more sensitive to economic change than
higher rated securities. The Large Cap Value Fund, Large Cap Growth Fund, Small
Cap Fund, Small Company Growth Fund, Mid Cap Growth Fund, and Mid Cap Value Fund
may each invest up to 20% of their total assets in such securities. An issuer
undergoing reorganization or restructuring may issue to its security holders
additional securities which may be different from the securities already held by
the security holder. The Funds may hold such additional securities even if they
do not generally invest in such securities.
NON-INVESTMENT GRADE DEBT SECURITIES. The Total Return Bond Fund may invest
in debt securities rated below investment grade, also known as junk bonds. These
securities are regarded as predominantly speculative. Securities rated below
investment grade generally provide a higher yield than higher rated securities
of similar maturity, but are subject to a greater degree of risk that the issuer
may not be able to make principal and interest payments. Issuers of these
securities may not be as strong financially as those issuing higher rated
securities. Such high yield issuers may include smaller, less creditworthy
companies or highly indebted firms.
The value of high yield securities may fluctuate more than the value of
higher rated securities, since high yield securities tend to reflect short-term
corporate and market developments to a greater extent than higher rated
securities. Thus, periods of economic uncertainty and change can result in the
increased volatility of market prices of high yield bonds and of the Fund's net
asset value. Additional risks of high yield securities include limited liquidity
and secondary market support. As a result, the prices of high yield securities
may decline rapidly in the event that a significant number of holders decide to
sell. Issuers of high yield securities also are more vulnerable to real or
perceived economic changes, political changes or adverse developments specific
to the issuer. A projection of an economic downturn, for example, could cause
the price of these securities to decline because a recession could lessen the
ability of a highly leveraged company to make principal and interest payments on
its debt securities. In the event of a default, the Total Return Bond Fund would
experience a decline in the value of its investment. In addition, a long-term
track record on bond default rates, such as that for investment grade corporate
bonds, does not exist for the high yield market. It may be that future default
rates on high-yield bonds will be more widespread and higher than in the past,
especially during periods of deteriorating economic conditions.
The market prices of debt securities generally fluctuate with changes in
interest rates so that these Funds' net asset values can be expected to decrease
as long-term interest rates rise and to increase as long-term rates fall. The
market prices of high yield securities structured as zero coupon or pay-in-kind
securities are generally affected to a greater extent by interest rate changes
and tend to be more volatile than securities which pay interest periodically.
Credit quality in the high yield market can change suddenly and
unexpectedly, and even recently-issued credit ratings may not fully reflect the
actual risks posed by a particular high-yield security. The Total Return Bond
Fund will limit its investments in non-investment grade securities to 25% of its
total assets. Subject to SEC restrictions, the Total Return Bond Fund may invest
in such securities by investing in investment companies that primarily invest in
non-investment grade securities.
CUSTODY RECEIPTS. The Taxable Bond Funds may invest in custody receipts
that represent debt securities. Custody receipts, such as Morgan Stanley TRACERs
and Lehman Brothers TRAINs are derivative products which, in the aggregate,
evidence direct ownership in a pool of securities. Typically, a sponsor will
deposit a pool of securities with a custodian in exchange for custody receipts
evidencing those securities. The sponsor will then generally sell those custody
receipts in negotiated transactions at varying prices that are determined at the
time of sale. Each custody receipt evidences the individual securities in the
pool and the holder of a custody receipt generally will have all the rights and
privileges of owners of those securities. Each holder of a custody receipt will
be
9
treated as directly purchasing its pro rata share of the securities in the pool
for an amount equal to the amount that such holder paid for its custody receipt.
If a custody receipt is sold, a holder will be treated as having directly
disposed of its pro rata share of the securities evidenced by the custody
receipt. Additionally, the holder of a custody receipt may withdraw the
securities represented by a custody receipt subject to certain conditions.
Custody receipts are generally subject to the same risks as those
securities evidenced by the receipts which, in the case of the Total Return Bond
Fund, are corporate debt securities. Additionally, custody receipts may also be
less liquid than the underlying securities if the sponsor fails to maintain a
trading market.
COLLATERALIZED MORTGAGE OBLIGATIONS. Each of the Bond Funds and Stock Funds
may also invest in collateralized mortgage obligations ("CMOs"). CMOs are
mortgage-related securities which are structured pools of mortgage pass-through
certificates or mortgage loans. CMOs are issued with a number of classes or
series which have different maturities and which may represent interests in some
or all of the interest or principal on the underlying collateral or a
combination thereof. CMOs of different classes are generally retired in sequence
as the underlying mortgage loans in the mortgage pool are repaid. In the event
of sufficient early prepayments on such mortgages, the class or series of CMO
first to mature generally will be retired prior to its maturity. Thus, the early
retirement of a particular class or series of CMO held by a Fund would have the
same effect as the prepayment of mortgages underlying a mortgage-backed
pass-through security.
CMOs may include stripped mortgage-backed securities ("SMBSs"). Such
securities are derivative multi-class mortgage securities issued by agencies or
instrumentalities of the United States Government, or by private originators of,
or investors in, mortgage loans, including savings and loan associations,
mortgage banks, commercial banks, investment banks and special purpose
subsidiaries of the foregoing. SMBSs are usually structured with two classes
that receive different proportions of the interest and principal distributions
on a pool of mortgage assets. A common type of stripped mortgage security will
have one class receiving all of the interest from the mortgage assets (the
interest-only or "IO" class), while the other class will receive all of the
principal (the principal-only or "PO" class). The yield to maturity on an IO
class is extremely sensitive to the rate of principal payments (including
prepayments) on the related underlying mortgage assets, and a rapid rate of
principal payments may have a material adverse effect on the securities' yield
to maturity. Generally, the value of the PO class is unusually volatile in
response to changes in interest rates. If the underlying mortgage assets
experience greater than anticipated prepayments of principal, the Fund may fail
to fully recoup its initial investment in these securities even if the security
is rated in the highest rating category.
Although stripped mortgage securities are purchased and sold by
institutional investors through several investment banking firms acting as
brokers or dealers, these securities are a fairly recent development. As a
result, established trading markets may not have fully developed. Stripped
mortgage securities issued or guaranteed by the U.S. Government and held by a
Fund may be considered liquid securities pursuant to guidelines established by
BB&T Funds' Board of Trustees. The Funds will not purchase a stripped mortgage
security that is illiquid if, as a result thereof, more than 15% (10% in the
case of the Prime Money Market Fund) of the value of the Fund's net assets would
be invested in such securities and other illiquid securities.
Unless stated otherwise, each Fund will limit its investment in CMOs to 25%
of the value of its total assets.
ASSET-BACKED SECURITIES. The Prime Money Market Fund and the Taxable Bond
Funds may invest in asset-backed securities which are securities created by the
grouping of certain private loans, receivables, and other lender assets, such as
automobile receivables and credit-card receivables, into pools.
Offerings of Certificates for Automobile Receivables ("CARs") are
structured either as flow-through grantor trusts or as pay-through notes. CARs
structured as flow-through instruments represent ownership interests in a fixed
pool of receivables. CARs structured as pay-through notes are debt instruments
supported by the cash flows from the underlying assets. CARs may also be
structured as securities with fixed payment schedules which are generally issued
in multiple-classes. Cash-flow from the underlying receivables is directed first
to paying interest and then to retiring principal via paying down the two
respective classes of notes sequentially. Cash-flows on fixed-payment CARs are
certain, while cash-flows on other types of CARs issues depends on the
prepayment rate of the underlying automobile loans. Prepayments of automobile
loans are triggered mainly by automobile sales and trade-ins. Many people buy
new cars every two or three years, leading to rising prepayment rates as a pool
becomes more seasoned.
Certificates for Amortizing Revolving Debt ("CARDs") represent
participation in a fixed pool of credit card accounts. CARDs pay "interest only"
for a specified period. The CARDs principal balance remains constant during this
period, while any cardholder repayments or new borrowings flow to the issuer's
participation. Once the principal amortization phase begins, the balance
declines with paydowns on the underlying portfolio. Cash flows on CARDs are
certain during the interest-only period. After this initial interest-only
period, the cash flow will depend on how fast cardholders repay their
borrowings. Historically, monthly cardholder
10
repayment rates have been relatively fast. As a consequence, CARDs amortize
rapidly after the end of the interest-only period. During this amortization
period, the principal payments on CARDs depend specifically on the method for
allocating cardholder repayments to investors. In many cases, the investor's
participation is based on the ratio of the CARDs' balance to the total credit
card portfolio balance. This ratio can be adjusted monthly or can be based on
the balances at the beginning of the amortization period. In some issues,
investors are allocated most of the repayments, regardless of the CARDs'
balance. This method results in especially fast amortization.
Credit support for asset-backed securities may be based on the underlying
assets or provided by a third party. Credit enhancement techniques include
letters of credit, insurance bonds, limited guarantees (which are generally
provided by the issuer), senior-subordinated structures and over
collateralization. Asset-backed securities purchased by the Prime Money Market
Fund and the Total Return Bond Fund will be subject to the same quality
requirements as other securities purchased by the Fund.
MUNICIPAL OBLIGATIONS. The Bond Funds and the Prime Money Market Fund may
invest in municipal obligations. Municipal Obligations include debt obligations
issued by governmental entities to obtain funds for various public purposes,
including the construction of a wide range of public facilities, the refunding
of outstanding obligations, the payment of general operating expenses, and the
extension of loans to public institutions and facilities. Private activity bonds
that are or were issued by or on behalf of public authorities to finance various
privately-operated facilities are included within the term Municipal Obligations
if the interest paid thereon is exempt from federal income tax. Opinions
relating to the validity of Municipal Obligations and to the exemption of
interest thereon from federal income taxes are rendered by counsel to the
issuers or bond counsel to the respective issuing authorities at the time of
issuance.
In some cases, Municipal Obligations are represented by custodial receipts
evidencing rights to receive specific future interest payments, principal
payments, or both, on the underlying municipal securities held by the custodian.
Under such arrangements, the holder of the custodial receipt has the option to
tender the underlying municipal securities at its face value to the sponsor
(usually a bank or broker dealer or other financial institution), which is paid
periodic fees equal to the difference between the bond's fixed coupon rate and
the rate that would cause the bond, coupled with the tender option, to trade at
par on the date of a rate adjustment.
An issuer's obligations under its Municipal Obligations are subject to the
provisions of bankruptcy, insolvency, and other laws affecting the rights and
remedies of creditors, such as the federal Bankruptcy Code, and laws, if any,
which may be enacted by federal or state legislatures extending the time for
payment of principal or interest, or both, or imposing other constraints upon
enforcement of such obligations or upon the ability of municipalities to levy
taxes. The power or ability of an issuer to meet its obligations for the payment
of interest on and principal of its Municipal Obligations may be materially,
adversely affected by litigation or other conditions.
TAXABLE OBLIGATIONS. The Taxable Bond Funds may invest in taxable municipal
obligations. Taxable municipal obligations are typically issued by
municipalities or their agencies for purposes which do not qualify for federal
tax exemption, but do qualify for state and local tax exemption ("Taxable
Municipal Obligations"). These debt obligations are issued to finance the cost
of buying, building or improving various projects, such as sporting facilities,
health care facilities, housing projects, electric, water and sewer utilities,
and colleges or universities. Generally, payments on these debt obligations
depend on the revenues generated by the projects, excise taxes or state
appropriations, or the debt obligations can be backed by the government's taxing
power. Due to federal taxation, Taxable Municipal Obligations offer yields more
comparable to other taxable sectors such as corporate bonds or agency bonds than
to other municipal obligations. These debt obligations are federally taxable to
individuals but may be exempt from state and local taxes.
TAX-EXEMPT OBLIGATIONS. Under normal market conditions, the Kentucky Fund
will invest at least 80% of its net assets plus borrowings in investments the
income from which, in the opinion of the issuer's bond counsel at the time of
issuance, is exempt both from federal income tax and Kentucky personal income
tax and not treated as a preference item for purposes of the federal alternative
minimum tax for individuals ("Kentucky Tax-Exempt Obligations"). Under normal
market conditions, the Maryland Fund will invest at least 80% of its net assets
plus borrowings in investments the income from which, in the opinion of the
issuer's bond counsel at the time of issuance, is exempt both from federal
income tax and Maryland personal income tax and not treated as a preference item
for purposes of the federal alternative minimum tax for individuals ("Maryland
Tax-Exempt Obligations"). Under normal market conditions, the North Carolina
Fund will invest at least 80% of its net assets plus borrowings in investments
the income from which, in the opinion of the issuer's bond counsel at the time
of issuance, is exempt both from federal income tax and North Carolina personal
income tax and not treated as a preference item for purposes of the federal
alternative minimum tax for individuals ("North Carolina Tax-Exempt
Obligations"). Under normal market conditions, the South Carolina Fund will
invest at least 80% of its net assets plus borrowings in investments the income
from which, in the opinion of the issuer's bond counsel at the time of issuance,
is exempt both from federal income tax and South Carolina personal income tax
and not treated as a preference item for purposes of the
11
federal alternative minimum tax for individuals ("South Carolina Tax-Exempt
Obligations"). Under normal market conditions, the Virginia Fund will invest at
least 80% of its net assets plus borrowings in investments the income from
which, in the opinion of the issuer's bond counsel at the time of issuance, is
exempt both from federal income tax and Virginia personal income tax and not
treated as a preference item for purposes of the federal alternative minimum tax
for individuals ("Virginia Tax-Exempt Obligations"). Under normal market
conditions, the West Virginia Fund will invest at least 80% of its net assets
plus borrowings in investments the income from which, in the opinion of the
issuer's bond counsel at the time of issuance, is exempt both from federal
income tax and West Virginia personal income tax and not treated as a preference
item for purposes of the federal alternative minimum tax for individuals ("West
Virginia Tax-Exempt Obligations"). In addition to Kentucky Tax-Exempt
Obligations, Maryland Tax-Exempt Obligations, North Carolina Tax-Exempt
Obligations, South Carolina Tax-Exempt Obligations, Virginia Tax-Exempt
Obligations, and West Virginia Tax-Exempt Obligations, the Kentucky Fund, the
Maryland Fund, the North Carolina Fund, the South Carolina Fund, the Virginia
Fund, and the West Virginia Fund may invest in tax-exempt obligations issued by
or on behalf of states other than Kentucky, Maryland, North Carolina, South
Carolina, Virginia, and West Virginia, territories and possessions of the United
States, the District of Columbia and their respective authorities, agencies,
instrumentalities, and political subdivisions, the interest on which, in the
opinion of the issuer's counsel at the time of issuance, is exempt from federal
income tax and is not treated as a preference item for individuals for purposes
of the federal alternative minimum tax. Such securities, Kentucky Tax-Exempt
Obligations, Maryland Tax-Exempt Obligations, North Carolina Tax-Exempt
Obligations, South Carolina Tax-Exempt Obligations, Virginia Tax-Exempt
Obligations, and West Virginia Tax-Exempt Obligations are hereinafter
collectively referred to as "Tax-Exempt Obligations."
Tax-Exempt Obligations include debt obligations issued by governmental
entities to obtain funds for various public purposes, such as the construction
of a wide range of public facilities, the refunding of outstanding obligations,
the payment of general operating expenses, and the extension of loans to other
public institutions and facilities. Private activity bonds that are issued by or
on behalf of public authorities to finance various privately-operated facilities
are included within the term Tax-Exempt Obligations if the interest paid thereon
is both exempt from federal income tax and not treated as a preference item for
individuals for purposes of the federal alternative minimum tax.
Tax-Exempt Obligations may also include General Obligation Notes, Tax
Anticipation Notes, Bond Anticipation Notes, Revenue Anticipation Notes, Project
Notes, Tax-Exempt Commercial Paper, Construction Loan Notes and other forms of
short-term tax-exempt loans. Such instruments are issued with a short-term
maturity in anticipation of the receipt of tax funds, the proceeds of bond
placements or other revenues.
Project Notes are issued by a state or local housing agency and are sold by
the Department of Housing and Urban Development. While the issuing agency has
the primary obligation with respect to its Project Notes, they are also secured
by the full faith and credit of the United States through agreements with the
issuing authority which provide that, if required, the federal government will
lend the issuer an amount equal to the principal of and interest on the Project
Notes.
As described in the Prospectus, the two principal classifications of
Tax-Exempt Obligations consist of "general obligation" and "revenue" issues.
General obligation bonds are typically backed by the full faith and credit of
the issuer, whereas revenue bonds are payable from a specific project or other
limited source of revenue. The Tax-Free Bond Funds are permitted to invest in
Tax-Exempt Obligations and may also acquire "moral obligation" issues, which are
normally issued by special purpose authorities. Currently, neither North
Carolina, South Carolina nor West Virginia issuers have authority to issue moral
obligation securities. State and local governments in Virginia and Kentucky also
enter into financings that are not general obligations of the issuer but are
secured by the "moral obligation" of the state or local government. There are,
of course, variations in the quality of Tax-Exempt Obligations, both within a
particular classification and between classifications, and the yields on
Tax-Exempt Obligations depend upon a variety of factors, including general money
market conditions, the financial condition of the issuer, general conditions of
the municipal bond market, the size of a particular offering, the maturity of
the obligation and the rating of the issue. The ratings of Moody's and S&P
represent their opinions as to the quality of Tax-Exempt Obligations. It should
be emphasized, however, that ratings are general and are not absolute standards
of quality, and Tax-Exempt Obligations with the same maturity, interest rate and
rating may have different yields, while Tax-Exempt Obligations of the same
maturity and interest rate with different ratings may have the same yield.
Subsequent to purchase by a Tax-Free Bond Fund, an issue of Tax-Exempt
Obligations may cease to be rated or its rating may be reduced below the minimum
rating required for purchase by the Funds. Neither event would under all
circumstances require the elimination of such an obligation from the Tax-Free
Bond Fund's investment portfolio. However, the obligation generally would be
retained only if such retention was determined by the Board of Trustees to be in
the best interests of the Tax-Free Bond Fund.
An issuer's obligations for its Tax-Exempt Obligations are subject to the
provisions of bankruptcy, insolvency, and other laws affecting the rights and
remedies of creditors, such as the federal bankruptcy code, and laws, if any,
which may be enacted by Congress or state legislatures extending the time for
payment of principal or interest, or both, or imposing other constraints upon
the
12
enforcement of such obligations or upon the ability of municipalities to levy
taxes. The power or ability of an issuer to meet its obligations for the payment
of interest on and principal of its Tax-Exempt Obligations may be materially
adversely affected by litigation or other conditions.
Also included within the general category of Tax-Exempt Obligations are
participation certificates in a lease, an installment purchase contract, or a
conditional sales contract (hereinafter collectively called "lease obligations")
entered into by a state or political subdivisions to finance the acquisition or
construction of equipment, land, or facilities. Although lease obligations do
not generally constitute general obligations of the issuer for which the
lessee's unlimited taxing power is pledged (in South Carolina, certain
governmental lease obligations are included in calculation of the general
obligation debt limit while in Virginia, such obligations are not included in
the calculation of applicable debt limits, provided such obligations are
properly structured), the lease obligation is frequently assignable and backed
by the lessee's covenant to budget for, appropriate, and make the payments due
under the lease obligation. However, certain lease obligations contain
"non-appropriation" clauses which provide that the lessee has no obligation to
make lease or installment purchase payments in future years unless money is
appropriated for such purpose on a yearly basis. Although "non-appropriation"
lease obligations are secured by the leased property, disposition of the
property in the event of foreclosure might prove difficult. These securities
represent a relatively new type of financing that has not yet developed the
depth of marketability associated with more conventional securities. Certain
investments in lease obligations may be illiquid. Under guidelines established
by the Board of Trustees, the following factors will be considered when
determining the liquidity of a lease obligation: (1) the frequency of trades and
quotes for the obligation; (2) the number of dealers willing to purchase or sell
the obligation and the number of potential buyers; (3) the willingness of
dealers to undertake to make a market in the obligation; and (4) the nature of
the marketplace trades.
VARIABLE AND FLOATING RATE NOTES. The Tax-Free Bond Funds may acquire
variable and floating rate tax-exempt notes, subject to each Fund's investment
objective, policies, and restrictions. The Prime Money Market Fund may purchase
rated and unrated variable and floating rate instruments, which may have a
stated maturity in excess of 13 months but will, in any event, permit the Fund
to demand payment of the principal of the instrument at least once every 13
months upon not more than 30 days' notice. A variable rate note is one whose
terms provide for the adjustment of its interest rate on set dates and which,
upon such adjustment, can reasonably be expected to have a market value that
approximates its par value. A floating rate note is one whose terms provide for
the adjustment of its interest rate whenever a specified interest rate changes
and which, at any time, can reasonably be expected to have a market value that
approximates its par value. Such notes are frequently not rated by credit rating
agencies; however, unrated variable and floating rate notes purchased by a Fund
will be determined by BB&T Asset Management with respect to the Tax-Free Bond
Funds, (or FIMC with respect to the Prime Money Market Fund) under guidelines
established by BB&T Funds' Board of Trustees to be of comparable quality at the
time of purchase to rated instruments eligible for purchase under a Fund's
investment policies. In making such determinations, BB&T Asset Management with
respect to the Tax-Free Bond Funds (or FIMC with respect to the Prime Money
Market Fund) will consider the earning power, cash flow and other liquidity
ratios of the issuers of such notes (such issuers include financial,
merchandising, bank holding and other companies) and will continuously monitor
their financial condition. Although there may be no active secondary market with
respect to a particular variable or floating rate note purchased by the Prime
Money Market Fund or the Tax-Free Bond Funds, a Fund may resell a note at any
time to a third party. The absence of an active secondary market, however, could
make it difficult for a Fund to dispose of a variable or floating rate note in
the event the issuer of the note defaulted on its payment obligations and a Fund
could, as a result or for other reasons, suffer a loss to the extent of the
default. Variable or floating rate notes may be secured by bank letters of
credit. Variable and floating rate notes for which no readily available market
exists will be purchased in an amount which, together with other securities
which are not readily marketable, exceeds 15% of each Tax-Free Bond Fund's net
assets (10% for the Prime Money Market Fund) only if such notes are subject to a
demand feature that will permit the Fund to receive payment of the principal
within seven days after demand by the Fund.
For purposes of the Tax-Free Bond Funds and the Prime Money Market Fund,
the maturities of the variable and floating rate notes will be determined in
accordance with Rule 2a-7 under the 1940 Act.
WHEN-ISSUED SECURITIES. Each Fund, except the U.S. Treasury Fund, may
purchase securities on a when-issued basis. In addition, the Stock Funds and the
Prime Money Market Fund may purchase and sell securities on a forward commitment
basis (I.E., for delivery beyond the normal settlement date at a stated price
and yield), including "TBA" (to be announced) purchase commitments. When these
Funds agree to purchase securities on a when-issued or forward commitment basis,
the Fund's custodian will set aside cash or liquid portfolio securities equal to
the amount of the commitment in a separate account. Normally, the custodian will
set aside portfolio securities to satisfy the purchase commitment, and in such a
case, a Fund may be required subsequently to place additional assets in the
separate account in order to assure that the value of the account remains equal
to the amount of the Fund's commitment. It may be expected that any such Fund's
net assets will fluctuate to a greater degree when it sets aside portfolio
securities to cover such purchase commitments than when it sets aside cash.
13
When a Fund engages in when-issued or forward commitment transactions, it
relies on the seller to consummate the trade. Failure of the seller to do so may
result in the Fund incurring a loss or missing the opportunity to obtain a price
considered to be advantageous. In addition, the purchase of securities on a
when-issued or forward commitment basis involves a risk of loss if the value of
the security to be purchased declines prior to the settlement date. Each of the
Funds does not intend to purchase when-issued securities for speculative
purposes but only in furtherance of its investment objective. A Fund expects
that commitments by a Fund to purchase when-issued securities will not exceed
25% of the value of its total assets under normal market conditions.
CALLS. The Stock Funds and the Funds of Funds may write (sell) "covered"
call options and purchase options to close out options previously written by it.
Such options must be listed on a National Securities Exchange and issued by the
Options Clearing Corporation. In the case of a call option on a security, the
option is "covered" if the Fund owns the security underlying the call or has an
absolute and immediate right to acquire that security without additional cash
consideration (or, if additional cash consideration is required, cash or cash
equivalents in such amount as are held in a segregated account by its custodian)
upon conversion or exchange of other securities held by it. For a call option on
an index, the option is covered if the Fund maintains with its custodian cash or
liquid portfolio securities equal to the contract value. A call option is also
covered if the Fund holds a call on the same security or index as the call
written where the exercise price of the call held is (i) equal to or less than
the exercise price of the call written, or (ii) greater than the exercise price
of the call written provided the difference is maintained by the Fund in cash or
liquid portfolio securities in a segregated account with its custodian.
The purpose of writing covered call options is to generate additional
premium income for the Funds. This premium income will serve to enhance each
Fund's total return and will reduce the effect of any price decline of the
security involved in the option. Covered call options will generally be written
on securities which, in the opinion of a Fund's Adviser or Sub-Adviser, are not
expected to make any major price moves in the near future but which, over the
long term, are deemed to be attractive investments for the Funds.
A call option gives the holder (buyer) the right to purchase a security at
a specified price (the exercise price) at any time until a certain date (the
expiration date). So long as the obligation of the writer of a call option
continues, he or she may be assigned an exercise notice by the broker-dealer
through whom such option was sold, requiring the writer to deliver the
underlying security against payment of the exercise price. This obligation
terminates upon the expiration of the call option, or such earlier time at which
the writer effects a closing purchase transaction by repurchasing an option
identical to that previously sold. To secure the writer's obligation to deliver
the underlying security in the case of a call option, a writer is required to
deposit in escrow the underlying security or other assets in accordance with the
rules of the Options Clearing Corporation. The Funds will write only covered
call options. This means that a Fund will only write a call option on a security
which it already owns. A Fund will not write a covered call option if, as a
result, the aggregate fair value of all portfolio securities covering call
options or subject to put options exceeds 25% of the fair value of its net
assets.
Fund securities on which call options may be written will be purchased
solely on the basis of investment considerations consistent with a Fund's
investment objectives. The writing of covered call options is a conservative
investment technique believed to involve relatively little risk (in contrast to
the writing of naked or uncovered options which the Funds will not do), but
capable of enhancing a Fund's total return. When writing a covered call option,
a Fund, in return for the premium, gives up the opportunity for profit from a
price increase in the underlying security above the exercise price, but retains
the risk of loss should the price of the security decline. Unlike one who owns
securities not subject to an option, a Fund does not have any control over the
point at which it may be required to sell the underlying securities, because it
may be assigned an exercise notice at any time prior to the expiration of its
obligation as a writer. If a call option which a Fund has written expires, a
Fund will realize a gain in the amount of the premium; however, such gain may be
offset by a decline in the market value of the underlying security during the
option period. If the call option is exercised, a Fund will realize a gain or
loss from the sale of the underlying security. The security covering the call
will be maintained in a segregated account of a Fund's custodian. A Fund does
not consider a security covered by a call to be "pledged" as that term is used
in its policy which limits the pledging or mortgaging of its assets.
The premium received is the market value of an option. The premium a Fund
will receive from writing a call option will reflect, among other things, the
current market price of the underlying security, the relationship of the
exercise price to such market price, the historical price volatility of the
underlying security, and the length of the option period. Once the decision to
write a call option has been made, BB&T Asset Management or the Sub-Adviser, in
determining whether a particular call option should be written on a particular
security, will consider the reasonableness of the anticipated premium and the
likelihood that a liquid secondary market will exist for those options. The
premium received by a Fund for writing covered call options will be recorded as
a liability in a Fund's statement of assets and liabilities. This liability will
be readjusted daily to the option's current market value, which will be the
latest sale price at the time at which the net asset value per share of a Fund
is computed (close of the New York Stock Exchange), or, in the
14
absence of such sale, the latest asked price (or, with respect to the
International Equity Fund, the mean between the last bid and asked prices). The
liability will be extinguished upon expiration of the option, the purchase of an
identical option in the closing transaction, or delivery of the underlying
security upon the exercise of the option.
Closing transactions will be effected in order to realize a profit on an
outstanding call option, to prevent an underlying security from being called, or
to permit the sale of the underlying security. Furthermore, effecting a closing
transaction will permit a Fund to write another call option on the underlying
security with either a different exercise price or expiration date or both. If a
Fund desires to sell a particular security from its portfolio on which it has
written a call option, it will seek to effect a closing transaction prior to, or
concurrently with, the sale of the security. There is, of course, no assurance
that a Fund will be able to effect such closing transactions at a favorable
price. If a Fund cannot enter into such a transaction, it may be required to
hold a security that it might otherwise have sold, in which case it would
continue to be at market risk on the security. This could result in higher
transaction costs. A Fund will pay transaction costs in connection with the
writing of options to close out previously written options. Such transaction
costs are normally higher than those applicable to purchases and sales of
portfolio securities.
Call options written by a Fund will normally have expiration dates of less
than nine months from the date written. The exercise price of the options may be
below, equal to, or above the current market values of the underlying securities
at the time the options are written. From time to time, a Fund may purchase an
underlying security for delivery in accordance with an exercise notice of a call
option assigned to it, rather than delivering such security from its portfolio.
In such cases, additional costs will be incurred.
A Fund will realize a profit or loss from a closing purchase transaction if
the cost of the transaction is less or more than the premium received from the
writing of the option. Because increases in the market price of a call option
will generally reflect increases in the market price of the underlying security,
any loss resulting from the repurchase of a call option is likely to be offset
in whole or in part by appreciation of the underlying security owned by a Fund.
PUTS. The Tax-Free Bond Funds may acquire "puts" with respect to Tax-Exempt
Obligations held in their portfolios, and the Funds of Funds may acquire puts
with respect to the securities in their portfolios. The Large Cap Growth Fund
and the International Equity Fund may buy put options, buy call options, and
write secured put options for the purpose of hedging or earning additional
income, which may be deemed speculative or, with respect to the International
Equity Fund, cross-hedging. A put is a right to sell a specified security (or
securities) within a specified period of time at a specified exercise price.
Each of these Funds may sell, transfer, or assign a put only in conjunction with
the sale, transfer, or assignment of the underlying security or securities.
The amount payable to a Fund upon its exercise of a "put" is normally (i)
the Fund's acquisition cost of the securities subject to the put (excluding any
accrued interest which the Fund paid on the acquisition), less any amortized
market premium or plus any amortized market or original issue discount during
the period the Fund owned the securities, plus (ii) all interest accrued on the
securities since the last interest payment date during that period.
Puts may be acquired by the Tax-Free Bond Funds and the Funds of Funds to
facilitate the liquidity of their portfolio assets or to shorten the maturity of
underlying assets. Puts may also be used to facilitate the reinvestment of
assets at a rate of return more favorable than that of the underlying security.
The Tax-Free Bond Funds and the Funds of Funds will generally acquire puts
only where the puts are available without the payment of any direct or indirect
consideration. However, if necessary or advisable, a Fund may pay for puts
either separately in cash or by paying a higher price for portfolio securities
which are acquired subject to the puts (thus reducing the yield to maturity
otherwise available for the same securities).
The Tax-Free Bond Funds and the Funds of Funds intend to enter into puts
only with dealers, banks, and broker-dealers which, in BB&T Asset Management's
opinion, present minimal credit risks.
PUT AND CALL OPTIONS. A Fund will not purchase put and call options when
the aggregate premiums on outstanding options exceed 5% of its net assets at the
time of purchase, and will not write options on more than 25% of the value of
its net assets (measured at the time an option is written). Options trading is a
highly specialized activity that entails greater than ordinary investment risks.
In addition, unlisted options are not subject to the protections afforded
purchasers of listed options issued by the Options Clearing Corporation, which
performs the obligations of its members if they default. Cross-hedging is the
use of options or forward contracts in one currency to hedge against
fluctuations in the value of securities denominated in a different currency
based on a belief that there is a pattern of correlation between the two
currencies.
15
Each Fund of BB&T Funds (other than the U.S. Treasury Money Market Fund and
the Prime Money Market Fund) may purchase and sell call and put options on
futures contracts traded on an exchange or board of trade. When a Fund purchases
an option on a futures contract, it has the right to assume a position as a
purchaser or a seller of a futures contract at a specified exercise price during
the option period. When a Fund sells an option on a futures contract, it becomes
obligated to sell or buy a futures contract if the option is exercised. In
connection with a Fund's position in a futures contract or related option, a
Fund will create a segregated account of liquid assets or will otherwise cover
its position in accordance with applicable SEC requirements.
STAND-BY COMMITMENTS. The Tax-Free Bond Funds may acquire "stand-by
commitments" with respect to Tax-Exempt Obligations held in their portfolios.
Under a stand-by commitment, a dealer would agree to purchase at a Fund's option
specified securities at their amortized cost value to the Fund plus accrued
interest, if any. (Stand-by commitments acquired by a Fund may also be referred
to as "put" options.) Stand-by commitments may be exercisable by a Fund at any
time before the maturity of the underlying securities and may be sold,
transferred, or assigned only with the instruments involved. A Fund's right to
exercise stand-by commitments will be unconditional and unqualified.
The amount payable to a Fund upon its exercise of a stand-by commitment
will normally be (i) the Fund's acquisition cost of the securities (excluding
any accrued interest which the Fund paid on their acquisition), less any
amortized market premium or plus any amortized market or original issue discount
during the period the Fund owned the securities, plus (ii) all interest accrued
on the securities since the last interest payment date during the period.
Each Fund expects that stand-by commitments will generally be available
without the payment of any direct or indirect consideration. However, if
necessary or advisable, a Fund may pay for a stand-by commitment either
separately in cash or by paying a higher price for portfolio securities which
are acquired subject to the commitment (thus reducing the yield to maturity
otherwise available for the same securities). The total amount paid in either
manner for outstanding stand-by commitments held by a Fund will not exceed 1/2
of 1% of the value of that Fund's total assets calculated immediately after each
stand-by commitment is acquired.
Each Fund intends to enter into stand-by commitments only with dealers,
banks, and broker-dealers which, in the investment adviser's opinion, present
minimal credit risks. A Fund's reliance upon the credit of these dealers, banks,
and broker-dealers will be secured by the value of the underlying securities
that are subject to the commitment.
A Fund would acquire stand-by commitments solely to facilitate portfolio
liquidity and does not intend to exercise its rights thereunder for trading
purposes. The acquisition of a stand-by commitment would not affect the
valuation or assumed maturity of the underlying securities, which would continue
to be valued in accordance with the amortized cost method. Stand-by commitments
acquired by a Fund would by valued at zero in determining net asset value. Where
the Fund paid any consideration directly or indirectly for a stand-by
commitment, its cost would be reflected as unrealized depreciation for the
period during which the commitment was held by that Fund.
RISK FACTORS RELATING TO OPTIONS. There are several risks associated with
transactions in put and call options. For example, there are significant
differences between the securities and options markets that could result in an
imperfect correlation between these markets, causing a given transaction not to
achieve its objectives. In addition, a liquid secondary market for particular
options, whether traded over-the-counter or on a national securities exchange
("Exchange") may be absent for reasons which include the following: there may be
insufficient trading interest in certain options, restrictions may be imposed by
an Exchange on opening transactions or closing transactions or both; trading
halts, suspensions or other restrictions may be imposed with respect to
particular classes or series of options or underlying securities; unusual or
unforeseen circumstances may interrupt normal operations on an Exchange; the
facilities of an Exchange or the Options Clearing Corporation may not at all
times be adequate to handle current trading volume; or one or more Exchanges
could, for economic or other reasons, decide or be compelled at some future date
to discontinue the trading of options (or a particular class or series of
options), in which event the secondary market on that Exchange (or in that class
or series of options) would cease to exist, although outstanding options that
had been issued by the Options Clearing Corporation as a result of trades on
that Exchange would continue to be exercisable in accordance with their terms.
In addition, the success of a hedging strategy based on options transactions may
depend on the ability of the Fund's Adviser or Sub-Adviser to predict movements
in the prices of individual securities, fluctuations in markets and movements in
interest rates.
FUTURES CONTRACTS AND RELATED OPTIONS. Each Fund of BB&T Funds (other than
the U.S. Treasury Money Market Fund and the Prime Money Market Fund) may invest
in futures contracts and options thereon (interest rate futures contracts or
index futures contracts, as applicable). The value of a Fund's contracts may
equal or exceed 100% of the Fund's total assets, although a Fund will not
purchase or sell a futures contract unless immediately afterwards the aggregate
amount of margin deposits on its existing
16
futures positions plus the amount of premiums paid for related futures options
entered into for other than bona fide hedging purposes is 5% or less of its net
assets.
Futures contracts obligate a Fund, at maturity, to take or make delivery of
securities, the cash value of a securities index or a stated quantity of a
foreign currency. A Fund may sell a futures contract in order to offset an
expected decrease in the value of its portfolio positions that might otherwise
result from a market decline or currency exchange fluctuation. A Fund may do so
either to hedge the value of its securities portfolio as a whole, or to protect
against declines occurring prior to sales of securities in the value of the
securities to be sold. In addition, a Fund may utilize futures contracts in
anticipation of changes in the composition of its holdings or in currency
exchange rates. Positions in futures contracts may be closed out only on an
exchange which provides a secondary market for such futures. However, there can
be no assurance that a liquid secondary market will exist for any particular
futures contract at any specific time. Thus, it may not be possible to close a
futures position. In the event of adverse price movements, the 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 at a time when it may be
disadvantageous to do so. In addition, a Fund may be required to make delivery
of the instruments underlying futures contracts it holds. The inability to close
options and futures positions also could have an adverse impact on a Fund's
ability to effectively hedge.
Successful use of futures by the Funds is also subject to an Adviser's or
Sub-Adviser's ability to correctly predict movements in the direction of the
market. For example, if a Fund has hedged against the possibility of a decline
in the market adversely affecting securities held by it and securities prices
increase instead, a Fund will lose part or all of the benefit to the increased
value of its securities which it has hedged because it will have approximately
equal offsetting losses in its futures positions. In addition, in some
situations, if a Fund has insufficient cash, it may have to sell securities to
meet daily variation margin requirements. Such sales of securities may be, but
will not necessarily be, at increased prices which reflect the rising market. A
Fund may have to sell securities at a time when it may be disadvantageous to do
so.
The risk of loss in trading futures contracts in some strategies can be
substantial, due both to the low margin deposits required, and the extremely
high degree of leverage involved in futures pricing. As a result, a relatively
small price movement in a futures contract may result in immediate and
substantial loss (as well as 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, before any deduction for the
transaction costs, if the contract were closed out. Thus, a purchase or sale of
a futures contract may result in losses in excess of the amount invested in the
contract.
Utilization of futures transactions by a Fund involves the risk of loss by
a Fund of margin deposits in the event of bankruptcy of a broker with whom a
Fund has an open position in a futures contract or related option.
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 futures positions and subjecting some futures
traders to substantial losses.
The trading of futures contracts is also subject to the risk of trading
halts, suspensions, exchange or clearing house equipment failures, government
intervention, insolvency of a brokerage firm or clearing house or other
disruptions of normal trading activity, which could at times make it difficult
to impossible to liquidate existing positions or to recover excess variation
margin payments.
RIGHTS OFFERINGS AND WARRANTS TO PURCHASE. The Stock Funds may participate
in rights offerings and may purchase warrants, which are privileges issued by
corporations enabling the owners to subscribe to and purchase a specified number
of shares of the corporation at a specified price during a specified period of
time. Subscription rights normally have a short life span to expiration. The
purchase of rights or warrants involves the risk that the Fund could lose the
purchase value of a right or warrant if the right to subscribe to additional
shares is not exercised prior to the rights' and warrants' expiration. Also, the
purchase of rights and/or warrants involves the risk that the effective price
paid for the right and/or warrant added to the subscription price of the related
security may exceed the value of the subscribed security's market price such as
when there is no movement in the level of the underlying security.
17
EXCHANGE-TRADED FUNDS. Each Stock Fund, Capital Manager Fund and the Prime
Money Market Fund may invest in index-based exchange-traded funds, such as
iShares(R) Trust and iShares,(R) Inc. ("iShares(R)*"). However, the Prime Money
Market Fund does not intend to invest in exchange-traded funds.
iShares(R) is a registered investment company unaffiliated with the Funds
that offers several series of securities, each of which seeks to replicate the
performance of a market index. Thus, investment in iShares(R) offers, among
other things, an efficient means to achieve diversification in a particular
industry that would otherwise only be possible through a series of transactions
and numerous holdings. Although similar diversification benefits may be achieved
through an investment in another investment company, exchange-traded funds
generally offer greater liquidity and lower expenses. Because an exchange-traded
fund charges its own fees and expenses, fund shareholders will indirectly bear
these costs. The Funds will also incur brokerage commissions and related charges
when purchasing shares in an exchange-traded fund in secondary market
transactions. Unlike typical investment company shares, which are valued once
daily, shares in an exchange-traded fund may be purchased or sold on a listed
securities exchange throughout the trading day at market prices that are
generally close to net asset value.
Because exchange-traded funds are investment companies, investment in such
funds would, absent exemptive relief, be limited under applicable Federal
statutory provisions. Those provisions restrict a fund's investment in the
shares of another investment company to up to 5% of its total assets (which may
represent no more than 3% of the securities of such other investment company)
and limit aggregate investments in all investment companies to 10% of total
assets. The Funds may invest in iShares(R) in excess of the statutory limit in
reliance on an exemptive order issued to that entity, provided that certain
conditions are met.
*iShares(R) is a registered trademark of Barclays Global Investors, N.A.
("BGI"). Neither BGI nor the iShares(R) Funds make any representations regarding
the advisability of investing in an iShares(R) fund.
INVESTMENT COMPANIES. Each Fund, except the U.S. Treasury Fund and the
Funds of Funds, may, to the extent permitted by the 1940 Act, invest in the
securities of unaffiliated money market mutual funds. Pursuant to exemptive
relief granted by the SEC for each Fund, except the Prime Money Market Fund and
the U.S. Treasury Fund, each Fund may invest in Shares of the Prime Money Market
Fund and the U.S. Treasury Fund. In order to avoid the imposition of additional
fees as a result of investments in Shares of the Prime Money Market Fund or the
U.S. Treasury Fund, BB&T Asset Management (as adviser and administrator) and
BISYS Fund Services (the "Sub-Administrator") will reduce that portion of their
usual asset-based service fees from each investing Fund by an amount equal to
their service fees from the Prime Money Market Fund or the U.S. Treasury Fund,
that are attributable to those Fund investments. BB&T Asset Management will
promptly forward such fees to the investing Funds. The Funds will incur
additional expenses due to the duplication of expenses as a result of investing
in securities of other unaffiliated money market mutual funds.
In addition, the International Equity Fund may purchase shares of
investment companies (which may include exchange-traded funds) investing
primarily in foreign securities, including so-called "country funds." Country
funds have portfolios consisting exclusively of securities of issuers located in
one country.
The Total Return Bond Fund may invest in investment companies that invest
primarily in debt securities.
CONVERTIBLE SECURITIES. The Total Return Bond Fund and the Stock Funds may
invest in convertible securities. Convertible securities are fixed
income-securities which may be exchanged or converted into a predetermined
number of the issuer's underlying common stock at the option of the holder
during a specified time period. Convertible securities may take the form of
convertible preferred stock, convertible bonds or debentures, units consisting
of "usable" bonds and warrants or a combination of the features of several of
these securities. Convertible bonds and convertible preferred stocks are
fixed-income securities that generally retain the investment characteristics of
fixed-income securities until they have been converted, but also react to
movements in the underlying equity securities. The holder is entitled to receive
the fixed-income of a bond or the dividend preference of a preferred stock until
the holder elects to exercise the conversion privilege. Usable bonds are
corporate bonds that can be used in whole or in part, customarily at full face
value, in lieu of cash to purchase the issuer's common stock. When owned as part
of a unit along with warrants, which are options to buy the common stock, they
function as convertible bonds, except that the warrants generally will expire
before the bond's maturity. Convertible securities are senior to equity
securities, and, therefore, have a claim to assets of the corporation prior to
the holders of common stock in the case of liquidation. However, convertible
securities are generally subordinated to similar non-convertible securities of
the same company. The interest income and dividends from convertible bonds and
preferred stocks provide a stable stream of income with generally higher yields
than common stocks, but lower than non-convertible securities of similar
quality.
18
RESTRICTED SECURITIES. Each Fund of BB&T Funds (other than the U.S.
Treasury Money Market Fund) may invest in commercial paper issued by
corporations without registration under the Securities Act of 1933 (the "1933
Act") in reliance on the exemption in Section 3(a)(3), and commercial paper
issued in reliance on the so-called "private placement" exemption in Section
4(2) ("Section 4(2) paper"). Section 4(2) paper is restricted as to disposition
under the Federal securities laws in that any resale must similarly be made in
an exempt transaction. Section 4(2) paper is normally resold to other
institutional investors through or with the assistance of investment dealers
which make a market in Section 4(2) paper, thus providing liquidity.
Each Fund of BB&T Funds (other than the U.S. Treasury Money Market Fund)
may purchase securities which are not registered under the 1933 Act but which
can be sold to "qualified institutional buyers" in accordance with Rule 144A
under the 1933 Act. These securities will not be considered illiquid so long as
the Adviser or Sub-Adviser determines that an adequate trading market exists for
the securities. This investment practice could have the effect of increasing the
level of illiquidity in a Fund during any period that qualified institutional
buyers become uninterested in purchasing these restricted securities.
SECURITIES LENDING. In order to generate additional income, each Fund may,
from time to time, lend its portfolio securities to broker-dealers, banks or
institutional borrowers of securities which BB&T Asset Management and/or a
Fund's respective Sub-Adviser has determined are creditworthy under guidelines
established by BB&T Funds' Board of Trustees. BB&T Funds will employ one or more
securities lending agents to initiate and affect securities lending transactions
for BB&T Funds. While the lending of securities may subject a Fund to certain
risks, such as delays or the inability to regain the securities in the event the
borrower was to default on its lending agreement or enter into bankruptcy, the
Fund will lend only on a fully collateralized basis in order to reduce such
risk. During the time portfolio securities are on loan, the Fund is entitled to
receive any dividends or interest paid on such securities. Additionally, cash
collateral received will be invested on behalf of the Fund exclusively in money
market instruments. While a Fund will not have the right to vote securities on
loan, the Funds intend to terminate the loan and retain the right to vote if
that is considered important with respect to the investment. Each Fund will
restrict its securities lending to 33 1/3% of its total assets.
CALLABLE SECURITIES. Certain fixed income securities invested in by the
Bond Funds and the Money Market Funds are callable at the option of the issuer.
Callable Securities are subject to Prepayment/Call risk.
STRUCTURED PRODUCTS. One common type of security is a "structured" product.
Structured products, such as structured notes, generally are individually
negotiated agreements and may be traded over the counter. They are organized and
operated to restructure the investment characteristics of the underlying
security. This structuring involves the deposit with or purchase by an entity,
such as a corporation or trust, of specified instruments (such as commercial
bank loans) and the issuance by that entity of one or more classes of securities
("structured securities") backed by, or representing interests in, the
underlying instruments. The cash flow on the underlying instruments may be
apportioned among the newly issued structured securities to create securities
with different investment characteristics, such as varying maturities, payment
priorities and interest rate provisions, and the extent of such payments made
with respect to structured securities is dependant on the extent of the cash
flow of the underlying instruments. With respect to structured products, because
structured securities typically involve no credit enhancement, their credit risk
generally will be equivalent to that of the underlying instruments. Investments
in structured securities age generally of a class that is either subordinated or
unsubordinated to the right of payment of another class. Subordinated structured
securities typically have higher yields and present greater risks than
unsubordinated structured securities. Structured securities are typically sold
in private placement transactions, and there is currently no active trading
market for these securities.
INVESTMENT RESTRICTIONS
Except as provided otherwise, the following investment restrictions may be
changed with respect to a particular Fund only by a vote of a majority of the
outstanding Shares of that Fund (as defined under "GENERAL INFORMATION -
Miscellaneous" in this Statement of Additional Information).
THE PRIME MONEY MARKET FUND AND THE U.S. TREASURY FUND MAY NOT:
1. Purchase securities of any issuer, other than obligations issued or
guaranteed by the U.S. Government if, as a result, with respect to 75% of its
portfolio, more than 5% of the value of the Fund's total assets would be
invested in such issuer. In addition, although not a fundamental investment
restriction (and therefore subject to change without shareholder vote), to the
extent required by rules of the Securities and Exchange Commission, the Prime
Money Market Fund and the U.S. Treasury Fund will apply this restriction to 100%
of its portfolio, except that for the Prime Money Market Fund, 25% of the value
of its total assets may be invested in any one issuer for a period of up to
three business days.
19
EACH TAXABLE BOND FUND MAY NOT:
1. Purchase securities of any one issuer, other than obligations issued or
guaranteed by the U.S. Government or its agencies or instrumentalities, if,
immediately after such purchase with respect to 75% of its portfolio, more than
5% of the value of the Fund's total assets would be invested in such issuer.
There is no limit as to the percentage of assets that may be invested in U.S.
Treasury bills, notes, or other obligations issued or guaranteed by the U.S.
Government or its agencies or instrumentalities.
2. Purchase any securities that would cause 25% or more of the value of
such Fund's total assets at the time of purchase to be invested in securities of
one or more issuers conducting their principal business activities in the same
industry, provided that (a) there is no limitation with respect to obligations
issued or guaranteed by the U.S. Government or its agencies or instrumentalities
and repurchase agreements secured by obligations of the U.S. Government or its
agencies or instrumentalities; (b) wholly-owned finance companies will be
considered to be in the industries of their parents if their activities are
primarily related to financing the activities of their parents; and (c)
utilities will be divided according to their services. For example, gas, gas
transmission, electric and gas, electric, and telephone will each be considered
a separate industry.
EACH OF THE FUNDS OF FUNDS MAY NOT:
1. Purchase any securities that would cause 25% or more of the value of
such Fund's total assets at the time of purchase to be invested in securities of
one or more issuers conducting their principal business activities in the same
industry, provided that (a) there is no limitation with respect to obligations
issued or guaranteed by the U.S. Government or its agencies or
instrumentalities, repurchase agreements secured by obligations of the U.S.
Government or its agencies or instrumentalities or securities issued by
"regulated investment companies" as defined in the Internal Revenue Code of
1986, as amended (the "Code"); (b) wholly-owned finance companies will be
considered to be in the industries of their parents if their activities are
primarily related to financing the activities of their parents; and (c)
utilities will be divided according to their services. For example, gas, gas
transmission, electric and gas, electric, and telephone will each be considered
a separate industry.
2. Purchase securities of any one issuer, other than obligations issued or
guaranteed by the U.S. Government or its agencies or instrumentalities or
"regulated investment companies" as defined in the Code, if, immediately after
such purchase, more than 5% of the value of the Fund's total assets would be
invested in such issuer, or the Fund would hold more than 10% of any class of
securities of the issuer or more than 10% of the outstanding voting securities
of the issuer, except that up to 25% of the value of the Fund's total assets may
be invested without regard to such limitations. There is no limit to the
percentage of assets that may be invested in U.S. Treasury bills, notes, or
other obligations issued or guaranteed by the U.S. Government or its agencies or
instrumentalities.
THE LARGE CAP VALUE FUND, THE LARGE CAP GROWTH FUND, THE SMALL CAP FUND,
THE SMALL COMPANY GROWTH FUND, THE MID CAP GROWTH FUND, THE MID CAP VALUE FUND,
AND THE SPECIAL OPPORTUNITIES EQUITY FUND MAY NOT:
1. Purchase any securities that would cause 25% or more of the value of
such Fund's total assets at the time of purchase to be invested in securities of
one or more issuers conducting their principal business activities in the same
industry, provided that (a) there is no limitation with respect to obligations
issued or guaranteed by the U.S. Government or its agencies or instrumentalities
and repurchase agreements secured by obligations of the U.S. Government or its
agencies or instrumentalities; (b) wholly-owned finance companies will be
considered to be in the industries of their parents if their activities are
primarily related to financing the activities of their parents; and (c)
utilities will be divided according to their services. For example, gas, gas
transmission, electric and gas, electric, and telephone will each be considered
a separate industry.
2. Purchase securities of any one issuer, other than obligations issued or
guaranteed by the U.S. Government or its agencies or instrumentalities, if,
immediately after such purchase, more than 5% of the value of the Fund's total
assets would be invested in such issuer, or the Fund would hold more than 10% of
any class of securities of the issuer or more than 10% of the outstanding voting
securities of the issuer, except that up to 25% of the value of the Fund's total
assets may be invested without regard to such limitations. There is no limit to
the percentage of assets that may be invested in U.S. Treasury bills, notes, or
other obligations issued or guaranteed by the U.S. Government or its agencies or
instrumentalities.
THE INTERNATIONAL EQUITY FUND MAY NOT:
1. Purchase securities of any one issuer (other than securities issued or
guaranteed by the U.S. Government, its agencies or instrumentalities or
certificates of deposit for any such securities) if more than 5% of the value of
the Fund's total assets would (taken
20
at current value) be invested in the securities of such issuer, or more than 10%
of the issuer's outstanding voting securities would be owned by the Fund, except
that up to 25% of the value of the Fund's total assets may (taken at current
value) be invested without regard to these limitations. For purposes of this
limitation, a security is considered to be issued by the entity (or entities)
whose assets and revenues back the security. A guarantee of a security shall not
be deemed to be a security issued by the guarantors when the value of all
securities issued and guaranteed by the guarantor, and owned by the Fund, does
not exceed 10% of the value of the Fund's total assets.
2. Purchase any securities which would cause 25% or more of the value of
the Fund's total assets at the time of purchase to be invested in the securities
of one or more issuers conducting their principal business activities in the
same industry, provided that (a) there is no limitation with respect to (i)
instruments issued (as defined in Investment Limitation No. 1 above) or
guaranteed by the United States, any state, territory or possession of the
United States, the District of Columbia or any of their authorities, agencies,
instrumentalities or political subdivision, and (ii) repurchase agreements
secured by the instruments described in clause (i); (b) wholly-owned finance
companies will be considered to be in the industries of their parents if their
activities are primarily related to financing the activities of the parents; and
(c) utilities will be divided according to their services; for example, gas, gas
transmission, electric and gas, electric and telephone will each be considered a
separate industry.
3. Act as an underwriter of securities within the meaning of the Securities
Act of 1933 except to the extent that the purchase of obligations directly from
the issuer thereof, or the disposition of securities, in accordance with the
Fund's investment objective, policies and limitations may be deemed to be
underwriting.
4. Write or sell unsecured put options, call options, straddles, spreads,
or any combination thereof, except for transactions in options on securities,
securities indices, futures contracts and options on futures contracts.
THE INTERNATIONAL EQUITY FUND MAY:
1. Purchase or sell real estate to the extent permitted by the Investment
Company Act of 1940, or the rules or regulations thereunder as such statute,
rules or regulations may be amended from time to time, or by regulatory guidance
or interpretation of such statute, rules or regulations.
2. Purchase or sell commodities, commodities contracts, or futures
contracts to the extent permitted by the Investment Company Act of 1940, or the
rules or regulations thereunder as such statute, rules or regulations may be
amended from time to time, or by regulatory guidance or interpretation of such
statute, rules or regulations.
EACH OF THE FUNDS MAY:
1. Borrow money or lend to the extent permitted by the Investment Company
Act of 1940, or the rules or regulations thereunder as such statute, rules or
regulations may be amended from time to time, or by regulatory guidance or
interpretation of such statute, rules or regulations.
2. Issue senior securities to the extent permitted by the Investment
Company Act of 1940, or the rules or regulations thereunder as such statute,
rules or regulations may be amended from time to time, or by regulatory guidance
or interpretation of such statute, rules or regulations.
THE KENTUCKY FUND, THE MARYLAND FUND, THE NORTH CAROLINA FUND, THE SOUTH
CAROLINA FUND, THE VIRGINIA FUND, AND THE WEST VIRGINIA FUND MAY NOT:
1. Write or sell puts, calls, straddles, spreads, or combinations thereof
except that the Funds may acquire puts with respect to Tax-Exempt Obligations in
their portfolios and sell those puts in conjunction with a sale of those
Tax-Exempt Obligations.
2. Purchase any securities which would cause 25% or more of the value of
the Fund's total assets at the time of purchase to be invested in securities of
one or more issuers conducting their principal business activities in the same
industry, provided that (a) there is no limitation with respect to obligations
issued or guaranteed by the U.S. Government or its agencies or instrumentalities
and repurchase agreements secured by obligations of the U.S. Government or its
agencies or instrumentalities, and (b) this limitation shall not apply to
Tax-Exempt Obligations or governmental guarantees of Tax-Exempt Obligations. For
purposes of this limitation, a security is considered to be issued by the
government entity (or entities) whose assets and revenues back the security, or,
with respect to a private activity bond that is backed only by the assets and
revenues of a non-governmental user, such nongovernmental user.
