As filed with the Securities and Exchange Commission on September 17, 1997
1940 Act Registration No. 811-8243
1933 Act Registration No. 333-28697
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-1A
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 [X]
Pre-Effective Amendment No. 1
Post-Effective Amendment No.
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 [X]
Amendment No. 1
POTOMAC FUNDS
(Exact name of registrant as specified in charter)
550 Mamaroneck Avenue
Harrison, New York 10528
(Address of principal executive offices)
Registrant's telephone number, including area code: (914) 381-2080
Thomas A. Mulrooney
550 Mamaroneck Avenue
Harrison, New York 10528
(Name and address of agent for service)
Copies to:
Robert J. Zutz, Esq.
Kirkpatrick & Lockhart LLP
1800 Massachusetts Avenue, N.W., 2nd Floor
Washington, D.C. 20036-1800
Telephone: (202) 778-9000
Approximate Date of Proposed Public Offering: As soon as practicable after the
effective date of this Registration Statement.
Pursuant to Rule 24f-2 under the Investment Company Act of 1940, as amended, an
indefinite number of shares of beneficial interest, no par value, is being
registered by this Registration Statement under the Securities Act of 1933, as
amended.
Registrant hereby amends this Registration Statement on such date or dates as
may be necessary to delay its effective date until the Registrant shall file a
further amendment which specifically states that this Registration Statement
shall thereafter become effective in accordance with Section 8(a) of the
Securities Act of 1933 or until the Registration Statement shall become
effective on such date as the Commission, acting pursuant to Section 8(a), may
determine.
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POTOMAC FUNDS
CONTENTS OF REGISTRATION STATEMENT
This registration document is comprised of the following:
Cover Sheet
Contents of Registration Statement
Cross Reference Sheet
Prospectus
Statement of Additional Information
Part C of Form N-1A
Signature Page
Exhibits
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POTOMAC FUNDS
FORM N-1A CROSS-REFERENCE SHEET
PART A ITEM NO. AND CAPTION PROSPECTUS CAPTION
<TABLE>
<CAPTION>
<S> <C> <C>
1. Cover Page Cover Page
2. Synopsis Prospectus Summary; Fees and Expenses of the Funds
3. Condensed Financial Information Not Applicable
4. General Description of Registrant Cover Page; Prospectus Summary; Investment Objectives
and Policies; Special Risk Considerations; Investment
Techniques and Other Investment Policies; General
Information About the Trust
5. Management of the Fund Management and Administration of the Trust
5A. Management's Discussion of Fund Not Applicable
Performance
6. Capital Stock and other Securities Determination of Net Asset Value; Dividends and
Distributions; Taxes
7. Purchase of Securities Being How to Invest in the Funds; Tax-Sheltered Retirement
Offered Plans; Portfolio Transactions and Brokerage
8. Redemption or Repurchase Redeeming Shares (Withdrawals); Exchanges; Procedures
for Redemptions and Exchanges
9. Pending Legal Proceedings Not Applicable
STATEMENT OF ADDITIONAL
PART B ITEM NO. AND CAPTION INFORMATION CAPTION
10. Cover Page Cover Page
11. Table of Contents Table of Contents
12. General Information and History The Potomac Funds
13. Investment Objectives and Investment Policies and Techniques; Investment Restrictions
Policies
14. Management of the Registrant Management of the Trust
15. Control Persons and Principal Not Applicable
Holders of Securities
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16. Investment Advisory and Other Management of the Trust - Investment Adviser; Fund
Services Administrator, Fund Accountant, Transfer Agent and
Custodian; Independent Accountants
17. Brokerage Allocation and Other Portfolio Transactions and Brokerage
Provisions
18. Capital Stock and Other Securities The Potomac Funds
19. Purchase, Redemption and Pricing Determination of Net Asset Value; Dividends, Other
of Securities Being Offered Distributions and Taxes
20. Tax Status Dividends, Other Distributions and Taxes - Taxes
21. Underwriters Management of the Trust - Distributor
22. Calculation of Performance Data Performance Information
23. Financial Statements Financial Statements
</TABLE>
PART C. OTHER INFORMATION
Information required to be included in Part C is set forth under the
appropriate item, so numbered, in Part C of this Registration Statement.
<PAGE>
POTOMAC FUNDS
(LOGO)
PROSPECTUS
100 South Royal Street
Alexandria, Virginia 22314
550 Mamaroneck Avenue
Harrison, New York 10528
(800) 851-0511
The Potomac Funds (the "Trust") is a no-load management investment company, or
mutual fund, which consists of seven separate investment portfolios (the
"Funds"). The Funds are designed principally for experienced investors who
intend to follow a global asset allocation strategy. The Funds are not designed
for inexperienced or less sophisticated investors. An important feature of the
Trust is that it primarily consists of pairs of Funds, one of which attempts to
provide results correlating to a specific index, while the other attempts to
provide inverse performance that is similar to a short position in the specific
index. In particular, the following Funds seek investment results that
correspond over time to the following benchmarks:
FUND BENCHMARK
Potomac Japan/Long Fund Nikkei 225 Stock Average
Potomac Japan/Short Fund Inverse (opposite) of the Nikkei 225 Stock Average
Potomac U.S. Plus Fund 150% of the performance of the Standard & Poor's
500 Composite Stock Price Index[TRADEMARK]
Potomac U.S./Short Fund Inverse (opposite) of the Standard & Poor's
500 Composite Stock Price Index[TRADEMARK]
Potomac OTC Plus Fund 125% of the performance of the Nasdaq 100
Index[TRADEMARK]
Potomac OTC/Short Fund Inverse (opposite) of the Nasdaq 100
Index[TRADEMARK]
The Trust also offers the Potomac U.S. Government Money Market Fund, which seeks
security of principal, current income and liquidity by investing primarily in
money market instruments issued or guaranteed, as to principal and interest, by
the U.S. Government, its agencies or instrumentalities. THIS FUND SEEKS TO
MAINTAIN A CONSTANT $1.00 NET ASSET VALUE PER SHARE, ALTHOUGH THIS CANNOT BE
ASSURED.
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The Funds (other than the Potomac U.S. Government Money Market Fund) may engage
in certain aggressive investment techniques, which include engaging in short
sales and transactions in options and futures contracts. The Potomac U.S. Plus
Fund and the Potomac OTC Plus Fund may use the speculative technique known as
leverage to increase funds available for investment. SEE "Special Risk
Considerations." Investors in the Potomac Japan/Long Fund, Potomac U.S. Plus
Fund and Potomac OTC Plus Fund may experience substantial losses during
sustained periods of falling equity prices. Investors in the Potomac Japan/Short
Fund, Potomac U.S./Short Fund and Potomac OTC/Short Fund may experience
substantial losses during periods of sustained periods of rising equity prices.
None of the Funds alone constitutes a balanced investment plan, and investments
in certain of the Funds involve special risks not traditionally associated with
investment companies, including significant portfolio turnover. SHARES OF THE
POTOMAC U.S. GOVERNMENT MONEY MARKET FUND ARE NOT DEPOSITS OR OBLIGATIONS, OR
GUARANTEED OR ENDORSED BY, THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE
FEDERAL RESERVE BOARD OR ANY OTHER AGENCY. AN INVESTMENT IN THIS FUND IS NEITHER
INSURED NOR GUARANTEED BY THE UNITED STATES GOVERNMENT. SEE "Special Risk
Considerations." There can be no assurance that a Fund will achieve its
investment objective.
Investors should read this Prospectus and retain it for future reference. This
Prospectus is designed to set forth concisely the information an investor should
know about the Trust before investing. A Statement of Additional Information
(`SAI"), dated September __, 1997, containing additional information about the
Trust, has been filed with the Securities and Exchange Commission ("SEC") and is
incorporated herein by reference. A copy of the SAI is available, without
charge, upon request to the Trust at the address or telephone numbers above.
The SEC maintains a Web site (http://www.sec.gov) that contains the SAI,
material incorporated by reference and other information regarding the Funds.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
PROSPECTUS DATED SEPTEMBER __, 1997
2
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TABLE OF CONTENTS
PAGE
PROSPECTUS SUMMARY....................................................... 4
FEES AND EXPENSES OF THE FUNDS........................................... 7
INVESTMENT OBJECTIVES AND POLICIES....................................... 8
SPECIAL RISK CONSIDERATIONS............................................... 13
INVESTMENT TECHNIQUES AND OTHER INVESTMENT POLICIES....................... 16
PORTFOLIO TRANSACTIONS AND BROKERAGE...................................... 21
HOW TO INVEST IN THE FUNDS................................................ 22
TAX-SHELTERED RETIREMENT PLANS............................................ 23
REDEEMING SHARES (WITHDRAWALS)............................................ 23
EXCHANGES................................................................. 24
PROCEDURES FOR REDEMPTIONS AND EXCHANGES.................................. 25
DETERMINATION OF NET ASSET VALUE.......................................... 26
PERFORMANCE INFORMATION................................................... 27
DIVIDENDS AND OTHER DISTRIBUTIONS......................................... 28
TAXES..................................................................... 28
MANAGEMENT AND ADMINISTRATION OF THE TRUST................................ 29
GENERAL INFORMATION ABOUT THE TRUST....................................... 31
3
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PROSPECTUS SUMMARY
THE POTOMAC FUNDS
Each Fund has its own distinct investment objective. There is no guarantee that
any Fund will achieve its investment objective. The investment objectives of the
Funds are as follows.
The POTOMAC JAPAN/LONG FUND ("Japan/Long Fund") seeks to provide investment
returns that correspond to the Nikkei 225 Stock Average ("Nikkei Index"). The
Nikkei Index is a price-weighted index of the 225 largest Japanese companies
listed on the Tokyo Stock Exchange. In attempting to achieve its objective, the
Fund may invest in securities included in that index and may enter into long
positions in Nikkei Index futures contracts, options on such futures contracts
and options on securities and on the Nikkei Index traded on foreign and domestic
exchanges. In addition, the Fund will use forward contracts on Japanese Yen,
futures contracts on Japanese Yen, options on such futures contracts, and
options on Japanese Yen to attempt to eliminate the effect that fluctuations in
the U.S. Dollar/Japanese Yen exchange rate may have on the Fund's net asset
value per share. The Fund also will invest in short-term debt securities.
4
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The POTOMAC JAPAN/SHORT FUND ("Japan/Short Fund") seeks to provide investment
returns that inversely correlate to the performance of the Nikkei Index. If the
Fund is successful in achieving its objective, the net asset value of the Fund
will increase in direct proportion to any decrease in the level of the Nikkei
Index and, conversely, the net asset value of the Fund will decrease in direct
proportion to any increase in the Nikkei Index. In attempting to achieve its
objective, the Fund may enter into short positions in Nikkei Index futures
contracts, options on such futures contracts and options on securities and on
the Nikkei Index traded on foreign and domestic exchanges. In addition, the Fund
will use forward contracts on Japanese Yen, futures contracts on Japanese Yen,
options on such futures contracts, and options on Japanese Yen to attempt to
eliminate the effect that fluctuations in the U.S. Dollar/Japanese Yen exchange
rate may have on the Fund's net asset value per share. The Fund involves special
risks not traditionally associated with investment companies. Investors in this
Fund may experience substantial losses during sustained periods of rising
Japanese equity prices. The Fund also will invest in short-term debt securities.
The POTOMAC U.S. PLUS FUND ("U.S. Plus Fund") seeks to provide investment
returns that correspond to 150% of the performance of the Standard & Poor's 500
Composite Stock Price Index[TRADEMARK] (the "S&P 500 Index"). In attempting to
achieve its objective, the Fund may invest in securities included in that index
and may enter into long positions in stock index futures contracts, options on
stock index futures contracts and options on securities and on stock indices. In
contrast to the returns of a mutual fund that seeks to approximate the return of
the S&P 500 Index, the Fund may produce gains greater than that return during
periods when the prices of securities included in the S&P 500 Index are rising
and below that return during periods when such prices are declining. Investors
in the Fund may experience substantial losses during sustained periods of
falling U.S. equity prices. The Fund also will invest in short-term debt
securities.
The POTOMAC U.S./SHORT FUND ("U.S./Short Fund") seeks to provide investment
returns that inversely correlate to the performance of the S&P 500 Index. If the
Fund is successful in meeting its objective, the Fund's net asset value per
share will increase in direct proportion to any decrease in the level of the S&P
500 Index and, conversely, the net asset value of the Fund will decrease in
direct proportion to any increase in the level of the S&P 500 Index. In seeking
to achieve its objective, the Fund may enter into positions in stock index
futures contracts, options on stock index futures contracts and options on
securities and on stock indices. The Fund involves special risks not
traditionally associated with investment companies. Investors in the Fund may
experience substantial losses during sustained periods of rising U.S. equity
prices. The Fund also will invest in short-term debt securities.
5
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The POTOMAC OTC PLUS FUND ("OTC Plus Fund") seeks to provide investment returns
that correspond to 125% of the performance of the Nasdaq 100 Index[TRADEMARK]
("Nasdaq Index"). The Fund will invest in the securities included in that index,
as well as enter into long positions in stock index futures contracts, options
on such index futures contracts and options on securities and on stock indices.
In contrast to the returns of a mutual fund that seeks to approximate the return
of the Nasdaq Index, the Fund may produce gains greater than that return during
periods when prices of securities in the Nasdaq Index are rising and below that
return during periods when such prices are declining. Investors in the Fund may
experience substantial losses during sustained periods of falling U.S. equity
prices. The Fund also will invest in short-term debt securities.
The POTOMAC OTC/SHORT FUND ("OTC/Short Fund") seeks to provide investment
results that will inversely correlate to the performance of the Nasdaq Index. If
the Fund is successful in meeting its objective, the Fund's net asset value per
share will increase in direct proportion to any decrease in the level of the
Nasdaq Index and, conversely, the net asset value of the Fund will decrease in
direct proportion to any increase in the level of the Nasdaq Index. In seeking
to achieve its objective, the Fund may enter into short positions in stock index
futures contracts, options on stock index futures contracts, and options on
securities and on stock indices. The Fund involves risks not traditionally
associated with investment companies. Investors in the Fund may experience
substantial losses during sustained periods of rising U.S. equity prices. The
Fund also will invest in short-term debt securities.
The POTOMAC U.S. GOVERNMENT MONEY MARKET FUND ("Money Market Fund") seeks to
provide security of principal, current income and liquidity. To achieve its
objective, the Money Market Fund invests primarily in money market instruments
that are issued or guaranteed as to principal and interest by the U.S.
Government, its agencies or instrumentalities, as well as in repurchase
agreements collateralized fully by U.S. Government securities.
Further discussion of each Fund's investment objective and policies and the
risks associated with investing in the Funds may be found under "Investment
Objectives and Policies," "Special Risk Considerations" and "Investment
Techniques and Other Investment Policies" below.
SPECIAL RISK CONSIDERATIONS
Each Fund (except the Money Market Fund) may engage in certain aggressive
investment techniques, which may include engaging in short sales and
transactions in futures contracts and options on securities, stock indices and
futures contracts. As discussed more fully under "Investment Objectives and
Policies," "Special Risk Considerations" and "Investment Techniques and Other
Investment Policies," these techniques are specialized and involve risks not
traditionally associated with investment companies.
6
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The Trust expects that a substantial number of the Funds' investors will be
experienced and will invest in the Funds as part of an asset allocation
investment strategy. These shareholders likely will redeem or exchange their
Fund shares frequently to take advantage of anticipated changes in market
conditions. The strategies employed by investors in the Funds may result in
considerable assets moving in and out of the Funds and, consequently, a high
portfolio turnover rate. A high portfolio turnover rate generally causes a Fund
to incur higher expenses and additional costs and may adversely affect the
ability of a Fund to meet its investment objective.
Investors in the Japan/Long Fund and the Japan/Short Fund should be able to
assume the special risks of investing in foreign securities, which include
possible adverse political and economic developments abroad, fluctuations in
foreign currency values and differing characteristics of foreign economies and
markets.
The U.S. Plus Fund and the OTC Plus Fund may borrow money from banks for
investment purposes, which is a form of leveraging. This leverage may exaggerate
the gains and losses on a Fund's investments and the changes in a Fund's net
asset value per share. Each Fund may borrow money for temporary or emergency
purposes and to meet redemption requests without immediately selling portfolio
securities.
While the Funds do not expect their returns over a twelve-month period to
deviate adversely from their respective current benchmarks by more than 10%,
certain factors may affect each Fund's ability to achieve this correlation.
Under certain circumstances, trading on an exchange may be halted or closed
early, resulting in a Fund being unable to execute buy or sell orders that day.
If that occurs and a Fund needs to execute a high volume of trades on that
trading day, a Fund may incur substantial trading losses.
7
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PURCHASES, REDEMPTIONS, AND EXCHANGES OF TRUST SHARES
The minimum initial investment is $10,000, which can be allocated in any amounts
among the Funds. The shares of each Fund may be purchased and redeemed without
any sales or redemption charges at the net asset value of the Fund next
determined. Exchanges must be for at least the lesser of $1,000 or the entire
account balance for the Fund from which the exchange is made. Shares of any Fund
may be exchanged at any time for shares of any other Fund, on the basis of the
relative net asset values next computed, without charge. Because of the
administrative expense of handling small accounts, the Trust reserves the right
to redeem involuntarily an investor's account, including a retirement account,
that falls below the minimum investment of $10,000 in total value in the Trust
due to redemptions. The Trust reserves the right to modify its minimum
investment requirements and the corresponding amounts below which an involuntary
redemption may be effected. SEE "How to Invest in the Funds," "Redeeming Shares
(Withdrawals)" and "Procedures for Redemptions and Exchanges."
INVESTMENT ADVISER
Rafferty Asset Management, LLC ("Adviser") serves as the investment adviser to
each Fund. The Adviser is a newly created investment adviser and has had no
previous experience advising investment companies. Lawrence C. Rafferty controls
the Adviser.
FEES AND EXPENSES OF THE FUNDS
Shown below are all expenses expected to be incurred by each Fund during its
initial fiscal year. Because each Fund's shares were not offered for sale prior
to the date of this Prospectus, Other Expenses are based on estimated expenses.
ANNUAL FUND OPERATING EXPENSES
Total Fund
Management 12B-1 Other Operating
Fees Fees+ Expenses Expenses
---------- ------ -------- ----------
Japan/Long Fund 0.75% None 0.75% 1.50%
Japan/Short Fund 0.90 None 0.75 1.65
U.S. Plus Fund 0.75 None 0.75 1.50
U.S./Short Fund 0.90 None 0.75 1.65
OTC Plus Fund 0.75 None 0.75 1.50
OTC/Short Fund 0.90 None 0.75 1.65
Money Market Fund 0.50 None 0.50 1.00
- -----------
+ The Funds have adopted a Rule 12b-1 Distribution Plan; however, the Board
of Trustees has not authorized payment of any fees pursuant to such Plan. SEE
"General Information about the Trust - DISTRIBUTION of Fund Shares" below.
8
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EXAMPLE
Assuming a hypothetical investment of $1,000 in each Fund, a 5% annual return,
and redemption at the end of each time period, an investor in each Fund would
pay transaction and operating expenses at the end of each period as follows:
1 YEAR 3 YEARS
------ -------
Japan/Long Fund $15 $47
Japan/Short Fund $17 $52
U.S. Plus Fund $15 $47
U.S./Short Fund $17 $52
OTC Plus Fund $15 $47
OTC/Short Fund $17 $52
Money Market Fund $10 $32
The preceding table of fees and expenses is provided to assist investors in
understanding the various costs and expenses that may be borne directly or
indirectly by an investor in each of the Funds. The assets of the Japan/Short
Fund, the U.S./Short Fund and the OTC/Short Fund may decline in a rising stock
market. During such periods, it is possible that the expense ratio of those
funds may increase. The 5% assumed annual return is for comparison purposes
only. THE FOREGOING EXAMPLES SHOULD NOT BE CONSIDERED A REPRESENTATION OF FUTURE
EXPENSES OR PERFORMANCE. ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN
AND PERFORMANCE MAY BE BETTER OR WORSE THAN THE 5% ANNUAL RETURN ASSUMED IN THE
EXAMPLES. For additional information about the Funds' fees, SEE "Management and
Administration of the Trust" in this Prospectus and in the SAI.
INVESTMENT OBJECTIVES AND POLICIES
GENERAL
The Funds are designed principally for experienced investors who intend to
follow an asset allocation investment strategy. The Funds are not designed for
inexperienced or less sophisticated investors. Except for the Money Market Fund,
each Fund is intended to provide investment exposure to a particular segment of
the domestic or international securities markets. These Funds seek investment
results that correspond over time to a specified benchmark. The terms "long" and
"short" in the Funds' names are not intended to refer to the duration of the
Funds' investment portfolios. The Funds may be used independently or in
combination with each other as part of an overall investment strategy.
Additional funds may be offered by the Trust from time to time.
The Adviser uses a number of investment techniques in an effort to correlate a
Fund's return with the return of its respective benchmark. The Adviser generally
does not use fundamental securities analysis to accomplish such correlation.
Rather, the Adviser primarily uses statistical and quantitative analysis to
determine the investments a Fund makes and techniques it employs. While the
Adviser attempts to minimize any "tracking error" (the statistical measure of
the difference between the investment results of a Fund and the performance of
its benchmark), certain factors will tend to cause a Fund's investment results
to vary from a perfect correlation to its benchmark. The Funds, however, do not
expect that their total returns will vary from their respective current
benchmarks by more than 10% over a twelve-month period. SEE "Special Risk
Considerations - Tracking Error." It is the Funds' policy to pursue their
respective investment objectives regardless of market conditions, to remain
fully invested and not to take defensive positions.
9
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Each Fund's investment objective and certain investment restrictions are
fundamental policies and may not be changed without the affirmative vote of at
least the majority of the outstanding shares of that Fund, as defined in the
Investment Company Act of 1940, as amended (the "1940 Act"). All other
investment policies of the Funds not specified as fundamental may be changed by
the Board of Trustees of the Trust ("Trustees" or the "Board") without
shareholder approval. There can be no assurance that a Fund will achieve its
objective. For a discussion of the instruments a Fund may use, sEE "Investment
Techniques and Other Investment Policies."
THE POTOMAC JAPAN/LONG FUND
The investment objective of the Japan/Long Fund is to provide investment returns
that correspond to the performance of the Nikkei Index. In attempting to achieve
its objective, the Fund may enter into long positions in Nikkei Index futures
contracts, options on such futures contracts and options on securities and on
the Nikkei Index traded on domestic and foreign exchanges. Under the investment
techniques that the Fund employs, the Fund generally will incur a loss if the
price of the underlying security or index decreases between the date of the
employment of the technique and the date on which it terminates the position.
The amount of any gain or loss on these transactions may be affected by any
premium or interest income the Fund pays or receives as a result of the
transaction. The Fund may invest in the shares of individual securities that are
included in its benchmark. The Fund will use forward contracts on Japanese Yen,
futures contracts on Japanese Yen, options on such futures contracts and options
on Japanese Yen to attempt to eliminate the effect that fluctuations in the U.S.
Dollar/Japanese Yen exchange rate may have on the Fund's net asset value per
share. The Fund also may invest in U.S. Government securities in order to
deposit such securities as initial or variation margin, as "cover" for the
investment techniques it employs, as part of a cash reserve and for liquidity
purposes.
THE POTOMAC JAPAN/SHORT FUND
The Japan/Short Fund is intended to allow investors to benefit from anticipated
decreases in the Nikkei Index or to hedge an existing portfolio of Japanese
stocks. The Fund's investment objective is to provide investment results that
will inversely correlate to the performance of the Nikkei Index.
If the Fund achieves a perfect inverse correlation for any single trading day,
the Fund's net asset value per share would increase for that day in direct
proportion to any decrease in the level of the Nikkei Index and, conversely, the
Fund's net asset value per share would decrease for that day in direct
proportion to any increase in the level of the Nikkei Index. For example, if the
Nikkei Index were to decrease by 1% by the close of business on a particular
trading day, investors in the Fund should experience a gain in net asset value
of approximately 1% for that day. Conversely, if the Nikkei Index were to
increase by 1% by the close of business on a particular trading day, investors
in the Fund should experience a loss in net asset value of approximately 1% for
that day.
The Fund intends to pursue its investment objective regardless of market
conditions and does not intend to take defensive positions in anticipation of
rising Japanese equity prices. Consequently, investors in the Fund may
experience substantial losses during sustained periods of rising Japanese equity
prices.
10
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In pursuing its investment objective, the Fund generally does not invest in
traditional equity securities, such as common stock. Rather, the Fund employs
certain investment techniques, including engaging in short sales and entering
into short positions in Nikkei Index futures contracts, options on such futures
contracts, and options on securities and on the Nikkei Index. SEE "Investment
Techniques and Other Investment Policies." Under these techniques, the Fund
generally will incur a loss if the price of the underlying security or index
increases between the date the Fund initially entered into the transaction and
the date on which the Fund terminates its position. The Fund generally will
realize a gain if the underlying security or index declines in price between
those dates. This result is the opposite of what one would expect from a cash
purchase of a long position in a security. In addition, the Fund will use
forward contracts on Japanese Yen, futures contracts on Japanese Yen, options on
such futures contracts and options on Japanese Yen to attempt to eliminate the
effect that fluctuations in the U.S. Dollar/Japanese Yen exchange rate may have
on the Fund's net asset value per share. The Fund also may invest in U.S.
Government securities in order to deposit such securities as initial or
variation margin, as "cover" for the investment techniques it employs, as part
of a cash reserve and for liquidity purposes.
THE POTOMAC U.S. PLUS FUND
The investment objective of the U.S. Plus Fund is to provide investment returns
that correspond to 150% of the performance of the S&P 500 Index. In attempting
to achieve its objective, the Fund may enter into long positions in stock index
futures contracts, options on stock index futures contracts, and options on
securities and on stock indices. Under these techniques, the Fund generally will
incur a loss if the price of the underlying security or index decreases between
the date the Fund initially entered into the transaction and the date on which
the Fund terminates its position. The Fund also may invest in shares of
individual stocks that are included in its benchmark. The Fund also may invest
in U.S. Government securities in order to deposit such securities as initial or
variation margin, as "cover" for the investment techniques it employs, as part
of a cash reserve and for liquidity purposes.
In contrast to a mutual fund that seeks to approximate the return of the S&P 500
Index, the Fund may produce greater returns than such a fund during periods when
the prices of the securities in the S&P 500 Index are rising and lower returns
than such a fund during periods when the price of securities are declining.
Investors in the Fund may experience substantial losses during sustained periods
of falling U.S. equity prices.
THE POTOMAC U.S./SHORT FUND
The U.S./Short Fund is intended to allow investors to benefit from anticipated
decreases in the S&P 500 Index or hedge an existing portfolio of U.S. securities
or mutual fund shares. The Fund's investment objective is to provide investment
results that will inversely correlate to the performance of the S&P 500 Index.
If the Fund achieves a perfect inverse correlation for any single trading day,
the net asset value of the Fund would increase for that day in direct proportion
to any decrease in the level of the S&P 500 Index and, conversely, the net asset
value of the Fund would decrease for that day in direct proportion to any
increase in the level of the S&P 500 Index. For example, if the S&P 500 Index
were to decrease by 1% by the close of business on a particular trading day,
investors in the Fund should experience a gain in net asset value of
approximately 1% for that day. Conversely, if the S&P 500 Index were to increase
by 1% by the close of business on a particular trading day, investors in the
Fund should experience a loss in net asset value of approximately 1% for that
day.
11
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The Fund intends to pursue its investment objective regardless of market
conditions and does not intend to take defensive positions in anticipation of
rising U.S. equity prices. Consequently, investors in the Fund may experience
substantial losses during sustained periods of rising U.S. equity prices.
In pursuing its investment objective, the Fund generally does not invest in
traditional equity securities, such as common stock. Rather, the Fund employs
certain investment techniques, including engaging in short sales and entering
into short positions in stock index futures contracts, options on stock index
futures contracts, and options on securities and on indices. SEE "Investment
Techniques and Other Investment Policies." Under these techniques, the Fund
generally will incur a loss if the price of the underlying security or index
increases between the date the Fund initially entered into the transaction and
the date on which the Fund terminates its position. The Fund generally will
realize a gain if the underlying security or index declines in price between
those dates. This result is the opposite of what one would expect from a cash
purchase of a long position in a security. The Fund also may invest in U.S.
Government securities in order to deposit such securities as initial or
variation margin, as "cover" for the investment techniques it employs, as part
of a cash reserve and for liquidity purposes.
THE POTOMAC OTC PLUS FUND
The investment objective of the OTC Plus Fund is to provide investment results
that correspond to 125% of the performance of the Nasdaq Index. The Fund may not
necessarily hold all 100 stocks included in the Nasdaq Index. Instead, the Fund
may hold representative stocks included in that index or other securities that
the Adviser believes will provide returns that correspond to those of the Nasdaq
Index. The Fund may enter into long positions in stock index futures contracts,
options on stock index futures, and options on securities and on stock indices.
Under these techniques, the Fund generally will incur a loss if the price of the
underlying security or index decreases between the date the Fund initially
entered into the transaction and the date on which the Fund terminates its
position. The Fund also may invest in U.S. Government securities in order to
deposit such securities as initial or variation margin, as "cover" for the
investment techniques it employs, as part of a cash reserve and for liquidity
purposes.
Companies whose securities are traded on the over-the-counter ("OTC") markets,
which include the Nasdaq Stock Market ("Nasdaq"), generally are newer companies
or have smaller market-capitalization than those listed on the New York Stock
Exchange ("NYSE") or the American Stock Exchange ("AMEX"). OTC companies often
have limited product lines or relatively new products or services, and may lack
established markets, experienced management, financial resources or the ability
to raise capital. In addition, the securities of these companies may have
limited marketability and may be more volatile in price than securities of
larger capitalized and widely recognized companies. Among the reasons for the
greater price volatility of securities of certain small OTC companies are less
certain growth prospects of comparably smaller firms, the lower degree of
liquidity in the OTC markets for such securities and the greater sensitivity of
smaller capitalized companies to changing economic conditions than larger
capitalized, exchange-traded stocks. Conversely, the Adviser believes that,
because many of these OTC securities may be overlooked by investors and
undervalued in the marketplace, there is potential for significant capital
appreciation.
In contrast to a mutual fund that seeks to approximate the return of the Nasdaq
Index, the Fund may produce greater returns than such a fund during periods when
the prices of the securities in the Nasdaq Index are rising and lower returns
than such a fund during periods when the price of securities are declining.
Investors in the Fund may experience substantial losses during sustained periods
of falling U.S. equity prices.
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THE POTOMAC OTC/SHORT FUND
The OTC/Short Fund is intended to allow investors to benefit from anticipated
decreases in the Nasdaq Index or hedge an existing portfolio of U.S. securities
or mutual fund shares. The Fund's investment objective is to provide investment
results that will inversely correlate to the performance of the Nasdaq Index.
If the Fund achieves a perfect inverse correlation for any single trading day,
the net asset value of the Fund would increase for that day in direct proportion
to any decrease in the level of the Nasdaq Index and, conversely, the net asset
value of the shares of the Fund would decrease for that day in direct proportion
to any increase in the level of the Nasdaq Index. For example, if the Nasdaq
Index were to decrease by 1% by the close of business on a particular trading
day, investors in the Fund should experience a gain in net asset value of
approximately 1% for that day. Conversely, if the Nasdaq Index were to increase
by 1% by the close of business on a particular trading day, investors in the
Fund should experience a loss in net asset value of approximately 1% for that
day.
The Fund intends to pursue its investment objective regardless of market
conditions and does not intend to take defensive positions in anticipation of
rising U.S. equity prices. Consequently, investors in the Fund may experience
substantial losses during sustained periods of rising equity prices.
In pursuing its investment objective, the Fund generally does not invest in
traditional equity securities, such as common stock. Rather, the Fund employs
certain investment techniques, including engaging in short sales and entering
into short positions in stock index futures contracts, options on stock index
futures contracts, and options on securities and on indices. SEE "Investment
Techniques and Other Investment Policies." Under these transactions, the Fund
generally will incur a loss if the price of the underlying security or index
increases between the date the Fund initially entered into the transaction and
the date on which the Fund terminates its position. The Fund generally will
realize a gain if the underlying security or index declines in price between
those dates. This result is the opposite of what one would expect from a cash
purchase of a long position in a security. The Fund also may invest in U.S.
Government securities in order to deposit such securities as initial or
variation margin, as "cover" for the investment techniques it employs, as part
of a cash reserve and for liquidity purposes.
THE POTOMAC U.S. GOVERNMENT MONEY MARKET FUND
The investment objectives of the Money Market Fund are to provide security of
principal, current income, and liquidity. The Fund seeks to achieve these
objectives by investing in high quality, U.S. dollar-denominated short-term
obligations that have been determined by the Trustees or by the Adviser, subject
to supervision by the Trustees, to present minimal credit risk. The Fund will
invest exclusively in obligations issued or guaranteed by the U.S. Government,
its agencies or instrumentalities ("U.S. Government Securities") and repurchase
agreements that are fully collateralized by such obligations.