21
EACH FUND (EXCEPT THE INTERNATIONAL EQUITY FUND AND PRIME MONEY MARKET
FUND) MAY:
1. Purchase or sell commodities, commodities contracts, or future contracts
or real estate to the extent permitted by the Investment Company Act of 1940, or
the rules or regulations thereunder as such statute, rules or regulations may be
amended from time to time, or by regulatory guidance or interpretation of such
statute, rules or regulations.
The U.S. Treasury Fund may not buy common stocks or voting securities, or
state, municipal, or private activity bonds. The U.S. Treasury Fund, the
Kentucky Fund, the Maryland Fund, the North Carolina Fund, the South Carolina
Fund, the Virginia Fund, the West Virginia Fund, the Short Fund, the
Intermediate U.S. Government Fund and the Total Return Bond Fund may not write
or purchase call options. Each of the Funds may not write put options. The U.S.
Treasury Fund, the Short Fund, the Intermediate U.S. Government Fund and the
Total Return Bond Fund may not purchase put options.
THE PRIME MONEY MARKET FUND MAY NOT:
1. Make investments that will result in the concentration of its
investments in the securities of issuers primarily engaged in the same industry.
Government securities, municipal securities and bank instruments will not be
deemed to constitute and industry. Bank instruments include bank accounts, time
deposits, certificates of deposit, and bankers' acceptances. As a matter of
non-fundamental policy, (i) instruments of foreign banks will not be considered
bank instruments for purposes of the above-described exclusion from the above
industry concentration limit; (ii) wholly-owned finance companies will be
considered to be in the industries of their parents if their activities are
primarily related to financing the activities of the parents; and (iii)
utilities will be divided according to their services, for example, gas, gas
transmission, electric and gas, electric and telephone will be each considered a
separate industry. For purposes of this limitation, a security is considered to
be issued by the entity (or entities) whose assets and revenues back the
security. A guarantee of a security is not deemed to be a security issued by the
guarantor, for purposes of diversification, when the value of all securities
issued and guaranteed by the guarantor, and owned by the Fund, does not exceed
10% of the value of the Fund's total assets.
2. Underwrite securities except to the extent permitted by the Investment
Company Act of 1940 or the rules or regulations thereunder, as such statutes,
rules or regulations may be amended from time to time.
3. Purchase or sell commodities, commodities contracts, futures contracts,
or real estate except to the extent permitted by the Investment Company Act of
1940 or the rules or regulations thereunder, as such statutes, rules or
regulations may be amended from time to time.
Although the foregoing investment limitations would permit the Prime Money
Market Fund to invest in options, futures contracts and options on futures
contracts, the Fund does not currently intend to trade in such instruments or
engage in such transactions during the next twelve months (except to the extent
a portfolio security may be subject to a "demand feature" or "put" as permitted
under SEC regulations for money market funds). Prior to making any such
investments, the Prime Money Market Fund would notify its shareholders and add
appropriate descriptions concerning the instruments and transactions to its
Prospectus.
THE EQUITY INCOME FUND MAY NOT:
1. Concentrate investments in a particular industry or group of
industries, as concentration is defined or interpreted under the
Investment Company Act of 1940, or the rules or regulations
thereunder, as such statute, rules or regulations may be amended from
time to time, or by regulatory guidance or interpretations of such
statute, rules or regulations.
THE EQUITY INCOME FUND MAY:
1. Purchase securities of any issuer only when consistent with the
maintenance of its status as a diversified company under the
Investment Company Act of 1940, or the rules or regulations
thereunder, as such statute, rules or regulations may be amended from
time to time, or by regulatory guidance or interpretations of such
statute, rules or regulations.
2. Underwrite securities to the extent permitted by the Investment
Company Act of 1940, or the rules or regulations thereunder, as such
statute, rules or regulations may be amended from time to time, or by
regulatory guidance or interpretations of such statute, rules or
regulations.
22
The Fundamental investment restrictions of the Equity Income Fund have been
adopted to avoid wherever possible the necessity of shareholder meetings unless
otherwise required by the 1940 Act. This recognizes the need to react quickly to
changes in the law or new investment opportunities in the securities markets and
the cost and time involved in obtaining shareholder approvals for diversely held
investment companies. However, the Equity Income Fund has also adopted
non-fundamental investment restrictions, set forth below, which in some
instances may be more restrictive than its fundamental restrictions. Any changes
in the Equity Income Fund's non-fundamental investment policies will be
communicated to its Shareholders prior to effectiveness.
1940 ACT RESTRICTIONS. Under the 1940 Act, and the rules, regulations, and
interpretations thereunder, a "diversified company," as to 75% of its total
assets, may not purchase securities of any issuer (other than obligations of, or
guaranteed by, the U.S. Government, its agencies or its instrumentalities) if,
as a result, more than 5% of the value of its total assets would be invested in
the securities of such issuer or more than 10% of the issuer's voting securities
would be held by the fund. "Concentration" is generally interpreted under the
1940 Act to be investing more than 25% of net assets in an industry or group of
industries. The 1940 Act limits the ability of investment companies to borrow
and lend money and to underwrite securities. The 1940 Act currently prohibits an
open-end fund from issuing senior securities, as defined in the 1940 Act, except
under very limited circumstances.
The 1940 Act also limits the amount that a Fund may invest in other
investment companies, prohibiting the Fund from (i) owning more than 3% of the
total outstanding voting stock of a single other investment company; (ii)
investing more than 5% of its total assets in the securities of a single other
investment company; and (iii) investing more than 10% of its total assets in
securities of all other investment companies. Pursuant to exemptive relief
granted by the SEC to iShares(R) as well as procedures approved by the Board,
the Equity Income Fund may invest in iShares(R) ETFs in excess of the 5% and 10%
limits described in this paragraph, provided that the Equity Income Fund has
described ETF investments in its prospectus and otherwise complies with the
conditions of the exemptive relief, as they may be amended, and any other
applicable investment limitations.
Additionally, the 1940 Act limits a Fund's ability to borrow money,
prohibiting a fund from issuing senior securities, except that it may borrow
from any bank, provided that immediately after any such borrowing there is an
asset coverage of at least 300% for all borrowings by a fund and provided
further, that in the event that such asset coverage shall at any time fall below
300%, a fund shall, within three days thereafter or such longer period as the
SEC may prescribe by rules and regulations, reduce the amount of its borrowings
to such an extent that the asset coverage of such borrowing shall be at least
300%.
The following investment restrictions are considered NON-FUNDAMENTAL and
therefore may be changed by a vote of a majority of the Trustees of BB&T Funds:
1. The Prime Money Market Fund and the U.S. Treasury Fund may not invest
more than 10% of its net assets in illiquid securities.
2. The Prime Money Market Fund and the U.S. Treasury Fund may not invest
more than 10% of its net assets in instruments which are not readily marketable.
3. If any percentage restriction described above is satisfied at the time
of investment, a later increase or decrease in such percentage resulting from a
change in net asset value will not constitute a violation of such restriction.
4. All Funds except the Prime Money Market Fund may not purchase securities
on margin, except that a Fund may obtain such short-term credits as are
necessary for the clearance of portfolio transactions, and a Fund may make
margin payments in connection with futures contracts, options, forward
contracts, swaps, caps, floors, collars and other financial instruments.
5. All Funds except the Prime Money Market Fund may not sell securities
short (unless they own or have the right to obtain securities equivalent in kind
and amount to the securities sold short), however that policy does not prevent
the above Funds from entering into short positions in foreign currency, futures
contracts, options, forward contracts, swaps, caps, floors, collars, and other
financial instruments, and the Funds may obtain such short-term credits as are
necessary for the clearance of portfolio transactions.
6. The Equity Income Fund may not purchase or sell real estate, real estate
limited partnership interests, and commodities or commodities contracts (except
that the Equity Income Fund may invest in futures contracts and options on
futures contracts, as disclosed in the applicable Prospectus). However, subject
to its permitted investments, the Equity Income Fund may invest in companies
which invest in real estate, securities or loans secured by interests in real
estate, commodities or commodities contracts.
23
7. The Equity Income Fund may not borrow money or issue senior securities,
except that the Equity Income Fund may obtain such short-term credits as are
necessary for the clearance of portfolio transactions, and the Equity Income
Fund may enter into reverse repurchase agreements for temporary emergency
purposes in amounts up to 33 1/3% of the value of its total assets at the time
of such borrowing.
8. Each Fund except the Money Market Funds may not invest more than 15% of
its net assets in "illiquid" securities, which include securities with legal or
contractual restrictions on resale or for which no readily available market
exists but exclude such securities if resalable pursuant to Rule 144A under the
Securities Act.
For purposes of the concentration policies described above, the Funds do
not consider exchange-traded funds to constitute an "industry." Rather, the
Funds will "look-through" investments in exchange-traded funds to the underlying
securities held by such exchange-traded funds when determining fund exposure to
a particular industry.
PORTFOLIO TURNOVER
The portfolio turnover rate for each Fund of BB&T Funds is calculated by
dividing the lesser of a Fund's purchases or sales of portfolio securities for
the year by the monthly average value of the portfolio securities. The
calculation excludes all securities whose maturities at the time of acquisition
were one year or less.
For the fiscal years ended September 30, 2005 and September 30, 2004, the
portfolio turnover rates for each of the Funds with a full year of operations in
the subject fiscal years (other than the Money Market Funds) were as follows:
FUND 2005 (%) 2004 (%)
---- -------- --------
Large Cap Value Fund....................... 19.50 16.40
Large Cap Growth Fund...................... 62.78 127.47
Mid Cap Value Fund......................... 126.99 19.17
Mid Cap Growth Fund........................ 92.74 138.61
Small Cap Fund............................. 8.39 11.25
Small Company Growth Fund.................. 81.37 211.60
International Equity Fund.................. 44.96 50.68
Special Opportunities Equity Fund.......... 30.38 32.06
Equity Income Fund*........................ 39.65 1.65
Short U.S. Government Fund................. 33.67 62.59
Intermediate U.S. Government Fund.......... 107.04 98.35
Total Return Bond Fund..................... 173.74 31.95
Kentucky Fund.............................. 37.50 24.78
Maryland Fund.............................. 44.67 55.18
North Carolina Fund........................ 60.84 67.80
South Carolina Fund........................ 56.03 32.63
Virginia Fund.............................. 48.04 45.07
West Virginia Fund......................... 32.10 16.24
Prime Money Market Fund.................... NA NA
U.S. Treasury Money Market Fund............ NA NA
Capital Manager Conservative Growth Fund... 52.50 2.47
Capital Manager Moderate Growth Fund....... 37.83 0.17
Capital Manager Growth Fund................ 26.22 0.19
Capital Manager Equity Fund................ 2.14 3.10
----------
* Equity Income Fund commenced operations on July 2, 2004
High turnover rates will generally result in higher transaction costs to
the Funds and may result in higher levels of taxable realized gains (including
short-term taxable gains generally taxed at ordinary income tax rates) to a
Fund's shareholders. The portfolio turnover rate may vary greatly from year to
year as well as within a particular year, and may also be affected by cash
requirements for redemptions of Shares. A higher portfolio turnover rate for
each Fund of BB&T Funds other than the U.S. Treasury Fund may lead to increased
taxes and transaction costs. Portfolio turnover will not be a limiting factor in
making investment decisions. See "Additional Tax Information."
24
Because the U.S. Treasury Fund and the Prime Money Market Fund intend to
invest entirely in securities with maturities of less than one year and because
the Securities and Exchange Commission requires such securities to be excluded
from the calculation of the portfolio turnover rate, the portfolio turnover with
respect to each of the Money Market Fund was zero percent for the fiscal years
ended September 30, 2005 and September 30, 2004, and is expected to remain zero
percent for regulatory purposes.
25
VALUATION
The net asset value of each of the Funds, other than the Money Market
Funds, is determined and its Shares are priced as of the close of regular
trading of the New York Stock Exchange (generally 4:00 p.m. Eastern Time) on
each Business Day ("Valuation Time"). As used herein a "Business Day"
constitutes any day on which the New York Stock Exchange (the "NYSE") is open
for trading and any other day (other than a day on which no Shares are tendered
for redemption and no orders to purchase Shares are received) during which there
is sufficient trading in a Fund's portfolio securities that a Fund's net asset
value per Share might be materially affected. Currently, the NYSE is closed on
the customary national business holidays of New Year's Day, Martin Luther King,
Jr. Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor
Day, Thanksgiving Day and Christmas Day. The net asset value of the Prime Money
Market Fund and the U.S. Treasury Fund is determined and their Shares are priced
as of 3:00 p.m., on each day that the NYSE and the Federal Reserve are open. The
Prime Money Market Fund and the U.S. Treasury Fund will be closed on weekends
and days on which the NYSE or the federal reserve is closed, including the
following holidays: New Year's day, Martin Luther King Jr. day, President's day,
Good Friday, Memorial day, the Fourth of July, Labor day, Christopher Columbus
day, Veterans day, Thanksgiving and Christmas day.
VALUATION OF THE MONEY MARKET FUNDS
The U.S. Treasury Fund and the Prime Money Market Fund have elected to use
the amortized cost method of valuation pursuant to Rule 2a-7 under the 1940 Act.
This involves valuing an instrument at its cost initially and thereafter
assuming a constant amortization to maturity of any discount or premium,
regardless of the impact of fluctuating interest rates on the value of the
instrument. This method may result in periods during which value, as determined
by amortized cost, is higher or lower than the price the U.S. Treasury Fund and
the Prime Money Market Fund would receive if it sold the instrument. The value
of securities in the U.S. Treasury Fund and the Prime Money Market Fund can be
expected to vary inversely with changes in prevailing interest rates.
Pursuant to Rule 2a-7, each Money Market Fund will maintain a
dollar-weighted average portfolio maturity appropriate to its objective of
maintaining a stable net asset value per Share, provided that the Fund will not
purchase any security with a remaining maturity of more than 397 days
(securities subject to maturity dates) nor maintain a dollar-weighted average
portfolio maturity which exceeds 90 days. BB&T Funds' Board of Trustees has also
undertaken to establish procedures reasonably designed, taking into account
current market conditions and each Money Market Fund's investment objective, to
stabilize the net asset value per Share of each Money Market Fund for purposes
of sales and redemptions at $1.00. These procedures include review by the
Trustees, at such intervals as they deem appropriate, to determine the extent,
if any, to which the net asset value per Share of the Money Market Fund
calculated by using available market quotations deviates from $1.00 per Share
(the "Mark to Market"). In performing the Mark to Market, securities for which
market quotations are not readily available and other assets will be valued at
fair value and may include yield equivalents or a price produced through use of
a pricing matrix provided by a national pricing service approved by the Board.
In the event such deviation exceeds one-half of one percent, Rule 2a-7
requires that the Board of Trustees promptly consider what action, if any,
should be initiated. If the Trustees believe that the extent of any deviation
from a Money Market Fund's $1.00 amortized cost price per Share may result in
material dilution or other unfair results to new or existing investors, they
will take such steps as they consider appropriate to eliminate or reduce to the
extent reasonably practicable any such dilution or unfair results. These steps
may include selling portfolio instruments prior to maturity, shortening the
average portfolio maturity, withholding or reducing dividends, reducing the
number of the Fund's outstanding Shares without monetary consideration, or
utilizing a net asset value per Share determined by using available market
quotations.
VALUATION OF THE BOND FUNDS, THE STOCK FUNDS AND THE FUNDS OF FUNDS
Except as noted below, investments of the Stock Funds, Bond Funds, and
Funds of Funds of the Trust in securities the principal market for which is a
securities exchange or an over-the-counter market are valued at their latest
available sale price (except for those securities traded on NASDAQ, which will
be valued at the NASDAQ Official Closing Price) or, absent such a price, by
reference to the latest available bid price in the principal market in which
such securities are normally traded. Except as noted below, investments of the
International Equity Fund in securities the principal market for which is a
securities exchange are valued at the closing price on that exchange on the day
of computation.
With regard to each of the above-mentioned Funds, securities the principal
market for which is not a securities exchange are valued at their latest bid
quotation in such principal market. Securities and other assets for which
quotations are not readily available are valued at their fair value as
determined by the BB&T Fund's Pricing Committee in their best judgment pursuant
to procedures established by and under the general supervision of the Board of
Trustees and may include yield equivalents or a price produced
26
through use of a pricing matrix provided by a national pricing service approved
by the Board. The Pricing Committee, as designated by the Board of Trustees, is
comprised of employees of the Adviser and/or its affiliates. Pricing
determinations require an affirmative vote of a majority of the Pricing
Committee.
Short-term securities are valued at either amortized cost or original cost
plus interest, which approximates current value. Repurchase Agreements are
valued at original cost. Open ended mutual fund investments will be valued at
the most recently calculated net asset value. Closed end mutual funds are valued
at their market values based upon the latest available sale price or, absent
such a price, by reference to the latest available bid prices in the principal
market in which such securities are normally traded.
The value of a foreign security is determined in its national currency as
of the close of trading on the foreign exchange or other principal market on
which it is traded, which value is then converted into its U.S. dollar
equivalent at the prevailing foreign rate reported by FT Interactive Data
Corporation as the closing rate for that date. When an occurrence subsequent to
the time a value of a foreign security was so established is likely to have
changed the value, then the fair value of those securities will be determined by
consideration of other factors by the Pricing Committee.
Securities for which market quotations are readily available will be valued
on the basis of quotations provided by dealers in such securities or furnished
through a national pricing service approved by the Board of Trustees. Securities
for which market quotations are not readily available and other assets will be
valued at fair value using methods determined in good faith by the Pricing
Committee under the supervision of the Trustees and may include yield
equivalents or a price produced through use of a pricing matrix provided by a
national pricing service approved by the Board.
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION
Each class of Shares of each Fund of BB&T Funds are sold on a continuous
basis by BB&T Funds Distributor, Inc. In addition to purchasing Shares directly
from BB&T Funds Distributor, Inc., Class A, Class B, Class C, or Institutional
Shares may be purchased through procedures established by BB&T Funds
Distributor, Inc. in connection with the requirements of accounts at BB&T, or
BB&T's affiliated or correspondent banks. Customers purchasing Shares of BB&T
Funds may include officers, directors, or employees of BB&T or BB&T's affiliated
or correspondent banks.
PURCHASE OF CLASS A, CLASS B, AND CLASS C SHARES
As stated in the Class A, Class B, and Class C Prospectus, the public
offering price of Class A Shares of a Fund, except the U.S. Treasury Fund and
the Prime Money Market Fund, is its net asset value next computed after an order
is received, plus a sales charge which varies based upon the quantity purchased.
The public offering price of such Class A Shares of a Fund is calculated by
dividing net asset value by the difference (expressed as a decimal) between 100%
and the sales charge percentage of offering price applicable to the purchase.
The offering price is rounded to two decimal places each time a computation is
made. The sales charge scale set forth in the Class A, Class B, and Class C
Prospectus applies to purchases of Class A Shares of such a Fund by a Purchaser.
Shares of the U.S. Treasury Fund and the Prime Money Market Fund and Class
B Shares and Class C Shares of each Fund offering such Shares are sold at their
net asset value per share, as next computed after an order is received. However,
as discussed in the Class A, Class B, and Class C Prospectus, the Class B Shares
and Class C Shares are subject to a Contingent Deferred Sales Charge if they are
redeemed prior to the sixth and first anniversary of purchase, respectively.
Investors purchasing Shares of the U.S. Treasury Fund and the Prime Money Market
Fund are generally required to purchase Class A or Institutional Shares, since
such Shares are not subject to any initial sales charge or contingent deferred
sales charge. Shareholders investing directly in Class B Shares of the U.S.
Treasury Money Market Fund or the Prime Money Market Fund as opposed to
Shareholders obtaining Class B Shares of the U.S. Treasury Money Market Fund or
the Prime Money Market Fund upon an exchange of Class B Shares of any of the
other Funds, will be requested to participate in the Auto Exchange and to set
the time and amount of their regular, automatic withdrawals in such a way that
all of their Class B Shares have been withdrawn from the U.S. Treasury Money
Market Fund or the Prime Money Market Fund, within two years of purchase. Such
Class B shares may be exchanged for Class B Shares of any other Fund through the
Auto Exchange (see "Auto Exchange Plan").
An order to purchase Class A Shares of the Prime Money Market Fund or the
U.S. Treasury Fund will be deemed to have been received by the Distributor only
when federal funds with respect thereto are available to BB&T Funds' custodian
for investment. Federal funds are monies credited to a bank's account within a
Federal Reserve Bank. Payment for an order to purchase Shares of the Prime Money
Market Fund or the U.S. Treasury Fund which is transmitted by federal funds wire
will be available the same day for investment by BB&T Funds' custodian, if
received prior to the last Valuation Time (see "VALUATION OF SHARES"). It is
strongly
27
recommended that investors of substantial amounts use federal funds to purchase
Shares of the Prime Money Market Fund or the U.S. Treasury Fund.
Shares of the Prime Money Market Fund or the U.S. Treasury Fund purchased
before 12:00 noon, Eastern Time, begin earning dividends on the same Business
Day. All Shares of the Prime Money Market Fund or the U.S. Treasury Fund
continue to earn dividends through the day before their redemption.
Shares of a Fund sold to Participating Organizations acting in a fiduciary,
advisory, custodial, or other similar capacity on behalf of Customers will
normally be held of record by the Participating Organizations. With respect to
Shares so sold, it is the responsibility of the Participating Organization to
transmit purchase or redemption orders to the Distributor and to deliver federal
funds for purchase on a timely basis. Beneficial ownership of the Shares will be
recorded by the Participating Organizations and reflected in the account
statements provided by the Participating Organizations to Customers. Depending
upon the terms of a particular Customer account, a Participating Organization or
Bank may charge a Customer's account fees for services provided in connection
with investment in the Funds.
In the case of orders for the purchase of Shares placed through a
broker-dealer, the public offering price will be the net asset value as so
determined plus any applicable sales charge, but only if the broker-dealer
receives the order prior to the Valuation Time for that day and transmits to
BB&T Funds by the Valuation Time. The broker-dealer is responsible for
transmitting such orders promptly. If the broker-dealer fails to do so, the
investor's right to that day's closing price must be settled between the
investor and the broker-dealer. If the broker-dealer receives the order after
the Valuation Time for that day, the price will be based on the net asset value
determined as of the Valuation Time for the next Business Day.
Every Shareholder will be mailed a confirmation of each new transaction in
the Shareholder's account. In the case of Class A, Class B, and Class C Shares
held of record by a Participating Organization but beneficially owned by a
Customer, confirmations of purchases, exchanges and redemptions of Class A,
Class B, and Class C Shares by a Participating Organization will be sent to the
Customer by the Participating Organization. Certificates representing Shares
will not be issued.
AUTO INVEST PLAN. BB&T Funds Auto Invest Plan enables Shareholders to make
regular purchases of Class A, Class B, and Class C Shares through automatic
deduction from their bank accounts. With Shareholder authorization, BB&T Funds'
transfer agent will deduct the amount specified (subject to the applicable
minimums) from the Shareholder's bank account and will automatically invest that
amount in Class A, Class B, or Class C Shares at the public offering price on
the date of such deduction.
For a Shareholder to change the Auto Invest instructions or to discontinue
the feature, the request must be made in writing to BB&T Funds, P.O. Box 182533,
Columbus, OH 43218-2533. The Auto Invest Plan may be amended or terminated
without notice at any time by the Distributor.
BB&T FUNDS INDIVIDUAL RETIREMENT ACCOUNT ("IRA"). A BB&T Funds IRA enables
individuals, even if they participate in an employer-sponsored retirement plan,
to establish their own retirement program by purchasing Class A, Class B, or
Class C Shares for an IRA. BB&T Funds IRA contributions may be tax-deductible
and earnings are tax deferred. Under the Tax Reform Act of 1986 and Taxpayer
Relief Act of 1997, the tax deductibility of IRA contributions is restricted or
eliminated for individuals who participate in certain employer pension plans and
whose annual income exceeds certain limits. Existing IRAs and future
contributions up to the IRA maximums, whether deductible or not, still earn
income on a tax-deferred basis.
All BB&T Funds IRA distribution requests must be made in writing to BISYS
Fund Services. Any additional deposits to a BB&T Funds IRA must distinguish the
type and year of the contribution.
For more information on a BB&T Funds IRA call BB&T Funds at (800) 228-1872.
Investment in Shares of the Tax-Free Bond Funds would not be appropriate for any
IRA. Shareholders are advised to consult a tax adviser on BB&T Funds IRA
contribution and withdrawal requirements and restrictions.
SALES CHARGES
As BB&T Funds' principal underwriter, BB&T Funds Distributor, Inc. acts as
principal in selling Class A, Class B, and Class C Shares of the Funds to
dealers. BB&T Funds Distributor, Inc. re-allows the applicable sales charge as
dealer discounts and brokerage commissions. The Distributor pays each dealer all
of the sales charge it receives. As a result, broker-dealer that sell shares of
BB&T Funds may receive more revenue from the sale of BB&T Funds than from the
sale of other mutual funds offered by such firms. Under
28
federal securities laws, a broker or dealer who receives a reallowance in excess
of 90% of the sales charge may be deemed to be an "underwriter" for purposes of
the 1933 Act. From time to time dealers who receive dealer discounts and broker
commissions from the Distributor may reallow all or a portion of such dealer
discounts and broker commissions to other dealers or brokers.
The Distributor, at its expense, will also provide additional compensation
to dealers in connection with sales of Class A Shares of any Fund of the BB&T
Funds. The maximum cash compensation payable by the Distributor is 5.75% of the
public offering price of Class A Shares. In addition, the Adviser may provide
financial assistance to financial intermediaries (including, but not limited to,
broker dealers, shareholder servicing agents, and financial advisors) in
connection with conferences, sales or training programs for their employees,
seminars for the public, advertising campaigns regarding one or more of the
Funds, and/or broker dealer-sponsored special events. Financial intermediaries
may not use sales of a Fund's Shares to qualify for this compensation to the
extent such may be prohibited by the laws of any state or any self-regulatory
agency, such as the National Association of Securities Dealers, Inc. Financial
intermediaries are not permitted to delay the placement of orders to benefit
themselves by a price change.
CLASS A SHARES
Class A Shares are sold at their public offering price. This price equals
NAV plus the initial sales charge, if applicable. Therefore, part of the money
you invest will be used to pay the sales charge. The remainder is invested in
Fund shares. The sales charge decreases with larger purchases. There is no sales
charge on reinvested dividends and distributions.
The current sales charge rates are as follows:
FOR THE STOCK FUNDS, FUNDS OF FUNDS, INTERMEDIATE U.S. GOVERNMENT FUND, AND
TOTAL RETURN BOND FUND
SALES CHARGE SALES CHARGE COMMISSION
AS A % OF AS OF % OF AS A % OF
YOUR INVESTMENT OFFERING PRICE YOUR INVESTMENT OFFERING PRICE
--------------- -------------- --------------- --------------
Up to $49,999 5.75% 6.10% 5.75%
$50,000 to $99,999 4.50% 4.71% 4.50%
$100,000 up to $249,999 3.50% 3.63% 3.50%
$250,000 up to $499,999 2.50% 2.56% 2.50%
$500,000 up to $999,999 2.00% 2.04% 2.00%
$1,000,000 and above(1) 0.00% 0.00% 0.00%
FOR THE TAX-FREE BOND FUNDS AND THE SHORT FUND
SALES CHARGE SALES CHARGE COMMISSION
AS A % OF AS OF % OF AS A % OF
YOUR INVESTMENT OFFERING PRICE YOUR INVESTMENT OFFERING PRICE
--------------- -------------- --------------- --------------
Up to $49,999 3.00% 3.09% 3.00%
$50,000 to $99,999 2.50% 2.56% 2.50%
$100,000 up to $249,999 2.00% 2.04% 2.00%
$250,000 up to $499,999 1.50% 1.52% 1.50%
$500,000 up to $999,999 1.00% 1.01% 1.00%
$1,000,000 and above(1) 0.00% 0.00% 0.00%
----------
(1) There is no initial sales charge on purchases of $1 million or more.
However, a contingent deferred sales charge (CDSC) of up to 1.00% of the
purchase price will be charged to the shareholder if shares are redeemed in
the first year after purchase. This charge will be based on the lower of
your cost for the shares or their NAV at the time of redemption. There will
be no CDSC on reinvested distributions. For sales of over $1 million or
more, the Distributor pays broker-dealers out of its own assets, a fee of
up to 1% of the offering price of such shares up to $2.5 million, 0.5% of
the offering price from $2.5 million to $5 million, and 0.25% of the
offering price over $5 million.
29
FOR THE MONEY MARKET FUNDS
No sales charges.
The sales charges set forth in the table above are applicable to purchases
made at one time by any purchaser (a "Purchaser"), which includes: (i) an
individual, his or her spouse and children under the age of 21; (ii) a trustee
or other fiduciary of a single trust estate or single fiduciary account; or
(iii) any other organized group of persons, whether incorporated or not,
provided that such organization has been in existence for at least six months
and has some purpose other than the purchase of redeemable securities of a
registered investment company. In order to qualify for a lower sales charge, all
orders from a Purchaser will have to be placed through a single investment
dealer and identified at the time of purchase as originating from the same
Purchaser, although such orders may be placed into more than one discrete
account which identifies the Purchasers.
In determining whether a particular redemption is subject to a Contingent
Deferred Sales Charge, it is assumed that the redemption is first of any Class A
Shares, then of any Class C Shares, and then of any Class B Shares in the
Shareholder's Fund account, (unless the Shareholder elects to redeem in a
different order) or Shares representing capital appreciation, next of Shares
acquired pursuant to reinvestment of dividends and capital gain distributions,
and finally of other Shares held by the Shareholder for the longest period of
time. This method should result in the lowest possible sales charge.
SALES CHARGE REDUCTIONS AND WAIVERS
Certain sales of Class A Shares are made without a sales charge, as
described in the Class A, Class B, and Class C Prospectus under the caption
"Sales Charge Waivers," to promote goodwill with employees and others with whom
BB&T Funds Distributor, Inc., BB&T and/or BB&T Funds have business
relationships, and because the sales effort, if any, involved in making such
sales is negligible.
LETTER OF INTENT. Any Purchaser may obtain a reduced sales charge by means
of a written Letter of Intent which expresses the intention of such Purchaser to
invest a certain amount in Class A Shares of any of the Variable NAV Funds,
i.e., those Funds which charge a sales charge, within a period of 13 months.
Each purchase of Shares under a Letter of Intent will be made at the public
offering price plus the sales charge applicable at the time of such purchase to
a single transaction of the total dollar amount indicated in the Letter of
Intent. A Letter of Intent may include purchases of Class A Shares made not more
than 90 days prior to the date such Purchaser signs a Letter of Intent; however,
the 13-month period during which the Letter of Intent is in effect will begin on
the date of the earliest purchase to be included. When a purchaser enters into a
Letter of Intent which includes shares purchased prior to the date of the Letter
of Intent, the sales charge will be adjusted and used to purchase additional
Shares of the Fund at the then current public offering price at the end of the
13 month period. This program may be modified or eliminated at any time or from
time to time by BB&T Funds without notice.
A Letter of Intent is not a binding obligation upon the investor to
purchase the full amount indicated. The minimum initial investment under a
Letter of Intent is 5% of such amount. Class A Shares purchased with the first
5% of such amount will be held in escrow (while remaining registered in the name
of the investor) to secure payment of the higher sales charge applicable to the
Class A Shares actually purchased if the full amount indicated is not purchased,
and such escrowed Class A Shares will be involuntarily redeemed to pay the
additional sales charge, if necessary. Dividends on escrowed Class A Shares,
whether paid in cash or reinvested in additional Class A Shares are not subject
to escrow. The escrowed Class A Shares will not be available for disposal by the
investor until all purchases pursuant to the Letter of Intent have been made or
the higher sales charge has been paid. When the full amount indicated has been
purchased, the escrow will be released. To the extent that an investor purchases
more than the dollar amount indicated on the Letter of Intent and qualifies for
a further reduced sales charge, the sales charge will be adjusted for the entire
amount purchased at the end of the 13-month period. The difference in sales
charges will be used to purchase additional Class A Shares subject to the rate
of sales charge applicable to the actual amount of the aggregate purchases at
the net asset value next calculated.
For further information, interested investors should contact the
Distributor. Letter of Intent privileges may be amended or terminated without
notice at any time by the Distributor.
CONCURRENT PURCHASES AND RIGHT OF ACCUMULATION. A Purchaser (as defined
above) may qualify for a reduced sales charge by combining concurrent purchases
of Class A Shares of one or more of the Variable NAV Funds or by combining a
current purchase of Class A Shares of a Variable NAV Fund with prior purchases
of Shares of any Variable NAV Fund. The applicable sales charge is based on the
sum of (i) the Purchaser's current purchase of Class A Shares of any Variable
NAV Fund sold with a sales charge plus (ii) the then current net asset value of
all Class A Shares held by the Purchaser in any Variable NAV Fund. To
30
receive the applicable public offering price pursuant to the right of
accumulation, Shareholders must at the time of purchase provide the Transfer
Agent or the Distributor with sufficient information to permit confirmation of
qualification. Accumulation privileges may be amended or terminated without
notice at any time by the Distributor.
Proceeds from the Contingent Deferred Sales Charge and the distribution and
Shareholder service fees under the Distribution Plan are payable to the
Distributor to defray the expenses of advance brokerage commissions and expenses
related to providing distribution-related and Shareholder services to the Fund
in connection with the sale of the Class B and Class C Shares, such as the
payment of compensation to dealers and agents selling Class B and Class C
Shares. A dealer commission of 4.00% of the original purchase price of the Class
B Shares of the Fund and of 1.00% of the original purchase price of the Class C
Shares of the Fund will be paid to financial institutions and intermediaries.
However, the Distributor may, in its sole discretion, pay a higher dealer
commission at its sole discretion.
CLASS B SHARES AND CLASS C SHARES. The Contingent Deferred Sales Charge is
waived on redemption of Shares: (i) following the death or disability (as
defined in the Code) of a Shareholder or a participant or beneficiary of a
qualifying retirement plan if redemption is made within one year of such death
or disability; (ii) to the extent that the redemption represents a minimum
required distribution from an Individual Retirement Account or other qualifying
retirement plan to a Shareholder who has attained the age of 70 1/2; (iii)
provided that the Shareholder withdraws no more than 12% of the account value
annually using the Auto Withdrawal Plan Feature; and (iv) for Investors who
purchased Class B Shares of the Prime and Money Market Fund or Class B Shares of
the U.S. Treasury Fund through the Cash Sweep Program at BB&T Treasury Services
Division. A Shareholder or his or her representative should contact the Transfer
Agent to determine whether a retirement plan qualifies for a waiver and must
notify the Transfer Agent prior to the time of redemption if such circumstances
exist and the Shareholder is eligible for this waiver. In addition, the
following circumstances are not deemed to result in a "redemption" of Class B or
Class C Shares for purposes of the assessment of a Contingent Deferred Sales
Charge, which is therefore waived: (i) plans of reorganization of the Fund, such
as mergers, asset acquisitions and exchange offers to which the Fund is a party;
and (ii) exchanges for Class B or Class C Shares of other Funds of BB&T Funds as
described under "Exchange Privilege."
For purposes of conversion to Class A Shares, shares received as dividends
and other distributions paid on Class B Shares in a Shareholder's Fund account
will be considered to be held in a separate sub-account. Each time any Class B
Shares in a Shareholder's Fund account (other than those in the sub-account)
convert to Class A Shares, a pro-rata portion of the Class B Shares in the
sub-account will also convert to Class A Shares.
If a Shareholder effects one or more exchanges among Class B Shares of the
Funds of BB&T Funds during the eight-year period, BB&T Funds will aggregate the
holding periods for the shares of each Fund of BB&T Funds for purposes of
calculating that eight-year period. Because the per share net asset value of the
Class A Shares may be higher than that of the Class B Shares at the time of
conversion, a Shareholder may receive fewer Class A Shares than the number of
Class B Shares converted, although the dollar value will be the same.
31
EXCHANGE PRIVILEGE
CLASS A. Only residents of Kentucky, Maryland, North Carolina, South
Carolina, Virginia, and West Virginia may exchange their Class A Shares of the
other Funds for Class A Shares of the Kentucky Fund, the Maryland Fund, the
North Carolina Fund, the South Carolina Fund, the Virginia Fund, and the West
Virginia Fund, respectively.
If Class A Shares of the Prime Money Market Fund or the U.S. Treasury Fund
were acquired in a previous exchange involving Shares of a Variable NAV Fund,
then such Shares of the Prime Money Market Fund or the U.S. Treasury Fund may be
exchanged for Shares of a Variable NAV Fund without payment of any additional
sales load within a twelve month period. Under such circumstances, the
Shareholder must notify the Distributor that a sales load was originally paid.
Depending upon the terms of a particular Customer account, a Participating
Organization may charge a fee with regard to such an exchange. Information about
such charges will be supplied by the Participating Organization.
CLASS B. Class B Shares of each Fund may be exchanged for Class B Shares of
the other Funds on the basis of relative net asset value per Class B Share,
without the payment of any Contingent Deferred Sales Charge which might
otherwise be due upon redemption of the outstanding Class B Shares.
For purposes of computing the Contingent Deferred Sales Charge that may be
payable upon a disposition of the newly acquired Class B Shares, the holding
period for outstanding Class B Shares of the Fund from which the exchange was
made is "tacked" to the holding period of the newly acquired Class B Shares. For
purposes of calculating the holding period applicable to the newly acquired
Class B Shares, the newly acquired Class B Shares shall be deemed to have been
issued on the date of receipt of the Shareholder's order to purchase the
outstanding Class B Shares of the Fund from which the exchange was made.
CLASS C. Class C Shares of each Fund may be exchanged for Class C Shares of
the other Funds on the basis of relative net asset value per Class B Share,
without the payment of any Contingent Deferred Sales Charge which might
otherwise be due upon redemption of the outstanding Class C Shares.
For purposes of computing the Contingent Deferred Sales Charge that may be
payable upon a disposition of the newly acquired Class C Shares, the holding
period for outstanding Class C Shares of the Fund from which the exchange was
made is "tacked" to the holding period of the newly acquired Class C Shares. For
purposes of calculating the holding period applicable to the newly acquired
Class C Shares, the newly acquired Class C Shares shall be deemed to have been
issued on the date of receipt of the Shareholder's order to purchase the
outstanding Class C Shares of the Fund from which the exchange was made.
ADDITIONAL INFORMATION. An exchange is considered a sale of Shares and will
result in a capital gain or loss for federal income tax purposes, which, in
general, is calculated by netting the Shareholder's tax cost (or "basis") in the
Shares surrendered and the value of the Shares received in the exchange. If a
Shareholder exchanges Class A Shares within 90 days of acquiring them and if a
sales charge is waived on the exchange, for purposes of measuring the capital
gain or loss on the exchange, the Shareholder's basis in the surrendered Shares
is reduced by the lesser of (i) the sales charge paid for the surrendered shares
or (ii) the amount of the sales charge that is waived on the exchange.
If not selected on the Account Registration form, the Shareholder will
automatically receive Exchange privileges. A Shareholder wishing to exchange
Class A, Class B, or Class C Shares purchased through a Participating
Organization or Bank may do so by contacting the Participating Organization or
Bank. If an exchange request in good order is received by the Distributor or the
Transfer Agent by 12:00 noon (Eastern Time) on any Business Day, the exchange
usually will occur on that day.
MATTERS AFFECTING REDEMPTION
REDEMPTION BY MAIL. A written request for redemption must be received by
BB&T Funds in order to constitute a valid tender for redemption from an
Individual Retirement Account ("IRA"). Also, the signature on the written
request must be guaranteed by a bank, broker, dealer, credit union, securities
exchange, securities association, clearing agency or savings association, as
those terms are defined in Rule 17Ad-15 under the Securities Exchange Act of
1934 if (a) a redemption check is to be payable to anyone other than the
Owner(s) of record or (b) a redemption check is to be mailed to the Owner(s) at
an address other than the address of record or (c) the Owner(s) address of
record has changed within the last ten business days or (d) the redemption
proceeds are being transferred to another Fund account with a different
registration or (e) the redemption proceeds are being wired to bank instructions
currently not on the account. The Distributor reserves the right to reject any
signature guarantee if (1) it has reason to believe that the signature is not
genuine, (2) it has reason to believe that the transaction would otherwise be
improper, or (3) the guarantor institution is
32
a broker or dealer that is neither a member of a clearing corporation nor
maintains net capital of at least $100,000. Proceeds may be mailed to the
address of record or sent electronically or mailed to a previously designated
bank account without a signature guarantee. See "Redemption by Telephone" for
further discussion on sending proceeds to your bank account.
REDEMPTION BY TELEPHONE. Shares may be redeemed by telephone if the
Shareholder selected that option on the Account Registration Form. A Shareholder
may have the proceeds mailed to the address of record or sent electronically or
mailed directly to a domestic commercial bank account previously designated by
the Shareholder on the Account Registration Form. Under most circumstances, such
payments will be transmitted on the next Business Day following receipt of a
valid request for redemption. Such electronic redemption requests may be made by
the Shareholder by telephone to the Transfer Agent. The Transfer Agent may
reduce the amount of a wire redemption payment by its then-current wire
redemption charge. Such charge is currently being waived. There is no charge for
having payment of redemption requests mailed or sent via the Automated Clearing
House to a designated bank account. For telephone redemptions, call BB&T Funds
at (800) 228-1872. If not selected on the Account Registration form, the
Shareholder will automatically receive telephone redemption privileges. None of
the Distributor, BB&T Funds' transfer agent, BB&T or BB&T Funds will be liable
for any losses, damages, expense or cost arising out of any telephone
transaction (including exchanges and redemptions) effected in accordance with
BB&T Funds' telephone transaction procedures, upon instructions reasonably
believed to be genuine. BB&T Funds will employ procedures designed to provide
reasonable assurance that instructions communicated by telephone are genuine; if
these procedures are not followed, BB&T Funds may be liable for any losses due
to unauthorized or fraudulent instructions. These procedures include recording
all phone conversations, sending confirmations to Shareholders within 72 hours
of the telephone transaction, verifying the account name and a shareholder's
account number or tax identification number and sending redemption proceeds only
to the address of record or to a previously authorized bank account. If, due to
temporary adverse conditions, investors are unable to effect telephone
transactions, Shareholders may also mail the redemption request to BB&T Funds.
BB&T Funds may suspend the right of redemption or postpone the date of
payment for Shares during any period when (a) trading on the New York Stock
Exchange (the "Exchange") is restricted by applicable rules and regulations of
the Securities and Exchange Commission, (b) the Exchange is closed for other
than customary weekend and holiday closings, (c) the Securities and Exchange
Commission has by order permitted such suspension, or (d) an emergency exists as
a result of which (i) disposal by BB&T Funds of securities owned by it is not
reasonably practical or (ii) it is not reasonably practical for the Company to
determine the value of its total net assets.
BB&T Funds may redeem any class of Shares involuntarily if redemption
appears appropriate in light of BB&T Funds' responsibilities under the 1940 Act.
AUTO WITHDRAWAL PLAN. BB&T Funds Auto Withdrawal Plan enables Shareholders
to make regular redemptions of Class A Shares, Class B Shares, and Class C
Shares of a Fund. With Shareholder authorization, BB&T Funds' transfer agent
will automatically redeem Class A Shares, Class B Shares, and Class C Shares at
the net asset value of the applicable Fund on the dates of withdrawal and have
the amount specified transferred according to the instructions of the
Shareholder.
Purchase of additional Class A Shares concurrent with withdrawals may be
disadvantageous to certain Shareholders because of tax liabilities.
To participate in the Auto Withdrawal Plan, Shareholders should complete a
supplemental sign-up form that can be acquired by calling the Distributor. For a
Shareholder to change the Auto Withdrawal instructions or to discontinue the
feature, the request must be made in writing to BB&T Funds, P.O. Box 182533,
Columbus, OH 43218-2533. The Auto Withdrawal Plan may be amended or terminated
without notice at any time by the Distributor.
PAYMENTS TO SHAREHOLDERS. Redemption orders are effected at the net asset
value per Share next determined after the Shares are properly tendered for
redemption, as described above. Payment to Shareholders for Shares redeemed will
be made within seven days after receipt by the Distributor of the request for
redemption. However, to the greatest extent possible, BB&T Funds will attempt to
honor requests from Shareholders for next Business Day payments upon redemptions
of Shares if the request for redemption is received by the Transfer Agent before
the last Valuation Time on a Business Day or, if the request for redemption is
received after the last Valuation Time, to honor requests for payment within two
Business Days, unless it would be disadvantageous to BB&T Funds or the
Shareholders of the particular Fund to sell or liquidate portfolio securities in
an amount sufficient to satisfy requests for payments in that manner. The Prime
Money Market Fund and the U.S. Treasury Fund will attempt to honor requests from
its Shareholders for same day payment upon redemption of Shares if the request
for redemption is received by the Transfer Agent before 12:00 noon Eastern Time,
on a Business Day or, if the request for redemption is received after 12:00 noon
Eastern Time, to honor requests for payment on the next Business Day, unless it
would be disadvantageous to the Fund or its Shareholders to sell or liquidate
portfolio securities in an amount sufficient to satisfy requests for payments in
that manner.
33
REDEMPTION FEES. Shares of a BB&T Fund, with the exception of the BB&T
Money Market Funds, sold or exchanged for shares of another BB&T Fund within
seven (7) days of the date of purchase will be charged a 2.00% redemption fee on
the current net asset value of the shares sold or exchanged. This redemption fee
is paid to the BB&T Funds to offset the costs associated with market timing.
This redemption fee will not be imposed on omnibus accounts whose trading
activity is not related to market timing. While the BB&T Funds will attempt to
impose redemption fees on the underlying account holders of the omnibus
accounts, there can be no guarantee that the Funds will be successful in doing
so. The Funds do not have in place any arrangements to permit any person to
engage in market timing in the Funds.
ADDITIONAL TAX INFORMATION
TAXATION OF THE FUNDS. Each Fund will be treated as a separate entity for
federal income tax purposes. It is the policy of each Fund of BB&T Funds to
elect to be treated as, and to qualify for, the favorable tax treatment accorded
regulated investment companies under Subchapter M of the Internal Revenue Code
of 1986, as amended (the "Code"). By following such policy, each Fund of BB&T
Funds expects to eliminate or reduce to a nominal amount the federal income
taxes to which such Fund may be subject. Regulated investment companies are
subject to a federal excise tax if they do not distribute substantially all of
their income on a timely basis. Each Fund intends to avoid paying federal income
and excise taxes by timely distributing substantially all its net investment
income and net realized capital gains.
In order to qualify for the special tax treatment accorded regulated
investment companies and their shareholders, a Fund must, among other things,
(a) derive at least 90% of its gross income for each taxable year from
dividends, interest, payments with respect to certain securities loans, and
gains from the sale or other disposition of stock, securities, and foreign
currencies, or other income (including but not limited to gains from options,
futures, or forward contracts) derived with respect to its business of investing
in such stock, securities, or currencies; (b) each taxable year distribute at
least 90% of the sum of its investment company taxable income (as that term is
defined in the Code without regard to the deduction for dividends paid -
generally taxable ordinary income and the excess, if any, of net short-term
capital gains over net long-term capital losses) and net tax-exempt interest
income, for such year; and (c) diversify its holdings so that, at the end of
each fiscal quarter (i) at least 50% of the market value of its total assets is
represented by cash, cash items, U.S. Government securities, securities of other
regulated investment companies, and other securities, limited in respect of any
one issuer to a value not greater than 5% of the value of the Fund's total
assets and 10% of the outstanding voting securities of such issuer, and (ii) not
more than 25% of the value of its assets is invested (x) in the securities
(other than those of the U.S. Government or other regulated investment
companies) of any one issuer or of two or more issuers which the Fund controls
and which are engaged in the same, similar, or related trades or businesses, or
(y) in the securities of one or more qualified publicly traded partnerships (as
defined below). In the case of the Fund's investments in loan participations,
the issuer may be the financial intermediary or the borrower.
In general, for purposes of the 90% gross income requirement described in
paragraph (a) above, income derived from a partnership will be treated as
qualifying income only to the extent such income is attributable to items of
income of the partnership which would be qualifying income if realized by the
regulated investment company. However, for taxable years of a regulated
investment company beginning after October 22, 2004, 100% of the net income
derived from an interest in a "qualified publicly traded partnership" (defined
as a partnership (i) interests in which are traded on an established securities
market or readily tradable on a secondary market or the substantial equivalent
thereof and (ii) that derives less than 90% of its income from the qualifying
income described in paragraph (a) above) will be treated as qualifying income.
In addition, although in general the passive loss rules of the Code do not apply
to regulated investment companies, such rules do apply to a regulated investment
company with respect to items attributable to an interest in a qualified
publicly traded partnership. Finally, for purposes of paragraph (c) above, the
term "outstanding voting securities of such issuer" will include the equity
securities of a qualified publicly traded partnership.
If a Fund qualifies as a regulated investment company that is accorded
special tax treatment, the Fund will not be subject to federal income tax on
income distributed in a timely manner to its shareholders in the form of
dividends (including capital gain dividends).
A non-deductible excise tax is imposed on regulated investment companies
that do not distribute in each calendar year (regardless of whether they have a
non-calendar taxable year) an amount equal to 98% of their "ordinary income" (as
defined) for the calendar year plus 98% of their capital gain net income for the
1-year period ending on October 31 of such calendar year plus any undistributed
amounts from prior years. For the foregoing purposes, a Fund is treated as
having distributed any amount on which it is subject to income tax for any
taxable year ending in such calendar year. If distributions during a calendar
year by a Fund were less than the required amount, the Fund would be subject to
a non-deductible excise tax equal to 4% of the deficiency. Each Fund intends
generally to make distributions sufficient to avoid imposition of the 4% excise
tax, although there can be no assurance that they will be able to do so.
34
Although each Fund expects to qualify as a "regulated investment company"
(a "RIC") and to be relieved of all or substantially all federal income taxes,
depending upon the extent of their activities in states and localities in which
their offices are maintained, in which their agents or independent contractors
are located, or in which they are otherwise deemed to be conducting business,
the Funds may be subject to the tax laws of such states or localities. If for
any taxable year a Fund does not qualify for the special federal tax treatment
afforded a RIC, all of its taxable income will be subject to federal income tax
at regular corporate rates at the Fund level (without any deduction for
distributions to its Shareholders). In addition, all distributions to
Shareholders from earnings and profits will be taxed as ordinary income, even if
the distributions are attributable to capital gains or exempt interest earned by
the Fund. Furthermore, in order to re-qualify for taxation as a RIC, the Fund
may be required to recognize unrealized gains, pay substantial taxes and
interest, and make certain distributions.
DISTRIBUTIONS. Distributions from a Fund (other than exempt-interest
dividends, as discussed below) are generally taxable to Shareholders as ordinary
income. Taxes on distributions of capital gains are determined by how long the
Fund owned the investments that generated them, rather than how long a
Shareholder owned his or her shares. Distributions of each Fund's net capital
gains from the sale of investments that such Fund owned for more than one year
and that are properly designated by the Fund as capital gain dividends will be
taxable as long-term capital gains (generally subject to a 15% tax rate, with
lower rates applying to taxpayers in the 10% and 15% rate brackets, through
December 31, 2008), and are not eligible for the dividends received deduction.
Distributions of gains from the sale of investments that a Fund owned for one
year or less will be taxable as ordinary income.
Dividends and distributions on a Fund's shares are generally subject to
federal income tax as described herein to the extent they do not exceed the
Fund's realized income and gains, even though such dividends and distributions
may economically represent a return of a particular Shareholder's investment.
Such distributions are likely to occur in respect of shares purchased at a time
when a Fund's net asset value reflects gains that are either unrealized, or
realized but not distributed. Such realized gains may be required to be
distributed even when a Fund's net asset value also reflects unrealized losses.
Any distributions that are not from a Fund's investment company taxable
income or net capital gains may be characterized as a return of capital to
Shareholders or, in some cases, as capital gain. A return of capital is not
taxable, but it reduces the Shareholder's tax basis in his or her shares, thus
reducing any loss or increasing any gain on subsequent taxable disposition by
each Shareholder of his or her shares.
For taxable years beginning on or before December 31, 2008, "qualified
dividend income" received by an individual will be taxed at the rates applicable
to long-term capital gain. In order for some portion of the dividends received
by a Fund shareholder to be qualified dividend income, the Fund must meet
holding period and other requirements with respect to some portion of the
dividend-paying stocks in its portfolio and the shareholder must meet holding
period and other requirements with respect to the Fund's shares. A dividend will
not be treated as qualified dividend income (at either the Fund or shareholder
level) (1) if the dividend is received with respect to any share of stock held
for fewer than 61 days during the 121-day period beginning on the date which is
60 days before the date on which such share becomes ex-dividend with respect to
such dividend (or, in the case of certain preferred stock, 91 days during the
181-day period beginning 90 days before such date), (2) to the extent that the
recipient is under an obligation (whether pursuant to a short sale or otherwise)
to make related payments with respect to positions in substantially similar or
related property, (3) if the recipient elects to have the dividend income
treated as investment interest, or (4) if the dividend is received from a
foreign corporation that is (a) not eligible for the benefits of a comprehensive
income tax treaty with the United States (with the exception of dividends paid
on stock of such a foreign corporation readily tradable on an established
securities market in the United States) or (b) treated as a passive foreign
investment company. To the extent that a Fund makes a distribution of income
received by the Fund in lieu of dividends ( a "substitute payment") with respect
to securities on loan pursuant to a securities lending transaction, such income
will not constitute qualified dividend income and thus will not be eligible for
taxation at the rates applicable to long-term capital gain. The Funds expect to
use such substitute payments to meet a given Fund's expenses, and therefore
generally will not make distributions of substitute payments.
In general, distributions of investment income designated by a Fund as
derived from qualified dividend income will be treated as qualified dividend
income by a shareholder taxed as an individual provided the shareholder meets
the holding period and other requirements described above with respect to such
Fund's shares. In any event, if the aggregate qualified dividends received by a
Fund during any taxable year are 95% or more of its gross income, then 100% of
the Fund's dividends (other than dividends properly designated as capital gain
dividends) will be eligible to be treated as qualified dividend income. For this
purpose, the only gain included in the term "gross income" is the excess of net
short-term capital gain over net long-term capital loss. The BB&T Bond Funds and
the BB&T Money Market Funds do not expect a significant portion of their
distributions to be derived from qualified dividend income.
35
Certain dividends paid by a Fund, and so-designated by such Fund, may
qualify for the 70% dividends received deduction for corporate shareholders. A
dividend received by the Fund will not be treated as a qualifying dividend (1)
if the stock on which the dividend is paid is considered to be "debt financed"
(generally, acquired with borrowed funds), (2) if it has been received with
respect to any share of stock that the Fund has held for less than 46 days (91
days in the case of certain preferred stock) during the 90-day period (180-day
period in the case of certain preferred stock) surrounding the ex-dividend date,
or (3) to the extent that the Fund is under an obligation (pursuant to a short
sale or otherwise) to make related payments with respect to positions in
substantially similar or related property. Moreover, the dividends received
deduction may be disallowed or reduced (1) if the corporate shareholder fails to
satisfy the foregoing requirements with respect to its shares of the Fund or (2)
by application of the Code. The Funds do not expect any distributions to qualify
for the dividends received deduction.
A Fund's investment in securities issued at a discount and certain other
obligations will (and investments in securities purchased at a discount may)
require the Fund to accrue and distribute income not yet received. In order to
generate sufficient cash to make the requisite distributions, a Fund may be
required to sell securities in its portfolio that it otherwise would have
continued to hold.
Distributions are taxable to a Shareholder of a Fund even if they are paid
from income or gains earned by the Fund prior to the Shareholder's investment
(and thus were included in the price paid by the Shareholder). The tax treatment
of dividends and distributions will be the same whether a Shareholder reinvests
them in additional shares or elects to receive them in cash.
Distributions from capital gains are generally made after applying any
capital loss carryovers.
Dividends are generally taxable in the taxable year received. However,
dividends declared in October, November or December to Shareholders of record
during such a month and paid during the following January are treated for tax
purposes as if they were received by each Shareholder on December 31 of the year
in which the dividends were declared. Shareholders will be advised at least
annually as to the amount and federal income tax character of distributions made
during the year.