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THE BENCHMARKS
THE NIKKEI 225 STOCK AVERAGE. The Nikkei Index is a price-weighted index of 225
top-rated Japanese companies listed in the First Section of the Tokyo Stock
Exchange. The Nikkei Index was first published in 1949.
STANDARD & POOR'S 500 COMPOSITE STOCK PRICE INDEX.[TRADEMARK] Standard & Poor's,
a division of The McGraw-Hill Companies, Inc. ("Standard & Poor's"), selects the
500 stocks comprising the S&P 500 Index on the basis of market values and
industry diversification. Most of the stocks in the S&P 500 Index are issued by
the 500 largest companies, in terms of the aggregate market value of their
outstanding stock, and generally are listed on the NYSE. Standard & Poor's is
not a sponsor of, or in any way affiliated with, the Funds.
NASDAQ 100 INDEX.[TRADEMARK] The Nasdaq Index is a capitalization-weighted index
composed of 100 of the largest non-financial domestic companies listed on the
Nasdaq National Market tier of the Nasdaq. All listed on the index have a
minimum market capitalization of $500 million and an average daily trading
volume of at least 100,000 shares. The Nasdaq Index was created in 1985.
SPECIAL RISK CONSIDERATIONS
Investors should consider the following special notes in determining the
appropriateness of investing in the Funds.
AGGRESSIVE INVESTMENT TECHNIQUES. Each Fund (other than the Money Market Fund)
may engage in certain aggressive investment techniques that may include engaging
in short sales and transactions in futures contracts and options on securities,
securities indices, and futures contracts. The Japan/Long Fund, the Japan/Short
Fund, the U.S. Plus Fund, the U.S./Short Fund and the OTC/Short Fund will use
these techniques primarily in seeking to achieve their investment objectives.
The OTC Plus Fund also will use these techniques in seeking to achieve its
investment objective. In doing so, a significant portion of these Funds' assets
will be held in an account consisting of cash or liquid assets as "cover" for
these investment techniques.
The use of options, futures contracts, options on futures contracts, forward
contracts, swaps, caps, floors and collars, and the investment in indexed
securities, involve special risks, including (1) imperfect or no correlation
between the price of options and futures contracts and the movements in the
price of the underlying securities, indices, or futures contracts, (2) possible
lack of a liquid secondary market for any particular instrument at a particular
time, (3) the fact that the skills needed to use these strategies are different
from those needed to select portfolio securities, (4) losses due to
unanticipated market price movements, (5) incorrect forecasts by the Adviser
concerning interest or currency exchange rates or direction of price
fluctuations of the investment involved in the transaction, which may result in
the strategy being ineffective, (6) loss of premiums paid by a Fund on options
it purchases, and (7) the possible inability of a Fund to purchase or sell a
portfolio security at a time when it would otherwise be favorable for it to do
so, or the possible need for a Fund to sell a portfolio security at a
disadvantageous time, due to the need for the Fund to maintain "cover" or to
segregate assets in connection with such transactions and the possible inability
of a Fund to close out or liquidate its position.
These instruments may increase the volatility of a Fund and may involve a small
investment of cash relative to the magnitude of the risk assumed. In addition,
these instruments could result in a loss if the counterparty to the transaction
does not perform as promised or if there is not a liquid secondary market to
close out a position that a Fund has entered into.
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The ordinary spreads between prices in the cash and futures markets, due to the
differences in the natures of those markets, are subject to distortion. Due to
the possibility of distortion, a correct forecast of general interest rates,
currency exchange rates or stock market trends by the Adviser may still not
result in a successful transaction. The Adviser may be incorrect in its
expectations as to the extent of various interest or currency exchange rates or
stock market movements or the time span within which the movements take place.
Options and futures transactions may increase portfolio turnover rates, which
results in correspondingly greater commission expenses and transaction costs and
may result in certain tax consequences.
New financial products and risk management techniques continue to be developed.
Each Fund may use these instruments and techniques to the extent consistent with
its investment objective and regulatory requirements applicable to investment
companies. For further information regarding these techniques, SEE "Investment
Techniques and Other Investment Policies" below.
PORTFOLIO TURNOVER. The Trust anticipates that investors in the Funds frequently
will redeem Fund shares, as well as exchange their Fund shares for shares of
another Fund. A Fund may have to dispose of certain investments in order to
maintain sufficient liquid assets to meet such redemption and exchange requests,
thereby causing a high portfolio turnover rate. Because each Fund's portfolio
turnover rate will depend largely on the purchase, redemption, and exchange
activity of its investors, it is difficult to estimate what each Fund's actual
turnover rate will be. Based on the formula prescribed by the SEC, the portfolio
turnover rate of each Fund is calculated without regard to securities, including
options and futures contracts, having a maturity of less than one year. The
Japan/Long Fund, the Japan/Short Fund, the U.S. Plus Fund, the U.S./Short Fund,
and the OTC/Short Fund typically will hold most of their investments in options
and futures contracts, which are excluded from the portfolio turnover rate
calculations. If, however, options and futures contracts were included in such
calculation, it is expected that the portfolio turnover rate of each Fund would
be approximately 500%. The OTC Plus Fund, which will invest primarily in common
stocks, is expected to have a similar rate.
A higher portfolio turnover ratio would likely involve correspondingly higher
brokerage commissions and other expenses borne by a Fund. Such higher expenses
can adversely affect the ability of a Fund to achieve its investment objective.
FOREIGN SECURITIES. Investing in foreign companies may involve risks not
typically associated with investing in U.S. companies. The value of securities
denominated in foreign currencies, and of dividends from such securities, can
change significantly when foreign currencies strengthen or weaken relative to
the U.S. Dollar. Foreign securities markets generally have less trading volume
and less liquidity than U.S. markets, and prices in some foreign markets can be
extremely volatile. Many foreign countries lack uniform accounting and
disclosure standards comparable to those that apply to U.S. companies, and it
may be more difficult to obtain reliable information regarding a foreign
issuer's financial condition and operations. In addition, the costs of foreign
investing, including withholding taxes, brokerage commissions and custodial
fees, generally are higher than for U.S.
investments.
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BORROWING. The U.S. Plus Fund and the OTC Plus Fund may borrow money from banks
for investment purposes, which is a form of leveraging. This leverage may
exaggerate the gains and losses on a Fund's investments and on changes in a
Fund's net asset value. Leverage also creates interest expenses -- if those
expenses exceed the return on the transactions that the borrowings facilitate,
the Fund will be in a worse position than if it had not borrowed. The use of the
derivatives in connection with leverage may create the potential for significant
losses.
TRACKING ERROR. While the Funds do not expect that their returns over a
twelve-month period will deviate adversely from their respective benchmarks by
more than 10%, several factors may affect the Funds' ability to achieve this
correlation. Among these factors are: (1) Fund expenses, including brokerage
expenses and commissions (which may be increased by high portfolio turnover);
(2) less than all of the securities in the benchmark being held by a Fund and
securities not included in the benchmark being held by a Fund; (3) an imperfect
correlation between the performance of instruments held by a Fund, such as
futures contracts and options, and the performance of the underlying securities
in the cash market comprising an index; (4) bid-ask spreads (the effect of which
may be increased by portfolio turnover); (5) a Fund holding instruments that are
illiquid or the market for which becomes disrupted; (6) the need to conform a
Fund's portfolio holdings to comply with that Fund's investment restrictions or
policies, or regulatory or tax law requirements and (7) market movements that
run counter to a leveraged Fund's investments (which will cause divergence
between the Fund and its benchmark over time due to the mathematical effects of
leveraging).
Investors should be aware that while index futures and options contracts closely
correlate with the applicable indices over long periods, shorter-term deviation,
such as on a daily basis, does occur with these instruments. As a result, a
Fund's short-term performance will reflect such deviation from its benchmark.
In the case of the Funds' whose net asset values move inversely from their
benchmarks - the Japan/Short Fund, the U.S./Short Fund and the OTC/Short Fund -
the factor of compounding also may lead to tracking error. Even if there is a
perfect inverse correlation between a Fund and the return of its applicable
benchmark on a daily basis, the symmetry between the changes in the benchmark
and the changes in the Fund's net asset value can be altered significantly over
time by a compounding effect. For example, if the Japan/Short Fund achieved a
perfect inverse correlation with the Nikkei Index on every trading day over an
extended period and the level of returns of the Nikkei Index significantly
decreased during that period, a compounding effect for that period would result,
causing an increase on the Japan/Short Fund's net asset value by a percentage
that is somewhat greater than the percentage the Nikkei Index returns decreased.
Conversely, if the Japan/Short Fund maintained a perfect inverse correlation
with the Nikkei Index over an extended period and if the level of returns of the
Nikkei Index significantly increased over that period, a compounding effect
would result, causing a decrease of the Japan/Short Fund's net asset value by a
percentage that would be somewhat less than the percentage the Nikkei Index
returns increased.
TRADING HALTS. All of the Funds, with the exception of the OTC Plus Fund and the
Money Market Fund, typically will hold most of their investments in short-term
options and futures contracts. The major exchanges on which these contracts are
traded, such as the Chicago Mercantile Exchange ("CME"), the Chicago Board of
Options Exchange ("CBOE"), the Singapore International Monetary Exchange
("SIMEX") and the Osaka Securities Exchange, have established limits on how much
an option or futures contract may decline over various time periods within a
day. If an option or futures contract's price declines more than the established
limits, trading is halted on that instrument. If such trading halts are
instituted by an options or futures exchange at the close of a trading day, a
Fund will not be able to execute purchase or sales transactions in the specific
option or futures contracts affected. In such an event, a Fund also would be
unable to accurately price its outstanding contracts. A trading halt at the end
of a business day would constitute an emergency situation under SEC regulations.
A Fund affected by such an emergency would not be able to accept investors'
orders for purchases, redemptions, or exchanges received earlier during the
business day.
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EARLY NASDAQ CLOSINGS. The normal close of trading of securities listed on the
Nasdaq is 4:00 p.m. While an infrequent occurrence, trading on the Nasdaq has
closed as much as 15 minutes prior to the normal close because of computer
systems failures. Early closing of the Nasdaq may result in a Fund, particularly
the OTC Plus Fund and the OTC/Short Fund, being unable to execute buy or sell
orders on the Nasdaq that day. If that occurs and a Fund needs to execute a high
volume of trades late in a trading day, a Fund may incur substantial trading
losses.
INVESTMENT TECHNIQUES AND
OTHER INVESTMENT POLICIES
FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS
Each Fund, other than the Money Market Fund, may purchase and sell stock index
futures contracts and options on such futures contracts. The Japan/Long Fund and
the Japan/Short Fund may also purchase and sell futures contracts on Japanese
Yen and options on such futures contracts. Each Fund, other than the Money
Market Fund, may purchase and sell futures and options thereon as a substitute
for a comparable market position in the underlying securities or currency, to
attempt to hedge or limit the exposure of its position, to create a synthetic
money market position, for certain tax-related purposes and to effect closing
transactions.
A futures contract obligates the seller to deliver (and the purchaser to take
delivery of) the specified security or currency on the expiration date of the
contract. An index futures contract obligates the seller to deliver (and the
purchaser to take) an amount of cash equal to a specific dollar amount times the
difference between the value of a specific index at the close of the last
trading day of the contract and the price at which the agreement is made. No
physical delivery of the underlying securities in the index is made.
When a Fund writes an option on a futures contract, it becomes obligated, in
return for the premium paid, to assume a position in the futures contract at a
specified exercise price at any time during the term of the option. If a Fund
writes a call, it assumes a short futures position. If it writes a put, it
assumes a long futures position. When the Fund purchases an option on a futures
contract, it acquires the right in return for the premium it pays to assume a
position in a futures contract (a long position if the option is a call and a
short position if the option is a put).
Whether a Fund realizes a gain or loss from futures activities depends upon
movements in the underlying security, currency or index. The extent of the
Fund's loss from an unhedged short position in futures contracts or from writing
unhedged call options on futures contracts is potentially unlimited. The Funds
will only purchase and sell futures contracts and options on futures contracts
that are traded on a U.S. exchange or board of trade or, in the case of the
Japan/Long and Japan/Short Funds, also on the Osaka Securities Exchange or
SIMEX.
To the extent that a Fund enters into futures contracts, options on futures
contracts or options on foreign currencies traded on an exchange regulated by
the Commodity Futures Trading Commission ("CFTC"), in each case other than for
BONA FIDE hedging purposes (as defined by the CFTC), the aggregate initial
margin and the premiums required to establish those positions (excluding the
amount by which options are "in-the-money" at the time of purchase) will not
exceed 5% of the liquidation value of the Fund's portfolio, after taking into
account unrealized profits and unrealized losses on any contracts the Fund has
entered into. (In general, a call option on a futures contract is "in-the-money"
if the value of the underlying futures contract exceeds the strike, I.E.,
exercise, price of the call. A put option on a futures contract is
"in-the-money" if the value of the underlying futures contract is exceeded by
the strike price of the put.) This policy does not limit to 5% the percentage of
a Fund's assets that are at risk in futures contracts, options on futures
contracts and currency options.
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OPTIONS ON INDICES, SECURITIES AND CURRENCIES
Each Fund, other than the Money Market Fund, may purchase and sell put and call
options on stock indices and on individual securities. The Japan/Long Fund and
the Japan/Short Fund may also purchase and sell put and call options on Japanese
Yen. Each Fund, other than the Money Market Fund, may purchase and sell put and
call options as a substitute for a comparable market position in the underlying
securities or currency, to attempt to hedge or limit the exposure of its
position, to create a synthetic money market position, for certain tax-related
purposes and to effect closing transactions.
An index fluctuates with changes in the market values of the securities included
in the index. Options on indices give the holder the right to receive an amount
of cash upon exercise of the option. Receipt of this cash amount will depend
upon the closing level of the index upon which the option is based being greater
than (in the case of a call) or less than (in the case of put) the exercise
price of the option. The amount of cash received, if any, will be the difference
between the closing price of the index and the exercise price of the option,
multiplied by a specified dollar multiple. The writer (seller) of the option is
obligated, in return, for the premium received from the purchaser of the option,
to make delivery of this amount to the purchaser. Unlike the option on
securities discussed below, all settlements of index options transactions are in
cash.
Some stock index options are based on a broad market index such as the S&P 500
Index, the NYSE Composite Index or the AMEX Major Market Index, or on a narrower
index such the Philadelphia Stock Exchange Over-the-Counter Index. Options
currently are traded on the CBOE, the AMEX and other exchanges. Options also are
traded in the OTC markets and each Fund may buy and sell both exchange-traded
and OTC options.
Each of the exchanges has established limitations governing the maximum number
of call or put options on the same index that may be bought or written by a
single investor, whether acting alone or in concert with others (regardless of
whether such options are written on the same or different exchanges or are held
or written on one or more accounts or through one or more brokers). Under these
limitations, option positions of all investment companies advised by the same
investment adviser are combined for purposes of these limits. Pursuant to these
limitations, an exchange may order the liquidation of positions and may impose
other sanctions or restrictions. These positions limits may restrict the number
of listed options that a Fund may buy or sell.
By buying a call option on a security or currency, a Fund has the right, in
return for the premium paid, to buy the security or currency underlying the
option at the exercise price. By writing (selling) a call option and receiving a
premium, a Fund becomes obligated during the term of the option to deliver
securities or currency underlying the option at the exercise price if the option
is exercised. By buying a put option, a Fund has the right, in return for the
premium, to sell the security or currency underlying the option at the exercise
price. By writing a put option, a Fund becomes obligated during the term of the
option to purchase the securities or currency underlying the option at the
exercise price.
Because options premiums paid or received by a Fund are small in relation to the
market value of the investments underlying the options, buying and selling put
and call options can be more speculative than investing directly in securities.
FORWARD CONTRACTS AND FOREIGN CURRENCY
Both the Japan/Long Fund and the Japan/Short Fund may enter into forward
currency contracts for the purchase or sale of Japanese Yen at a specified
future date to attempt to eliminate the effect that fluctuations in the U.S.
Dollar/Japanese Yen exchange rate may have on the Fund's net asset value per
share. Forward currency contracts are traded directly between currency traders
(usually large commercial banks) and their customers.
These Funds also may purchase and sell foreign currency and invest in foreign
currency deposits. Currency conversion involves dealer spreads and other costs,
although commissions usually are not charged.
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INDEXED SECURITIES
Each Fund (other than the Money Market Fund) may purchase indexed securities,
which are securities the value of which varies positively or negatively in
relation to the value of other securities, securities indices, currencies or
other financial indicators, consistent with its investment objective. Indexed
securities typically, but not always, are debt securities or deposits whose
value at maturity or coupon rate is determined by reference to a specific
instrument or statistic. The performance of indexed securities depends to a
great extent on the performance of the security, currency or other instrument to
which they are indexed and also may be influenced by interest rate changes in
the United States and abroad. At the same time, indexed securities are subject
to the credit risks associated with the issuer of the security, and their values
may decline substantially if the issuer's creditworthiness deteriorates. Indexed
securities may be more volatile than the underlying instruments.
SWAPS, CAPS, FLOORS AND COLLARS
A Fund (other than the Money Market Fund) may enter into equity swaps, caps,
floors and collars. For example, the Japan/Long Fund, the U.S. Plus Fund and the
OTC Plus Fund may enter into equity swaps where the Fund receives a return based
on the increase in value of a specified index, and pays the counterparty an
amount based on a floating rate of interest, on the notional amount of the swap.
The Japan/Short Fund, the U.S./Short Fund and the OTC/Short Fund may enter into
reverse equity swaps where the Fund receives a floating rate of interest, and
pays an amount equal to the increase in value of a specified index, on the
notional amount of the swap. The Japan/Long Fund and the Japan/Short Fund also
may use swaps, caps, floors and collars where a payment stream is payable in
Japanese Yen or is based on the U.S. Dollar/Japanese Yen exchange rate. Each
Fund (other than the Money Market Fund) may use equity swaps, caps, floors and
collars consistent with its investment objective and also may enter into
offsetting positions.
Swaps involve the exchange by a Fund with another party of their respective
commitments to pay or receive cash flows, E.G., an exchange of payments based on
the increase in value of an equity index for floating interest rate payments.
The purchase of a cap entitles the purchaser, to the extent that a specified
index exceeds a predetermined value, to receive payments on a notional principal
amount from the party selling such cap. The purchase of a floor entitles the
purchaser, to the extent that a specified index falls below a predetermined
value, to receive payments on a notional principal amount from the party selling
such floor. A collar combines elements of buying a cap and selling a floor.
A Fund usually will enter into swaps on a net basis, I.E., the two payment
streams are netted out, with the Fund receiving or paying, as the case may be,
only the net amount of the two payments. If, however, an agreement calls for
payments by a Fund, the Fund must be prepared to make such payments when due.
The creditworthiness of firms with which a Fund enters into swaps, caps, floors
or collars will be monitored by the Adviser in accordance with procedures
adopted by the Trustees. If a firm's creditworthiness declines, the value of an
agreement would be likely to decline, potentially resulting in losses. If a
default occurs by the other party to such transaction, a Fund will have
contractual remedies pursuant to the agreements related to the transaction.
SHORT SALES
The Japan/Short Fund, the U.S./Short Fund and the OTC/Short Fund may engage in
short sales transactions under which the Fund sells a security it does not own.
To complete such a transaction, the Fund must borrow the security to make
delivery to the buyer. The Fund then is obligated to replace the security
borrowed by purchasing the security at the market price at the time of
replacement. The price at such time may be more or less than the price at which
the security was sold by the Fund. Until the security is replaced, the Fund is
required to pay to the lender amounts equal to any dividends that accrue during
the period of the loan. The proceeds of the short sale will be retained by the
broker, to the extent necessary to meet the margin requirements, until the short
position is closed out.
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Until a Fund closes its short position or replaces the borrowed stock, the Fund
will: (1) maintain an account containing cash or liquid assets at such a level
that (a) the amount deposited in the account plus that amount deposited with the
broker as collateral will equal the current value of the stock sold short and
(b) the amount deposited in the account plus the amount deposited with the
broker as collateral will not be less than the market value of the stock at the
time the stock was sold short; or (2) otherwise cover the Fund's short position.
The Japan/Long Fund, the U.S. Plus Fund and the OTC Plus Fund each may engage in
short sales if, at the time of the short sale, the Fund owns or has the right to
acquire an equal amount of the stock being sold at no additional cost ("selling
short against the box").
FOREIGN SECURITIES
The Japan/Long Fund and the Japan/Short Fund may invest in issuers located
outside the United States. These investments may be made by purchasing American
Depository Receipts ("ADRs"), "ordinary shares" or "New York" shares in the
United States. The Japan/Short Fund also may sell these securities short.
ADRs are dollar denominated receipts representing interests in the securities of
a foreign issuer, which securities may not necessarily be denominated in the
same currency as the securities into which they may be converted. ADRs are
receipts typically issued by United States banks and trust companies that
evidence ownership of underlying securities issued by a foreign corporation.
Generally, ADRs in registered form are designed for use in domestic securities
markets and are traded on exchanges or OTC in the United States. Ordinary shares
are shares of foreign issuers that are traded abroad and on a U.S. exchange. New
York shares are shares that a foreign issuer has allocated for trading in the
United States. ADRs, ordinary shares and New York shares all may be purchased
with and sold for U.S. Dollars.
Investing in companies located abroad carries political and economic risks
distinct from those associated with investing in the United States. Foreign
investments may be affected by actions of foreign governments adverse to the
interests of U.S. investors, including the possibility of expropriation or
nationalization of assets, confiscatory taxation, restrictions on U.S.
investment, or on the ability to repatriate assets or to convert currency into
U.S. dollars. There may be a greater possibility of default by foreign
governments or foreign-government sponsored enterprises. Investments in foreign
countries also involve a risk of local political, economic, or social
instability, military action or unrest, or adverse diplomatic developments.
U.S. GOVERNMENT SECURITIES
The Money Market Fund will invest in U.S. Government Securities in pursuit of
its investment objectives. The other Funds may invest in U.S. Government
Securities in order to deposit such securities as initial or variation margin,
as "cover" for the investment techniques they employ, as part of a cash reserve
and for liquidity purposes. U.S. Government Securities include direct
obligations of the U.S. Treasury (such as Treasury bills, Treasury notes and
Treasury bonds).
U.S. Government Securities are high-quality instruments issued or guaranteed as
to principal or interest by the U.S. Treasury or by an agency or instrumentality
of the U.S. Government. Not all U.S. Government Securities are backed by the
full faith and credit of the United States. Some are backed by the right of the
issuer to borrow from the U.S. Treasury; others are backed by discretionary
authority of the U.S. Government to purchase the agencies' obligations; while
others are supported only by the credit of the instrumentality. In the case of
securities not backed by the full faith and credit of the United States, the
investor must look principally to the agency issuing or guaranteeing the
obligation for ultimate repayment.
Yields on short-, intermediate- and long-term U.S. Government Securities are
dependent on a variety of factors, including the general conditions of the money
and bond markets, the size of a particular offering and the maturity of the
obligation. Debt securities with longer maturities tend to produce higher
capital appreciation and depreciation than obligations with shorter maturities
and lower yields. The market value of U.S. Government Securities generally
varies inversely with changes in the market interest rates. An increase in
interest rates, therefore, generally would reduce the market value of a Fund's
portfolio investments in U.S. Government Securities; while a decline in interest
rates generally would increase the market value of a Fund's portfolio
investments in these securities.
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REPURCHASE AGREEMENTS
Under a repurchase agreement, a Fund purchases a U.S. Government Security and
simultaneously agrees to sell the security back to the seller at a mutually
agreed-upon future price and date, normally one day or a few days later. The
resale price is greater than the purchase price, reflecting an agreed-upon
market interest rate during the Fund's holding period. While the maturities of
the underlying securities in repurchase agreement transactions may be more than
one year, the term of each repurchase agreement always will be less than one
year. Each Fund may enter into repurchase agreements with banks that are members
of the Federal Reserve System or securities dealers who are members of a
national securities exchange or are primary dealers in U.S. Government
Securities. The Adviser will monitor the creditworthiness of each firm that is a
party to a repurchase agreement with any Fund. In the event of default or
bankruptcy by the seller, the Fund will liquidate those securities (whose market
value, including accrued interest, must be at least 100% of the amount invested
by the Fund) held under the applicable repurchase agreement, which securities
constitute collateral for the seller's obligation to repurchase the security.
ILLIQUID INVESTMENTS
Each Fund may purchase and hold illiquid investments, including securities that
are not readily marketable and securities that are not registered ("restricted
securities") under the Securities Act of 1933, as amended ("1933 Act'), but
which can be offered and sold to "qualified institutional buyers" pursuant to
Rule 144A under the 1933 Act. A Fund will not invest more than 15% (10% with
respect to the Money Market Fund) of its net assets in illiquid investments. The
term "illiquid investments" for this purpose means investments that cannot be
disposed of within seven days in the ordinary course of business at
approximately the amount at which a Fund has valued the investments. Under the
current SEC staff guidelines, illiquid investments also include purchased OTC
options, certain cover for OTC options, securities involved in swap, cap, floor
and collar transactions, repurchase agreements not terminable in seven days and
restricted securities not determined to be liquid pursuant to guidelines
established by the Trustees.
OTHER INVESTMENT PRACTICES
The U.S. Plus Fund and the OTC Plus Fund may borrow for investment purposes.
Each Fund may borrow money as a temporary measure for extraordinary or emergency
purposes and to meet redemption requests without immediately selling portfolio
securities. In addition, each Fund may lend securities to broker-dealers and
financial institutions, provided that the borrower at all times maintains cash
collateral in an amount equal to at least 100% of the market value of the
securities loaned. Such loans will not be made if, as a result, the aggregate
amount of all outstanding loans by any Fund would exceed 33 1/3% (10% in the
case of the Money Market Fund) of its total assets. For a more detailed
discussion of these practices, see the SAI.
PORTFOLIO TRANSACTIONS
AND BROKERAGE
The Adviser will place orders to execute securities transactions that are
designed to implement each Fund's investment objective and policies. In placing
such orders, the Adviser will seek the most favorable price and efficient
execution available. In order to obtain brokerage and research services,
however, a higher commission sometimes may be paid. Brokerage commissions
normally are paid on exchange-traded securities transactions and on options and
futures transactions.
When selecting a broker or dealer to execute portfolio transactions, the Adviser
considers many factors, including the rate of commission or the size of the
broker-dealer's "spread," the size and difficulty of the order, the nature of
the market for the security, operational capabilities of the broker-dealer and
the research, statistical and economic data furnished by the broker-dealer to
the Adviser. The Adviser may select one broker-dealer over another based on
whether the broker-dealer provides research services to the Adviser.
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HOW TO INVEST IN THE FUNDS
GENERAL
The minimum initial investment is $10,000, which can be allocated in any amounts
among the Funds. The shares of each Fund are offered at the daily public
offering price, which is the net asset value per share next computed after
receipt of the investor's order. SEE "Determination of Net Asset Value." No
sales charges are imposed on initial or subsequent investments in a Fund. The
Trust reserves the right to reject or refuse, at the Trust's discretion, any
order for the purchase of a Fund's shares in part or whole. The minimum amount
for subsequent investments in a Fund is $1,000.
Investments in the Funds may be made (1) through securities dealers who have the
responsibility to transmit orders promptly and who may charge a processing fee
or (2) directly with the Trust either by mail or bank wire transfer to the
Trust's transfer agent, Firstar Trust Company ("Transfer Agent") as described
below.
BY MAIL
You may purchase shares of a Fund directly by completing and signing the Account
Application included with the Prospectus and making out a check payable to
"Potomac Funds". Your investment will be allocated among the Funds as you
specify on the Account Application. Mail the check, along with the completed
Account Application, to Potomac Funds, c/o Firstar Trust Company, P.O. Box 1993,
Milwaukee, Wisconsin 53201-1993.
Completed Account Applications and checks also may be sent by overnight or
express mail. To ensure proper delivery, please use the following address:
Potomac Funds, c/o Firstar Trust Company, Mutual Fund Services, 3rd Floor, 615
East Michigan Street, Milwaukee, Wisconsin 53202.
Third party checks will not by accepted by the Funds. All purchases must be
in U.S. Dollars. A $20.00 fee will be imposed by the Transfer Agent if any
check used for investment in an account does not clear due to insufficient
funds.
BY BANK WIRE TRANSFER
To establish a new account by wire transfer, please call the Transfer Agent at
(800) 851-0511 to obtain a Potomac Funds account number. You must send a
completed Account Application to the Trust at the above address immediately
following the investment. Payment for Fund shares should be wired through the
Federal Reserve System as follows:
Firstar Bank Milwaukee, N.A.
777 East Wisconsin Avenue
Milwaukee, Wisconsin 53202
ABA number 0750-00022
For credit to Firstar Trust Company
Account Number 112-952-137
For further credit to the Potomac Funds
Shareholder name: ______________________________
Shareholder account number:_____________________
Your bank may charge a fee for such services. If the purchase is canceled
because your wire transfer is not received, you may be liable for any the loss
the Trust may incur.
Physical certificates representing a Fund's shares are not issued. Shares of
each Fund are recorded on a register by the Transfer Agent.
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TAX-SHELTERED RETIREMENT PLANS
The Trust offers the following retirement plans that may be funded with
purchases of Fund shares and may allow investors to shelter or defer some of
their income from taxes:
Individual retirement accounts ("IRAs"),
Self-employed individual retirement plans ("Keogh Plans") - defined
contribution plans, and Code section 403(b) plans.
A description of applicable service fees and certain limitations on
contributions and withdrawals, as well as Application Forms are available from
the Trust upon request.
REDEEMING SHARES (WITHDRAWALS)
GENERAL
You may withdraw all or any part of your investment by redeeming Fund shares at
the next determined net asset value per share after receipt of the order. The
amount received will depend on the market value of the investments in a Fund's
portfolio at the time of determination of net asset value. Shares of the Funds
may be redeemed by written request or by telephone to the Transfer Agent subject
to the procedures described below. When you redeem shares over the telephone,
those redemption proceeds will be sent only to your address of record or to a
bank account specified in your Account Application. In addition, redemption
proceeds may be sent by wire transfer to a bank account specified in your
Account Application. The minimum amount of a wire transfer redemption is $5,000.
You will be charged $12.00 for wire redemptions to cover transaction costs.
If you request payment of redemption proceeds to a third party or to a location
other than your address of record or a bank account specified in the Account
Application, your request must be in writing and your signature guaranteed. In
addition, if you request in writing redemption of $100,000 or more, your
signature must be guaranteed. A signature guarantee will be accepted from a
commercial bank, savings association, securities broker or dealer, or credit
union. A notary public cannot provide a signature guarantee.
Payment of redemption proceeds will be made within seven days following a Fund's
receipt of your request for redemption. For investments that have been made by
check, payment on redemption requests may be delayed until the Transfer Agent is
reasonably satisfied that the purchase payment has been collected by the Trust
(which may require up to 10 business days). To avoid redemption delays,
purchases may be made by cashiers or certified check or by direct wire
transfers.
With respect to the U.S. Plus Fund, the U.S./Short Fund, the OTC Plus Fund, the
OTC/Short Fund and the Money Market Fund, the right of redemption may be
suspended or the date of payment postponed for any period during which the NYSE,
the Nasdaq, the CME, or the CBOE, or the Federal Reserve Bank of New York, as
appropriate, is closed (other than customary weekend or holiday closings) or
trading on the NYSE, the Nasdaq, the CME, or the CBOE, as appropriate, is
restricted. With respect to the Japan/Long Fund and the Japan/Short Fund, the
right of redemption may be suspended or the date of payment postponed for any
period during which the SIMEX or the Osaka Securities Exchange is closed (other
than customary weekend or holiday closings) or trading on that exchange is
restricted. In addition, the rights of redemption may be suspended or the date
of payment postponed for any Fund for a period during which an emergency exists
so that disposal of the Fund's investments or the determination of its net asset
value is not reasonably practicable or for a such periods as the SEC, by order,
may permit for protection of a Fund's investors.
DRAFT CHECKS
Checkwriting privileges are available to investors in the Money Market Fund.
With a Money Market Fund checking account, shares may be redeemed simply by
writing a check for $500 or more. The redemption will be made at the net asset
value next determined after the Transfer Agent presents the check to the Money
Market Fund. A check should not be written to close an account. There is a $20
charge for each stop payment request on Money Market Fund checks. You are
subject to the same rules and regulations that banks apply to checking accounts.
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LOW BALANCE ACCOUNTS
Because of the high cost of maintaining accounts with low balances, it is the
Trust's policy to redeem involuntarily Fund shares in any account, including a
retirement account, if the account balance falls below $10,000 in total value in
the Trust. This policy does not apply to accounts that fall below the minimum
balance due to market fluctuations. The Trust will provide 30 days' written
notice to all such shareholders to bring the account balance up to the minimum
investment required or the Trust may redeem shares in the account and pay the
proceeds to the shareholder. A redemption from a tax-qualified retirement plan
may have adverse tax consequences and a shareholder contemplating such a
redemption should consult his or her tax adviser.
EXCHANGES
Shares of a Fund may be exchanged, without any charge, for shares of any other
Fund on the basis of the respective net asset values of the shares involved.
Exchanges may be effected by written request or by telephone to the Transfer
Agent subject to the procedures described below. Exchanges must be for at least
the lesser of $1,000 or the entire account balance for the Fund from which the
exchange is made.
When you exchange shares from one Fund to another, your investment may be
uninvested in shares of a Fund until that Fund's next determined net asset
value. For example, if you exchange shares from the Japan/Short Fund to the U.S.
Plus Fund, your investment will be uninvested from 1:15 a.m., the time the
Japan/Short Fund determines net asset value, until 4:15 p.m., the time the U.S.
Plus Fund next determines its net asset value. See "Determination of Net Asset
Value" below.
PROCEDURES FOR REDEMPTIONS
AND EXCHANGES
GENERAL
In requesting a redemption or exchange, you should provide your account name,
account number, the number of or percentage of shares or the dollar value of
shares to be exchanged or redeemed, as applicable, and the names of the Funds
involved. Exchanges may only be made between identically registered accounts. In
addition, any written request must be signed by a shareholder and all co-owners
of the account with exactly the same name or names used in establishing the
account.
BY MAIL
Requests for redemptions and exchanges may be made in writing and directed to
the Potomac Funds, c/o Firstar Trust Company, P.O. Box 701 Milwaukee, Wisconsin
53201. Any such requests sent overnight or express mail should be directed to
the Potomac Funds, c/o Firstar Trust Company, Mutual Fund Services, 3rd Floor,
615 East Michigan Street, Milwaukee, Wisconsin 53202.
BY TELEPHONE
You may redeem or exchange Funds shares by calling the Transfer Agent at (800)
851-0511. Shares may be redeemed by telephone only if your Account Application
reflects that option. Telephone requests may be made only between 9:00 a.m.,
Eastern time, and the times listed below. For telephone exchanges, the closing
time is the earlier closing time below of the two Funds involved in the
exchange:
Japan/Long Fund 4:00 p.m.
Japan/Short Fund 4:00 p.m.
U.S. Plus Fund 3:40 p.m.
U.S./Short Fund 3:40 p.m.
OTC Plus Fund 3:40 p.m.
OTC/Short Fund 3:40 p.m.
Money Market Fund 4:00 p.m.
TELEPHONE REDEMPTION AND EXCHANGE ORDERS WILL BE ACCEPTED ONLY DURING THE
PERIODS INDICATED ABOVE.
By establishing such telephone services, you authorize the Funds or their agents
to act upon verbal instructions to redeem or exchange Fund shares for any
account for which such service has been authorized. In an effort to prevent
unauthorized or fraudulent telephone transaction requests, the transfer agent
will employ reasonable procedures specified by the Funds to confirm that such
instructions are genuine. For instance, the Transfer Agent will require some
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form of personal identification prior to acting upon telephone instructions,
provide written confirmation after such transactions, and record telephone
instructions. When acting on instructions believed to be genuine, the Trust,
Adviser, Transfer Agent and their trustees, directors, officers and employees
are not liable for any loss resulting from a fraudulent telephone transaction
request and the investor will bear the risk of loss. To the extent that the
Trust, Adviser, Transfer Agent and their trustees, directors, officers and
employees do not employ such procedures, some or all of them may be liable for
losses due to unauthorized or fraudulent transactions. You also should be aware
that telephone redemption or exchanges may be difficult to implement in a timely
manner during periods of drastic economic or markets changes. If such conditions
occur, redemption or exchange orders can be made by mail.
DETERMINATION OF NET ASSET VALUE
The net asset value per share of the U.S. Plus Fund, the U.S./Short Fund, the
OTC Plus Fund and the OTC/Short Fund is determined as of 4:15 p.m. Eastern time,
fifteen minutes after the close of normal trading on the NYSE (currently 4:00
p.m., Eastern time) each day the NYSE is open for business. The net asset value
per share of the Japan/Long Fund and the Japan/Short Fund is determined as of
1:15 a.m., Eastern time, fifteen minutes after the close of normal trading on
the SIMEX (currently 1:00 a.m., Eastern time) each day that exchange is open for
business. The Money Market Fund's net asset value per share is determined as of
1:00 p.m., Eastern time, each day that both the NYSE and the Federal Bank of New
York are open for business.
Purchase, redemption and exchange requests for the Japan/Long Fund and the
Japan/Short Fund properly received by the Transfer Agent by 4:00 p.m., Eastern
time on Monday through Thursday are priced based on the net asset value
determined at 1:15 a.m. Eastern time, 15 minutes after the close of regular
trading on the SIMEX on the following day. Requests received by the Transfer
Agent prior to 4:00 p.m., Eastern time on a Friday will be effected at the net
asset value determined as of the close of regular trading on the SIMEX on the
following Monday.
A Fund's net asset value serves as the basis for the purchase and redemption
price of its shares. The net asset value per share of a Fund is calculated by
dividing the market value of the Fund's securities plus the value of its other
assets, less all liabilities, by the number of outstanding shares of the Fund.
If market quotations are not readily available, a security will be valued at
fair value by the Trustees or by the Adviser using methods established or
ratified by the Trustees.
The Money Market Fund will utilize the amortized cost method in valuing its
portfolio securities. This method involves valuing a security at its cost
adjusted by a constant amortization to maturity of any discount or premium,
regardless of the impact of fluctuating interest rates on the market value of
the instrument. The purpose of this method of calculation is to facilitate the
maintenance of a constant net asset value per share for the Money Market Fund of
$1.00. However, there is no assurance that the $1.00 net asset value per share
will be maintained. For further information on valuing the Money Market Fund's
portfolio securities, SEE "Determination of Net Asset Value" in the SAI.
For purposes of determining net asset value per share of a Fund, options and
futures contracts are valued at the closing prices of the exchanges on which
they trade. The value of a futures contract equals the unrealized gain or loss
on the contract that is determined by marking the contract to the current
settlement price for a like contract acquired on the day on which the futures
contract is being valued. The value of options on futures contracts is
determined based upon the current settlement price for a like option acquired on
the day on which the option is being valued. A settlement price may not be used
for the foregoing purposes if the market makes a limited move with respect to a
particular commodity.
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OTC securities held by a Fund shall be valued at the last sales price or, if no
sales price is reported, the mean of the last bid and asked price is used. The
portfolio securities of a Fund that are listed on national exchanges or foreign
stock exchanges are valued at the last sales price of such securities; if no
sales price is reported, the mean of the last bid and asked price is used. For
valuation purposes, all assets and liabilities initially expressed in foreign
currency values will be converted into U.S. Dollars at the mean between the bid
and offered quotations of such currencies against U.S. Dollars as last quoted by
a recognized dealer. Dividend income and other distributions are recorded on the
ex-distribution date, except for certain dividends from foreign securities that
are recorded as soon as the Trust is informed after the ex-distribution date.
Illiquid securities, securities for which reliable quotations or pricing
services are not readily available, and all other assets not valued in
accordance with the foregoing principles will be valued at their respective fair
value as determined in good faith by, or under procedures established by, the
Trustees, which procedures may include the delegation of certain
responsibilities regarding valuation to the Adviser or the officers of the
Trust. The officers of the Trust report, as necessary, to the Trustees regarding
portfolio valuation determinations. The Trustees, from time to time, will review
these methods of valuation and will recommend changes that may be necessary to
assure that the investments of the Funds are valued at fair value.
PERFORMANCE INFORMATION
TOTAL RETURN
From time to time each Fund may advertise its average annual total return and
compare its performance to that of other mutual funds with similar investment
objectives and to relevant indices. Performance information is computed
separately for those Funds in accordance with the methods discussed below.
Each Fund may include the total return of its shares in advertisements or other
written material. When a Fund advertises the total return of its shares, it will
be calculated for the one-, five-, and ten-year periods or, if such periods have
not yet elapsed, the period since the establishment of that Fund. Total return
is measured by comparing the value of an investment in a Fund at the beginning
of the relevant period to the redemption value of the investment in that Fund at
the end of the period (assuming reinvestment of any dividends capital gain
distributions at net asset value). For more information on Fund performance, SEE
"Performance Information" in the SAI.
YIELD
From time to time the Money Market Fund may advertise "yield" and "effective
yield." The Money Market Fund's yield figure is based on historical earnings and
is not intended to indicate future performance. The yield of the Money Market
Fund refers to the income generated by an investment in the Fund over a
seven-day period. This income is then "annualized." The effective yield is
calculated similarly but, when annualized, the income earned by an investment in
the Fund is assumed to be reinvested. The effective yield will be slightly
higher than the average yield because of the compounding effect of this assumed
reinvestment. SEE "Performance Information - Yield Computations" in the SAI.
DIVIDENDS AND OTHER DISTRIBUTIONS
Each Fund, except the Money Market Fund, intends to distribute to its
shareholders annually any net investment income, net realized capital gains, and
net realized gains from foreign currency transactions. The Money Market Fund
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ordinarily will declare dividends from net investment income on a daily basis
and distribute those dividends monthly. All income dividends and distributions
of net capital gains and net gains from foreign currency transactions, if any,
of each Fund will be automatically reinvested in additional shares of the Fund
at the net asset value calculated on the ex-distribution date, unless you
request otherwise in writing. Dividends and other distributions of a Fund are
taxable to its shareholders, as discussed below under "Taxes," whether the
dividends or other distributions are reinvested in additional shares or are
received in cash. You will receive a statement of your account at least
quarterly.
TAXES
Each Fund is treated as a separate corporation for Federal income tax purposes
and will seek to qualify as a RIC. Because of the investment strategies of each
Fund other than the Money Market Fund, there can be no assurance that any such
Fund will qualify as a RIC. If a Fund so qualifies and satisfies the
distribution requirement under the Code for a taxable year, the Fund will not be
subject to Federal income tax on the part of its investment company taxable
income (generally consisting of net investment income, net short-term capital
gains, and net gains from certain foreign currency transactions) and net capital
gain (the excess of net long-term capital gain over net short-term capital loss)
it distributes to its shareholders for that year. If a Fund fails to qualify as
a RIC for any taxable year, its taxable income, including net capital gain, will
be taxed at corporate income tax rates (up to 35%) and it will not receive a
deduction for distributions to its shareholders.
To qualify as a RIC, a Fund must satisfy certain requirements, including certain
diversification requirements. The investment by a Fund, other than the Money
Market Fund, primarily in options and futures positions entails some risk that
such a Fund might fail to satisfy those diversification requirements because of
some uncertainty regarding the valuation of such positions. For additional
information concerning these requirements, SEE "Dividends, Other Distributions
and Taxes" in the SAI.
If the Trust determines that a Fund will not qualify as a RIC and that Federal
income tax likely will be payable by the Fund for its current taxable year, the
Trust will make a good-faith estimate of the Fund's anticipated tax liability,
which will be accrued as tax expenses, and will establish procedures for the
Fund to reflect that liability in its net asset value per share. Thereafter, the
Trust will determine daily whether it is appropriate to continue to accrue that
tax expense and, if so, will make a good-faith estimate of the amount thereof.
Any amount by which any such accrual is reduced, or the entire amount of the
accrual if the Trust determines that accrual is no longer appropriate, will be
reclassified as a reduction of tax expenses.
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Dividends from a Fund's investment company taxable income, if any, are taxable
to its shareholders as ordinary income (at rates up to 39.6% for individuals),
regardless of whether the dividends are reinvested in Fund shares or received in
cash. Distributions of a Fund's net capital gain, if any, when designated as
such, are taxable to its shareholders as long-term capital gains (at rates of up
to 28% for individuals), regardless of how long they have held their Fund shares
and whether the distributions are reinvested in Fund shares or received in cash.
The Taxpayer Relief Act of 1997 ("Act"), enacted in August 1997, dramatically
changes the taxation of net capital gain, by applying different rates (including
reduced maximum rates of 20%, 18%, 10%, and 8%) thereto depending on the
taxpayer's holding period and marginal rate of Federal income tax. The Act,
however, does not address the application of these rules to distributions by
RICs and instead authorizes the issuance of regulations to do so. Accordingly,
shareholders should consult their tax advisers as to the effect of the Act on
distributions by a Fund to them of net capital gain. Shareholders that are not
subject to tax on their income generally will not be required to pay tax on
distributions. Statements as to the Federal tax status of each Fund's
distributions will be mailed to its shareholders annually. Shareholders should
consult their tax advisers concerning the tax status of a Fund's distributions
in their own states and localities.
If Fund shares are redeemed at a loss after being held for six months or less,
the loss is treated as long-term, instead of short-term, capital loss to the
extent of any capital gain distributions on those shares.
Shareholders are required by law to certify that their taxpayer identification
number ("TIN") is correct and that they are not subject to back-up withholding.
Each Fund is required to withhold 31% of all dividends, capital gain
distributions, and redemption proceeds payable to individuals and certain other
non-corporate shareholders who do not provide the Fund with a correct TIN.
Withholding at that rate also is required from dividends and capital gain
distributions payable to such shareholders who otherwise are subject to backup
withholding.
Because the foregoing only summarizes some of the important tax considerations
affecting the Funds and their shareholders, please see the further discussion in
the SAI. Prospective investors are urged to consult their tax advisers.
MANAGEMENT AND ADMINISTRATION OF THE TRUST
BOARD OF TRUSTEES
The business and affairs of each Fund are managed under the direction of the
Trustees. The Trustees are responsible for the general supervision of the Funds'
business affairs and for exercising all the Funds' powers except those reserved
to the shareholders. The day-to-day operations of the Funds are the
responsibility of the Trust's officers.
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INVESTMENT ADVISER
Rafferty Asset Management, LLC, 550 Mamaroneck Avenue, Harrison, New York 10528,
provides investment advice to the Funds. The Adviser is a newly created
investment adviser and has had no previous experience advising investment
companies. The Adviser was organized as a New York limited liability corporation
in May 1997. Lawrence C. Rafferty owns a controlling interest in the Adviser.
The Adviser manages the investment of the assets of each Fund, in accordance
with its investment objective, policies and limitations, subject to the general
supervision and control of the Trustees and the officers of the Trust. The
Adviser bears all costs associated with providing these advisory services and
the expenses of the Trustees who are affiliated persons of the Adviser. The
Adviser, from its own resources, also may make payments to broker-dealers and
other financial institutions for their expenses in connection with the
distribution of Fund shares, and otherwise currently pays all distribution costs
for Fund shares.
Under an investment agreement between the Trust and the Adviser, dated
September, 1997, each Fund pays the Adviser a fee at an annualized rate, based
on a percentage of its daily net assets: 0.75% for the Japan/Long Fund, the U.S.
Plus Fund, and the OTC Plus Fund; 0.90% for the Japan/Short Fund, the U.S./Short
Fund, and the OTC/Short Fund; and 0.50% for the Money Market Fund.
PORTFOLIO MANAGEMENT
Each Fund, except for the OTC Plus Fund and the OTC/Short Fund, is managed by an
investment committee, which is responsible for the investment activities of the
Funds.
James T. Apple is the portfolio manager for the OTC Plus Fund and the OTC/Short
Fund. From 1992 to December 1993, he was Director of Investments for The
Rushmore Funds, Inc. From February 1994 to May 1997, Mr. Apple was portfolio
manager for the Rydex OTC and U.S. Government Bond Funds. The Rydex OTC Fund,
which seeks to match the performance of the Nasdaq Index, has similar investment
objective and policies as the OTC Plus Fund. At May 15, 1997, that fund had $___
million in assets. As portfolio manager of the Rydex OTC Fund, Mr. Apple had
full discretionary authority over the selection of investments for that fund.
Average annual total returns for the one-year and three-year periods ended May
15, 1997 during which Mr. Apple managed that fund compared with the performance
of the Nasdaq Index were:
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Rydex OTC Nasdaq
Fund Index
--------- ------
One Year 36.91% 34.02%
Three Years 151.61% 150.68%
Historical performance is not indicative of future performance. The Rydex OTC
Fund is a separate fund and its historical performance is not indicative of the
potential performance of the Funds. Share prices and investment returns will
fluctuate reflecting market conditions, as well as changes in company-specific
fundamentals of portfolio securities.
ADMINISTRATOR
The Trust has entered into an Administrative Services Agreement with Firstar
Trust Company ("Administrator") that obligates the Administrator to provide the
Funds with administrative and management services, other than investment
advisory services. As compensation for these services, the Trust pays the
Administrator a fee of .06% of the first $200,000,000 of the Trust's average
daily net assets, .05% of the next $300,000,000 of the Trust's average net
assets, and .03% of the Trust's average net assets in excess of $500,000,000.
Notwithstanding the foregoing, the Administrator's minimum annual fee is
$170,000.
DISTRIBUTOR
First Data Distributors, Inc. ('Distributor") 4400 Computer Drive, Westboro,
Massachusetts 01581, serves as the distributor of the Funds' shares. The
Distributor has entered into dealer agreements with participating dealers who
will distribute shares of the Funds.
TRANSFER AGENT AND CUSTODIAN
Firstar Trust Company, 615 East Michigan Street, Milwaukee, Wisconsin 53202,
serves as the transfer agent and custodian of the portfolio securities of the
Trust.
INDEPENDENT AUDITORS
Price Waterhouse LLP, 100 East Wisconsin Avenue, Suite 1500, Milwaukee,
Wisconsin 53202, are the auditors of and the independent public accountants for
the Trust.
GENERAL INFORMATION ABOUT THE TRUST
ORGANIZATION OF THE TRUST AND VOTING RIGHTS
The Trust was organized as a Massachusetts business trust on June 6, 1997 and
registered with the SEC as an open-end management investment company under the
1940 Act. The Trust may issue unlimited shares of beneficial interest, no par
value, in such separate and distinct series and classes of shares as the
Trustees shall from time to time establish. The shares of beneficial interest of
the Trust presently are divided into seven separate series.
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Fund shares have equal voting rights. Only shares of a particular Fund may vote
on matters affecting that Fund. All shares of the Trust vote on matters
affecting the Trust as a whole and to elect Trustees. Share voting rights are
not cumulative, and shares have no preemptive or conversion rights.
Shares of the Trust are nontransferable.
As a Massachusetts business trust, the Trust is not obligated to conduct annual
shareholder meetings. However, the Trust will hold special shareholder meetings
whenever required to do so under the Federal securities laws or the Trust's
Declaration of Trust or its By-Laws. Shareholders may remove Trustees from
office by votes cast at a special meeting of shareholders. If requested by the
shareholders of at least 10% of the outstanding shares of the Trust, the
Trustees will call a special meeting of shareholders to vote on the removal of a
Trustee and will assist in communications with other shareholders.
FUND EXPENSES
Expenses of the Trust that are not directly attributable to a Fund are typically
allocated among the Funds in proportion to their respective net assets, number
of shareholder accounts, or net sales, where applicable. Each Fund pays all of
its own expenses. These expenses include organizational costs, expenses for
legal accounting and auditing services, preparing (including typesetting and
printing) reports, prospectuses, supplements thereto and notices to its existing
shareholders, advisory and management fees, fees and expenses of the custodian
and transfer and dividend disbursing agents, the distribution fee, the expense
of issuing and redeeming shares, the cost of registering shares under the
Federal and state laws, shareholder meeting and related proxy solicitation
expenses, the fees and out-of-pocket expenses of Trustees who are not affiliated
with the Adviser, insurance, brokerage costs, litigation, and other expenses
properly payable by the Funds.
CLASSIFICATION OF THE FUNDS
Each Fund (other than the Money Market Fund) is a "non-diversified" series of
the Trust pursuant to the 1940 Act. A Fund is considered "non-diversified"
because a relatively high percentage of its assets may be invested the
securities of a limited number of issuers, primarily within same the industry or
economic sector. A non-diversified Fund's portfolio securities, therefore, may
be more susceptible to any single economic, political, or regulatory occurrence
than the portfolio securities of a diversified investment company.
A Fund's classification as a "non-diversified" investment company means that the
proportion of its assets that may be invested in the securities of a single
issuer is not limited by the 1940 Act. Each Fund, however, intends to qualify as
a RIC. This requires, among other things, that each Fund, at the end of each
quarter of its tax year, meet certain diversification standards.
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CONCENTRATION OF INVESTMENTS
The OTC Plus Fund and the OTC/Short Fund generally do not intend to concentrate
more than 25% of their respective investments in a particular industry. However,
because these Funds seek investment results that correspond to 125% and the
inverse, respectively, of the performance of the Nasdaq Index, the Funds may
invest more than 25% of their assets in securities of issuers in one industry.
When a Fund concentrates its investments in an industry, financial, economic,
business and other developments affecting issuers in that industry will have a
greater effect on the Fund than if the Fund had not concentrated its assets in
that industry. Accordingly, the performance of these Funds may be subject to a
greater risk of market fluctuation than that of a fund invested in a wider
spectrum of industries.
DISTRIBUTION OF FUND SHARES
The Funds have adopted a distribution plan (the "Plan") pursuant to Rule 12b-1
under the 1940 Act. The Plan provides that each Fund will compensate the
Distributor for certain expenses incurred in the distribution of that Fund's
shares and the servicing and maintenance of existing Fund shareholder accounts.
However, the Trustees have not authorized payment of any fees pursuant to the
Plan.
MASTER/FEEDER OPTION
The Trust may in the future seek to achieve a Fund's investment objective by
investing all net assets of that Fund ("Feeder Fund") in another investment
company ("Master Fund") having the same investment objective and substantially
the same investment policies and restrictions as those applicable to the Feeder
Fund. It is expected than any such investment company would be managed by the
Adviser in substantially the same manner as the Feeder Fund. If permitted by
applicable laws and policies then in effect, any such investment may be made in
the sole discretion of the Trustees without further approval of shareholders of
the Funds. However, the Funds' shareholders will be given 30 days' prior notice
of any such investment. Such investment would be made only if the Trustees
determine it to be in the best interests of the Funds and their shareholders. In
making that determination, the Trustees will consider, among other things, the
benefits to shareholders and/or the opportunity to reduce costs and achieve
operational efficiencies. No assurance can be given that costs will be
materially reduced if this option is implemented.
SHAREHOLDER INQUIRIES
Shareholder inquiries can be made by telephone to the Trust at (800) 851-0511.
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATION NOT CONTAINED IN THIS PROSPECTUS, OR IN THE SAI INCORPORATED
HEREIN BY REFERENCE, IN CONNECTION WITH THE OFFERING MADE BY THIS PROSPECTUS
AND, IF GIVEN OR MADE, SUCH INFORMATION OR PRESENTATIONS MUST NOT BE RELIED UPON
AS HAVING BEEN AUTHORIZED BY THE TRUST. THIS PROSPECTUS DOES NOT CONSTITUTE AN
OFFERING BY THE TRUST IN ANY JURISDICTION IN WHICH SUCH AN OFFERING MAY NOT
LAWFULLY BE MADE
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POTOMAC FUNDS
STATEMENT OF ADDITIONAL INFORMATION
100 South Royal Street
Alexandria, Virginia 22314
550 Mamaroneck Avenue
Harrison, New York 10528
(800) 851-0511
The Potomac Funds (the "Trust") is a no-load management investment company, or
mutual fund, which consists of seven separate investment portfolios (the
"Funds"). The Funds are designed principally for experienced investors who
intend to follow a global asset allocation strategy. The Funds are not designed
for inexperienced or less sophisticated investors. An important feature of the
Trust is that it primarily consists of pairs of Funds, one of which attempts to
provide results correlating to a specific index, while the other attempts to
provide inverse performance, that is, similar to a short position in the
specific index. In particular, the following Funds seek investment results that
correspond over time to the following benchmarks:
FUND BENCHMARK
Potomac Japan/Long Fund Nikkei 225 Stock Average
Potomac Japan/Short Fund Inverse (opposite) of the Nikkei 225 Stock Average
Potomac U.S. Plus Fund 150% of the performance of the
Standard & Poor's 500 Composite Stock Price
IndexTM
Potomac U.S./Short Fund Inverse (opposite) of the Standard & Poor's 500
Composite Stock Price IndexTM
Potomac OTC Plus Fund 125% of the performance of the Nasdaq 100 Stock
IndexTM
Potomac OTC/Short Fund Inverse (opposite) of the Nasdaq 100 Stock IndexTM
The Trust also offers the Potomac U.S. Government Money Market Fund, which seeks
security of principal, current income and liquidity by investing primarily in
money market instruments issued or guaranteed, as to principal and interest, by
the U.S. Government, its agencies or instrumentalities. THE FUND SEEKS TO
MAINTAIN A CONSTANT $1.00 NET ASSET VALUE PER SHARE, ALTHOUGH THIS CANNOT BE
ASSURED. SHARES OF THIS FUND ARE NOT DEPOSITS OR OBLIGATIONS, OR GUARANTEED OR
ENDORSED BY, THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE
BOARD OR ANY OTHER AGENCY. AN INVESTMENT IN THIS FUND IS NEITHER INSURED NOR
GUARANTEED BY THE UNITED STATES GOVERNMENT.
This Statement of Additional Information is not a prospectus. It should be read
in conjunction with the Trust's Prospectus dated September __, 1997. A copy of
the Prospectus is available, without charge, upon request to the Trust at the
address or telephone numbers above.
STATEMENT OF ADDITIONAL INFORMATION DATED SEPTEMBER __, 1997
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TABLE OF CONTENTS
Page
THE POTOMAC FUNDS........................................................ 3
INVESTMENT POLICIES AND TECHNIQUES....................................... 3
General............................................................... 3
Options, Futures and Other Strategies................................. 3
U.S. Government Securities............................................. 10
Indexed Securities..................................................... 10
American Depository Receipts........................................... 11
Repurchase Agreements.................................................. 11
Borrowing.............................................................. 11
Lending Portfolio Securities........................................... 12
Investments in Other Investment Companies.............................. 12
Illiquid Investments and Restricted Securities......................... 13
Portfolio Turnover..................................................... 13
INVESTMENT RESTRICTIONS................................................... 14
PORTFOLIO TRANSACTIONS AND BROKERAGE...................................... 17
MANAGEMENT OF THE TRUST................................................... 18
Trustees and Officers.................................................. 18
Investment Adviser..................................................... 20
Fund Administrator, Fund Accountant, Transfer Agent and Custodian...... 21
Distributor............................................................ 22
Distribution Plan...................................................... 22
Independent Accountants .............................................. 22
DETERMINATION OF NET ASSET VALUE.......................................... 22
PERFORMANCE INFORMATION................................................... 23
Comparative Information................................................ 24
Total Return Computations.............................................. 24
Yield Computations..................................................... 25
DIVIDENDS, OTHER DISTRIBUTIONS AND TAXES.................................. 26
FINANCIAL STATEMENTS...................................................... 29
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THE POTOMAC FUNDS
The Trust is a Massachusetts business trust organized on June 6, 1997 and is
registered with the Securities and Exchange Commission ("SEC") as an open-end
management investment company under the Investment Company Act of 1940, as
amended ("1940 Act"). The Trust currently consists of seven separate series: the
Potomac Japan/Long Fund ("Japan/Long Fund"), the Potomac Japan/Short Fund
("Japan/Short Fund"), the Potomac U.S. Plus Fund ("U.S. Plus Fund"), the Potomac
U.S./Short Fund ("U.S. Short Fund"), the Potomac OTC Plus Fund ("OTC Plus
Fund"), the Potomac OTC/Short Fund ("OTC/Short Fund") and the Potomac U.S.
Government Money Market Fund ("Money Market Fund") (collectively, the "Funds").
The Trust may offer additional series in the future.
The Funds are designed principally for experienced investors seeking a global
asset allocation vehicle. Except for the Money Market Fund, the Funds provide
investment exposure to various securities markets. Each Fund seeks investment
results that correspond over time to a specific benchmark. The terms "long" and
"short" in the Funds' names are not intended to refer to the duration of the
Funds' investment portfolios. The Funds may be used independently or in
combination with each other as part of an overall strategy.
INVESTMENT POLICIES AND TECHNIQUES
GENERAL
The following information supplements the discussion in the Prospectus of the
investment objective, policies and limitations of each Fund. Please refer to the
sections entitled "Investment Objectives and Policies" and "Investment
Techniques and Other Investment Policies" in the Prospectus for a discussion of
the investment objectives and policies of the Funds. Rafferty Asset Management,
LLC (the "Adviser") serves as each Fund's investment adviser. Capitalized terms
not otherwise defined herein shall have the same meaning as assigned in the
Prospectus.
The Funds may engage in the investment strategies discussed below. There is no
assurance that any of these strategies or any other strategies and methods of
investment available to a Fund will result in the achievement of the Fund's
objectives.
OPTIONS, FUTURES AND OTHER STRATEGIES
GENERAL. As discussed in the Prospectus, each Fund (other than the Money Market
Fund) may use certain options, futures contracts (sometimes referred to as
"futures"), options on futures contracts, forward currency contracts, swaps,
caps, floors and collars (collectively "Financial Instruments") as a substitute
for a comparable market position in the underlying security or currency, to
attempt to hedge or limit the exposure of a Fund's position, to create a
synthetic money market position, for certain tax-related purposes and to effect
closing transactions. Each of the Japan/Long Fund and the Japan/Short Fund also
may purchase and sell Financial Instruments on Japanese Yen to attempt to
eliminate the effect that fluctuations in the U.S. Dollar/Japanese Yen exchange
rate may have on each Fund's net asset value per share.
The use of Financial Instruments is subject to applicable regulations of the
SEC, the several exchanges upon which they are traded and the Commodity
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Futures Trading Commission (the "CFTC"). In addition, a Fund's ability to
use Financial Instruments will be limited by tax considerations. See
"Dividends, Other Distributions and Taxes."
In addition to the instruments, strategies and risks described below and in the
Prospectus, the Adviser may discover additional opportunities in connection with
Financial Instruments and other similar or related techniques. These new
opportunities may become available as the Adviser develops new techniques, as
regulatory authorities broaden the range of permitted transactions and as new
Financial Instruments or other techniques are developed. The Adviser may utilize
these opportunities to the extent that they are consistent with a Fund's
investment objective and permitted by a Fund's investment limitations and
applicable regulatory authorities. The Funds' Prospectus or SAI will be
supplemented to the extent that new products or techniques involve materially
different risks than those described below or in the Prospectus.
SPECIAL RISKS. The use of Financial Instruments involves special considerations
and risks, certain of which are described below. Risks pertaining to particular
Financial Instruments are described in the sections that follow.
(1) Successful use of most Financial Instruments depends upon the Adviser's
ability to predict movements of the overall securities and currency markets,
which requires different skills than predicting changes in the prices of
individual securities. There can be no assurance that any particular strategy
will succeed.
(2) Options and futures prices can diverge from the prices of their underlying
instruments. Options and futures prices are affected by such factors as current
and anticipated short-term interest rates, changes in volatility of the
underlying instrument and the time remaining until expiration of the contract,
which may not affect security prices the same way. Imperfect correlation also
may result from differing levels of demand in the options and futures markets
and the securities markets, from structural differences in how options and
futures and securities are traded, and from imposition of daily price
fluctuation limits or trading halts.
(3) As described below, a Fund might be required to maintain assets as
"cover," maintain segregated accounts or make margin payments when it takes
positions in Financial Instruments involving obligations to third parties (E.G.,
Financial Instruments other than purchased options). If a Fund were unable to
close out its positions in such Financial Instruments, it might be required to
continue to maintain such assets or accounts or make such payments until the
position expired or matured. These requirements might impair a Fund's ability to
sell a portfolio security or make an investment at a time when it would
otherwise be favorable to do so, or require that a Fund sell a portfolio
security at a disadvantageous time. A Fund's ability to close out a position in
a Financial Instrument prior to expiration or maturity depends on the existence
of a liquid secondary market or, in the absence of such a market, the ability
and willingness of the other party to the transaction (the "counterparty") to
enter into a transaction closing out the position. Therefore, there is no
assurance that any position can be closed out at a time and price that is
favorable to a Fund.
COVER. Transactions using Financial Instruments, other than purchased options,
expose a Fund to an obligation to another party. A Fund will not enter into any
such transactions unless it owns either (1) an offsetting ("covered") position
in securities, currencies or other options, futures contracts or forward
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currency contracts, or (2) cash and liquid assets with a value, marked-to-market
daily, sufficient to cover its potential obligations to the extent not covered
as provided in (1) above. Each Fund will comply with SEC guidelines regarding
cover for these instruments and will, if the guidelines so require, set aside
cash or liquid assets in an account with its custodian, Firstar Trust Company
("Custodian"), in the prescribed amount as determined daily.
Assets used as cover or held in an account cannot be sold while the position in
the corresponding Financial Instrument is open, unless they are replaced with
other appropriate assets. As a result, the commitment of a large portion of a
Fund's assets to cover or accounts could impede portfolio management or the
Fund's ability to meet redemption requests or other current obligations.