EXEMPT-INTEREST DIVIDENDS. A Fund will be qualified to pay exempt-interest
dividends to its Shareholders only if, at the close of each quarter of the
Fund's taxable year, at least 50% of the total value of the Fund's assets
consists of obligation the interest on which is exempt from federal income tax.
Such dividends will not exceed, in the aggregate, the net interest a Fund
receives during the taxable year from securities exempt from regular federal
income tax. An exempt-interest dividend is any dividend or part thereof (other
than a capital gain dividend) paid by a Fund and properly designated as an
exempt-interest dividend in a notice mailed to Shareholders after the close of
the Fund's taxable year. Generally, exempt-interest dividends will be excluded
from gross income for federal income tax purposes. However, exempt-interest
dividends attributable to investments in certain "private activity" bonds will
be treated as tax preference items in computing the alternative minimum tax.
Also, a portion of all other exempt-interest dividends earned by a corporation
may be subject to the alternative minimum tax.
If a Shareholder receives an exempt-interest dividend with respect to any
share held by the Shareholder for six months or less, any loss or the sale or
exchange of such share will be disallowed to the extent of the amount of such
exempt-interest dividend. In certain limited instances, the portion of Social
Security or Railroad Retirement benefits that may be subject to federal income
taxation may be affected by the amount of tax-exempt interest income, including
exempt-interest dividends, received by the Shareholder.
Part or all of the interest on indebtedness, if any, incurred or continued
by a Shareholder to purchase or carry shares of a Fund paying exempt-interest
dividends is not deductible. The portion of interest that is not deductible is
equal to the total interest paid or accrued on the indebtedness, multiplied by
the percentage of the Fund's total distributions of exempt-interest dividends
(not including distributions from net long-term capital gains) paid to the
Shareholder. Under rules used by the Internal Revenue Service to determine when
borrowed funds are considered used for the purpose of purchasing or carrying
particular assets, the purchase of shares may be considered to have been made
with borrowed funds even though such funds are not directly traceable to the
purchase of shares.
In general, exempt-interest dividends, if any, attributable to interest
received on certain private activity obligations and certain industrial
development bonds will not be tax-exempt to any Shareholders who are
"substantial users" of the facilities financed by such obligations or bonds or
who are "related persons" of such substantial users. "Substantial user" is
defined under U.S. Treasury Regulations to include a non-exempt person who
regularly uses a part of such facilities in his trade or business, and whose
gross revenues derived with respect to the facilities financed by the issuance
of bonds represent more than 5% of the total revenues derived by all users of
such facilities, or who occupies more than 5% of the usable area of such
facilities, or for whom such facilities or a part thereof were specifically
constructed, reconstructed or acquired. "Related person" includes certain
related natural persons, affiliated corporations, a partnership and its partners
and an S Corporation and its shareholders. Each Shareholder who may be
considered a
36
"substantial user" should consult a tax adviser with respect to whether
exempt-interest dividends would retain the exclusion under Section 103 of the
Code if the Shareholder were treated as a "substantial user" or a "related
person."
If a tax-exempt Fund makes a distribution in excess of its net investment
income and net realized capital gains, if any, in any taxable year, the excess
distribution will be treated as ordinary dividend income (not eligible for
tax-exempt treatment) to the extent of the Fund's current and accumulated
"earnings and profits" (including earnings and profits arising from tax-exempt
income, and also specifically including the amount of any non-deductible
expenses arising in connection with such tax-exempt income).
Dividends received by a Shareholder of a Fund that are derived from such
Fund's investments in U.S. Government Securities may not be entitled to the
exemption from state and local income taxes that would be available if the
Shareholder had purchased U.S. Government Securities directly. Depending upon
the extent of their activities in states and localities in which their offices
are maintained, in which their agents or independent contractors are located, or
in which they are otherwise deemed to be conducting business, the Funds may be
subject to the tax laws of such states or localities. Shareholders are advised
to consult their tax adviser concerning the application of state and local taxes
to distributions received from a Fund.
Dividends that are derived from interest on a Fund's investments in U.S.
Government Securities and that are received by a Shareholder who is a Kentucky,
Maryland, North Carolina, South Carolina, Virginia, or West Virginia resident
are currently eligible for exemption from those states' income taxes. Such
dividends may be eligible for exemption from the state and local taxes of other
jurisdictions as well, although state and local tax authorities may not agree
with this view. However, in Kentucky, Maryland, North Carolina, South Carolina,
Virginia, and West Virginia as well as in other states, distributions of income
derived from repurchase agreements and securities lending transactions generally
will not qualify for exemption from state and local income taxes.
SELLING SHARES. Upon the disposition of shares of a Fund (whether by
redemption, sale or exchange), a Shareholder will realize a gain or loss. Such
gain or loss will be capital gain or loss if the shares are capital assets in
the Shareholder's hands, and will be long-term or short-term generally depending
upon the Shareholder's holding period for the shares. The tax rate generally
applicable to net capital gains recognized by individuals and other
non-corporate taxpayers is (i) the same as the maximum ordinary income tax rate
for gains recognized on the sale of capital assets held for one year or less or
(ii) for taxable years beginning on or before December 31, 2008, 15% for gains
recognized on the sale of capital assets held for more than one year (as well as
capital gain dividends). For taxable years beginning after December 31, 2008,
long-term capital gains will generally be taxed at a maximum capital gain rate
of 20% to non-corporate Shareholders (or 10% in the case of such Shareholders in
the 10% or 15% tax bracket). Long-term capital gains from capital assets
(including Fund shares) held by a non-corporate Shareholder for more than 5
years will be 8% and 18% (rather than 10% and 20%).
If a Shareholder sells Fund shares at a loss within six months of purchase,
any loss will be disallowed for Federal income tax purposes to the extent of any
exempt-interest dividends received on such shares. In addition, any loss (not
already disallowed as provided in the preceding sentence) realized upon a
taxable disposition of shares held for six months or less will be treated as
long-term, rather than short-term, to the extent of any long-term capital gain
distributions received by the Shareholder with respect to the shares. All or a
portion of any loss realized upon a taxable disposition of Fund shares will be
disallowed if other shares of the same Fund are purchased within 30 days before
or after the disposition. In such a case, the basis for the newly purchased
shares will be adjusted to reflect the disallowed loss.
Under Treasury regulations, if a Shareholder recognizes a loss with respect
to Common Shares of $2 million or more for an individual Shareholder, or $10
million or more for a corporate Shareholder, the Shareholder must file with the
Internal Revenue Service a disclosure statement on Form 8886. Direct Shareholder
of portfolio securities are in many cases excepted from this reporting
requirement, but under current guidance, Shareholders of a regulated investment
company are not excepted. Future guidance may extend the current exception from
this reporting requirement to shareholders of most or all regulated investment
companies. The fact that a loss is reportable under these regulations does not
affect the legal determination of whether the taxpayer's treatment of the loss
is proper. Shareholders should consult their tax advisers to determine the
applicability of these regulations in light of their individual circumstances.
BACKUP WITHHOLDING. Each Fund of BB&T Funds generally is required to
withhold and remit to the U.S. Treasury a percentage of the proceeds of share
sales, exchanges, or redemptions made by, and the taxable dividends and other
distributions paid to any individual shareholder who fails to properly furnish
the Fund with a correct taxpayer identification number (TIN), who has
under-reported dividend or interest income, or who fails to certify to the Fund
that he or she is a United States person and is not subject to such withholding.
The backup withholding tax rate is 28% for amounts paid through 2010. Backup
withholding is not an
37
additional tax. Any amounts withheld may be credited against the Shareholder's
U.S. federal income tax liability, provided the appropriate information is
furnished to the Internal Revenue Service.
In order for foreign investors in order to qualify for exemption from the
back-up withholding tax rates under income tax treaties, the foreign investor
must comply with special certification and filing requirements. Foreign
investors in a Fund should consult their tax advisers with respect to this
regard.
HEDGING. A Fund's transactions in futures contracts, options, and
foreign-currency-denominated securities, and certain other investment and
hedging activities of the Fund, will be subject to special tax rules (including
"mark-to-market," "straddle," "wash sale," "constructive sale," and "short sale"
rules), the effect of which may be to accelerate income to the Fund, defer
losses to the Fund, cause adjustments in the holding periods of the Fund's
assets, convert short-term capital losses into long-term capital losses, convert
long-term capital gains into short-term capital gains, and otherwise affect the
character of the Fund's income. These rules could therefore affect the amount,
timing, and character of distributions to Shareholders. Income earned as a
result of these transactions would, in general, not be eligible for the
dividends received deduction or for treatment as exempt-interest dividends when
distributed to Shareholders. Each Fund will endeavor to make any available
elections pertaining to these transactions in a manner believed to be in the
best interest of the Fund.
A Fund's investments in certain debt obligations may cause the Fund to
recognize taxable income in excess of the cash generated by such obligations.
Certain of the Fund's hedging activities (including its transactions, if any, in
foreign currencies or foreign currency-denominated instruments) are likely to
produce a difference between its book income and its taxable income (or, in the
case of a tax-exempt Fund, the sum of its net tax-exempt and taxable income). If
the Fund's book income exceeds its taxable income (or in the case of a
tax-exempt Fund, its tax-exempt income) the distribution, if any, of such excess
will be treated as (i) a dividend to the extent of the Fund's remaining earnings
and profits (including earnings and profits arising from tax-exempt income),
(ii) thereafter as a return of capital to the extent of the recipient's basis in
the shares, and (iii) thereafter as gain from the sale or exchange of a capital
asset. If the Fund's book income is less than its taxable income (or, in the
case of a tax-exempt Fun, the sum of its net tax-exempt and taxable income) the
Fund could be required to make distributions exceeding book income to qualify as
a regulated investment company that is accorded special tax treatment.
FOREIGN TAXES, FOREIGN CURRENCY-DENOMINATED SECURITIES AND RELATED HEDGING
TRANSACTIONS. Dividends and interest received by a Fund may be subject to
income, withholding or other taxes imposed by foreign countries and U.S.
possessions that would reduce the yield on the Fund's securities. Tax
conventions between certain countries and the United States may reduce or
eliminate these taxes. Foreign countries generally do not impose taxes on
capital gains with respect to investments by foreign investors. Shareholders
generally will not be entitled to claim a credit or deduction with respect to
foreign taxes. However, if more than 50% of a Fund's assets at year end consists
of the securities of foreign corporations, the Fund may elect to permit
shareholders to claim a credit or deduction on their income tax returns for
their pro rata portion of qualified taxes paid by the Fund to foreign countries
in respect of foreign securities the Fund has held for at least the minimum
period specified in the Code. In such a case, shareholders will include in gross
income from foreign sources their pro rata shares of such taxes. A shareholder's
ability to claim a foreign tax credit or deduction in respect of foreign taxes
paid by the Fund may be subject to certain limitations imposed by the Code, as a
result of which a shareholder may not get a full credit or deduction for the
amount of such taxes. In particular, shareholders must hold their Fund shares
(without protection from risk of loss) on the ex-dividend date and for at least
15 additional days during the 30-day period surrounding the ex-dividend date to
be eligible to claim a foreign tax credit with respect to a given dividend.
Shareholders who do not itemize on their federal income tax returns may claim a
credit (but no deduction) for such foreign taxes. Because a Fund of Funds cannot
pass through credits or deductions for foreign taxes paid, the Funds of Funds do
not intend to make this election if it is available.
A Fund's transactions in foreign currencies, foreign currency-denominated
debt securities and certain foreign currency options, futures contracts and
forward contracts (and similar instruments) may give rise to ordinary income or
loss to the extent such income or loss results from fluctuations in the value of
the foreign currency concerned.
Equity investments by a Fund in certain "passive foreign investment
companies" ("PFICs") could potentially subject the Fund to a U.S. federal income
tax (including interest charges) on distributions received from the company or
on proceeds received from the disposition of shares in the company, which tax
cannot be eliminated by making distributions to Fund shareholders. However, the
Fund may elect to avoid the imposition of that tax. For example, the Fund may
elect to treat a PFIC as a "qualified electing fund" (a "QEF election"), in
which case the Fund will be required to include its share of the company's
income and net capital gains annually, regardless of whether it receives any
distribution from the company. The Fund also may make an election to mark the
gains (and to a limited extent losses) in such holdings "to the market" as
though it had sold and repurchased its holdings in those PFICs on the last
38
day of the Fund's taxable year. Such gains and losses are treated as ordinary
income and loss. The QEF and mark-to-market elections may accelerate the
recognition of income (without the receipt of cash) and increase the amount
required to be distributed by the Fund to avoid taxation. Making either of these
elections therefore may require the Fund to liquidate other investments
(including when it is not advantageous to do so) to meet its distribution
requirement, which also may accelerate the recognition of gain and affect the
Fund's total return.
A "passive foreign investment company" is any foreign corporation: (i) 75
percent of more of the income of which for the taxable year is passive income,
or (ii) the average percentage of the assets of which (generally by value, but
by adjusted tax basis in certain cases) that produce or are held for the
production of passive income is at least 50 percent. Generally, passive income
for this purpose means dividends, interest (including income equivalent to
interest), royalties, rents, annuities, the excess of gains over losses from
certain property transactions and commodities transactions, and foreign currency
gains. Passive income for this purpose does not include rents and royalties
received by the foreign corporation from active business and certain income
received from related persons.
ADDITIONAL TAX INFORMATION CONCERNING THE INTERNATIONAL EQUITY FUND
Dividends and certain interest income earned by the International Equity
Fund from foreign securities may be subject to foreign withholding taxes or
other taxes. So long as more than 50% of the value of the Fund's total assets at
the close of any taxable year consists of stock or securities of foreign
corporations, the Fund may elect, for U.S. federal income tax purposes, to treat
certain foreign taxes paid by it on securities it has held for at least the
minimum period specified in the Code, including generally any withholding taxes
and other foreign income taxes, as paid by its shareholders. It is possible that
the International Equity Fund will make this election in certain years. The
remaining Funds do not expect to be eligible to make this election. If the Fund
makes the election, the amount of such foreign taxes paid by the Fund will be
included in its shareholders' income pro rata (in addition to taxable
distributions actually received by them), and each shareholder will be entitled
either (a) to credit a proportionate amount of such taxes against a
shareholder's U.S. Federal income tax liabilities, so long as the shareholder
held the Fund shares (without protection from risk of loss) on the ex-dividend
date and for at least 15 other days during the 30-day period surrounding the
ex-dividend date, or (b) if a shareholder itemizes deductions, to deduct such
proportionate amounts from U.S. Federal taxable income. Although a Fund of Funds
may itself be entitled to a deduction for such taxes paid by a Fund in which the
Fund of Funds invests, the Fund of Funds will not be able to pass any such
credit or deduction through to its own shareholders.
Fund transactions in foreign currencies and hedging activities may give
rise to ordinary income or loss to the extent such income or loss results from
fluctuations in value of the foreign currency concerned. In addition, such
activities will likely produce a difference between book income and taxable
income. This difference may cause a portion of a Fund's income distributions to
constitute a return of capital for tax purposes or require the Fund to make
distributions exceeding book income to qualify as a RIC for tax purposes.
ADDITIONAL TAX INFORMATION CONCERNING THE TAX-FREE BOND FUNDS
As indicated in the Prospectuses, the Kentucky Fund, the Maryland Fund, the
North Carolina Fund, the South Carolina Fund, the Virginia Fund, and the West
Virginia Fund are designed to provide Kentucky, Maryland, North Carolina, South
Carolina, Virginia, and West Virginia Shareholders, respectively, with current
tax-exempt interest income. The Funds are not intended to constitute a balanced
investment program and are not designed for investors seeking capital
appreciation or maximum tax-exempt income irrespective of fluctuations in
principal. Shares of the Tax-Free Bond Funds would not be suitable for
tax-exempt institutions and may not be suitable for retirement plans qualified
under Section 401 of the Code, so-called Keogh or H.R. 10 plans, and individual
retirement accounts. Such plans and accounts are generally tax-exempt and,
therefore, would not realize any additional benefit from the dividends of the
Tax-Free Bond Funds being tax-exempt, and such dividends would be ultimately
taxable to the beneficiaries of such plans and accounts when distributed to
them.
The portions of dividends paid for each year that are exempt from federal,
and Kentucky, Maryland, North Carolina, South Carolina, Virginia, or West
Virginia income tax, respectively, will be designated within 60 days after the
end of a Fund's taxable year and will be based for each of the Kentucky,
Maryland, North Carolina, South Carolina, Virginia, and West Virginia Funds upon
the ratio of net tax-exempt income to total net income earned by the Fund during
the entire year. That ratio may be substantially different from the ratio of net
tax-exempt income to total net income earned during any portion of the year.
Thus, a Shareholder who holds Shares in either Fund for only a part of the year
may be allocated more or less tax-exempt dividends than would be the case if the
allocation were based on the ratio of net tax-exempt income to total net income
actually earned by the Fund while he or she was a Shareholder.
39
Distributions from the Maryland Fund will not be subject to Maryland income
tax if the Maryland Fund pays distributions to Shareholders that it derived from
interest on, or gain from the sale of, debt obligations of Maryland or its
political subdivisions or interest on debt obligations of the United States and
some of its authorities, commissions, or instrumentalities, possessions or
territories.
Distributions from the North Carolina Fund will not be subject to North
Carolina income tax if made to individual Shareholders residing in North
Carolina or to trusts or estates subject to North Carolina income tax to the
extent such distributions are either (i) attributable to interest on obligations
of North Carolina or its political subdivisions, or Guam, Puerto Rico, or the
United States Virgin Islands, including the governments thereof and their
agencies, instrumentalities and authorities, or (ii) attributable to interest on
direct obligations of the United States.
Distributions from the South Carolina Fund will not be subject to South
Carolina income tax if made to individual Shareholders residing in South
Carolina or to trusts or estates subject to South Carolina income tax to the
extent such distributions are either (i) attributable to interest on obligations
of South Carolina or its political subdivisions, including any agencies,
instrumentalities and authorities thereof, or (ii) attributable to interest on
direct obligations of the United States. However, distributions from the South
Carolina Fund may be subject to certain estate transfer and bank transfer taxes
by South Carolina.
Distributions from the Virginia Fund will not be subject to Virginia income
tax if the Virginia Fund pays distributions to Shareholders that it derived from
interest on debt obligations of Virginia or its political subdivisions, debt
obligations of the United States excludable from Virginia income tax under the
laws of the United States, or debt obligations of Puerto Rico, Guam, or the
Virgin Islands, which debt obligations are backed by the full faith and credit
of the borrowing government.
Distributions from the West Virginia Fund will not be subject to West
Virginia income tax if the West Virginia Fund pays distributions to Shareholders
that it derived from interest on debt obligations of West Virginia or its
political subdivisions or debt obligations of the United States and some of its
authorities, commissions, or instrumentalities.
Distributions designated by the Funds as "exempt-interest dividends" are
generally not subject to federal income tax. However, if the Shareholder
receives Social Security or railroad retirement benefits, the Shareholder should
consult his or her tax adviser to determine what effect, if any, an investment
in a Fund may have on the taxation of such benefits.
Dividends derived from interest income from certain types of securities in
which the Tax-Free Bond Funds may invest, may subject individual and corporate
investors to liability under the federal alternative minimum tax. As a matter of
policy, under normal market conditions, not more than 10% of a Fund's total
assets will be invested in securities the interest on which is treated as a
preference item for purposes of the federal alternative minimum tax for
individuals. To the extent the Tax-Free Bond Funds invest in securities the
interest on which is subject to federal alternative minimum tax, Shareholders,
depending on their tax status, may be subject to alternative minimum tax on that
part of the Fund's distributions derived from those securities. Interest income
on all Tax-Exempt Obligations is included in "adjusted current earnings" for
purposes of computing the federal alternative minimum tax applicable to
corporate Shareholders of the Tax-Free Bond Funds.
Under the Code, if a Shareholder receives an exempt-interest dividend with
respect to any Share and such Share is held for six months or less, any loss on
the sale or exchange of such Share will be disallowed for Kentucky, Maryland,
North Carolina, South Carolina, Virginia, West Virginia and federal income tax
purposes to the extent of the amount of such exempt-interest dividend, even
though, in the case of Kentucky, Maryland, North Carolina, South Carolina,
Virginia, or West Virginia, some portion of such dividend actually may have been
subject to Kentucky, Maryland, North Carolina, South Carolina, Virginia, or West
Virginia income tax. Although the Treasury Department is authorized to issue
regulations reducing such period to as short as 31 days for RICs that regularly
distribute at least 90% of their net tax-exempt interest, no such regulations
have been issued as of the date of this Statement of Additional Information.
The Tax-Free Bond Funds may at times purchase Tax-Exempt Obligations at a
discount from the price at which they were originally issued. For federal income
tax purposes, some or all of this market discount will be included in a Fund's
ordinary income and will be taxable to Shareholders as such when it is
distributed to them.
To the extent dividends paid to Shareholders are derived from taxable
income (for example, from interest on certificates of deposit, market discount,
securities lending transactions or repurchase agreements), or from long-term or
short-term capital gains, such dividends will be subject to federal income tax,
whether such dividends are paid in the form of cash or additional Shares.
Distributions by the Tax-Free Bond Funds of net gains on securities held for
more than one year are taxable to Shareholders as such, regardless of
40
how long the Shareholder has held Shares in a Tax-Free Bond Fund, except that
distributions which are directly attributable to gains from certain obligations
of the State of North Carolina and its political subdivisions that were issued
before July 1, 1995 are exempt from North Carolina State income tax and
distributions which are directly attributable to gains from certain obligations
of the State of Maryland and its political subdivisions is exempt for Maryland
State income tax. Distributions will be taxable as described above even if the
net asset value of a Share in a Tax-Free Bond Fund is reduced below the
Shareholder's cost of that Share by the distribution of income or gain realized
on the sale of securities and the distribution is, as an economic matter, a
return of capital. If a shareholder purchases mutual fund shares, receives a
capital gain dividend (or is credited with an undistributed capital gain) and
then sells the shares at a loss within 6 months after purchasing the shares, the
loss is treated as a long-term capital loss to the extent of the capital gain
dividend (or undistributed capital gain).
Part or all of the interest on indebtedness incurred by a Shareholder to
purchase or carry Shares of the Kentucky Fund, the Maryland Fund, the North
Carolina Fund, the South Carolina Fund, the Virginia Fund, or the West Virginia
Fund is not deductible, or requires a modification increasing adjusted gross
income, for federal, Kentucky, Maryland, North Carolina, South Carolina,
Virginia, or West Virginia income tax purposes. The portion of interest that is
not deductible for federal income tax purposes is equal to the total interest
multiplied by the percentage of the Fund's total distributions (not including
distributions from net long-term capital gains) paid to the Shareholder that are
exempt-interest dividends. It is anticipated that none of the distributions from
a Tax-Free Bond Fund will be eligible for the dividends received deduction for
corporations.
In addition, the Tax-Free Bond Funds may not be tax-exempt investments for
Shareholders who are "substantial users" of facilities financed by private
activity bonds or "related persons" thereof.
The Code permits a RIC which invests at least 50% of its total assets in
Tax-Exempt Obligations to pass through to its investors, tax-free, net
Tax-Exempt Obligations interest income. The policy of the Tax-Free Bond Funds is
to pay each year as dividends substantially all the Fund's Tax-Exempt
Obligations interest income net of certain deductions. An exempt-interest
dividend is any dividend or part thereof (other than a capital gain dividend)
paid by the Tax-Free Bond Funds and designated as an exempt-interest dividend in
a written notice mailed to Shareholders within sixty days after the close of the
Fund's taxable year, but not to exceed in the aggregate the net Tax-Exempt
Obligations interest received by the Fund during the taxable year. The
percentage of the total dividends paid for any taxable year which qualifies as
federal exempt-interest dividends will be the same for all Shareholders
receiving dividends from the Tax-Free Bond Funds, respectively, during such
year, regardless of the period for which the Shares were held.
While the Tax-Free Bond Funds do not expect to realize any significant
amount of long-term capital gains, any net realized long-term capital gains will
be distributed annually. The Tax-Free Bond Funds will have no tax liability with
respect to such distributed gains, and the distributions will be taxable to
Shareholders as net gains on securities held for more than one year regardless
of how long a Shareholder has held the Shares of a Tax-Free Bond Fund. Such
distributions will be designated as a capital gains dividend in a written notice
mailed by the Tax-Free Bond Funds to their respective Shareholders within sixty
days after the close of each Fund's taxable year.
Distributions of exempt-interest dividends, to the extent attributable to
interest on Kentucky, Maryland, North Carolina, South Carolina, Virginia, and
West Virginia Tax-Exempt Obligations and to interest on direct obligations of
the United States (including territories thereof), are not subject to, or result
in adjustments decreasing, Kentucky, Maryland, North Carolina, South Carolina,
Virginia, or West Virginia (respectively) individual or corporate income tax.
However, distributions from the South Carolina Fund may be subject to certain
estate transfer and bank transfer taxes by South Carolina. Distributions of
gains attributable to certain obligations of the State of Maryland and its
political subdivisions are not subject to Maryland individual or corporate
income tax. Distributions of gains attributable to certain obligations of the
State of North Carolina and its political subdivisions issued prior to July 1,
1995 are not subject to North Carolina individual or corporate income tax;
however, distributions of gains attributable to such types of obligations that
were issued after June 30, 1995 will be subject to North Carolina individual or
corporate income tax. Distributions of gains attributable to obligations of the
State of South Carolina are subject to South Carolina individual and corporate
income tax. Individuals who are shareholders in West Virginia cannot reduce
their West Virginia AGI for any portion of interest or dividends received from
the Fund derived from income on obligations of any state, or political
subdivision thereof, other than West Virginia, regardless of any Federal law
exemption, such as that accorded "exempt-interest dividends;" and they must
increase their West Virginia Adjusted Gross Income ("AGI") by the amount of such
interest or dividend income. Also, an individual who is a shareholder must
increase his West Virginia AGI by interest on indebtedness incurred (directly or
indirectly) to purchase or hold shares of the Fund to the extent such interest
was deductible in determining Federal AGI. The sale, exchange, or redemption of
Fund shares is subject to the West Virginia income tax to the extent the gain or
loss therefrom affects the determination of the shareholder's Federal AGI.
41
While the Tax-Free Bond Funds do not expect to earn any significant amount
of investment company taxable income, taxable income earned by the Tax-Free Bond
Funds will be distributed to their respective Shareholders. In general, the
investment company taxable income will be the taxable income of each Fund (for
example, short-term capital gains) subject to certain adjustments and excluding
the excess of any net long-term capital gains for the taxable year over the net
short-term capital loss, if any, for such year. Any such income will be taxable
to Shareholders as ordinary income (whether paid in cash or additional Shares).
As indicated in the Prospectuses, the Funds may acquire puts with respect
to Tax-Exempt Obligations held in the portfolios. See "INVESTMENT OBJECTIVES AND
POLICIES - Additional Information on Portfolio Instruments - Puts" in this
Statement of Additional Information. The policy of the Tax-Free Bond Funds is to
limit the acquisition of puts to those under which the Fund will be treated for
federal income tax purposes as the owner of the Tax-Exempt Obligations acquired
subject to the put and the interest on the Tax-Exempt Obligations will be
tax-exempt to the Fund. Although the Internal Revenue Service has issued a
published ruling that provides some guidance regarding the tax consequences of
the purchase of puts, there is currently no guidance available from the Internal
Revenue Service that definitively establishes the tax consequences of many of
the types of puts that the Tax-Free Bond Funds could acquire under the 1940 Act.
Therefore, although the Tax-Free Bond Funds will only acquire a put after
concluding that such put will have the tax consequences described above, the
Internal Revenue Service could reach a different conclusion from that of the
Tax-Free Bond Funds. If a Tax-Free Bond Fund were not treated as the owners of
the Tax-Exempt Obligations, income from such securities would probably not be
tax exempt.
The foregoing is only a summary of some of the important federal tax
considerations generally affecting purchasers of Shares of the Tax-Free Bond
Funds. No attempt has been made to present a detailed explanation of the Federal
or state income tax treatment of the Tax-Free Bond Funds or their Shareholders
and this discussion is not intended as a substitute for careful tax planning.
Accordingly, potential purchasers of Shares of the Tax-Free Bond Funds are urged
to consult their tax advisers with specific reference to their own tax
situation. In addition, the foregoing discussion is based on tax laws and
regulations which are in effect on the date of this Statement of Additional
Information; such laws and regulations may be changed by legislative or
administrative action.
ADDITIONAL TAX INFORMATION CONCERNING THE FUNDS OF FUNDS.
A Fund of Funds will not be able to offset gains realized by one Fund in
which it invests against losses realized by another Fund in which it invests.
The use of a fund-of-funds structure can therefore affect the amount, timing and
character of distributions to shareholders, and may increase the amount of taxes
payable by shareholders.
Depending on a Fund of Fund's percentage ownership in an underlying Fund,
both before and after a redemption of shares of an underlying fund, the Fund of
Funds may be treated as not receiving capital gain income on the amount by which
the distribution exceeds the tax basis of the Fund of Funds in the shares of the
underlying Fund, but rather as receiving a dividend. Such a distribution may be
treated as qualified dividend income and thus be eligible to be taxed at the
rates applicable to long-term capital gain. However, dividends of a Fund of
Funds may not be eligible for treatment as qualified dividend income unless the
holding period and other requirements for such treatment are met by both the
Fund of Funds and the underlying Fund, as well as by the Shareholder. If
qualified dividend income treatment is not available, the distribution may be
taxed at ordinary income rates. This could cause Shareholders of the Fund of
Funds to recognize higher amounts of ordinary income than if the Shareholders
had held the shares of the underlying Funds directly.
Although each Fund of Funds may itself be entitled to a deduction for
foreign taxes paid by a Fund in which such Fund of Funds invests, it will not be
able to pass any such credit or deduction through to their own Shareholders.
Funds of Funds cannot pass through to their Shareholders exempt-interest
dividends. Accordingly, the Funds of Funds are not likely to invest in
underlying Funds that invest substantially in tax-exempt obligations and that
pay exempt-interest dividends.
Under recent legislation, which is effective for taxable years of the Funds
beginning on or after October 1, 2005, and which applies to distributions made
or deemed made on or before December 31, 2007, if a Fund of Funds invests in an
underlying Fund that pays distributions from properly designated (i) U.S.-source
interest income that, in general, would not be subject to U.S. federal income
tax if earned directly by an individual foreign person, or (ii) net short-term
capital gains in excess of net long-term capital losses, to the Fund of Funds,
such distributions will retain their character as not subject to withholding
when paid by the Fund of Funds to its foreign shareholders. The fact that a Fund
of Funds achieves its investment objectives by investing in underlying Funds
generally will not adversely affect the Fund of Funds' ability to pass on to
foreign shareholders the full benefit of the interest-related dividends and
short-term capital gain dividends that it receives from its investments in the
underlying Funds, except possibly to the extent that (i) interest-related
dividends received by the Fund of Funds are offset by deductions allocable to
the Fund of Funds' qualified interest income, or (ii) short-term capital gain
dividends received by the Fund of Funds are offset by the Fund of Funds' net
short- or long-
42
term capital losses, in which case the amount of a distribution from the Fund of
Funds to a foreign shareholder that is properly designated as either an
interest-related dividend or a short-term capital gain dividend, respectively,
may be less than the amount that such shareholder would have received had they
invested directly in the underlying Fund. A Fund of Funds will not, under
current law, receive or pass through distributions to foreign persons
attributable to gains from the sale or exchange of USRPIs as a result of its
investment in an underlying Fund; this result may be changed by future
regulations.
The foregoing is only a general description of the federal tax consequences
of a fund of funds structure. Accordingly, prospective purchasers of shares of a
Fund of Funds are urged to consult their tax advisors with specific reference to
their own tax situation, including the potential application of state, local and
foreign taxes.
ADDITIONAL TAX INFORMATION CONCERNING NON-US SHAREHOLDERS
Capital gain dividends will not be subject to withholding of federal income
tax. In general, dividends (other than capital gain dividends) paid by a Fund to
a shareholder that is not a "U.S. person" within the meaning of the Code (such
shareholder, a "foreign person") are subject to withholding of U.S. federal
income tax at a rate of 30% (or lower applicable treaty rate) even if they are
funded by income or gains (such as portfolio interest, short-term capital gains,
or foreign-source dividend and interest income) that, if paid to a foreign
person directly, would not be subject to withholding. However, effective for
taxable years of the Fund beginning after December 31, 2004 and before January
1, 2008, a Fund will not be required to withhold any amounts (i) with respect to
distributions (other than distributions to a foreign person (w) that has not
provided a satisfactory statement that the beneficial owner is not a U.S.
person, (x) to the extent that the dividend is attributable to certain interest
on an obligation if the foreign person is the issuer or is a 10% shareholder of
the issuer, (y) that is within certain foreign countries that have inadequate
information exchange with the United States, or (z) to the extent the dividend
is attributable to interest paid by a person that is a related person of the
foreign person and the foreign person is a controlled foreign corporation) from
U.S.-source interest income that, in general, would not be subject to U.S.
federal income tax if earned directly by an individual foreign person, to the
extent such distributions are properly designated by the Fund, and (ii) with
respect to distributions (other than distributions to an individual foreign
person who is present in the United States for a period or periods aggregating
183 days or more during the year of the distribution) of net short-term capital
gains in excess of net long-term capital losses, to the extent such
distributions are properly designated by the Fund. This provision will first
apply to each Fund in its taxable year beginning October 1, 2005.
If a beneficial holder who is a foreign person has a trade or business in
the United States, and the dividends are effectively connected with the conduct
by the beneficial holder of a trade or business in the United States, the
dividend will be subject to U.S. federal net income taxation at regular income
tax rates.
Recent legislation modifies the tax treatment of distributions from a Fund
that are paid to a foreign person and are attributable to gain from "U.S. real
property interests" ("USRPIs"), which the Code defines to include direct
holdings of U.S. real property and interests (other than solely as a creditor)
in "U.S. real property holding corporations" such as REITs. The Code deems any
corporation that holds (or held during the previous five-year period) USRPIs
with a fair market value equal to 50% or more of the fair market value of the
corporation's U.S. and foreign real property assets and other assets used or
held for use in a trade or business to be a U.S. real property holding
corporation; however, if any class of stock of a corporation is traded on an
established securities market, stock of such class shall be treated as a USRPI
only in the case of a person who holds more than 5% of such class of stock at
any time during the previous five-year period. Effective for dividends paid or
deemed paid on or before December 31, 2007, distributions to foreign persons
attributable to gains from the sale or exchange of USRPIs will give rise to an
obligation for those foreign persons to file a U.S. tax return and pay tax, and
may well be subject to withholding under future regulations.
Under U.S. federal tax law, a beneficial holder of shares who is a foreign
person is not, in general, subject to U.S. federal income tax on gains (and is
not allowed a deduction for losses) realized on the sale of shares of a Fund or
on capital gain dividends unless (i) such gain or capital gain dividend is
effectively connected with the conduct of a trade or business carried on by such
holder within the United States, (ii) in the case of an individual holder, the
holder is present in the United States for a period or periods aggregating 183
days or more during the year of the sale or capital gain dividend and certain
other conditions are met, or (iii) the shares constitute USRPIs or (effective
for taxable years of the Funds beginning on or after October 1, 2005) the
capital gain dividends are paid or deemed paid on or before December 31, 2007
and are attributable to gains from the sale or exchange of USRPIs. Effective
after December 31, 2004, and before January 1, 2008, if the Fund is a U.S. real
property holding corporation (as described above) the Fund's shares will
nevertheless not constitute USRPIs if the Fund is a "domestically controlled
qualified investment entity," which is defined to include a RIC that, at all
times during the shorter of the 5-year period ending on the date of the
disposition or the period during which the RIC was in existence, had less than
50 percent in value of its stock held directly or indirectly by foreign persons.
Information set forth in the Prospectuses and this Statement of Additional
Information which relates to federal taxation is only a summary of some of the
important federal tax considerations generally affecting purchasers of Shares of
BB&T Funds. No attempt has
43
been made to present a detailed explanation of the federal income tax treatment
of a Fund or its Shareholders and this discussion is not intended as a
substitute for careful tax planning. Accordingly, potential purchasers of Shares
of a Fund are urged to consult their tax advisers with specific reference to
their own tax situation (especially with respect to foreign, state or local
taxation). In addition, the tax discussion in the Prospectuses and this
Statement of Additional Information is based on tax laws and regulations which
are in effect on the date of the Prospectuses and this Statement of Additional
Information; such laws and regulations may be changed by legislative or
administrative action.
Special tax rules apply to investments through defined contribution plans
and other tax-qualified retirement plans. Shareholders should consult their tax
advisers to determine the suitability of shares of BB&T Funds as an investment
through such plans and the precise effect on an investment on their particular
tax situation.
SPECIAL CONSIDERATIONS REGARDING INVESTMENT IN KENTUCKY TAX-EXEMPT OBLIGATIONS
The concentration of investments in Kentucky Tax-Exempt Obligations by the
Kentucky Fund raises special investment considerations. In particular, changes
in the economic condition and governmental policies of Kentucky and its
political subdivisions, agencies, instrumentalities, and authorities could
adversely affect the value of the Kentucky Fund and its portfolio securities.
This section briefly describes current economic trends in Kentucky and
constitutes only a brief summary of some of the many complex factors that may
have an effect. The information set forth below is derived from official
statements prepared in connection with the issuance of Kentucky Tax-Exempt
Obligations and other sources that are generally available to investors. No
independent verification has been made of the following information.
Economy. Kentucky's economy, dominated in previous generations by coal,
tobacco, bourbon, and horses, has since diversified to include prominently the
manufacture of industrial machinery, automobiles and automotive parts, and
consumer appliances and service industries such as air transportation, financial
services, retail trade, and tourism. In the 1990's, Kentucky outpaced the
national economic recovery and outperformed the U.S. average in both personal
income and employment growth. In the current decade, however, Kentucky's
economic recovery and growth in income and employment are expected to be
slightly below the national average. The difference stems from the rapid growth
in Asian markets and the availability of low-cost manufacturing centers which
provide strong competition to states like Kentucky with a large manufacturing
base. The Kentucky economy is converging towards the national average, but
manufacturing still counts for 15% of the jobs and 21% of the wages within
Kentucky, compared to the equivalent U.S. figures of 11% and 13%, respectively.
Kentucky's growth in personal income, the broadest measure of economic recovery,
has closely tracked growth in U.S. personal income since 2000, with personal
income in both the U.S. and Kentucky rising 122% during the five-year period
ended June 30, 2005.
State Budget. The General Assembly is required by the Kentucky Constitution
to adopt measures providing for the state's revenues and appropriations for each
fiscal year, including appropriations for the payment of debt service. The
Governor is required by law to submit a biennial state budget to the General
Assembly during the legislative session held in each even numbered year. State
budgets have generally been adopted by the General Assembly during those
legislative sessions, which end in mid-April, to be effective upon the
Governor's signature, for appropriations commencing for a two-year period
beginning the following July 1. In 2002 and 2004, the regular legislative
session for the General Assembly adjourned without adoption of a state budget.
On both occasions, the Governor signed executive orders authorizing the
Secretary of the Finance and Administration Cabinet to issue warrants for the
payment of all claims made by the executive branch of state government in
accordance with an executive branch spending plan providing for the continued
operation of state government in the absence of a legislatively adopted state
budget, including the payment of all debt service coming due. In both cases, the
Kentucky General Assembly enacted a state budget in March of the following year,
which incorporated the executive spending plans and appropriated funds for the
remainder of the biennium.
Credit Ratings. S&P currently assigns to Kentucky an issuer credit rating
of AA- with a stable outlook. Moody's currently assigns to Kentucky an issuer
credit rating of Aa2 and a lease appropriation-backed debt rating of Aa3 with a
negative outlook. Fitch does not maintain an issuer rating for Kentucky and
currently assigns to Kentucky an appropriation-backed debt rating of AA-.
The municipal securities of many states and their agencies and political
subdivisions constitute general obligations of the state itself or of an agency
or political subdivision of the state which holds substantial assets. This is
not the case with respect to securities issued by Kentucky and its agencies and
has not been the case with respect to Kentucky political subdivisions until
recent years. Municipal securities in Kentucky have generally been issued by
public entities which are created primarily for that purpose and which have no
substantial assets, with the real source of funds for repayment being restricted
to either revenues from the property financed by the municipal security or
rentals due from another public entity which has an enforceable obligation to
pay rent to the issuer on only a short-term basis. In 1994, Kentucky's
constitution was amended to allow local governmental entities in Kentucky to
issue
44
general obligation debt instruments subject to certain limitations. As stated
below, however, general obligation debt of Kentucky must be authorized by voter
referendum.
The Fund is not required to invest any particular percentage of its assets
in Kentucky Municipal Securities which are general obligations of issuers with
substantial assets.
Overview of Commonwealth of Kentucky's Debt Authorities. Kentucky's
indebtedness is classified as either appropriation supported debt or
non-appropriation supported debt.
Appropriation supported debt carries the name of Kentucky and is either (i)
a general obligation of Kentucky or (ii) a revenue obligation of one of its
debt-issuing agencies, which is subject to state appropriation for all or a
portion of the debt service.
General obligation bonds pledge the full faith, credit and taxing power of
Kentucky for the repayment of the debt. The Kentucky Constitution requires voter
approval by general referendum prior to the issuance of general obligation bonds
in amounts exceeding $500,000. Kentucky has not issued general obligation bonds
since 1966, and Kentucky has no general obligation bonds outstanding.
Project revenue notes and bonds are issued by various debt issuing
authorities of Kentucky. The revenues produced by the projects funded by the
debt are pledged as security for repayment of the debt. Project revenue debt is
not a direct obligation of Kentucky. Project revenues are, in some cases,
derived partially or solely from biennial appropriations of the Kentucky General
Assembly. In other cases, the direct revenues generated from the project funded
constitute the entire source of payment.
Non-appropriation or moral obligation debt carries the name of Kentucky for
the benefit and convenience of other entities or agencies within Kentucky. The
bonds are special obligations of the issuer, secured and payable solely from the
sources pledged for the payment thereof and do not constitute a debt, liability,
obligation or a pledge of the faith and credit of Kentucky. The General Assembly
does not intend to appropriate any funds to fulfill the financial obligations
represented by these types of bonds. In the event of a shortfall, however, the
issuer generally covenants to request from the Governor and the General Assembly
sufficient amounts to pay debt service.
Default Record. Neither Kentucky nor any of its agencies have ever
defaulted in the payment of principal or interest on general obligation
indebtedness or project revenue obligations.
Debt Issuing Entities of Kentucky. The following entities are active
issuers of debt in Kentucky: State Property and Buildings Commission, Kentucky
Asset/Liability Commission, Turnpike Authority of Kentucky, Kentucky Housing
Corporation, Kentucky Infrastructure Authority, Kentucky Higher Education
Student Loan Corporation, School Facilities Construction Commission, Kentucky
Economic Development Finance Authority, Kentucky Local Correctional Facilities
Construction Authority, and the nine State Universities. The ratings of each
issuer vary.
The Kentucky Housing Corporation and the Kentucky Higher Education Student
Loan Corporation issue obligations to finance projects that are not repaid by
governmental appropriations. The General Assembly has placed specific
limitations on the outstanding principal amount of the debt of the Kentucky
Housing Corporation ($2.5 billion), and the Kentucky Higher Education Student
Loan Corporation ($1.95 billion). The State Property and Buildings Commission,
Turnpike Authority of Kentucky, and the nine State Universities may not incur
debt without prior approval of the projects and appropriation of the debt
service by the General Assembly. The Kentucky Asset/Liability Commission may not
incur debt without prior approval of the projects and appropriation of the debt
service by the General Assembly, exclusive of cash flow borrowing within a
fiscal year. The School Facilities Construction Commission may not incur debt
without appropriation of debt service by the General Assembly. The Kentucky
Infrastructure Authority, in its revolving fund programs, cannot incur debt
without appropriation of the debt service. Without legislative approval, other
programs of the Kentucky Infrastructure Authority are limited to $500,000,000 of
debt outstanding. The debt of the Kentucky Local Correctional Facilities
Construction Authority is limited to the level of debt service supported by
court fees pledged to the payment of the debt service. No debt limitation is
currently in effect for the Kentucky Economic Development Finance Authority,
which acts as a conduit issuer of revenue bonds for the benefit of private
businesses and nonprofit entities and for which the state has no liability for
the payment of the debt service.
SPECIAL CONSIDERATIONS REGARDING INVESTMENT IN MARYLAND TAX-EXEMPT OBLIGATIONS
The concentration of investments in Maryland Tax-Exempt Obligations by the
Maryland Fund raises special investment considerations. In particular, changes
in the economic condition and governmental policies of Maryland and its
political subdivisions, agencies, instrumentalities, and authorities could
adversely affect the value of the Maryland Fund and its portfolio securities.
This section briefly describes current economic trends in Maryland, and
constitutes only a brief summary of some of the many complex
45
factors that may have an effect. The information set forth below is derived from
official statements prepared in connection with the issuance of Maryland
Tax-Exempt Obligations and other sources that are generally available to
investors. No independent verification has been made of the following
information.
The Maryland Funds' concentration in the debt obligations of one state
carries a higher risk than a portfolio that is more geographically diversified.
In addition to State of Maryland general obligation bonds and debt issued by
state agencies, the Fund will invest in local issues, lease bond obligations,
and revenue bonds, the credit quality and risk of which will vary according to
each security's own structure and underlying economics.
DEBT. The State of Maryland and its local governments issue two basic types
of debt, with varying degrees of credit risk: general obligation bonds backed by
the unlimited taxing power of the issuer and revenue bonds secured by specific
pledged fees or charges for a related project. Included within the revenue
sector are tax-exempt lease obligations that are subject to bond annual
appropriations of a governmental body, usually with no implied tax or specific
revenue pledge.
The State of Maryland disclosed in its fiscal year 2003 Comprehensive
Annual Financial Report (CAFR) dated June 30, 2004, that it has approximately
$4.102 billion in general obligation bonds outstanding and an additional $4.1
billion in other long-term debt plus capital lease obligations of approximately
$649 million. Total bonds and obligations under long-term leases at fiscal year
end were $8.9 billion, a net increase of $199 million (2.3%) over the prior
year.. As of June 30, 2004, general obligation debt of the State of Maryland is
rated Triple-A by Moody's, S&P, and Fitch. There is no general debt limit
imposed by the state constitution or public general laws. The state constitution
imposes a 15-year maturity limit on state general obligation bonds. Although
voters approved a constitutional amendment in 1982 permitting the state to
borrow up to $100 million in short-term notes in anticipation of taxes and
revenues, the state has not made use of this authority.
Many agencies of the state government are authorized to borrow money under
legislation which expressly provides that the loan obligations shall not be
deemed to constitute debt or a pledge of the faith and credit of the state. The
Community Development Administration of the Department of Housing and Community
Development, the Maryland Water Quality Financing Administration of the
Department of Environment, the Maryland State Lottery Agency, certain state
higher education institutions, the Maryland Stadium Authority, the Maryland Food
Center Authority, and the Maryland Environmental Service have issued and have
outstanding bonds of this type. The principal of and interest on bonds issued by
these bodies are payable solely from pledged revenues, principally fees
generated from use of the facilities, enterprises financed by the bonds, or
other dedicated fees.
ECONOMY. The Maryland Board of Revenue Estimates reported on December 21,
2004 that, according to most measures, the State's economy had outperformed the
nation over the past five years. The strong economy is evidenced by the fact
that personal income growth accelerated for five consecutive quarters through
the second quarter of 2004. At a rate of 1.3% through most of 2004, Maryland had
the fifteenth fastest rate of employment growth. While the State unemployment
rate rose from the unprecedented low of 3.5% achieved in 1999 by a full
percentage point to 4.5% in 2003, the national unemployment rate rose from 4.2%
to 6.0% during that same period.
FINANCIAL. To a large degree, the risk of the portfolio is dependent upon
the financial strength of the State of Maryland and its localities. The general
fund is the major operating fund of the State. AT the end of the fiscal year
2004, the unreserved, designated fund balance of the general fund was $127
million, compared to an unreserved fund balance deficit of $110 million last
year. The total fund balance reached $1.5 billion.
SECTORS. Investment concentration in a particular sector can present unique
risks. A significant portion of the funds' assets may be invested in health care
issues. For over a decade, the hospital industry has been under significant
pressure to reduce expenses and shorten length of stay, a phenomenon which has
negatively affected the financial health of some hospitals. All hospitals are
dependent on third-party reimbursement mechanisms. At the present time, Maryland
hospitals operate under a system in which reimbursement is determined by a
state-administered set of rates and charges that applies to all payers. A
federal waiver also allows this system to be applied to Medicare reimbursement
rather than the Federal Diagnosis-Related Group (DRG) system required elsewhere.
In order to maintain this Medicare waiver, the cumulative rate of increase in
Maryland hospital charges since the base year 1980 must remain below that of
U.S. hospitals overall. From 1983 through 1992, the rate of increase for
Maryland hospitals was below the national average; for the seven years from 1993
through 1999, Maryland hospital costs grew faster than the national rate, but
for the period from 1999 through 2002, Maryland hospital costs again grew slower
than the national average and the cumulative rate of increase since the base
year is below the national average. Any loss of the Medicare waiver in the
future may have an adverse impact upon the credit quality of Maryland hospitals.
46
The Maryland Fund may from time to time invest in electric revenue issues
which have exposure to or participate in nuclear power plants which could affect
the issuer's financial performance. Such risks include delay in construction and
operation due to increased regulation, unexpected outages or plant shutdowns,
increased Nuclear Regulatory Commission surveillance or inadequate rate relief.
In addition, the financial performance of electric utilities may be impacted by
increased competition and deregulation of the industry. The Fund may invest in
private activity issues for corporate and nonprofit borrowers. These issues sold
through various governmental conduits are backed solely by the revenues pledged
by the respective borrowing corporations. No governmental support is implied. In
addition, changes in regulatory requirements could adversely impact the
financial performance of nuclear and non-nuclear power plants.
MARYLAND RISK FACTORS. The financial condition of the State of Maryland is
affected by various national, economic, social and environmental policies and
conditions, including any impact of recent, unprecedented natural disasters
occurring in other parts of the country. Additionally, Constitutional and
statutory limitations imposed on the State and its local governments concerning
taxes, bond indebtedness and other matters may constrain the revenue-generating
capacity of the State and its local governments and, therefore, the ability of
the issuers of the Bonds to satisfy their obligations.
The economic vitality of the State and its various regions and, therefore,
the ability of the State and its local governments to satisfy the Bonds, are
affected by numerous factors. The State's economic base is diversified,
consisting of manufacturing, construction and service industries, supplemented
by rural areas with selective commercial agriculture. The State has a relatively
high wage labor market which has resulted in the State's business sector
becoming more vulnerable to competitive pressures.
The State is a party to numerous lawsuits in which an adverse final
decision could materially affect the State's governmental operations and
consequently its ability to pay debt service on its obligations.
The State of Maryland currently maintains a "triple A" bond rating from
Standard & Poor's and Moody's on its general obligation indebtedness.
SPECIAL CONSIDERATIONS REGARDING INVESTMENT IN NORTH CAROLINA TAX-EXEMPT
OBLIGATIONS
The concentration of investments in North Carolina Tax-Exempt Obligations
by the North Carolina Fund raises special investment considerations. In
particular, changes in the economic condition and governmental policies of North
Carolina and its political subdivisions, agencies, instrumentalities, and
authorities could adversely affect the value of the North Carolina Fund and its
portfolio securities. This section briefly describes current economic trends in
North Carolina, and constitutes only a brief summary of some of the many complex
factors that may have an effect. The information set forth below is derived from
official statements prepared in connection with the issuance of North Carolina
Tax-Exempt Obligations and other sources that are generally available to
investors. No independent verification has been made of the following
information.
The State of North Carolina (the "State") has three major operating funds:
the General Fund, the Highway Fund, and the Highway Trust Fund. The State
derives most of its revenue from taxes, including individual income taxes,
corporation income taxes, sales and use taxes, highway use taxes on motor
vehicle rentals, corporation franchise taxes, piped natural gas excise taxes,
alcoholic beverage taxes, insurance taxes, estate taxes, tobacco products taxes,
and other taxes, e.g., gift taxes, freight car taxes, and various privilege
taxes. A streamlined sales tax collection system has been adopted to improve
collection efforts, particularly as to out-of-state catalog and internet sales.
The State receives other non-tax revenues which are also deposited in the
General Fund. The most important are federal funds collected by State agencies,
university fees and tuition, interest earned by the State Treasurer on
investments of General Fund moneys, and revenues from the judicial branch. The
proceeds from the motor fuel tax, highway use tax, and motor vehicle license tax
are deposited in the Highway Fund and the Highway Trust Fund.
Extraordinary events occurred during fiscal year 1999-2000 that caused
significant stress on the budget for the fiscal year. In the fall of 1999, the
State was the victim of two major hurricanes, Dennis and Floyd, in a period of a
few weeks. In response to the devastation caused by these storms, a special
session of the General Assembly was convened in December 1999 to create relief
programs to address the damages, culminating in the enactment of legislation
appropriating $836.6 million for disaster relief programs. The General Assembly
funded the $836.6 million for Hurricane Floyd relief programs from $228.7
million of reallocated appropriations from department operating budgets and
$607.9 million from unspent capital improvement appropriations and reserves,
including $286 million from the Budget Stabilization Reserve, and the
unappropriated fund balance. In addition, during 1998 and 1999, the State
settled two major lawsuits involving taxes held to be illegally collected. The
total amount paid for these settlements was $1.24 billion, $400 million of which
was paid in fiscal year 1998-1999 and another $600 million of which was paid in
fiscal year
47
1999-2000. Additionally, actual revenues received during fiscal year 1999-2000
were below budget due in part to the hurricanes and a major winter storm in
early 2000 that paralyzed much of the State for over a week.
On account of the stress caused by these events on the budget for fiscal
year 1999-2000, certain adjustments were made to assure that the budget for the
fiscal year would remain balanced and to assure that the budget for fiscal year
2000-2001 would be balanced. In addition, approximately $98.7 million of tax
refunds not paid before June 30, 2000 resulted in overstated revenues for fiscal
year 1999-2000 by that amount. Due to the presence of these revenues, additional
adjustments to balance the budget for fiscal year 1999-2000 were not required.
The payment of these refunds after June 30, 2000 resulted in a decrease in
revenues for fiscal year 2000-2001 by a like amount. In the past, payments for
teacher salaries for services rendered in a fiscal year have been funded as an
expenditure in that fiscal year's budget, even though payments would be made
after June 30. The State deferred funding of $271 million required for the
payment of teacher salaries to be paid after fiscal year 1999-2000 to fund a
reserve to pay the final $240 million settlement payment on one of the lawsuits
referred to above. This final payment settling these cases was made by the State
on July 10, 2000. In the budget for fiscal year 2000-2001, the State reduced by
$252 million the budgeted contributions to the State plans for employee's
retirement ($191.3 million), retiree health benefits ($50 million), and death
benefits ($10.9 million). This reduction was provided from the realization of a
portion of the gains from the investment of amounts previously contributed to
the plans and excess available reserves set aside for this purpose.
Fiscal year 1999-2000 ended with a positive General Fund balance of $447.5
million. Along with additional reserves, $37.5 million was reserved in the
Savings Reserve Account, $117.7 million was reserved in the Retirees' Health
Premiums Reserve, $7.1 million was reserved in the Repairs and Renovations
Reserve Account, and $1.1 million was reserved in the Clean Water Management
Trust Fund. Additionally, $240.0 million was reserved in the Intangibles Tax
Refunds Reserve. After additional reserves, there was no balance remaining in
the unreserved General Fund at the end of fiscal year 1999-2000. The ending
General Fund balance did not include $541.9 million of unexpended funds
designated to relief of Hurricane Floyd victims, which funds were to be expended
during subsequent fiscal years.
On June 30, 2000, the General Assembly adopted a $14.1 billion budget for
fiscal year 2000-2001, an increase of 4.1% from the previous year, with no new
taxes or tax relief, although a streamlined sales tax collection system was
implemented to improve collections, particularly as to out-of-state catalog and
internet sales. Continuing to focus on education, the General Assembly approved
a $3.1 billion bond referendum for construction and renovation at the State's 16
university campuses and 59 community colleges. North Carolina's citizens
approved the $3.1 billion bond package - the largest in State history - on
November 7, 2000. The bonds will be issued over five years and paid back over 20
years. The General Assembly also authorized 6.5% raises for teachers in the
public schools, bringing the State's teachers' salaries up to the national
average. State employees received 4.2% raises and $500 bonuses disbursed in
October 2000. The General Assembly placed $170 million over the next two years
in reserve to help cover expected cost increases in the state employee's health
insurance plan, and an additional $120 million was set aside to replenish the
depleted State Emergency Reserves. The General Assembly also placed in reserve
$100 million for the Repairs and Renovations Reserve Account, $14.9 million in
the Reserve for Capital Improvements, $120 million in the Savings Reserve
Account, and $30 million in the Clean Water Management Trust Fund.