OPTIONS. The value of an option position will reflect, among other things, the
current market value of the underlying investment, the time remaining until
expiration, the relationship of the exercise price to the market price of the
underlying investment and general market conditions. Options that expire
unexercised have no value.
A Fund may effectively terminate its right or obligation under an option by
entering into a closing transaction. For example, a Fund may terminate its
obligation under a call or put option that it had written by purchasing an
identical call or put option; this is known as a closing purchase transaction.
Conversely, a Fund may terminate a position in a put or call option it had
purchased by writing an identical put or call option; this is known as a closing
sale transaction. Closing transactions permit a Fund to realize profits or limit
losses on an option position prior to its exercise or expiration.
RISKS OF OPTIONS ON SECURITIES. Exchange-traded options in the United States are
issued by a clearing organization affiliated with the exchange on which the
option is listed that, in effect, guarantees completion of every exchange-traded
option transaction. In contrast, over-the-counter ("OTC") options are contracts
between a Fund and its counterparty (usually a securities dealer or a bank) with
no clearing organization guarantee. Thus, when a Fund purchases an OTC option,
it relies on the counterparty from whom it purchased the option to make or take
delivery of the underlying investment upon exercise of the option. Failure by
the counterparty to do so would result in the loss of any premium paid by the
Fund as well as the loss of any expected benefit of the transaction.
A Fund's ability to establish and close out positions in exchange-traded options
depends on the existence of a liquid market. However, there can be no assurance
that such a market will exist at any particular time. Closing transactions can
be made for OTC options only by negotiating directly with the counterparty, or
by a transaction in the secondary market if any such market exists. There can be
no assurance that a Fund will in fact be liable to close out an OTC option
position at a favorable price prior to expiration. In the event of insolvency of
the counterparty, a Fund might be unable to close out an OTC option position at
any time prior to its expiration.
If a Fund were unable to effect a closing transaction for an option it had
purchased, it would have to exercise the option to realize any profit. The
inability to enter into a closing purchase transaction for a covered call option
written by a Fund could cause material losses because the Fund would be unable
to sell the investment used as cover for the written option until the option
expires or is exercised.
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OPTIONS ON INDICES. Puts and calls on indices are similar to puts and calls on
securities or futures contracts except that all settlements are in cash and gain
or loss depends on changes in the index in question rather than on price
movements in individual securities or futures contracts. When a Fund writes a
call on an index, it receives a premium and agrees that, prior to the expiration
date, the purchaser of the call, upon exercise of the call, will receive from
the Fund an amount of cash if the closing level of the index upon which the call
is based is greater than the exercise price of the call. The amount of cash is
equal to the difference between the closing price of the index and the exercise
price of the call times a specified multiple ("multiplier"), which determines
the total value for each point of such difference. When a Fund buys a call on an
index, it pays a premium and has the same rights as to such call as are
indicated above. When a Fund buys a put on an index, it pays a premium and has
the right, prior to the expiration date, to require the seller of the put, upon
the Fund's exercise of the put, to deliver to the Fund an amount of cash if the
closing level of the index upon which the put is based is less than the exercise
price of the put, which amount of cash is determined by the multiplier, as
described above for calls. When a Fund writes a put on an index, it receives a
premium and the purchaser of the put has the right, prior to the expiration
date, to require the Fund to deliver to it an amount of cash equal to the
difference between the closing level of the index and the exercise price times
the multiplier if the closing level is less than the exercise price.
RISKS OF OPTIONS ON INDICES. If a Fund has purchased an index option and
exercises it before the closing index value for that day is available, it runs
the risk that the level of the underlying index may subsequently change. If such
a change causes the exercised option to fall out-of-the-money, the Fund will be
required to pay the difference between the closing index value and the exercise
price of the option (times the applicable multiplier) to the assigned writer.
OTC OPTIONS. Unlike exchange-traded options, which are standardized with respect
to the underlying instrument, expiration date, contract size and strike price,
the terms OTC options (options not traded on exchanges) generally are
established through negotiation with the other party to the option contract.
While this type of arrangement allows a Fund great flexibility to tailor the
option to its needs, OTC options generally involve greater risk than
exchange-traded options, which are guaranteed by the clearing organization of
the exchanges where they are traded.
Generally, OTC foreign currency options used by the Japan/Long Fund and the
Japan/Short Fund are European-style options. This means that the option is
exercisable only immediately prior to its expiration. This is in contrast to
American-style options, which are exercisable at any time prior to the
expiration date of the option.
FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS. No price is paid upon
entering into a futures contract. Instead, at the inception of a futures
contract a Fund is required to deposit "initial margin" in an amount generally
equal to 10% or less of the contract value. Margin also must be deposited when
writing a call or put option on a futures contract, in accordance with
applicable exchange rules. Unlike margin in securities transactions, initial
margin does not represent a borrowing, but rather is in the nature of a
performance bond or good-faith deposit that is returned to the Fund at the
termination of the transaction if all contractual obligations have been
satisfied. Under certain circumstances, such as periods of high volatility, the
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Fund may be required by an exchange to increase the level of its initial margin
payment, and initial margin requirements might be increased generally in the
future by regulatory action.
Subsequent "variation margin" payments are made to and from the futures
commission merchant daily as the value of the futures position varies, a process
known as "marking-to-market." Variation margin does not involve borrowing, but
rather represents a daily settlement of the Fund's obligations to or from a
futures commission merchant. When a Fund purchases an option on a futures
contract, the premium paid plus transaction costs is all that is at risk. In
contrast, when a Fund purchases or sells a futures contract or writes a call or
put option thereon, it is subject to daily variation margin calls that could be
substantial in the event of adverse price movements. If the Fund has
insufficient cash to meet daily variation margin requirements, it might need to
sell securities at a time when such sales are disadvantageous.
Purchasers and sellers of futures contracts and options on futures can enter
into offsetting closing transactions, similar to closing transactions in
options, by selling or purchasing, respectively, an instrument identical to the
instrument purchased or sold. Positions in futures and options on futures
contracts may be closed only on an exchange or board of trade that provides a
secondary market. However, there can be no assurance that a liquid secondary
market will exist for a particular contract at a particular time. In such event,
it may not be possible to close a futures contract or options position.
Under certain circumstances, futures exchanges may establish daily limits on the
amount that the price of a futures contract or an option on a futures contract
can vary from the previous day's settlement price; once that limit is reached,
no trades may be made that day at a price beyond the limit. Daily price limits
do not limit potential losses because prices could move to the daily limit for
several consecutive days with little or no trading, thereby preventing
liquidation of unfavorable positions.
If a Fund were unable to liquidate a futures contract or an option on a futures
position due to the absence of a liquid secondary market or the imposition of
price limits, it could incur substantial losses. The Fund would continue to be
subject to market risk with respect to the position. In addition, except in the
case of purchased options, the Fund would continue to be required to make daily
variation margin payments and might be required to maintain cash or liquid
assets in an account.
RISKS OF FUTURES CONTRACTS AND OPTIONS THEREON. The ordinary spreads between
prices in the cash and futures markets (including the options on futures
market), due to differences in the natures of those markets, are subject to the
following factors, which may create distortions. First, all participants in the
futures market are subject to margin deposit and maintenance requirements.
Rather than meeting additional margin deposit requirements, investors may close
futures contracts through offsetting transactions, which could distort the
normal relationships between the cash and futures markets. Second, the liquidity
of the futures market depends on participants entering into offsetting
transactions rather than making or taking delivery. To the extent participants
decide to make or take delivery, liquidity in the futures market could be
reduced, thus producing distortion. Third, from the point of view of
speculators, the deposit requirements in the futures market are less onerous
than margin requirements in the securities market. Therefore, increased
participation by speculators in the futures market may cause temporary price
distortions.
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FOREIGN CURRENCY STRATEGIES - SPECIAL CONSIDERATIONS. The Japan/Long Fund and
the Japan/Short Fund may use options and futures contracts on Japanese Yen, as
described above, and forward contracts, swaps, caps, floors and collars on
Japanese Yen, as described below.
The value of Financial Instruments on foreign currencies depends on the value of
the underlying currency relative to the U.S. Dollar. Because foreign currency
transactions occurring in the interbank market might involve substantially
larger amounts than those involved in the use of such Financial Instruments, a
Fund could be disadvantaged by having to deal in the odd lot market (generally
consisting of transactions of less than $1 million) for the underlying foreign
currencies at prices that are less favorable than for round lots.
There is no systematic reporting of last sale information for foreign currencies
or any regulatory requirement that quotations available through dealers or other
market sources be firm or revised on a timely basis. Quotation information
generally is representative of very large transactions in the interbank market
and thus might not reflect odd-lot transactions where rates might be less
favorable. The interbank market in foreign currencies is a global,
round-the-clock market. To the extent the U.S. options or futures markets are
closed while the markets for the underlying currencies remain open, significant
price and rate movements might take place in the underlying markets that cannot
be reflected in the markets for the Financial Instruments until they reopen.
Settlement of transactions involving foreign currencies might be required to
take place within the country issuing the underlying currency. Thus, a Fund
might be required to accept or make delivery of the underlying foreign currency
in accordance with any U.S. or foreign regulations regarding the maintenance of
foreign banking arrangements by U.S. residents and might be required to pay any
fees, taxes and charges associated with such delivery assessed in the issuing
country.
FORWARD CURRENCY CONTRACTS. The Japan/Long Fund and the Japan/Short Fund may
enter into forward currency contracts to purchase or sell Japanese Yen for a
fixed amount of U.S. Dollars. A forward currency contract involves an obligation
to purchase or sell a specific currency at a future date, which may by any fixed
number of days (term) from the date of the forward currency contract agreed upon
by the parties, at a price set at the time of the forward currency contract.
These forward currency contracts are traded directly between currency traders
(usually large commercial banks) and their customers.
The cost to a Fund of engaging in forward currency contracts varies with factors
such as the currency involved, the length of the contract period and the market
conditions then prevailing. Because forward currency contracts are usually
entered into on a principal basis, no fees or commissions are involved. When a
Fund enters into a forward currency contract, it relies on the counterparty to
make or take delivery of the underlying currency at the maturity of the
contract. Failure by the counterparty to do so would result in the loss of any
expected benefit of the transaction.
As is the case with futures contracts, purchasers and sellers of forward
currency contracts can enter into offsetting closing transactions, similar to
closing transactions on futures contracts, by selling or purchasing,
respectively, an instrument identical to the instrument purchased or sold.
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Secondary markets generally do not exist for forward currency contracts, with
the result that closing transactions generally can be made for forward currency
contracts only by negotiating directly with the counterparty. Thus, there can be
no assurance that a Fund will in fact be able to close out a forward currency
contract at a favorable price prior to maturity. In addition, in the event of
insolvency of the counterparty, a Fund might be unable to close out a forward
currency contract at any time prior to maturity. In either event, the Fund would
continue to be subject to market risk with respect to the position, and would
continue to be required to maintain a position in securities denominated in the
foreign currency or to maintain cash or liquid assets in a segregated account.
The precise matching of forward currency contract amounts and the value of the
securities involved generally will not be possible because the value of such
securities, measured in the foreign currency, will change after the forward
currency contract has been established. Thus, a Fund might need to purchase or
sell foreign currencies in the spot (cash) market to the extent such foreign
currencies are not covered by forward currency contracts.
COMBINED POSITIONS. A Fund may purchase and write options in combination with
each other, or in combination with futures or forward currency contracts. For
example, a Fund may purchase a put option and write a call option on the same
underlying instrument, in order to construct a combined position whose risk and
return characteristics are similar to selling a futures contract. Another
possible combined position would involve writing a call option at one strike
price and buying a call option at a lower price, in order to reduce the risk of
the written call option in the event of a substantial price increase. Because
combined options positions involve multiple trades, they result in higher
transaction costs and may be more difficult to open and close out.
SWAPS, CAPS, FLOORS AND COLLARS. Swap agreements, including caps, floors and
collars, can be individually negotiated and structured. Swap agreements will
tend to shift a Fund's investment exposure from one type of investment to
another. For example, if a Fund agrees to exchange payments based on a floating
rate of interest for payments based on a specified stock index, the swap
agreement would tend to decrease the Fund's exposure to U.S. interest rates and
increase its exposure to changes in the value of the index. Caps and floors have
an effect similar to buying or writing options.
The creditworthiness of firms with which a Fund enters into swaps, caps, floors
or collars will be monitored by the Adviser in accordance with procedures
adopted by the Trust's Board of Trustees ("Trustees" or the "Board"). If a
default occurs by the other party to such transaction, a Fund will have
contractual remedies pursuant to the agreements related to the transaction.
The net amount of the excess, if any, of a Fund's obligations over its
entitlements with respect to each swap entered into on a net basis will be
accrued on a daily basis and an amount of cash or liquid assets having an
aggregate net asset value at least equal to the accrued excess will be
maintained in an account with the Custodian that satisfies the requirements of
the 1940 Act. Each Fund also will establish and maintain such account with
respect to its total obligations under any swaps that are not entered into on a
net basis and with respect to any caps or floors that are written by the Fund.
The Adviser and the Funds believe that such obligations do not constitute senior
securities under the 1940 Act and, accordingly, will not treat them as being
subject to a Fund's borrowing restrictions.
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U.S. GOVERNMENT SECURITIES
Securities issued or guaranteed by the U.S. Government or its agencies or
instrumentalities ("U.S. Government Securities") include Treasury Bills (which
mature within one year of the date they are issued), Treasury Notes (which have
maturities of one to ten years) and Treasury Bonds (which generally have
maturities of more than 10 years). All such Treasury securities are backed by
the full faith and credit of the United States.
U.S. Government agencies and instrumentalities that issue or guarantee
securities include, but are not limited to, the Federal Housing Administration,
Fannie Mae (formerly, the Federal National Mortgage Association), the Farmers
Home Administration, the Export-Import Bank of the United States, the Small
Business Administration, the Government National Mortgage Association ("Ginnie
Mae"), the General Services Administration, the Central Bank for Cooperatives,
the Federal Home Loan Banks, the Federal Home Loan Mortgage Corporation
("Freddie Mac"), the Farm Credit Banks, the Maritime Administration, the
Tennessee Valley Authority, the Resolution Funding Corporation and the Student
Loan Marketing Association.
Securities issued or guaranteed by U.S. Government agencies and
instrumentalities are not always supported by the full faith and credit of the
United States. Some, such as securities issued by the Federal Home Loan Banks,
are backed by the right of the agency or instrumentality to borrow from the
Treasury. Others, such as securities issued by Fannie Mae, are supported only by
the credit of the instrumentality and by a pool of mortgage assets. If the
securities are not backed by the full faith and credit of the United States, the
owner of the securities must look principally to the agency issuing the
obligation for repayment and may not be able to assert a claim against the
United States in the event that the agency or instrumentality does not meet its
commitment. The Money Market Fund will invest in securities of agencies and
instrumentalities only if the Adviser is satisfied that the credit risk involved
is acceptable.
INDEXED SECURITIES
Each Fund (other than the Money Market Fund) may purchase securities the value
of which varies in relation to the value of other securities, securities
indices, currencies or other financial indicators, consistent with its
investment objective. Indexed securities typically, but not always, are debt
securities or deposits whose value at maturity or coupon rate is determined by
reference to a specific instrument or statistic. Currency-indexed securities
typically are short-term to intermediate-term debt securities whose maturity
values or interest rates are determined by reference to the values of one more
specified foreign currencies, and may offer higher yields than U.S.
Dollar-denominated securities of equivalent issuers. Currency-indexed securities
may be positively or negatively indexed; that is, their maturity value may
increase when the value of a specified foreign currency increases, resulting in
a security that performs similarly to a foreign-denominated instrument, or their
maturity value may decline when the value of a specified foreign currency
increases, resulting in a security whose price characteristics are similar to a
put on the underlying currency.
Recent issuers of indexed securities have included banks, corporations and
certain U.S. Government agencies. Certain indexed securities that are not traded
on an established market may be deemed illiquid. See "Illiquid Investments and
Restricted Securities" below.
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AMERICAN DEPOSITORY RECEIPTS ("ADRS")
ADRs include ordinary shares and New York shares. ADRs may be purchased through
"sponsored" or "unsponsored" facilities. A sponsored facility is established
jointly by the issuer of the underlying security and a depository, whereas a
depository may establish an unsponsored facility without participation by the
issuer of the depository security. Holders of unsponsored depository receipts
generally bear all the costs of such facilities and the depository of an
unsponsored facility frequently is under no obligation to distribute shareholder
communications received from the issuer of the deposited security or to pass
through voting rights to the holders of such receipts of the deposited
securities. ADRs are not necessarily denominated in the same currency as the
underlying securities to which they may be connected. Generally, ADRs in
registered form are designed for use in the U.S. securities market and ADRs in
bearer form are designed for used outside the United States.
REPURCHASE AGREEMENTS
Each Fund may enter into repurchase agreements with banks that are members of
the Federal Reserve System or securities dealers who are members of a national
securities exchange or are primary dealers in U.S. Government Securities.
Repurchase agreements generally are for a short period of time, usually less
than a week. Repurchase agreements with a maturity of more than seven days are
considered to be illiquid investments. No Fund may enter into such a repurchase
agreement if, as a result, more than 15% (10% in the case of the Money Market
Fund) of the value of its net assets would then be invested in such repurchase
agreements and other illiquid investments. See "Illiquid Investments and
Restricted Securities" below.
Each Fund follows certain procedures and guidelines adopted by the Trustees
designed to minimize the risks inherent in such transactions. These procedures
include effecting repurchase transactions only with large, well-capitalized and
well-established institutions whose financial condition will be monitored by the
Adviser. In addition, each Fund will always receive, as collateral, securities
whose market value, including accrued interest, at all times will be at least
equal to 100% of the dollar amount invested by the Fund in each repurchase
agreement. If the seller defaults, a Fund might incur a loss if the value of the
collateral securing the repurchase agreement declines and might incur
disposition costs in connection with liquidating the collateral. In addition, if
bankruptcy or similar proceedings are commenced with respect to the seller of
the security, realization upon the collateral by a Fund may be delayed or
limited.
BORROWING
The U.S. Plus Fund and the OTC Plus Fund may borrow money for investment
purposes. Each Fund may borrow money as a temporary measure for extraordinary or
emergency purposes and to meet redemption requests without immediately selling
portfolio securities.
U.S. PLUS FUND AND OTC PLUS FUND. Borrowing for investment in known as
leveraging. Leveraging investments, by purchasing securities with borrowed
money, is a speculative technique that increases investment risk while
increasing investment opportunity. Leverage may exaggerate changes in a Fund's
net asset value. Although the principal of such borrowings will be fixed, a
Fund's assets may change in value during the time the borrowing is outstanding.
Leverage also creates interest expenses for a Fund. To the extent the income
derived from securities purchased with borrowed funds exceeds the interest a
Fund will have to pay, that Fund's net income will be greater than it would be
if leverage were not used. Conversely, if the income from the assets obtained
with borrowed funds is not sufficient to cover the cost of leveraging, the net
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income of a Fund will be less than it would be if leverage were not used, and
therefore the amount available for distribution to shareholders as dividends
will be reduced.
ALL FUNDS. Each Fund may borrow money to facilitate management of the Fund's
portfolio by enabling the Fund to meet redemption requests when the liquidation
of portfolio instrument would be inconvenient or disadvantageous. Such borrowing
is not for investment purposes and will be repaid by the borrowing Fund
promptly.
As required by the 1940 Act, a Fund must maintain continuous asset coverage
(total assets, including assets acquired with borrowed funds, less liabilities
exclusive of borrowings) of 300% of all amounts borrowed. If at any time the
value of the required asset coverage declines as a result of market fluctuations
or other reasons, a Fund may be required to sell some of its portfolio
investments within three days to reduce the amount of its borrowings and restore
the 300% asset coverage, even though it may be disadvantageous from an
investment standpoint to sell portfolio instruments at that time.
In addition to the foregoing, each Fund may borrow money from a bank as a
temporary measure for extraordinary or emergency purposes in amounts not in
excess of 5% of the value of its total assets. This borrowing is not subject to
the foregoing 300% asset coverage requirement. Each Fund may pledge portfolio
securities as the Adviser deems appropriate in connection with any borrowings.
LENDING PORTFOLIO SECURITIES
Each Fund may lend portfolio securities with a value not exceeding 33 1/3% (10%
in the case of the Money Market Fund) of its total assets to brokers, dealers,
and financial institutions. Borrowers are required continuously to secure their
obligations to return securities on loan from a Fund by depositing any
combination of short-term government securities and cash as collateral with the
Fund. The collateral must be equal to at least 100% of the market value of the
loaned securities, which will be marked to market daily. While a Fund's
portfolio securities are on loan, the Fund continues to receive interest on the
securities loaned and simultaneously earns either interest on the investment of
the collateral or fee income if the loan is otherwise collateralized. The Fund
may invest the interest received and the collateral, thereby earning additional
income. Loans would be subject to termination by the lending Fund on four
business days' notice or by the borrower on one day's notice. Borrowed
securities must be returned when the loan is terminated. Any gain or loss in the
market price of the borrowed securities that occurs during the term of the loan
inures to the lending Fund and that Fund's shareholders. A lending Fund may pay
reasonable finders, borrowers, administrative and custodial fees in connection
with a loan. Each Fund currently has no intention of lending its portfolio
securities.
INVESTMENTS IN OTHER INVESTMENT COMPANIES
Each Fund may invest in the securities of other investment companies to the
extent that such an investment would be consistent with the requirements of the
1940 Act. The Money Market Fund will invest only in those investment companies
that invest in the same quality of investments as the Money Market Fund.
Investments in the securities of other investment companies may involve
duplication of advisory fees and certain other expenses. By investing in another
investment company, a Fund becomes a shareholder of that investment company. As
a result, Fund shareholders indirectly will bear a Fund's proportionate share of
the fees and expenses paid by shareholders of the other investment company, in
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addition to the fees and expenses Fund shareholders directly bear in connection
with the Fund's own operations.
ILLIQUID INVESTMENTS AND RESTRICTED SECURITIES
Each Fund will not purchase or otherwise acquire any security if, as a result,
more than 15% (10% for the Money Market Fund) of its net assets (taken at
current value) would be invested in investments that are illiquid by virtue of
the absence of a readily available market or legal or contractual restrictions
on resale. This policy does not include restricted securities eligible for
resale pursuant to Rule 144A under the Securities Act of 1933, as amended ("1933
Act"), which the Board or the Adviser has determined under Board-approved
guidelines are liquid. None of the Funds, however, currently anticipates
investing in such restricted securities.
The term "illiquid investments" for this purpose means investments that cannot
be disposed of within seven days in the ordinary course of business at
approximately the amount at which a Fund has valued the investments. Investments
currently considered to be illiquid include: (1) repurchase agreements not
terminable within seven days, (2) securities for which market quotations are not
readily available, (3) OTC options and their underlying collateral, (4) bank
deposits, unless they are payable at principal amount plus accrued interest on
demand or within seven days after demand, (5) restricted securities not
determined to be liquid pursuant to guidelines established by the Board, and (6)
securities involved in swap, cap, floor and collar transactions. The assets used
as cover for OTC options written by a Fund will be considered illiquid unless
the OTC options are sold to qualified dealers who agree that the Fund may
repurchase any OTC option it writes at a maximum price to be calculated by a
formula set forth in the option agreement. The cover for an OTC option written
subject to this procedure would be considered illiquid only to the extent that
the maximum repurchase price under the formula exceeds the intrinsic value of
the option.
A Fund may not be able to sell illiquid investments when the Adviser considers
it desirable to do so or may have to sell such investments at a price that is
lower than the price that could be obtained if the investments were liquid. In
addition, the sale of illiquid investments may require more time and result in
higher dealer discounts and other selling expenses than does the sale of
investments that are not illiquid. Illiquid investments also may be more
difficult to value due to the unavailability of reliable market quotations for
such investments, and investment in illiquid investments may have an adverse
impact on net asset value.
Rule 144A under the 1933 Act establishes a "safe harbor" from the registration
requirements of the 1933 Act for resales of certain securities to qualified
institutional buyers. Institutional markets for restricted securities that have
developed as a result of Rule 144A provide both readily ascertainable values for
certain restricted securities and the ability to liquidate an investment satisfy
share redemption orders. An insufficient number of qualified institutional
buyers interested in purchasing Rule 144-eligible securities held by a Fund,
however, could affect adversely the marketability of such portfolio securities
and a Fund may be unable to dispose of such securities promptly or at reasonable
prices.
PORTFOLIO TURNOVER
As discussed in the Prospectus, the Trust anticipates that investors in the
Funds, as part of an asset allocation investment strategy, frequently will
redeem Fund shares, as well as exchange their Fund shares for shares of other
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Funds. A Fund may have to dispose of certain portfolio investments to maintain
sufficient liquid assets to meet such redemption and exchange requests, thereby
causing a high portfolio turnover.
A Fund's portfolio turnover rate is calculated by the value of the securities
purchased or securities sold, excluding all securities whose maturities at the
time of acquisition were one year or less, divided by the average monthly value
of such securities owned during the year. Based on this calculation, instruments
with remaining maturities of less than one year are excluded from the portfolio
turnover rate. Such instruments generally would include futures contracts and
options, since such contracts generally have a remaining maturity of less than
one year. In any given period, all of a Fund's investments may have a remaining
maturity of less than one year; in which case, the portfolio turnover rate for
that period would be equal to zero. However, each Fund's portfolio turnover
rate, except for the Money Market Fund, calculated with all securities whose
maturities were one year or less is anticipated to be unusually high.
INVESTMENT RESTRICTIONS
In addition to the investment policies and limitations described above and
described in the Prospectus, each Fund has adopted the following investment
limitations, which are fundamental policies and may not be changed without the
vote of a majority of the outstanding voting securities of that Fund. Under the
1940 Act, a "vote of the majority of the outstanding voting securities" of a
Fund means the affirmative vote of the lesser of: (1) more than 50% of the
outstanding shares of a Fund or (2) 67% or more of the shares of a Fund present
at a shareholders meeting if more than 50% of the outstanding shares are
represented at the meeting in person or by proxy.
For purposes of the following limitations, all percentage limitations apply
immediately after a purchase or initial investment. Except with respect to
borrowing money, if a percentage limitation is adhered to at the time of the
investment, a later increase or decrease in the percentage resulting from any
change in value or net assets will not result in a violation of such
restrictions. If at any time a Fund's borrowings exceed its limitations due to a
decline in net assets, such borrowings will be reduced promptly to the extent
necessary to comply with the limitation.
EACH FUND HAS ADOPTED THE FOLLOWING FUNDAMENTAL INVESTMENT POLICY that enables
it to invest in another investment company or series thereof that has
substantially similar investment objectives and policies:
Notwithstanding any other limitation, the Fund may invest all of its
investable assets in an open-end management investment company with
substantially the same investment objectives, policies and limitations as
the Fund. For this purpose, "all of the Fund's investable assets" means
that the only investment securities that will be held by the Fund will be
the Fund's interest in the investment company.
EACH FUND, EXCEPT THE MONEY MARKET FUND, HAS ADOPTED THE FOLLOWING INVESTMENT
LIMITATIONS:
A Fund shall not:
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1. Lend any security or make any other loan if, as a result, more than 33 1/3%
of the value of the Fund's total assets would be lent to other parties,
except (1) through the purchase of a portion of an issue of debt securities
in accordance with the Fund's investment objective, policies and limitations,
or (2) by engaging in repurchase agreements with respect to portfolio
securities.
2. Underwrite securities of any other issuer.
3. Purchase, hold, or deal in real estate or oil and gas interests.
4. Issue any senior security (as such term is defined in Section 18(f) of the
1940 Act) (including the amount of senior securities issued by excluding
liabilities and indebtedness not constituting senior securities), except (1)
that the Fund may issue senior securities in connection with transactions in
options, futures, options on futures, forward contracts, swaps, caps, floors,
collars and other similar investments, (2) as otherwise permitted herein and
in Investment Limitations Nos. 5, 7, 8, and (3) the Japan/Short Fund, the
U.S./Short Fund and the OTC/Short Fund may make short sales of securities.
5. Pledge, mortgage, or hypothecate the Fund's assets, except (1) to the extent
necessary to secure permitted borrowings, (2) in connection with the purchase
of securities on a forward-commitment or delayed-delivery basis or the sale
of securities on a delayed-delivery basis, and (3) in connection with
options, futures contracts, options on futures contracts, forward contracts,
swaps, caps, floors, collars and other financial instruments.
6. Invest in physical commodities, except that the Fund may purchase and sell
foreign currency, options, futures contracts, options on futures contracts,
forward contracts, swaps, caps, floors, collars, securities on a
forward-commitment or delayed-delivery basis, and other financial
instruments.
EACH FUND, EXCEPT THE U.S. PLUS FUND AND THE OTC PLUS FUND, HAS ADOPTED THE
FOLLOWING INVESTMENT LIMITATION:
A Fund shall not:
7. Borrow money, except (1) as a temporary measure for extraordinary or
emergency purposes and then only in amounts not to exceed 5% of the value of
the Fund's total assets, (2) in an amount up to 33 1/3% of the value of the
Fund's total assets, including the amount borrowed, in order to meet
redemption requests without immediately selling portfolio securities, (3) to
enter into reverse repurchase agreements, and (4) to lend portfolio
securities. For purposes of this investment limitation, the purchase or sale
of options, futures contracts, options on futures contracts, forward
contracts, swaps, caps, floors, collars and other financial instruments shall
not constitute borrowing.
THE JAPAN/LONG FUND, THE U.S PLUS FUND AND THE OTC PLUS FUND HAVE ADOPTED THE
FOLLOWING INVESTMENT LIMITATION:
A Fund shall not:
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8. Make short sales of portfolio securities or purchase any portfolio securities
on margin but may make short sales "against the box," obtain such short-term
credits as are necessary for the clearance of transactions, and make margin
payments in connection with options, futures contracts, options on futures
contracts, forward contracts, swaps, caps, floors, collars and other
financial instruments.
THE U.S. PLUS FUND AND THE OTC PLUS FUND HAVE ADOPTED THE FOLLOWING INVESTMENT
LIMITATION:
A Fund shall not:
9. Borrow money, except (1) to the extent permitted under the 1940 Act (which
currently limits borrowing to no more than 33 1/3% of the value of the Fund's
total assets), (2) as a temporary measure and then only in amounts not to
exceed 5% of the value of the Fund's total assets, (3) to enter into reverse
repurchase agreements, and (4) to lend portfolio securities. For purposes of
this investment limitation, the purchase or sale of options, futures
contracts, options on futures contracts, forward contracts, swaps, caps,
floors, collars and other financial instruments shall not constitute
borrowing.
EACH FUND, EXCEPT THE OTC PLUS FUND AND THE OTC/SHORT FUND, HAS ADOPTED THE
FOLLOWING INVESTMENT LIMITATION:
A Fund shall not:
10.Invest more than 25% of the value of its total assets in the securities of
issuers in any single industry, provided that there shall be no limitation on
the purchase of obligations issued or guaranteed by the U.S. Government, its
agencies or instrumentalities.
THE OTC PLUS FUND AND THE OTC/SHORT FUND HAVE ADOPTED THE FOLLOWING INVESTMENT
LIMITATION:
A Fund shall not:
11.Invest more than 25% of the value of its total assets in the securities of
issuers in any single industry, except for the software and hardware
industries when the percentage of the securities of either industry
constitute more than 25% of the Nasdaq Index . There shall be no limitation
on the purchase of obligations issued or guaranteed by the U.S. Government,
its agencies or instrumentalities.
THE MONEY MARKET FUND HAS ADOPTED THE FOLLOWING INVESTMENT LIMITATIONS:
The Money Market Fund shall not:
1. Make loans, except through the purchase of qualified debt obligations, loans
of portfolio securities and entry into repurchase agreements.
2. Lend the Fund's portfolio securities in excess of 15% of its total assets.
Any loans of the Fund's portfolio securities will be made according to
guidelines established by the Trustees, including the maintenance of cash
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collateral of the borrower equal at all times to the current market value of
the securities loaned.
3. Underwrite securities of any other issuer.
4. Purchase, hold, or deal in real estate or oil and gas interests.
5. Issue senior securities, except as permitted by the Fund's investment
objective and policies.
6. Purchase or sell physical commodities; PROVIDED, HOWEVER, that this
investment limitation does not prevent the Fund from purchasing and selling
options, futures contracts, options on futures contracts, forward contracts,
swaps, caps, floors, collars and other financial instruments.
7. Invest in securities of other investment companies, except to the extent
permitted under the 1940 Act.
8. Mortgage, pledge, or hypothecate the Money Market Fund's assets except to
secure permitted borrowings or in connection with options, futures contracts,
options on futures contracts, forward contracts, swaps, caps, floors, collars
and other financial instruments. In those cases, the Money Market Fund may
mortgage, pledge, or hypothecate assets having a market value not exceeding
the lesser of the dollar amount borrowed or 15% of the value of total assets
of the Money Market Fund at the time of the borrowing.