On August 24, 2000, the State Supreme Court issued an order in the Chrysler
Credit case denying the State's request for discretionary review of a decision
of the State Court of Appeals. As a result, the State was required to refund
$20.5 million of taxes previously paid by Chrysler. On November 1, 2000, the
State Court of Appeals issued an order accepting the State's motion to dismiss
an appeal previously filed by the State in the Ford Motor Credit case. As a
result, the State was required to refund $38.2 of taxes previously paid by Ford.
On May 1, 2001, the State Office of State Budget, Planning and Management
and the Fiscal Research Division of the State General Assembly estimated there
would be a General Fund revenue shortfall of $697.1 million from the authorized
2000-2001 fiscal year budget, and a total budget shortfall for fiscal year
2000-2001 of approximately $850 million. The shortfall was attributed to four
major factors: (1) the State was required to refund approximately $123 million
of income tax refunds in the 2000-2001 budget year that should have been
refunded in the prior year, creating a corresponding decrease in revenues; (2)
the State was required to refund approximately $63.3 million in taxes and fees
arising from lawsuits involving privilege fees charged to major automobile
finance companies and involving the intangibles tax previously levied by the
State, creating an $18.3 million reduction in individual income taxes and a $45
million reduction in privilege taxes; (3) the State's share of the federal
Medicaid program generated expenses approximately $108 million greater than the
budgeted appropriation for this purpose; and (4) decreased revenues attributable
to a general slow down of the national economy resulted in a forecasted general
revenue shortfall of $300 to $450 million, particularly affecting revenues from
taxes associated with the State's manufacturing sector. Also, the general
economic slow down and its effects
48
on capital markets lead to decreases in taxes attributable to capital gains
income. The slow down resulted in decreased forecasted revenues in several
categories, including individual income taxes, corporate income taxes, and sales
taxes.
In response to the budget shortfall, the Governor, as Director of the
Budget, issued Executive Order No. 3 directing a number of actions to be taken
to insure the State met its constitutional requirement of a balanced budget.
Specifically, the Governor identified budgetary resources that would cover a
budget shortfall of up to approximately $1 billion. These resources consisted of
a combination of reversions of unexpended appropriations, the diversion of other
resources from their otherwise appropriated use, and the identification and use
of available reserves.
At the end of fiscal year 2000-2001, General Fund revenues, including tax,
non-tax, diverted funds, and delayed reimbursements, fell short of estimated
revenue by $598.4 million. Individual income tax fell short of estimates by
$259.4 million, sales and use tax payments fell short of estimates by $177.7
million, and corporate income and franchise tax payments fell short of estimates
by $149.3 million. With lowered available investment balances in the General
Fund, investment earnings fell short of estimates by $43.1 million.
Nevertheless, as a result of the actions taken pursuant to Executive Order No.
3, fiscal year 2000-2001 ended June 30, 2001 with a positive General Fund
balance of $871.3 million. Along with additional reserves, $157.5 million was
reserved in the Savings Reserve Account, and $53.9 million was reserved in the
Retirees' Health Premiums Reserve. After additional reserves, there was no
balance remaining in the unreserved General Fund at the end of fiscal year
2000-2001. The ending General Fund balance included $448.6 million of unexpended
funds designated to relief of Hurricane Floyd victims, which funds were to be
expended during subsequent fiscal years, and $178.5 million of unexpended
budgetary shortfall funds reserved pursuant to Executive Order No. 3 restricting
State expenditures.
On September 21, 2001, the General Assembly adopted a $14.5 billion budget
for fiscal year 2001-2002. Due to the need to increase revenues, the budget
contained several new and increased taxes, including the following: a two-year
half-cent increase in the statewide sales tax; a two-year increase to 8.25% of
the income tax rate for taxable incomes of single and married individuals over
$120,000 and $200,000, respectively; a 6% telecommunications tax on out-of-state
long distance calls, with the tax on in-state long distance calls dropping from
6.5% to 6%; a 5% tax on satellite television; a 1% gross premiums tax for HMOs
and Blue Cross/Blue Shield; and a 3% increase on liquor taxes. Additionally,
tuition for students attending the University of North Carolina was raised 9%.
The budget increased spending on education and human services while trimming 400
positions from the State's payrolls. The General Assembly included in the budget
$25 million to reduce class size, $93 million for teacher bonuses, and another
$44 million to help struggling students meet testing standards. Teachers and
school administrators received salary increases averaging close to 3%, while
community college instructors and professional staff received a 1.25% salary
increase. Each state employee got a $625 raise. The General Assembly provided
$15 million for the One North Carolina Fund for the Governor to use to provide
incentives in the recruitment of industries to the State. The budget established
a mental health trust fund and provided $47.5 million in funding to be used to
renovate existing mental health and substance abuse facilities and to help
patients move from institutional to community treatment. The General Assembly
set aside $181 million to replenish the depleted State Emergency Reserves and
placed in reserve $125 million for the Repairs and Renovations Reserve Account
and $40 million for the Clean Water Management Trust Fund.
Due to many factors, an overall budget shortfall in the General Fund for
fiscal year 2001-2002 of $1.6 billion was projected. The shortfall was primarily
a result of an under-realization of budgeted revenues and an increase in
Medicaid expenditures exceeding budgeted appropriations. In particular, State
personal income tax collections in April 2002 were $595 million, which was over
$250 million less than in 2001 and over $350 million less than projected for the
fiscal year 2001-2002 budget. Overall, tax collections declined 6 percent from
the previous fiscal year while the fiscal year 2001-2002 budget had projected a
4 percent revenue increase, a difference of 10 percentage points. Medicaid
expenditures were expected to exceed well over $100 million of budgeted
appropriations. Both the under-realization of revenues and the increased
Medicaid expenditures were attributed to the on-going national and regional
economic recession, the severity of which was deepened by the impact of the
September 11, 2001 terrorist attacks.
In response to the projected budgetary shortfall, the Governor invoked his
constitutional authority to insure that the State would meet its constitutional
requirement of a balanced budget by issuing Executive Order No. 19, which
rescinded previous Executive Order No. 3 and identified over $1.3 billion of
resources available if needed to balance the budget. Executive Order No. 19
reduced expenditures for use by State agencies and for capital improvement
projects and transferred funds from General Fund reserves and non-General Fund
receipts and reserves. Following the issuance of Executive Order No. 19, the
Governor ordered the transfer of an additional $200 million from the Hurricane
Floyd relief fund and the Tobacco Trust Fund to cover any remaining budgetary
shortfall for fiscal year 2001-2002.
49
As of the close of the 2001-2002 fiscal year, the General Fund reported a
total fund balance of $393.9 million, with reserves of over $390 million and an
unreserved fund balance of $3.8 million. For fiscal year 2001-2002, the State
experienced a shortfall in tax and non-tax receipts of $1.55 billion. As with
other state governments, the slowing national and state economy resulted in a
general decline in tax collections. Individual income taxes fell short by over
$1 billion, corporate income taxes by $177 million, sales and use taxes by $90.5
million, and franchise taxes by $192.7 million. Inheritance and capital gains
taxes were similarly lower than budget expectations. In an effort to meet the
State constitutional mandate of balancing the General Fund budget, reductions of
$789.2 million were implemented, with the remainder of the budget funded by
$437.7 million of non-General Fund dollars, and $239.3 million transferred from
the Savings Reserve account.
On September 20, 2002, the General Assembly adopted a $14.3 billion budget
for fiscal year 2002-2003, a more than 2% reduction in the budget from the
previous year but an increase of 4% over actual spending of $13.7 billion during
last year's fiscal crises. The budget used $800 million in non-recurring revenue
to fund ongoing expenses, including $333 million in reimbursements withheld from
local governments. To replace that revenue, the General Assembly granted
counties the authority to approve an additional half-cent local-option sales
tax. This budget included revenue growth of only 1.8% over last year, which was
a far more conservative growth projection than had been used in past years. The
budget contained over $100 million in unidentified future cuts to be made by
various State departments and agencies, and the heads of those departments and
agencies were given additional management flexibility to cut programs. The
budget provided no raises for state employees but did grant 10 bonus vacation
days. Teachers and principals received career step raises. The State Board of
Education was required to cut $42 million from its budget, and appropriations
for local partnerships with the Smart Start program were reduced by $20 million.
Nevertheless, the budget provided $26.8 million to reduce the student-teacher
ratio in both kindergarten and first grade classrooms and $28 million to expand
a voluntary pre-kindergarten program to prepare at-risk 4-year olds. The budget
for the children's health insurance program, Health Choice, was increased by
$7.7 million, while spending for area mental health programs was reduced by $3
million. Three prison facilities were closed, and many positions with the
Department of Correction were eliminated, including 23 chaplain positions. The
State's public universities received full funding for enrollment growth, at
$66.8 million, and $4.5 million in additional financial aid for students.
Individual campuses, however, shared the burden of a $50.2 million spending
reduction statewide, amounting to 2.9% for each institution. University tuition
increased 8% for in-state students and 12% for out-of-state students. The
State's community colleges received $9 million less than the year before, with
more than half of the cuts to be determined by the system's board. Nevertheless,
the 59-campus system also got a $52 million increase for enrollment growth.
Community college students also saw a tuition increase.
The conservative revenue growth projections used for the fiscal year
2002-2003 budget were more in line with actual revenues, which spared the State
from a mid-year fiscal emergency for the first time in three years. As of the
close of the 2002-2003 fiscal year, the General Fund reported a total fund
balance of $603.9 million, with reserves of over $353 million and an unreserved
fund balance of $250.5 million. Key factors improving the fiscal year-end
General Fund balance were higher corporate income and sales tax collections, the
accelerated repeal of local government reimbursements, increased transfers from
other funds, and significant spending reductions by State agencies.
Additionally, the State received $136.9 million in federal fiscal relief in June
2003, which is the first of two equal flexible grant payments. The second
flexible grant payment of $136.9 million was received in October 2003.
On June 30, 2003, the General Assembly adopted a $14.8 billion budget for
fiscal year 2003-2004. Due to the current budget difficulties, the General
Assembly made permanent a .5% State sales tax increase which was due to expire
at the end of fiscal year 2002-2003. Additionally, the fiscal year 2003-2004
budget reduced spending for positions, programs, and general administration at
most levels of State government, including at the Departments of Agriculture,
Labor, Environment and Natural Resources, Justice, Corrections, Cultural
Resources, Insurance, Revenue, and the Administrative Office of the Courts.
Teachers received a pay increase averaging 1.81%, while other State employees
received a one-time bonus of $550. An initiative to reduce second grade class
sizes received $25.3 million, and $96 million in projected bonuses under the
State's ABC's plan was funded. State and local boards of education found funding
reduced for administrative positions and transportation costs, although an
increase of $5 million was earmarked for funding low-wealth schools. University
tuition increased 5% for both in-state and out-of-state students, while
community college tuition increased 3.2% for in-state students and 8.2% for
out-of-state students. The State university system received $46.6 million to
fund the additional 518 positions needed to meet a projected 4.5% enrollment
increase, while need-based financial aid increased by $5.1 million. An
additional $2.8 million was provided to increase aid for in-state students
attending private colleges. The community colleges also received $32 million in
increased funding for staff and supplies to meet enrollment growth. Funding was
reduced for many services provided by the State Department of Health and Human
Services, including reduced funding of inflationary increases for Medicaid
providers and public agencies and cuts to the Smart Start child care program.
The fiscal year 2003-2004 budget increased funding to the Health Choice
insurance program by $12.2 million. Various licensing fees were also implemented
for health and child care facilities. The General Assembly set aside $150
million for the State Emergency Reserves and placed in reserve $50 million for
the Repairs and Renovations Reserve Account and $12.5 million for the Mental
Health Trust Fund; however, $38 million was cut from the Clean Water Management
Trust Fund.
50
In December 2003, the Governor called a Special Session of the General
Assembly at which the General Assembly appropriated $24 million for economic
development. The General Assembly also appropriated $20 million for the One
North Carolina Fund, $4.1 million to the community college system for new and
expanding industry training, and $20 million to the North Carolina Rural
Economic Development Center.
The State ended fiscal year 2003-2004 with an over-collection of revenues
of $242.4 million, which was 1.7% of the budgeted revenue forecast. The major
tax categories that exceeded the budgeted forecast were individual income,
corporate income, and sales and use tax. In addition, unexpended appropriation
or reversions of $159 million were realized, and the State received $136.9
million in federal fiscal relief in October 2003. Therefore, the State closed
fiscal year 2003-2004 with a $289.4 million unreserved fund balance after
transferring $116.7 million to the Rainy Day Fund and $76.8 million to the
Repair and Renovation Reserve.
On July 18, 2004, the General Assembly adopted a $15.9 billion budget for
fiscal year 2004-2005. State workers received their first pay raises in three
years - the greater of $1,000 or 2.5% of their current salaries. Teachers got an
average raise of 2.5%. State university faculty also received an average 2.5%
raise, while community college faculty got a 4.5% raise. Retired State employees
got a 1.7% cost of living adjustment. The budget provided public schools with
over $50 million to hire up to 1,100 new teachers to reduce third-grade class
sizes, $7.5 million to improve test scores in the State's poorest school
districts, and $9.1 million to add 2,000 students to the State's More at Four
pre-kindergarten program. Another $4 million was provided to hire 80 school
nurses. $6.6 million was budgeted to provide health insurance for children of
the working poor, $4 million was provided to hire 75 to 100 additional child
abuse care workers, and $3 million was used to increase the foster care and
adoption assistance reimbursements by $25 per child per month. Twenty-four
independent, nonprofit community healthcare centers serving poor patients
received $5 million, while $2 million was distributed among 100 shelters for
domestic violence victims. $2.7 million was used to add over 1,400 prison beds
at correctional facilities throughout the State. Another $8.6 million was used
for economic development to fund the State Biotechnology Center in the Research
Triangle Park, the Global TransPark in Kinston, and a Motorsports Testing and
Research Center Complex near Charlotte. Another $30 million was allocated to a
fund for underground storage tank cleanup.
The General Assembly also approved the issuance of $468 million in special
indebtedness over two years to fund a cancer hospital, a cardiovascular center,
a health promotion center, a genetics data center, and a pharmacy school at
several State universities. The funds will also be used to pay for several other
projects at State universities and to preserve land for State parks and to
protect land near military bases from encroachment. The funds will also be used
to build new juvenile detention facilities. No more than $310 million of this
special indebtedness may be issued during the 2004-2005 fiscal year. The fiscal
impact of the $468 million of special indebtedness on the General Fund is
expected to be zero because of the annual transfer of revenue from other sources
to the General Fund in an amount to cover the estimated debt service. The debt
service for the State universities projects and the juvenile detention
facilities will be reimbursed from the special revenue funds known as the Health
and Wellness Trust Fund and the Tobacco Trust Fund. The debt service for the
State parks projects is fully funded by the streams of revenue available to the
special revenue funds known as the Parks and Recreation Trust Fund, the Natural
Heritage Trust Fund, and the Clean Water Management Trust Fund. The special
indebtedness is non-voted debt that is generally secured only by an interest in
State property being acquired or improved (e.g., certificates of participation
and lease-purchase revenue bonds). With this type of debt, there is no pledge of
the State's faith, credit, or taxing power to secure the debt, which is why
voter approval is not required. If the State defaulted on its repayments, no
deficiency judgment could be rendered against the State, but the State property
that serves as security could be disposed of to generate funds to satisfy the
debt. Failure to repay the debt would have negative consequences for the State's
credit rating. Article 9 of Chapter 142 of the State's General Statutes
prohibits the issuance of special indebtedness except for projects specifically
authorized by the General Assembly. The use of alternative financing methods
provides financing flexibility to the State and permits the State to take
advantage of changing financial and economic environments.
In November 2004, the Governor announced that Dell, Inc. would build a
computer manufacturing facility in the State. Dell, a leading manufacturer and
distributor of personal computers and related products, has now built and
equipped a state-of-the-art, 400,000 square-foot manufacturing and distribution
facility in the Piedmont Triad region. Dell currently has two other U.S.
factories in Nashville, Tennessee and Austin, Texas. The North Carolina General
Assembly convened a one-day special session on November 4, 2004 and approved an
economic incentive for computer manufacturing companies that, in the case of
Dell, would provide up to $225 million in tax credits over the next fifteen
years. For each year in which Dell meets the required performance targets, the
State will provide a grant equal to 75 percent of the State personal income
withholding taxes derived from the creation of new jobs.
As of April 30, 2005, the State's revenue collections were above the
2004-2005 fiscal year forecast of $14,470.4 million primarily due to more than
$250 million in one-time collection from a Voluntary Compliance Program
undertaken by the State Department of
51
Revenue and higher than expected personal income tax collection. A budget
surplus of $527 million is projected for the end of fiscal year 2005-2005.
On August 11, 2005, the General Assembly adopted a $17.2 billion budget for
fiscal year 2005-2006. State workers received pay raises equaling the greater of
$850 or 2% of their current salaries and one extra week of vacation. Teachers
got an average raise of 2.24%. State community college faculty and professional
staff got a 4.5% raise. Retired State employees received a 2% cost of living
adjustment. The budget provided $9.48 billion for education, which is a 2.73% or
$250 million increase over the previous year's education budget. The budget
funds education at the State's K-12 schools, community colleges, and
universities, including additional funding to cover the more than 35,000 new
students enrolled in State public schools this year. The budget dedicated close
to $80 million to address the on-going Leandro school funding lawsuit by
providing additional funding to low wealth school districts, disadvantaged
students, high school reforms, school-based family support teams, and teacher
recruitment. The budget provides $100 million for ABC bonuses for teachers and
fully funds teacher assistant positions. More than $3.2 million is provided to
expand Governor Mike Easley's "Learn and Earn" program, which allows students
the opportunity to graduate with a high school diploma and a college degree
after just five years of study. The budget makes numerous investments in job
creation efforts and provides funding for programs to attract new jobs to the
State, including $4.5 million in additional funds for the Job Development
Investment Grant program, $6 million for the One North Carolina Fund, and $20
million for the North Carolina Rural Center, which has helped create thousands
of new jobs in rural communities and update water systems. The budget also
included $9 million for the Wilmington and Morehead City ports, $1 million in
new funds for community college Small Business Centers, and $2.65 million for
customized industry training, which will help employees and companies remain
competitive in an ever-changing economy.
For the first time, the General Assembly has also authorized the creation
of a State lottery for the purpose of providing additional education funding.
The lottery is expected to raise more than $425 million in its first year for
pre-kindergarten programs, school construction and reducing class size, and
college scholarships for needy students. The State Lottery Commission is now in
the process of establishing this lottery.
The foregoing results are presented on a budgetary basis. Accounting
principles applied to develop data on a budgetary basis differ significantly
from those principles used to present financial statements in conformity with
generally accepted accounting principles. For example, based on a modified
accrual basis, the General Fund balance as of June 30, 2000 was positive $265.7
million, as of June 30, 2001 it was negative $32.4 million, as of June 30, 2002
it was negative $349 million, as of June 30, 2003 it was negative $167 million,
and as of June 30, 2004 it was negative $196 million.
Under the State's constitutional and statutory scheme, the Governor is
required to prepare and propose a biennial budget to the General Assembly. The
General Assembly is responsible for considering the budget proposed by the
Governor and enacting the final budget, which must be balanced. In enacting the
final budget, the General Assembly may modify the budget proposed by the
Governor as it deems necessary. The Governor is responsible for administering
the budget enacted by the General Assembly.
The State budget is based upon a number of existing and assumed State and
non-State factors, including State and national economic conditions,
international activity, federal government policies and legislation, and the
activities of the State's General Assembly. Such factors are subject to change
which may be material and affect the budget. The Congress of the United States
is considering a number of matters affecting the federal government's
relationship with the state governments that, if enacted into law, could affect
fiscal and economic policies of the states, including North Carolina.
In 1998, the State, along with forty-five other states, signed the Master
Settlement Agreement ("MSA") with the nation's largest tobacco companies to
settle existing and potential claims of the states for damages arising from the
use of the companies' tobacco products. Under the MSA, the tobacco companies are
required to adhere to a variety of marketing, advertising, lobbying, and youth
access restrictions, support smoking cessation and prevention programs, and
provide payments to the states in perpetuity. The amount that the State will
actually receive from this settlement remains uncertain, but projections are
that the state will receive approximately $4.6 billion through the year 2025. In
the early years of the MSA, participating states received initial payments that
were distinct from annual payments. The initial payments were made for five
years: 1998 and 2000 through 2003. The annual payments began in 2000 and will
continue indefinitely. However, these payments are subject to a number of
adjustments including an inflation adjustment and a volume adjustment. Some
adjustments (e.g., inflation) should result in an increase in the payments while
others (e.g., domestic cigarette sales volume) may decrease the payments. Also,
future payments may be impacted by continuing and potential litigation against
the tobacco industry and changes in the financial condition of the tobacco
companies. In 1999, the General Assembly approved legislation implementing the
terms of the MSA in the State. The Golden LEAF, Inc., a nonprofit foundation,
was created to distribute half of the settlement funds received by the State.
The legislation directed that these funds be used for the purposes of providing
economic impact assistance to economically affected or tobacco-dependent regions
of the State. However, the foundation's
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share of the payments may be diverted by the General Assembly prior to the funds
being received by the State Specific Account. The foundation is reported as a
discretely presented component unit. In 2000, the State enacted legislation
establishing the Health and Wellness Trust Fund and the Tobacco Trust Fund and
created commissions charged with managing these funds. Each fund will receive a
quarter of the tobacco settlement payments. The purpose of the Health and
Wellness Trust Fund is to finance programs and initiatives to improve the health
and wellness of the people of North Carolina. An eighteen-member Health and
Wellness Trust Fund Commission will administer this fund. The primary purpose of
the Tobacco Trust Fund is to compensate the tobacco-related segment of the
State's economy for the economic hardship it is expected to experience as a
result of the MSA. An eighteen-member Tobacco Trust Fund Commission will
administer this fund.
The economic profile of the State consists of a combination of services,
trade, agriculture, manufacturing, and tourism. Non-agricultural wage and salary
employment accounted for approximately 3,888,600 jobs as of September 2005. The
largest segment of jobs was approximately 1,267,300 in various service
categories, followed by 724,100 in trade, transportation, and utilities, and
657,100 in government and 570,600 in manufacturing. Based on September 2005 data
from the United States Bureau of Labor Statistics, the State ranked eleventh
among the states in non-agricultural employment, thirteenth in services
employment, eleventh in trade employment, and ninth in manufacturing employment.
According to the U.S. Department of Commerce, Bureau of Economic Analysis, per
capita income in the State during the period from 1990 to 2004 grew from $17,295
to $29,246, an increase of over 69%. Over a similar period, according to the
North Carolina Employment Security Commission, the seasonally-adjusted labor
force grew from 3,441,436 to 4,302,043, an increase of 25%, and it has undergone
significant changes during this period, as the State has moved from an
agricultural economy to a service and goods-producing economy. As reported by
the North Carolina Employment Security Commission, the seasonally-adjusted
unemployment rate in September 2005 was 5.5% of the labor force, as compared to
the nationwide unemployment rate for the same period of 5.1%.
Agriculture is another basic element of the State's economy. In calendar
year 2003, the State's agricultural industry contributed over $62 billion to the
State's economy, and accounted for 22% of the State's income. Gross agricultural
income was in excess of $6.9 billion in 2003, placing the State eighth in the
nation in gross agricultural income and tenth in the nation in net farm income.
The poultry industry is the leading source of agricultural income in the State,
accounting for approximately 32% of gross agricultural income in 2003, followed
by the pork industry and approximately 22%, nursery and greenhouse products at
approximately 12%, and the tobacco industry at approximately 9%. According to
the State Commissioner of Agriculture, the State ranks first in the nation in
the production of all tobacco, flue-cured tobacco, and sweet potatoes, second in
hog production, cucumbers for pickles, turkeys and Christmas tree production,
and third in poultry and egg products and trout.
A significant military presence in the State contributes further to the
diversity of the State's economic base. Six percent (6%) of the State's 2004
Gross State Product (total goods and services), or $18.1 billion, is attributed
to the military sector in the State. The major military installations in the
State are Camp Lejuene Marine Corps Base, New River Air Station, Fort Bragg Army
Base, Pope Air Force Base, Cherry Point Marine Corps Air Station, and Seymour
Johnson Air Force Base. The State has created a task force, headed by the
Lieutenant Governor, to assist the federal Base Realignment and Closure
Commission (the "BRAC Commission") in reviewing proposed realignments and
closures of federal military bases. On May 13, 2005, the Department of Defense
recommended to the BRAC Commission that none of the State military bases be
closed and that due to realignments elsewhere, the State's military base should
see an increase in personnel and operations.
The following are cases pending in which the State faces the risk of either
a loss of revenue or an unanticipated expenditure. In the opinion of the
Department of State Treasurer after consultation with the State Attorney
General, an adverse decision in any of these cases would not materially
adversely affect the State's ability to meet its financial obligations.
1. HOKE COUNTY ET AL. V. STATE OF NORTH CAROLINA, ET AL (FORMERLY LEANDRO,
ET AL. V. STATE OF NORTH CAROLINA AND STATE BOARD OF EDUCATION) - FUNDING OF
PUBLIC EDUCATION. In 1994, students and boards of education in five counties in
the State filed suit requesting a declaration that the public education system
of North Carolina, including its system of funding, violates the State
constitution by failing to provide adequate or substantially equal educational
opportunities, by denying due process of law, and by violating various statutes
relating to public education. Five other school boards and students intervened,
and alleged claims for relief on the basis of the high proportion of at-risk and
high-cost students in their counties' systems. The suit is similar to a number
of suits in other states, some of which resulted in holdings that the respective
systems of public education funding were unconstitutional under the applicable
state law.
The State filed a motion to dismiss, which was denied. On appeal the State
Supreme Court upheld the present funding system against the claim that it
unlawfully discriminated against low wealth counties but remanded the case for
trial on the claim for relief based on the Court's conclusion that the
constitution guarantees every child the opportunity to obtain a sound basic
education. The trial on the claim of one plaintiff's county was held in the Fall
of 1999. In rulings issued in the Fall of 2000 and Spring of 2001, the
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trial court concluded that at-risk children in the State are constitutionally
entitled to such pre-kindergarten educational programs as may be necessary to
prepare them for higher levels of education, and ordered an investigation into
why certain school systems succeed without additional funding. Following the
State's filing of an appeal of these rulings, the trial court re-opened the
trial and called additional witnesses in the Fall of 2001.
On April 4, 2002, the trial court issued its final order in the case,
reaffirming its prior rulings and finding that the State must take all necessary
actions to provide each child with the "sound basic education" guaranteed by the
State Constitution. The trial court's order directed the State to provide
written reports every 90 days on the steps it has taken to comply with the
order. On July 30, 2004, the State Supreme Court affirmed the majority of the
trial court's orders, thereby directing the executive and legislative branches
to take corrective action necessary to ensure that every child has the
opportunity to obtain a sound, basic education. The Supreme Court did agree with
the State that the trial court exceeded its authority in ordering
pre-kindergarten programs for at-risk children. The State is now undertaking
measures to respond to the trial court's directives. The magnitude of State
resources which may ultimately be required cannot be determined at this time;
however, the total cost could exceed $100 million.
2. N.C. SCHOOL BOARDS ASSOCIATION, ET AL. V. RICHARD H. MOORE, STATE
TREASURER, ET AL. - USE OF ADMINISTRATION PAYMENTS. On December 14, 1998,
plaintiffs, including the county school boards of Wake, Durham, Johnston,
Buncombe, Edgecombe, and Lenoir Counties, filed suit requesting a declaration
that certain payments to State administrative agencies must be distributed to
the public schools on the theory that such amounts are fines which under the
North Carolina Constitution must be paid to the schools. The trial court ruled
in favor of plaintiffs on December 14, 2001.
In its order, the trial court concluded that specifically identified
monetary payments assessed and collected by state agencies are civil fines or
penalties whose disposition is controlled by Article IX, Section 7 of the State
Constitution. The trial court also concluded the statutes under which these
funds are distributed are "unconstitutional and void" to the extent they provide
that the money is to "go to agencies or for purposes other than the public
schools." Based upon these conclusions of law, the trial court directed the
"clear proceeds" of the affected civil fines and penalties be remitted to the
public schools.
The trial court also declared "unconstitutional and void" the portions of
the State Civil Penalty and Forfeiture Fund and the State School Technology Fund
which operate to collect in a central fund and equitably distribute civil fines
and penalties to the State's school system for the purpose of supporting local
school technology plans. The order required state agencies to remit civil fines
and penalties directly to the local board(s) of education in the county in which
the violation leading to the payment occurred for use in the board(s)
discretion.
Finally, the trial court determined a three-year statute of limitations
applies, allowing the order to be enforced retroactively from the date the civil
action was filed to include all affected civil fines and penalties collected by
State agencies since December 1995. However, the court stayed the operation and
enforcement of the order pending appeal. On appeal, the State Court of Appeals
rendered a decision in September 2003 mostly favorable to the State. Further
appeal was made to the State Supreme Court, which on July 1, 2005 affirmed in
part and reversed in part the decision of the State Court of Appeals.
For the last fiscal year for which information was available to them,
plaintiffs alleged liability of approximately $84 million. Until this matter is
resolved, any refunds and interest will continue to accrue.
3. SOUTHEAST COMPACT COMMISSION - DISPOSAL OF LOW-LEVEL RADIOACTIVE WASTE.
North Carolina and seven other southeastern states created the Southeast
Interstate Low-Level Radioactive Waste Management Compact to plan and develop a
site for the disposal of low-level radioactive waste generated in the member
states. North Carolina was assigned responsibility for development of the first
disposal site, with costs to be distributed equitably among the Compact members.
In 1997, the Compact Commission discontinued funding of the development of the
North Carolina site, alleging that the State was not actively pursuing the
permitting and development of the proposed site. North Carolina withdrew from
the Compact in 1999. The Compact subsequently petitioned the United States
Supreme Court to allow the filing of its complaint against the State demanding
repayment of $80 million of Compact payments expended on the permitting of the
site, plus $10 million of future lost income, interest, and attorneys' fees. The
United States Supreme Court denied the Compact's petition in August 2001. On
August 5, 2002, the Compact, with the addition of four member states as
plaintiffs, filed a new motion requesting the United States Supreme Court to
accept the claim under its original jurisdiction. On June 16, 2003, the United
States Supreme Court accepted jurisdiction of the case, and the State filed an
answer and motion to dismiss. On November 17, 2003, the motion to dismiss was
denied, and the United States Supreme Court appointed a special master with
authority to determine when additional pleadings will be filed in the case. The
Special Master hear oral arguments on dispositive motions filed by both sides on
September 3, 2004. The State Attorney General's office believes that sound legal
arguments support the State's position on this matter.
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4. PHILLIP MORRIS USA INC. V. TOLSON - REFUND OF CORPORATE INCOME TAX. On
June 13, 2000, Philip Morris filed an action for a refund of approximately $30
million in corporate income taxes paid for 1989 through 1991. An order of the
Augmented Tax Review Board in the 1970's allowed it to apportion its income
under a modified formula, which included a more favorable property factor. When
the law changed in 1989 to move to double weighting of the sales factor, Philip
Morris incorporated this change into its formula. The Board's order did not
permit double weighting. Philip Morris argued that the principle of in pari
materia required incorporation of the amendment, and that failure to allow
double weighting violated the equal protection and separation of powers clauses.
The Wake County Superior Court recently ruled that Philip Morris was required to
use the formula approved by the Board without double weighting the sales factor
unless the statutory formula (without the modified property factor) produced a
more favorable result. Philip Morris appealed this ruling, and the record on
appeal was filed in March 2005.
5. STATE EMPLOYEES ASSOCIATION OF NORTH CAROLINA V. STATE OF NORTH
CAORLINA; STONE V. STATE OF NORTH CAROLINA - DIVERSION OF EMPLOYER'S RETIREMENT
SYSTEM CONTRIBUTION. On May 22, 2001, SEANC filed an action demanding repayment
of approximately $129 million in employer retirement contributions to the State
retirement system. The Governor withheld, and subsequently used, the withheld
funds under his constitutional authority to balance the State budget. The trial
court dismissed the action on May 23, 2001 for lack of standing, among other
things. Plaintiffs appealed to the State Court of Appeals, and on December 3,
2002, the Court of Appeals affirmed the trial court's dismissal of the action
for lack of standing. On June 13, 2003, the State Supreme Court reversed the
lower courts on the issue of standing and remanded the case back to the State
Court of Appeals for further consideration. In June 2002, the Stone case was
filed on behalf of individual State employees and retirees seeking repayment of
the withheld employer contribution and a prohibition against future diversions.
A class comprised of all members of the retirement system has been certified and
the case is proceeding through class notification and toward trial. The State
Attorney General's office believes that sound legal arguments support the
State's defense of these cases.
6. CABARRUS COUNTY V. TOLSON - DIVERSION OF LOCAL GOVERNMENT TAX
REIMBURSEMENTS AND SHARED REVENUE. On September 17, 2002, six counties and three
municipalities filed suit against the State Secretary of Revenue demanding that
the State release payments of local tax reimbursements and shared revenues in
excess of $200 million and a prohibition against future diversions. The
Governor, in the exercise of his constitutional responsibility to balance the
State budget, withheld tax revenues designated by statute for payment to local
governments. Summary judgment was granted in favor of the State on all issues,
and Plaintiffs appealed. On April 5, 2005, the State Court of Appeals ruled in
favor of the State. Plaintiffs are expected to seek review by the State Supreme
Court. The State Attorney General's office believes that sound legal arguments
support the State's defense of this action.
7. GOLDSTON, ET AL. V. STATE OF NORTH CAROLINA, ET AL. - DIVERSION OF
HIGHWAY TRUST FUNDS. On November 14, 2002, a former Secretary of the Department
of Transportation and a retired State Senator sued the Governor and the State
for using Highway Trust Fund money in the State's General Fund. The Governor's
Executive Order No. 19 transferred $80 million from the Highway Trust Fund to
the General Fund for purposes of balancing the State budget. Also, the General
Assembly in its 2002 Special Session authorized this transfer and the transfer
of an additional $125 million during fiscal year 2003 in the form of a loan to
be repaid with interest through 2009. The suit alleges that these actions are
unlawful and unconstitutional and requests a declaration that taxes collected
for purposes of Highway Trust Fund expenditures cannot be used for other
purposes. Summary judgment was granted in favor of the State on all issues, and
Plaintiffs appealed. In a unanimous decision filed September 20, 2005, the State
Court of Appeals affirmed the granting of summary judgment in favor of the
State.
8. DIANA COLEY, ET AL. V. STATE OF NORTH CAROLINA, ET AL. (FORMERLY EDWARD
N. RODMAN, ET AL. V. STATE OF NORTH CAROLINA, ET AL.) - RETROACTIVE INCOME TAX
RATES. On April 25, 2003, Plaintiffs filed suit against the State and the
Secretary of Revenue challenging the constitutionality of retroactively applying
the 2001 increase in the highest rate of North Carolina's state income tax to
the entire 2001 tax year. Plaintiffs seek refunds, for themselves and a proposed
class of similarly situated taxpayers, of all taxes paid for the year 2001 in
excess of the prior 7.75% maximum rate, on the theory that a retroactive
mid-year tax increase violates the State and federal constitutions. Plaintiffs
claim the total amount of taxes involved exceeds $76 million, plus interest. On
June 30, 2004, the trial court granted summary judgment in favor of the State on
all issues. Plaintiffs appealed to the State Court of Appeals, and oral
arguments were held in April 2005. The State Attorney General's office has filed
a motion to dismiss and believes sound legal arguments support dismissal of the
case.
9. MEDICAL MUTUAL INSURANCE CORPORATION OF NORTH CAROLINA V. THE BOARD OF
GOVERNORS OF THE UNIVERSITY OF NORTH CAROLINA AND ITS CONSTITUENT INSTITUTION,
EAST CAROLINA UNIVERSITY, THE EAST CAROLINA SCHOOL OF MEDICINE, ET AL. -
INSURANCE POLICY TERMINATION PREMIUM. On March 18, 2003, Medical Mutual
Insurance Corporation of North Carolina ("MMI") filed this action in Wake County
Superior Court against the Board of Governors of the University of North
Carolina, East Carolina University Brody School of Medicine ("ECM"), and various
doctors.
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In 2002, in order to raise additional capital, MMI demanded that all policy
holders, including ECM, purchase guaranteed capital shares under threat of
termination or nonrenewal of policies. In the face of MMI's demand, ECM decided
to purchase insurance for almost all of its healthcare professionals from
another insurance company. In this lawsuit, MMI claims that ECM's decision not
to purchase insurance for all its healthcare professionals from MMI triggered an
obligation to pay a termination fee to MMI of approximately $26.7 million. ECM
believes that MMI is not entitled to any further payments. The State Attorney
General's Office believes that no fee may be owed because of MMI's termination
of the contract; however, in the event that a fee is owed, the State Attorney
General's Office believes that it would be substantially less than $26.7
million. The suit is pending in Superior Court and related administrative
proceedings before the State Department of Insurance are ongoing. In August
2004, the trial court entered an order referring the case to arbitration. The
State has appealed the arbitration order, and the State Court of Appeals has
agreed to hear the case. The State also has filed an administrative proceeding
with the State Department of Insurance seeking determination MMI is violating
various aspects of State insurance practice in its attempt to impose this
penalty.
10. DirecTV, Inc. and EchoStar Satellite Corp. v. State of North Carolina
et al. - Refund of Sales Tax. On September 30, 2003, DirecTV and Echostar filed
an action for a $32 million refund of State sales tax paid. The State General
Assembly recently enacted a provision to impose the sales tax on satellite TV
service providers. Plaintiffs claim this tax, which is not imposed on cable
television providers, is unconstitutional in that it violates the Commerce
Clause (because it is discriminatory and not fairly related to benefits provided
by the State), the equal protection clause and North Carolina's uniformity of
taxation constitutional requirement. It is the State's position that although
cable providers are not subject to this tax, they are subject to city and county
franchise taxes. The tax on satellite companies was enacted to equalize the tax
burden on these various forms of entertainment. The case has been designated as
exceptional under the State's Rules of Civil Procedure. The parties'
cross-motions for summary judgment were argued in May 2005, and the trial court
granted summary judgment in favor of the State.
11. Lessie J. Dunn, et al. v. State of North Carolina, et al. - Tax on
Non-State Municipal Bonds. On February 9, 2004, Plaintiffs, on behalf of a class
of all others similarly situated, filed suit alleging that the State's
imposition and collection of State income tax on interest received by certain
taxpayers on municipal bonds issued by non-North Carolina State and local
governments constitutes a violation of the Commerce Clause of the United States
Constitution. A similar case recently filed in Ohio was ultimately unsuccessful.
The State Attorney General's Office has filed an answer in the case, and
plaintiffs are currently seeking class certification. The State Attorney
General's Office believes that sound legal arguments support the defense of this
case.
12. Sanders, et al v. State Personnel Commission, et al. - Temporary
Employees. On April 1, 2005 this action was filed on behalf of two former
temporary employees of the State government seeking class action certification,
injunctive relief and declaratory relief alleging that the State has engaged in
unlawful and unconstitutional practices designed to deprive temporary employees
who have worked 12 consecutive months or more of compensation rights benefits
and permanent employee status. The complaint references a rule promulgated by
the Office of State Personnel stating that temporary employees shall not work
longer than 12 consecutive months; asserts the creation of implied contracts;
and relies in addition on various provisions of the State Constitution. The
complaint has been amended once to add two additional plaintiffs and a motion is
pending to allow a second amendment adding a State "whistleblower" allegation
because several agencies began strictly applying the rule after the complaint
was filed. Significant defenses exist as to each claim alleged in the lawsuit.
On June 1, 2005 a Superior Court judge entered a limited temporary restraining
order prohibiting the State from termination temporary employees either on the
basis of the rule in question or because of the lawsuit. A motions hearing on
the preliminary injunction and other pending motions, including a request for
"provisional" class certification, is scheduled for June 2005. If the State were
to ultimately be required to provide to a class of several thousand former and
current temporary employees retroactive benefits in the form of leave
compensation, retirement, and health insurance benefits, the liability would be
substantial.
The State is also involved in numerous other claims and legal proceedings,
many of which normally occur in governmental operations. A review of the status
of outstanding lawsuits involving the State by the State Attorney General did
not disclose any other proceedings that are expected to have a material adverse
effect on the financial position of the State.
In its 1996 Short Session, the North Carolina General Assembly approved
State general obligation bonds in the amount of $950 million for highways and
$1.8 billion for schools. These bonds were approved by the voters of the State
in November 1996. In March 1997, the State issued $450 million of the authorized
school bonds. In November 1997, the State issued $250 million of the authorized
highway bonds. In April 1998, the State issued an additional $450 million of the
authorized school bonds. In April 1999, the State again issued an additional
$450 million of the authorized school bonds. In September 2000, the State issued
an additional $295 million of the authorized school bonds, and another $100
million of the authorized school bonds were issued in March 2001. In May 2002,
the State issued the final $55 million of the authorized school bonds. In
November 2003, the State issued an additional $400 million of the authorized
highway bonds. The remaining $300 million of the authorized highway bonds was
issued by the State in September 2004.
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On November 3, 1998, North Carolina voters approved the issuance of $800
million in clean water bonds and $200 million in natural gas facilities bonds.
The clean water bonds provide grants and loans for needed water and sewer
improvement projects for the State's municipalities, and fund programs to reduce
pollution in the State's waterways. The natural gas bonds provide grants, loans
and other financing for local distribution companies or state or local
government agencies to build natural gas facilities, in part to help attract
industry to the State's rural regions. In September 1999, the State issued a
total of $197.4 million of authorized clean water bonds and natural gas
facilities bonds, $177.4 million of which were a combination of clean water
bonds ($172.4 million) and natural gas facilities bonds ($5 million) and $20
million of which were solely natural gas facilities bonds. In October 1999, the
State issued an additional $2.6 million of the authorized clean water bonds. In
September 2000, the State issued an additional $5 million of the authorized
natural gas facilities bonds. In March 2001, the State issued an additional $30
million of the authorized clean water bonds. In March 2002, the State issued an
additional $204.4 million of the authorized clean water bonds and an additional
$35 million of the authorized natural gas facilities bonds. In April 2002, the
State issued an additional $10.6 million of the authorized clean water bonds. In
December 2002, the State issued an additional $18.8 million of the authorized
clean water bonds and an additional $50 million of the authorized natural gas
facilities bonds. In January 2003, the State issued an additional $2.9 million
of the authorized clean water bonds. In April 2003, the State issued an
additional $33 million of the authorized natural gas facilities bonds. In May
2003, the State issued an additional $3.65 million of the authorized clean water
bonds. In March 2004, the State issued an additional $36 million of the
authorized natural gas facilities bonds. The remaining $16 million of the
authorized natural gas facilities bonds were issued by the State in January
2005.
On November 7, 2000, North Carolina voters approved the issuance of $3.1
billion in general obligation higher education bonds to finance improvements to
the facilities of the 16 public universities and 59 community colleges in the
State. In March 2001, the State issues $250 million of the authorized higher
education bonds. In March 2002, the State issued an additional $300 million of
the authorized higher education bonds.
In March 2003, the State issued bonds representing a consolidation of the
clean water bonds and the higher education bonds in the approximate amount of
$320 million. In April 2003, the State issued approximately $283.3 million of
additional consolidated public improvement bonds. These two issuances consisted
of a total of $38.4 million of the clean water bonds and $564.9 million of the
higher education bonds. In March 2005, the State issued approximately $707.9
million of additional consolidated public improvement bonds. This issuance
consisted of a total of $90.8 million of the clean water bonds and $617.1
million of the higher education bonds. An additional $15.255 million of the
clean water bonds was issued separately by the State in March 2004. In January
2005, the State issued $705.5 million of additional consolidated public
improvement bonds, consisting of a total of $41 million of the clean water bonds
and $664.5 million of the higher education bonds. A total of approximately $169
million of the authorized clean water bonds remains unissued, and a total of
approximately $703.5 million of the authorized higher education bonds remains
unissued.
In addition, the State refinanced over $1,372 million of its existing debt
in the years 2002 through January 2005 to improve cash flow and to take
advantage of lower interest rates by reducing its future debt service payments.
It is anticipated that in July 2005 the State will issue $609.61 million in
additional refunding bonds.
Hurricane Floyd struck North Carolina on September 16, 1999, causing
significant flood and wind damage and some loss of life. The effects of the
storm and its aftermath have been, and continue to be, felt in the eastern part
of the State. The final estimate of property damage caused by the storm and its
aftermath is $6 billion. In the opinion of the Offices of the Governor and the
State Treasurer, notwithstanding the devastation caused by Hurricane Floyd, the
storm and its consequences should not have a material adverse impact upon the
ability of the State to meet its financial obligations, including timely payment
of principal and interest on the State's general obligation bonds.
Hurricane Isabel came ashore near Ocracoke on the Outer Banks of the State
on September 18, 2003. The storm hammered the fragile Outer Banks and raked
across the northeastern portion of the State, causing widespread destruction to
homes, business, and farms. 47 of the State's 100 counties were declared
disaster areas. The State Department of Agriculture reports that damage to
crops, livestock, and farm structures in the State exceeds $152 million. Damage
to timber in the State is estimated at $565 million, with more than 833,000
acres sustaining some level of damage. By the end of December 2003, more than
$155 million in federal and State disaster assistance to individuals,
households, local governments, and private nonprofits has been approved. The
federal government covers 75 percent of the costs; the State pays the other 25
percent.
The State suffered the effects of six tropical weather systems in 2004. In
August, Hurricanes Alex, Bonnie, and Charley caused flooding and widespread
power outages in eastern North Carolina. In September, Hurricanes Frances, Ivan,
and Jeanne devastated central and western North Carolina with torrential
rainfall that spawned flash flooding and numerous debris flows, including
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mudslides and rock falls. Only Hurricanes Frances and Ivan have met the criteria
necessary to achieve a Federal Disaster Declaration, while Hurricanes Alex,
Bonnie, Charley, and Jeanne met the criteria necessary for a State Disaster
Declaration. Preliminary estimates indicate that these storms caused over $230
million in damages that are eligible for state and federal governmental
assistance. The State's share is estimated to be approximately $90 million. In
order to match federal funds available to the State for federal disaster
recovery services, the Governor ordered State agencies to revert 0.75 percent of
their 2004-05 budgets to provide an estimated $120 million for storm relief.
Currently, Standard & Poor's and Fitch both rate the State's general
obligation bonds as AAA. On August 19, 2002, Moody's downgraded the State's
general obligation bonds from Aaa, its highest rating, to Aa1 with stable
outlook, one step below Aaa. Moody's cited the State's "continued budget
pressure, its reliance on non-recurring revenues, and its weakened balance
sheet" as reasons for this downgrade. This represents the first time since 1960
that the State has had less than a AAA rating on its general obligation bonds.
In September 2004, Moody's revised the State's outlook from stable to positive
and noted the following:
"This rating reflects the State's slowly stabilizing economy, its improving
tax revenues, its conservative debt policy, and its effective financial
management. While general fund balances remain negative, flexible cash
reserves outside the general fund are ample, and pension funding is
exceptionally strong. Moody's expects that the state will continue to take
actions to restore structural balance and rebuild reserves."
SPECIAL CONSIDERATIONS REGARDING INVESTMENT IN SOUTH CAROLINA TAX-EXEMPT
OBLIGATIONS
The concentration of investments in South Carolina Tax-Exempt Obligations
by the South Carolina Fund raises special investment considerations. In
particular, changes in the economic condition and governmental policies of South
Carolina and its political subdivisions, agencies, instrumentalities, and
authorities could adversely affect the value of the South Carolina Fund and its
portfolio securities. This section briefly describes current economic trends in
South Carolina. The information set forth below is derived from official
statements prepared in connection with the issuance of South Carolina Tax-Exempt
Obligations and other sources that are generally available to investors. BB&T
Funds has not independently verified this information.
The South Carolina Constitution requires the General Assembly to provide a
balanced budget. South Carolina Law provides that the State Budget and Control
Board shall, if a deficit appears likely, effect such reductions in
appropriations as may be necessary to prevent a deficit. The State Constitution
further provides that annual increases in State appropriations may not exceed
the annual growth rate of the economy of the State and that the annual increases
in the number of State employees may not exceed the average growth of the
population of the State. Such limits on growth are subject to suspension by a
super-majority of the General Assembly. The State Constitution also establishes
a General Reserve Fund to be maintained in an amount equal to 3% (4% prior to
1988) of General Fund revenue for the latest completed fiscal year for the
purpose of covering operating deficits of State government.
In the November 1988 general election the electorate approved a
constitutional amendment creating a Capital Reserve Fund equal to 2% of the
prior fiscal year's General Fund revenues to provide capital improvements or
retire State bonds previously issued. The State Constitution requires that the
General Assembly provide that, if revenue forecasts before March 1 project that
revenues for the current Fiscal Year will be less than expenditures authorized
by appropriation for that fiscal year, the current fiscal year's appropriation
to the Capital Reserve Fund shall be reduced to the extent necessary before any
reduction is made in operating appropriations. If it is determined that the
Fiscal Year has ended with an operating deficit, the State Constitution requires
that funds in the Capital Reserve Fund shall be applied, to the extent
necessary, to the fiscal year's end operating deficit before withdrawing moneys
from the General Reserve Fund for such purpose.
As noted above, the state Constitution requires a procedure for the
monitoring of revenues and expenditures with a view to a reduction of
appropriations as may be necessary to prevent a deficit. For the purpose of
providing projections and forecasts of revenues and expenditures and advising
the State Budget and Control Board on economic trends, the General Assembly
established the Board of Economic Advisors. In particular with respect to the
Constitutional requirement of monitoring revenues, statutory provisions require
that the Board of Economic Advisors provide to the State Budget and Control
Board quarterly estimates of State revenues. If at the end of the first or
second quarter of any fiscal year, quarterly revenue collections are 4% or more
below the amount projected for such quarter by the Board of Economic Advisors,
the State Budget and Control Board is required, within fifteen days of such
determination, to take action to avoid a Fiscal Year End deficit.
For many years, each annual Appropriations Act has contained a provision
requiring the State Budget and Control Board to monitor the collection of
revenues and the expenditure of funds.
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For the Fiscal Year ended June 30, 1995, the State had a budgetary surplus
of $393 million. The General Assembly designated the application of all of this
surplus, including a transfer to the Capital Reserve Fund in the amount of $73.4
million.
For the Fiscal Year ended June 30, 1996, the State had a budgetary surplus
of $316.7 million. The General Assembly designated the application of all of
this surplus, including a transfer to the Capital Reserve Fund in the amount of
$80.5 million.
For the Fiscal Year ended June 30, 1997, the State had a budgetary surplus
of $297.8 million. The General Assembly designated the application of all of
this surplus, including a transfer to the Capital Reserve Fund in the amount of
$83.6 million.
For the Fiscal Year ended June 30, 1998, the State had a budgetary surplus
of $254 million. The General Assembly designated the application of all of this
surplus, including a transfer to the Capital Reserve Fund in the amount of $86.9
million.
For the Fiscal Year ended June 30, 1999, the State had a budgetary surplus
of $410 million. The General Assembly designated the application of $322 million
of this surplus, including a transfer to the Capital Reserve Fund in the amount
of $92 million.
For the Fiscal Year ended June 30, 2000, the State had a budgetary surplus
of $213 million. The General Assembly designated the application of all of this
surplus, including a transfer to the Capital Reserve Fund in the amount of $97
million.
As described previously, South Carolina law requires that the State Budget
and Control Board take immediate action to avoid year-end deficits if, at the
end of the first or second quarter of a Fiscal Year, base revenue collections
are four percent or more below the amount projected for such quarter. Actions
taken by the State Budget and Control Board in Fiscal Year ended June 30, 2001,
reflected the required process of monitoring revenues and making adjustments to
avoid a deficit. The revenue estimate for the State's Budgetary General Fund at
the beginning of Fiscal Year 2000-2001 as enacted by the General Assembly
totaled $5,316.9 million.
On November 9, 2000, the State's Board of Economic Advisors reduced its
base revenue estimate for Fiscal Year 2000-2001 by $96.9 million to $5,220.0
million. In response, the State Budget and Control Board at its November 21,
2000 meeting sequestered the State's Capital Reserve Fund of $98,610,931 as
required by the State Constitution and the State's Fiscal Year 2001
Appropriation Act. Sequestration reduces appropriations to the Capital Reserve
Fund to the extent necessary to avoid mandatory reductions in operating
appropriations.
On May 8, 2001, the State Budget and Control Board mandated 1% agency
budget reductions totaling $48.1 million. Additionally, $45.7 million in agency
appropriations lapsed as a result of suspension of a provision that, in some
years, has allowed agencies to carry forward to the next fiscal year up to 10%
of their unexpended appropriations. This provision was automatically suspended
for the fiscal year because of sequestration of the Capital Reserve Fund. Other
action resulted in a further deficit reduction of $1.9 million. Despite such
actions, for the Fiscal Year ended June 30, 2001, expenditures exceeded revenues
by $87.4 million, and, as required by the State Constitution, such amount was
withdrawn from the General Reserve Fund to cover the shortfall.
The General Reserve Fund Balance at the beginning of Fiscal Year 2000-2001
was $145.4 million and was increased during 2000-2001 by $2.5 million.
Accordingly, the $87.4 million withdrawal at year-end left the reserve funded at
$60.5 million. In accordance with the State Constitution, the General Reserve
Fund must be restored within three years to its full-funding amount of 3% of the
State's Budgetary General Fund revenues for the latest completed Fiscal Year.
On October 18, 2001, the Board of Economic Advisors reduced its fiscal year
2001-2002 General Fund revenue estimate from $5,918.9 million to $5,608.9
million, a revenue reduction of $310 million. In response to the Board of
Economic Advisor's report, the State Budget and Control Board at its October 30,
2001, meeting took action to avoid year-end deficits in accordance with the
State law requirement previously described. This action included sequestration
of $100,134,739 from the State's Capital Reserve Fund; approval of an
across-the-board reduction of General Fund appropriations of 4% for all agencies
except where prohibited by proviso; and the approval of a reduction of the local
Government Fund to the level of Fiscal Year 2000-2001 allocations.
On March 21, 2002, the Board of Economic Advisors further reduced its
fiscal year 2001-2002 General Fund revenue estimate by approximately $92 million
and, in response to this revision, the State Budget and Control Board at its
March 26, 2002 meeting took additional steps to avoid year-end deficits by
imposing an additional across-the-board reduction of General Fund appropriations
of 2.52% for all agencies except where prohibited by proviso. Additionally, the
Board of Economic Advisors revised the estimate for a revenue transfer to the
State's Tax Relief Trust Fund from $448 million to $458.7 million, which
resulted in an additional $10.7 million reduction in anticipated revenue to the
General Fund. Also, the Fiscal Year 2001-2002, Appropriation Act contained
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appropriations for open-ended obligations totaling approximately $16.5 million,
which were to be paid regardless of the revenue shortfall.
In its 2002 legislative session, the General Assembly adopted legislation
providing that, upon a determination by the State's Comptroller General that, at
the close of a Fiscal Year, funds will be needed to balance the Budgetary
General Fund, the Budget and Control Board is authorized to borrow any amount
needed to balance the Budgetary General Fund by borrowing from any department of
State government any surplus which may be on hand in the Office of the State
Treasurer to the credit of any such department. Upon approval of a repayment
schedule, the State Treasurer is authorized to transfer to the State Budget and
Control Board from the general fund the amount necessary to repay the loan with
interest no later than June 30 of the following Fiscal Year. No such borrowing
was effected in closing the Fiscal Year ended June 30, 2002.
Despite the mid-year actions taken by the State Budget and Control Board
during Fiscal Year 2002, the State's Budgetary General Fund ended the year with
a cumulative unreserved fund deficit of $155 million, after giving effect to
withdrawal of the $63 million balance held in the State's General Reserve Fund.
As required by the South Carolina Constitution, the General Assembly made
provision in the 2002-2003 Appropriation Act by appropriating the amounts of
$38.8 million toward restoration of the General Reserve Fund requirement and
$101.6 million, representing the Capital Reserve Fund's full funding amount for
Fiscal Year 2002-2003.