9. Make short sales of portfolio securities or purchase any portfolio securities
on margin, except to obtain such short-term credits as are necessary for the
clearance of purchases and sales of securities, provided, HOWEVER, that this
investment limitation does not prevent the Fund from purchasing and selling
options, futures contracts, options on futures contracts, forward contracts,
swaps, caps, floors, collars and other financial instruments.
In addition, the Money Market Fund does not presently intend to purchase and
sell foreign currency, options, futures contracts, options on futures contracts,
forward contracts, swaps, caps, floors and collars.
PORTFOLIO TRANSACTIONS AND BROKERAGE
Subject to the general supervision by the Trustees, the Adviser is responsible
for decisions to buy and sell securities for each Fund, the selection of
brokers-dealers to effect the transactions, and the negotiation of brokerage
commissions, if any. The Adviser expects that the Funds may execute brokerage or
other agency transactions through registered broker-dealers, for a commission,
in conformity with the 1940 Act, the Securities Exchange Act of 1934, as
amended, and the rules and regulations thereunder.
In effecting portfolio transactions for the Funds, the Adviser seeks best
execution of trades either (1) at the most favorable price and efficient
execution of transactions, or (2) with respect to agency transactions, at a
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higher rate of commission if reasonable in relation to brokerage and research
services provided to the Funds or the Adviser. Such services may include the
following: information as to the availability of securities for purchase or
sale; statistical or factual information or opinions pertaining to investment;
wire services; and appraisals or evaluations of portfolio securities. Each Fund
believes that the requirement always to seek the lowest possible commission cost
could impede effective portfolio management and preclude the Fund and the
Adviser from obtaining a high quality of brokerage and research services. In
seeking to determine the reasonableness of brokerage commissions paid in any
transaction, the Adviser relies upon its experience and knowledge regarding
commissions generally charged by various brokers and on its judgment in
evaluating the brokerage and research services received from the broker
effecting the transaction.
The Adviser may use research and services provided to it by brokers in servicing
all the Funds; however, not all such services may be used by the Adviser in
connection with a Fund. While the receipt of such information and services is
useful in varying degrees and generally would reduce the amount of research or
services otherwise performed by the Adviser, this information and these services
are of indeterminable value and would not reduce the Adviser's investment
advisory fee to be paid by the Funds.
Purchases and sales of U.S. Government Securities normally are transacted
through issuers, underwriters or major dealers in U.S. Government Securities
acting as principals. Such transactions are made on a net basis and do not
involve payment of brokerage commissions. The cost of securities purchased from
an underwriter usually includes a commission paid by the issuer to the
underwriters; transactions with dealers normally reflect the spread between bid
and asked prices.
MANAGEMENT OF THE TRUST
TRUSTEES AND OFFICERS
The following table lists the Trustees and officers of the Trust, their age,
business address and principal occupation during the past five years. Unless
otherwise noted, an individual's business address is 550 Mamaroneck Avenue,
Harrison, New York 10528.
Position With Principal Occupation
Name the Trust During Past Five Years
---- --------- ----------------------
Lawrence C. Rafferty* Chief Executive Chairman and Chief Executive
(55) Officer, President, Officer of the Adviser,
Chairman of the 1997-present; Chief Executive
Board of Trustees Officer of Rafferty Companies,
LLC, 1996-present; Chief Executive
Officer of Cohane Rafferty
Securities, Inc., 1987-present
(investment banking); Chief
Executive Officer of Rafferty
Capital Markets, Inc.,
1995-present; Trustee of Fairfield
University.
Jay F. Higgins* (52) Trustee Managing Partner of CloverLeaf
411 West Putnam Street Partners, Inc., 1992-1997
Greenwich, CT 06830 (investment banking).
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Daniel J. Byrne (53) Trustee President and Chief Executive
1325 Franklin Avenue Officer of Byrne Securities
Suite 285 Inc., 1992-present; Partner of
Garden City, NY 11530 Byrne Capital Management llp,
1996-present.
George T. Glisker (50) Trustee President of GTG Securities
1010 Franklin Avenue Corp., April 1997-present (hedge
Garden City, NY 11530 fund); President of New York
Capital Mkts. Inc.
Gerald E. Shanley III Trustee Business Consultant,
(53) 1985-present; Trustee of Estate
12 First Street of Charles S. Payson,
Pelham, NY 10803 1987-present.
James Terry Apple (58) Chief Investment Vice President of the Adviser,
100 S. Royal Street Officer 1997-present; Portfolio Manager
Alexandria, VA 22314 of PADCO Advisors, 1994-1997;
Portfolio Manager of Money
Management Associates, 1992-1993.
Timothy P. Hagan (55) Chief Financial Vice President of the Adviser,
100 S. Royal Street Officer 1997-present; Vice President of
Alexandria, VA 22314 PADCO Advisers, 1993-1997, Vice
President of Money Management
Associates, 1981-1993.
Philip A. Harding (54) Senior Vice President Vice President of the Adviser,
100 S. Royal Street 1997-present; Vice President of
Alexandria, VA 22314 Commerzbank (USA), 1995-1997;
Senior Vice President of Sanwa
Bank (USA), 1992-1995.
Thomas A. Mulrooney Chief Operating Chief Operating Officer of the
(50) Officer Adviser, 1997-present; President
of Rafferty Capital Markets,
1995-1997; Managing Partner of
Cantor Fitzgerald, Inc.,
1993-1995; Executive Vice
President and Director of
Trading for J.J. Kenny Drake,
Inc., 1985-1993.
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Stephen P. Sprague (48) Treasurer, Vice President and Chief
Controller and Financial Officer of the
Assistant Secretary Adviser, 1997-present; Chief
Financial Officer of Rafferty
Companies, LLC, 1994-present;
Chief Accountant--International
Sub., Goldman Sachs & Co.,
1983-1993.
Robert J. Zutz (44) Secretary Partner, Kirkpatrick & Lockhart
1800 Massachusetts Ave. LLP (law firm).
Washington, DC 20036
Joseph C. Neuberger Assistant Secretary Vice President, Firstar Trust
(35) Company,
615 East Michigan 1994-present; Tax Manager with
Street Arthur Andersen LLP, 1984-1994.
Milwaukee, WI 53202
Mary S. Kraft (28) Assistant Secretary Compliance Officer, Firstar
615 East Michigan Trust Company, 1994-present;
Street Audit Senior with Arthur
Milwaukee, WI 53202 Andersen LLP, 1991-1994.
- ------------------
* Messrs. Rafferty and Higgins are deemed to be "interested persons" of the
Trust, as defined by the 1940 Act.
The Trustees and officers of the Trust, as a group, own less than 1% of each
Fund's shares outstanding. The Trust's Declaration of Trust provides that the
Trustees will not be liable for errors of judgment or mistakes of fact or law.
However, they are not protected against any liability to which they would
otherwise be subject by reason of willful misfeasance, bad faith, gross
negligence or reckless disregard of the duties involved in the conduct of their
office.
The Trust will pay the Trustees who are not "interested persons" of the Trust as
defined by the 1940 Act ("Independent Trustees") $500 per meeting of the Board.
The Adviser will pay Mr. Higgins similar compensation per meeting of the Board.
Trustees also are reimbursed for any expenses incurred in attending Board
meetings.
INVESTMENT ADVISER
The Funds' investment adviser, Rafferty Asset Management, LLC, was organized as
a New York limited liability corporation in 1997. The Adviser is a newly
registered investment adviser and has no prior experience advising investment
companies. The Adviser is controlled by Lawrence C. Rafferty.
Under an Investment Advisory Agreement, dated September __, 1997, between the
Trust, on behalf of the Funds, and the Adviser ("Advisory Agreement"), the
Adviser provides a continuous investment program for each Fund's assets in
accordance with its investment objectives, policies and limitations, and
oversees the day-to-day operations of the Funds, subject to the supervision of
the Trustees . The Adviser bears all costs associated with providing these
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advisory services and the expenses of the Trustees who are affiliated with or
interested persons of the Adviser. The Trust bears all other expenses that are
not assumed by the Adviser as described in the Prospectus. The Trust also is
liable for nonrecurring expenses as may arise, including litigation to which a
Fund may be a party. The Trust also may have an obligation to indemnify its
Trustees and officers with respect to any such litigation.
Pursuant to the Advisory Agreement, each Fund pays the Adviser the following fee
at an annual rate based on its average daily net assets of: 0.75% of the
Japan/Long Fund, U.S. Plus Fund and OTC Plus Fund; 0.90% of the Japan/Short
Fund, U.S./Short Fund and OTC/Short Fund; and 0.50% of the Money Market Fund .
The Advisory Agreement was approved by the Trustees (including all Independent
Trustees) and the Adviser, as sole shareholder of each Fund, in compliance with
the 1940 Act. The Advisory Agreement will continue in force for a period of two
years after the date of its approval. The Agreement is renewable thereafter from
year to year with respect to each Fund, so long as its continuance is approved
at least annually (1) by the vote, cast in person at a meeting called for that
purpose, of a majority of those Trustees who are not "interested persons" of the
Adviser or the Trust, or by (2) the majority vote of either the full Board or
the vote of a majority of the outstanding shares of a Fund. The Advisory
Agreement automatically terminates on assignment and is terminable on 60 days'
written notice either by the Trust or the Adviser.
FUND ADMINISTRATOR, FUND ACCOUNTANT, TRANSFER AGENT AND CUSTODIAN Firstar Trust
Company, 615 East Michigan Street, Milwaukee, Wisconsin 53202, provides
administrative, fund accounting, transfer agent and custodian services to the
Funds.
Pursuant to an Administration Servicing Agreement between the Trust and Firstar
Trust Company ("Administrator") dated September __, 1997 ("Service Agreement"),
the Administrator provides the Trust with administrative and management services
(other than investment advisory services). As compensation for these services,
the Trust pays the Administrator a fee of .06% of the first $200,000,000 of the
Trust's average daily net assets , .05% of the next $300,000,000 of the Trust's
average net assets, and .03% of the Trust's average net assets in excess of
$500,000,000. Notwithstanding the foregoing, the Administrator's minimum annual
fee is $170,000.
Pursuant to a Fund Accounting Servicing Agreement between the Trust and Firstar
Trust Company ("Fund Accountant") dated September __, 1997, the Fund Accountant
provides the Trust with accounting services, including portfolio accounting
services, tax accounting services and furnishing financial reports. For these
services, the Trust pays the Fund Accountant a flat fee of $25,000 for the first
$40 million of average daily net assets for each the Japan/Long, Japan/Short,
OTC/Short and Money Market Funds; and $22,000 for the first $40 million of
average daily net assets for each the U.S. Plus, U.S./Short and OTC Plus Funds.
The Fund Accountant also is entitled to certain out-of-pocket expenses,
including pricing expenses.
Pursuant to a Custodian Agreement, Firstar Trust Company ("Custodian") also
serves as the Custodian of the Funds' assets. Under the terms of the Custodian
Agreement, the Custodian holds and administers the assets in the Funds'
portfolios.
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<PAGE>
DISTRIBUTOR
First Data Distributors, Inc., 4400 Computer Drive, Westboro, Massachusetts
01581, serves as the distributor ("Distributor") in connection with the offering
of each Fund's shares on a no-load basis. The Distributor receives from the
Adviser a minimum fee of $10,000 plus .01% of the first $1 billion of the
Trust's average daily net assets and out-of-pocket expenses for distributing the
shares of the Funds.
DISTRIBUTION PLAN
Rule 12b-1 under the 1940 Act provides that an investment company may bear
expenses of distributing its shares only pursuant to a plan adopted in
accordance with the Rule. The Trustees have adopted such a plan (the "Plan") for
each Fund pursuant to which the Funds would compensate the Distributor for
certain expenses incurred in the distribution of that Fund's shares and the
servicing and maintenance of existing Fund shareholder accounts. Pursuant to the
Plan, a Fund may pay the Distributor a service fee of up to 0.25% and a
distribution fee of up to 0.75% of the Fund's average daily net assets. However,
the Trustees have not authorized payment of any fees pursuant to the Plan. The
Trustees will authorize such payments only when they believe that there is a
reasonable likelihood that the Plan will benefit each Fund and its shareholders.
If the Trustees do authorize payment of fees pursuant to the Plan, the Trustees
will review quarterly and annually a written report provided by the Treasurer of
the amounts expended under the Plan and the purposes for which such expenditures
were made.
The Plan will continue in effect, with respect to a Fund, from year to year as
long as its continuance is approved annually by either the Trustees or by a vote
of a majority of the outstanding voting securities of that Fund. In either case,
to continue, the Plan must be approved by the vote of a majority of Independent
Trustees. The Plan can be terminated, with respect to a Fund, at any time by a
vote of a majority of the Independent Trustees or by a vote of a majority of the
outstanding voting securities of that Fund.
INDEPENDENT ACCOUNTANTS
Price Waterhouse LLP, 100 East Wisconsin Avenue, Suite 1500, Milwaukee,
Wisconsin 53202, are the auditors and the independent accountants for the Trust.
DETERMINATION OF NET ASSET VALUE
As described in the Prospectus, the net asset value per share of the U.S. Plus
Fund, the U.S./Short Fund, the OTC Plus Fund and the OTC/Short Fund is
determined daily, Monday through Friday, each day on the New York Stock Exchange
("NYSE") is open for business, which excludes New Year's Day, Presidents' Day,
Martin Luther King's Birthday, Good Friday, Memorial Day, Independence Day,
Labor Day, Thanksgiving Day, and Christmas Day. The net asset value per share of
the Japan Plus Fund and the Japan/Short Fund is determined each day the
Singapore International Monetary Exchange ("SIMEX") is open for business.
Trading on the SIMEX may not take place on all days on which the NYSE is open.
The SIMEX is closed on the following Japanese holidays: New Year's Day, New
Year's Holiday, Bank Holiday, Coming-of-Age Day, National Foundation Day, Vernal
Equinox Day, Greenery Day, Constitution Memorial Day, Children's Day, Marine
Day, Respect-for-the-Aged Day, Autumnal Equinox Day, Health-Sports Day, Culture
Day, Labor Thanksgiving Day and the Emperor's Birthday. The net asset value per
22
<PAGE>
share of the Money Market Fund is determined each day that both the NYSE and the
Federal Reserve Bank of New York are open for business.
It is the policy of the Money Market Fund to attempt to maintain a constant
price per share of $1.00. There can be no assurance that a $1.00 net asset value
per share will be maintained. The portfolio instruments held by the Money Market
Fund are valued based on the amortized cost valuation method pursuant to Rule
2a-7 under the 1940 Act. This involves valuing an instrument at its cost and
thereafter assuming a constant amortization to maturity of any discount or
premium, even though the portfolio security may increase or decrease in market
value. Such fluctuations generally are in response to changes in interest rates.
Use of the amortized cost valuation method requires the Money Market Fund to
purchase instruments having remaining maturities of 397 days or less, to
maintain a dollar-weighted average portfolio maturity of 90 days or less, and to
invest only in securities determined by the Trustees to be of high quality with
minimal credit risks. The Money Market Fund may invest in issuers or instruments
that at the time of purchase have received the highest short-term rating by any
two nationally recognized statistical rating organizations ("NRSROs").
Rule 2a-7 requires the Trustees to establish procedures reasonably deigned to
stabilize the net asset value per share as computed for purposes of distribution
and redemption. The Board's procedures include monitoring the relationship
between the amortized cost value per share and a net asset value per share based
upon available indications of market value. The Board will decide what, if any,
steps should be taken if there is a difference of more than .5% between the two
methods. The Board will take any steps they consider appropriate (such as
redemption in kind or shortening the average portfolio maturity) to minimize any
material dilution or other unfair results arising from differences between the
two methods of determining net asset value.
A security listed or traded on an exchange, domestic or foreign, is valued at
its last sales price on the principal exchange on which it is traded prior to
the time when assets are valued. If no sale is reported at that time, the most
recent bid price is used. When market quotations for options and futures
positions held by a Fund are readily available, those positions will be valued
based upon such quotations. Securities and other assets for which market
quotations are not readily available, or for which the Adviser has reason to
question the validity of quotations received, are valued at fair value as
determined in good faith by the Board. For valuation purposes, quotations of
foreign securities or other assets denominated in foreign currencies are
translated to U.S. Dollar equivalents using the net foreign exchange rate in
effect at the close of the stock exchange in the country where the security is
issued. Short-term investments having a maturity of 60 days or less are valued
at amortized cost, which approximates market value.
PERFORMANCE INFORMATION
Each Fund's performance data quoted in reports, advertising and other
promotional materials represents past performance and is not intended to
indicate future performance. The investment return and principal value for each
Fund, except for the Money Market Fund, will fluctuate so that an investor's
shares, when redeemed, may be worth more or less than their original costs.
23
<PAGE>
COMPARATIVE INFORMATION
From time to time each Fund's performance may be compared with recognized stock
and other indices, such as the Standard & Poor's Composite Stock Price Index
("S&P 500 Index"), the Dow Jones Industrial Average ("DJIA"), Nasdaq 100 Stock
IndexTM ("Nasdaq Index"), and the Nasdaq Composite IndexTM ("Nasdaq Composite"),
Nikkei 225 Stock Average ("Nikkei Index") and various other domestic,
international and global indices. The S&P 500 Index is a broad index of common
stock prices, while the DJIA represents a narrower segment of industrial
companies. Each assumes reinvestment of distributions and is calculated without
regard to tax consequences or operating expenses. The Nasdaq Composite
comparison may be provided to show how the OTC/Long and the OTC/Short Funds'
total returns compare to the record of a broad average of OTC stock prices over
the same period. The OTC/Long and the OTC/Short Funds have the ability to invest
in securities not included in the Nasdaq Index or the Nasdaq Composite, and the
OTC/Long and the OTC/Short Funds' investment portfolio may or may not be similar
in composition to the Nasdaq Index or the Nasdaq Composite.
In addition, a Fund's total return may be compared to the performance of broad
groups of comparable mutual funds with similar investment objectives, as such
performance is tracked and published by such independent organizations as Lipper
Analytical Services, Inc. ("Lipper'), and CDA Investment Technologies, Inc. When
Lipper's tracking results are used, the Fund will be compared to Lipper's
appropriate fund category, that is, by fund objective and portfolio holdings.
Accordingly, the Lipper ranking and comparison, which may be used by the Trust
in performance reports, will be drawn from the "Capital Appreciation Funds"
grouping for the U.S. Plus Fund and the U.S./Short Fund, from the "Small Company
Growth Funds" grouping for the OTC/Long and the OTC/Short Funds, and from the
"International Funds" grouping for the Japan/Long and the Japan/Short Funds.
Since the assets in all mutual funds are always changing, a Fund may be ranked
within one Lipper asset-size class at one time and in another Lipper asset-size
class at some other time. Footnotes in advertisements and other marketing
literature will include the time period and Lipper asset-size class, as
applicable, for the ranking in question. Performance figures are based on
historical results and are not intended to indicate future performance.
TOTAL RETURN COMPUTATIONS
For purposes of quoting and comparing the performance of a Fund to that of other
mutual funds and to other relevant market indices in advertisements or in
reports to shareholders, performance for the Fund may be stated in terms of
total return. Such average annual total return quotes for the Funds are
calculated according to the following formula:
P(1+T)n(SUPERSCRIPT)=ERV
Where: P= a hypothetical initial payment of $1,000
T= average annual total return
n= number of years (either 1, 5 or 10)
ERV= ending redeemable value of a hypothetical $1,000
payment made at the beginning of the 1, 5 or 10 year
periods, as applicable, at the end of that period
Under the foregoing formula, the time periods used in advertising will be based
on rolling calendar quarters, updated to the last day of the most recent quarter
prior to submission of the advertising for publication, and will cover 1,5 and
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<PAGE>
10 year periods or a shorter period dating from the commencement of a Fund's
operations. In calculating the ending redeemable value, all dividends and
distributions by a Fund are assumed to have been reinvested at net asset value
on the reinvestment dates during the period. Total return, or "T" in the formula
above, is computed by finding the average annual compounded rates of return over
the 1, 5 and 10 year periods (or fractional portion thereof) that would equate
the initial amount invested to the ending redeemable value.
From time to time, each Fund also may include in such advertising a total return
figure that is not calculated according to the formula set forth above in order
to compare more accurately the performance of a Fund with other measures of
investment return. For example, in comparing the total return of a Fund with
data published by Lipper or with such market indices as the performance of (1)
the S&P 500 Index or the DJIA for the U.S. Plus and the U.S./Short Funds, (2)
the Nasdaq Index for the OTC/Long and the OTC/Short Funds; and (3) the Nikkei
Index for the Japan/Long and the Japan/Short Funds, each respective Fund
calculates its aggregate total return for the specified periods of time by
assuming an investment of $10,000 in Fund shares and assuming the reinvestment
of each dividend or other distribution at net asset value on the reinvestment
date. Percentage increases are determined by subtracting the initial value of
the investment from the ending value and by dividing the remainder by the
beginning value.
YIELD COMPUTATIONS
The Money Market Fund's annualized current yield, as may be quoted from time to
time in advertisements and other communications to shareholders and potential
investors, is computed for a seven-day period by determining the net change,
exclusive of capital changes and including the value of additional shares
purchased with dividends and any dividends declared therefrom (which reflect
deductions of all expenses of the Fund such as advisory fees), in the value of a
hypothetical pre-existing account having a balance of one share at the beginning
of the period, subtracting a hypothetical charge reflecting deductions from
shareholder accounts, and dividing the difference by the value of the account at
the beginning of the base period to obtain the base period return, and then
multiplying the base period return by (365/7).
The Money Market Fund's annualized effective yield, as may be quoted from time
to time in advertisements and other communications to shareholders and potential
investors, is computed by determining (for the same stated seven-day period as
the current yield) the net change, exclusive of capital changes and including
the value of additional shares purchased with dividends and any dividends
declared therefrom (which reflect deductions of all expenses of the Fund such as
advisory fees), in the value of a hypothetical pre-existing account having a
balance of one share at the beginning of the period, and dividing the difference
by the value of the account at the beginning of the base period to obtain the
base period return, and then compounding the base period return by adding 1,
raising the sum to a power equal to 365 divided by 7, and subtracting 1 from the
result, according to the following formula:
Effective Yield = [(Base Period Return + 1) 365/7] - 1
The yields quoted in any advertisement or other communication should not be
considered a representation of the yields of the Money Market Fund in the future
since the yield is not fixed. Actual yields will depend not only on the type,
25
<PAGE>
quality, and maturities of the investments held by the Money Market Fund and
changes in interest rates on such investments, but also on changes in the Money
Market Fund's expenses during the period.
Yield information may be useful in reviewing the performance on the Money Market
Fund and for providing a basis for comparison with other investment
alternatives. However, unlike bank deposits or other investments, which
typically pay a fixed yield for a stated period of time, the Money Market Fund's
yield will fluctuate.
DIVIDENDS, OTHER DISTRIBUTIONS AND TAXES
DIVIDENDS AND OTHER DISTRIBUTIONS
Dividends from net investment income and any distributions of realized net
capital gains and net gains from foreign currency transactions will be
distributed as described in the Prospectus under "Dividends and Other
Distributions." All distributions from a Fund normally will be automatically
reinvested without charge in additional shares of that Fund.
As discussed in the Prospectus, the Money Market Fund ordinarily will declare
dividends daily from net investment income and distribute such dividends
monthly. Net income, for these purposes, includes accrued interest and accretion
of original issue and market discounts, less amortization of market premium and
estimated expenses, and will be calculated immediately prior to the
determination of the Fund's net asset value per share. The Fund distributes its
net short-term capital gain, if any, annually but may make more frequent
distributions thereof if necessary to maintain its net asset value per share at
$1.00 or to avoid income or excise taxes. The Fund does not expect to realize
net long-term capital gain and thus does not anticipate payment of any
distributions of net capital gain (the excess of net long-term capital gain over
net short-term capital loss). The Trustees may revise this dividend policy, or
postpone the payment of dividends, if the Fund has or anticipates any large
unexpected expense, loss, or fluctuation in net assets that, in the Trustees'
opinion, might have a significant adverse effect on its shareholders.
TAXES
REGULATED INVESTMENT COMPANY STATUS. To qualify for treatment as a regulated
investment company ("RIC") under the Internal Revenue Code of 1986, as amended
("Code"), each Fund -- which is treated as a separate corporation for these
purposes -- must distribute to its shareholders for each taxable year at least
90% of its investment company taxable income (consisting generally of net
investment income, net short-term capital gain, and net gains from certain
foreign currency transactions) ("Distribution Requirement") and must meet
several additional requirements. For each Fund, these requirements include the
following: (1) the Fund must derive at least 90% of its gross income each
taxable year from dividends, interest, payments with respect to securities
loans, and gains from the sale or other disposition of securities or foreign
currencies, or other income (including gains from options, futures, or forward
contracts) derived with respect to its business of investing in securities or
those currencies ("Income Requirement"); and (2) at the close of each quarter of
the Fund's taxable year, (i) at least 50% of the value of its total assets must
be represented by cash and cash items, U.S. Government securities, securities of
other RICs, and other securities, with those other securities limited, in
respect of any one issuer, to an amount that does not exceed 5% of the value of
the Fund's total assets and that does not represent more than 10% of the
issuer's outstanding voting securities, and (ii) not more than 25% of the value
of its total assets may be invested in securities (other than U.S. Government
26
<PAGE>
securities or the securities of other RICs) of any one issuer (collectively,
"Diversification Requirements").
Although the Funds intend to satisfy all the foregoing requirements, there is no
assurance that each Fund will be able to do so. The investment by a Fund other
than the Money Market Fund primarily in options and futures positions entails
some risk that such a Fund might fail to satisfy the Diversification
Requirements. There is some uncertainty regarding the valuation of such
positions for purposes of those requirements; accordingly, it is possible that
the method of valuation used by the Funds, pursuant to which each of them would
be treated as satisfying the Diversification Requirements, would not be accepted
in an audit by the Internal Revenue Service, which would apply a different
method resulting in disqualification of one or more of those Funds.
GENERAL. If Fund shares are sold at a loss after being held for six months or
less, the loss will be treated as long-term, instead of short-term, capital loss
to the extent of any capital gain distributions received on those shares.
Investors also should be aware that if shares are purchased shortly before the
record date for any dividend or capital gain distribution, the shareholder will
pay full price for the shares and receive some portion of the purchase price
back as a taxable distribution.
Each Fund will be subject to a nondeductible 4% excise tax ("Excise Tax") to the
extent it fails to distribute by the end of any calendar year substantially all
of its ordinary income for that year and capital gain net income for the
one-year period ending on October 31 of that year, plus certain other amounts.
INCOME FROM FOREIGN SECURITIES. Dividends and interest received by the
Japan/Long Fund and dividends received by the Japan/Short Fund, and gains
realized by each such Fund, may be subject to income, withholding, or other
taxes imposed by foreign countries and U.S. possessions that would reduce the
yield and/or total return on their securities. Tax conventions between certain
countries and the United States may reduce or eliminate these foreign taxes,
however, and many foreign countries do not impose taxes on capital gains in
respect of investments by foreign investors.
The Japan/Long Fund may invest in the stock of "passive foreign investment
companies" ("PFICs"). A PFIC is a foreign corporation -- other than a
"controlled foreign corporation" (I.E., a foreign corporation in which, on any
day during its taxable year, more than 50% of the total voting power of all
voting stock therein or the total value of all stock therein is owned, directly,
indirectly, or constructively, by "U.S. shareholders," defined in the singular
as a U.S. person that owns, directly, indirectly, or constructively, at least
10% of that voting power) as to which the Fund is a U.S. shareholder (effective
for the Fund's taxable years beginning after 1997) -- that, in general, meets
either of the following tests: (1) at least 75% of its gross income is passive
or (2) an average of at least 50% of its assets produce, or are held for the
production of, passive income. Under certain circumstances, the Fund will be
subject to Federal income tax on a portion of any "excess distribution" received
on the stock of a PFIC or of any gain on disposition of the stock (collectively
"PFIC income"), plus interest thereon, even if the Fund distributes the PFIC
income as a taxable dividend to its shareholders. The balance of the PFIC income
will be included in the Fund's investment company taxable income and,
accordingly, will not be taxable to it to the extent that income is distributed
to its shareholders. If the Fund invests in a PFIC and elects to treat the PFIC
as a "qualified electing fund" ("QEF"), then in lieu of the foregoing tax and
interest obligation, the Fund would be required to include in income each year
its PRO RATA share of the QEF's annual ordinary earnings and net capital gain
27
<PAGE>
- --- which probably would have to be distributed by the Fund to satisfy the
Distribution Requirement and avoid imposition of the Excise Tax --- even if
those earnings and gain were not received by the Fund from the QEF. In most
instances it will be very difficult, if not impossible, to make this election
because of certain requirements thereof.
Effective for its taxable years beginning after 1997, the Japan/Long Fund may
elect to "mark to market" its stock in any PFIC. "Marking-to-market," in this
context, means including in ordinary income each taxable year the excess, if
any, of the fair market value of the PFIC's stock over the Fund's adjusted basis
therein as of the end of that year. Pursuant to the election, the Fund also
would be allowed to deduct (as an ordinary, not capital, loss) the excess, if
any, of its adjusted basis in PFIC stock over the fair market value thereof as
of the taxable year-end, but only to the extent of any net mark-to-market gains
with respect to that stock included by the Fund for prior taxable years. The
Fund's adjusted basis in each PFIC's stock with respect to which it makes this
election would be adjusted to reflect the amounts of income included and
deductions taken under the election. Regulations proposed in 1992 would provide
a similar election with respect to the stock of certain PFICs.
Gains or losses (1) from the disposition of foreign currencies, (2) from the
disposition of debt securities denominated in foreign currency that, in each
instance, are attributable to fluctuations in the value of the foreign currency
between the date of acquisition of the security and the date of disposition
thereof, and (3) that are attributable to fluctuations in exchange rates that
occur between the time a Fund accrues dividends, interest, or other receivables
or expenses or other liabilities denominated in a foreign currency and the time
the Fund actually collects the receivables or pays the liabilities, generally
will be treated as ordinary income or loss. These gains or losses, referred to
under the Code as "section 988" gains or losses, may increase or decrease the
amount of a Fund's investment company taxable income to be distributed to its
shareholders.
DISTRIBUTIONS TO FOREIGN SHAREHOLDERS. Dividends paid by a Fund to a shareholder
who, as to the United States, is a nonresident alien individual or nonresident
alien fiduciary of a trust or estate, foreign corporation, or foreign
partnership ("foreign shareholder") generally will be subject to U.S.
withholding tax (at a rate of 30% or, if the United States has an income tax
treaty with the foreign country where the foreign shareholder resides, any lower
treaty rate). An investor claiming to be a foreign shareholder will be required
to provide a Fund with supporting documentation in order for the Fund to apply a
reduced withholding rate or exemption from withholding. Withholding will not
apply if a dividend paid by a Fund to a foreign shareholder is "effectively
connected with the conduct of a U.S. trade or business," in which case the
reporting and withholding requirements applicable to domestic shareholders will
apply.
DERIVATIVES STRATEGIES. The use of derivatives strategies, such as writing
(selling) and purchasing options and futures contracts and entering into forward
contracts, involves complex rules that will determine for income tax purposes
the amount, character, and timing of recognition of the gains and losses a Fund
realizes in connection therewith. Gains from the disposition of foreign
currencies (except certain gains that may be excluded by future regulations),
and gains from options, futures, and forward contracts derived by a Fund with
respect to its business of investing in securities or foreign currencies, will
qualify as permissible income under the Income Requirement.
Certain options (including options on "broad-based" stock indices) and futures
in which the Funds may invest will be "section 1256 contracts." Section 1256
28
<PAGE>
contracts held by a Fund at the end of each taxable year, other than section
1256 contracts that are part of a "mixed straddle" with respect to which the
Fund has made an election not to have the following rules apply, must be
"marked-to-market" (that is, treated as sold for their fair market value) for
Federal income tax purposes, with the result that unrealized gains or losses
will be treated as though they were realized. Sixty percent of any net gain or
loss recognized on these deemed sales, and 60% of any net realized gain or loss
from any actual sales of section 1256 contracts, will be treated as long-term
capital gain or loss, and the balance will be treated as short-term capital gain
or loss. Section 1256 contracts also may be marked-to-market for purposes of the
Excise Tax.
Code section 1092 (dealing with straddles) also may also affect the taxation of
options and futures contracts in which the Funds may invest. Section 1092
defines a "straddle" as offsetting positions with respect to personal property;
for these purposes, options and futures contracts are personal property. Section
1092 generally provides that any loss from the disposition of a position in a
straddle may be deducted only to the extent the loss exceeds the unrealized gain
on the offsetting position(s) of the straddle. Section 1092 also provides
certain "wash sale" rules, which apply to transactions where a position is sold
at a loss and a new offsetting position is acquired within a prescribed period,
and "short sale" rules applicable to straddles. If a Fund makes certain
elections, the amount, character, and timing of recognition of gains and losses
from the affected straddle positions would be determined under rules that vary
according to the elections made. Because only a few of the regulations
implementing the straddle rules have been promulgated, the tax consequences to
the Funds of straddle transactions are not entirely clear.