On September 9, 2002, the Board of Economic Advisors reduced its Fiscal
Year 2002-2003 General Fund revenue estimate from the 2002-2003 Appropriation
Act base of $5,850 million to $5,519 million, a revenue reduction of $331
million. In response to the report of the Board of Economic Advisors, the State
Budget and Control Board at its September 17, 2002 meeting took action to avoid
year-end deficits in accordance with the State law requirement previously
described by sequestering the State's Capital Reserve Fund in the amount of
$101,606,475. Additionally, at its December 10, 2002 meeting, the State Budget
and Control Board took action to impose an across-the-board reduction of 4.5%
and sequestration of an additional 0.5%.
On February 10, 2003, the Board of Economic Advisors further reduced its
fiscal year 2002-2003 General Fund revenue estimate to $5,399 million, a revenue
reduction of $120 million. In response to this report of the Board of Economic
Advisors, the State Budget and Control Board at its February 11, 2003 meeting
took action to impose an additional across-the-board reduction of 3.73%, except
where prohibited by proviso.
Despite the mid-year actions taken by the State Budget and Control Board
during fiscal year 2002-2003, the State's Budgetary General Fund ended the year
with a cumulative unreserved fund deficit of $177 million, including the $155
million unreserved fund deficit realized in fiscal year 2001-2002, and after
giving effect to withdrawal of the $39 million balance held in the State's
General Reserve Fund.
As required by the South Carolina Constitution, the General Assembly made
provision in the 2003-2004 Appropriation Act appropriating the amounts of $49.2
million toward restoration of the General Reserve Fund requirement and $98.6
million representing the Capital Reserve Fund's full funding amount for fiscal
year 2003-2004.
On August 15, 2003, the Board of Economic Advisors revised its fiscal year
2003-2004 General Fund revenue estimate from the 2003-2004 Appropriation Act
base of $5,489.4 million to $5,381.8 million, a revenue reduction of $107.6
million. In response to the report of the Board of Economic Advisors, the State
Budget and Control Board at its August 20,2003 meeting took action to avoid
year-end deficits in accordance with the State law previously described by
sequestering the State's Capital Reserve Fund in the amount of $98,599,197 and
approved an across-the-board sequestration of 1% of General Fund appropriations
of all agencies totaling $43.2 million except where prohibited by proviso.
In its report to the State Budget and Control Board on August 15, 2003, the
Board of Economic Advisors also advised that it would review circumstances in
September, 2003, upon the availability of further economic data, to determine if
additional adjustments to its fiscal year 2003-2004 General Fund revenue
estimate would be necessary. No such adjustments were deemed to be necessary as
a result of that review.
The State Budget and Control Board also took action in its August 20, 2003
meeting to effect an interfund borrowing in the amount of $22 million, with
proceeds from the loan to be applied to the fiscal year 2002-2003 deficit, in
accordance with the 2002 legislative authorization discussed previously. The
borrowing was made against funds available to the State and was paid in full on
December 1, 2003.
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Acting on the advice of counsel under question of the State Budget and
Control Board's constitutional authority to commit funds of a current fiscal
year for a prior fiscal year purpose (including an unreserved fund deficit), the
State Budget and Control Board deferred action on the $155 million unreserved
fund deficit until such time as the General Assembly reconvened in January,
2004.
On June 14, 2004, the General Assembly enacted the "Fiscal Discipline Plan
of 2004" (the "Fiscal Plan"), which (i) clarifies actions necessary for the
State Budget and Control Board to cover an operating deficit from fiscal years
2001-2003; (ii) provides for repayment of the accumulated State operating
deficit; (iii) limits general fund appropriations growth to three percent in
fiscal years 2003-04 through 2008-09; (iv) designates the use of surplus
revenues; and (v) designates required transfers to the General Reserve fund as
recurring general fund appropriations.
The Fiscal Plan provides that upon the close of a fiscal year, the State's
Comptroller General must account for general fund revenues and expenditures from
a budgetary-based approach no later than August 31 succeeding the end of the
fiscal year. If expenditures exceed revenues and an operating deficit is
determined, this information must be reported to the State Budget and Control
Board before September 1, and the matter of the operating deficit must be placed
as the first item on the agenda for the first meeting of the State Budget and
Control Board following the closing of the books for the fiscal year. The Fiscal
Plan includes similar provisions to existing law by authorizing interfund
borrowing to restore balance to the budgetary general fund and directing that
the State Treasurer transfer the amount necessary to repay the loan with
interest no later than June 30 of the following fiscal year.
The Fiscal Plan further provides for partial resolution of the fiscal year
2001-02 operating deficit by directing the State Treasurer to transfer up to $50
million of fiscal year 2003-04 General Reserve Fund revenue prior to the close
of the State's books for fiscal year 2003-04. The legislation expresses the
intent of the General Assembly to resolve any remaining accumulated operating
deficit for fiscal year 2001-02 by designating $50 million per year, if so much
is necessary, as the first priority of appropriation of Capital Reserve Fund
revenues, provided that revenues in the Capital Reserve Fund for fiscal years
2004-05 and 2005-06 are available for appropriation by the General Assembly.
Moreover, for the period 2003-04 through 2008-09, to the extent that
surplus general fund revenue is realized while the fiscal year 2001-02
accumulated operating deficit remains unresolved, the State Treasurer is
directed to transfer as much of the surplus as is necessary to eliminate the
deficit. If any surplus remains after full resolution of the accumulated
deficit, the remaining surplus must be applied to restore amounts previously
withdrawn from the General Reserve Fund. Upon resolution of the 2001-02
accumulated deficit and restoration of the General Reserve Fund to its full
funding requirement, any remaining surplus general fund revenue would be deemed
Capital Reserve Fund revenues and made available for appropriation in accordance
with existing law.
In addition to other applicable limitations on general fund appropriations
under existing law, the Fiscal Plan would restrict any increase in total general
fund appropriations (excluding nonrecurring amounts) for a given fiscal year
during the period 2004-05 through 2008-09 to an amount not exceeding three
percent of general fund appropriations made in the immediately preceding fiscal
year.
Finally, the Fiscal Plan provides that, for fiscal years 2004-05 through
2008-09, amounts required to be transferred to the General Reserve Fund,
including amounts necessary to restore previously withdrawn amounts, are deemed
to be recurring general fund appropriations, with the exception that this
budgetary treatment does not affect the calculations of spending formulas based
on a percentage of general fund revenues.
The provisions of the Plan are deemed to be no longer applicable following
resolution of the fiscal year 2001-02 accumulated general fund operating deficit
and full restoration of the General Reserve Fund, both of which criteria were
met no later than July 1, 2005.
The State's Budgetary General Fund ended fiscal year 2003-2004 with a net
budgetary surplus of $242,654,275, including application of $49,299,599 from the
General Reserve Fund to the fiscal year 2001-2002 deficit. From the net
budgetary surplus, $176,915,948 was applied to the accumulated unreserved fund
deficit, $40,583,799 was designated for expenditure in fiscal year 2004-2005,
and $25,154,528 was applied to restoration of the General Reserve Fund. At June
30, 2004, the balance of the General Reserve Fund was $25,154,528, and the
balance of the Capital Reserve Fund was $0.
As required by the South Carolina Constitution, the General Assembly made
provision in the 2004-2005 Appropriation Act appropriating the amounts of $50.0
million toward restoration of the General Reserve Fund requirement and $99.4
million
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representing the Capital Reserve Fund's full funding amount for fiscal year
2004-2005. At June 30, 2005, the balance of the General Reserve Fund was
$75,154,528, and the balance of the Capital Reserve Fund was $99,356,026.
The revenue estimate for the State's Budgetary General Fund for fiscal year
2004-2005 as enacted by the General Assembly was $5,594.8 million. On May 9,
2005, the Board of Economic Advisors revised its estimates of fiscal year
2004-05 budgetary general fund revenue to $5,881.7 million, an increase of
$286.9 million or 5.1% over the fiscal year 2004-05 Appropriation Act estimate.
On August 11, 2005, the State's Comptroller General reported that the State
recognized a $300 million surplus for the fiscal year ended June 30, 2005, after
giving effect to a one-time adjustment in the amount of $105 million to correct
errors in accruals from prior fiscal years. Further information concerning the
State's preliminary and unedited financial results for the fiscal year ended
June 30, 2005 is available at
http://www.cg.state.sc.us/press/20050811/PressPackage2005.pdf.
The 2005-06 Appropriation Act assumes budgetary general fund revenues of
$5,5617.4 million, excluding $506.3 million earmarked for tax relief trust
funds. The 2005-06 Appropriation Act provides for restoration of the general
reserve fund to its full funding of the capital reserve fund at $102.3 million.
Through August 31, 2005, total general fund revenue collections exceeded prior
year collections for the same period by 10.5% and exceeded the Fiscal Year
2005-06 revenue estimate for the period by 11.5%.
During the 2005 legislative session, the General Assembly enacted Act No.
156 of the Acts and Joint Resolutions, Regular Session of 2005 ("Act No. 156")
to provide for a formal process of forecasting expenditures. Act No. 156
provides that each state agency, department, institution, or entity receiving in
the aggregate one percent or more of the State's general fund expenditures for
the next three fiscal years. This data, in conjunction with the Board of
Economic Advisors' long-term revenue estimate, must be compiled by the Office of
the State Budget into a three-year financial plan that will assist the State in
determining and planning for its long-term financial commitments.
In addition to forecasting expenditures described above, Act No. 156 also
provides that any appropriation from the Capital Reserve Fund must be ranked in
priority and is effective on September 1 of the following fiscal year. If a
year-end operating deficit occurs, any amounts appropriated from the Capital
Reserve Fund must be reduced by the State Budget and Control Board based on the
rank of priority, beginning with the lowest priority, to the extent necessary
and applied to the year-end operating deficit before withdrawing monies from the
General Reserve Fund.
Beginning July 1, 2006, Act No. 156 also provides for the suspension of any
appropriation contained in a general or supplemental appropriation act which
expends surplus General Fund Revenues or in a Capital Reserve Fund appropriation
act to be effective during the next fiscal year which must be used to the extent
necessary to offset a negative Generally Accepted Accounting Principles Fund
balance (a "GAAP Fund Deficit") in the manner provided by the General Assembly.
Act No. 156 further provides beginning July 1, 2005, surplus General Fund
Revenues for any fiscal year not otherwise obligated and appropriations to the
Capital Reserve Fund are deemed to have occurred and are available for
expenditures after September 1 of the next fiscal year and after the State's
financial books for the previous fiscal year have been closed.
The 2005-06 Appropriations Act mandates if, upon the closing of the State's
financial books for the fiscal year ended June 30, 2005, it is determined that
the State has a GAAP Fund Deficit, the expenditures of surplus General Fund
Revenues shall be suspended and must be used to the extent necessary to offset
the GAAP Fund Deficit.
Act No. 156 also contains a provision requiring the first ten percent of
any surplus General Fund Revenues must be applied to fully restore all funds
previously transferred out of these trust accounts beginning in the fiscal year
ended June 30, 2002 msut be restored to each trust account on a pro rata basis.
The State of South Carolina has not defaulted on its bonded debt since 1879
and has not incurred any debt to fund operating deficits since 1932. As noted
above, however, the State did experience certain budgeting difficulties over
several of the last ten fiscal years resulting in mid-year cutbacks in funding
of state agencies in those years. Such difficulties have not to date impacted on
the State's ability to pay its indebtedness, but did result in Standard & Poor's
Rating Service lowering its rating on South Carolina general obligation bonds
from AAA to AA+ in July 2005. South Carolina's general obligation bonds are
currently rated Aaa by Moody's Investor Services, Inc., as they have been
continuously for several decades and AAA by Fitch Ratings. Such ratings apply
only to the general obligation bonded indebtedness of the State and do not apply
to bonds issued by political subdivisions or to revenue bonds not backed by the
full faith and credit of the State. There can be no assurance that the economic
conditions on which the above ratings are based will continue or that particular
bond issues may not be adversely affected by changes in economic or political
conditions.
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The State of South Carolina is primarily a manufacturing state. In 2002,
nearly one-sixth of all jobs in the State were in the manufacturing industry,
compared to eleven percent nationally. While the textile industry is still the
major industrial employer in the State, since 1950 the State's economy has
undergone a gradual transition to greater diversification in the manufacturing
sector. In addition, the economic base of the State has diversified in other
areas such as trade, health care services, and durable goods manufacturing.
Personal income in South Carolina grew three and seven-tenths percent
(3.7%) during 2003 compared to income growth of three and one-tenth percent
(3.1%) nationwide and three and seven-tenths percent (3.7%) in the Southeast.
Over the last five (5) years (1998-2003) personal income in South Carolina rose
at a compounded annual rate of four and five-tenths percent (4.5%), while the
annual income growth in the Southeast region rose four and six-tenths percent
(4.6%), and the annual growth in the United States rose four and three-tenths
percent (4.3%) during the same period.
In 2003, employment in the State increased four-tenths percent (0.4%) while
the rate of employment in the United States decreased three-tenths percent
(0.3%). The unemployment rate for South Carolina in 2003 was six and
eight-tenths percent (6.8%) compared to six percent (6.0%) nationwide.
SPECIAL FACTORS AFFECTING THE SOUTH CAROLINA TAX-EXEMPT FUND
The State of South Carolina has the power to issue general obligation bonds
based on the full faith and credit of the State. Under Article X of the
Constitution of the State of South Carolina, the State may issue general
obligation debt without either a referendum or a supermajority of the General
Assembly, within limits defined by reference to anticipated sources of revenue
for bonds issued for particular purposes. A referendum or supermajority of the
General Assembly may authorize additional general obligation debt. Article X
further requires the levy and collection of an ad valorem tax if debt service
payments on general obligation debt are not made.
Political subdivisions are also empowered to issue general obligation
bonds, which are backed only by the full faith and credit of that political
subdivision, and not by the resources of the State of South Carolina or any
other political subdivision. Political subdivisions are empowered to levy ad
valorem property taxes on certain real property and personal property to raise
funds for the payment of general obligation bonds. General obligation debt may
be incurred only for a public purpose which is also a corporate purpose of the
applicable political subdivision.
Under Article X of the Constitution of the State of South Carolina,
political subdivisions are empowered to issue aggregate general obligation
indebtedness up to 8% of the assessed value of all taxable property within the
political subdivision (exclusive of debt incurred before the effective date of
Article X with respect to such subdivisions) without a referendum. A referendum
may authorize additional general obligation debt. The ordinance or resolution
authorizing bonded debt of a political subdivision also directs the levy and
collection of ad valorem taxes to pay the debt. In addition, Article X of the
State Constitution provides for withholding by the State Treasurer of any state
appropriations to a political subdivision which has failed to make punctual
payment of general obligation bonds. Such withheld appropriations, to the extent
available, shall be applied to the bonded debt. Political subdivisions are not
generally authorized to assess income taxes, or to pledge any form of tax other
than ad valorem property taxes, for the payment of general obligation bonds.
Political subdivisions may pledge certain additional revenues, however, to
secure their general obligation bonds and, certain political subdivisions have
been authorized to impose a limited-duration 1% sales tax to defray the debt
service on bonds for certain capital projects.
Industrial development bonds and other forms of revenue bonds issued by the
State or a political subdivision are not secured by the full faith and credit of
the State or the issuing entity. Such bonds are payable only from revenues
derived from a specific facility or revenue source.
Most recently, Moody's has rated the long-term general obligation bonds of
South Carolina Aaa, Standard & Poor's has rated such bonds AA+ and Fitch Ratings
has rated such bonds AAA. There can be no assurance that the economic conditions
on which these ratings are based will continue or that particular bond issues
may not be adversely affected by changes in economic or political conditions.
See the Appendix to this SAI.
SPECIAL CONSIDERATIONS REGARDING INVESTMENT IN VIRGINIA TAX-EXEMPT OBLIGATIONS
The Virginia Intermediate Tax-Free Fund will invest primarily in Virginia
Intermediate Tax-Free Fund Obligations. For this reason, the Fund is affected by
political, economic, regulatory or other developments that constrain the taxing,
revenue-collecting and spending authority of Virginia issuers or otherwise
affect the ability of Virginia issuers to pay interest, principal, or any
premium. The
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following information constitutes only a brief summary of certain of these
developments and does not purport to be a complete description of them. The
information has been obtained from recent official statements prepared by the
Commonwealth of Virginia relating to its securities, and no independent
investigation has been undertaken to verify its accuracy. Moreover, the
information relates only to the state itself and not to the numerous special
purpose or local government units whose issues may also be held by the Fund. The
credits represented by such issues may be affected by a wide variety of local
factors or structuring concerns, and no disclosure is made here relating to such
matters.
The rate of economic growth in the Commonwealth of Virginia has increased
steadily over the past decade. Per capita income in Virginia has been
consistently above national levels during that time. The services sector in
Virginia generates the largest number of jobs, followed by wholesale and retail
trade, state and local government, and manufacturing.
Because of Northern Virginia, with its proximity to Washington, D.C., and
Hampton Roads, which has one of the nation's largest concentration of military
installations, the federal government has a greater economic impact on Virginia
relative to its size than all states except Alaska and Hawaii.
According to statistics published by the U.S. Department of Labor, Virginia
typically has one of the lowest unemployment rates in the nation. This is
generally attributed to the balance among the various sectors represented in the
economy. Virginia is one of twenty-one states with a right-to-work law and is
generally regarded as having a favorable business climate marked by few strikes
or other work stoppages. Virginia is also one of the least unionized among the
industrialized states.
Virginia's state government operates on a two-year budget, The Constitution
vests the ultimate responsibility and authority for levying taxes and
appropriating revenue in the General Assembly, but the Governor has broad
authority to manage the budgetary process. Once an appropriation act becomes
law, revenue collections and expenditures are constantly monitored by the
Governor, assisted by the Secretary of Finance and the Department of Planning
and Budget, to ensure that a balanced budget is maintained. If projected revenue
collections fall below amounts appropriated at any time, the Governor must
reduce expenditures and withhold allotments of appropriations (other than for
debt service and other specified purposes) to restore balance. Virginia law
provides that up to 15 percent of a general fund appropriation to an agency may
be withheld, if required. An amendment to the Constitution, effective January 1,
1993, established a Revenue Stabilization Fund. This Fund is used to offset a
portion of anticipated shortfalls in revenues in years when appropriations based
on previous forecasts exceed expected revenues in subsequent forecasts. The
Revenue Stabilization Fund consists of an amount not to exceed 10 percent of
Virginia's average annual tax revenues derived from taxes on income and retail
sales for the three preceding fiscal years.
General Fund revenues are principally composed of direct taxes. In recent
fiscal years most of the total tax revenues have been derived from five major
taxes imposed by Virginia on individual and fiduciary income, sales and use,
corporate income, public service corporations and premiums of insurance
companies. Historically, balances in the General Fund have decreased in some
years, for example in fiscal years 1995, 2001, 2002 and 2003, and have increased
at varying rates in other years, such as fiscal years 1996, 1997, 1998, 1999,
2000 and 2004. In fiscal year 2005, the General Fund revenues and other sources
were more than expenditures and other uses by $755.8 million, resulting in a
68.1 percent increase in the General Fund balance over fiscal year 2004. Overall
revenue increased by 17.3 percent and non-tax revenues increased by 13.7
percent. Overall expenditures rose by 14 percent in fiscal year 2005, compared
to a 2.5 percent increase in fiscal year 2004. The fiscal year 2004 amounts are
unaudited.
In September 1991, the Debt Capacity Advisory Committee was created by the
Governor through an executive order. The Committee is charged with annually
estimating the amount of tax-supported debt that may prudently be authorized,
consistent with the financial goals, capital needs and policies of Virginia. The
Committee annually reviews the outstanding debt of all agencies, institutions,
boards and authorities of Virginia for which Virginia has either a direct or
indirect pledge of tax revenues or moral obligation. The Committee provides its
recommendations on the prudent use of such obligations to the Governor and the
General Assembly.
The Constitution of Virginia prohibits the creation of debt by or on behalf
of Virginia that is backed by Virginia's full faith and credit, except as
provided in Section 9 of Article X. Section 9 of Article X contains several
different provisions for the issuance of general obligation and other debt, and
Virginia is well within its limit for each:
Section 9(a) provides that the General Assembly may incur general
obligation debt to meet certain types of emergencies; subject to limitations on
amount and duration, to meet casual deficits in the revenue or in anticipation
of the collection of revenues of Virginia; and to redeem a previous debt
obligation of Virginia. Total indebtedness issued pursuant to Section 9(a)(2)
may not exceed 30 percent
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of an amount equal to 1.15 times the annual tax revenues derived from taxes on
income and retail sales, as certified by the Auditor of Public Accounts for the
preceding fiscal year.
Section 9(b) provides that the General Assembly may authorize the creation
of general obligation debt for capital projects. Such debt is required to be
authorized by an affirmative vote of a majority of each house of the General
Assembly and approved in a statewide referendum. The outstanding amount of such
debt is limited in the aggregate to an amount equal to 1.15 times the average
annual tax revenues derived from taxes on income and retail sales, as certified
by the Auditor of Public Accounts for the three immediately preceding fiscal
years less the total amount of bonds outstanding. The amount of 9(b) debt that
may be authorized in any single fiscal year is limited to 25 percent of the
limit on all 9(b) debt less the amount of 9(b) debt authorized in the current
and prior three fiscal years.
Section 9(c) provides that the General Assembly may authorize the creation
of general obligation debt for revenue producing capital projects (so-called
"double-barrel" debt) for executive branch agencies and institutions of higher
learning. Such debt is required to be authorized by an affirmative vote of two-
thirds of each house of the General Assembly and approved by the Governor. The
Governor must certify before the enactment of the authorizing legislation and
again before the issuance of the debt that the net revenues pledged are expected
to be sufficient to pay principal of and interest on the debt. The outstanding
amount of 9(c) debt is limited to an amount equal to 1.15 times the avenge
annual tax revenues derived from taxes on income and retail sales, as certified
by the Auditor of Public Accounts for the three preceding fiscal years. While
the debt limits under Sections 9(b) and 9(c) are each calculated as the same
percentage of the same average tax revenues, these debt limits are separately
computed and apply separately to each type of debt.
Section 9(d) provides that the restrictions of Section 9 are not applicable
to any obligation incurred by Virginia or any of its institutions, agencies or
authorities if the full faith and credit of Virginia is not pledged or committed
to the payment of such obligation. There are currently outstanding various types
of such 9(d) revenue bonds. Certain of these bonds, however, are paid in part or
in whole from revenues received as appropriations by the General Assembly from
general tax revenues, while others are paid solely from revenues of the
applicable project. The repayment of debt issued by the Virginia Public Building
Authority, the Virginia College Building Authority 21st Century College and
Equipment Program, The Innovative Technology Authority and the Virginia
Biotechnology Research Park Authority is supported in large part by General Fund
appropriations.
The Commonwealth Transportation Board has issued various series of bonds
authorized under the State Revenue Bond Act. These bonds are secured by and are
payable from funds appropriated by the General Assembly from the Transportation
Trust Fund for such purpose. The Transportation Trust Fund was established by
the General Assembly in 1986 as a special non-reverting fund administered and
allocated by the Transportation Board to provide increased funding for
construction, capital and other needs of state highways, airports, mass
transportation and ports. The Virginia Port Authority has also issued bonds that
are secured by a portion of the Transportation Trust Fund.
Virginia is involved in numerous leases that are subject to appropriation
of funding by the General Assembly. Virginia also finances the acquisition of
certain personal property and equipment through installment purchase agreements.
Bonds issued by the Virginia Housing Development Authority, the Virginia
Resources Authority and the Virginia Public School Authority are designed to be
self-supporting from their individual loan programs. A portion of the Virginia
Housing Development Authority bonds, Virginia Public School Authority bonds, and
Virginia Resources Authority bonds are secured in part by a moral obligation
pledge of Virginia. Should the need arise, Virginia may consider finding
deficiencies in the respective debt service reserves for such moral obligation
debt but the General Assembly is not legally required to make any appropriation
for such purpose. To date, none of these authorities has advised Virginia that
any such deficiencies exist.
As of June 30, 2005, local government in Virginia was comprised of 95
counties, 39 incorporated cities, and 190 incorporated towns. Virginia is unique
among the several states in that cities and counties are independent, and their
land areas do not overlap. The largest expenditures by local governments in
Virginia are for education, but local governments also provide other services
such as water and sewer, police and fire protection and recreational facilities.
The Virginia Constitution imposes numerous restrictions on local indebtedness,
affecting both its incurrence and amount.
Most recently, Moody's Investor's Service has rated the long-term general
obligation bonds of Virginia Aa1, and Standard & Poor's has rated such bonds
AA+, and Fitch Ratings has rated such bonds AA+. There can be no assurance that
the economic conditions on which these ratings are based will continue or that
particular bond issues may not be adversely affected by changes in economic or
political conditions. See the Appendix to this SAI.
65
On December 17, 2003, Governor Warner presented the 2004 Budget Bill for
the 2004-2006 biennium. The 2004 Budget Bill included a number of actions to
balance a shortfall of $1.9 billion over the biennium between projected
resources and spending requirements. The House and Senate were unable to reach
agreement on the 2004-2006 biennial budget. The Governor called a special
session of the 2004 General Assembly and on May 7, 2004, the General Assembly
passed a compromise budget for the 2004-2006 biennial. Tax returns adopted by
the General Assembly as part of the compromised budget are projected to generate
additional revenues of $616.3 million in fiscal year 2005 and $775.6 million in
fiscal year 2006.
SPECIAL CONSIDERATIONS REGARDING INVESTMENT IN WEST VIRGINIA AND/OR SPECIAL
FACTORS AFFECTING THE WEST VIRGINIA FUND
Being invested primarily in West Virginia Municipal Securities, the West
Virginia Municipal Bond Fund is subject to the risks of West Virginia's economy
and of the financial condition of its state and local governments and their
agencies.
West Virginia's economy is relatively stable and continues to see some
improvement, but there is little growth and significant challenges lie ahead. It
is rooted in old economy industries which are undergoing significant
consolidation and change. Coal mining, chemicals and manufacturing make up an
important part of the economy. While an increase in coal prices has caused an
increase in coal mining activity, the coal industry continues to be under
increased scrutiny and the use of coal faces future regulatory requirements,
which may affect the economic feasibility of conducting mining operations in the
future. The State continues to lose jobs in manufacturing, with several losses
in glass products, chemicals and steel. There has been job growth in the service
industries, with the fastest growth being in leisure and hospitality and
healthcare. State and local governments continue to make concentrated efforts to
encourage diversification of the State's economy with some success; and there
has been legislation adopted with regards to some tort reform and the
privatization of the workers' compensation system to engender a more favorable
view of the State in the business community. In August 2005, West Virginia's
seasonally adjusted unemployment rate was 5.5 percent compared to the national
rate of 4.9 percent.
In recent years, the State and most local governments have had adequate
financial resources but not without struggling to keep expenses in line with
revenues. While the State had a significant surplus at the end of its most
recent fiscal year, which ended June 30, 2005, the State continues to face
significant future financial challenges, including substantial unfunded pension
and workers' compensation liabilities. With minimal population growth,
population shifting away from the State's cities, the continuing decline in
school enrollment, and an aging population, local governments and school boards
continue to struggle to fund operations and support public education.
DIVERSIFICATION AND CONCENTRATION
The Tax-Free Bond Funds are non-diversified funds under the 1940 Act. This
means they may concentrate their investments in the securities of a limited
number of issuers. Under the Internal Revenue Code of 1986, as amended, at the
end of each fiscal quarter each Tax-Free Bond Fund must nevertheless diversify
its portfolio such that, with respect to 50% of its total assets, not more than
25% of its total assets is invested in the securities of any one issuer (other
than U.S. Government Securities or securities of other regulated investment
companies), and with respect to the remainder of its total assets, no more than
5% of its assets is invested in the securities of any one issuer (other than
U.S. Government Securities or securities of other regulated investment
companies). Because of the relatively small number of issuers of Kentucky
Tax-Exempt Obligations, Maryland Tax-Exempt Obligations, North Carolina
Tax-Exempt Obligations, South Carolina Tax-Exempt Obligations, Virginia
Tax-Exempt Obligations, and West Virginia Tax-Exempt Obligations, the Kentucky
Fund, the Maryland Fund, the North Carolina Fund, the South Carolina Fund, the
Virginia Fund, and the West Virginia Fund are more likely to invest a higher
percentage of their assets in the securities of a single issuer than is an
investment company that invests in a broad range of tax-exempt securities. This
concentration involves an increased risk of loss to a Tax-Free Bond Fund if the
issuer is unable to make interest or principal payments or if the value of such
securities declines, and consequently may cause greater fluctuation in the net
asset value of the Tax-Free Bond Fund's Shares.
ADDITIONAL INFORMATION
The foregoing is only a summary of some of the important federal tax
considerations generally affecting purchasers of Shares of each Fund. This
summary is based on tax laws and regulations which are in effect on the date of
this Statement of Additional Information; such laws and regulations may be
changed by legislative or administrative action, and such changes may be
retroactive.
No attempt is made to present a detailed explanation of the federal income tax
treatment of each Fund or its Shareholders, and this discussion is not intended
as a substitute for careful tax planning. Accordingly, potential purchasers of
Shares of a Fund are urged to
66
consult their tax advisers with specific reference to their own tax situation,
including the potential application of foreign, state and local taxes.
MANAGEMENT OF BB&T FUNDS
The Trustees and officers of the Funds, their ages, the position they hold with
the Funds, their term of office and length of time served, a description of
their principal occupations during the past five years, the number of portfolios
in the fund complex that the Trustee oversees and any other directorships held
by the Trustee are listed in the two tables immediately following. The business
address of the persons listed below is 3435 Stelzer Road, Columbus, Ohio
43219-3035.
67
INDEPENDENT TRUSTEES
(1) (2) (3) (4) (5) (6)
NUMBER OF
PORTFOLIOS
TERM OF IN FUND
POSITION(S) OFFICE AND COMPLEX OTHER
HELD WITH LENGTH OF PRINCIPAL OCCUPATION OVERSEEN DIRECTORSHIPS
NAME, ADDRESS AND AGE THE FUNDS TIME SERVED DURING THE LAST 5 YEARS BY TRUSTEE HELD BY TRUSTEE
--------------------- ------------ --------------- ----------------------------------- ---------- -----------------
Thomas W. Lambeth Trustee Indefinite, From January 2001 to present, 31 None
700 Yorkshire Road Chairman of 8/92 - Present Senior Fellow, Z. Smith Reynolds
Winston-Salem, NC 27106 the Board of Foundation; from 1978 to January
Birthdate: 01/08/35 Trustees 2001, Executive Director, Z. Smith
Reynolds Foundation.
Drew T. Kagan Trustee Indefinite, From December 2003 to present, 31 None
Montecito Advisors, Inc. 8/00 - Present President and Director, Montecito
810 N. Jefferson St., Advisors, Inc.; from March 1996 to
Ste 101. December 2003, President,
Lewisburg, WV 24901 Investment Affiliate, Inc.; March
Birthdate: 02/21/48 1992 to March 1996, President,
Provident Securities & Investment
Co.
Laura C. Bingham Trustee Indefinite, From July 1998 to present, 31 None
Peace College 2/01 - Present President of Peace College.
Office of the President
15 East Peace Street
Raleigh, NC 27604-1194
Birthdate: 11/09/56
Douglas R. Van Scoy Trustee Indefinite Retired; From November 1974 to July 31 None
841 Middle St 5/04 - present 2001, employee of Smith Barney
Sullivans Island, SC 26481 (investment banking), most recently
Birthdate: 11/09/43 as the Director of Private Client
Group and Senior Executive Vice
President
James L. Roberts Trustee Indefinite Retired; From January 1999 to 31 None
P.O. Box 4165 11/04 - present December 2003, President, CEO and
Breckenridge, CO 80424 Director, Covest Bancshares, Inc.
Birthdate: 11/23/42
68
INTERESTED TRUSTEES
(1) (2) (3) (4) (5) (6)
NUMBER OF
PORTFOLIOS
TERM OF IN FUND
POSITION(S) OFFICE AND COMPLEX OTHER
HELD WITH LENGTH OF PRINCIPAL OCCUPATION OVERSEEN DIRECTORSHIPS
NAME, ADDRESS AND AGE THE FUNDS TIME SERVED DURING THE LAST 5 YEARS BY TRUSTEE HELD BY TRUSTEE
--------------------- ------------ --------------- ----------------------------------- ---------- -----------------
*Kenneth L. Miller, Jr. Trustee Indefinite, From August 1997 to present, 31 Chairman of Board
200 W. Second Street, 11/02 - Present Executive Vice President, Branch of BB&T Asset
16th Floor Banking and Trust Company; employee Management, Inc.
Winston-Salem, NC 27101 of Branch Banking and Trust Company
Birthdate: 09/19/46 since 1982
----------
* Mr. Miller is treated by the Funds as an "interested person" (as defined in
Section 2(a)(19) of the 1940 Act) of the Funds. Mr. Miller is an
"interested person" because he owns shares of BB&T Corporation and is an
Executive Vice President of Branch Banking and Trust Company, the parent of
the Adviser.
The Trustees receive fees and are reimbursed for expenses in connection
with each meeting of the Board of Trustees they attend. However, no officer or
employee of BB&T Funds Distributors, Inc., BISYS Fund Services Ohio, Inc. or
Branch Banking and Trust Company, except the Chief Compliance Officer, receives
any compensation from BB&T Funds for acting as a Trustee.
Mr. Pavlak serves as Chief Compliance Officer. Mr. Pavlak's compensation is
reviewed and approved by the Board and paid by BISYS, subject to a Compliance
Services Agreement between BISYS and the Trust ("CS Agreement"). The fee paid
pursuant to the CS Agreement by the Funds is not indicative of the total
compensation received by Mr. Pavlak.
OFFICERS
(1) (2) (3) (4) (5) (6)
NUMBER OF
PORTFOLIOS
TERM OF IN FUND OTHER
POSITION(S) OFFICE AND COMPLEX DIRECTORSHIPS
HELD WITH LENGTH OF PRINCIPAL OCCUPATION OVERSEEN HELD BY
NAME, ADDRESS AND AGE THE FUNDS TIME SERVED DURING THE LAST 5 YEARS BY TRUSTEE TRUSTEE
--------------------- -------------- --------------- ----------------------------------- ---------- -------------
Keith F. Karlawish President Indefinite, From May 2002 to present, N/A N/A
Birthdate: 08/22/64 2/05 - Present President, BB&T Asset Management,
Inc.; from 1996 to 2002, Senior
Vice President and Director of
Fixed Income, BB&T Asset
Management, Inc.
James T. Gillespie Vice President Indefinite, From February 2005 to present, Vice N/A N/A
Birthdate: 11/12/66 5/02 - Present President and Manager of Mutual
Fund Administration, BB&T Asset
Management, Inc., From February
1992 to 2005, employee of BISYS
Fund Services
E.G. Purcell, III Vice President Indefinite, From 1995 to present, Senior Vice N/A N/A
Birthdate: 01/01/55 11/00 - Present President, BB&T Asset Management,
Inc. and its predecessors
Todd M. Miller Vice President Indefinite, From June 2005 to present, Mutual N/A N/A
Birthdate: 9/18/71 8/05 - Present Fund Administrator, BB&T Asset
Management; from May 2001 to May
2005, Manager, BISYS Fund Services
C. David Bunstine Secretary Indefinite, From December 1987 to present, Vice N/A N/A
Birthdate: 7/30/65 5/05 - Present President, BISYS Fund Services
Troy A. Sheets Treasurer Indefinite, From April 2002 to present, N/A N/A
Birthdate:05/29/71 5/02 - Present employee of BISYS Fund Services;
from September 1993 to April 2002,
employee of KPMG LLP
69
(5)
NUMBER OF
(3) PORTFOLIOS (6)
(2) TERM OF IN FUND OTHER
POSITION(S) OFFICE AND (4) COMPLEX DIRECTORSHIPS
(1) HELD WITH LENGTH OF PRINCIPAL OCCUPATION(S) OVERSEEN HELD BY
NAME, ADDRESS AND AGE THE FUNDS TIME SERVED DURING THE LAST 5 YEARS BY TRUSTEE TRUSTEE
--------------------- -------------- --------------- ----------------------------------- ---------- -------------
Frank Pavlak Vice President Indefinite, From May 2004 to September 2004, N/A N/A
Birthdate: 3/23/47 Chief 9/04 - Present Senior Vice President, BISYS Fund
Compliance Services From January 1999 to April
Officer and 2004, Vice President, Oppenheimer
AML Compliance Funds Inc.
Officer
Alaina V.Metz Assistant Indefinite, From June 1995 to present, N/A N/A
Birthdate: 04/07/67 Secretary 9/95 - Present employee, BISYS Fund Services
Chris Sabato Assistant Indefinite From February 1993 to present, N/A N/A
Birthdate: 12/15/68 Treasurer 11/02 - Present employee of BISYS Fund Services
For interested Trustees and officers, positions held with affiliated persons or
principal underwriters of the Trust are listed in the following table:
POSITIONS HELD WITH AFFILIATED PERSONS OR PRINCIPAL
NAME UNDERWRITERS OF THE FUNDS
---- ---------------------------------------------------------------
Keith F. Karlawish BB&T Asset Management, Inc., President
Kenneth L. Miller BB&T Corporation, Executive Vice President
BB&T Asset Management, Inc., Chairman of the Board of Directors
James T. Gillespie BB&T Asset Management, Inc., Vice President
Troy A. Sheets BISYS Fund Services, Vice President
Alaina V. Metz BISYS Fund Services, Vice President
Chris Sabato BISYS Fund Services, Director
E.G. Purcell, III BB&T Asset Management, Inc., Senior Vice President
Frank Pavlak BISYS Fund Services, Chief Compliance Officer
C. David Bunstine BISYS Fund Services, Vice President
Todd Miller BB&T Asset Management, Inc., Mutual Funds Administrator
The officers of BB&T Funds receive no compensation directly from BB&T Funds for
performing the duties of their offices. BB&T Asset Management, Inc. receives
fees from BB&T Funds for acting as Administrator and BISYS Fund Services Ohio,
Inc. receives fees from BB&T Funds for acting as Transfer Agent and for
providing fund accounting services to BB&T Funds. In addition, BISYS Fund
Services Ohio, Inc. receives fees from the Administrator for acting as
Sub-Administrator.
COMMITTEES OF THE BOARD OF TRUSTEES
AUDIT COMMITTEE
The purposes of the Audit Committee are to oversee the Trust's accounting and
financial reporting policies and practices; to oversee the quality and
objectivity of the Trust's financial statements and the independent audit
thereof; to consider the selection of independent public accountants for the
Trust and the scope of the audit; and to act as a liaison between the Trust's
independent public accounting firm and the full Board of Trustees. Messrs.
Kagan, Lambeth, Roberts, and Van Scoy, and Ms. Bingham serve on this Committee;
Mr. Kagan serves as chair of the committee. For the fiscal year ended September
30, 2005, there were three (3) meetings of the Audit Committee.
NOMINATING COMMITTEE
The purpose of the Nominating Committee is to recommend qualified candidates to
the Board in the event that a position is vacated or created. Messrs. Kagan,
Lambeth, Roberts, and Van Scoy and Ms. Bingham serve on this committee; Mr.
Lambeth serves as chair of the committee. The Committee will consider nominees
recommended by shareholders. Recommendations should be submitted to the
Nominations Committee in care of BB&T Funds. For the fiscal year ended September
30, 2005, the Nominations Committee did not meet.
70
SECURITIES OWNERSHIP
For each Trustee, the following table discloses the dollar range of equity
securities beneficially owned by the Trustee in the Fund and, on an aggregate
basis, in any registered investment companies overseen by the Trustee within the
Fund's family of investment companies as of December 31, 2005:
AGGREGATE DOLLAR RANGE OF EQUITY
SECURITIES IN ALL REGISTERED
INVESTMENT COMPANIES OVERSEEN BY
DOLLAR RANGE OF EQUITY TRUSTEE IN THE FAMILY OF INVESTMENT
NAME OF TRUSTEE FUND NAME SECURITIES IN THE FUND COMPANIES
------------------ ---------------------------- ---------------------- -----------------------------------
Thomas W. Lambeth Mid Cap Growth Fund $1-$10,000 $1-$10,000
Robert W. Stewart* South Carolina Tax-Free Fund >$100,000
Equity Index Fund $10,001-$50,000
Mid Cap Growth Fund $10,001-$50,000 >$100,000
Special Opportunities Fund $10,001-$50,000
Conservative Growth Fund $10,001-$50,000
Drew T. Kagan Large Cap Value Fund $10,001-$50,000 >$100,000
West Virginia Fund >$100,000
Laura C. Bingham North Carolina Tax-Free Fund $10,001-$50,000
Special Opportunities Fund $10,001-$50,000 $10,001-$50,000
Kenneth L. Miller Large Company Value Fund >$100,000
Small Company Growth Fund $10,001-$50,000 >$100,000
Mid Cap Growth Fund $50,001-$100,000
International Equity Fund $10,001-$50,000
James L. Roberts Total Return Bond Fund $10,001-$50,000 >$100,000
Intermediate U.S. Government $50,001-$100,000
Bond Fund
Small Cap Fund $10,001-$50,000
Douglas Van Scoy Large Cap Growth Fund $50,001-$100,000 >$100,000
Large Cap Value Fund $50,001-$100,000
----------
* Figures are for the calendar year ended December 31, 2004. Mr. Stewart
retired as a trustee of the BB&T Funds on May 21, 2005.
As of January 2, 2006, the Officers and Trustees owned less than 1% of any class
of any Fund.
TRUSTEES COMPENSATION
AGGREGATE TOTAL COMPENSATION
COMPENSATION FROM FROM FUNDS AND FUND
THE COMPLEX PAID TO
FUNDS FOR THE FISCAL PENSION OR RETIREMENT ESTIMATED ANNUAL TRUSTEES FOR THE
NAME OF PERSON, YEAR ENDING BENEFITS ACCRUED AS PART BENEFITS UPON FISCAL YEAR ENDING
POSITION SEPTEMBER 30, 2005 OF FUND EXPENSES RETIREMENT SEPTEMBER 30, 2005
------------------- -------------------- ------------------------ ---------------- -------------------
Thomas W. Lambeth $30,000.00 None None $30,000.00
Robert W. Stewart* $23,000.00 None None $23,000.00
Drew T. Kagan $36,000.00 None None $36,000.00
Laura C. Bingham $30,000.00 None None $30,000.00
Douglas R. Van Scoy $30,000.00 None None $30,000.00
James L. Roberts $29,000.00 None None $29,000.00
Kenneth L. Miller None None None None
----------
* Mr. Stewart retired as a trustee of the BB&T Funds on May 21, 2005.
71
CODE OF ETHICS
BB&T Funds, BB&T Asset Management, Inc., UBS Global Asset Management
(Americas) Inc., Federated Investment Management Company, Scott & Stringfellow,
Inc., Sterling Capital Management LLC., and BB&T Funds Distributor, Inc. have
each adopted a code of ethics ("Codes") pursuant to Rule 17j-1 of the 1940 Act,
and these Codes permit personnel covered by the Codes to invest in securities,
including securities that may be purchased or held by each Fund, subject to
certain restrictions.
INVESTMENT ADVISER
Investment advisory and management services are provided to each Fund of
BB&T Funds by BB&T Asset Management pursuant to an Investment Advisory Agreement
("Advisory Agreement") dated as of February 1, 2001.
Under the Advisory Agreement between BB&T Funds and BB&T Asset Management,
the fee payable to BB&T Asset Management by each Fund, for investment advisory
services is the lesser of: (a) a fee computed daily and paid monthly at the
annual rate of forty one hundredths of one percent (0.40%) of each of the Money
Market Fund's average daily net assets; sixty one-hundredths of one percent
(0.60%) of each of the Bond Funds' (except the West Virginia Fund) average daily
net assets; forty-five one-hundredths of one percent (0.45%) of the West
Virginia Fund's average daily net assets; and seventy-four one-hundredths of one
percent (0.74%) of the Large Cap Growth Fund's and the Large Cap Value Fund's
average daily net assets; one percent (1.00%) of the Small Cap, Small Company
Growth, and International Equity Funds' average daily net assets; seventy-four
one-hundredths of one percent (0.74%) of the Mid Cap Growth Fund's average daily
net assets; seventy-four one-hundredths of one percent (0.74%) of the Mid Cap
Value Fund's average daily net assets; seventy one-hundredths of one percent
(0.70%) of the Equity Income Fund's average daily net assets; eighty
one-hundredths of one percent (0.80%) of the Special Opportunities Fund; and
twenty-five one-hundredths of one percent (0.25%) of each Funds of Funds'
average daily net assets; or (b) such fee as may from time to time be agreed
upon in writing by BB&T Funds and BB&T Asset Management. A fee agreed to in
writing from time to time by BB&T Funds and BB&T Asset Management may be
significantly lower than the fee calculated at the annual rate and the effect of
such lower fee would be to lower a Fund's expenses and increase the net income
of the fund during the period when such lower fee is in effect.
The Advisory Agreement provides that BB&T Asset Management shall not be
liable for any error of judgment or mistake of law or for any loss suffered by
BB&T Funds in connection with the performance of such Advisory Agreement, except
a loss resulting from a breach of fiduciary duty with respect to the receipt of
compensation for services or a loss resulting from willful misfeasance, bad
faith, or gross negligence on the part of BB&T Asset Management in the
performance of its duties, or from reckless disregard by BB&T Asset Management
of its duties and obligations thereunder.
Unless sooner terminated, the Advisory Agreement will continue in effect
until September 30, 2006 as to each of the Funds and from year to year if such
continuance is approved at least annually by BB&T Funds' Board of Trustees or by
vote of the holders of a majority of the outstanding Shares of that Fund (as
defined under "GENERAL INFORMATION - Miscellaneous"). The Advisory Agreement is
terminable as to a particular Fund at any time upon 60 days written notice
without penalty by the Trustees, by vote of the holders of a majority of the
outstanding Shares of that Fund, or by BB&T Asset Management. The Advisory
Agreement also terminates automatically in the event of any assignment, as
defined in the 1940 Act.
For the fiscal years ended September 30, 2005, September 30, 2004, and
September 30, 2003, the Adviser received the following investment advisory fees:
INVESTMENT ADVISOR FEES PAID/WAIVED FOR THE YEAR ENDED SEPTEMBER 30, 2005
SEPTEMBER 30, 2005 SEPTEMBER 30, 2004 SEPTEMBER 30, 2003
--------------------- --------------------- --------------------
PAID WAIVED PAID WAIVED PAID WAIVED
--------- --------- --------- --------- --------- --------
Large Cap Value Fund ........ 4,611,048 481,749 4,083,335 576,267 2,605,176 607,870
Large Cap Growth Fund ....... 2,521,240 263,412 2,272,575 320,811 1,352,096 315,487
Mid Cap Value Fund .......... 1,413,636 147,693 1,184,356 167,725 726,083 183,226
Mid Cap Growth Fund ......... 879,120 91,848 806,147 115,682 505,776 144,317
Small Cap Fund .............. 522,953 130,739 491,835 80,664 132,171 --
Small Company Growth Fund ... 757,192 133,622 1,085,723 105,016 1,215,502 --
International Equity Fund ... 2,160,364 240,039 2,096,626 175,993 671,715 23,118
Special Opportunities
Equity Fund .............. 1,218,109 -- 430,781 93,561 -- 86,576
72
Equity Income Fund .......... 286,376 112,886 27,002 20,252 -- --
Short U.S. Government Fund .. 855,305 285,102 972,217 277,956 950,862 190,169
Intermediate U.S. ...........
Government Fund .......... 2,995,689 599,132 2,594,343 518,815 2,042,063 408,407
Total Return
Bond Fund ................ 1,743,096 348,616 1,294,243 258,823 922,532 199,479
Kentucky Intermediate
Tax-Free Fund ............... 59,486 45,268 34,914 65,908 205 42,855
Maryland Intermediate
Tax-Free Fund* .............. 19,983 45,972 -- 45,175 -- 15,554
North Carolina Intermediate
Tax-Free Fund ............... 513,242 171,078 570,463 162,887 599,306 119,860
South Carolina Intermediate
Tax-Free Fund ............... 90,995 32,482 101,991 33,997 102,029 36,702
Virginia Intermediate
Tax-Free Fund ............... 362,051 120,684 384,493 109,661 418,139 83,080
West Virginia Intermediate
Tax-Free Fund ............... 323,029 -- 358,251 -- 374,126 19,980
Prime Money Market
Fund ..................... 2,917,382 1,060,743 3,121,650 1,040,444 3,180,236 839,381
U.S. Treasury Money
Market Fund .............. 2,546,773 1,091,482 3,321,997 1,307,050 3,322,073 976,447
Capital Manager Conservative
Growth Fund .............. 40,627 164,632 111,112 74,068 49,637 33,090
Capital Manager
Moderate Growth Fund ..... 39,496 173,119 94,430 62,949 53,144 35,430
Capital Manager
Growth Fund .............. 21,618 138,327 56,469 59,675 44,652 29,767
Capital Manager
Equity Fund .............. 3,302 85,363 16,839 47,688 24,752 16,500
----------
* The Investment Advisor reimbursed the Fund $3,476 and $9,184, in 2004 and
2003, respectively.
For the fiscal year ended September 30, 2003, the Former OVB Funds paid the
following advisory fees:
FEES PAID (000) FEES WAIVED (000)
--------------- -----------------
FUND 9/2003 9/2003
---- ------ ------
Mid Cap Value Fund $726 $183
Mid Cap Growth Fund $506 $144
West Virginia Intermediate Tax-Free Fund $374 $ 20
Branch Banking and Trust Company ("BB&T") reorganized its investment
advisory division as BB&T Asset Management, Inc., a separate, wholly owned
subsidiary of BB&T Corporation, a financial holding company and parent of BB&T.
BB&T Asset Management has replaced BB&T as the investment adviser to BB&T Funds.
Management and investment advisory personnel of BB&T that provided investment
management services to BB&T Funds now do so as the personnel of BB&T Asset
Management.
The Funds bear all cost of their organization and operation, including but
not limited to expenses of preparing, printing and mailing all shareholders'
reports, notices, prospectuses, proxy statements and reports to regulatory
agencies; expenses relating to the issuance, registration and qualification of
shares; government fees; interest charges; expenses of furnishing to
shareholders their account statements; taxes; expenses of redeeming shares;
brokerage and other expenses connected with the execution of portfolio
securities transactions; expenses pursuant to the Funds' plans of distribution;
fees and expenses of custodian including those for keeping books and accounts,
maintaining a committed line of credit, and calculating the net asset value of
shares; fees and expenses of transfer agents and dividend disbursing agents;
legal, accounting, financial, management, tax and auditing fees and expenses of
the Funds (including and allocable portion of the cost of the Adviser's
employees rendering such services to the Funds); the compensation and expenses
of Trustees who are not otherwise affiliated with the Trust, the Adviser or any
of their affiliates; expenses of Trustees' and shareholders' meeting; trade
association memberships; insurance premiums; and any extraordinary expenses.
73
Pursuant to the American Institute of Certified Public Accountants (AICPA)
Statement of Position (SOP) 98-5, any Fund organizational or start-up costs
incurred on or after January 1, 1999 will be expensed as they are incurred.
The portfolio managers of each Fund are assisted in the management of their
respective Funds by one of four portfolio management teams: Fixed Income, Value
Equity, Growth Equity, and Balanced. The Fixed Income Team, consisting of Robert
F. Millikan, CFA, (Director), Carrie R. Breswitz, Brad D. Eppard, CFA, David T.
Johnson, Kevin E. McNair, CFA, Michael D. Nichols, CFA, and Justin B. Nicholson,
assists in the management of the Bond Funds and the Money Market Funds. The
Value Equity Team, consisting of Rick B. Jones, CFA (Director), Daniel J. Kane,
CFA, Robert A. Gowen, and John T. Kvantas, CFA, assists in the management of the
Large Cap Value Fund and the Small Cap Fund. The Growth Equity Team, consisting
of Jeffrey J. Schappe, CFA (Chief Investment Officer), Brandon W. Carl, David P.
Nolan, Keith L. Maher, CFA, and Michele H. Van Dyke, assists in the management
of the Large Cap Growth Fund, the Mid Cap Growth Fund, and the Small Company
Growth Fund. The Balanced Team, consisting of Jeffrey J. Schappe, CFA, (Chief
Investment Officer), Rick B. Jones, CFA, Eric L. Farls, CFA, and Robert F.
Millikan, CFA, assists in the management of the Funds of Funds.
SUB-ADVISERS
Special Opportunities Fund and Equity Income Fund. Investment sub-advisory
and management services are provided to the Special Opportunities Fund and the
Equity Income Fund by Scott & Stringfellow, Inc. ("Scott & Stringfellow"), a
wholly owned subsidiary of BB&T Corporation, pursuant to a Sub-Advisory
Agreement ("Sub-Advisory Agreement") dated as of May 16, 2003 (Schedule A dated
May 21, 2004) between BB&T Asset Management and Scott & Stringfellow.
For its services and expenses incurred under the Sub-Advisory Agreement,
Scott & Stringfellow is entitled to a fee, payable by BB&T Asset Management. The
fee is computed daily and paid monthly at the annual rates of 0.48% and 0.42% of
the average daily net assets of the Special Opportunities Fund and the Equity
Income Fund, respectively. For the fiscal years ended September 30, 2005, 2004
and 2003, BB&T paid Scott & Stringfellow $613,857, $264,243 and $43,455,
respectively, for sub-advisory services to the Special Opportunities Equity
Fund. For the fiscal years ended September 30, 2005 and 2004, BB&T paid Scott &
Stringfellow $199,875 and $23,766, respectively, for sub-advisory services to
the Equity Income Fund.
Unless sooner terminated, the Sub-Advisory Agreement will continue in
effect until October 31, 2006 and thereafter will continue from year to year if
such continuance is approved at least annually by BB&T Funds' Board of Trustees
or by vote of the holders of a majority of the outstanding Shares of the Fund
(as defined under "GENERAL INFORMATION - Miscellaneous"). The Sub-Advisory
Agreement is terminable at any time without penalty, on 60 days' written notice
by the Trustees, by vote of the holders of a majority of the outstanding Shares
of the Fund, by Scott & Stringfellow, or by BB&T Asset Management. The
Sub-Advisory Agreement also terminates automatically in the event of any
assignment, as defined in the 1940 Act. Sub-advisory fees payable to Scott &
Stringfellow are borne exclusively by BB&T Asset Management as Adviser to the
Special Opportunities Fund and the Equity Income Fund.
International Equity Fund. Investment sub-advisory and management services
are provided to the International Equity Fund by UBS Global Asset Management
(Americas) Inc. ("UBS Global AM") pursuant to an investment sub-advisory
agreement with BB&T Asset Management (the "Sub-Advisory Agreement") between BB&T
Asset Management and UBS Global AM.
For its services and expenses incurred under the Sub-Advisory Agreement,
UBS Global AM is entitled to a fee payable by BB&T Asset Management. The fee is
computed daily and paid monthly at the following annual rates (as a percentage
of the International Equity Fund's average daily net assets):
On the first $50 million 0.48%
On the next $50 million 0.42%
Over $100 million 0.38%
For the fiscal years ended September 30, 2005, 2004 and 2003, BB&T paid UBS
Global AM $968,540, $770,647 and $343,065, respectively, for sub-advisory
services to the International Equity Fund.
UBS Global AM, located at One North Wacker Drive, Chicago, IL 60606, began
managing institutional assets in 1974 through its predecessor entities,
including Brinson Partners, Inc. and First Chicago Investment Advisors. Swiss
Bank Corporation ("SBC") acquired the firm in 1995. In 1998, SBC merged with
Union Bank of Switzerland to form UBS AG. UBS Global AM is a member of the UBS
Global Asset Management business group (the "Group") of UBS AG. As of September
30, 2005, UBS Global AM had approximately $66.8 billion in assets under
management and the Group had approximately $568.9 billion in assets under
management.
74
Prior to April 28, 2003, investment sub-advisory and management services
were provided to the International Equity Fund by BlackRock International
Limited, an indirect majority-owned subsidiary of PNC Financial Services Group,
Inc., pursuant to a sub-advisory agreement dated as of February 1, 2001 between
BB&T Asset Management and BlackRock International. For the fiscal year ended
September 30, 2003, BB&T Asset Management paid BlackRock International $490,935
for sub-advisory services to the International Equity Fund.
Prime Money Market Fund. Investment sub-advisory and management services
are provided to the Prime Money Market Fund by Federated Investment Management
Company ("FIMC"), a wholly-owned subsidiary of FII Holdings, Inc., pursuant to a
Sub-Advisory Agreement ("Sub-Advisory Agreement") dated as of February 1, 2001,
between BB&T Asset Management and FIMC.
For its services and expenses incurred under the Sub-Advisory Agreement,
FIMC is entitled to a fee, payable by BB&T Asset Management. The fee is computed
and paid monthly at the annual rate of seven one-hundredths of one percent
(0.07%) of the Prime Money Market Fund's average daily net assets, subject to a
minimum of $250,000 per year, or such lower fee as may be agreed upon in writing
by BB&T Asset Management and FIMC.
The Sub-Advisory Agreement will continue from year to year if such
continuance is approved at least annually by BB&T Funds' Board of Trustees or by
vote of the holders of a majority of the outstanding Shares of the Fund (as
defined under "GENERAL INFORMATION - Miscellaneous"). The Sub-Advisory Agreement
is terminable at any time without penalty, by the Trustees, by vote of the
holders of a majority of the outstanding Shares of the Fund, or on 60 days'
written notice by FIMC or by BB&T Asset Management. The Sub-Advisory Agreement
also terminates automatically in the event of any assignment, as defined in the
1940 Act. For the fiscal years ended September 30, 2005, 2004, and 2003, BB&T
Asset Management paid FIMC $828,966, $781,878, and 910,165, respectively, for
sub-advisory services to the Prime Money Market Fund.
BB&T Mid Cap Value Fund and Total Return Bond Fund (formerly the
"Intermediate Corporate Bond Fund"). Investment sub-advisory and management
services are provided to the BB&T Mid Cap Value Fund and the Total Return Bond
Fund by Sterling Capital Management LLC ("Sterling Capital"), an affiliate of
BB&T Asset Management, pursuant to a Sub-Advisory Agreement ("Sub-Advisory
Agreement") dated as of July 18, 2005, between BB&T Asset Management and
Sterling Capital.
In consideration for the services provided and expenses assumed under the
Sterling Capital Investment Sub-Advisory Agreement, BB&T Asset Management has
agreed to pay Sterling Capital a fee, computed daily and paid monthly, at an
annual rate of 0.42% of the average daily net assets of the Mid Cap Value Fund,
and at an annual rate of 0.25% of the average daily net assets of the Total
Return Bond Fund. For the fiscal year ended September 30, 2005, BB&T Asset
Management paid Sterling Capital $98,615 and $122,700 for sub-advisory services
to the Mid Cap Value Fund and the Total Return Bond Fund, respectively. For the
fiscal year ended September 30, 2004, BB&T Asset Management made no payments to
Sterling Capital.
The Sub-Advisory Agreement will continue in effect until October 31, 2006
and thereafter will continue from year to year if such continuance is approved
at least annually by BB&T Funds' Board of Trustees or by vote of the holders of
a majority of the outstanding Shares of the Fund (as defined under "GENERAL
INFORMATION - Miscellaneous"). The Sub-Advisory Agreement is terminable at any
time without penalty, by the Trustees, by vote of the holders of a majority of
the outstanding Shares of the Fund, or on 60 days' written notice by Sterling
Capital or by BB&T Asset Management. The Sub-Advisory Agreement also terminates
automatically in the event of any assignment, as defined in the 1940 Act. BB&T
Asset Management will bear the sole responsibility for the payment of the
sub-advisory fee to Sterling Capital.
From time to time, advertisements, supplemental sales literature and
information furnished to present or prospective shareholders of BB&T Funds may
include descriptions of each Sub-Adviser including, but not limited to, (i)
descriptions of the Sub-Adviser's operations; (ii) descriptions of certain
personnel and their functions; and (iii) statistics and rankings related to the
Sub-Adviser's operations.
PORTFOLIO MANAGERS
The portfolio managers identified under "Investment Management" in each
Prospectus are responsible for the day-to-day management of the Funds. Each
portfolio manager also has responsibility for the day-to-day management of
accounts other than the Fund(s) for which he or she serves as portfolio manager.
Information regarding these accounts is set forth below.
75
NUMBER OF OTHER ACCOUNTS MANAGED AND ASSETS BY ACCOUNT TYPE
AS OF SEPTEMBER 30, 2005*
----------------------------------------------------------------------------------------
OTHER REGISTERED INVESTMENT OTHER POOLED
PORTFOLIO MANAGER COMPANIES INVESTMENT VEHICLES OTHER ACCOUNTS
------------------ --------------------------- -------------------------- -----------------------------
Rick Jones Number: 1 Number: None Number: 3
Assets: $142 million Assets: $0 Assets: $15 million
Jeffrey J. Schappe Number: 2 Number: None Number: 2
Assets: $52 million Assets: $0 Assets: $3.9 million
Timothy P. Beyer Number: 1* Number: 1* Number: 7*
Assets: $8.2 million Assets: $3.8 million Assets: $148.8 million
David Nolan Number: 1 Number: None Number: 1
Assets: $38 million Assets: $0 Assets: $0.3 million
John Kvantas Number: None Number: None Number: None
Assets: $0 Assets: $0 Assets: $0
Thomas Madsen Number: 4 Number: 3 Number: None
Assets: $ 850 million Assets: $2,400 Assets: $0
George F. Shipp Number: None Number: None Number: 1800
Assets: $0 Assets: $0 Assets: $ 548.6 million
Kevin McNair Number: None Number: None Number: 30
Assets: $0 Assets: $0 Assets: $446 million
Brad D. Eppard Number: None Number: None Number: 9
Assets: $0 Assets: $0 Assets: $191 million
David M. Ralston Number: 1 Number: None Number: 97
Assets: $18.1 million Assets: $0 Assets: $5.942 billion
Robert Millikan Number: 1 Number: None Number: 10
Assets: $28 million Assets: $ Assets: $143 million
Eric Farls Number: 1 Number: None Number: 10
Assets: $28 million Assets: $0 Assets: $143 million
* If an account has a co-manager, the total number of accounts and assets has
been allocated to each respective manager. Therefore, some accounts and
assets have been counted more than once.
As of September 30, 2005, the following portfolio managers managed the following
numbers of accounts in each of the indicated categories, having the indicated
total assets, with respect to which the advisory fee is based on the performance
of the account.
PERFORMANCE BASED ADVISORY FEES
NUMBER OF OTHER ACCOUNTS MANAGED AND ASSETS BY ACCOUNT TYPE
AS OF SEPTEMBER 30, 2005
-----------------------------------------------------------------------
OTHER REGISTERED OTHER POOLED
PORTFOLIO MANAGER INVESTMENT COMPANIES INVESTMENT VEHICLES OTHER ACCOUNTS
------------------ -------------------- ------------------- --------------------------
Rick Jones Number: None Number: None Number: None
Assets: $0 Assets: $0 Assets: $0
Jeffrey J. Schappe Number: None Number: None Number: None
Assets: $0 Assets: $0 Assets: $0
76
PERFORMANCE BASED ADVISORY FEES
NUMBER OF OTHER ACCOUNTS MANAGED AND ASSETS BY ACCOUNT TYPE
AS OF SEPTEMBER 30, 2005
-----------------------------------------------------------------------
OTHER REGISTERED OTHER POOLED
PORTFOLIO MANAGER INVESTMENT COMPANIES INVESTMENT VEHICLES OTHER ACCOUNTS
------------------ -------------------- ------------------- --------------------------
Timothy P. Beyer Number: None Number: None Number: None
Assets: $0 Assets: $0 Assets: $0
David Nolan Number: None Number: None Number: None
Assets: $0 Assets: $0 Assets: $0
John Kvantas Number: None Number: None Number: None
Assets: $0 Assets: $0 Assets: $0
Thomas Madsen Number: None Number: None Number: None
Assets: $0 Assets: $0 Assets: $0
George F. Shipp Number: None Number: None Number: None
Assets: $0 Assets: $0 Assets: $0
Kevin McNair Number: None Number: None Number: None
Assets: $0 Assets: $0 Assets: $0
Brad D. Eppard Number: None Number: None Number: None
Assets: $0 Assets: $0 Assets: $0
David M. Ralston Number: None Number: None Number: 1
Assets: $0 Assets: $0 Assets: $ 1.9 million
Robert Millikan Number: None Number: None Number: None
Assets: $0 Assets: $0 Assets: $0
Eric Farls Number: None Number: None Number: None
Assets: $0 Assets: $0 Assets: $0
CONFLICTS OF INTEREST
From time to time, potential conflicts of interest may arise between a portfolio
manager's management of the investments of a Fund and the management of other
registered investment companies, pooled investment vehicles and other accounts
(collectively, the "Managed Accounts"). The Managed Accounts might have similar
investment objectives or strategies as the Fund, track the same indexes the Fund
tracks or otherwise hold, purchase, or sell securities that are eligible to be
held, purchased or sold by the Fund. The Managed Accounts might also have
different investment objectives or strategies than the Fund. Consequently,
portfolio managers may purchase or sell securities for one Fund and not for a
Managed Account.
BB&T ASSET MANAGEMENT
A potential conflict of interest may arise as a result of the portfolio
manager's management of a number of accounts with varying investment guidelines.
Often, an investment opportunity may be suitable for both the Fund and the
Managed Accounts, but may not be available in sufficient quantities for both the
Fund and the Managed Accounts to participate fully. Similarly, there may be
limited opportunity to sell an investment held by the Fund and another Managed
Account. BB&T Asset Management has adopted policies and procedures reasonably
designed to allocate investment opportunities on a fair and equitable basis over
time. BB&T Asset Management has also adopted a Code of Ethics that governs
personal trading and which is reasonably designed to address potential conflicts
of interest that may arise in connection with a portfolio manager's management
of personal accounts.
STERLING CAPITAL
77
Sterling Capital manages portfolios for multiple institutional and individual
clients. All portfolios are managed as separate accounts, including mutual fund
portfolios. Each portfolio has its own set of investment objectives and
investment policies that may differ from those of the Fund. The portfolio
managers make investment decisions for each portfolio based on the investment
objectives and policies and other relevant investment considerations applicable
to that portfolio. Accordingly, an individual portfolio may contain different
securities than other portfolios, and investment decisions may be made in other
accounts that are different than the decisions made for the BB&T Mid Cap Value
Fund or the BB&T Total Return Bond Fund. As an example, the portfolio manager
may decide to buy a security in one or more portfolios, while selling the same
security in other portfolios based on the different objectives, restrictions,
and cash flows in the portfolios. In addition, some of these portfolios have fee
structures, including performance fees, which are or have the potential to be
higher than the fees paid by the Fund to Sterling Capital. Because performance
fees are tied to performance, the incentives associated with any given portfolio
may be higher or lower than those associated with other accounts managed by the
firm.
Sterling Capital's objective is to meet its fiduciary obligation to treat all
clients fairly. To help accomplish this objective and to address the potential
conflicts discussed above, Sterling Capital has adopted and implemented policies
and procedures, including brokerage and trade allocation policies and
procedures. Sterling Capital's compliance procedures include actively monitoring
compliance with investment policies, trade allocation, and Code of Ethics
requirements. In addition, Sterling Capital's senior management team reviews the
performance of portfolio managers and analysts.
SCOTT & STRINGFELLOW
Scott & Stringfellow also manages portfolios for multiple institutional and
individual clients. All portfolios are managed as separate accounts, including
mutual fund portfolios. Each portfolio has its own set of investment objectives
and investment policies that may differ from those of the Fund. The portfolio
managers make investment decisions for each portfolio based on the investment
objectives and policies and other relevant investment considerations applicable
to that portfolio. Accordingly, an individual portfolio may contain different
securities than other portfolios, and investment decisions may be made in other
accounts that are different than the decisions made for the BB&T Special
Opportunities Equity Fund or the BB&T Equity Income Fund. As an example, the
portfolio manager may decide to buy a security in one or more portfolios, while
selling the same security in other portfolios based on the different objectives,
restrictions, and cash flows in the portfolios.
UBS
The management of a Fund and other accounts by a portfolio manager could result
in potential conflicts of interest if the Fund and other accounts have different
objectives, benchmarks and fees because the portfolio manager and his team must
allocate time and investment expertise across multiple accounts, including the
Fund. The portfolio manager and his team manage the Fund and other accounts
utilizing a model portfolio approach that groups similar accounts within a model
portfolio. The Advisor manages accounts according to the appropriate model
portfolio, including where possible, those accounts that have specific
investment restrictions. Accordingly, portfolio holdings, position sizes, and
industry and sector exposures tend to be similar across accounts, which may
minimize the potential for conflicts of interest.
If a portfolio manager identifies a limited investment opportunity that may be
suitable for more than one account or model portfolio, the Fund may not be able
to take full advantage of that opportunity due to an allocation of filled
purchase or sale orders across all eligible model portfolios and accounts. To
deal with these situations, the Advisor has adopted procedures for allocating
portfolio trades across multiple accounts to provide fair treatment to all
accounts.
The management of personal accounts by a portfolio manager may also give rise to
potential conflicts of interest. The Advisor and the Trust have adopted Codes of
Ethics that govern such personal trading but there is no assurance that the
Codes will adequately address all such conflicts.
PORTFOLIO MANAGER COMPENSATION
BB&T Asset Management offers investment professionals a compensation plan which
has two components: (i) base compensation, which is linked to job function,
responsibilities and experience, and (ii) incentive compensation, which varies
based on investment performance. The majority of the total cash compensation is
derived by the incentive compensation, which could ultimately make up more than
half of the investment professional's compensation. The incentive compensation
is based on two components: (1) the pre-tax investment performance of the Funds
on a one- and three-fiscal year basis in comparison to their respective Lipper
peer group, and (2) active support and promotion of the funds through various
channels, management of personnel, and other subjective criteria as
78
determined by executive management. The incentive compensation is used as a
retention tool, in order to facilitate long-term commitments from key investment
professionals.
BB&T ASSET MANAGEMENT
The investment analysts who assist the portfolio managers also receive a base
compensation and incentive compensation. The incentive compensation is
calculated based on outstanding performance categories, designed to recognize
meaningful performance to the team. As with the portfolio managers, BB&T Asset
Management seeks to utilize the incentive compensation to investment analysts as
a retention tool.
STERLING CAPITAL
Sterling Capital has an incentive compensation plan linking all employees to
performance standards for portfolio management, marketing, and client service.
The plan is based on the individual meeting or exceeding their individual
performance goals. Performance goals for investment professionals are based on
market indices and manager universes. Each member of the investment team
receives a fixed base salary plus variable bonus compensation. The bonus is
based on the individual's performance contribution to the portfolio and on the
group's overall pre-tax performance versus a universe of managers.
The benchmarks by which the performance of the BB&T Total Return Bond Fund and
the BB&T Mid Cap Value Fund is measured for the purposes of compensation are the
Lehman Aggregate Bond Index and the Russell Midcap Value Index, respectively.
SCOTT & STRINGFELLOW
Each portfolio manager is compensated using a salary plus bonus structure. The
salary is fixed and subject to annual review for increase or decrease. Bonuses
are computed based on assets under management, which is believed to create an
indirect tie to performance, as poor portfolio management performance could
result in an outflow of assets, and consistent positive portfolio performance
could stimulate asset inflows. Computed bonus amounts can be adjusted based on
annual performance appraisal of each individual's work.
UBS
The compensation received by portfolio managers at UBS Global Asset Management,
including the Funds' portfolio managers, includes a base salary and incentive
compensation based on their personal performance. UBS Global Asset Management's
compensation and benefits programs are designed to provide its investment
professionals with incentives to excel, and to promote an entrepreneurial,
performance-oriented culture. They also align the interests of the investment
professionals with the interests of UBS Global Asset Management's clients.
Overall compensation can be grouped into four categories:
- Competitive salary, benchmarked to maintain competitive compensation
opportunities.
- Annual bonus, tied to individual contributions and investment
performance.
- UBS equity awards, promoting company-wide success and employee
retention.
- Partnership Incentive Program (PIP), a phantom-equity-like program for
key senior staff.
Base salary is fixed compensation used to recognize the experience, skills and
knowledge that the investment professionals bring to their roles. Salary levels
are monitored and adjusted periodically in order to remain competitive within
the investment management industry.
Annual bonuses are strictly and rigorously correlated with performance. As such,
annual incentives can be highly variable, and are based on three components: 1)
the firm's overall business success; 2) the performance of the respective asset
class and/or investment mandate; and 3) an individual's specific contribution to
the firm's results. UBS Global Asset Management strongly believes that tying
bonuses to both long-term (3-year) and shorter-term (1-year) portfolio pre-tax
performance closely aligns the investment professionals' interests with those of
UBS Global Asset Management's clients. A portion of each portfolio manager's
bonus is based on the performance of each Fund the portfolio manager manages as
compared to the Fund's broad-based index over a three-year rolling period.
79
UBS AG Equity. Senior investment professionals, including each portfolio manager
of the Funds, may receive a portion of their annual performance-based incentive
in the form of deferred or restricted UBS AG shares or employee stock options.
UBS Global Asset Management believes that this reinforces the critical
importance of creating long-term business value and also serves as an effective
retention tool as the equity shares typically vest over a number of years.
Broader equity share ownership is encouraged for all employees through "Equity
Plus." This long-term incentive program gives employees the opportunity to
purchase UBS stock with after-tax funds from their bonus or salary. Two UBS
stock options are given for each share acquired and held for two years. UBS
Global Asset Management feels this engages its employees as partners in the
firm's success, and helps to maximize its integrated business strategy.
Partnership Incentive Program (PIP). Designed to promote an entrepreneurial
culture and drive long-term thinking, the PIP is a phantom equity-like program
for key senior staff (approximately top 2%). By tying compensation to overall
firm performance over the mid-to longer-term, the program offers significant
compensation opportunities for UBS Global Asset Management's senior staff. The
portfolio manager of the BB&T International Equity Fund is eligible for this
program.
Securities Ownership
The following table discloses the dollar range of equity securities of each of
the Funds beneficially owned by the portfolio managers as of September 30, 2005:
NAME OF PORTFOLIO
MANAGER DOLLAR RANGE OF EQUITY SECURITIES IN EACH FUND
------------------ ----------------------------------------------
Rick Jones $100,001 - $1,000,000 - Large Cap Value Fund
Jeffrey J. Schappe None
Timothy P. Beyer $10,001 - $50,000 - Mid Cap Value
David Nolan $10,001 - $50,000 - Mid Cap Growth Fund
John Kvantas None
Thomas Madsen None
George F. Shipp $10,000 - $50,000 - Equity Income Fund
$10,000-$50,000 - Special Opportunities Fund
Brad D. Eppard None
David M. Ralston None
Robert Millikan $1 - $10,000 - Capital Manager Equity Fund
Eric Farls $10,000-$50,000 - Large Cap Value Fund
PROXY VOTING POLICIES AND PROCEDURES
The Board of Trustees has delegated the authority to vote proxies on behalf
of the Funds of the Trust that own voting securities to BB&T Asset Management.
The Board has authorized BB&T Asset Management to delegate proxy voting
authority with respect to a Fund to that Fund's sub-adviser. Proxy voting
policies and procedures for BB&T Asset Management and each of the Sub-Advisers
are attached as Appendix B.
You may obtain information about how a Fund voted proxies related to its
portfolio securities during the 12-month period ended June 30 by visiting the
Securities and Exchange Commission's Web site at www.sec.gov or by visiting our
Web site at: www.bbtfunds.com or by contacting us in writing at BB&T Funds, 3435
Stelzer Road, Columbus, Ohio 43219.
PORTFOLIO TRANSACTIONS
80
Either pursuant to the Advisory Agreement, whereby BB&T Asset Management
determines, or pursuant to Sub-Advisory Agreements, whereby each Sub-Adviser
determines, subject to the direction and general supervision of the Board of
Trustees of BB&T Funds, review by BB&T Asset Management in the case of a
Sub-Adviser, and in accordance with each Fund's investment objective and
restrictions, which securities are to be purchased and sold by a Fund, and which
brokers are to be eligible to execute such Fund's portfolio transactions.
Purchases and sales of portfolio securities with respect to the Money Market
Funds, the Bond Funds, and the Funds of Funds usually are principal transactions
in which portfolio securities are normally purchased directly from the issuer or
from an underwriter or market maker for the securities. Purchases from
underwriters of portfolio securities generally include (but not in the case of
mutual fund shares purchased by the Funds of Funds) a commission or concession
paid by the issuer to the underwriter and purchases from dealers serving as
market makers may include the spread between the bid and asked price.
Transactions on stock exchanges involve the payment of negotiated brokerage
commissions. Transactions in the over-the-counter market are generally principal
transactions with dealers. With respect to the over-the-counter market, BB&T
Funds, where possible, will deal directly with dealers who make a market in the
securities involved except in those circumstances where better price and
execution are available elsewhere. While BB&T Asset Management and each
Sub-Adviser generally seek competitive spreads or commissions, BB&T Funds may
not necessarily pay the lowest spread or commission available on each
transaction, for reasons discussed below.
During the following fiscal years, the Funds listed below paid the
following aggregate brokerage commissions:
FISCAL YEAR ENDED FISCAL YEAR ENDED
SEPTEMBER 30, 2005 SEPTEMBER 30, 2004
-------------------------------------- --------------------------------------
AGGREGATE DIRECTED AGGREGATE DIRECTED
BROKERAGE AGGREGATE BROKERAGE BROKERAGE AGGREGATE BROKERAGE
COMMISSION TRANSACTIONS COMMISSION COMMISSION TRANSACTIONS COMMISSION
---------- ------------ ---------- ---------- ------------ ----------
Large Cap Value Fund........ 331,458 333,651,996 331,458 247,316 200,887,677 247,316
Large Cap Growth Fund....... 540,162 544,600,975 540,162 856,591 891,535,833 856,591
Mid Cap Value Fund.......... 405,218 601,599,594 405,218 112,949 83,942,368 112,949
Mid Cap Growth Fund......... 313,418 266,278,723 313,418 505,044 343,349,557 505,044
Small Cap Fund.............. 44,027 27,142,559 44,027 47,955 21,470,657 47,955
Small Company Growth Fund... 377,311 259,411,774 377,311 1,120,842 533,944,722 1,120,842
International Equity Fund... 314,674 254,374,914 314,674 263,987 211,093,093 263,987
Special Opportunities Fund.. 205,700 147,225,946 205,700 136,577 74,841,970 136,577
Total Return Bond Fund...... 360 1,009,234 360 360 1,026,862 360
Equity Income Fund.......... 110,463 81,347,226 110,463 38,952 27,542,780 38,952
FISCAL YEAR ENDED
SEPTEMBER 30, 2003
--------------------------------------
AGGREGATE DIRECTED
BROKERAGE AGGREGATE BROKERAGE
COMMISSION TRANSACTIONS COMMISSION
---------- ------------ ----------
Large Cap Value Fund........ 356,436 203,702,178 356,436
Large Cap Growth Fund....... 576,340 449,396,848 576,340
Mid Cap Value Fund.......... 148,595 72,443,039 148,595
Mid Cap Growth Fund......... 472,951 225,243,650 472,951
Small Cap Fund.............. 95,442 71,562,397 95,442
Small Company Growth Fund... 1,157,131 471,823,337 1,157,131
International Equity Fund... 989,246 690,826,972 989,246
Special Opportunities Fund.. 87,602 42,737,382 87,602
For the fiscal years ended September 30, 2005, 2004 and 2003, the Funds paid
$150,245, $123,940 and $87,602, respectively, in commissions to Scott &
Stringfellow, Inc., a wholly owned subsidiary of BB&T Corporation, for
transactions effected on behalf of the Special Opportunities Fund. For the
fiscal years ended September 30, 2005 and 2004, the Funds paid $97,025 and
$37,702 in commissions to Scott & Stringfellow for transactions effected on
behalf of the Equity Income Fund. The Funds paid no brokerage commissions to
Scott & Stringfellow, Inc. for the fiscal year ended September 30, 2002. For the
fiscal years ended September 30, 2005, 2004 and 2003, the aggregate percentage
of the Special Opportunities Fund's total brokerage commissions paid to Scott &
Stringfellow, Inc. were 73.0%, 90.7% and 100%, respectively, and the percentage
of the Funds' aggregate dollar amount of transactions involving commissions
effected through Scott & Stringfellow were 78.5%, 94.3% and 100%, respectively.
For the fiscal years ended September 30, 2005 and 2004, the aggregate percentage
of the Equity Income Fund's total brokerage commissions paid to Scott &
Stringfellow, Inc. were 87.8% and 96.8%, respectively, and the aggregate dollar
amount of transactions involving commissions effected through Scott &
Stringfellow were 87.2% and 95.3%, respectively.
Allocation of transactions, including their frequency, to various dealers
is determined by BB&T Asset Management or each Sub-Adviser in a manner deemed
fair and reasonable. The major consideration in allocating brokerage business is
the assurance that the
81
best execution is being received on all transactions effected for all
accounts. As detailed in the above chart, brokerage may be directed to brokers
because of research services provided. Brokerage will at times be allocated to
firms that supply research, statistical data and other services when the terms
of the transaction and the capabilities of different broker/dealers are
consistent with the guidelines set forth in Section 28(e) of the Securities
Exchange Act of 1934. Information so received is in addition to and not in lieu
of services required to be performed by BB&T Asset Management and each
Sub-Adviser and does not reduce the advisory fees payable to BB&T Asset
Management or each Sub-Adviser. Such information may be useful to BB&T Asset
Management or each Sub-Adviser in serving both BB&T Funds and other clients and,
conversely, supplemental information obtained by the placement of business of
other clients may be useful to BB&T Asset Management or each Sub-Adviser in
carrying out its obligations to BB&T Funds.
To the extent permitted by applicable rules and regulations, either BB&T
Asset Management or the Sub-Advisers may execute portfolio transactions on
behalf of the Funds through affiliates. As required by Rule 17e-1 under the 1940
Act, the Funds have adopted procedures which provide that commissions paid to
such affiliate must be fair and reasonable compared to the commission, fees or
other remuneration paid to other brokers in connection with comparable
transactions. The procedures also provide that the Board will review reports of
such affiliated brokerage transactions in connection with the foregoing
standard.
Investment decisions for each Fund of BB&T Funds are made independently
from those for the other Funds or any other investment company or account
managed by BB&T Asset Management or any Sub-Adviser. Any such other investment
company or account may also invest in the same securities as BB&T Funds. When a
purchase or sale of the same security is made at substantially the same time on
behalf of a Fund and another Fund of BB&T Funds, investment company or account,
the transaction will be averaged as to price and available investments will be
allocated as to amount in a manner which BB&T Asset Management or the
Sub-Adviser believes to be fair and equitable over time to the Fund(s) and such
other investment company or account. In some instances, this investment
procedure may adversely affect the price paid or received by a Fund or the size
of the position obtained by a Fund. To the extent permitted by law, BB&T Asset
Management or the Sub-Adviser may aggregate the securities to be sold or
purchased for a Fund with those to be sold or purchased for the other Funds or
for other investment companies or accounts in order to obtain best execution. As
provided by the Advisory Agreement and the Sub-Advisory Agreements, in making
investment recommendations for BB&T Funds, BB&T Asset Management or the
Sub-Adviser will provide its services in accordance with its fiduciary
obligations and will manage the Fund in the best interests of the Fund.
GLASS-STEAGALL ACT
In 1971, the United States Supreme Court held in Investment Company
Institute v. Camp that the Federal statute commonly referred to as the
Glass-Steagall Act prohibits a bank from operating a mutual fund for the
collective investment of managing agency accounts. Subsequently, the Board of
Governors of the Federal Reserve System (the "Board") issued a regulation and
interpretation to the effect that the Glass-Steagall Act and such decision: (a)
forbid a bank holding company registered under the Federal Bank Holding Company
Act of 1956 (the "Holding Company Act") or any non-bank affiliate thereof from
sponsoring, organizing, or controlling a registered, open-end investment company
continuously engaged in the issuance of its shares, but (b) do not prohibit such
a holding company or affiliate from acting as investment adviser, transfer
agent, and custodian to such an investment company. In 1981, the United States
Supreme Court held in Board of Governors of the Federal Reserve System v.
Investment Company Institute that the Board did not exceed its authority under
the Holding Company Act when it adopted its regulation and interpretation
authorizing bank holding companies and their non-bank affiliates to act as
investment advisers to registered closed-end investment companies. In the Board
of Governors case, the Supreme Court also stated that if a bank complied with
the restrictions imposed by the Board in its regulation and interpretation
authorizing bank holding companies and their non-bank affiliates to act as
investment advisers to investment companies, a bank performing investment
advisory services for an investment company would not violate the Glass-Steagall
Act.
BB&T Asset Management believes that it possesses the legal authority to
perform the services for each Fund contemplated by the Advisory Agreement and
described in the Prospectuses and this Statement of Additional Information and
has so represented in the Advisory Agreement. Future changes in either federal
or state statutes and regulations relating to the permissible activities of
banks or bank holding companies and the subsidiaries or affiliates of those
entities, as well as further judicial or administrative decisions or
interpretations of present and future statutes and regulations, could prevent or
restrict BB&T Asset Management's subsidiaries from continuing to perform such
services for BB&T Funds. Depending upon the nature of any changes in the
services which could be provided by BB&T Asset Management's subsidiaries, the
Board of Trustees of BB&T Funds would review BB&T Funds' relationship with BB&T
Asset Management and consider taking all action necessary in the circumstances.
Should future legislative, judicial, or administrative action prohibit or
restrict the proposed activities of BB&T Asset Management or any Sub-Adviser or
their affiliated and correspondent banks (the "Banks") in connection with
Customer's purchases of Shares of a Fund, the Banks might be required to alter
materially or discontinue the services offered by them to Customers. It is not
anticipated,
82
however, that any change in BB&T Funds' method of operations would affect its
net asset value per Share or result in financial losses to any Customer.
MANAGER AND ADMINISTRATOR
Effective February 1, 2005, BB&T Asset Management, Inc. became the
Administrator (the "Administrator") to each Fund pursuant to the Management and
Administration Agreement. Prior to February 1, 2005, BISYS Fund Services, LP
served as Administrator to each Fund pursuant to the Management and
Administration Agreement dated as of June 1, 2000. BISYS Fund Services is wholly
owned by The BISYS Group, Inc., 150 Clove Road, Little Falls, New Jersey 07424,
a publicly owned company engaged in information processing, loan servicing and
401(k) administration and recordkeeping services to and through banking and
other financial organizations. The Administrator assists in supervising all
operations of each Fund (other than those performed by BB&T Asset Management
under the Advisory Agreement, UBS Global AM, FIMC, Scott & Stringfellow, Inc.,
and Sterling Capital under the Sub-Advisory Agreements, and U.S. Bank National
Association, Bank of New York, and State Street Bank and Trust Company under
their custodial services agreements with BB&T Funds, and those performed by
BISYS Fund Services Ohio, Inc. under its transfer agency and shareholder service
and fund accounting agreements with BB&T Funds).
Under the Administration Agreement, the Administrator has agreed to monitor
the net asset value of the U.S. Treasury Fund and the Prime Money Market Fund,
to maintain office facilities for BB&T Funds, to maintain BB&T Funds' financial
accounts and records, and to furnish BB&T Funds statistical and research data
and certain bookkeeping services, and certain other services required by BB&T
Funds. The Administrator prepares annual and semi-annual reports to the
Securities and Exchange Commission, prepares Federal and state tax returns,
prepares filings with state securities commissions, and generally assists in
supervising all aspects of BB&T Funds' operations (other than those performed by
BB&T Asset Management under the Advisory Agreement, UBS Global AM, FIMC, Scott &
Stringfellow, Inc., and Sterling Capital under the Sub-Advisory Agreements, U.S.
Bank National Association, Bank of New York, and State Street Bank and Trust
Company under their custodial services agreements with BB&T Funds, and those
performed by BISYS Fund Services Ohio, Inc. under its transfer agency and
shareholder service and fund accounting agreements with BB&T Funds). Under the
Administration Agreement, the Administrator may delegate all or any part of its
responsibilities thereunder.
Under the Administration Agreement for expenses assumed and services
provided as manager and administrator, the Administrator receives a fee from
each Fund equal to the lesser of (a) a fee computed at the annual rate of twelve
one-hundredths of one percent (0.12%), applicable to the first $5 billion, and
eight one-hundredths of one percent (0.08%), applicable to over $5 billion, of
such Fund's average daily net assets or (b) such fee as may from time to time be
agreed upon in writing by BB&T Funds and the Administrator. A fee agreed to in
writing from time to time by BB&T Funds and the Administrator may be
significantly lower than the fee calculated at the annual rate and the effect of
such lower fee would be to lower a Fund's expenses and increase the net income
of such Fund during the period when such lower fee is in effect.
For its services as administrator and expenses assumed pursuant to the
Administration Agreement, the Administrator** received the following fees:
FISCAL YEAR ENDED
SEPTEMBER 30, 2005 SEPTEMBER 30, 2004 SEPTEMBER 30, 2003
---------------------- ---------------------- ----------------------
ADDITIONAL ADDITIONAL ADDITIONAL
AMOUNT AMOUNT AMOUNT
PAID WAIVED PAID WAIVED PAID WAIVED
--------- ---------- --------- ---------- ----------------------
Large Cap Value Fund....................... 898,785 208,804 1,429,470 144,681 1,085,485 --
Large Cap Growth Fund...................... 491,649 115,231 796,100 80,022 563,371 --
Mid Cap Value Fund......................... 274,212 62,108 415,107 41,666 307,198 --
Mid Cap Growth Fund........................ 170,874 39,222 283,931 27,490 219,625 --
Small Cap Fund............................. 85,672 20,351 129,626 13,495 33,043 --
Small Company Growth Fund.................. 118,882 31,056 274,204 23,471 303,874 --
International Equity Fund.................. 313,968 73,866 516,536 51,605 423,707 --
Special Opportunities Fund................. 191,789 35,116 146,991 16,864 27,055 --
Equity Income Fund*........................ 70,819 11,485 13,882 2,994 -- --
Short Fund................................. 250,719 59,091 443,975 76,913 381,333 94,094
Intermediate U.S. Government Fund.......... 775,698 170,542 1,178,010 119,101 1,021,024 --
Total Return Bond Fund..................... 445,088 89,208 587,316 59,776 467,504 --
Kentucky Intermediate Tax-Free Fund........ 22,593 4,971 32,996 9,012 10,764 7,177
Maryland Intermediate Tax-Free Fund........ 14,142 2,931 15,079 3,743 3,889 2,592
North Carolina Intermediate Tax-Free Fund.. 148,775 33,923 260,370 45,182 240,352 59,299
South Carolina Intermediate Tax-Free Fund.. 26,878 6,192 48,270 8,390 44,477 13,327
Virginia Intermediate Tax-Free Fund........ 105,020 24,153 175,244 30,647 167,526 41,314
83
West Virginia Intermediate Tax-Free Fund... 93,838 21,732 182,113 16,908 217,411 1,536
Prime Money Market Fund.................... 1,243,593 345,075 2,279,275 321,974 2,432,154 80,102
U.S. Treasury Money Market Fund............ 1,512,951 360,165 2,540,114 352,965 2,686,570 --
Capital Manager Conservative Growth Fund... 39,701 90,850 109,872 75,308 49,813 32,914
Capital Manager Moderate Growth Fund....... 38,581 94,275 93,460 63,919 53,321 35,253
Capital Manager Growth Fund................ 28,798 70,937 68,928 47,216 44,809 29,610
Capital Manager Equity Fund................ 16,131 39,314 38,311 26,216 24,833 16,419
----------
* Commenced operations June 30, 2004
** The figures in this table reflect fees received by the former Administrator
for periods prior to February 1, 2005.
The Administration Agreement shall, unless sooner terminated as provided in
the Administration Agreement (described below), continue until January 31, 2007.
Thereafter, the Administration Agreement shall be renewed automatically for
successive one year terms, unless written notice not to renew is given by the
non-renewing party to the other party at least 60 days prior to the expiration
of the then-current term. The Administration Agreement is terminable with
respect to a particular Fund only upon mutual agreement of the parties to the
Administration Agreement and for cause (as defined in the Administration
Agreement) by the party alleging cause, on not less than 60 days notice by BB&T
Funds' Board of Trustees or by the Administrator.
The Administration Agreement provides that the Administrator shall not be
liable for any loss suffered by BB&T Funds in connection with the matters to
which the Administration Agreement relates, except a loss resulting from willful
misfeasance, bad faith, or gross negligence in the performance of its duties, or
from the reckless disregard by the Administrator of its obligations and duties
thereunder.
SUB-ADMINISTRATOR
Effective February 1, 2005, BISYS Fund Services Ohio, Inc. became the
Sub-Administrator to the Funds pursuant to an agreement between the
Administrator and BISYS Fund Services Ohio, Inc. Pursuant to this agreement,
BISYS Fund Services Ohio, Inc. assumed many of the Administrator's duties, for
which BISYS Fund Services Ohio, Inc. receives a fee, paid by the Administrator,
calculated at an annual rate of five one-hundredths of one percent (0.05%),
applicable to the first $5 billion, and three one-hundredths of one percent
(0.03%), applicable to over $5 billion, of each Fund's average net assets.
Prior to February 1, 2005, BISYS served as the Administrator to the Funds.
Because BISYS did not serve as the Sub-Administrator during the fiscal year
ended September 30, 2004, BISYS received no fees for its services during that
fiscal year.
DISTRIBUTOR
Effective November 1, 2005, BB&T Funds Distributor, Inc. began serving as
distributor to each Fund of BB&T Funds pursuant to a Distribution Agreement
dated November 1, 2005 (the "Distribution Agreement"). The Distribution
Agreement provides that, unless sooner terminated it will continue in effect for
continuous one-year periods if such continuance is approved at least annually
(i) by BB&T Funds' Board of Trustees or by the vote of a majority of the
outstanding Shares of the Funds or Fund subject to such Distribution Agreement,
and (ii) by the vote of a majority of the Trustees of BB&T Funds who are not
parties to such Distribution Agreement or interested persons (as defined in the
1940 Act) of any party to such Distribution Agreement, cast in person at a
meeting called for the purpose of voting on such approval. The Distribution
Agreement may be terminated in the event of any assignment, as defined in the
1940 Act.
Under the Distribution Agreement the Distributor receives payment from the
Funds for distribution activities permitted and authorized under the
Distribution and Shareholder Services Plan, dated October 1, 1992, as restated
February 7, 1997 (the "Distribution Plan") adopted by the Funds. Under the
Distribution Plan, a Fund will pay a monthly distribution fee to the Distributor
as compensation for its services in connection with the Distribution Plan at an
annual rate equal to fifty one-hundredths of one percent (0.50%) of the average
daily net assets of Class A Shares of each Fund (twenty-five one-hundredths of
one percent (0.25%) for the Mid Cap Growth Fund, the Mid Cap Value Fund, and the
West Virginia Fund), one percent (1.00%) of the average daily net assets of
Class B Shares of each Fund, and one percent (1.00%) of the average daily net
assets of Class C Shares of each Fund. The Distributor may periodically waive
all or a portion of the fee with respect to a Fund in order to increase the net
investment income of the Fund available for distribution as dividends. The
Adviser may also compensate the Distributor for services provided to the Funds
under the
84
Distribution Agreement that either (i) are not authorized under the Distribution
Plan or (ii) represent amounts incurred in excess of the fee payable under the
Distribution Plan.
Because BB&T Funds Distributor, Inc. did not serve as the Distributor
during the fiscal year ended September 30, 2005, BB&T Funds Distributor, Inc.
received no fees for its services during that fiscal year.
Prior to November 1, 2005, BISYS Fund Services LP served as distributor to
each Fund of BB&T Funds.
85
For the fiscal year or period ended September 30, 2005, the Distributor*
received the following fees with respect to the Class A, Class B and Class C
Shares from the following Funds:
FUND A CLASS B CLASS C CLASS
------------------- ---------------- ----------------
PAID WAIVED PAID WAIVED PAID WAIVED
--------- ------- ------- ------ ------- ------
Large Cap Value Fund 90,841 90,841 246,387 -- 1,636 --
Large Cap Growth Fund 22,783 22,782 135,449 -- 307 --
Mid Cap Value Fund 27,641 -- 41,565 -- 4,459 --
Mid Cap Growth Fund 23,182 -- 22,117 -- 2,234 --
Small Company Value Fund 2,031 2,030 1,924 -- 35 --
Small Company Growth Fund 17,012 17,009 57,077 -- 315 --
International Equity Fund 5,364 5,364 21,528 -- 175 --
Special Opportunities Fund 142,362 142,362 183,107 -- 250,383 --
Equity Income Fund 54,486 54,485 33,004 -- 50,620 --
Short U.S. Government Fund 20,056 20,056 NA NA NA NA
Intermediate U.S. Government Fund 31,492 31,492 62,617 -- 4,729 --
Total Return Bond Fund 14,395 14,395 64,268 -- 2,355 --
Kentucky Intermediate Tax-Free Fund 5,702 7,612 NA NA NA NA
Maryland Intermediate Tax-Free Fund 2,337 2,881 NA NA NA NA
North Carolina Intermediate Tax-Free Fund 48,429 63,768 NA NA NA NA
South Carolina Intermediate Tax-Free Fund 8,127 9,630 NA NA NA NA
Virginia Intermediate Tax-Free Fund 28,057 37,143 NA NA NA NA
West Virginia Intermediate Tax-Free Fund 29,394 -- NA NA NA NA
Prime Money Market Fund 2,049,088 403,951 20,498 -- 3,656 --
U.S. Treasury Money Market Fund 505,477 108,756 7,655 -- 79 --
Capital Manager Conservative Growth Fund 17,086 17,085 49,747 -- 1,665 --
Capital Manager Moderate Growth Fund 61,882 61,882 206,613 -- 1,724 --
Capital Manager Growth Fund 36,147 36,146 156,284 -- 444 --
Capital Manager Equity Fund 12,113 12,113 67,937 -- 549 --
* The figures in this table reflect fees received by the former Distributor.
The Distribution Plan was initially approved on August 18, 1992 by the
Fund's Board of Trustees, including a majority of the trustees who are not
interested persons of the Fund (as defined in the 1940 Act) and who have no
direct or indirect financial interest in the Distribution Plan (the "Independent
Trustees"). An Amended and Re-Executed Distribution Plan was approved on
February 7, 1997. The Distribution Plan provides for fees only upon the Class A,
Class B, and Class C Shares of each Fund.
In accordance with Rule 12b-1 under the 1940 Act, the Distribution Plan may
be terminated with respect to any Fund by a vote of a majority of the
Independent Trustees, or by a vote of a majority of the outstanding Class A,
Class B, or Class C Shares of that Fund. The Distribution Plan may be amended by
vote of the Fund's Board of Trustees, including a majority of the Independent
Trustees, cast in person at a meeting called for such purpose, except that any
change in the Distribution Plan that would materially increase the distribution
fee with respect to a Fund requires the approval of the holders of that Fund's
Class A, Class B, and Class C Shares. BB&T Funds' Board of Trustees will review
on a quarterly and annual basis written reports of the amounts received and
expended under the Distribution Plan (including amounts expended by the
Distributor to Participating Organizations pursuant to the Servicing Agreements
entered into under the Distribution Plan) indicating the purposes for which such
expenditures were made.
The Distributor may use the distribution fee to provide distribution
assistance with respect to a Fund's Class A, Class B, and Class C Shares or to
provide shareholder services to the holders of such Shares. The Distributor may
also use the distribution fee (i) to pay financial institutions and
intermediaries (such as insurance companies and investment counselors but not
including banks), broker-dealers, and the Distributor's affiliates and
subsidiaries compensation for services or reimbursement of expenses incurred in
connection with distribution assistance or (ii) to pay banks, other financial
institutions and intermediaries, broker-dealers, and the Distributor's
affiliates and subsidiaries compensation for services or reimbursement of
expenses incurred in connection with the provision of shareholder services. All
payments by the Distributor for distribution assistance or shareholder services
under the Distribution Plan will be made pursuant to an agreement (a "Servicing
Agreement") between the Distributor and such bank, other financial institution
or intermediary, broker-dealer, or affiliate or subsidiary of the Distributor
(hereinafter referred to individually as "Participating Organizations"). A
Servicing Agreement will relate to the provision of distribution assistance in
connection with the distribution of a Fund's Class A, Class B, and Class C
Shares to the Participating Organization's customers on whose behalf the
investment in such Shares is made and/or to the provision of shareholder
services to the Participating Organization's customers
86
owning a Fund's Class A, Class B, and Class C Shares. Under the Distribution
Plan, a Participating Organization may include Southern National Corporation or
a subsidiary bank or nonbank affiliates, or the subsidiaries or affiliates of
those banks. A Servicing Agreement entered into with a bank (or any of its
subsidiaries or affiliates) will contain a representation that the bank (or
subsidiary or affiliate) believes that it possesses the legal authority to
perform the services contemplated by the Servicing Agreement without violation
of applicable banking laws (including the Glass-Steagall Act) and regulations.
The distribution fee will be payable without regard to whether the amount
of the fee is more or less than the actual expenses incurred in a particular
year by the Distributor in connection with distribution assistance or
shareholder services rendered by the Distributor itself or incurred by the
Distributor pursuant to the Servicing Agreements entered into under the
Distribution Plan. If the amount of the distribution fee is greater than the
Distributor's actual expenses incurred in a particular year (and the Distributor
does not waive that portion of the distribution fee), the Distributor will
realize a profit in that year from the distribution fee. If the amount of the
distribution fee is less than the Distributor's actual expenses incurred in a
particular year, the Distributor will realize a loss in that year under the
Distribution Plan and will not recover from a Fund the excess of expenses for
the year over the distribution fee, unless actual expenses incurred in a later
year in which the Distribution Plan remains in effect were less than the
distribution fee paid in that later year.
The Distribution Plan also contains a so-called "defensive" provision
applicable to all classes of Shares. Under this defensive provision to the
extent that any payment made to the Administrator, including payment of
administration fees, should be deemed to be indirect financing of any activity
primarily intended to result in the sale of Shares issued by the Funds within
the context of Rule 12b-1 under the 1940 Act, such payment shall be deemed to be
authorized by the Distribution Plan.
The Glass-Steagall Act and other applicable laws prohibit banks generally
from engaging in the business of underwriting securities, but in general do not
prohibit banks from purchasing securities as agent for and upon the order of
customers. Accordingly, BB&T Funds will require banks acting as Participating
Organizations to provide only those services which, in the banks' opinion, are
consistent with the then current legal requirements. It is possible, however,
that future legislative, judicial or administrative action affecting the
securities activities of banks will cause BB&T Funds to alter or discontinue its
arrangements with banks that act as Participating Organizations, or change its
method of operations. It is not anticipated, however, that any change in a
Fund's method of operations would affect its net asset value per share or result
in financial loss to any customer.
EXPENSES
BB&T Asset Management bears all expenses in connection with the performance
of its services as Adviser and Administrator, respectively, other than the cost
of securities (including brokerage commissions, if any) purchased for a Fund.
Each Fund bears the following expenses relating to its operations: taxes,
interest, any brokerage fees and commissions, fees and travel expenses of the
Trustees of BB&T Funds, Securities and Exchange Commission fees, state
securities qualification and renewal fees, costs of preparing and printing
prospectuses for regulatory purposes and for distribution to current
Shareholders, outside auditing and legal expenses, amortized organizational
expenses, advisory and administration fees, fees and out-of-pocket expenses of
the custodian and the transfer agent, fees and out-of-pocket expenses for fund
accounting services, expenses incurred for pricing securities owned by a Fund,
certain insurance premiums, costs of maintenance of a Fund's existence, costs
and expenses of Shareholders' and Trustees' reports and meetings, and any
extraordinary expenses incurred in its operation. As a general matter, expenses
are allocated to the Class A, Class B, Class C and Institutional Class of a Fund
on the basis of the relative net asset value of each class. At present, the only
expenses that will be borne solely by Class A, Class B, and Class C Shares,
other than in accordance with the relative net asset value of the class, are
expenses under the Distribution Plan which relate only to the Class A, Class B,
and Class C Shares.
SECURITIES LENDING AGENT
BB&T Funds has retained U.S. Bancorp Asset Management ("U.S. Bancorp AM")
as its securities lending agent and will compensate that firm based on a
percentage of the profitability generated by securities lending transactions
effected on the behalf of BB&T Funds. U.S. Bancorp AM has employed BISYS to
provide certain administrative services relating to securities lending
transactions entered into on behalf of BB&T Funds. U.S. Bancorp AM, rather than
BB&T Funds, will compensate BISYS for those services.
87
CUSTODIAN
State Street Bank and Trust Company serves as the Custodian to the Prime
Money Market Fund. Bank of New York serves as the Custodian to the International
Equity Fund. U.S. Bank National Association serves as the Custodian to the other
BB&T Funds.
TRANSFER AGENT AND FUND ACCOUNTING SERVICES
BISYS Fund Services Ohio, Inc. serves as transfer agent to each Fund of
BB&T Funds pursuant to a Transfer Agency Agreement with BB&T Funds. For its
services, BISYS Fund Services Ohio, Inc. receives a fee from each Fund at the
annual rate of 0.01% of such Fund's average daily net assets.
BISYS Fund Services Ohio, Inc. also provides fund accounting services to
each of the Funds pursuant to a Fund Accounting Agreement with BB&T Funds. For
its services, BISYS Fund Services Ohio, Inc. receives a fee from each Fund at
the annual rate of 0.01% of such Fund's average daily net assets.
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
KPMG LLP ("KPMG") has been selected as the independent registered public
accounting firm. KPMG's address is 191 West Nationwide Boulevard, Suite 500,
Columbus, Ohio 43215.
LEGAL COUNSEL
Ropes & Gray LLP, One Metro Center, 700 12th St., N.W., Suite 900,
Washington, DC 20005-3948 are counsel to BB&T Funds.
ADDITIONAL INFORMATION
ORGANIZATION AND DESCRIPTION OF SHARES
BB&T Funds (previously The BB&T Mutual Funds Group) was organized as a
Massachusetts business trust by the Agreement and Declaration of Trust, dated
October 1, 1987, under the name "Shelf Registration Trust IV." BB&T Funds'
Agreement and Declaration of Trust has been amended three times: (1) on June 25,
1992 to change the Trust's name, (2) on August 18, 1992, to provide for the
issuance of multiple classes of shares, and (3) on May 17, 1999 to change the
Trust's name. A copy of BB&T Funds' Amended and Restated Agreement and
Declaration of Trust, (the "Declaration of Trust") is on file with the Secretary
of State of The Commonwealth of Massachusetts. The Declaration of Trust
authorizes the Board of Trustees to issue an unlimited number of Shares, which
are units of beneficial interest. BB&T Funds presently has twenty-five series of
Shares offered to the public which represent interests in the Equity Index Fund,
the Large Cap Value Fund, the Large Cap Growth Fund, the Small Cap Fund, the
Small Company Growth Fund, the Special Opportunities Fund, the Equity Income
Fund, the International Equity Fund, the Mid Cap Growth Fund, the Mid Cap Value
Fund, the Kentucky Fund, the Maryland Fund, the North Carolina Fund, the South
Carolina Fund, the Virginia Fund, the West Virginia Fund, the Short Fund, the
Intermediate U.S. Government Fund, the Total Return Bond Fund, the U.S. Treasury
Fund, the Prime Money Market Fund, the Capital Manager Conservative Growth Fund,
the Capital Manager Moderate Growth Fund, the Capital Manager Growth Fund, and
the Capital Manager Equity Fund respectively. BB&T Funds' Declaration of Trust
authorizes the Board of Trustees to divide or redivide any unissued Shares of
BB&T Funds into one or more additional series.
Shares have no subscription or preemptive rights and only such conversion
or exchange rights as the Board of Trustees may grant in its discretion. When
issued for payment as described in the Prospectuses and this Statement of
Additional Information, BB&T Funds' Shares will be fully paid and
non-assessable. In the event of a liquidation or dissolution of BB&T Funds,
Shareholders of a Fund are entitled to receive the assets available for
distribution belonging to that Fund, and a proportionate distribution, based
upon the relative asset values of the respective Funds, of any general assets
not belonging to any particular Fund which are available for distribution.
Shares of BB&T Funds are entitled to one vote per share (with proportional
voting for fractional shares) on such matters as shareholders are entitled to
vote. Shareholders vote in the aggregate and not by series or class on all
matters except (i) when required by the 1940 Act, shares shall be voted by
individual series, (ii) when the Trustees have determined that the matter
affects only the interests of a particular series or class, then only
Shareholders of such series or class shall be entitled to vote thereon, and
(iii) only the holders of Class A, Class B and Class C Shares will be entitled
to vote on matters submitted to Shareholder vote with regard to the Distribution
Plan applicable to such class. There will normally be no meetings of
Shareholders for the purposes of electing Trustees
88
unless and until such time as less than a majority of the Trustees have been
elected by the Shareholders, at which time the Trustees then in office will call
a Shareholders' meeting for the election of Trustees. In addition, Trustees may
be removed from office by a written consent signed by the holders of two-thirds
of the outstanding shares of BB&T Funds and filed with BB&T Funds' custodian or
by vote of the holders of two-thirds of the outstanding shares of BB&T Funds at
a meeting duly called for the purpose, which meeting shall be held upon the
written request of the holders of not less than 10% of the outstanding shares of
any Fund. Except as set forth above, the Trustees shall continue to hold office
and may appoint their successors.
As used in this Statement of Additional Information, a "vote of a majority
of the outstanding Shares" of BB&T Funds or a particular Fund means the
affirmative vote, at a meeting of Shareholders duly called, of the lesser of (a)
67% or more of the votes of Shareholders of BB&T Funds or such Fund present at
such meeting at which the holders of more than 50% of the votes attributable to
the Shareholders of record of BB&T Funds or such Fund are represented in person
or by proxy, or (b) the holders of more than 50% of the outstanding votes of
Shareholders of BB&T Funds or such Fund.
SHAREHOLDER AND TRUSTEE LIABILITY
Under Massachusetts law, Shareholders could, under certain circumstances,
be held personally liable for the obligations of BB&T Funds. However, BB&T
Funds' Declaration of Trust disclaims Shareholder liability for acts or
obligations of BB&T Funds and requires that notice of such disclaimer be given
in every agreement, obligation or instrument entered into or executed by BB&T
Funds or the Trustees. The Declaration of Trust provides for indemnification out
of a Fund's property for all loss and expense of any Shareholder of such Fund
held liable on account of being or having been a Shareholder. Thus, the risk of
a Shareholder incurring financial loss on account of Shareholder liability is
limited to circumstances in which a Fund would be unable to meet its
obligations.
The Agreement and Declaration of Trust states further that no Trustee,
officer or agent of BB&T Funds shall be personally liable in connection with the
administration or preservation of the assets of BB&T Funds or the conduct of
BB&T Funds' business; nor shall any Trustee, officer, or agent be personally
liable to any person for any action or failure to act expect for his own bad
faith, willful misfeasance, gross negligence, or reckless disregard of his
duties. The Agreement and Declaration of Trust also provides that all persons
having any claim against the Trustees or BB&T Funds shall look solely to the
assets of BB&T Funds for payment.
DISCLOSURE OF PORTFOLIO HOLDINGS
Information regarding portfolio holdings may be made available to third
parties in the following circumstances:
- Through disclosure in a Fund's latest annual or semi-annual report or
Form N-Q;
- In marketing materials, provided that the information regarding
portfolio holdings contained therein is at least fifteen days old; or
- When a Fund has a legitimate business purpose for doing so (see
example below), and either the recipients are subject to a
confidentiality agreement or the Board has determined that the
policies of the recipient are adequate to protect the information that
is disclosed. Such disclosures will be authorized by the Fund's Chief
Executive Officer or Chief Financial Officer and will be reported
periodically to the Board. In no event shall information regarding the
Funds' portfolio holdings be disclosed for compensation.
Examples of instances in which a legitimate business purpose exists for the
selective disclosure of portfolio securities include: for due diligence purposes
to an investment adviser that is in merger or acquisition talks with the Fund's
adviser, to a newly hired investment adviser or sub-adviser prior to commencing
its duties, and to a performance reporting bureau or rating agency for use in
developing a rating.
It is the policy of the Funds to not disclose material information about
their portfolio holdings, trading strategies implemented or to be implemented,
or pending transactions to third parties other than the Funds' service
providers. The Funds' service providers are prohibited from disclosing to other
third parties material information about the Funds' portfolio holdings, trading
strategies implemented or to be implemented, or pending transactions. However,
the Funds may provide information regarding their portfolio holdings to their
service providers where relevant to duties to be performed for the Funds. Such
service providers include fund accountants, administrators, sub-administrators,
investment advisers, custodians, independent public accountants, and attorneys.
89
Other than the service provider arrangements discussed above, the Funds do
not have in place any ongoing arrangements to provide information regarding
portfolio holdings to any person.