If a call option written by a Fund lapses (I.E., terminates without being
exercised), the amount of the premium it received for the option will be
short-term capital gain. If a Fund enters into a closing purchase transaction
with respect to a written call option, it will have a short-term capital gain or
loss based on the difference between the premium it received for the option it
wrote and the premium it pays for the option it buys. If such an option is
exercised and a Fund thus sells the securities or futures contract subject to
the option, the premium the Fund received will be added to the exercise price to
determine the gain or loss on the sale. If a call option purchased by a Fund
lapses, it will realize short-term or long-term capital loss, depending on its
holding period for the security or futures contract subject thereto. If a Fund
exercises a purchased call option, the premium it paid for the option will be
added to the basis of the subject securities or futures contract.
The foregoing is only a general summary of some of the important Federal income
tax considerations generally affecting the Funds. No attempt is made to present
a complete explanation of the Federal tax treatment of their activities, and
this discussion is not intended as a substitute for careful tax planning.
Accordingly, potential investors are urged to consult their own tax advisers for
more detailed information and for information regarding any state, local or
foreign taxes applicable to the Funds and to dividends and other distributions
therefrom.
FINANCIAL STATEMENTS
The Trust's audited financial statements as of September 2, 1997, which
have been audited by Price Waterhouse LLP, are included hereafter this Statement
of Additional Information.
29
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
---------------------------------
To the Shareholder and Board of Trustees of
Potomac Funds
In our opinion, the accompanying statement of assets and liabilities presents
fairly, in all material respects, the financial position of each of the
portfolios of Potomac Funds (the "Fund") at September 2, 1997, in conformity
with generally accepted accounting principles. This financial statement is the
responsibility of the Fund's management; our responsibility is to express an
opinion on this financial statement based on our audits. We conducted our audits
of this financial statement in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statement is free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statement, assessing the accounting
principles used and significant estimates made by management, and evaluating the
overall financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
/s/ Price Waterhouse LLP
- -----------------------------------------
Price Waterhouse LLP
Milwaukee Wisconsin
September 2, 1997
<PAGE>
<TABLE>
<CAPTION>
Potomac Funds
Statement of Assets and Liabilities
September 2, 1997
U.S.
Government
Japan/ Japan/ U.S. U.S./ OTC OTC/ Money
Long Short Plus Short Plus Short Market
Fund Fund Fund Fund Fund Fund Fund
---- ---- ---- ---- ---- ---- ----------
ASSETS
<S> <C> <C> <C> <C> <C> <C> <C>
Cash $ 10 $ 10 $ 10 $ 10 $ 10 $ 10 $ 99,940
Unamortized organization costs 14,860 14,860 14,859 14,859 14,859 14,859 14,859
Prepaid initial registration expenses 15,575 15,575 15,576 15,576 15,576 15,576 15,576
-------- -------- -------- -------- -------- -------- --------
Total Assets 30,445 30,445 30,445 30,445 30,445 30,445 130,375
-------- -------- -------- -------- -------- -------- --------
LIABILITIES
Payable to adviser 30,435 30,435 30,435 30,435 30,435 30,435 30,435
-------- -------- -------- -------- -------- -------- --------
Total Liabilities 30,435 30,435 30,435 30,435 30,435 30,435 30,435
-------- -------- -------- -------- -------- -------- --------
NET ASSETS $ 10 $ 10 $ 10 $ 10 $ 10 $ 10 $ 99,940
======== ======== ======== ======== ======== ======== ========
Capital shares, no par value;
unlimited shares of beneficial
interest authorized 1 1 1 1 1 1 99,940
======== ======== ======== ======== ======== ======== ========
Net asset value, offering and
redemption price per share
(net assets/shares of beneficial
interest outstanding) $ 10.00 $ 10.00 $ 10.00 $ 10.00 $ 10.00 $ 10.00 $ 1.00
======== ======== ======== ======== ======== ======== ========
</TABLE>
The accompanying notes to the financial statement are an integral part of this
statement.
<PAGE>
Potomac Funds
Notes to the Financial Statement
September 2, 1997
1. Organization
Potomac Funds (the "Trust") was organized as a Massachusetts Business
Trust on June 6, 1997 and is registered under the Investment Company
Act of 1940, as amended (the "1940 Act"), as an open-end management
investment company issuing its shares in series, each series
representing a distinct portfolio with its own investment objectives
and policies. The series presently authorized are the Japan/Long Fund,
Japan/Short Fund, U.S. Plus Fund, U.S./Short Fund, OTC Plus Fund,
OTC/Short Fund and the U.S. Government Money Market Fund (collectively,
the "Funds"). Each Fund (other than the U.S. Government Money Market
Fund) is a "non-diversified" series of the Trust pursuant to the 1940
Act. The Funds have had no operations other than those relating to
organizational matters, including the sale of one share for cash in the
amount of $10 of each of the Japan/Long Fund, Japan/Short Fund, U.S.
Plus Fund, U.S./Short Fund, OTC Plus Fund, OTC/Short Fund and 99,940
shares for cash in the amount of $99,940 of the U.S. Government Money
Market Fund to capitalize the Funds, which were sold to Rafferty Asset
Management LLC (the "Adviser") on September 2, 1997.
2. Significant Accounting Policies
(a) Organization Costs
Costs incurred by the Trust in connection with the
organization, registration and the initial public
offering of shares, are being deferred and amortized
over the period of benefit, but not to exceed sixty
months from the Trust's commencement of operations.
These costs were advanced by the Adviser and will be
reimbursed by the Trust. The proceeds of any redemption
of the initial shares by the original shareholder will
be reduced by a pro-rata portion of any then unamortized
organizational expenses in the same proportion as the
number of initial shares being redeemed bears to the
number of initial shares outstanding at the time of such
redemption.
(b) Federal Income Taxes
Each Fund intends to comply with the requirements of the
Internal Revenue Code necessary to qualify as a
regulated investment company and to make the requisite
distributions of income and capital gains to their
shareholders sufficient to relieve it from all or
substantially all Federal income taxes.
3. Investment Adviser
The Trust has an agreement with the Adviser, with whom certain officers
and Trustees of the Trust are affiliated, to furnish investment
advisory services to the Funds. Under the terms of this agreement, the
<PAGE>
Adviser will receive the following percentage of average daily net
assets for each Fund: 0.75% for the Japan/Long Fund, 0.90% for the
Japan/Short Fund, 0.75% for the U.S. Plus Fund, 0.90% for the
U.S./Short Fund, 0.75% for the OTC Plus Fund, 0.90% for the OTC/Short
Fund and 0.50% for the U.S.
Government Money Market Fund.
4. Service and Distribution Plan
Pursuant to Rule 12b-1 under the 1940 Act, the Funds have adopted a
Service and Distribution Plan (the "Plan"). The Plan provides that each
Fund will compensate the distributor for certain expenses incurred in
the distribution of that Fund's shares and the servicing and
maintenance of existing Fund shareholder accounts. Pursuant to the
Plan, a Fund may pay the distributor a service fee of up to 0.25% and a
distribution fee of up to 0.75% of the Fund's average daily net assets.
However, the Plan will not be activated until such time as the Trust
obtains Trustee approval.
<PAGE>
POTOMAC FUNDS
PART C. OTHER INFORMATION
<TABLE>
<CAPTION>
Item 24. FINANCIAL STATEMENTS AND EXHIBITS
<S> <C> <C>
(a) Financial Statements
Included in Part A of the Registration Statement: None
Included in Part B of the Registration Statement: Statement of Assets and
Liabilities as of September 2, 1997
(b) Exhibits:
(1) Declaration of Trust*
(2) By-Laws*
(3) Voting trust agreement -- None
(4) Specimen security -- None
(5) (a) Form of Investment Advisory Agreement (filed herewith)
(b) Form of Fund Administration Servicing Agreement (filed herewith)
(6) (a) Form of Distribution Agreement (filed herewith)
(b) Form of Consulting Agreement (filed herewith)
(7) Bonus, profit sharing or pension plans -- None
(8) Form of Custodian Agreement (filed herewith)
(9) (a) Form of Transfer Agent Agreement (filed herewith)
(b) Form of Fund Accounting Servicing Agreement (filed herewith)
(c) Form of Fulfillment Servicing Agreement (filed herewith)
(10) Opinion and consent of counsel (filed herewith)
(11) Consent of Independent Auditors (filed herewith)
(12) Financial statements omitted from prospectus -- None
(13) Letter of investment intent (filed herewith)
(14) Prototype retirement plan -- None
(15) Plan pursuant to Rule 12b-1 (filed herewith)
<PAGE>
(16) Performance Computation Schedule -- None
(17) Financial Data Schedule -- None
(18) Plan pursuant to Rule 18f-3 -- (not applicable)
</TABLE>
- --------------------------
* Incorporated herein by reference from the Trust's Initial
Registration Statement on Form N-1A filed with the Securities
and Exchange Commission on June 6, 1997 via EDGAR, Accession
No.0000898432-97-000314.
Item 25. Persons Controlled by or under
Common Control With Registrant
------------------------------
None.
Item 26. Number Of Holders Of Securities
- -------- -------------------------------
Number of Record Holders
Title Of Class September 2,1997
-------------- ----------------
Shares of beneficial interest in:
Potomac Japan/Long Fund 1
Potomac Japan/Short Fund 1
Potomac U.S. Plus Fund 1
Potomac U.S./Short Fund 1
Potomac OTC Plus Fund 1
Potomac OTC/Short Fund 1
Potomac U.S. Government Money Market Fund 1
Item 27. Indemnification
- -------- ---------------
Article XI, Section 2 of the Trust's Declaration of Trust provides
that:
(a) Subject to the exceptions and limitations contained in paragraph
(b) below:
(i) every person who is, or has been, a Trustee or officer of
the Trust (hereinafter referred to as a "Covered Person") shall be indemnified
by the Trust and/or by the appropriate Series to the fullest extent permitted by
law against liability and against all expenses reasonably incurred or paid by
him or her in connection with any claim, action, suit or proceeding in which he
or she becomes involved as a party or otherwise by virtue of his or her being or
having been a Covered Person and against amounts paid or incurred by him or her
in the settlement thereof;
(ii) the words "claim," "action," "suit," or "proceeding"
shall apply to all claims, actions, suits or proceedings (civil, criminal or
other, including appeals), actual or threatened while a Covered Person is in
office or thereafter, and the words "liability" and "expenses" shall include,
without limitation, attorneys' fees, costs, judgments, amounts paid in
settlement, fines, penalties and other liabilities.
C-2
<PAGE>
(b) No indemnification shall be provided hereunder to a Covered Person:
(i) who shall have been adjudicated by a court or body before
which the proceeding was brought (A) to be liable to the Trust or its
Shareholders by reason of willful misfeasance, bad faith, gross negligence or
reckless disregard of the duties involved in the conduct of his or her office or
(B) not to have acted in good faith in the reasonable belief that his or her
action was in the best interest of the Trust; or
(ii) in the event of a settlement, unless there has been a
determination that such Covered Person did not engage in willful misfeasance,
bad faith, gross negligence or reckless disregard of the duties involved in the
conduct of his or her office, (A) by the court or other body approving the
settlement; (B) by at least a majority of those Trustees who are neither
Interested Persons of the Trust nor parties to the matter based upon a review of
readily available facts (as opposed to a full trial-type inquiry or full
investigation); or (C) by written opinion of independent legal counsel based
upon a review of readily available facts (as opposed to a full trial-type
inquiry); provided, however, that any Shareholder may, by appropriate legal
proceedings, challenge any such determination by the Trustees, or by independent
legal counsel.
(c) The rights of indemnification herein provided may be insured
against by policies maintained by the Trust, shall be severable, shall not be
exclusive of or affect any other rights to which any Covered Person may now or
hereafter be entitled, shall continue as to a person who has ceased to be such
Trustee or officer and shall inure to the benefit of the heirs, executors and
administrators of such a person. Nothing contained herein shall affect any
rights to indemnification to which Trust personnel, other than Trustees and
officers, and other persons may be entitled by contract or otherwise under law.
(d) Expenses in connection with the preparation and presentation of a
defense to any claim, action, suit or proceeding of the character described in
paragraph (a) of this Section 2 may be paid by the Trust from time to time prior
to final disposition thereof upon receipt of an undertaking by or on behalf of
such Covered Person that such amount will be paid over by him or her to the
Trust if it is ultimately determined that he or she is not entitled to
indemnification under this Section 2; provided, however, that:
(i) such Covered Person shall have provided appropriate
security for such undertaking,
(ii) the Trust is insured against losses arising out of any
such advance payments, or
(iii) either a majority of the Trustees who are neither
interested persons of the Trust nor parties to the matter, or independent legal
counsel in a written opinion, shall have determined, based upon a review of
readily available facts (as opposed to a trial-type inquiry or full
investigation), that there is reason to believe that such Covered Person will be
found entitled to indemnification under this Section 2.
According to Article XII, Section 1 of the Declaration of Trust, the
Trust is a trust and not a partnership. Trustees are not liable personally to
any person extending credit to, contracting with or having any claim against the
Trust a particular Series or the Trustees. A Trustee, however, is not protected
from liability due to willful misfeasance, bad faith, gross negligence or
reckless disregard of the duties involved in the conduct of his office.
C-3
<PAGE>
Article XII, Section 2 provides that, subject to the provisions of
Section 1 of Article XII and to Article XI, the Trustees are not liable for
errors of judgment or mistakes of fact or law, or for any act or omission in
accordance with advice of counsel or other experts or for failing to follow such
advice.
Item 28. Business And Other Connections Of Investment Adviser
- -------- ----------------------------------------------------
Rafferty Asset Management, LLC (the "Adviser"), 550 Mamaroneck Avenue,
Harrison, New York 10528, offers investment advisory services. Information as to
the officers and directors of the Adviser is included in its current Form ADV
filed with the Securities and Exchange Commission (Registration Number
801-54679) and is incorporated herein by reference.
Item 29. Principal Underwriter
- -------- ---------------------
(a) First Data Distributors, Inc. is the principal underwriter for
Fleet Bank (Galaxy Funds), Chicago Title and Trust Funds, Wilshire Target Funds,
BT Hartford Insurance Funds, and Pictet et Cie (Panorama Trust).
(b) The directors and officers of the Potomac Fund's principal
underwriter, First Data Distributors, Inc., are:
Positions and Officer with Position with
Name Underwriter Registrant
---- -------------------------- ----------
Bob Guillocheau Director None
Frank Koudelka Director, President and Chief None
Executive Officer
Jack Kutner Director None
Christine Ritch Director, Chief Legal Officer None
and Clerk
Barbara Worthen Director None
Scott M. Hacker Vice President & Treasurer, Chief None
Compliance Officer
Bernard Rothman Vice President - Tax None
Bradley Stearns Assistant Clerk None
The principal business address for all the above directors and officers is 4400
Computer Drive, Westborough, MA 01581-5120.
(c) Not applicable.
Item 30. Location Of Accounts And Records
- -------- --------------------------------
The books and records required to be maintained by Section 31(a) of the
Investment Company Act of 1940 are maintained in the physical possession of the
Potomac Funds' investment adviser, administrator, custodian, subcustodian, or
transfer agent.
C-4
<PAGE>
Item 31. Management Services
- -------- -------------------
Not applicable.
Item 32. Undertakings
- -------- ------------
Registrant hereby undertakes to file a Post-effective Amendment to the
Registration Statement, containing financial statements that need not be
certified, within four to six months from the effective date of this
Registration Statement or from the date of its commencement of operations.
Registrant hereby undertakes to furnish each person to whom a
prospectus is delivered with a copy of its latest annual report to Shareholders,
upon request and without charge.
Registrant hereby undertakes to carry out all indemnification
provisions of its Declaration of Trust in accordance with Investment Company Act
Release No. 11330 (September 4, 1980) and successor releases. Insofar as
indemnification for liability arising under the Securities Act of 1933, as
amended ("1933 Act"), may be permitted to trustees, officers and controlling
persons of the Registrant pursuant to the provisions in under Item 27 herein, or
otherwise, the Registrant has been advised that in the opinion of the SEC such
indemnification is against public policy as expressed in the 1933 Act and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the Registrant of expenses incurred
or paid by a trustee, officer or controlling person of the Registrant in the
successful defense of any action, suit or proceeding) is asserted by such
trustee, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the 1933 Act and will be governed by the final
adjudication.
C-5
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended,
and the Investment Company Act of 1940, as amended, the Registrant has duly
caused this Pre-Effective Amendment No. 1 to its Registration Statement on Form
N-1A to be signed on its behalf by the undersigned, thereunto duly authorized,
in the City of Harrison and the State of New York on September 16, 1997.
POTOMAC FUNDS
By: Lawrence C. Rafferty*
----------------------------
Lawrence C. Rafferty
President
Attest:
Timothy P. Hagan*
- ------------------------
Timothy P. Hagan
Chief Financial Officer
Pursuant to the requirements of the Securities Act of 1933, as amended,
this Pre-Effective Amendment No. 1 to its Registration Statement has been signed
below by the following persons in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
- --------- ----- ----
<S> <C> <C>
Lawrence C. Rafferty* Chairman of the Board September 16, 1997
- ------------------------------------ of Trustees and President
Lawrence C. Rafferty
Jay F. Higgins* Trustee September 16, 1997
- ------------------------------------
Jay F. Higgins
Daniel J. Byrne* Trustee September 16, 1997
- ------------------------------------
Daniel J. Byrne
George T. Glisker* Trustee September 16, 1997
- ------------------------------------
George T. Glisker
Gerald E. Shanley Iii* Trustee September 16, 1997
- ------------------------------------
Gerald E. Shanley III
/s/ Robert J. Zutz
- ------------------------------------
*Robert J. Zutz, Attorney-in-Fact
</TABLE>
<PAGE>
POWER OF ATTORNEY
Each of the undersigned trustees of the Potomac Funds (the "Trust") hereby
severally constitutes and appoints Thomas A. Mulrooney, Timothy P. Hagan and
Robert J. Zutz, and each of them singly, our true and lawful attorneys, with
full power to sign for each of us our names and in the capacities indicated
below, any and all instruments and filings of the Trust, and all instruments
necessary or desirable in connection therewith, filed with the Securities and
Exchange Commission, hereby ratifying and confirming our signatures as they may
be signed by said attorneys to any and all said instruments.
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, this instrument has been signed below by the
following persons in the capacities and dates indicated
SIGNATURE TITLE DATE
- --------- ----- ----
/s/ Lawrence C. Rafferty
- -------------------------- Trustee, Chairman of the August 26, 1997
Lawrence C. Rafferty Board of Trustees (Chief
Executive Officer and
President)
/s/ Jay F. Higgins
- -------------------------- Trustee August 26, 1997
Jay F. Higgins
/s/ Daniel J. Byrne
- -------------------------- Trustee August 26, 1997
Daniel J. Byrne
/s/ George T. Glisker
- -------------------------- Trustee August 26, 1997
George T. Glisker
/s/ Gerald E. Shanely III
- -------------------------- Trustee August 26, 1997
Gerald E. Shanely III
<PAGE>
INDEX TO EXHIBITS
Exhibit
Number Description
- ------ -----------
(1) Declaration of Trust*
(2) By-Laws*
(3) Voting trust agreement -- None
(4) Specimen security -- None
(5) (a) Form of Investment Advisory Agreement (filed herewith)
(b) Form of Fund Administration Servicing Agreement (filed herewith)
(6) (a) Form of Distribution Agreement (filed herewith)
(b) Form of Consulting Agreement (filed herewith)
(7) Bonus, profit sharing or pension plans -- None
(8) Form of Custodian Agreement (filed herewith)
(9) (a) Form of Transfer Agent Agreement (filed herewith)
(b) Form of Fund Accounting Servicing Agreement (filed herewith)
(c) Form of Fulfillment Servicing Agreement (filed herewith)
(10) Opinion and consent of counsel (filed herewith)
(11) Consent of Independent Auditors (filed herewith)
(12) Financial statements omitted from prospectus -- None
(13) Letter of investment intent (filed herewith)
(14) Prototype retirement plan -- None
(15) Plan pursuant to Rule 12b-1 (filed herewith)
(16) Performance Computation Schedule -- None
(17) Financial Data Schedule -- None
(18) Plan pursuant to Rule 18f-3 -- (not applicable)
- --------------------------
* Incorporated herein by reference from the Trust's Initial Registration
Statement on Form N-1A filed with the Securities and Exchange
Commission on June 6, 1997 via EDGAR, Accession
No.0000898432-97-000314.
POTOMAC FUNDS
INVESTMENT ADVISORY AGREEMENT
This Investment Advisory Agreement is made as of September __, 1997,
between the Potomac Funds (the "Trust"), a business trust organized under the
laws of the Commonwealth of Massachusetts with its principal place of business
at 550 Mamaroneck Avenue, Harrison, New York 10528, and Rafferty Asset
Management, LLC, a New York limited liability corporation (the "Adviser").
WHEREAS, the Trust is registered under the Investment Company Act of 1940,
as amended (the "Act"), as an open-end management investment company consisting
of one or more investment series of shares, each having its own assets and
investment policies;
WHEREAS, the Adviser provides investment advice and is registered with the
Securities and Exchange Commission (the "SEC") as an investment adviser under
the Investment Advisers Act of 1940, as amended (the "Advisers Act"); and
WHEREAS, the Trust desires to retain the Adviser to perform investment
advisory services for each series of the Trust listed in one or more Schedules
attached hereto (collectively, the "Portfolios"), and the Adviser is willing to
perform such services on the terms and conditions set forth in this Agreement;
NOW, THEREFORE, in consideration of the premises and mutual covenants
herein contained, it is agreed between the parties hereto as follows:
1. APPOINTMENT. The Trust hereby appoints the Adviser, subject to the
direction and control of the Trust's Board of Trustees (the "Board"), to manage
the investment and reinvestment of the assets of each Portfolio listed on
Schedule A of this Agreement (as such schedule may be amended from time to time)
for the period and on the terms set forth in this Agreement. The Adviser accepts
such appointment and agrees to render the services herein set forth for the
compensation as set forth on Schedule A. In the performance of its duties, the
Adviser will act in the best interests of the Trust and each Portfolio and will
comply with (a) applicable laws and regulations, including, but not limited to,
the 1940 Act, (b) the terms of this Agreement, (c) the Trust's Declaration of
Trust, By-Laws and currently effective registration statement under the
Securities Act of 1933, as amended, and the 1940 Act, and any amendments
thereto, (d) the stated investment objective, policies and restrictions of each
applicable Portfolio, and (e) such other guidelines as the Board reasonably may
establish.
<PAGE>
2. DUTIES AS INVESTMENT ADVISER.
(a) Subject to the supervision of the Board, the Adviser will provide
a continuous investment program for each Portfolio, including investment
research and management with respect to all securities, investments and cash
equivalents in each Portfolio. The Adviser will determine from time to time what
securities and other investments will be purchased, retained or sold by each
Portfolio. To carry out such decisions, the Adviser hereby is authorized, as
agent and attorney-in-fact for the Trust, for the account of, at the risk of and
in the name of the Trust, to place orders and issue instructions with respect to
those transactions of the Portfolios. The Adviser will exercise full discretion
and act for each Portfolio in the same manner and with the same force and effect
as such Portfolio itself might or could do with respect to purchases, sales, or
other transactions, as well as with respect to all other things necessary or
incidental to the furtherance or conduct of such purchases, sales or other
transactions.
(b) The Adviser will place orders pursuant to its investment
determinations for each Portfolio either directly with the issuer or through
other brokers. In the selection of brokers and the placement of orders for the
purchase and sale of portfolio investments for the Portfolios, the Adviser shall
use its best efforts to obtain for the Portfolios the most favorable price and
execution available, except to the extent it may be permitted to pay higher
brokerage commissions for brokerage and research services as described below. In
using its best efforts to obtain the most favorable price and execution
available, the Adviser, bearing in mind the Trust's best interests at all times,
shall consider all factors it deems relevant, including by way of illustration,
price, the size of the transaction, the nature of the market for the security,
the amount of the commission, the timing of the transaction taking into account
market prices and trends, the reputation, experience and financial stability of
the broker involved and the quality of service rendered by the broker in other
transactions. Subject to such policies as the Board may determine, the Adviser
shall not be deemed to have acted unlawfully or to have breached any duty
created by this Agreement or otherwise solely by reason of its having caused a
Portfolio to pay a broker that provides brokerage and research services to the
Adviser an amount of commission for effecting a portfolio investment transaction
in excess of the amount of commission another broker would have charged for
effecting that transaction if the Adviser determines in good faith that such
amount of commission was reasonable in relation to the value of the brokerage
and research services provided by such broker, viewed in terms of either that
particular transaction or the Adviser's overall responsibilities with respect to
the Trust and to other clients of the Adviser as to which the Adviser exercises
investment discretion. In no instance will portfolio securities of any Portfolio
be purchased from or sold to the Adviser or any affiliated person of the
Adviser. The Trust agrees that any entity or person associated with the Adviser
that is a member of a national securities exchange is authorized to effect any
transaction on such exchange for the account of the Trust which is permitted by
Section 11(a) of the Securities Exchange Act of 1934, as amended, and the rules
thereunder, and the Trust has consented to the retention of compensation for
such transactions.
-2-
<PAGE>
(c) The Adviser will report to the Board at each meeting thereof all
changes in the Portfolios since the prior report, and also will keep the Board
informed of important developments affecting the Trust, Portfolios and the
Adviser, and on its own initiative, will provide the Board from time to time
such information as the Adviser may believe appropriate for this purpose,
whether concerning the individual companies whose securities are included in a
Portfolio's holdings, the industries in which they engage, or the economic,
social or political conditions prevailing in each country in which the Portfolio
maintains investments. The Adviser also make available to the Board upon request
any economic, statistical and investment services normally available to
institutional or other customers of the Adviser.
(d) The Adviser will from time to time employ or associate with such
persons as the Adviser believes to be particularly fitted to assist in the
execution of the Adviser's duties hereunder, the cost of performance of such
duties to be borne and paid by the Adviser. No obligation may be incurred on the
Trust's behalf in any such respect.
(e) Any of the foregoing functions with respect to any or all Portfolios
may be delegated by the Adviser, at the Adviser's expense, to another
appropriate party (including an affiliated party), subject to such approval by
the Board and shareholders of each affected Portfolio as may be required by the
1940 Act. The Adviser shall oversee the performance of delegated functions by
any such party and shall furnish to the Trust with quarterly evaluations and
analyses concerning the performance of delegated responsibilities by those
parties.
3. SERVICES NOT EXCLUSIVE. The services furnished by the Adviser
hereunder are not to be deemed exclusive and the Adviser shall be free to
furnish similar services to others so long as its services under this
Agreement are not impaired thereby.
4. BOOKS AND RECORDS.
(a) The Adviser shall maintain records for each Portfolio relating to
portfolio transactions and the placing and allocation of brokerage orders as are
required to be maintained by the Trust under Rule 31a-1 of the Act. The Adviser
shall prepare and maintain, or cause to be prepared and maintained, in such form
and in such locations as may be required by applicable law, all documents and
records relating to the services provided by the Adviser pursuant to this
Agreement required to be prepared and maintained by the Trust pursuant to the
rules and regulations of any national, state or local government entity with
jurisdiction over the Trust, including the Internal Revenue Service.
-3-
<PAGE>
(b) In compliance with the requirements of Rule 31a-3 under the 1940 Act,
the Adviser hereby agrees that all records which it maintains for the Trust are
the property of the Trust and further agrees to surrender promptly to the Trust
any of such records upon the Trust's request. The Adviser further agrees to
preserve for the periods prescribed by Rule 31a-2 under the 1940 Act the records
required to be maintained by Rule 3la-1 under the 1940 Act.
5. EXPENSES. During the term of this Agreement, the Trust will bear all
expenses not specifically assumed by the Adviser incurred in its operations and
the offering of its shares. Expenses borne by the Trust will include, the
following (or each Portfolio's proportionate share of the following): (a)
brokerage commissions relating to securities purchased or sold by the Trust or
any losses incurred in connection therewith; (b) fees payable to and expenses
incurred on behalf of the Trust by the Adviser; (c) expenses of organizing the
Trust and the Portfolios; (d) filing fees and expenses relating to the
registration and qualification of the Trust's shares and the Trust under federal
or state securities laws and maintaining such registrations and qualifications;
(e) distribution fees; (f) fees and salaries payable to the members of the Board
and officers who are not officers or employees of the Adviser or interested
persons (as defined in the 1940 Act) of any investment adviser or distributor of
the Trust; (g) taxes (including any income or franchise taxes) and governmental
fees; (h) costs of any liability, uncollectible items of deposit and other
insurance or fidelity bonds; (i) any costs, expenses or losses arising out of
any liability of or claim for damage or other relief asserted against the Trust
for violation of any law; (j) legal, accounting and auditing expenses, including
legal fees of special counsel for the independent trustees; (k) charges of
custodians, transfer agents and other agents; (l) costs of preparing share
certificates; (m) expenses of setting in type and printing prospectuses and
supplements thereto for existing shareholders, reports and statements to
shareholders and proxy material; (n) any extraordinary expenses (including fees
and disbursements of counsel) incurred by the Trust; and (o) fees and other
expenses incurred in connection with membership in investment company
organizations.
The Trust may pay directly any expense incurred by it in its normal
operations and, if any such payment is consented to by the Adviser and
acknowledged as otherwise payable by the Adviser pursuant to this Agreement, the
Trust may reduce the fee payable to the Adviser pursuant to paragraph 7 hereof
by such amount. To the extent that such deductions exceed the fee payable to the
Adviser on any monthly payment date, such excess shall be carried forward and
deducted in the same manner from the fee payable on succeeding monthly payment
dates.
In addition, if the expenses borne by the Trust or any Portfolio in any
fiscal year exceed the expense limitations voluntarily imposed by the Adviser,
the Adviser will reimburse the Trust or Portfolio for any excess up to the
amount of the fee payable to it during that fiscal year pursuant to paragraph 7
hereof.
-4-
<PAGE>
6. LIMITATION OF LIABILITY OF THE ADVISER. The Adviser shall not be liable
for any error of judgment or mistake of law or for any loss suffered by the
Trust or any Portfolio in connection with the matters to which this Agreement
relate except a loss resulting from the willful misfeasance, bad faith or gross
negligence on its part in the performance of its duties or from reckless
disregard by it of its obligations and duties under this Agreement. Any person,
even though also an officer, partner, employee, or agent of the Adviser, who may
be or become an officer, trustee, employee or agent of the Trust shall be
deemed, when rendering services to the Trust or acting in any business of the
Trust, to be rendering such services to or acting solely for the Trust and not
as an officer, partner, employee, or agent or one under the control or direction
of the Adviser even though paid by it.
7. COMPENSATION. For the services provided and the expenses assumed
pursuant to this Agreement with respect to each Portfolio, the Trust will pay
the Adviser, effective from the date of this Agreement, a fee that is computed
daily and paid monthly from each Portfolio's assets at the annual rates as
percentages of that Portfolio's average daily net assets as set forth in the
attached Schedule A, which schedule can be modified from time to time to reflect
changes in annual rates or the addition or deletion of a Portfolio from the
terms of this Agreement, subject to appropriate approvals required by the 1940
Act. If this Agreement becomes effective or terminates with respect to any
Portfolio before the end of any month, the fee for the period from the effective
date to the end of the month or from the beginning of such month to the date of
termination, as the case may be, shall be prorated according to the proportion
that such period bears to the full month in which such effectiveness or
termination occurs.
8. DURATION AND TERMINATION. This Agreement shall become effective upon
its execution; provided, that with respect to any Portfolio now existing or
hereafter created, this Agreement shall not take effect unless it first has been
approved (i) by a vote of the majority of those trustees of the Trust who are
not parties to this Agreement or interested persons of such party, cast in
person at a meeting called for the purpose of voting on such approval, and (ii)
by vote of a majority of that Portfolio's outstanding voting securities. This
Agreement shall remain in full force and effect continuously thereafter until
terminated without the payment of any penalty as follows:
(a) By vote of a majority of its trustees, or by the affirmative vote of a
majority of the outstanding shares of such Portfolio, the Trust may at any time
terminate this Agreement with respect to any or all Portfolios by providing not
more than 60 days' written notice delivered or mailed by registered mail,
postage prepaid, to the Adviser at its principal offices; or
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<PAGE>
(b) With respect to any Portfolio, this Agreement shall be approved for an
initial period of two year and at least annually thereafter by (i) the Trustees
or the shareholders of that Portfolio by the affirmative vote of a majority of
the outstanding shares of such Portfolio, and (ii) a majority of the Trustees
who are not interested persons of the Trust or of the Adviser or of any
subadviser, by vote cast in person at a meeting called for the purpose of voting
on such approval. If the continuance of this Agreement is not approved at least
annually after the initial two-year period, then this Agreement shall
automatically terminate at the close of business on the second anniversary of
its execution, or upon the expiration of one year from the effective date of the
last such continuance, whichever is later; provided, however, that if the
continuance of this Agreement is submitted to the shareholders of a Portfolio
for their approval and such shareholders fail to approve such continuance of
this Agreement as provided herein, the Adviser may continue to serve hereunder
in a manner consistent with the 1940 Act and the rules and regulations
thereunder with respect to that Portfolio; or
(c) The Adviser may at any time terminate this Agreement with respect to
any or all Portfolios by not less than 60 days' written notice delivered or
mailed by registered mail, postage prepaid to the Trust.