MISCELLANEOUS
BB&T Funds may include information in its Annual Reports and Semi-Annual
Reports to Shareholders that (1) describes general economic trends, (2)
describes general trends within the financial services industry or the mutual
fund industry, (3) describes past or anticipated portfolio holdings for one or
more of the Funds within BB&T Funds, or (4) describes investment management
strategies for such Funds. Such information is provided to inform Shareholders
of the activities of BB&T Funds for the most recent fiscal year or half-year and
to provide the views of the Adviser and/or BB&T Funds officers regarding
expected trends and strategies.
The organizational expenses of each Fund of BB&T Funds except the Virginia
Fund and the Total Return Bond Fund are amortized over a period of two years
from the commencement of the public offering of Shares of the Fund. On June 30,
1998, the Funds adopted Statement of Position (SOP) 98-5, "Reporting on the
Costs of Start-Up Activities." Under the provisions of SOP 98-5, costs
associated with organizing a fund which commences operating subsequent to June
30, 1998, must be expensed as incurred and may not be amortized over future
periods. Accordingly, costs incurred in connection with the organization of the
Virginia Fund and Total Return Bond Fund were paid during the fiscal year ended
September 30, 1999 and the past fiscal year, respectively. In the event any of
the initial Shares of BB&T Funds are redeemed during the amortization period by
any holder thereof, the redemption proceeds will be reduced by a pro rata
portion of any unamortized organization expenses in the same proportion as the
number of initial Shares being redeemed bears to the total number of initial
Shares outstanding at the time of redemption. Investors purchasing Shares of
BB&T Funds subsequent to the date of the Prospectus and this Statement of
Additional Information bear such expenses only as they are amortized against a
Fund's investment income.
BB&T Funds is registered with the Securities and Exchange Commission as a
management investment company. Such registration does not involve supervision by
the Securities and Exchange Commission of the management or policies of BB&T
Funds.
The following table indicates the name, address, and percentage of
ownership of each person who owns of record or is known by the Trust to own
beneficially 5% or more of any Class of a Fund's outstanding shares as of
January 4, 2006:
PERCENT OF THE CLASS TOTAL
FUND/CLASS ASSETS HELD BY THE SHAREHOLDER
---------- ------------------------------
CAPITAL MANAGER CONSERV GROWTH- A SHARES
PERSHING LLC 34.55%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
BEULAH V WACHTER 6.73%
9103 OPOSSUMTOWN PIKE
FREDERICK MD 21702
CAPITAL MANAGER CONSERV GROWTH- B SHARES
PERSHING LLC 10.32%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
CAPITAL MANAGER CONSERV GROWTH- C SHARES
FLORENCE MARIE MCGEE 21.11%
PO BOX 1476
MAGGIE VALLEY NC 28751
TOMMY F LOPEZ 19.14%
4700 WILSHAM COURT
CHARLOTTE NC 28226
DELBERT L LEADMON 16.89%
90
RT 1 BOX 129 J
WALKER WV 26180
MARIA CORINA DEVICENTE 14.44%
7748 KINROSS DR
NEW PORT RICHEY FL 34653
RICHARD ALLEN SAFFLE 12.16%
112 E OLIVE ST
BRIDGEPORT WV 26330
JOHN ANTHONY CIRELLO 6.41%
PO BOX 128
LAWNDALE NC 28090-0128
LOYCE J CRUMP 5.64%
20 FLEMING RD
CUMBERLAND VA 23040
CAPITAL MANAGER CONSERV GROWTH- I SHARES
BRANCH BANKING & TRUST CO 62.83%
DAILY RECORDKEEPING PLANS
300 EAST WENDOVER AVENUE
ATTN DAILY TRADE TEAM
GREENSBORO NC 27401
WILBRANCH & CO 36.03%
PT NO FEE CASH
223 W NASH ST
WILSON NC 27893-3801
CAPITAL MANAGER EQUITY FUND - A SHARES
PERSHING LLC 13.72%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
BRANCH T CO 11.03%
DAILY R PLANS
434 FAYETTEVILLE ST
ATTN CORP EMPLOYEE BENEFIT SERV/OPS MGR
RALEIGH NC 27601-1767
RAF & CO 7.39%
7650 MAGNA DR
BELLEVILLE IL 62223
CAPITAL MANAGER EQUITY FUND - B SHARES
PERSHING LLC 8.34%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
CAPITAL MANAGER EQUITY FUND - C SHARES
PERSHING LLC 100.00%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
91
CAPITAL MANAGER EQUITY FUND - I SHARES
WILBRANCH & CO 65.70%
PT NO FEE CASH
223 W NASH ST
WILSON NC 27893-3801
BRANCH BANKING & TRUST CO 34.30%
DAILY RECORDKEEPING PLANS
300 EAST WENDOVER AVENUE
ATTN DAILY TRADE TEAM
GREENSBORO NC 27401
CAPITAL MANAGER GROWTH - A SHARES
PERSHING LLC 18.67%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
CAPITAL MANAGER GROWTH - B SHARES
PERSHING LLC 7.54%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
CAPITAL MANAGER GROWTH - C SHARES
HERBERT P SKILES 32.52%
3281 CLOVER DRIVE
CHARLESTON WV 25306
STEPHEN E CAMPBELL 28.94%
MARY W CAMPBELL
112 STARBOARD LN
MONETA VA 24121
STANLEY S TAO 27.96%
302 TURNBERRY PT
BARBOURSVILLE WV 25504-1948
CAPITAL MANAGER GROWTH - I SHARES
WILBRANCH & CO 61.22%
223 W NASH ST
WILSON NC 27893-3801
BRANCH BANKING & TRUST CO 38.34%
DAILY RECORDKEEPING PLANS
300 EAST WENDOVER AVENUE
ATTN DAILY TRADE TEAM
GREENSBORO NC 27401
CAPITAL MANAGER MOD GROWTH - A SHARES
PERSHING LLC 19.73%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
BRANCH BANKING & TRUST CO 13.17%
DAILY RECORDKEEPING PLANS
92
300 EAST WENDOVER AVENUE
ATTN DAILY TRADE TEAM
GREENSBORO NC 27401
CAPITAL MANAGER MOD GROWTH - B SHARES
PERSHING LLC 6.69%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
CAPITAL MANAGER MOD GROWTH - C SHARES
MG TRUST CUSTODIAN OR TRUSTEE 55.61%
COMDOC BUSINESS SYSTEMS INC
700 17TH STREET SUITE 150
DENVER CO 80202
PATRICIA F CHANDLER 19.33%
2440 CLOVERDALE RD
BREMO BLUFF VA 23022
BETSY B CREECH 12.36%
DONALD L CREECH
10344 PARK WILLOW DRIVE
JTWROS
CHARLOTTE NC 28210
CAPITAL MANAGER MOD GROWTH - I SHARES
WILBRANCH & CO 54.75%
PT NO FEE CASH
223 W NASH ST
WILSON NC 27893-3801
BRANCH BANKING & TRUST CO 45.11%
DAILY RECORDKEEPING PLANS
300 EAST WENDOVER AVENUE
ATTN DAILY TRADE TEAM
GREENSBORO NC 27401
EQUITY INCOME FUND - A SHARES
SCOTT & STRINGFELLOW INC. 62.54%
8006 DISCOVERY DRIVE
RICHMOND VA 23229
THE WSY INVESTMENTS LTD LP 7.91%
208 UNION SQUARE NW
HICKORY NC 28601
PERSHING LLC 6.11%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
EQUITY INCOME FUND - B SHARES
SCOTT & STRINGFELLOW INC. 60.83%
8006 DISCOVERY DRIVE
RICHMOND VA 23229
93
PERSHING LLC 7.42%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
EQUITY INCOME FUND - C SHARES
SCOTT & STRINGFELLOW INC. 99.33%
8006 DISCOVERY DRIVE
RICHMOND VA 23229
EQUITY INCOME FUND - I SHARES
WILBRANCH & CO 96.39%
223 NASH ST W
WILSON NC 27893-3801
INTERMEDIATE US GOVERNMENT FD - A SHARES
BRANCH BANKING & TRUST CO 35.39%
DAILY RECORDKEEPING PLANS
300 EAST WENDOVER AVENUE
ATTN DAILY TRADE TEAM
GREENSBORO NC 27401
PERSHING LLC 14.91%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
MG TRUST CUSTODIAN OR TRUSTEE 5.61%
WILLIAMS ROBERTS YOUNG INC
700 17TH ST
DENVER CO 80202
INTERMEDIATE US GOVERNMENT FD - B SHARES
PERSHING LLC 32.76%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
INTERMEDIATE US GOVERNMENT FD - C SHARES
MG TRUST CUSTODIAN OR TRUSTEE 25.05%
WETLAND & ENVIRONMENTAL SERVICE
700 17TH ST STE 150
DENVER CO 80202
PERSHING LLC 14.04%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
STANLEY J ATMA 11.94%
MARGARET S ATMA JTWROS
3708 TABLE ROCK ROAD
CHARLOTTE NC 28226
AMERITRADE, INC. 10.71%
1005 NORTH AMERITRADE PLACE
BELLEVUE NE 68005
VERNELLE C ILER 10.39%
94
140 ISLAND CREEK DR
SPARTA GA 31087
INTERMEDIATE US GOVERNMENT FD - I SHARES
WILBRANCH & CO 81.09%
223 NASH ST W
WILSON NC 27893-3801
BRANCH BANKING & TRUST CO 17.28%
DAILY RECORDKEEPING PLANS
300 EAST WENDOVER AVENUE
ATTN DAILY TRADE TEAM
GREENSBORO NC 27401
INTERNATIONAL EQUITY - A SHARES
RAF & CO 24.18%
7650 MAGNA DR
BELLEVILLE IL 62223
PERSHING LLC 12.24%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
INTERNATIONAL EQUITY - B SHARES
PERSHING LLC 7.18%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
INTERNATIONAL EQUITY - C SHARES
SCOTT & STRINGFELLOW INC. 86.85%
8006 DISCOVERY DRIVE
RICHMOND VA 23229
PATRICIA C REMACLE 6.55%
4641 REVERE DR
VIRGINIA BEACH VA 23456
INTERNATIONAL EQUITY - I SHARES
WILBRANCH & CO 71.23%
223 NASH ST W
WILSON NC 27893-3801
BRANCH BANKING & TRUST CO 14.01%
DAILY RECORDKEEPING PLANS
300 EAST WENDOVER AVENUE
ATTN DAILY TRADE TEAM
GREENSBORO NC 27401
KENTUCKY INTERMEDIATE TAX FREE- A SHARES
PERSHING LLC 73.92%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
PATRICK R HALL 5.77%
BERTA O HALL
95
1440 CAMPBELL LN 600
BOWLING GREEN KY 42104-4160
KENTUCKY INTERMEDIATE TAX FREE- I SHARES
WILBRANCH & CO 99.85%
PT NO FEE CASH
223 W NASH ST
WILSON NC 27893-3801
LARGE COMPANY GROWTH FUND - A SHARES
PERSHING LLC 10.86%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
AMBRO AND COMPANY 10.83%
628 MAIN ST
PO BOX 191
DANVILLE VA 24543-0191
LARGE COMPANY GROWTH FUND - B SHARES
PERSHING LLC 5.57%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
LARGE COMPANY GROWTH FUND - C SHARES
TERESA L LUHN 41.24%
PO BOX 48525
CUMBERLAND NC 28331
RICHARD G BLAKE 24.75%
3525 LEWIS LOOP
BOLIVIA NC 28422
HEIDI P SCEARCE 12.73%
60 BRICKHORN DR
RIDGEWAY VA 24148
PERSHING LLC 12.36%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
CLAUDIA CLARA PADILLA 8.63%
11210 AUBURNDALE STREET
SPRING HILL FL 34609-2719
LARGE COMPANY GROWTH FUND - I SHARES
WILBRANCH & CO 60.62%
223 NASH ST W
WILSON NC 27893-3801
BRANCH BANKING & TRUST CO 22.72%
DAILY RECORDKEEPING PLANS
300 EAST WENDOVER AVENUE
ATTN DAILY TRADE TEAM
GREENSBORO NC 27401
96
LARGE COMPANY VALUE FUND - A SHARES
PERSHING LLC 12.13%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
LARGE COMPANY VALUE FUND - B SHARES
PERSHING LLC 5.38%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
LARGE COMPANY VALUE FUND - C SHARES
MG TRUST CUSTODIAN OR TRUSTEE 42.94%
WETLAND & ENVIRONMENTAL SERVICE
700 17TH ST STE 150
DENVER CO 80202
A WAYNE ANNAS 22.70%
CAROLYN B ANNAS
P O BOX 563
VALDESE NC 28690
SCOTT & STRINGFELLOW INC. 20.45%
8006 DISCOVERY DRIVE
RICHMOND VA 23229
LARGE COMPANY VALUE FUND - I SHARES
WILBRANCH & CO 50.55%
223 NASH ST W
WILSON NC 27893[3801
BRANCH BANKING & TRUST CO 34.07%
DAILY RECORDKEEPING PLANS
300 EAST WENDOVER AVENUE
ATTN DAILY TRADE TEAM
GREENSBORO NC 27401
MARYLAND INTERMEDIATE TAX FREE- A SHARES
KAY T SIMMONS 23.04%
11547 CHARLES ST
LA PLATA MD 20646-4457
PERSHING LLC 16.89%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
ROBERT SIBOLE 9.42%
PO BOX 303
LUSBY MD 20657
EARL E GRIFFITH 9.05%
LILLIAN M GRIFFITH JTWROS
5571 GREENOCK RD
LOTHIAN MD 20711
97
CELESTE P HERBERT 6.71%
3017 GREENCASTLE RD
BURTONSVILLE MD 20866
CAROL A DEPRATO 5.93%
DONALD L DEPRATO JTWROS
6209 44TH PLACE
RIVERDALE MD 20737
MARYLAND INTERMEDIATE TAX FREE- I SHARES
WILBRANCH & CO 100.00%
PT NO FEE CASH
223 W NASH ST
WILSON NC 27893-3801
MID CAP GROWTH FUND - A SHARES
PERSHING LLC 16.92%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
BRANCH BANKING & TRUST CO 6.23%
DAILY RECORDKEEPING PLANS
300 EAST WENDOVER AVENUE
ATTN DAILY TRADE TEAM
GREENSBORO NC 27401
MID CAP GROWTH FUND - B SHARES
PERSHING LLC 8.15%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
CHARLES S HESTER 5.70%
178 ELLERSLIE DR
FAYETTEVILLE NC 28303
NHAN NGUYEN QUACH 5.36%
3164 SAMUEL ST
NEWTON NC 28658-8338
MID CAP GROWTH FUND - C SHARES
SCOTT & STRINGFELLOW INC. 65.24%
8006 DISCOVERY DRIVE
RICHMOND VA 23229
CHARLES H MANSELL 23.71%
1563 BRUNSWICK RD
BLACKSTONE VA 23824
MG TRUST CUSTODIAN OR TRUSTEE 6.02%
COMDOC BUSINESS SYSTEMS INC
700 17TH ST STE 150
DENVER CO 80202
MID CAP GROWTH FUND - I SHARES
WILBRANCH & CO 59.83%
98
223 NASH ST W
WILSON NC 27893-3801
BRANCH BANKING & TRUST CO 30.19%
DAILY RECORDKEEPING PLANS
300 EAST WENDOVER AVENUE
ATTN DAILY TRADE TEAM
GREENSBORO NC 27401
MID CAP VALUE - A SHARES
PERSHING LLC 24.86%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
BRANCH BANKING & TRUST CO 5.22%
DAILY RECORDKEEPING PLANS
300 EAST WENDOVER AVENUE
ATTN DAILY TRADE TEAM
GREENSBORO NC 27401
MID CAP VALUE - B SHARES
PERSHING LLC 13.31%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
MID CAP VALUE - C SHARES
MG TRUST CUSTODIAN OR TRUSTEE 36.83%
FORSYTH COUNTY DEVELOPMENT COR
700 17TH ST STE 150
DENVER CO 80202
PERSHING LLC 28.04%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
A WAYNE ANNAS 10.82%
CAROLYN B ANNAS
P O BOX 563
VALDESE NC 28690
NATIONAL FINANCIAL SERVICES LLC 9.48%
777 COMMERCE BLVD
CARLSTADT NJ 07072
THEODORA J KURCABA 5.91%
RT 1 BOX 163-C
TERRA ALTA WV 26764
MID CAP VALUE - I SHARES
WILBRANCH & CO 47.82%
223 NASH ST W
WILSON NC 27893-3801
BRANCH BANKING & TRUST CO 42.07%
DAILY RECORDKEEPING PLANS
99
300 EAST WENDOVER AVENUE
ATTN DAILY TRADE TEAM
GREENSBORO NC 27401
NC INTERMEDIATE TAX-FREE - A SHARES
PERSHING LLC 17.30%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
R L HONBARRIER CO 9.61%
1507 CRESTLIN RD
HIGH POINT NC 27262-8308
THE WSY INVESTMENTS LTD LP 8.18%
208 UNION SQUARE N W
HICKORY NC 28601
NC INTERMEDIATE TAX-FREE - I SHARES
WILBRANCH & CO 98.08%
223 NASH ST W
WILSON NC 27893-3801
PRIME MONEY MARKET - A SHARES
SCOTT & STRINGFELLOW OMNIBUS FUND 92.29%
US TREASURY MM - A
909 E MAIN ST
RICHMOND VA 23219
PERSHING LLC 6.52%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
PRIME MONEY MARKET - B SHARES
PERSHING LLC 19.68%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
BURLEIGH J WITHERS 7.45%
424 SINCLAIR ST
GASTONIA NC 28054-7410
JULIA D SMITH 6.59%
3480 POORS FORD RD
RUTHERFORDTON NC 28139
LARRY T BLALOCK 5.47%
TERRY L BLALOCK JTWROS
224 CIRCLE B FARM ROAD
ROUGEMONT NC 27572
PRIME MONEY MARKET - C SHARES
MG TRUST CUSTODIAN OR TRUSTEE 99.75%
CHARLES A. TORRENCE CO. 401K
700 17TH ST STE 150
100
DENVER CO 80202
PRIME MONEY MARKET - I SHARES
WILBRANCH CO 73.83%
P O BOX 2887
ATTN J MICHAEL POLLOCK
WILSON NC 27894-1847
BISYS FUND SERVICES 14.84%
BB&T SWEEP CUSTOMERS
3435 STELZER RD
ATTN CHRIS WEBER
COLUMBUS OH 43219
BRANCH BANKING & TRUST CO 11.33%
DAILY RECORDKEEPING PLANS
300 EAST WENDOVER AVENUE
ATTN DAILY TRADE TEAM
GREENSBORO NC 27401
SC INTERMEDIATE TAX-FREE - A SHARES
PERSHING LLC 16.07%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
GEORGE S MORGAN 6.94%
JOYCE MORGAN DEBESIS
4477 MANDI DR
LITTLE RIVER SC 29566
TIMOTHY J METZLER 6.53%
LISABETH S METZLER
24 COUNTRY CLUB DR
CHARLESTON SC 29412
NANCY JENKINS STEWART 5.15%
NANCY JENKINS STEWART TRUST
201 HUNTINGTON RD
GREENVILLE SC 29615
SC INTERMEDIATE TAX-FREE - I SHARES
WILBRANCH & CO 99.72%
PT NO FEE CASH
223 W NASH ST
WILSON NC 27893-3801
SHORT U.S. GOVERNMENT FUND - A SHARES
PERSHING LLC 18.04%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
HENRY FIBERS INC 14.02%
PO BOX 1675
ATTN GEORGE F HENRY JR PRESIDENT
GASTONIA NC 28053
101
THE BATEMAN COMPANY 12.79%
PO BOX 869
MACON GA 31202
BRANCH BANKING & TRUST CO 10.96%
DAILY RECORDKEEPING PLANS
ATTN DAILY TRADE TEAM
300 EAST WENDOVER AVENUE
GREENSBORO NC 27401
SHORT U.S. GOVERNMENT FUND - I SHARES
WILBRANCH & CO 92.86%
223 NASH ST W
WILSON NC 27893-3801
BRANCH BANKING & TRUST CO 6.78%
DAILY RECORDKEEPING PLANS
300 EAST WENDOVER AVENUE
ATTN DAILY TRADE TEAM
GREENSBORO NC 27401
SMALL COMPANY GROWTH FUND - A SHARES
PERSHING LLC 10.48%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
SMALL COMPANY GROWTH FUND - B SHARES
PERSHING LLC 5.34%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
SMALL COMPANY GROWTH FUND - C SHARES
MG TRUST CUSTODIAN OR TRUSTEE 84.45%
WETLAND & ENVIRONMENTAL SERVICE
700 17TH ST STE 150
DENVER CO 80202
KEVIN B WEEKS 15.55%
1045 DELMONT TER
ROSWELL GA 30075-3805
SMALL COMPANY GROWTH FUND - I SHARES
WILBRANCH & CO 78.01%
223 NASH ST W
WILSON NC 27893-3801
SMALL CAP FUND - A SHARES
RAF & CO 11.18%
7650 MAGNA DR
BELLEVILLE IL 62223
BRANCH T CO 12.34%
DAILY R PLANS
434 FAYETTEVILLE ST
102
ATTN CORP EMPLOYEE BENEFIT SERV/OPS MGR
RALEIGH NC 27601-1767
PERSHING LLC 12.28%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
SCOTT & STRINGFELLOW INC. 8.78%
8006 DISCOVERY DRIVE
RICHMOND VA 23229
SMALL CAP FUND - B SHARES
VALERIE L IRELAND 8.15%
134 CANEBREAK DR
GREER SC 29650
PERSHING LLC 7.26%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
AMERITRADE, INC. 6.75%
1005 NORTH AMERITRADE PLACE
BELLEVUE NE 68005
MICHAEL STEVEN ESTEP 6.26%
4949 ANTIOCH CHURCH RD
MATTHEWS NC 28104-8958
DANNY YOUNG 5.34%
6035 GEORGE HILDEBRAN SCHOOL ROAD
HICKORY NC 28602
SMALL CAP FUND - C SHARES
MICHAEL E LEONARD 50.00%
1130 BURKSDALE RD
NORFOLK VA 23518
VICKI S COURTEMANCHE 50.00%
4414 DURHAM CHAPEL HILL BLVD
DURHAM NC 27707-2509
SMALL CAP FUND - I SHARES
WILBRANCH & CO 80.01%
223 NASH ST W
WILSON NC 27893-3801
SPECIAL OPPORTUNITY EQUITY FD - A SHARES
SCOTT & STRINGFELLOW INC. 66.18%
8006 DISCOVERY DRIVE
RICHMOND VA 23229
PERSHING LLC 7.89%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
103
AMERITRADE, INC. 5.69%
1005 NORTH AMERITRADE PLACE
BELLEVUE NE 68005
SPECIAL OPPORTUNITY EQUITY FD - B SHARES
SCOTT & STRINGFELLOW INC. 72.37%
8006 DISCOVERY DRIVE
RICHMOND VA 23229
SPECIAL OPPORTUNITY EQUITY FD - C SHARES
SCOTT & STRINGFELLOW INC. 98.32%
8006 DISCOVERY DRIVE
RICHMOND VA 23229
SPECIAL OPPORTUNITY EQUITY FD - I SHARES
WILBRANCH & CO 96.39%
PT NO FEE CASH
223 W NASH ST
WILSON NC 27893-3801
TOTAL RETURN BOND FUND - A SHARES
PERSHING LLC 25.86%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
BRANCH BANKING & TRUST CO 16.10%
DAILY RECORDKEEPING PLANS
300 EAST WENDOVER AVENUE
ATTN DAILY TRADE TEAM
GREENSBORO NC 27401
TOTAL RETURN BOND FUND - B SHARES
PERSHING LLC 28.28%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
TOTAL RETURN BOND FUND - C SHARES
PERSHING LLC 75.01%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
ERNEST D RHODES 14.27%
1112 CREWS SHOP RD
LYNCHBURG VA 24504-4189
TOTAL RETURN BOND FUND - I SHARES
WILBRANCH & CO 73.27%
223 NASH ST W
WILSON NC 27893-3801
BB&T CAPITAL MGR CONSERVATIVE GRWTH 10.29%
434 FAYETTEVILLE ST
RALEIGH NC 27601
BB&T CAPITAL MGR MODERATE GROWTH FD 7.52%
104
434 FAYETTEVILLE ST
RALEIGH NC 27601
US TREASURY MONEY MARKET - A SHARES
SCOTT & STRINGFELLOW OMNIBUS FUND 78.63%
US TREASURY MM - A
909 E MAIN ST
RICHMOND VA 23219
PERSHING LLC 19.30%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
US TREASURY MONEY MARKET - B SHARES
LOUIS D BENTON 17.64%
DOROTHY B BENTON
4500 BAKER ST
LITTLE RIVER SC 29566
DANNY W WRIGHT 11.01%
BETTY C WRIGHT
PO BOX 803
HENDERSON NC 27536
CLYDE MAHLON BAILEY 5.77%
3170 REIDVILLE RD
SPARTANBURG SC 29301
PERSHING LLC 5.83%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
ELISABETH KROLICKI 5.19%
2488 BURNING TREE LN
LITTLE RIVER SC 29566
US TREASURY MONEY MARKET - C SHARES
BISYS FUND SERVICES INC 98.67%
3435 STELZER RD
ATTN CORPORATE FINANCE
COLUMBUS OH 43219
US TREASURY MONEY MARKET - I SHARES
WILBRANCH 63.18%
P O BOX 2887
ATTN J MICHAEL POLLOCK
WILSON NC 27894-1847
BRANCH BANKING & TRUST CO 28.27%
DAILY RECORDKEEPING PLANS
300 EAST WENDOVER AVENUE
ATTN DAILY TRADE TEAM
GREENSBORO NC 27401
BISYS FUND SERVICES 6.26%
105
BB&T SWEEP CUSTOMERS
3435 STELZER RD
ATTN CHRIS WEBER
COLUMBUS OH 43219
VIRGINIA INTERMEDIATE TAX FREE- A SHARES
AMBRO AND COMPANY 29.89%
628 MAIN ST
PO BOX 191
DANVILLE VA 24543-0191
PERSHING LLC 12.60%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
VIRGINIA INTERMEDIATE TAX FREE- I SHARES
WILBRANCH & CO 96.39%
PT NO FEE CASH
223 W NASH ST
WILSON NC 27893-3801
WEST VA INTERMEDIATE TAX FREE - A SHARES
PERSHING LLC 39.12%
1 PERSHING PLAZA
JERSEY CITY NJ 07399
SCOTT & STRINGFELLOW INC. 8.33%
8006 DISCOVERY DRIVE
RICHMOND VA 23229
WEST VA INTERMEDIATE TAX FREE - I SHARES
WILBRANCH & CO 97.72%
223 NASH ST W
WILSON NC 27893-3801
As of January 11, 2006, Branch Banking & Trust Company and its affiliates
possessed, on behalf of its underlying accounts, voting or investment power with
respect to the Institutional Shares in the following amounts: 65.18% of the U.S.
Treasury Money Market Fund, 71.57% of the Prime Money Market Fund, 80.98% of the
Intermediate U.S. Government Fund, 92.83% of the Short U.S. Government Fund,
98.08% of the North Carolina Intermediate Tax-Free Fund, 96.40% of the Virginia
Intermediate Tax-Free Fund, 99.72% of the South Carolina Intermediate Tax-Free
Fund, 94.47% of the Total Return Bond Fund, 97.68% of the West Virginia
Intermediate Tax-Free Bond Fund, 99.85% of the Kentucky Intermediate Tax-Free
Bond Fund, 100% of the Maryland Intermediate Tax-Free Fund, 64.64% of the Large
Cap Value Fund, 85.68% of the International Equity Fund, 36.21% of the Capital
Manager Conservative Growth Fund, 54.67% of the Capital Manager Moderate Growth
Fund, 67.22% of the Capital Manager Growth Fund, 65.92% of the Capital Manager
Equity Fund, 77.12% of the Large Cap Growth Fund, 67.85% of the Mid Cap Growth
Fund, 56.90% of the Mid Cap Value Fund, 97.63% of the Small Cap Fund, 95.41% of
the Small Company Growth Fund, 96.13% of the Special Opportunities Fund, and
99.88% of the Equity Income Fund. As a result, BB&T may be deemed to be a
"controlling person" of the Institutional Shares of each of the Funds under the
1940 Act. The Prospectuses of the Funds and this Statement of Additional
Information omit certain of the information contained in the Registration
Statement filed with the Securities and Exchange Commission. Copies of such
information may be obtained from the Securities and Exchange Commission upon
payment of the prescribed fee.
The Prospectuses of the Funds and this Statement of Additional Information
are not an offering of the securities herein described in any state in which
such offering may not lawfully be made. No salesman, dealer, or other person is
authorized to give any
106
information or make any representation other than those contained in the
Prospectuses of the Funds and this Statement of Additional Information.
107
FINANCIAL STATEMENTS
Audited Financial Statements as of September 30, 2005 are incorporated by
reference to the Annual Report to Shareholders, dated as of September 30, 2005,
which has been previously sent to Shareholders of each Fund pursuant to the 1940
Act and previously filed with the Securities and Exchange Commission. A copy of
the Annual Report and the Funds' latest Semi-Annual Report may be obtained
without charge by contacting the Distributor at 3435 Stelzer Road, Columbus,
Ohio 43219 or by telephoning toll-free at (800) 228-1872.
APPENDIX A
The nationally recognized statistical rating organizations (individually, an
"NRSRO") that may be utilized by the Funds with regard to portfolio investments
for the Funds include, but are not limited to, Moody's Investors Service, Inc.
("Moody's"), Standard & Poor's Corporation ("S&P"), Fitch IBCA, Duff & Phelps
("Fitch IBCA"), and Dominion Bond Ratings Services ("DBRS"). Set forth below is
a description of the relevant ratings of each such NRSRO. The NRSROs that may be
utilized by the Funds and the description of each NRSRO's ratings is as of the
date of this Statement of Additional Information, and may subsequently change.
LONG - TERM DEBT RATINGS (may be assigned, for example, to corporate and
municipal bonds)
Description of the five highest long-term debt ratings by Moody's (Moody's
applies numerical modifiers (1,2, and 3) in each rating category to indicate the
security's ranking within the category):
Aaa Bonds which are rated Aaa are judged to be of the best quality. They carry
the smallest degree of investment risk and are generally referred to as
"gilt edged." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized
are most unlikely to impair the fundamentally strong position of such
issues.
Aa Bonds which are rated Aa are judged to be of high quality by all standards.
Together with the Aaa group they comprise what are generally known as
high-grade bonds. They are rated lower than the best bonds because margins
of protection may not be as large as in Aaa securities or fluctuation of
protective elements may be of greater amplitude or there may be other
elements present which make the long-term risk appear somewhat larger than
the Aaa securities.
A Bonds which are rated A possess many favorable investment attributes and
are to be considered as upper-medium-grade obligations. Factors giving
security to principal and interest are considered adequate, but elements
may be present which suggest a susceptibility to impairment some time in
the future.
Baa Bonds which are rated Baa are considered as medium-grade obligations (i.e.,
they are neither highly protected nor poorly secured). Interest payments
and principal security appear adequate for the present but certain
protective elements may be lacking or may be characteristically unreliable
over any great length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well.
Ba Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well-assured. Often the protection of
interest and principal payments may be very moderate, and thereby not well
safeguarded during both good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
Description of the five highest long-term debt ratings by S & P (S&P may apply a
plus (+) or minus (-) to a particular rating classification to show relative
standing within that classification):
AAA An obligation rated 'AAA' has the highest rating assigned by Standard &
Poor's. The obligor's capacity to meet its financial commitment on the
obligation is extremely strong.
AA An obligation rated 'AA' differs from the highest rated obligations only in
small degree. The obligor's capacity to meet its financial commitment on
the obligation is very strong.
A An obligation rated 'A' is somewhat more susceptible to the adverse effects
of changes in circumstances and economic conditions than obligations in
higher rated categories. However, the obligor's capacity to meet its
financial commitment on the obligation is still strong.
108
BBB An obligation rated 'BBB' exhibits adequate protection parameters. However,
adverse economic conditions or changing circumstances are more likely to
lead to a weakened capacity of the obligor to meet its financial commitment
on the obligation. Obligations rated 'BB', 'B', 'CCC', 'CC', and 'C' are
regarded as having significant speculative characteristics. 'BB' indicates
the least degree of speculation and 'C' the highest. While such obligations
will likely have some quality and protective characteristics, these may be
outweighed by large uncertainties or major exposures to adverse conditions.
BB An obligation rated 'BB' is less vulnerable to nonpayment than other
speculative issues. However, it faces major ongoing uncertainties or
exposure to adverse business, financial, or economic conditions which could
lead to the obligor's inadequate capacity to meet its financial commitment
on the obligation.
Description of the three highest long-term debt ratings by Fitch IBCA:
AAA Highest credit quality. 'AAA' ratings denote the lowest expectation of
credit risk. They are assigned only in case of exceptionally strong
capacity for timely payment of financial commitments. This capacity is
highly unlikely to be adversely affected by foreseeable events.
AA Very high credit quality. 'AA' ratings denote a very low expectation of
credit risk. They indicate very strong capacity for timely payment of
financial commitments. This capacity is not significantly vulnerable to
foreseeable events.
A High credit quality. 'A' ratings denote a low expectation of credit risk.
The capacity for timely payment of financial commitments is considered
strong. This capacity may, nevertheless, be more vulnerable to changes in
circumstances or in economic conditions than is the case for higher
ratings.
Description of DBRS long-term debt rating categories:
AAA Bonds rated AAA are of the highest credit quality, with exceptionally
strong protection for the timely repayment of principal and interest.
Earnings are considered stable, the structure of the industry in which the
entity operates is strong, and the outlook for future profitability is
favorable. There are few qualifying factors present which would detract
from the performance of the entity, the strength of liquidity and coverage
ratios is unquestioned and the entity has established a creditable track
record of superior performance. Given the extremely tough definition which
DBRS has established for the category, few entities are able to achieve a
AAA rating.
AA Bonds rated AA are of superior credit quality, and protection of interest
and principal is considered high. In many cases, they differ from bonds
rated AAA only to a small degree. Given the extremely tough definitions
which DBRS has for the AAA category (which few companies are able to
achieve), entities rated AA are also considered to be strong credits which
typically exemplify above-average strength in key areas of consideration
and are unlikely to be significantly affected by reasonably foreseeable
events.
A Bonds rated A are of satisfactory credit quality. Protection of interest
and principal is still substantial, but the degree of strength is less than
with AA rated entities. While a respectable rating, entities in the A
category are considered to be more susceptible to adverse economic
conditions and have greater cyclical tendencies than higher-rated
companies.
(high, low) grades are used to indicate the relative standing of a credit
within a particular rating category. The lack of one of these designations
indicates a rating which is essentially in the middle of the category. Note that
"high" and "low" grades are not used for the AAA category.
SHORT-TERM DEBT RATINGS (may be assigned, for example, to commercial paper,
master demand notes, bank instruments, and letters of credit)
Moody's description of its three highest short-term debt ratings:
Prime-1 Issuers rated Prime-1 (or supporting institutions) have a superior
ability for repayment of senior short-term debt obligations. Prime-1
repayment ability will often be evidenced by many of the following
characteristics:
- Leading market positions in well-established industries.
- High rates of return on funds employed.
109
- Conservative capitalization structure with moderate reliance on
debt and ample asset protection.
- Broad margins in earnings coverage of fixed financial charges and
high internal cash generation.
- Well-established access to a range of financial markets and
assured sources of alternate liquidity.
Prime-2 Issuers rated Prime-2 (or supporting institutions) have a strong ability
for repayment of senior short-term debt obligations. This will normally be
evidenced by many of the characteristics cited above but to a lesser
degree. Earnings trends and coverage ratios, while sound, may be more
subject to variation. Capitalization characteristics, while still
appropriate, may be more affected by external conditions. Ample alternate
liquidity is maintained.
Prime-3 Issuers rated Prime-3 (or supporting institutions) have an acceptable
ability for repayment of senior short-term obligations. The effect of
industry characteristics and market compositions may be more pronounced.
Variability in earnings and profitability may result in changes in the
level of debt protection measurements and may require relatively high
financial leverage. Adequate alternate liquidity is maintained.
S & P's description of its three highest short-term debt ratings:
A-1 A short-term obligation rated 'A-1' is rated in the highest category by
Standard & Poor's. The obligor's capacity to meet its financial commitment
on the obligation is strong. Within this category, certain obligations are
designated with a plus sign (+). This indicates that the obligor's capacity
to meet its financial commitment on these obligations is extremely strong.
A-2 A short-term obligation rated 'A-2' is somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions than
obligations in higher rating categories. However, the obligor's capacity to
meet its financial commitment on the obligation is satisfactory.
A-3 A short-term obligation rated 'A-3' exhibits adequate protection
parameters. However, adverse economic conditions or changing circumstances
are more likely to lead to a weakened capacity of the obligor to meet its
financial commitment on the obligation.
Fitch IBCA's description of its three highest short-term debt ratings:
F1 Highest credit quality. Indicates the Best capacity for timely payment of
financial commitments; may have an added "+" to denote any exceptionally
strong credit feature.
F2 Good credit quality. A satisfactory capacity for timely payment of
financial commitments, but the margin of safety is not as great as in the
case of the higher ratings.
F3 Fair credit quality. The capacity for timely payment of financial
commitments is adequate; however, near-term adverse changes could result in
a reduction to non-investment grade.
DRBS description of its short-debt ratings:
R-1 (high) Short-term debt rated R-1 (high) is of the highest credit quality,
and indicates an entity which possesses unquestioned ability to repay
current liabilities as they fall due. Entities rated in this category
normally maintain strong liquidity positions, conservative debt levels and
profitability which is both stable and above average. Companies achieving
an R-1 (high) rating are normally leaders in structurally sound industry
segments with proven track records, sustainable positive future results and
no substantial qualifying negative factors. Given the extremely tough
definition which DBRS has established for an R-1 (high), few entities are
strong enough to achieve this rating.
R-1 (middle) Short-term debt rated R-1 (middle) is of superior credit quality
and, in most cases, ratings in this category differ from R-1 (high) credits
to only a small degree. Given the extremely tough definition which DBRS has
for the R81 (high) category (which few companies are able to achieve),
entities rated R-1 (middle) are also considered strong credits which
typically exemplify above average strength in key areas of consideration
for debt protection.
R-1 (low) Short-term debt rated R-1 (low) is of satisfactory credit quality.
The overall strength and outlook for key liquidity, debt and profitability
ratios is not normally as favorable as with higher rating categories, but
these considerations are still respectable.
110
Any qualifying negative factors which exist are considered manageable, and
the entity is normally of sufficient size to have some influence in its
industry.
R-2 (high), R-2 (middle), R-2 (low) Short-term debt rated R-2 is of adequate
credit quality and within the three subset grades, debt protection ranges
from having reasonable ability for timely repayment to a level which is
considered only just adequate. The liquidity and debt ratios of entities in
the R-2 classification are not as strong as those in the R-1 category, and
the past and future trend may suggest some risk of maintaining the strength
of key ratios in these areas. Alternative sources of liquidity support are
considered satisfactory; however, even the strongest liquidity support will
not improve the commercial paper rating of the issuer. The size of the
entity may restrict its flexibility, and its relative position in the
industry is not typically as strong as an R-1 credit. Profitability trends,
past and future, may be less favorable, earnings not as stable, and there
are often negative qualifying factors present which could also make the
entity more vulnerable to adverse changes in financial and economic
conditions.
SHORT-TERM LOAN/MUNICIPAL NOTE RATINGS
Moody's description of its two highest short-term loan/municipal note ratings:
MIG1/VMIG 1 This designation denotes superior credit quality. Excellent
protection is afforded by established cash flows, highly reliable
liquidity support, or demonstrated broad-based access to the
market for refinancing.
MIG 2/VMIG 2 This designation denotes strong credit quality. Margins of
protection are ample, although not as large as in the preceding
group.
APPENDIX B
PROXY VOTING POLICIES AND PROCECURES
The proxy voting policies and procedures of the following are attached:
1. BB&T Asset Management, Inc. (Adviser to each of the BB&T Funds) and Scott &
Stringfellow, Inc. (Sub-Adviser to the BB&T Special Opportunities Equity
Fund and the Equity Income Fund)
2. Federated Investment Management Company (Sub-Adviser to the BB&T Prime
Money Market Fund)
3. UBS Global Asset Management (Americas) Inc. (Sub-Adviser to the BB&T
International Equity Fund)
4. Sterling Capital Management LLC (Sub-Adviser to the Mid Cap Value Fund and
the Total Return Bond Fund
* Scott & Stringfellow, Inc., a wholly owned subsidiary of BB&T Corporation,
the parent of BB&T Asset Management ("BTAM"), will use BTAM's proxy voting
policy and procedures.
(1) BB&T ASSET MANAGEMENT, INC. PROXY VOTING POLICY AND PROCEDURES
13.1. AUTHORIZATION TO VOTE PROXIES
Each client whose account is assigned to a BB&T AM IAR, when executing his or
her Advisory Contract with BB&T AM, may select whether he or she wishes to be
responsible for voting his or her proxies or whether he or she instead
authorizes BB&T AM to vote proxies on behalf of the client. BB&T AM shall not
cause to be voted the proxies of any client who indicates that he or she wishes
to be responsible for voting his or her proxies. With respect to any BB&T AM
client who has not executed an Advisory Contract with BB&T AM that includes a
proxy voting selection provision, BB&T AM will cause the proxies of such client
to be voted, until such time as the client instructs BB&T AM to the contrary or
unless the client has otherwise arranged for their proxies to be delivered to
them for voting.
BB&T AM may also cause to be voted the proxies for securities held by any BB&T
Fund whose board of trustees has authorized BB&T AM to do so.
111
13.2. PROXY COMMITTEE
With respect to clients' securities (including BB&T Funds' securities) for which
BB&T AM has responsibility for voting proxies, the Proxy Committee of BB&T AM
will monitor corporate actions, make voting decisions, ensure proxies are
submitted timely, and, as described in Section 13.5.2, below, make
determinations regarding actual or potential conflicts of interests. The Proxy
Committee may elect to engage (or terminate) the services of a third party
provider to perform or assist with one or more of these functions. BB&T AM has
engaged Institutional Shareholder Services ("ISS") to monitor corporate actions,
make voting recommendations, ensure proxies are submitted timely, and maintain
the records described in Section 13.7(b & c), below.
Except as provided in Section 13.5, below, to the extent that any member of the
Proxy Committee reviews a given ISS recommendation and determines that the best
interests of the BB&T AM clients who hold the proxies would likely be better
served by rejecting the ISS recommendation, then the member shall promptly
notify the Proxy Committee, which shall then review the issue and determine,
based on the principles set forth in Sections 13.3 and 13.4, below, whether to
accept or reject the ISS recommendation. If the Proxy Committee chooses to
reject the ISS recommendation, it shall instruct ISS to vote the proxies
accordingly and shall forward to the Director of Compliance originals or copies
of all documents that memorialize the basis for the decision and all documents
created by the Proxy Committee or by any other area or employee of BB&T AM that
were material to making the decision.
13.3. PROXIES WILL BE VOTED IN ACCORDANCE WITH THE CLIENTS' BEST INTERESTS
It is BB&T AM's policy that all proxies for clients' securities be voted
strictly in accordance with the best interests of the clients' accounts. The key
element underlying any evaluation of the interests of a client in a proposal,
election, or issue presented to a shareholder vote is the effect, if any, the
proposal, election, or issue could have on the current or future value of the
investment.
13.4. PROXY VOTING DETERMINATION GUIDELINES
As discussed in Section 13.2, above, BB&T AM has engaged ISS to make voting
recommendations with respect to proxies for clients' securities. BB&T AM
accordingly relies on ISS's voting policies and judgments, which BB&T AM has
found to be sound and well regarded. Nevertheless, as also discussed in Section
13.2, above, BB&T AM reserves the right to reject any given ISS recommendation,
except as provided in Section 13.5, below. In determining whether to reject an
ISS recommendation, BB&T AM will be guided by the policy expressed in Section
13.3, above, and the following guidelines.
Generally, BB&T AM will support company managements which, in its opinion, have
the intent and ability to maximize shareholder wealth over the long term. Long
term shareholder value need not be sacrificed in favor of short term gains.
Proposals that diminish the rights of shareholders or diminish management or
board accountability to the shareholders will typically be opposed. However,
reasonable measures that provide the board or management with flexibility for
negotiation during unsolicited takeover attempts might be supported provided
that such measures do not deter every potential acquisition.
Likewise, compensation plans that appear excessive relative to comparable
companies' compensation packages and/or appear unreasonable in light of the
performance of the issuer will typically be opposed. Matters involving social
issues or corporate responsibility will be evaluated principally based on their
likely impact on the economic value of the issuer.
13.5. CONFLICTS OF INTERESTS
In some circumstances, an issuer's proxies may present an actual or potential
conflict of interests between BB&T AM and a client account holding securities of
the issuer. As explained in section 13.3, above, it is BB&T AM's policy that all
proxies for a client's securities be voted strictly in accordance with the best
interests of the client's account. Nevertheless, BB&T AM also employs additional
safeguards in situations potentially involving a material conflict of interests.
13.5.1. BB&T CORPORATION STOCK
BB&T AM is a wholly-owned subsidiary of BB&T Corporation, which is an
issuer of equity securities. If a client's account holds BB&T Corporation
common stock and the client has authorized BB&T AM to vote proxies on the
client's behalf, then a potential conflict of interests exists with respect
to BB&T AM's ability to vote proxies for such stock because BB&T AM and its
employees are controlled (directly or indirectly) by BB&T Corporation and
its management. Such management will often have a stake in, or an opinion
regarding, the subject of a shareholder vote. As a result, to the extent
that BB&T AM is authorized to vote proxies on
112
behalf of its clients who hold shares of BB&T Corporation common stock,
BB&T AM will rely exclusively upon the recommendations made by ISS with
respect to BB&T Corporation proxies and will not consider rejecting such
recommendations.
13.5.2. OTHER MATERIAL CONFLICTS OF INTERESTS
The Proxy Committee will compile, maintain, and update a list of issuers
with which BB&T AM or its affiliates has such a relationship that proxies
presented with respect to such issuers may give rise to a material conflict
of interests. Examples may include issuers for which BB&T AM manages a
pension or employee benefits plan or for which a BB&T AM affiliate is known
by the Proxy Committee to provide brokerage, underwriting, insurance, or
banking services. To the extent that BB&T AM receives proxies from such
issuers for clients who have authorized BB&T AM to vote their proxies, the
Proxy Committee will examine the proxy solicitations and assess the
potential conflict in order to determine what procedures to employ with
respect to the proxy. Likewise, the Proxy Committee will make such an
examination and determination with respect to other proxy solicitations
that may give rise to a material conflict of interests, such as where BB&T
AM or one or more of its executives or directors has a business or personal
relationship with a proponent of a proxy proposal, a participant in a proxy
contest, a corporate director, or a candidate for a directorship. Depending
on the circumstances, the Proxy Committee may:
(a) Cause the proxies to be voted according to ordinary guidelines and
procedures if it determines that the proxies do not present a material
conflict of interests and documents its reasons for making that
determination and delivers such documentation to the Director of
Compliance; or
(b) Where the client is a BB&T Fund, BB&T AM must disclose the
material conflict of interests to the Fund's board of trustees (or a
committee of the board) and obtain the board's (or committee's)
consent or direction to vote the proxies; and/or
(c) Rely exclusively upon the recommendation made by ISS and not
consider rejecting such recommendation if the Proxy Committee
determines that a material conflict of interests exists and documents
that determination and delivers such documentation to the Director of
Compliance.
13.5.3. BB&T FUNDS PROXIES
To the extent that BB&T AM is authorized to vote proxies on behalf of its
clients who hold shares or interests in any BB&T Fund, BB&T AM will rely
exclusively upon the recommendations made by ISS with respect to such BB&T
Fund proxies and will not consider rejecting such recommendations.
13.6. PROVIDING INFORMATION REGARDING PROXY VOTING POLICIES AND PROCEDURES
Upon opening any new client account, BB&T will provide the client with the
Description of BB&T Asset Management's Proxy Voting Policies and Procedures
("Description"), which shall be a concise summary of the policies and
procedures, shall indicate that a copy of the full policies and procedures is
available upon request, and shall include instructions for obtaining information
regarding how a client's proxies were voted. (A copy of the Description is
included at Appendix V.) The Proxy Committee or its delegate shall be
responsible for providing a copy of the full policies and procedures and of
information regarding how a client's proxies were voted to any client who so
requests. The Proxy Committee or its delegate shall also forward to the Director
of Compliance the client's written request for information regarding how the
client's proxies were voted and a copy of BB&T AM's written response to any such
written or oral request.
13.7. RECORD-KEEPING
The Director of Compliance shall maintain the following materials for five years
in an easily accessible place (the first two years in BB&T AM's home office):
(a) BB&T AM's proxy voting policies and procedures;
(b) Proxy statements received regarding client securities;
(c) Records of votes cast by BB&T AM (including by any third party
provider, such as ISS, that BB&T AM has engaged to cast votes) on
behalf of any client;
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(d) Copies of all documents created by BB&T AM that were material to
making a decision as to how to vote proxies on behalf of a client
or that memorialize the basis for such a decision;
(e) Copies of all written client requests for information on how BB&T
AM voted proxies on behalf of the client, and copies of all
written responses by BB&T AM to any written or oral client
request for information on how BB&T AM voted proxies on behalf of
the client;
(f) All documents received from the Proxy Committee pursuant to
Sections 13.2 and 13.5.2, above.
BB&T AM may satisfy requirements (b) and (c), above, by relying on a third
party, such as ISS, to make and retain the relevant documents on BB&T AM's
behalf if BB&T AM first obtains an undertaking from the third party to provide a
copy of the documents promptly upon request. BB&T AM also may satisfy the
requirements of (b), above, by relying on obtaining a copy of a proxy statement
from the SEC's EDGAR system.
2. FEDERATED INVESTORS PROXY VOTING POLICIES AND PRACTICES
Federated Investment Management Company, Federated Global Investment Management
Corp., Federated Investment Counseling and Passport Research Ltd. (collectively
the "Advisers") have adopted the following procedures to implement their proxy
voting policies and practices (the "Proxy Policies") in compliance with Rule
206(4)-6 of the Investment Advisers Act of 1940. These Proxy Policies shall also
apply to any investment company registered under the Investment Company Act of
1940 (the "1940 Act") for which an Adviser serves as an "investment adviser" (as
defined in Section 2(a)(20) of the 1940 Act), provided that the board of
directors or trustees of such investment company has delegated to the Adviser
authority to vote the investment company's proxies.
GENERAL POLICY
Unless otherwise directed by a client or the board of directors or trustees of
an investment company, it is the policy of the Advisers to cast proxy votes in
favor of proposals that the Advisers anticipate will enhance the long-term value
of the securities being voted. Generally, this will mean voting for proposals
that the Advisers believe will (a) improve the management of a company, (b)
increase the rights or preferences of the voted securities or (c) increase the
chance that a premium offer would be made for the company or for the voted
securities. Nothing in these policies shall be deemed to limit the securities
that the Advisers may purchase or hold on behalf of their clients.
APPLICATION TO SPECIFIC PROPOSALS
The following examples illustrate how this general policy may apply to proposals
submitted by a company's board of directors (or similar governing body, the
"board," and the individuals comprising a board, the "directors") for approval
or ratification by holders of the company's voting securities. However, whether
the Advisers support or oppose a proposal will always depend on the specific
circumstances described in the proxy statement and other available information.
CORPORATE GOVERNANCE
Generally, the Advisers will vote proxies:
- In favor of the full slate of directors nominated in an uncontested
election;
- In favor of a proposal to require a company's audit committee to be
comprised entirely of independent directors;
- In favor of a proposal to require independent tabulation of proxies
and/or confidential voting of shareholders;
- In favor of a proposal to reorganize in another jurisdiction, unless
it would reduce the rights or preferences of the securities being
voted;
- In favor of a proposal to ratify the board's selection of auditors,
unless: (a) compensation for non-audit services exceeded 50% of the
total compensation received from the company, or (b) the previous
auditor was dismissed because of a disagreement with the company; and
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- In favor of a proposal to repeal a shareholder rights plan (also known
as a "poison pill") and against the adoption of such a plan, unless
the plan is designed to facilitate, rather than prevent, unsolicited
offers for the company.
CAPITAL STRUCTURE
Generally, the Advisers will vote proxies:
- Against a proposal to authorize or issue shares that are senior in
priority or voting rights to the voted securities;
- In favor of a proposal to reduce the amount of shares authorized for
issuance (subject to adequate provisions for outstanding convertible
securities, options, warrants, rights and other existing obligations
to issue shares);
- In favor of a proposal to grant preemptive rights to the securities
being voted and against a proposal to eliminate such preemptive
rights; and
- In favor of a proposal authorizing a stock repurchase program.
COMPENSATION AND STOCK OPTION PLANS
Generally, the Advisers will vote proxies:
- In favor of stock incentive plans (including plans for directors) that
align the recipients of stock incentives with the interests of
shareholders, without creating undue dilution;
- Against proposals that would permit the amendment or replacement of
outstanding stock incentives with new stock incentives having more
favorable terms (e.g., lower purchase prices or easier vesting
requirements); and
- Against executive compensation plans that do not disclose the maximum
amounts of compensation that may be awarded or the criteria for
determining awards.
CORPORATE TRANSACTIONS AND CONTESTED ELECTIONS
The Advisers will vote proxies relating to proposed mergers, purchases and sales
of assets, capital reorganizations and similar transactions in accordance with
the general policy, based upon the Advisers' analysis of the terms, conditions
and anticipated results of the proposed transaction. The Advisers will vote
proxies in contested elections of directors in accordance with the general
policy, based upon the Advisers' analysis of the opposing slates and their
proposed business strategy. When the company's board or another party involved
in a proposed transaction or change in the board submits proposals for the
purpose of facilitating or impeding such transaction or change, the Advisers
will cast their proxies based on their evaluation of the proposed transaction or
change to the board. In these circumstances, the Advisers may vote in a manner
contrary to their general practice for similar proposals made outside the
context of such a proposed transaction or change in the board. For example, if
the Advisers decide to vote against a proposed transaction, they may vote in
favor of anti-takeover measures reasonably designed to prevent the transaction.
SHAREHOLDER PROPOSALS
The Advisers generally vote proxies against proposals submitted by shareholders
without the favorable recommendation of a company's board. The Advisers believe
that a company's board should manage its business and policies, and that
shareholders who seek specific changes should strive to convince the board of
their merits or seek direct representation on the board. The Advisers intend to
limit exceptions to this practice to shareholder proposals that the Advisers
regard as (a) likely to result in an immediate and favorable improvement in the
price of the voted security and (b) unlikely to be adopted by the company's
board in the absence of shareholder direction.
COST/BENEFIT ANALYSIS
Notwithstanding the foregoing policies and practices, the Advisers shall not
vote any proxy if they determine that the consequences or costs of voting
outweigh the potential benefit of casting a proxy for their clients. For
example, if a foreign market requires shareholders casting proxies to retain the
voted shares until the meeting date (thereby rendering the shares illiquid), the
Advisers will
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not vote proxies for such shares. In addition, the Advisers shall not be
obligated to incur any expense to send a representative to a shareholder meeting
or to translate proxy materials into English. Finally, with respect to an
investment company that seeks to produce the returns of a index (an "Index
Fund") by investing in large numbers of the securities without independent
evaluation by the Advisers, the Advisers will vote its proxies as follows:
- In accordance with any general guideline adopted by the Adviser with
respect to issues subject to the proxies;
- If the Advisers are directing votes for the same proxy on behalf of
non-index Funds, in the same manner as the non- index Funds;
- If neither of the first two conditions apply, as recommended by a
subadviser to the index Fund; and
- If none of the previous conditions apply, as recommended by the board;
in each case, without independent analysis by the Advisers of the Index Fund's
interest in the proxy.
FEDERATED INVESTORS PROXY VOTING PROCEDURES
Federated Investment Management Company, Federated Global Investment Management
Corp., Federated Investment Counseling and Passport Research Ltd. (collectively
the "Advisers") have adopted the following procedures to implement their Proxy
Voting Policies and Practices (the "Proxy Policies") in compliance with Rule
206(4)-6 of the Investment Advisers Act of 1940.