(d) This Agreement automatically and immediately will terminate in
the event of its assignment.
9. AMENDMENT OF THIS AGREEMENT. No provision of this Agreement may be
changed, waived, discharged or terminated orally, except by an instrument in
writing signed by the party against which enforcement of the change, waiver,
discharge or termination is sought. No material amendment of this Agreement with
respect to any Portfolio shall be effective except, if required by law, by vote
of the holders of a majority of that Portfolio's outstanding voting securities.
10. GOVERNING LAW. This Agreement shall be construed in accordance with
the laws of the Commonwealth of Massachusetts, without giving effect to the
conflicts of laws principles thereof, and in accordance with the 1940 Act. To
the extent that the applicable laws of the Commonwealth of Massachusetts
conflict with the applicable provisions of the 1940 Act, the latter shall
control.
11. DEFINITIONS. As used in this Agreement, the terms "majority of
the outstanding voting securities," "interested person," and "assignment"
shall have the same meanings as such terms have in the 1940 Act.
12. SEVERABILITY. If any provision of this Agreement shall be held or made
invalid by a court decision, statute, rule or otherwise, the remainder of this
Agreement shall not be affected thereby. This Agreement shall be binding upon
and shall inure to the benefit of the parties hereto and their respective
successors.
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<PAGE>
13. MISCELLANEOUS. The captions in this Agreement are included for
convenience of reference only and in no way define or delimit any of the
provisions hereof or otherwise affect their construction or effect.
IN WITNESS WHEREOF, the parties hereto have caused this instrument to be
executed by their officers designated below as of the day and year first above
written.
Attest: POTOMAC FUNDS
By:_________________________ By:__________________________
Attest: RAFFERTY ASSET MANAGEMENT, LLC
By:_________________________ By:__________________________
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<PAGE>
SCHEDULE A
TO THE
INVESTMENT ADVISORY AGREEMENT
BETWEEN
THE POTOMAC FUNDS
AND
RAFFERTY ASSET MANAGEMENT, LLC
Pursuant to section 1 of the Investment Advisory Agreement between the
Potomac Funds (the "Trust") and Rafferty Asset Management, LLC (the "Rafferty"),
the Trust hereby appoints Rafferty to manage the investment and reinvestment of
the Portfolios of the Trust listed below. As compensation for such, the Trust
shall pay to Rafferty pursuant to section 7 of the Investment Advisory Agreement
a fee, computed daily and paid monthly, at the following annual rates as
percentages of each Portfolio's average daily net assets:
Advisory Fee as a %
of Average Daily Net
Portfolios Of The Trust Assets Under Management
- ----------------------- -----------------------
Japan/Long Fund 0.75%
Japan/Short Fund 0.90%
U.S. Plus Fund 0.75%
U.S./Short Fund 0.90%
OTC Plus Fund 0.75%
OTC/Short Fund 0.90%
Money Market Fund 0.50%
Dated: September ___, 1997
FUND ADMINISTRATION SERVICING AGREEMENT
This Agreement is made and entered into on this _____ day of September 1997, by
and between the Potomac Funds, a Massachusetts business trust (hereinafter
referred to as the "Fund"), and Firstar Trust Company, a corporation organized
under the laws of the State of Wisconsin (hereinafter referred to as "FTC").
WHEREAS, the Fund is an open-end management investment company which is
registered under the Investment Company Act of 1940, as amended ("1940 Act");
and
WHEREAS, FTC is a trust company and, among other things, is in the business of
providing fund administration services for the benefit of its customers;
NOW, THEREFORE, the Fund and FTC do mutually promise and agree as follows:
I. Appointment of Administrator
The Fund hereby appoints FTC as Administrator of the Fund on the terms and
conditions set forth in this Agreement, and FTC hereby accepts such
appointment and agrees to perform the services and duties set forth in
this Agreement in consideration of the compensation provided for herein.
II. Duties and Responsibilities of FTC
A. General Fund Management
1. Act as liaison among all Fund's service providers
2. Coordinate Board communication by:
a. Assisting Fund's counsel in establishing meeting
agendas
b. Preparing reports based on financial and administrative
data to the Fund's Board of Trustees ("Board")
c. Evaluating independent auditors
d. Securing and monitoring fidelity bond and director and
officers liability coverage, and making the necessary
Securities and Exchange Commission ("SEC") filings
relating thereto
3. Audits
a. Prepare appropriate schedules and assist independent
auditors
<PAGE>
b. Provide information to SEC and facilitate audit process
c. Provide office facilities
4. Assist in overall operations of the Fund
B. Compliance
1. Regulatory Compliance
a. Monthly, quarterly and intra-month spot checks as
needed to monitor compliance with the following 1940
Act requirements:
1) Asset diversification tests
2) Total return and SEC yield calculations
3) Maintenance of books and records under Rule 31a-3
4) Code of Ethics
b. Periodically monitor Fund's compliance with the
policies and investment limitations of the Fund as set
forth in its most current prospectus and statement of
additional information
2. Blue Sky Compliance
a. Prepare and file with the appropriate state securities
authorities any and all required compliance filings
(including initial filings) relating to the
registration of the securities of the Fund so as to
enable the Fund to make a continuous offering of its
shares
b. Monitor status and maintain registrations in each state
3. SEC Registration and Reporting
a. Assist in updating the Fund's registration statement;
assist in the preparation of proxy statements and Rule
24f-2 notices, as instructed by the Fund
b. Prepare annual and semiannual reports
4. IRS Compliance
a. Monthly, quarterly and intra-month spot checks as
needed to monitor the Fund's status as a regulated
investment company under Subchapter M of the Internal
Revenue Code of 1986 through review of the following:
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<PAGE>
1) Asset diversification requirements
2) Qualifying income requirements
3) Distribution requirements
b. Calculate required distributions (including excise tax
distributions)
C. Financial Reporting
1. Provide financial data to be included in the Fund's
registration statement
2. Prepare financial reports for shareholders, the Board, the
SEC, and independent auditors
3. Supervise the Fund's custodian and Fund accountants in the
maintenance of the Fund's general ledger and in the
preparation of the Fund's financial statements including
oversight of expense accruals and payments, of the
determination of net asset value of the Fund's net assets
and of the Fund's shares, and of the declaration and
payment of dividends and other distributions to
shareholders, as declared by the Board
D. Tax Reporting
1. Prepare and file on a timely basis appropriate federal and
state tax returns including Forms 1120/8610 with any
necessary schedules
2. Prepare state income breakdowns where relevant
3. File Form 1099 Miscellaneous for payments to trustees and
other service providers
4. Monitor wash losses
5. Calculate eligible dividend income for corporate shareholders
III. Compensation
The Fund agrees to pay FTC for performance of the duties listed in this
Agreement and the fees and out-of-pocket expenses as set forth in the
attached Schedule A.
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<PAGE>
These fees may be changed from time to time, subject to mutual written
Agreement between the Fund and FTC.
The Fund agrees to pay all fees and out-of-pocket expenses within ten (10)
business days following the mailing of the billing notice.
IV. Additional Series
In the event that the Fund establishes one or more additional series of
shares other than those listed in this Section IV with respect to which it
desires to have FTC perform services under the terms hereof for such
services, it shall so notify FTC in writing, and if FTC agrees in writing
to provide such services, such series will be subject to the terms and
conditions of this Agreement, and shall be maintained and accounted for by
FTC on a discrete basis. The Funds currently covered by this Agreement
are: the Potomac Japan/Long Fund, Potomac Japan/Short Fund, Potomac U.S.
Plus Fund, Potomac U.S./Short Fund, Potomac OTC Plus Fund, Potomac
OTC/Short Fund and the Potomac U.S. Government Money Market Fund.
V. Performance of Service; Limitation of Liability
A. FTC shall exercise reasonable care and to act in good faith in
the performance of its duties under this Agreement. FTC shall not be
liable for any error of judgment or mistake of law or for any loss
suffered by the Fund in connection with matters to which this Agreement
relates, including losses resulting from mechanical breakdowns or the
failure of communication or power supplies beyond FTC's control, except a
loss resulting from FTC's refusal or failure to comply with the terms of
this Agreement or from bad faith, negligence, or willful misconduct on its
part in the performance of its duties under this Agreement.
Notwithstanding any other provision of this Agreement, the Fund shall
indemnify and hold harmless FTC from and against any and all claims,
demands, losses, expenses, and liabilities (whether with or without basis
in fact or law) of any and every nature (including reasonable attorneys'
fees) which FTC may sustain or incur or which may be asserted against FTC
by any person arising out of or attributed to any action taken or omitted
to be taken by it in performing the services hereunder (i) in accordance
with the foregoing standards, or (ii) in reliance upon any written or oral
instruction for a proper corporate purpose provided to FTC by any duly
authorized officer of the Fund, such duly authorized officer to be
included in a list of authorized officers furnished to FTC and as amended
from time to time in writing by resolution of the Board.
In the event of a mechanical breakdown or failure of communication
or power supplies beyond its control, FTC shall take all reasonable steps
to minimize service interruptions for any period that such interruption
continues beyond FTC's control. FTC will make every reasonable effort to
restore any lost or damaged data and correct any errors resulting from
such a breakdown at the expense of FTC. FTC agrees that it shall, at all
times, have reasonable contingency plans with appropriate parties, making
reasonable provision for emergency use of electrical data processing
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<PAGE>
equipment to the extent appropriate equipment is available.
Representatives of the Fund shall be entitled to inspect FTC's premises
and operating capabilities at any time during regular business hours of
FTC, upon reasonable notice to FTC.
Regardless of the above, FTC reserves the right to reprocess and
correct administrative errors at its own expense.
B. In order that the indemnification provisions contained in this
section shall apply, it is understood that in any case in which the Fund
may be asked to indemnify or hold FTC harmless, the Fund shall be fully
and promptly advised of all pertinent facts concerning the situation in
question, and it is further understood that FTC will use all reasonable
care to notify the Fund promptly concerning any situation which presents
or appears likely to present the probability of such a claim for
indemnification against the Fund. The Fund shall have the option to defend
FTC against any claim which may be the subject of this indemnification. In
the event that the Fund so elects, it will so notify FTC and thereupon the
Fund shall take over complete defense of the claim, and FTC shall in such
situation initiate no further legal or other expenses for which it shall
seek indemnification under this section. FTC shall in no case confess any
claim or make any compromise in any case in which the Fund will be asked
to indemnify FTC except with the Fund's prior written consent.
C. FTC shall indemnify and hold the Fund harmless from and against
any and all claims, demands, losses, expenses, and liabilities (whether
with or without basis in fact or law) of any and every nature (including
reasonable attorneys' fees) which the Fund may sustain or incur or which
may be asserted against the Fund by any person arising out of or
attributed to any action taken or omitted to be taken by FTC as a result
of FTC's refusal or failure to comply with the terms of this Agreement, or
from its bad faith, negligence, or willful misconduct of FTC or any of its
employees and agents.
VI. Confidentiality
FTC agrees on behalf of itself and its employees and agents to treat
confidentially all information relating to the Fund's business which is
received by FTC during the course of rendering any service hereunder. FTC
agrees on behalf of itself and its employees and agents to treat
confidentially all records and other information relative to the Fund and
its shareholders and shall not disclose to any other party, except after
prior notification to and approval in writing by the Fund, which approval
shall not be unreasonably withheld and may not be withheld where FTC may
be exposed to civil or criminal contempt proceedings for failure to comply
after being requested to divulge such information by duly constituted
authorities.
VII. Data Necessary to Perform Service
The Fund or its agent, which may be FTC, shall furnish to FTC the data
necessary to perform the services described herein at times and in such
form as mutually agreed upon.
VIII. Terms of Agreement
This Agreement shall become effective upon its execution and, unless
sooner terminated as provided herein, shall remain in effect for
successive annual periods. The Agreement may be terminated by either party
upon giving ninety (90) days' prior written notice to the other party or
such shorter period as is mutually agreed upon in writing by the parties.
This Agreement will automatically and immediately terminate in the event
of its assignment. Termination of this Agreement pursuant to this Section
VIII shall be without the payment of any penalty.
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<PAGE>
IX. Duties in the Event of Termination
In the event that, in connection with termination, a successor to any of
FTC's duties or responsibilities hereunder is designated by the Fund by
written notice to FTC, FTC will promptly, upon such termination and at the
expense of the Fund, transfer to such successor all relevant books,
records, correspondence, and other data established or maintained by FTC
under this Agreement in a form reasonably acceptable to the Fund (if such
form differs from the form in which FTC has maintained such records, the
Fund shall pay any expenses associated with transferring the data to such
form), and will cooperate in the transfer of such duties and
responsibilities, including provision for assistance from FTC's personnel
in the establishment of books, records, and other data by such successor.
X. Choice of Law
This Agreement shall be construed in accordance with the laws of the State
of Wisconsin. Trustees and shareholders of the Fund shall not be
personally liable for the obligations of the Fund in connection with any
matter arising from or in connection with this Agreement.
XI. Notices
Notices of any kind to be given by either party to the other party shall
be in writing and shall be duly given if mailed or delivered as follows:
notice to FTC shall be sent to Mutual Fund Services located at 615 East
Michigan Street, Milwaukee, Wisconsin 53202 and notice to the Fund shall
be sent to the Potomac Funds located at 550 Mamaroneck Avenue, Harrison,
NY 10528.
XII. Records
FTC shall keep records relating to the services to be performed hereunder,
in the form and manner, and for such period as it may deem advisable and
is acceptable to the Fund but not inconsistent with the rules and
regulations of appropriate government authorities, in particular, Section
31 of the 1940 Act, and the rules thereunder. FTC agrees that all such
records prepared or maintained by FTC relating to the services to be
performed by FTC hereunder are the property of the Fund and will be
preserved, maintained, and made available with such section and rules of
the 1940 Act and will be promptly surrendered to the Fund on and in
accordance with its request.
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<PAGE>
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to
be executed as of the date first written above by their respective officers
thereunto duly authorized.
POTOMAC FUNDS FIRSTAR TRUST COMPANY
By:_____________________________ By:______________________________
Title: ___________________________ Title: First Vice President
Date: ___________________________ Date: ____________________________
Attest: __________________________ Attest: ___________________________
-7-
DISTRIBUTION AGREEMENT
THIS AGREEMENT is made as of this _____ day of ____________, 1997 (the
"Agreement") by and between The Potomac Funds, a ______________business trust
(the "Company") and First Data Distributors, Inc. (the "Distributor"), a
Massachusetts corporation.
WHEREAS, the Company is registered as a diversified, open-end management
investment company under the Investment Company Act of 1940, as amended (the
"1940 Act"); and is currently offering units of beneficial interest (such units
of all series are hereinafter called the "Shares"), representing interests in
investment portfolios of the Company identified on Schedule A hereto (the
"Funds") which are registered with the Securities and Exchange Commission (the
"SEC") pursuant to the Company's Registration Statement on Form N-1A (the
"Registration Statement"); and
WHEREAS, the Company desires to retain the Distributor as distributor for
the Funds to provide for the sale and distribution of the Shares of the Funds
identified on Schedule A and for such additional classes or series as the
Company may issue, and the Distributor is prepared to provide such services
commencing on the date first written above.
NOW THEREFORE, in consideration of the premises and mutual covenants set
forth herein and intending to be legally bound hereby the parties hereto agree
as follows:
1. SERVICE AS DISTRIBUTOR
1.1. The Distributor will act on behalf of the Company for the distribution
of the Shares covered by the Registration Statement under the Securities
Act of 1933, as amended (the "1933 Act"). The Distributor will have no
liability for payment for the purchase of Shares sold pursuant to this
Agreement or with respect to redemptions or repurchases of Shares.
1.2. The Distributor agrees to use efforts deemed appropriate by the
Distributor to solicit orders for the sale of the Shares and will
undertake such advertising and promotion as it believes reasonable in
connection with such solicitation; provided, however, that each Fund
will bear the expenses incurred and other payments made in accordance
with the provisions of the Agreement and any plan now or hereafter
adopted with respect to any Fund pursuant to Rule 12b-1 under the 1940
Act (the "Plans"). To the extent that the Distributor receives
shareholder services fees under any shareholder services plan adopted by
the Company, the Distributor agrees to furnish, and/or enter into
arrangements with others for the furnishing of, personal and/or account
maintenance services with respect to the relevant shareholders of the
Company as may be required pursuant to such plan. It is contemplated
that the Distributor will enter into sales or servicing agreements with
securities dealers, financial institutions and other industry
professionals, such as investment advisers, accountants and estate
planning firms.
<PAGE>
1.3. The Company understands that the Distributor is now, and may in the
future be, the distributor of the shares of several investment companies
or series (collectively, the "Investment Entities"), including
Investment Entities having investment objectives similar to those of the
Company. The Company further understands that investors and potential
investors in the Company may invest in shares of such other Investment
Entities. The Company agrees that the Distributor's duties to such
Investment Entities shall not be deemed in conflict with its duties to
the Company under this Section 1.3.
1.4. The Distributor shall not utilize any materials in connection with the
sale or offering of Shares except the Company's prospectus and statement
of additional information and such other materials as the Company shall
provide or approve.
1.5. All activities by the Distributor and its employees, as distributor of
the Shares, shall comply with all applicable laws, rules and
regulations, including, without limitation, all rules and regulations
made or adopted by the SEC or the National Association of Securities
Dealers.
1.6. The Distributor will transmit any orders received by it for purchase or
redemption of the shares to the transfer agent for the Company
1.7. Whenever in its judgment such action is warranted by unusual market,
economic or political conditions or abnormal circumstances of any kind,
the Company may decline to accept any orders for, or make any sales of,
the Shares until such time as the Company deems it advisable to accept
such orders and to make such sales, and the Company advises the
Distributor promptly of such determination.
1.8. The Distributor may enter into selling agreements with selected dealers
or other institutions with respect to the offering of Shares to the
public. Each such selling agreement will provide (a) that all payments
for purchases of Shares will be sent directly from the dealer or such
other institution to the Funds' transfer agent and (b) that, if payment
is not made with respect to purchases of Shares at the customary or
required time for settlement of the transaction, the Distributor will
have the right to cancel the sale of the Shares ordered by the dealer or
such other institution, in which case the dealer or such other
institution will be responsible for any loss suffered by any Fund or the
Distributor resulting from such cancellation. The Distributor may also
act as disclosed agent for a Fund and sell Shares of that Fund to
individual investors, such transactions to be specifically approved by
an officer of that Fund.
2
<PAGE>
1.9. The Company agrees to pay all costs and expenses in connection with the
registration of Shares under the Securities Act of 1933, as amended, and
all expenses in connection with maintaining facilities for the issue and
transfer of Shares and for supplying information, prices and other data
to be furnished by the Fund hereunder, and all expenses in connection
with the preparation and printing of the Fund's prospectuses and
statements of additional information for regulatory purposes and for
distribution to shareholders.
1.10. The Company agrees at its own expense to execute any and all documents
and to furnish any and all information and otherwise to take all actions
that may be reasonably necessary in connection with the qualification of
the Shares for sale in such states as the Distributor may designate. The
Company shall notify the Distributor in writing of the states in which
the Shares may be sold and shall notify the Distributor in writing of
any changes to the information contained in the previous notification.
1.11. The Company shall furnish from time to time, for use in connection with
the sale of the Shares, such information with respect to the Company and
the Shares as the Distributor may reasonably request; and the Company
warrants that the statements contained in any such information shall
fairly show or represent what they purport to show or represent. The
Company shall also furnish the Distributor upon request with: (a)
audited annual statements and unaudited semi-annual statements of a
Fund's books and accounts prepared by the Company, (b) quarterly
earnings statements prepared by the Company, (c) a monthly itemized list
of the securities in the Funds, (d) monthly balance sheets as soon as
practicable after the end of each month, and (e) from time to time such
additional information regarding the financial condition of the Company
as the Distributor may reasonably request.
1.12. The Company represents to the Distributor that all Registration
Statements and prospectuses filed by the Company with the SEC under the
1933 Act with respect to the Shares have been prepared in conformity
with the requirements of the 1933 Act and the rules and regulations of
the SEC thereunder. As used in this Agreement, the term "Registration
Statement" shall mean any Registration Statement and any prospectus and
any statement of additional information relating to the Company filed
with the SEC and any amendments or supplements thereto at any time filed
with the SEC. Except as to information included in the Registration
Statement in reliance upon information provided to the Company by the
Distributor or any affiliate of the Distributor expressly for use in the
Registration Statement, the Company represents and warrants to the
Distributor that any Registration Statement, when such Registration
Statement becomes effective, will contain statements required to be
stated therein in conformity with the 1933 Act and the rules and
regulations of the SEC; that all statements of fact contained in any
such Registration Statement will be true and correct when such
Registration Statement becomes effective; and that no Registration
Statement when such Registration Statement becomes effective will
3
<PAGE>
include an untrue statement of a material fact or omit to state a
material fact required to be stated therein or necessary to make the
statements therein not misleading to a purchaser of the Shares. The
Company may but shall not be obligated to propose from time to time such
amendment or amendments to any Registration Statement and such
supplement or supplements to any prospectus as, in the light of future
developments, may, in the opinion of the Company's counsel, be necessary
or advisable. The Company shall promptly notify the Distributor of any
advice given to it by its counsel regarding the necessity or
advisability of amending or supplementing such Registration Statement.
If the Company shall not propose such amendment or amendments and/or
supplement or supplements within fifteen days after receipt by the
Company of a written request from the Distributor to do so, the
Distributor may, at its option, terminate this Agreement. The Company
shall not file any amendment to any Registration Statement or supplement
to any prospectus without giving the Distributor reasonable notice
thereof in advance; provided, however, that nothing contained in this
Agreement shall in any way limit the Company's right to file at any time
such amendments to any Registration Statements and/or supplements to any
prospectus, of whatever character, as the Company may deem advisable,
such right being in all respects absolute and unconditional.
1.13. The Company authorizes the Distributor to use any prospectus or
statement of additional information in the form furnished from time to
time in connection with the sale of the Shares. The Company agrees to
indemnify and hold harmless the Distributor, its officers, directors,
and employees, and any person who controls the Distributor within the
meaning of Section 15 of the 1933 Act, free and harmless (a) from and
against any and all claims, costs, expenses (including reasonable
attorneys' fees) losses, damages, charges, payments and liabilities of
any sort or kind which the Distributor, its officers, directors,
employees or any such controlling person may incur under the 1933 Act,
under any other statute, at common law or otherwise, arising out of or
based upon: (i) any untrue statement, or alleged untrue statement, of a
material fact contained in the Company's Registration Statement,
prospectus, statement of additional information, or sales literature
(including amendments and supplements thereto), or (ii) any omission, or
alleged omission, to state a material fact required to be stated in the
Company's Registration Statement, prospectus, statement of additional
information or sales literature (including amendments or supplements
thereto), necessary to make the statements therein not misleading,
provided, however, that insofar as losses, claims, damages, liabilities
or expenses arise out of or are based upon any such untrue statement or
omission or alleged untrue statement or omission made in reliance on and
in conformity with information furnished to the Company by the
4
<PAGE>
Distributor or its affiliated persons for use in the Company's
Registration Statement, prospectus, or statement of additional
information or sales literature (including amendments or supplements
thereto), such indemnification is not applicable; and (b) from and
against any and all such claims, demands, liabilities and expenses
(including such costs and counsel fees) which you, your officers and
directors, or such controlling person, may incur in connection with this
Agreement or the Distributor's performance hereunder (but excluding such
claims, demands, liabilities and expenses (including such costs and
counsel fees) arising out of or based upon any untrue statement, or
alleged untrue statement, of a material fact contained in any
registration statement or any prospectus or arising out of or based upon
any omission, or alleged omission, to state a material fact required to
be stated in either any registration statement or any prospectus or
necessary to make the statements in either thereof not misleading),
unless such claims, demands, liabilities and expenses (including such
costs and counsel fees) arise by reason of the Distributor's willful
misfeasance, bad faith or negligence in the performance of the
Distributor's duties hereunder. The Company acknowledges and agrees that
in the event that the Distributor, at the request of the Company, are
required to give indemnification comparable to that set forth in clause
(a) of this Section 1.13 to any entity selling Shares of the Company or
providing shareholder services to shareholders of the Company and such
entity shall make a claim for indemnification against the Distributor,
the Distributor shall make a similar claim for indemnification against
the Company.
1.14. The Distributor agrees to indemnify and hold harmless the Company, its
several officers and Trustees and each person, if any, who controls a
Fund within the meaning of Section 15 of the 1933 Act against any and
all claims, costs, expenses (including reasonable attorneys' fees),
losses, damages, charges, payments and liabilities of any sort or kind
which the Company, its officers, Trustees or any such controlling person
may incur under the 1933 Act, under any other statute, at common law or
otherwise, but only to the extent that such liability or expense
incurred by the Company, its officers or Trustees, or any controlling
person resulting from such claims or demands arose out of the
acquisition of any Shares by any person which may be based upon any
untrue statement, or alleged untrue statement, of a material fact
contained in the Company's Registration Statement, prospectus or
statement of additional information (including amendments and
supplements thereto), or any omission, or alleged omission, to state a
material fact required to be stated therein or necessary to make the
statements therein not misleading, if such statement or omission was
made in reliance upon information furnished or confirmed in writing to
the Company by the Distributor or its affiliated persons (as defined in
the 1940 Act).
5
<PAGE>
1.15. In any case in which one party hereto (the "Indemnifying Party") may be
asked to indemnify or hold the other party hereto (the "Indemnified
Party") harmless, the Indemnified Party will notify the Indemnifying
Party promptly after identifying any situation which it believes
presents or appears likely to present a claim for indemnification (an
"Indemnification Claim") against the Indemnifying Party, although the
failure to do so shall not prevent recovery by the Indemnified Party,
and shall keep the Indemnifying Party advised with respect to all
developments concerning such situation. The Indemnifying Party shall
have the option to defend the Indemnified Party against any
Indemnification Claim which may be the subject of this indemnification,
and, in the event that the Indemnifying Party so elects, such defense
shall be conducted by counsel chosen by the Indemnifying Party and
satisfactory to the Indemnified Party, and thereupon the Indemnifying
Party shall take over complete defense of the Indemnification Claim and
the Indemnified Party shall sustain no further legal or other expenses
in respect of such Indemnification Claim. The Indemnified Party will not
confess any Indemnification Claim or make any compromise in any case in
which the Indemnifying Party will be asked to provide indemnification,
except with the Indemnifying Party's prior written consent. The
obligations of the parties hereto under this Section 1.15 and Section
3.1 shall survive the termination of this Agreement.
In the event that the Company is the Indemnifying Party and the
Indemnifying Party does not elect to assume the defense of any such
suit, or in case the Distributor reasonably does not approve of counsel
chosen by the Company, or in case there is a conflict of interest
between the Company or the Distributor, the Company will reimburse the
Distributor, its officers, directors and employees, or the controlling
person or persons named as defendant or defendants in such suit, for the
fees and expenses of any counsel retained by the Distributor or them.
The Company's indemnification agreement contained in this Section 1.15
and Section 3.1 and the Company's representations and warranties in this
Agreement shall remain operative and in full force and effect regardless
of any investigation made by or on behalf of the Distributor, its
officers, directors and employees, or any controlling person, and shall
survive the delivery of any Shares. This agreement of indemnity will
inure exclusively to the Distributor's benefit, to the benefit of its
several officers, directors and employees, and their respective estates
and to the benefit of the controlling persons and their successors. The
Company agrees promptly to notify the Distributor of the commencement of
any litigation or proceedings against the Company or any of its officers
or directors in connection with the issue and sale of any Shares.
6
<PAGE>
1.16. No Shares shall be offered by either the Distributor or the Company
under any of the provisions of this Agreement and no orders for the
purchase or sale of Shares hereunder shall be accepted by the Company if
and so long as effectiveness of the Registration Statement then in
effect or any necessary amendments thereto shall be suspended under any
of the provisions of the 1933 Act, or if and so long as a current
prospectus as required by Section 5(b)(2) of the 1933 Act is not on file
with the SEC; provided, however, that nothing contained in this Section
1.16 shall in any way restrict or have any application to or bearing
upon the Company's obligation to redeem Shares tendered for redemption
by any shareholder in accordance with the provisions of the Company's
Registration Statement, Declaration of Company, or bylaws.
1.17. The Company agrees to advise the Distributor as soon as reasonably
practical by a notice in writing delivered to the Distributor:
(a) of any request by the SEC for amendments to the Registration
Statement, prospectus or statement of additional information then in
effect or for additional information;
(b) in the event of the issuance by the SEC of any stop order
suspending the effectiveness of the Registration Statement, prospectus
or statement of additional information then in effect or the initiation
by service of process on the Company of any proceeding for that purpose;
(c) of the happening of any event that makes untrue any statement of a
material fact made in the Registration Statement, prospectus or
statement of additional information then in effect or that requires the
making of a change in such Registration Statement, prospectus or
statement of additional information in order to make the statements
therein not misleading; and
(d) of all actions of the SEC with respect to any amendments to any
Registration Statement, prospectus or statement of additional
information which may from time to time be filed with the SEC.
For purposes of this section, informal requests by or acts of the Staff
of the SEC shall not be deemed actions of or requests by the SEC.
2. TERM
----
2.1. This Agreement shall become effective on the date first written above
and, unless sooner terminated as provided herein, shall continue for an
initial two-year term and thereafter shall be renewed for successive
7
<PAGE>
one-year terms, provided such continuance is specifically approved at
least annually by (i) the Company's Board of Trustees or (ii) by a vote
of a majority (as defined in the 1940 Act and Rule 18f-2 thereunder) of
the outstanding voting securities of the Company, provided that in
either event the continuance is also approved by a majority of the
Trustees who are not parties to this Agreement and who are not
interested persons (as defined in the 1940 Act) of any party to this
Agreement, by vote cast in person at a meeting called for the purpose of
voting on such approval. This Agreement is terminable without penalty,
on at least sixty days' written notice, by the Company's Board of
Trustees, by vote of a majority (as defined in the 1940 Act and Rule
18f-2 thereunder) of the outstanding voting securities of the Company,
or by the Distributor. This Agreement will also terminate automatically
in the event of its assignment (as defined in the 1940 Act and the rules
thereunder).
2.2. In the event a termination notice is given by the Company, all expenses
associated with movement of records and materials and conversion thereof
will be borne by the Company.
3. LIMITATION OF LIABILITY
-----------------------
3.1. The Distributor shall not be liable to the Company for any error of
judgment or mistake of law or for any loss suffered by the Company in
connection with the performance of its obligations and duties under this
Agreement, except a loss resulting from the Distributor's willful
misfeasance, bad faith or negligence in the performance of such
obligations and duties, or by reason of its reckless disregard thereof.
The Company will indemnify the Distributor against and hold it harmless
from any and all claims, costs, expenses (including reasonable
attorneys' fees), losses, damages, charges, payments and liabilities of
any sort or kind which may be asserted against the Distributor for which
the Distributor may be held to be liable in connection with this
Agreement or the Distributor's performance hereunder (a "Section 3.1
Claim"), unless such Section 3.1 Claim resulted from a negligent act or
omission to act or bad faith by the Distributor in the performance of
its duties hereunder. The provisions of paragraph 1 of Section 1.12
shall apply to any indemnification provided by the Company pursuant to
this Section 3.1. The obligations of the parties hereto under this
Section 3.1 shall survive termination of this Agreement.
3.2. Notwithstanding any provision in this Agreement to the contrary, the
Distributor's cumulative liability (to the Company) for all losses,
claims, suits, controversies, breaches, or damages ("Liability Claims")
for any cause whatsoever and regardless of the form of action or legal
theory, shall not exceed $500,000. The Company understands the
limitation on the Distributor's damages to be a reasonable allocation of
risk and the Company expressly consents with respect to such allocation
of risk.
8
<PAGE>
3.3. Neither party may assert any cause of action against the other party
under this Agreement that accrued more than two (2) years prior to the
filing of the suit (or commencement of arbitration proceedings) alleging
such cause of action.
3.4. Each party shall have the duty to mitigate damages for which the other
party may become responsible.