PROXY VOTING COMMITTEE
The Advisers hereby establish a Proxy Voting Committee (the "Committee")
consisting of the following individuals:
President of the Advisers (Keith Schappert)
Vice Chairman of the Advisers (J. Thomas Madden)
Chief Investment Officer for Global Equity (Stephen Auth)
Director of Global Equity Research of the Advisers (Christopher Corapi)
Investment Management Administrator (Lori Wolff)
A majority of the Committee will exercise all voting discretion granted to the
Advisers by their clients or the investment companies that they manage in
accordance with the Proxy Policies. The Committee will adopt such practices as
it deems appropriate to regulate its meetings and means of directing votes,
including directions authorized by voice or electronic messages.
EMPLOYMENT OF PROXY VOTING SERVICES
The Advisers have hired Investor Responsibility Research Center ("IRRC") to
obtain, vote and record proxies in accordance with the directions of the
Committee. The Committee shall direct IRRC by completing Proxy Voting Guidelines
in such form as IRRC may require. IRRC may vote any proxy as directed in the
Proxy Voting Guidelines without further direction from the Committee and may
make any determinations required to implement the Proxy Voting Guidelines.
However, if the Proxy Voting Guidelines require case-by-case direction for a
proposal, IRRC shall provide the Committee with all information that it has
obtained regarding the proposal and the Committee will provide specific
direction to IRRC. The Committee shall provide such direction in a timely
manner. Subject to the provisions of these Procedures relating to conflicts of
interest, the Committee may amend the Proxy Voting Guidelines, or override the
directions provided in such Guidelines, whenever the Committee deems it
necessary to comply with the Proxy Policies.
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The Advisers and IRRC shall take the following steps to implement these
procedures:
- The Advisers shall cause IRRC to receive a list of all voting
securities (both domestic and international) held in portfolios
managed by the Advisers, updated daily.
- The Advisers shall execute and deliver to IRRC a limited power of
attorney to cast ballots on behalf of the Advisers' clients.
- IRRC shall verify portfolio holdings (other than securities on loan)
on the record date for any proxy with the custodian of the voting
securities to confirm that IRRC has received ballots for all such
voting securities on the record date.
- IRRC has not received ballots for all voting securities, IRRC will
contact the Advisers and assist in obtaining the missing ballots from
the custodians.
- IRRC will provide monthly reports to the Committee of proxies voted.
IRRC will also compile and provide such other reports as the Advisers
are required to provide to their clients or file with the Securities
and Exchange Commission.
CONFLICTS OF INTEREST
A significant business relationship between the Advisers and a company involved
with a proxy vote may give rise to an apparent or actual conflict of interest.
For purposes of these procedures, a company with a "significant business
relationship with the Advisers" includes: (a) any company for which an Adviser
manages any investments of the company, any plan sponsored by the company or any
affiliated person of the company, (b) any investment company for which an
Adviser acts as an investment adviser and any affiliated person of such an
investment company and (c) any company that has another form of significant
business relationship with an affiliated person of the Adviser. A company that
is a proponent, opponent or the subject of a proxy vote, and which to the
knowledge of the Committee has a significant business relationship with the
Advisers, is referred to as an "Interested Company." The terms "affiliated
person" and "investment adviser" shall be interpreted according to the
definitions provided by Section 2(a) of the Investment Company Act of 1940, as
amended.
In order to avoid concerns that the conflicting interests of the Advisers have
influenced proxy votes, the Advisers will take the following steps:
1. Any employee of the Advisers who is contacted by an Interested Company
regarding proxies to be voted by the Advisers shall refer the
Interested Company to a member of the Committee. Any such employee
shall inform the Interested Company that the Committee has exclusive
authority to determine how the Adviser will exercise its voting
discretion.
2. Any Committee member contacted by an Interested Company shall report
it to the full Committee and provide a written summary of the
communication. Under no circumstances will the Committee or any member
of the Committee make a commitment to an Interested Company regarding
the voting of proxies or disclose to an Interested Company how the
Committee has directed such proxies to be voted.
3. If the Proxy Voting Guidelines already provide specific direction on
the proposal regarding which the Interested Company contacted the
Committee, the Committee shall not alter or amend such directions. If
the Proxy Voting Guidelines require further direction from the
Committee, the Committee shall provide such direction in accordance
with the Proxy Policies, without regard for the interests of the
Advisers with respect to the Interested Company.
4. If the Committee provides any direction as to the voting of proxies
relating to a proposal affecting an interested Company, the Committee
shall disclose to the clients (or, in the case of an investment
company, its Board of Directors or Trustees) on behalf of whom proxies
were cast:
- That the Advisers have a significant business relationship with
the Interested Company;
- The proposals regarding which proxies were cast;
- Any material communications between the Advisers and the
Interested Company regarding the proposal; and
- Whether the Advisers voted for or against the proposal (or
abstained from voting) and the reasons for its decision.
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5. Unless otherwise directed by the client (or in the case of an
investment company, its Board of Directors or Trustees) that holds
shares of another investment company for which an Adviser acts as an
investment adviser, the Committee will vote the client's proxies in
the same proportion as the votes cast by shareholders
who are not clients of the Advisers at any shareholders meeting called by
such investment company.
RECORDKEEPING
The Advisers shall keep copies of the Proxy Policies and of these Procedures in
their offices. IRRC shall maintain copies of each proxy statement received on
behalf of the Advisers' clients and a record of the vote cast on behalf of each
client, and provide them as directed by the Advisers promptly upon the Advisers
request. The Committee shall keep copies of (a) any document created by an
employee of the Advisers that was material to the Committee's directions
regarding how to vote proxies or that memorializes the basis for their decision
(including any voting guidelines directed to IRRC), (b) any written client
request for information on how a client's proxies were voted and (c) any written
response to such a request (whether written or oral). All such copies shall be
maintained for the time and in the manner required by Rule 204-2(e)(I) (i.e., in
an easily accessible place for a period of not less than five years).
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3.
UBS GLOBAL ASSET MANAGEMENT
GLOBAL CORPORATE GOVERNANCE PHILOSOPHY
VOTING GUIDELINES
AND
POLICY
VERSION 1.0
28 JULY 2003
UBS Global Asset Management
Global Voting and Corporate Governance Guidelines and Policy -Version 1.0
TABLE OF CONTENTS
GLOBAL VOTING AND CORPORATE GOVERNANCE POLICY
A. GENERAL CORPORATE GOVERNANCE BENCHMARKS
B. PROXY VOTING GUIDELINES -MACRO RATIONALES
C. PROXY VOTING DISCLOSURE GUIDELINES
D. PROXY VOTING CONFLICT GUIDELINES
UBS GLOBAL ASSET MANAGEMENT
GLOBAL VOTING AND CORPORATE GOVERNANCE GUIDELINES AND POLICY
VERSION 1.0
GLOBAL VOTING AND CORPORATE GOVERNANCE POLICY
Our philosophy, guidelines and policy are based on our active investment style
and structure whereby we have detailed knowledge of the investments we make on
behalf of our clients and therefore are in a position to judge what is in the
best interests of our clients as shareholders. We believe voting rights have
economic value and must be treated accordingly. Proxy votes that impact the
economic value of client investments involve the exercise of fiduciary
responsibility. Good corporate governance should, in the long term, lead toward
both better corporate performance and improved shareholder value. Thus, we
expect board members of companies we have invested in (the "company" or
"companies") to act in the service of the shareholders, view themselves as
stewards of the financial assets of the company, exercise good judgment and
practice diligent oversight with the management of the company. Underlying our
voting and corporate governance policies we have three fundamental objectives:
1. We seek to act in the best financial interests of our clients to
protect and enhance the long-term value of their investments.
2. In order to do this effectively, we aim to utilize the full weight of
our clients' shareholdings in making our views felt.
3. As investors, we have a strong commercial interest in ensuring that
the companies in which we invest are successful. We actively pursue
this interest by promoting best practice in the boardroom.
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To achieve these objectives, we have implemented this Policy, which we believe
is reasonably designed to guide our exercise of voting rights and the taking of
other appropriate actions, within our ability, and to support and encourage
sound corporate governance practice. This Policy is being implemented globally
to harmonize our philosophies across UBS Global Asset Management offices
worldwide and thereby maximize our ability to influence the companies we invest
in. However, this Policy is also supplemented by the UBS Global Asset Management
Local Proxy and Corporate Governance Guidelines to permit individual regions or
countries within UBS Global Asset Management the flexibility to vote or take
other actions consistent with their local laws or standards where necessary.
A. GENERAL CORPORATE GOVERNANCE BENCHMARKS
UBS Global Asset Management will evaluate issues that may have an impact on the
economic value of client investments during the time period it expects to hold
the investment. While there is no absolute set of rules that determine
appropriate governance under all circumstances and no set of rules will
guarantee ethical behavior, there are certain benchmarks, which, if substantial
progress is made toward, give evidence of good corporate governance. Therefore,
we will generally exercise voting rights on behalf of clients in accordance with
this policy.
PRINCIPAL 1: INDEPENDENCE OF BOARD FROM COMPANY MANAGEMENT
GUIDELINES:
- Board exercises judgment independently of management.
- Separate Chairman and Chief Executive.
- Board has access to senior management members.
- Board is comprised of a significant number of independent outsiders.
- Outside directors meet independently.
- CEO performance standards are in place.
- CEO performance is reviewed annually by the full board.
- CEO succession plan is in place.
- Board involvement in ratifying major strategic initiatives.
- Compensation, audit and nominating committees are led by a majority of
outside directors.
PRINCIPLE 2: QUALITY OF BOARD MEMBERSHIP
GUIDELINES:
- Board determines necessary board member skills, knowledge and
experience.
- Board conducts the screening and selection process for new directors.
- Directors whose present job responsibilities change are reviewed as to
the appropriateness of continued directorship.
- Directors are reviewed every 3-5 years to determine appropriateness of
continued directorship.
- Board meets regularly (at least four times annually).
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PRINCIPLE 3: APPROPRIATE MANAGEMENT OF CHANGE IN CONTROL
GUIDELINES:
- Protocols should ensure that all bid approaches and material proposals
by management are brought forward for board consideration.
- Any contracts or structures which impose financial constraints on
changes in control should require prior shareholder approval.
- Employment contracts should not entrench management.
- Management should not receive substantial rewards when employment
contracts are terminated for performance reasons.
PRINCIPLE 4: REMUNERATION POLICIES ARE ALIGNED WITH SHAREHOLDER INTERESTS
GUIDELINES:
- Executive remuneration should be commensurate with responsibilities
and performance.
- Incentive schemes should align management with shareholder objectives.
- Employment policies should encourage significant shareholding by
management and board members.
- Incentive rewards should be proportionate to the successful
achievement of pre-determined financial targets.
- Long-term incentives should be linked to transparent long-term
performance criteria.
- Dilution of shareholders' interests by share issuance arising from
egregious employee share schemes and management incentives should be
limited by shareholder resolution.
PRINCIPLE 5: AUDITORS ARE INDEPENDENT
GUIDELINES:
- Auditors are approved by shareholders at the annual meeting.
- Audit, consulting and other fees to the auditor are explicitly
disclosed.
- The Audit Committee should affirm the integrity of the audit has not
been compromised by other services provided by the auditor firm.
- Periodic (every 5 years) tender of the audit firm or audit partner.
B. PROXY VOTING GUIDELINES MACRO RATIONALES
Macro Rationales are used to explain why we vote on each proxy issue. The Macro
Rationales reflect our guidelines enabling voting consistency between offices
yet allowing for flexibility so the local office can reflect specific knowledge
of the company as it relates to a proposal.
1. GENERAL GUIDELINES
a. When our view of the issuer's management is favorable, we generally
support current management initiatives. When our view is that changes
to the management structure would probably increase shareholder value,
we may not support existing management proposals.
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b. If management's performance has been questionable we may abstain or
vote against specific proxy proposals.
c. Where there is a clear conflict between management and shareholder
interests, even in those cases where management has been doing a good
job, we may elect to vote against management.
d. In general, we oppose proposals, which in our view, act to entrench
management.
e. In some instances, even though we strongly support management, there
are some corporate governance issues that, in spite of management
objections, we believe should be subject to shareholder approval.
f. We will vote in favor of shareholder resolutions for confidential
voting.
2. BOARD OF DIRECTORS & AUDITORS
a. Unless our objection to management's recommendation is strenuous, if
we believe auditors to be competent and professional, we support
continuity in the appointed auditing firm subject to regular review.
b. We generally vote for proposals that seek to fix the size of the board
and/or require shareholder approval to alter the size of the board and
that allow shareholders to remove directors with or without cause.
c. We generally vote for proposals that permit shareholders to act by
written consent and/or give the right to shareholders to call a
special meeting.
d. We generally oppose proposals to limit or restrict shareholder ability
to call special meetings.
e. We will vote for separation of Chairman and CEO if we believe it will
lead to better company management, otherwise, we will support an
outside lead director board structure.
3. COMPENSATION
a. We will not try to micro-manage compensation schemes, however, we
believe remuneration should not be excessive, and we will not support
compensation plans that are poorly structured or otherwise egregious.
b. Senior management compensation should be set by independent directors
according to industry standards, taking advice from benefits
consultants where appropriate.
c. All senior management and board compensation should be disclosed
within annual financial statements. including the value of fringe
benefits. company pension contributions, deferred compensation and any
company loans.
d. We may vote against a compensation or incentive program if it is not
adequately tied to a company's fundamental financial performance, is
vague, is not in line with market practices, allows for option
re-pricing, does not have adequate performance hurdles or is highly
dilative.
e. Where company and management's performance has been poor, we may
object to the issuance of additional shares for option purposes such
that management is rewarded for poor performance or further entrenches
its position.
f. Given the increased level of responsibility and oversight required of
directors, it is reasonable to expect that compensation should
increase commensurably. We consider that there should be an
appropriate balance between fixed and variable elements of
compensation and between short and long term incentives.
4. GOVERNANCE PROVISIONS
a. We believe that votes at company meetings should be determined on the
basis of one share one vote. We will vote against cumulative voting
proposals.
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b. We believe that "poison pill" proposals, which dilute an issuer's
stock when triggered by particular events such as take over bids or
buy-outs should be voted on by the shareholders and will support
attempts to bring them before the shareholders.
c. Any substantial new share issuance should require prior shareholder
approval.
d. We believe proposals that authorize the issuance of new stock without
defined terms or conditions and are intended to thwart a take-over or
restrict effective control by shareholders should be discouraged.
e. We will support directives to increase the independence of the board
of directors when we believe that the measures will improve
shareholder value.
f. We generally do not oppose management's recommendation to implement a
staggered board and generally support the regular re-election of
directors on a rotational basis as it may provide some continuity of
oversight,
5. CAPITAL STRUCTURE AND CORPORATE RESTRUCTURING
a. It is difficult to direct where a company should incorporate, however,
in instances where a move is motivated solely to entrench management
or restrict effective corporate governance, we will vote accordingly.
b. In general we will oppose management initiatives to create dual
classes of stock, which serves to insulate company management from
shareholder opinion and action. We support shareholder proposals to
eliminate dual class schemes.
6. MERGERS, TENDER OFFERS & PROXY CONTESTS
a. Based on our analysis and research we will support proposals that
increase shareholder value and vote against proposals that do not.
7. SOCIAL, ENVIRONMENTAL, POLITICAL & CULTURAL
a. Depending on the situation, we do not typically vote to prohibit a
company from doing business anywhere in the world.
b. There are occasional issues, we support, that encourage management to
make changes or adopt more constructive policies with respect to
social, environmental, political and other special interest issues,
but in many cases we believe that the shareholder proposal may be too
binding or restrict management's ability to find an optimal solution.
While we wish to remain sensitive to these issues, we believe there
are better ways to resolve them than through a proxy proposal. We
prefer to address these issues through engagement.
c. Unless directed by clients to vote in favor of social, environmental,
political and other special interest proposals, we are generally
opposed to special interest proposals that involve an economic cost to
the company or that restrict the freedom of management to operate in
the best interest of the company and its shareholders.
8. ADMINISTRATIVE & OPERATIONS
a. Occasionally, stockholder proposals, such as asking for reports and
donations to the poor, are presented in a way that appear to be honest
attempts at bringing up a worthwhile issue. Nevertheless, judgment
must be exercised with care, as we do not expect our shareholders
companies to be charitable institutions.
b. We are sympathetic to shareholders who are long-term holders of a
company's stock, who desire to make concise statements about the
long-term operations of the company in the proxy statement. However,
because regulatory agencies do not require such actions. we may
abstain unless we believe there are compelling reasons to vote for or
against.
9. MISCELLANEOUS
a. Where a client has given specific direction as to how to exercise
voting rights on its behalf, we will vote in accordance with a
client's direction.
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b. Where we have determined that the voting of a particular proxy is of
limited benefit to clients or where the costs of voting a proxy
outweigh the benefit to clients, we may abstain or choose not to vote.
Among others, such costs may include the cost of translating a proxy,
a requirement to vote in person at a shareholders meeting or if the
process of voting restricts our ability to sell for a period of time
(an opportunity cost).
c. For holdings managed pursuant to quantitative, index or index-like
strategies, we may delegate the authority to exercise voting rights
for such strategies to an independent proxy voting and research
service with the direction that the votes be exercised in accordance
with this Policy.
C. PROXY VOTING DISCLOSURE GUIDELINES
- Upon request or as required by law or regulation, UBS Global Asset
Management will disclose to a client or a client's fiduciaries, the
manner in which we exercised voting rights on behalf of the client.
- Upon request, we will inform a client of our intended vote. Note,
however, in some cases, because of the controversial nature of a
particular proxy, our intended vote may not be available until just
prior to the deadline. If the request involves a conflict due to the
client's relationship with the company that has issued the proxy, the
Legal and Compliance Department should be contacted immediately. (See
Proxy Voting Conflict Guidelines below).
- Other than as described herein, we will not disclose our voting
intentions or make public statements to any third party (except
electronically to our proxy vote processor or regulatory agencies)
including but not limited to proxy solicitors, non-clients, the media,
or other UBS divisions, but we may inform such parties of the
provisions of our Policy. We may communicate with other shareholders
regarding a specific proposal but will not disclose our voting
intentions or agree to vote in concert with another shareholder
without approval from the Global Chief Investment Officer and regional
Legal & Compliance representative.
- Any employee, officer or director of UBS Global Asset Management
receiving an inquiry directly from a company will notify the
appropriate industry analyst and persons responsible for voting the
company's proxies.
- Proxy solicitors and company agents will not be provided with either
our votes or the number of shares we own in a particular company.
- In response to a proxy solicitor or company agent, we will acknowledge
receipt of the proxy materials, inform them of our intent to vote or
that we have voted, but not the result of the vote itself.
- We may inform the company (not their agent) where we have decided to
vote against any material resolution at their company.
- The Local and Global Chief Investment Officer must approve exceptions
to this disclosure policy.
Nothing in this policy should be interpreted as to prevent dialogue with the
company and its advisers by the industry analyst, proxy voting delegate or other
appropriate senior investment personnel when a company approaches us to discuss
governance issues or resolutions they wish to include in their proxy statement.
D. PROXY VOTING CONFLICT GUIDELINES
In addition to the Proxy Voting Disclosure Guidelines above, UBS Global Asset
Management has implemented the following guidelines to address conflicts of
interests that arise in connection with out exercise of voting rights on behalf
of clients:
- Under no circumstances will general business, sales or marketing
issues influence our proxy votes.
- UBS Global Asset Management and its affiliates engaged in banking,
broker-dealer and investment banking activities ("Affiliates") have
policies in place prohibiting the sharing of certain sensitive
information. These policies prohibit our personnel from disclosing
information regarding our voting intentions to any Affiliate. Any of
our personnel involved in the proxy voting process who are contacted
by an Affiliate regarding the manner in which we intend to vote on a
specific issue, must terminate the contact and notify the Legal &
Compliance Department immediately. [Note: Legal & Compliance personnel
may have contact with their counterparts working for an Affiliate on
matters involving information barriers.]
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UBS GLOBAL ASSET MANAGEMENT
GLOBAL CORPORATE GOVERNANCE PHILOSOPHY
AND PROXY
VOTING GUIDELINES
AND POLICY
Policy Summary
Underlying our voting and corporate governance policies we have three
fundamental objectives:
1. We seek to act in the best financial interests of our clients to protect
and enhance the long-term value of their investments.
2. In order to do this effectively, we aim to utilize the full weight of
our clients' shareholdings in making our views felt.
3. As investors, we have a strong commercial interest in ensuring that the
companies in which we invest are successful. We actively pursue this interest by
promoting best practice in the boardroom.
To achieve these objectives, we have implemented this Policy, which we
believe is reasonably designed to guide our exercise of voting rights and the
taking of other appropriate actions, within our ability, and to support and
encourage sound corporate governance practice. This Policy is being implemented
globally to harmonize our philosophies across UBS Global Asset Management
offices worldwide and thereby maximize our ability to influence the companies we
invest in. However, this Policy is also supplemented by the UBS Global Asset
Management Local Proxy and Corporate Governance Guidelines to permit individual
regions or countries within UBS Global Asset Management the flexibility to vote
or take other actions consistent with their local laws or standards where
necessary.
This policy helps to maximize the economic value of our clients' investments by
establishing proxy voting standards that conform with UBS Global Asset
Management's philosophy of good corporate governance.
Risks Addressed by this Policy
The policy is designed to address the following risks:
- Failure to provided required disclosures for investment
advisers and registered investment companies
- Failure to vote proxies in best interest of clients and
funds
- Failure to identify and address conflicts of interest
- Failure to provide adequate oversight of third party service
providers
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TABLE OF CONTENTS
Global Voting and Corporate Governance Policy
A. General Corporate Governance Benchmarks 2
B. Proxy Voting Guidelines - Macro Rationales 4
C. Proxy Voting Disclosure Guidelines 8
D. Proxy Voting Conflict Guidelines 9
E. Special Disclosure Guidelines for Registered
Investment Companies 9
F. Documentation 11
G. Compliance Dates 11
H. Other Policies 12
I. Disclosures 12
GLOBAL PROXY VOTING AND CORPORATE GOVERNANCE POLICY
PHILOSOPHY
Our philosophy, guidelines and policy are based on our active investment
style and structure whereby we have detailed knowledge of the investments we
make on behalf of our clients and therefore are in a position to judge what is
in the best interests of our clients as shareholders. We believe voting rights
have economic value and must be treated accordingly. Proxy votes that impact the
economic value of client investments involve the exercise of fiduciary
responsibility. Good corporate governance should, in the long term, lead toward
both better corporate performance and improved shareholder value. Thus, we
expect board members of companies we have invested in (the "company" or
"companies") to act in the service of the shareholders, view themselves as
stewards of the financial assets of the company, exercise good judgment and
practice diligent oversight with the management of the company.
A. GENERAL CORPORATE GOVERNANCE BENCHMARKS UBS Global Asset
Management (US) Inc. and UBS Global Asset Management (Americas)
Inc. (collectively, "UBS Global AM") will evaluate issues that
may have an impact on the economic value of client investments
during the time period it expects to hold the investment. While
there is no absolute set of rules that determine appropriate
governance under all circumstances and no set of rules will
guarantee ethical behavior, there are certain benchmarks, which,
if substantial progress is made toward, give evidence of good
corporate governance. Therefore, we will generally exercise
voting rights on behalf of clients in accordance with this
policy.
PRINCIPLE 1: INDEPENDENCE OF BOARD FROM COMPANY MANAGEMENT
GUIDELINES:
- Board exercises judgment independently of management.
- Separate Chairman and Chief Executive.
- Board has access to senior management members.
- Board is comprised of a significant number of independent
outsiders.
- Outside directors meet independently.
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- CEO performance standards are in place.
- CEO performance is reviewed annually by the full board.
- CEO succession plan is in place.
- Board involvement in ratifying major strategic initiatives.
- Compensation, audit and nominating committees are led by a
majority of outside directors.
PRINCIPLE 2: QUALITY OF BOARD MEMBERSHIP
GUIDELINES:
- Board determines necessary board member skills, knowledge and
experience.
- Board conducts the screening and selection process for new
directors.
- Shareholders should have the ability to nominate directors.
- Directors whose present job responsibilities change are reviewed
as to the appropriateness of continued directorship.
- Directors are reviewed every 3-5 years to determine
appropriateness of continued directorship.
- Board meets regularly (at least four times annually).
PRINCIPLE 3: APPROPRIATE MANAGEMENT OF CHANGE IN CONTROL
GUIDELINES:
- Protocols should ensure that all bid approaches and material
proposals by management are brought forward for board
consideration.
- Any contracts or structures, which impose financial constraints
on changes in control, should require prior shareholder approval.
- Employment contracts should not entrench management.
- Management should not receive substantial rewards when employment
contracts are terminated for performance reasons.
PRINCIPLE 4: REMUNERATION POLICIES ARE ALIGNED WITH SHAREHOLDER INTERESTS
GUIDELINES:
- Executive remuneration should be commensurate with
responsibilities and performance.
- Incentive schemes should align management with shareholder
objectives.
- Employment policies should encourage significant shareholding by
management and board members.
- Incentive rewards should be proportionate to the successful
achievement of pre-determined financial targets.
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- Long-term incentives should be linked to transparent long-term
performance criteria.
- Dilution of shareholders' interests by share issuance arising
from egregious employee share schemes and management incentives
should be limited by shareholder resolution.
PRINCIPLE 5: AUDITORS ARE INDEPENDENT
GUIDELINES:
- Auditors are approved by shareholders at the annual meeting.
- Audit, consulting and other fees to the auditor are explicitly
disclosed.
- The Audit Committee should affirm the integrity of the audit has
not been compromised by other services provided by the auditor
firm.
- Periodic (every 5 years) tender of the audit firm or audit
partner.
B. PROXY VOTING GUIDELINES - MACRO RATIONALES Macro Rationales are
used to explain why we vote on each proxy issue. The Macro
Rationales reflect our guidelines enabling voting consistency
between offices yet allowing for flexibility so the local office
can reflect specific knowledge of the company as it relates to a
proposal.
1. GENERAL GUIDELINES
a. When our view of the issuer's management is favorable,
we generally support current management initiatives.
When our view is that changes to the management
structure would probably increase shareholder value, we
may not support existing management proposals.
b. If management's performance has been questionable we
may abstain or vote against specific proxy proposals.
c. Where there is a clear conflict between management and
shareholder interests, even in those cases where
management has been doing a good job, we may elect to
vote against management.
d. In general, we oppose proposals, which in our view, act
to entrench management.
e. In some instances, even though we strongly support
management, there are some corporate governance issues
that, in spite of management objections, we believe
should be subject to shareholder approval.
f. We will vote in favor of shareholder resolutions for
confidential voting.
2. BOARD OF DIRECTORS AND AUDITORS
a. Unless our objection to management's recommendation is
strenuous, if we believe auditors to be competent and
professional, we support continuity in the appointed
auditing firm subject to regular review.
b. We generally vote for proposals that seek to fix the
size of the board and/or require shareholder approval
to alter the size of the board and that allow
shareholders to remove directors with or without cause.
c. We generally vote for proposals that permit
shareholders to act by written consent and/or give
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the right to shareholders to call a special meeting.
d. We generally oppose proposals to limit or restrict
shareholder ability to call special meetings.
e. We will vote for separation of Chairman and CEO if we
believe it will lead to better company management,
otherwise, we will support an outside lead director
board structure.
3. COMPENSATION
a. We will not try to micro-manage compensation schemes,
however, we believe remuneration should not be
excessive, and we will not support compensation plans
that are poorly structured or otherwise egregious.
b. Senior management compensation should be set by
independent directors according to industry standards,
taking advice from benefits consultants where
appropriate.
c. All senior management and board compensation should be
disclosed within annual financial statements, including
the value of fringe benefits, company pension
contributions, deferred compensation and any company
loans.
d. We may vote against a compensation or incentive program
if it is not adequately tied to a company's fundamental
financial performance;, is vague;, is not in line with
market practices;, allows for option re-pricing;, does
not have adequate performance hurdles; or is highly
dilutive.
e. Where company and management's performance has been
poor, we may object to the issuance of additional
shares for option purposes such that management is
rewarded for poor performance or further entrenches its
position.
f. Given the increased level of responsibility and
oversight required of directors, it is reasonable to
expect that compensation should increase commensurably.
We consider that there should be an appropriate balance
between fixed and variable elements of compensation and
between short and long term incentives.
4. GOVERNANCE PROVISIONS
a. We believe that votes at company meetings should be
determined on the basis of one share one vote. We will
vote against cumulative voting proposals.
b. We believe that "poison pill" proposals, which dilute
an issuer's stock when triggered by particular events,
such as take over bids or buy-outs, should be voted on
by the shareholders and will support attempts to bring
them before the shareholders.
c. Any substantial new share issuance should require prior
shareholder approval.
d. We believe proposals that authorize the issuance of new
stock without defined terms or conditions and are
intended to thwart a take-over or restrict effective
control by shareholders should be discouraged.
e. We will support directives to increase the independence
of the board of directors when we believe that the
measures will improve shareholder value.
f. We generally do not oppose management's recommendation
to implement a staggered board and generally support
the regular re-election of directors on a rotational
basis as it may provide some continuity of oversight.
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g. We will support proposals that enable shareholders to
directly nominate directors.
5. CAPITAL STRUCTURE AND CORPORATE RESTRUCTURING
a. It is difficult to direct where a company should
incorporate, however, in instances where a move is
motivated solely to entrench management or restrict
effective corporate governance, we will vote
accordingly.
b. In general we will oppose management initiatives to
create dual classes of stock, which serves to insulate
company management from shareholder opinion and action.
We support shareholder proposals to eliminate dual
class schemes.
6. MERGERS, TENDER OFFERS AND PROXY CONTESTS
a. Based on our analysis and research we will support
proposals that increase shareholder value and vote
against proposals that do not.
7. SOCIAL, ENVIRONMENTAL, POLITICAL AND CULTURAL
a. Depending on the situation, we do not typically vote to
prohibit a company from doing business anywhere in the
world.
b. There are occasional issues, we support, that encourage
management to make changes or adopt more constructive
policies with respect to social, environmental,
political and other special interest issues, but in
many cases we believe that the shareholder proposal may
be too binding or restrict management's ability to find
an optimal solution. While we wish to remain sensitive
to these issues, we believe there are better ways to
resolve them than through a proxy proposal. We prefer
to address these issues through engagement.
c. Unless directed by clients to vote in favor of social,
environmental, political and other special interest
proposals, we are generally opposed to special interest
proposals that involve an economic cost to the company
or that restrict the freedom of management to operate
in the best interest of the company and its
shareholders.
8. ADMINISTRATIVE AND OPERATIONS
a. Occasionally, stockholder proposals, such as asking for
reports and donations to the poor, are presented in a
way that appear to be honest attempts at bringing up a
worthwhile issue. Nevertheless, judgment must be
exercised with care, as we do not expect our
shareholder companies to be charitable institutions.
b. We are sympathetic to shareholders who are long-term
holders of a company's stock, who desire to make
concise statements about the long-term operations of
the company in the proxy statement. However, because
regulatory agencies do not require such actions, we may
abstain unless we believe there are compelling reasons
to vote for or against.
9. MISCELLANEOUS
a. Where a client has given specific direction as to how
to exercise voting rights on its behalf, we will vote
in accordance with a client's direction.
b. Where we have determined that the voting of a
particular proxy is of limited benefit to clients or
where the costs of voting a proxy outweigh the benefit
to clients, we may abstain or choose not to vote. Among
others, such costs may include the cost of translating
a proxy, a requirement to vote in person at a
shareholders meeting or if the process of voting
restricts our
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ability to sell for a period of time (an opportunity
cost).
c. For holdings managed pursuant to quantitative, index or
index-like strategies, we may delegate the authority to
exercise voting rights for such strategies to an
independent proxy voting and research service with the
direction that the votes be exercised in accordance
with this Policy. If such holdings are also held in an
actively managed strategy, we will exercise the voting
rights for the passive holdings according to the active
strategy.
d. In certain instances when we do not have enough
information we may choose to abstain or vote against a
particular Proposal.
C. PROXY VOTING DISCLOSURE GUIDELINES
- UBS Global AM will disclose to clients, as required by the Investment
Advisers Act of 1940, how they may obtain information about how we
voted with respect to their securities. This disclosure may be made on
Form ADV.
- UBS Global AM will disclose to clients, as required by the Investment
Advisers Act of 1940, these procedures and will furnish a copy of
these procedures to any client upon request. This disclosure may be
made on Form ADV.
- Upon request or as required by law or regulation, UBS Global AM will
disclose to a client or a client's fiduciaries, the manner in which we
exercised voting rights on behalf of the client.
- Upon request, we will inform a client of our intended vote. Note,
however, in some cases, because of the controversial nature of a
particular proxy, our intended vote may not be available until just
prior to the deadline. If the request involves a conflict due to the
client's relationship with the company that has issued the proxy, the
Legal and Compliance Department should be contacted immediately to
ensure adherence to UBS Global AM Corporate Governance Principles.
(See Proxy Voting Conflict Guidelines below.)
- Other than as described herein, we will not disclose our voting
intentions or make public statements to any third party (except
electronically to our proxy vote processor or regulatory agencies)
including but not limited to proxy solicitors, non-clients, the media,
or other UBS divisions, but we may inform such parties of the
provisions of our Policy. We may communicate with other shareholders
regarding a specific proposal but will not disclose our voting
intentions or agree to vote in concert with another shareholder
without approval from the Chairman of the Global Corporate Governance
Committee and regional Legal and Compliance representative.
- Any employee, officer or director of UBS Global AM receiving an
inquiry directly from a company will notify the appropriate industry
analyst and persons responsible for voting the company's proxies.
- Proxy solicitors and company agents will not be provided with either
our votes or the number of shares we own in a particular company.
- In response to a proxy solicitor or company agent, we will acknowledge
receipt of the proxy materials, inform them of our intent to vote or
that we have voted, but not the result of the vote itself.
- We may inform the company (not their agent) where we have decided to
vote against any material resolution at their company.
- The Chairman of the Global Corporate Governance Committee and the
applicable Chair of the Local Corporate Governance Committee must
approve exceptions to this disclosure policy.
Nothing in this policy should be interpreted as to prevent dialogue with
the company and its advisers by the industry analyst, proxy voting delegate or
other appropriate senior investment personnel when a company approaches us to
discuss governance issues or resolutions they wish to include in their proxy
statement.
D. PROXY VOTING CONFLICT GUIDELINES In addition to the Proxy Voting
Disclosure Guidelines above, UBS Global
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AM has implemented the following guidelines to address conflicts
of interests that arise in connection with our exercise of voting
rights on behalf of clients:
- Under no circumstances will general business, sales or marketing
issues influence our proxy votes.
- UBS Global AM and its affiliates engaged in banking, broker-dealer and
investment banking activities ("Affiliates") have policies in place
prohibiting the sharing of certain sensitive information. These
policies prohibit our personnel from disclosing information regarding
our voting intentions to any Affiliate. Any of our personnel involved
in the proxy voting process who are contacted by an Affiliate
regarding the manner in which we intend to vote on a specific issue,
must terminate the contact and notify the Legal and Compliance
Department immediately. [Note: Legal and Compliance personnel may have
contact with their counterparts working for an Affiliate on matters
involving information barriers.] In the event of any issue arising in
relation to Affiliates, the Chair of the Global Corporate Governance
Committee must be advised, who will in turn advise the Chief Risk
Officer.
E. SPECIAL DISCLOSURE GUIDELINES FOR REGISTERED INVESTMENT COMPANY
CLIENTS
1. REGISTRATION STATEMENT (OPEN-END AND CLOSED-END FUNDS)
MANAGEMENT IS RESPONSIBLE FOR ENSURING THE FOLLOWING:
- That these procedures, which are the procedures used by the
investment adviser on the Funds' behalf, are described in
the Statement of Additional Information (SAI). The
procedures may be described in the SAI or attached as an
exhibit to the registration statement.
- That the SAI disclosure includes the procedures that are
used when a vote presents a conflict between the interests
of Fund shareholders, on the one hand; and those of the
Funds investment adviser, principal underwriter or any
affiliated person of the Fund, its investment adviser or
principal underwriter, on the other.
- That the SAI disclosure states that information regarding
how the Fund voted proxies during the most recent 12-month
period ended June 30 is available (i) without charge, upon
request, by calling a specified toll-free (or collect)
telephone number; or on or through the Fund's website, or
both; and (ii) on the Commission's website. If a request for
the proxy voting record is received, the Fund must comply
within three business days by first class mail. If website
disclosure is elected, Form N-PX must be posted as soon as
reasonably practicable after filing the report with the
Commission, and must remain available on the website as long
as the Fund discloses that it its available on the website.
2. SHAREHOLDER ANNUAL AND SEMI-ANNUAL REPORT (OPEN-END AND
CLOSED-END FUNDS) Management is responsible for
ensuring the following:
- That each Fund's shareholder report contain a statement that
a description of these procedures is available (i) without
charge, upon request, by calling a toll-free or collect
telephone number; (ii) on the Fund's website, if applicable;
and (iii) on the Commission's website. If a request for the
proxy voting record is received, the Fund must comply within
three business days by first class mail.
- That the report contain a statement that information
regarding how the Fund voted proxies during the most recent
12-month period ended June 30 is available (i) without
charge, upon request, by calling a specified toll-free (or
collect) telephone number; or on or through the Fund's
website, or both; and (ii) on the Commission's website. If a
request for the proxy voting record is received, the Fund
must comply within three business days by first class mail.
If website disclosure is elected, Form N-PX must be posted
as soon as reasonably practicable after filing the report
with the Commission, and must remain available on the
website as long as the Fund discloses that it its available
on the website.
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3. FORM N-CSR (CLOSED-END FUND ANNUAL REPORTS ONLY) Management
is responsible for ensuring the following:
- That these procedures are described in Form N-CSR. In lieu of
describing the procedures, a copy of these procedures may simply
be included with the filing. However, the SEC's preference is
that the procedures be included directly in Form N-CSR and not
attached as an exhibit to the N-CSR filing.
- That the N-CSR disclosure includes the procedures that are used
when a vote presents a conflict between the interests of Fund
shareholders, on the one hand, and those of the Funds' investment
adviser, principal underwriter or any affiliated person of the
Fund, its investment adviser or principal underwriter, on the
other.
4. FORM N-PX (OPEN-END AND CLOSED-END FUNDS) Management is
responsible for ensuring the following:
- That each Fund files its complete proxy voting record on Form
N-PX for the 12 month period ended June 30 by no later than
August 31 of each year.
- Fund management is responsible for reporting to the Funds' Chief
Compliance Officer any material issues that arise in connection
with the voting of Fund proxies or the preparation, review and
filing of the Funds' Form N-PX.
5. OVERSIGHT OF DISCLOSURE The Funds' Chief Compliance Officer
shall be responsible for ensuring that the required
disclosures listed in these procedures are implemented and
complied with. The Funds' Chief Compliance Officer shall
recommend to each Fund's Board any changes to these policies
and procedures that he or she deems necessary or appropriate
to ensure the Funds' compliance with relevant federal
securities laws.
Responsible Parties
The following parties will be responsible for implementing and enforcing
this policy: THE CHIEF COMPLIANCE OFFICER AND HIS/HER DESIGNEES
Documentation
Monitoring and testing of this policy will be documented in the following
ways:
- Annual review by the Funds' and UBS Global AM's Chief Compliance
Officer of the effectiveness of these procedures
- Annual Report of Funds' Chief Compliance Officer regarding the
effectiveness of these procedures
- Periodic review of any proxy service vendor by the Chief
Compliance Officer
- Periodic review of proxy votes by the Proxy Voting Committee
Compliance Dates
The following compliance dates should be added to the Compliance Calendar:
- File Form N-PX by August 31 for each registered investment
company client
- Annual review by the Funds' and UBS Global AM's Chief Compliance
Officer of the effectiveness of these procedures
- Annual Report of Funds' Chief Compliance Officer regarding the
effectiveness of these procedures
- Form N-CSR, Shareholder Annual and Semi-Annual Reports, and
annual updates to Fund registration statements as applicable
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- Periodic review of any proxy service vendor by the Chief
Compliance Officer
- Periodic review of proxy votes by the Proxy Voting Committee
Other Policies
Other policies that this policy may affect include:
- Recordkeeping Policy
- Affiliated Transactions Policy
- Code of Ethics
- Supervision of Service Providers Policy
Other policies that may affect this policy include:
- Recordkeeping Policy
- Affiliated Transactions Policy
- Code of Ethics
- Supervision of Service Providers Policy
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Disclosures
The following disclosures are aligned with this policy:
- Form ADV
- Form N-PX
- Form N-1A
- Form N-2
- Investment Company Shareholder Reports
- Form N-CSR
- Request for Proposals (RFPs)
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STERLING CAPITAL MANAGEMENT LLC
Proxy Policy & Voting Procedures
(Effective October, 1989)
(Revised September, 2004)
I. VOTING POLICY AND GUIDELINES
Sterling Capital Management LLC ("SCM") believes it has a fiduciary obligation
to vote its clients' proxies in favor of the economic interest of shareholders.
Our fiduciary responsibility includes protecting and enhancing the economic
interests of the plan participants in the ERISA accounts we manage. The
following guidelines have been established to assist us in evaluating relevant
facts and circumstances which will enable us to vote in a manner consistent with
our fiduciary responsibility.
ROUTINE MANAGEMENT PROPOSALS
Election of Directors Case by Case
We believe that the structure and functioning of its board of directors are
critical to the economic success of every company therefore treat board
related issues in a separate section, below.
Appointment of Auditors Approve
Fix Auditor Remuneration Approve
Approval of Audited Financial Statements Approve
Set/Eliminate Dividends Approve
Grant Board Authority to Repurchase Shares Approve
Approve Stock Splits or Reverse Stock Splits Approve
Change Name of Corporation Approve
Eliminate Preemptive Rights
Preemptive rights give current shareholders the opportunity to maintain
their current percentage ownership through any subsequent equity offerings.
These provisions are no longer common in the U.S., and can restrict
management's ability to raise new capital.
We generally approve the elimination of preemptive rights, but will oppose
the elimination of limited preemptive rights, e.g., on proposed issues
representing more than an acceptable level of dilution.
Employee Stock Purchase Plan Approve
Establish 401(k) Plan Approve
BOARD OF DIRECTORS
We support measures which encourage and enable boards to fulfill their
primary responsibility to represent the economic interests of shareholders.
While we may take into consideration the specific needs of companies that
are in early rapid growth phases, closely held, or in severe financial
difficulties, we view strong independent boards as a key protection for
shareholder value.
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Election of Directors Case by Case
We support management in most elections. However, we will withhold approval
if the board gives evidence of acting contrary to the best economic
interests of shareholders. We will also withhold approval of individual
director/managers whose remuneration appears to be blatantly excessive and
exploitative of the shareholders.
Classified Board of Directors/Staggered Terms Oppose
A classified board of directors is one that is divided generally into three
classes, each of which is elected for a three-year term, but on a staggered
schedule. At each annual meeting therefore, one-third of the directors
would be subject to reelection.
Our belief is that all directors should be subject to reelection on an
annual basis to discourage entrenchment, and we will most frequently vote
against classification and for management and shareholder proposals to
eliminate classification of the board.
Occasionally, proposals to classify a board of directors will contain a
clause stipulating that directors may be removed only for cause. We will
oppose these proposals.
Confidential Voting Approve
Confidential voting is most often proposed by shareholders as a means of
eliminating undue management pressure on shareholders regarding their vote
on proxy issues.
Cumulative Voting for Directors Case by Case
Cumulative voting allocates one vote for each share of stock held times the
number of directors subject to election. A shareholder may cumulate his/her
votes and cast all of them in favor of a single candidate, or split them
among any combination of candidates. Cumulative voting enables minority
shareholders to secure board representation.
We generally support cumulative voting proposals. However, we may withhold
approval of proposals that further the candidacy of minority shareholders
whose interests do not coincide with our fiduciary responsibility.
Director Compensation Case by Case
We believe that compensation for independent outside directors should be
structured to align the interests of the directors with those of
shareholders, whom they have been elected to represent. To this end, we
have a preference toward compensation packages which are based on the
company's performance and which include stock and stock options.
Independent Board Committees Approve
We believe that a board's nominating, compensation and audit committees
should consist entirely of independent outside directors in order to avoid
conflict of interests. We will therefore normally approve reasonable
shareholder proposals to that effect; an example of an unreasonable request
would be a case where a board consists of only two or three directors.
Majority Independent Board Composition Approve
We will generally support shareholder proposals requesting that the board
consist of majority independent outside directors, as we believe that an
independent board faces fewer conflicts and is best prepared to protect
shareholder interests.
Separation of Chairman and CEO Positions Case by Case
We will support shareholder proposals requesting that the positions of
chairman and CEO be separated if the board is composed of less than a
majority independent directors.
CORPORATE GOVERNANCE
Adjourn Meeting to solicit Additional Votes Oppose
Additional solicitation is costly and could result in coercive pressure on
shareholders, who usually have sufficient information in the proxy
materials to make an informed decision prior to the original meeting date.
Anti-Greenmail Provision Approve
Eliminate Shareholders' Right to Call Special Meeting Oppose
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Increase in Authorized Shares Case by Case
We approve proposals for increases of up to 100%. We will consider larger
increases if a need is demonstrated. We may apply a stricter standard if
the company has no stated use for the additional shares and/or has
previously authorized shares still available for issue. Additionally,
proposals which include shares with unequal voting rights may warrant
opposition.
Indemnification of Directors and Officers Approve
We support the protection of directors and officers against frivolous and
potentially ruinous legal actions, in the belief that failure to do so
might severely limit a company's ability to attract and retain competent
leadership. We will support proposals to provide indemnification which is
limited to coverage of legal expenses.
Liability Insurance of Directors and Officers Approve
Proposals regarding liability insurance for directors and officers often
appear separately from indemnification proposals. We will generally support
insurance against liability for acts committed in an individual's capacity
as a director or officer of a company. However, we withhold approval of
proposals which cover breaches of the duty of loyalty, acts or omissions
not in good faith or which involve intentional misconduct or knowing
violation of law, willful or negligent conduct in connection with the
payment of an unlawful dividend, or any transaction from which the director
derived an improper personal benefit.
Prohibit Shareholder Action Outside Meetings Oppose
Reincorporate Case by Case
Proposals to reincorporate in another state are most frequently motivated
by considerations of anti-takeover protections or cost savings. Where cost
savings are the sole issue, we will favor reincorporation.
In cases where there are significant differences in anti-takeover
protections, we will vote in favor of reincorporation only if shareholder
discretion is not diminished by the change. As state corporation laws are
continuously evolving, such determination requires case by case analysis.
Change of Location of Corporate Headquarters Case by Case
Changes in location of headquarters must have clear economic benefits.
Changing the physical location of headquarters to meet the personal
geographic or lifestyle preferences of senior executives will be opposed.
Require more than simple majority vote to pass proposals. Oppose
ANTI-TAKEOVER
Blank Check Preferred Case by Case
These proposals are for authorization of a class of preferred stock in
which voting rights are not established in advance, but are left to the
discretion of the board of directors on a when issued basis. The authority
is generally viewed as affording the board the ability to place a block of
stock with an investor sympathetic to management, thereby foiling a
takeover bid without reference to a shareholder vote. However, in some
cases it may be used to provide management with the flexibility to
consummate beneficial acquisitions, combinations or financings.
We oppose these proposals as a transfer of authority from shareholders to
the board and a possible entrenchment device. However, if there are few or
no other anti-takeover measures on the books and the company appears to
have a legitimate financing motive for requesting the authority, or has
used blank check preferred stock for past financings, we will approve the
proposal.
Differential Voting Power Oppose
Authorize a class of common having superior voting rights over the existing
common or entitled to elect a majority of the board.
Poison Pill Plans Oppose
Also known as "shareholder rights plans," involve call options to purchase
securities in a target firm on favorable terms. The options are exercisable
only under certain circumstances, usually hostile tender offers. These
plans are not subject to
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shareholder vote. However, the shares required to fund the plan must be
authorized. Since these shares are generally blank check preferred, we
oppose them.
Therefore, these proposals generally only appear on the proxy as
shareholder proposals requesting that existing plans be put to a vote. The
vote is non-binding. We vote in favor of shareholder proposals to rescind
poison pills.
Our policy is to examine these plans individually. Most plans are opposed,
however. We approve most plans which include a "permitted bid" feature.
Permitted bid features have appeared in some Canadian poison pill plans.
They require shareholder ratification of the pill, stipulate a sunset
provision whereby the pill expires unless it is renewed and specify that an
all cash bid for all shares that includes a fairness opinion and evidence
of financing does not trigger the pill, but forces a special meeting at
which the offer is put to a shareholder vote.
Stakeholder Provision Oppose
Stakeholder provisions introduce the concept that the board may consider
the interests of constituencies other than shareholders in the evaluation
of takeover offers.
We believe that this concept is inconsistent with public ownership of
corporations.
MANAGEMENT COMPENSATION
Golden Parachutes Case by Case
Golden parachutes provide for compensation to management in the event of a
change in control. We view this as encouragement to management to consider
proposals which might be beneficial to shareholders, but we are very
sensitive to excess or abuse.
Pay-for-Performance Plans Approve
The Omnibus Budget Reconciliation Act requires companies to link executive
compensation exceeding $1 million to preset performance goals and submit
the plans for shareholder approval in order for such compensation to
qualify for federal tax deductions. The law further requires that such
plans be administered by a compensation committee comprised solely of
outside directors. Because the primary objective of such proposals is to
preserve the deductibility of such compensation, we are biased toward
approval in order to preserve net income. However, proposals which
authorize excessive dilution or provide executives extraordinary windfalls
will be opposed. Moreover, when an objectionable plan is coupled with poor
performance, we will consider withholding votes from compensation committee
members.
OPTION PLANS
We support option plans which provide incentive to directors, managers and
other employees by aligning their economic interests with those of the
shareholders while limiting the transfer of wealth out of the company.
Option plan evaluations are therefore based on the total cost to
shareholders and give effect to the incentive aspects of the plan. We are
wary of over-dilution or not-insignificant shareholder wealth transfer.
MERGERS, ASSET SALES & CAPITAL RESTRUCTURINGS
In reviewing merger and asset sale proposals, our primary concern is with
the best economic interests of shareholders. This does not necessarily
indicate that we will vote in favor of all proposals which provide a market
premium relative to pre-announcement prices. Due to the subjective nature
of the value of individual proposals, transaction-specific characteristics
or conditions may prevail. Factors affecting the voting decision will
likely include transaction consideration relative to intrinsic value,
strategic reason for transaction, board approval/transaction history, and
financial advisors' fairness opinions.
OTHER SHAREHOLDER PROPOSALS
For those shareholder-proposed issues that are not covered specifically
elsewhere.
Shareholder Proposal Requesting a Yearly Report on Director
Attendance at Meetings Approve
Shareholder Proposal Requesting a Minimum Stock Ownership by
Directors Oppose
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Shareholder Proposal to Compensate Directors in Stock Approve
SOCIAL ISSUES
We receive proxies containing shareholder proposals which address social
issues which are varied and tend to shift from year to year. However, our
philosophy in reviewing social proposals is consistent; that is, we vote in
all cases in the best economic interests of our clients.
II. PROCEDURES
A. Instructions to Bank/Broker Custodians
All custodian banks/brokers are to be notified that all proxy voting
materials should be forwarded to SCM upon receipt unless client has other
instructions. This notification typically occurs at the time the account is
opened at the custodian.
B. SCM Administrative Responsibilities for Proxy Voting
All proxy materials from custodian will be directed to Eric Ladley in
Operations. Cathy will delegate and oversee the proxy voting process to a
pool of persons, known as Proxy Administrators, who will in turn process
and vote all proxies.
(1) Upon receipt of proxy materials, the Proxy Administrator will create a
file with the Portfolio Company name and meeting date on the tab. All
proxies and related materials for this particular Portfolio Company will
then be placed in this file until ready to be voted on.
(2) The Proxy Administrator will look to see if the Portfolio Company is
listed on the "Business Relationship List," which is a listing of all
companies with whom SCM has a client or supplier relationship. If the
Portfolio Company is not listed on the Business Relationship List, then
steps (3)-(8) below in this Section B are to be executed. If the Portfolio
Company is listed on the Business Relationship List, then the Proxy
Administrator will execute the process provided in Section C (Treatment of
SCM Conflicts of Interest) and steps (3)-(8) below in this Section B will
not be executed.
(3) The Proxy Administrator will then forward a copy of the proxy and an
annual report to the appropriate member of the Proxy Committee for
instructions, with a request to return by a specific date, along with a
"Proxy Instruction Form" noting the items to be voted on and the voting
deadline. It will continue to be the Proxy Administrator's responsibility
to make sure all proxies are voted on time.
(4) When the Proxy Committee member completes his/her review of the proxy
statement, he/she will complete the "Proxy Instruction Form" which
instructs how to vote and briefly identifies reasons for voting against
management, if applicable. This form will be given to the Proxy
Administrator who will then vote the proxy.
(5) Each proxy is then cross-referenced to make sure the shares we are
voting on are the actual shares we own for that client.
(6) All proxies received from the same company for all clients will be
voted as the original without review by the Proxy Committee member unless
specific client circumstances require otherwise.
(7) After the proxy is voted, all Proxy Instruction Forms will be
maintained in a separate file.
(8) Copies of each proxy are kept in the above mentioned folder along with
a copy of the annual report, Proxy Instruction Form, and other notes
related to each company vote.
C. Treatment of SCM Conflicts of Interest
Occasionally, SCM may have a material business relationship with a Portfolio
Company that could create a conflict of interest with respect to the voting of a
proxy for such Portfolio Company. The following procedures are designed to hand
over the proxy voting responsibility to our clients in the event that such
potential conflicts of interest arise in a particular proxy vote.
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(1) As noted in Section B (SCM Administrative Responsibilities for Proxy
Voting), upon receipt of proxy materials, the Proxy Administrator will
determine if the Portfolio Company is listed on the Business Relationship
List. If the Portfolio Company is listed on the Business Relationship List,
then the Proxy Administrator will execute the process provided in steps
(2)-(4) below in this Section C.
(2) After determining that a Portfolio Company is listed on the Business
Relationship List, the Proxy Administrator will give the proxy materials to
Patrick Rau, who will determine if the proxy should be voted by our
clients. If (1) the relationship is not material or (2) if the issue to be
voted on is not a "case-by-case" issue as provided in Part I of this
document (Voting Policy and Guidelines), then Mr. Rau will return the proxy
materials to the Proxy Administrator, who will then follow the normal proxy
voting procedures in Section B (SCM Administrative Responsibilities for
Proxy Voting), steps (3)-(8).
(3) If (1) the relationship is material and (2) if the issue to be voted on
is a "case-by-case" issue as provided in Part I of this document (Voting
Policy and Guidelines), then Mr. Rau will return the proxy materials to the
Proxy Administrator, who will then mail the proxy ballot to each client,
along with a cover letter explaining the conflict of interest situation.
The client will then vote its own proxy ballot and SCM will not have any
involvement in the voting of that ballot. The Proxy Administrator will make
an entry in the proxy voting database that indicates that the particular
proxy ballot in question was voted by the client due to a conflict of
interest with a SCM business relationship.
(4) For purposes of determining materiality, a relationship is "material"
if it represents at least 1% of SCM revenues in the case of a client
relationship and at least 1% of SCM expenses in the case of a supplier
relationship.
D. Treatment of Personal Conflicts of Interest
From time to time, individuals on the Proxy Committee may have personal
relationships with people connected to the Portfolio Company, including (a)
individual members of the board of directors, (b) candidates for the board of
directors, (c) proponents of proxy proposals, and (d) participants in proxy
contests. Such relationships could create a conflict of interest with respect to
the voting of a proxy. The following procedures are designed to hand over the
proxy voting responsibility to a different member of the Proxy Committee in the
event that such conflicts of interest arise in a particular proxy vote.
(1) Upon receiving proxy materials from the Proxy Administrator, the member
of the Proxy Committee who receives such materials shall determine whether
a personal relationship exists between such member and the following people
connected with the Portfolio Company: (a) individual members of the board
of directors, (b) candidates for the board of directors, (c) proponents of
proxy proposals, and (d) participants in proxy contests. In the event that
such a personal relationship exists, the Proxy Committee member shall
return the proxy materials to Patrick Rau, who shall deliver the materials
to a different Proxy Committee member for voting.
III. THE PROXY COMMITTEE
The Proxy Committee will consist of Brian Walton, Ed Brea, Bob Bridges, Tim
Beyer, Patrick Rau, Will Thompson, Mary Weeks Fountain and Raleigh Shoemaker,
any of whom may act on a proxy issue. Dave Ralston will be the advisory member
and may substitute as necessary.
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