3.5. NOTWITHSTANDING ANYTHING IN THIS AGREEMENT TO THE CONTRARY, IN NO EVENT
SHALL THE DISTRIBUTOR, ITS AFFILIATES OR ANY OF ITS OR THEIR DIRECTORS,
OFFICERS, EMPLOYEES, AGENTS OR SUBCONTRACTORS BE LIABLE UNDER ANY THEORY
OF TORT, CONTACT, STRICT LIABILITY OF OTHER LEGAL OR EQUITABLE THEORY
FOR LOST PROFITS, EXEMPLARY, PUNITIVE, SPECIAL INCIDENTAL, INDIRECT OR
CONSEQUENTIAL DAMAGES, EACH OF WHICH IS HEREBY EXCLUDED BY AGREEMENT OF
THE PARTIES REGARDLESS OF WHETHER SUCH DAMAGES WERE FORESEEABLE OR
WHETHER EITHER PARTY OR ANY ENTITY HAS BEEN ADVISED OF THE POSSIBILITY
OF SUCH DAMAGES.
4. EXCLUSION OF WARRANTIES
-----------------------
THIS IS A SERVICE AGREEMENT. EXCEPT AS EXPRESSLY PROVIDED IN THIS
AGREEMENT, THE DISTRIBUTOR DISCLAIMS ALL OTHER REPRESENTATIONS OR
WARRANTIES, EXPRESS OR IMPLIED, MADE TO THE COMPANY, A FUND OR ANY OTHER
PERSON, INCLUDING, WITHOUT LIMITATION, ANY WARRANTIES REGARDING QUALITY,
SUITABILITY, MERCHANTABILITY, FITNESS FOR A PARTICULAR PURPOSE OR
OTHERWISE (IRRESPECTIVE OF ANY COURSE OF DEALING, CUSTOM OR USAGE OF
TRADE) OF ANY SERVICES OR ANY GOODS PROVIDED INCIDENTAL TO SERVICES
PROVIDED UNDER THIS AGREEMENT. THE DISTRIBUTOR DISCLAIMS ANY WARRANTY OF
TITLE OR NON-INFRINGEMENT EXCEPT AS OTHERWISE SET FORTH IN THIS
AGREEMENT.
5. MODIFICATION AND WAIVERS
------------------------
No change, termination, modification, or waiver of any term or condition
of the Agreement shall be valid unless in writing signed by each party.
No such writing shall be effective as against the Distributor unless
said writing is executed by a Senior Vice President, Executive Vice
President or President of the Distributor. A party's waiver of a breach
of any term or condition in the Agreement shall not be deemed a waiver
of any subsequent breach of the same or another term or condition.
6. NO PRESUMPTION AGAINST DRAFTER
------------------------------
The Distributor and the Company have jointly participated in the
negotiation and drafting of this Agreement. The Agreement shall be
construed as if drafted jointly by the Company and the Distributor, and
no presumptions arise favoring any party by virtue of the authorship of
any provision of this Agreement.
9
<PAGE>
7. PUBLICITY
---------
Neither the Distributor nor the Company shall release or publish news
releases, public announcements, advertising or other publicity relating
to this Agreement or to the transactions contemplated by it without
prior review and written approval of the other party; provided, however,
that either party may make such disclosures as are required by legal,
accounting or regulatory requirements after making reasonable efforts in
the circumstances to consult in advance with the other party.
8. SEVERABILITY
------------
The parties intend every provision of this Agreement to be severable. If
a court of competent jurisdiction determines that any term or provision
is illegal or invalid for any reason, the illegality or invalidity shall
not affect the validity of the remainder of this Agreement. In such
case, the parties shall in good faith modify or substitute such
provision consistent with the original intent of the parties. Without
limiting the generality of this paragraph, if a court determines that
any remedy stated in this Agreement has failed of its essential purpose,
then all other provisions of this Agreement, including the limitations
on liability and exclusion of damages, shall remain fully effective.
9. FORCE MAJEURE
-------------
No party shall be liable for any default or delay in the performance of
its obligations under this Agreement if and to the extent such default
or delay is caused, directly or indirectly, by (i) fire, flood, elements
of nature or other acts of God; (ii) any outbreak or escalation of
hostilities, war, riots or civil disorders in any country; (iii) any act
or omission of the other party or any governmental authority; (iv) any
labor disputes (whether or not the employees' demands are reasonable or
within the party's power to satisfy); or (v) nonperformance by a third
party or any similar cause beyond the reasonable control of such party,
including without limitation, failures or fluctuations in
telecommunications or other equipment. In any such event, the
non-performing party shall be excused from any further performance and
observance of the obligations so affected only for so long as such
circumstances prevail and such party continues to use commercially
reasonable efforts to recommence performance or observance as soon as
practicable.
10. MISCELLANEOUS
-------------
10.1. Any notice or other instrument authorized or required by this Agreement
to be given in writing to the Company or the Distributor shall be
sufficiently given if addressed to the party and received by it at its
office set forth below or at such other place as it may from time to
time designate in writing.
10
<PAGE>
To the Company:
The Potomac Funds
550 Mamaroneck Avenue
Harrison, New York 10528
To the Distributor:
First Data Distributors, Inc.
4400 Computer Drive
Westboro, Massachusetts 01581
Attention: President
with a copy to the Distributor's Chief Legal Officer
10.2. The laws of the Commonwealth of Massachusetts, excluding the laws on
conflicts of laws, and the applicable provisions of the 1940 Act shall
govern the interpretation, validity, and enforcement of this Agreement.
To the extent the provisions of Massachusetts law or the provisions
hereof conflict with the 1940 Act, the 1940 Act shall control. All
actions arising from or related to this Agreement shall be brought in
the state and federal courts sitting in the City of Boston, and the
Distributor and the Company hereby submit themselves to the exclusive
jurisdiction of those courts.
10.3. This Agreement may be executed in any number of counterparts, each of
which shall be deemed to be an original and which collectively shall be
deemed to constitute only one instrument.
10.4. The captions of this Agreement are included for convenience of reference
only and in no way define or delimit any of the provisions hereof or
otherwise affect their construction or effect.
10.5. This Agreement shall be binding upon and shall inure to the benefit of
the parties hereto and their respective successors and is not intended
to confer upon any other person any rights or remedies hereunder.
11. CONFIDENTIALITY
---------------
11.1. The parties agree that the Proprietary Information (defined below) and
the contents of this Agreement (collectively "Confidential Information")
are confidential information of the parties and their respective
licensers. The Company and the Distributor shall exercise reasonable
care to safeguard the confidentiality of the Confidential Information of
the other. The Company and the Distributor may each use the Confidential
11
<PAGE>
Information only to exercise its rights or perform its duties under this
Agreement. The Company and the Distributor shall not duplicate, sell or
disclose to others the Confidential Information of the other, in whole
or in part, without the prior written permission of the other party. The
Company and the Distributor may, however, disclose Confidential
Information to its employees who have a need to know the Confidential
Information to perform work for the other, provided that each shall use
reasonable efforts to ensure that the Confidential Information is not
duplicated or disclosed by its employees in breach of this Agreement.
The Company and the Distributor may also disclose the Confidential
Information to independent contractors, auditors and professional
advisors, provided they first agree in writing to be bound by the
confidentiality obligations substantially similar to this Section 11.
Notwithstanding the previous sentence, in no event shall either the
Company or the Distributor disclose the Confidential Information to any
competitor of the other without specific, prior written consent.
11.2. Proprietary Information means:
(a) any data or information that is completely sensitive material, and
not generally known to the public, including, but not limited to,
information about product plans, marketing strategies, finance,
operations, customer relationships, customer profiles, sales estimates,
business plans, and internal performance results relating to the past,
present or future business activities of the Company or the Distributor,
their respective subsidiaries and affiliated companies and the
customers, clients and suppliers of any of them;
(b) any scientific or technical information, design, process,
procedure, formula, or improvement that is commercially valuable and
secret in the sense that its confidentiality affords the Company or the
Distributor a competitive advantage over its competitors; and
(c) all confidential or proprietary concepts, documentation, reports,
data, specifications, computer software, source code, object code, flow
charts, databases, inventions, know-how, show-how and trade secrets,
whether or not patentable or copyrightable.
11.3. Confidential Information includes, without limitation, all documents,
inventions, substances, engineering and laboratory notebooks, drawings,
diagrams, specifications, bills of material, equipment, prototypes and
models, and any other tangible manifestation of the foregoing of either
party which now exist or come into the control or possession of the
other.
12
<PAGE>
11.4. The Company acknowledges that breach of the restrictions on use,
dissemination or disclosure of any Confidential Information would result
in immediate and irreparable harm, and money damages would be inadequate
to compensate the Distributor for that harm. The Distributor shall be
entitled to equitable relief, in addition to all other available
remedies, to redress any such breach.
12. The Company and the Distributor agree that the obligations of the
Company under the Agreement shall not be binding upon any of the
Trustees, shareholders, nominees, officers, employees or agents, whether
past, present or future, of the Company individually, but are binding
only upon the assets and property of the Company, as provided in the
Declaration of Trust. The execution and delivery of this Agreement have
been authorized by the Directors of the Company, and signed by an
authorized officer of the Company, acting as such, and neither such
authorization by such Trustees nor such execution and delivery by such
officer shall be deemed to have been made by any of them or any
shareholder of the Company individually or to impose any liability on
any of them or any shareholder of the Company personally, but shall bind
only the assets and property of the Company as provided in the
Declaration of Trust.
13. ENTIRE AGREEMENT
----------------
This Agreement, including all Schedules hereto, constitutes the entire
agreement between the parties with respect to the subject matter hereof
and supersedes all prior and contemporaneous proposals, agreements,
contracts, representations, and understandings, whether written or oral,
between the parties with respect to the subject matter hereof.
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be
duly executed all as of the day and year first above written.
POTOMAC FUNDS
BY:________________________________
NAME:______________________________
TITLE:_____________________________
FIRST DATA DISTRIBUTORS, INC.
BY:________________________________
NAME:______________________________
TITLE:_____________________________
13
<PAGE>
SCHEDULE A
----------
to the Distribution Agreement
between The Potomac Funds and
First Data Distributors, Inc.
NAME OF FUNDS
-------------
Potomac Japan/Long Fund
Potomac Japan/Short Fund
Potomac U.S. Plus Fund
Potomac U.S./Short Fund
Potomac OTC Plus Fund
Potomac OTC/Short Fund
Potomac U.S. Government Money Market Fund
14
CONSULTING AGREEMENT
AGREEMENT made as of this ____day of ____________, 1997 between Rafferty
Asset Management LLC ("Rafferty"), a limited liability corporation, and First
Data Distributors, Inc. ("FDDI"), a Massachusetts corporation.
WHEREAS, Rafferty serves as investment adviser to certain investment
portfolios or series of one or more open-end management investment companies
registered under the Investment Company Act of 1940, as amended (the "1940
Act"), as listed on Schedule A, as such Schedule shall automatically be amended
from time to time (each a "Fund" and collectively the "Funds");
WHEREAS, certain employees of Rafferty will be registered with the
National Association of Securities Dealers, Inc. ("NASD") as representatives of
FDDI) such persons shall hereinafter be referred to as "Registered
Representatives");
WHEREAS, such Registered Representatives will be wholesaling the Funds'
Shares and will also be actively selling investment advisory services of
Rafferty, a registered investment adviser to clients;
WHEREAS, Rafferty and FDDI desire to enter into this Agreement pursuant to
which Rafferty will perform certain services for FDDI with regard to monitoring
the performance of Registered Representatives and FDDI will perform certain
services for Rafferty with respect to Shares of each Fund; and
WHEREAS, Rafferty has agreed to enter into this Agreement as consideration
for FDDI entering into the Distribution Agreement;
NOW, THEREFORE, in consideration of the mutual agreements herein
contained, the parties agree as follows:
1. SERVICES PROVIDED BY FDDI. FDDI will assist Rafferty in providing
services with respect to each Fund as may reasonably be requested by Rafferty
from time to time. At the direction of Rafferty, specific assignments may
include any of the following:
(a) Legal review and principal sign-off of all Fund marketing
materials and other sales related materials to ensure compliance with the
advertising rules of the relevant regulatory authorities and file such
materials, and obtain such approvals for their use as may be required by
the Securities and Exchange Commission ("SEC"), the NASD or state
securities administrators. FDDI will forward all NASD comments on
marketing materials to Rafferty;
(b) The forwarding of sales related complaints concerning the
Fund to Rafferty;
<PAGE>
(c) Coordination of registration of the Fund with the National
Securities Clearing Corporation ("NSCC") and filing of required Fund/SERV
reports with NSCC;
(d) The provision of advice and counsel to the Funds with respect
to regulatory matters, including monitoring regulatory and legislative
developments that may affect the Funds and assisting the Funds in routine
regulatory examinations or investigations;
(e) Assistance in the Funds' operations and provision of general
consulting services on a day to day, as needed, basis;
(f) Assistance in the preparation of quarterly board materials with
regard to sales and other distribution related data reasonably requested
by the board;
(g) Preparation of materials for the board supporting the annual
renewal of the Distribution Agreement;
(h) In connection with the foregoing activities, maintenance of an
office facility (which may be in the offices of Rafferty or a corporate
affiliate); and
(i) In connection with the foregoing activities, the furnishing of
clerical services and internal executive and administrative services,
stationery and office supplies.
FDDI will keep and maintain all books and records relating to its services
in accordance with Rule 3la-1 under the 1940 Act.
2. SERVICES PROVIDED BY RAFFERTY. In furtherance of the responsibilities
under this Agreement, Rafferty will:
(a) monitor the performance of the Registered Representatives with
respect to compliance with the NASD's Rules of Conduct, and in particular
the NASD's interpretation of the applicability of Section 3040 of the
NASD's Rules of Conduct to certain activities of persons registered as
representatives with an NASD member and an investment adviser with the
SEC, and who conduct their advisory activities away from the NASD
employer/member as described in the NASD's SPECIAL NOTICE TO MEMBERS
94-44;
(b) cause the registration of the Shares under the Securities Act
of 1933 (the "1933 Act") and the qualification for the Shares for sale in
those states that the Funds may designate;
2
<PAGE>
(c) monitor or cause the Funds' transfer agent to monitor sales of
Shares with respect to compliance with applicable state securities and
Blue Sky laws;
(d) provide consulting services with regard to such advertising,
marketing and promotional activities as Rafferty believes reasonable,
including but not limited to (i) development of information, analyses and
reports; (ii) preparing, printing and distributing sales literature
brochures, letters, training materials and dealer guides and all similar
materials and advertisements as defined below; (iii) develop and implement
audio and video advertising programs; and (iv) arrange for the printing
and distribution of prospectuses and reports of the Funds to prospective
shareholders; provided that it is understood that FDDI shall have no
responsibility for strategic planning or development with respect to such
matter. For purposes of this Agreement, "sales literature" and
"advertisements" mean brochures, letters, electronic media, training
materials and dealers' guides materials for oral presentations and all
other similar materials, whether transmitted directly to potential
shareholders or published in print or audio visual media, but does not
include generic materials that do not mention the Funds or the Shares;
(e) submit all consulting related sales literature and
advertisements prepared pursuant to Section l(d) above to FDDI for
legal/compliance review in advance of use, and incorporate such changes as
FDDI may reasonably request therein. FDDI will file such materials and
obtain such approvals for their use as may be required by the SEC, NASD or
state securities commissioners;
(f) identify persons employed by Rafferty that will become
Registered Representatives and assist FDDI in ascertaining that such
persons meet all requirements established for being a Registered
Representative by the SEC, NASD and relevant state securities commissions;
(g) report sales-related complaints to FDDI and consult with FDDI
concerning the manner in which such complaints will be addressed;
(h) to the extent applicable, cause the Funds' transfer agent to
give necessary information for the presentation of quarterly reports in a
form reasonably satisfactory to FDDI regarding any Rule 12b-1 fees,
front-end sales loads, back-end sales loads and other data regarding sales
and sales loads as required by the 1940 Act or as requested by the board
of trustees of the applicable investment companies listed on Schedule A;
(i) to the extent applicable, cause the Funds' transfer agent to
provide FDDI with all necessary historical information so that FDDI can
calculate the maximum sales charges payable by the Funds pursuant to the
Rules of Conduct of the NASD and the actual sales charges paid by the
Funds; cause the Funds' transfer agent to provide FDDI with all of the
3
<PAGE>
necessary information so that FDDI can calculate the maximum sales charges
payable by the Funds pursuant to the Rules of Conduct of the NASD and the
actual sales charges paid by the Funds; and cause the Funds' transfer
agent to provide such information in a form satisfactory to FDDI no less
often than monthly for every Fund and on a daily basis for any Fund for
which FDDI determines that the remaining limit is approaching zero;
(j) support or cause the Funds' transfer agent to support the
servicing of the shareholders; in connection therewith the Funds' transfer
agent or Rafferty will provide one or more persons during normal business
hours to respond to telephone questions concerning the Funds;
(k) provide FDDI with copies of, or access to, any documents that
FDDI may reasonably request and notify FDDI as soon as possible of any
matter materially affecting FDDI's performance of services under this
Agreement;
(l) (i) identify persons to enter into agreements with FDDI for the
solicitation of Fund Shares, such as securities dealers, financial
institutions and other industry professionals such as investment advisers
and estate planning firms (collectively referred to herein as "Selling
Broker Dealers"); (ii) assist FDDI in ascertaining that such persons meet
any requirements established for Selling Broker Dealers by law, the Funds
or FDDI; (iii) request that FDDI enter into selling agreements with each
such Selling Broker Dealer ("Selling Agreements") using a request form
(the "Selling Agent Request Form") substantially similar to the attached
Exhibit B signed by a duly authorized officer or employee of Rafferty (who
shall be a person listed on Exhibit B until such time as Rafferty amends
or supplements such list) and Rafferty will assist in the performance of
the necessary due diligence to determine the qualification of the
prospective Selling Broker Dealer pursuant to clause (ii) above; (iv)
submit such Selling Agent Request Form and all related due diligence
materials that Rafferty may have to FDDI; (v) assist FDDI in coordinating
the execution of Selling Agreements between FDDI and the Selling Broker
Dealers; and (vi) use its best efforts to insure that no sales are
executed or processed prior to obtaining an executed Selling Agreement
from the Selling Broker Dealer making the sale;
(m) provide administrative support (e.g. telemarketing and
fulfillment services) with regard to, and use its best efforts to monitor
the performance of, the Selling Broker Dealers in their solicitation and
execution of sales of the Shares and all activities related thereto,
including compliance with applicable law, the Selling Agreements and the
multi-class procedures;
(n) use reasonable efforts to monitor the Selling Broker Dealers
and the Registered Representatives in their resolution of as of trades
with respect to Shares of the Funds in order to mitigate the risk of loss
to FDDI and the Funds from such trades;
4
<PAGE>
(o) report to FDDI, to the extent that Rafferty is aware, any and
all actions or inactions by any Selling Broker Dealer or Registered
Representative that (i) fail to comply with the terms of any Selling
Agreements; (ii) violate any applicable laws of any governmental
authorities, including the NASD's Rules of Conduct, or (iii) violate any
other agreements or procedures with which such Selling Broker Dealer is
required to comply; and
(p) (i) submit the form of confirmation statement to be used for the
sale of the Shares to FDDI for its approval and provide or cause to be
provided to customers of the Selling Broker Dealers ("Customers") and to
Selling Broker Dealers such confirmations of all transactions in the
Shares as may be required by the 1934 Act and the Selling Agreements; and
(ii) use reasonable efforts to monitor the Fund's transfer agent in its
preparation and mailing of such confirmations regarding the sales of the
Shares and report to FDDI any deficiencies of which Rafferty is aware in
the transfer agent's performance of such activities.
3. DELIVERY OF DOCUMENTS. In order to assist FDDI in the performance of
its duties, Rafferty has caused each Fund to furnish FDDI with, or provide FDDI
with access to, each of the following:
(a) Each Fund's most recent Post-Effective Amendment to its
Registration Statement on Form N-lA (the "Registration Statement") under
the Securities Act of 1933, as amended, and under the 1940 Act as filed
with the SEC relating to each Fund's Shares;
(b) Each Fund's most recent Prospectus(es);
(c) Each Fund's most recent Statement(s) of Additional
Information;
(d) Each Fund's most recent annual and semi-annual financial
statements;
(e) Each Fund's most recent filings pursuant to Rule 24f-2/24e-2
under the 1940 Act;
(f) Each Fund's most recent SEC examination letter to the extent
that such information contained in the SEC letter (i) materially affects
FDDI's performance under this Agreement, or (ii) the issues identified in
the letter may result in FDDI incurring any loss, claim, damage or
liability or action in respect thereof; and
(g) The Trust's charter documents and by-laws.
5
<PAGE>
Rafferty will furnish FDDI from time to time with copies of, or access to,
all amendments of or supplements to the foregoing. Furthermore, Rafferty will
provide FDDI with copies of, or access to, any other documents that FDDI may
reasonably request and will notify FDDI as soon as possible of any matter
materially affecting FDDI's performance of its services under this Agreement.
4. COMPENSATION; REIMBURSEMENT OF EXPENSES. Rafferty shall pay FDDI for
the services provided under this Agreement an annual fee of $10,000 per Fund
payable in equal monthly installments on the first business day of each month.
Compensation under this Agreement shall be calculated and accrued daily and the
amounts of the daily accruals shall be paid monthly in arrears. If this
Agreement becomes effective subsequent to the first day of a month or shall
terminate before the last day of a month, compensation for that part of the
month this Agreement is in effect shall be prorated in a manner consistent with
the calculation of the fees set forth above. In addition, Rafferty agrees to
reimburse FDDI for FDDI's reasonable out-of-pocket expenses in providing
services hereunder, as mutually agreed to in writing by the parties from time to
time.
5. EFFECTIVE DATE. This Agreement shall become effective with respect to a
Fund as of the date first written above (or, if a particular Fund is not in
existence on that date, on the date FDDI becomes the distributor of the Shares
of such Fund; Schedule A to this Agreement shall be deemed amended to include
such Fund from and after such date).
6. TERM.
(a) This Agreement shall continue for an initial two year period
and shall continue thereafter for successive one year terms unless
terminated pursuant to the provision of sub-section (b) of this Section 6.
(b) This Agreement shall automatically terminate as it relates to
any Fund upon the termination of the Distribution Agreement between such
Fund and FDDI or this Agreement may be terminated with respect to any Fund
at any time without payment of any penalty, upon 60 days' written notice,
by vote of a majority of the Board of Trustees of a Fund. In any event,
the provisions of Section 8 shall survive termination of this Agreement
and continue in full force and effect. Compensation due FDDI and unpaid by
Rafferty upon such termination shall be immediately due and payable upon
and notwithstanding such termination.
7. STANDARD OF CARE; INDEMNIFICATION AND LIMITATION ON CONSEQUENTIAL
DAMAGES.
(a) Rafferty will indemnify and hold FDDI harmless from and against
any losses, claims, damages or liabilities, or actions in respect thereof, to
which FDDI may become subject, including amounts paid in settlement with the
prior written consent of Rafferty, insofar as such losses, claims, damages or
liabilities, or actions with respect thereof, arise out of or result from:
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<PAGE>
(i) the failure of Rafferty to comply with the terms of this
Agreement;
(ii) the failure of any Registered Representative to comply with
the NASD's Rules of Conduct and in particular the NASD's SPECIAL
NOTICE TO MEMBERS 94-44;
(iii) any use of sales materials or advertisements or any oral or
written misrepresentations or any unlawful sales practices
concerning the Shares by a Registered Representative if such
misrepresentations or unlawful sales practices were the direct
result of Rafferty's bad faith, willful misfeasance, negligence or
reckless disregard of their duties and obligations under this
Agreement;
(iv) the failure of any Selling Broker Dealer (as referenced in
Exhibit C) to have entered into a Selling Agreement with FDDI prior
to the execution of any sale of Shares of any Fund; and
(v) the failure of any Selling Broker Dealer to comply with the
terms of any Selling Agreement to which it is a party if such
failure to comply was the direct result of Rafferty's bad faith,
willful misfeasance, negligence or reckless disregard of its duties
and obligations under this Agreement.
(b) FDDI will indemnify and hold harmless Rafferty from and against any
losses, claims, damages or liabilities, or actions in respect thereof, to which
Rafferty may become subject, including amounts paid in settlement with the prior
written consent of FDDI, insofar as such losses, claims, damages or liabilities,
or actions in respect thereof, arise out of or result from:
(i) the failure of FDDI to comply with the terms of this
Agreement;
(ii) the failure of FDDI to comply with the NASD' s Rules of
Conduct;
(iii) any use of sales materials or advertisements or any oral or
written misrepresentations or any unlawful sales practices
concerning the Shares by a Registered Representative if such
misrepresentations or unlawful sales practices were the direct
result of FDDI's bad faith, willful misfeasance, negligence or
reckless disregard of their duties and obligations under this
Agreement; and
(iv) the failure of any Selling Broker Dealer to comply with the
terms of any Selling Agreement to which it is a party if such
failure to comply was the direct result of FDDI's bad faith, willful
misfeasance, negligence or reckless disregard of its duties and
obligations under this Agreement.
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(c) Rafferty will reimburse FDDI for reasonable legal or other expenses
reasonably incurred by FDDI in connection with investigating or defending
against any such loss, claims, damage, liability or action. Rafferty shall not
be liable to FDDI for any action taken or omitted by FDDI in bad faith, with
willful misfeasance or negligence or from reckless disregard by FDDI of its
obligations and duties. The indemnities in this Section shall, upon the same
terms and conditions, extend to and inure to the benefit of each of the
directors and officers of FDDI and any person controlling FDDI within the
meaning of Section 15 of the 1933 Act or Section 20 of the 1934 Act.
(d) FDDI will reimburse Rafferty for reasonable legal or other expenses
reasonably incurred by Rafferty in connection with investigating or defending
against any such loss, claims, damage, liability or action. FDDI shall not be
liable to Rafferty for any action taken or omitted by Rafferty in bad faith,
with willful misfeasance or negligence or from reckless disregard by Rafferty of
its obligations and duties. The indemnities in this Section shall, upon the same
terms and conditions, extend to and inure to the benefit of each of the
directors and officers of Rafferty and any person controlling Rafferty within
the meaning of Section 15 of the 1933 Act or Section 20 of the 1934 Act.
(e) NOTWITHSTANDING ANYTHING IN THIS AGREEMENT TO THE CONTRARY, IN NO
EVENT SHALL EITHER PARTY, ITS AFFILIATES OR ANY OF ITS OR THEIR DIRECTORS,
OFFICERS, EMPLOYEES, AGENTS OR SUBCONTRACTORS BE LIABLE FOR LOST PROFITS OR
CONSEQUENTIAL DAMAGES.
8. RECORD RETENTION AND CONFIDENTIALITY. FDDI shall keep and maintain on
behalf of the Funds all books and records which the Funds and FDDI are, or may
be, required to keep and maintain in connection with the services to be provided
hereunder pursuant to any applicable statutes, rules and regulations, including
without limitation Rules 31a-1 and 31a-2 under the 1940 Act. FDDI further agrees
that all such books and records shall be the property of the Funds and to make
such books and records available for inspection by or upon the request of the
Funds, by Rafferty, or by the SEC at reasonable times and otherwise to keep
confidential all books and records and other information relative to the Funds
and its shareholders; except when requested to divulge such information by duly
constituted authorities or court process.
9. RIGHTS OF OWNERSHIP. All computer programs and procedures developed to
perform the services to be provided by FDDI under this Agreement are the
property of FDDI. All records and other data except such computer programs and
procedures are the exclusive property of the Funds and all such other records
and data will be furnished to Rafferty and/or the funds in appropriate form as
soon as practicable after termination of this Agreement for any reason.
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<PAGE>
10. RETURN OF RECORDS. FDDI may at its option at any time, and shall
promptly upon the demand of Rafferty and/or the Funds, turn over to Rafferty
and/or the Funds and cease to retain FDDI's files, records and documents created
and maintained by FDDI pursuant to this Agreement which are no longer needed by
FDDI in the performance of its services or for its legal protection. If not so
turned over to Rafferty and/or the Funds, such documents and records will be
retained by FDDI for six years from the year of creation. At the end of such
six-year period, such records and documents will be turned over to Rafferty
and/or the applicable Fund unless the applicable Fund authorizes in writing the
destruction of such records and documents.
11. REPRESENTATIONS OF RAFFERTY. Rafferty represents and warrants that
this Agreement has been duly authorized by Rafferty and, when executed and
delivered by Rafferty, will constitute a legal, valid and binding obligation of
Rafferty, enforceable against Rafferty in accordance with its terms, subject to
bankruptcy, insolvency, reorganization, moratorium and other laws of general
application affecting the rights and remedies of creditors and secured parties.
12. REPRESENTATIONS OF FDDI. (a) FDDI represents and warrants that this
Agreement has been duly authorized by FDDI and, when executed and delivered by
FDDI, will constitute a legal, valid and binding obligation of FDDI, enforceable
against FDDI in accordance with its terms, subject to bankruptcy, insolvency,
reorganization, moratorium and other laws of general application affecting the
rights and remedies of creditors and secured parties.
(b) FDDI further represents and warrants that it is a member of the
NASD and agrees to abide by all of the rules and regulations of the NASD. FDDI
agrees to comply with all applicable federal and state laws, rules and
regulations. FDDI agrees to notify Rafferty immediately in the event of its
expulsion or suspension by the NASD. Expulsion of FDDI by the NASD will
automatically terminate this Agreement immediately without notice. Suspension of
FDDI by the NASD will terminate this Agreement effective immediately upon
written notice of termination to FDDI from Rafferty.
13. NOTICES. Any notice provided hereunder shall be sufficiently given
when sent by registered or certified mail to the following:
To Rafferty:
Rafferty Asset Management, LLC
550 Mamaroneck Avenue
Harrison, New York 10528
Attention:
To FDDI:
First Data Distributors, Inc.
4400 Computer Drive
Westboro, Massachusetts 01581
Attention: President
with a copy to FDDI's Chief Legal Officer
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<PAGE>
14. HEADINGS. Paragraph headings in this Agreement are included for
convenience only and are not to be used to construe or interpret this Agreement.
15. ASSIGNMENT. This Agreement and the rights and duties hereunder shall
not be assignable by either of the parties hereto except by the specific written
consent of the other party.
16. GOVERNING LAW. This Agreement shall be governed by and provisions
shall be construed in accordance with the laws of the Commonwealth of
Massachusetts.
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be
duly executed all as of the day and year first above written.
RAFFERTY ASSET MANAGEMENT, LLC
By:____________________________________
Name:__________________________________
Title:_________________________________
FIRST DATA DISTRIBUTORS, INC.
By:____________________________________
Name:__________________________________
Title:_________________________________
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<PAGE>
SCHEDULE A
NAME OF FUNDS
-------------
THE POTOMAC FUNDS
-----------------
Potomac Japan/Long Fund
Potomac Japan/Short Fund
Potomac U.S. Plus Fund
Potomac U.S./Short Fund
Potomac OTC Plus Fund
Potomac OTC/Short Fund
Potomac U.S. Government Money Market Fund
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<PAGE>
EXHIBIT B
SELLING AGREEMENT REQUEST FORM
To: _________________________________
From: _________________________________
Telephone #:___________________________ Fax #:________________________
PROPOSED SELLING AGENT NAME AND ADDRESS:
_____________________________________________
_____________________________________________
_____________________________________________
_____________________________________________
TYPE OF AGREEMENT (CHECK ONE):
______ Bank Agreement
______ Bank Affiliated Broker-Dealer Agreement
______ Broker-Dealer Agreement
______ Registered Investment Adviser Agreement
_____________________________________________
Authorized Rafferty Representative
(Attached hereto as Attachment 1 is a list of Authorized Rafferty
Representatives)
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ATTACHMENT 1
AUTHORIZED RAFFERTY REPRESENTATIVES
The following individuals are authorized to request the issuance of sales
agreements to clients and/or potential clients of the Potomac Funds:
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<PAGE>
EXHIBIT C
Selling Agents That Have Entered Into Selling
Agreements With First Data Distributors, Inc.
14
CUSTODIAN AGREEMENT
THIS AGREEMENT made on this ________ day of September, 1997, between the
Potomac Funds, a Massachusetts business trust (hereinafter called the "Fund"),
and Firstar Trust Company, a corporation organized under the laws of the State
of Wisconsin (hereinafter called "Custodian").
WHEREAS, the Fund desires that its securities and cash shall be hereafter
held and administered by Custodian pursuant to the terms of this Agreement,
NOW, THEREFORE, in consideration of the mutual agreements herein made, the
Fund and Custodian agree as follows:
1. DEFINITIONS
"Securities" as used herein includes stocks, shares, bonds, debentures,
notes, mortgages or other obligations, and any certificates, receipts, warrants
or other instruments representing rights to receive, purchase or subscribe for
the same, or evidencing or representing any other rights or interests therein,
or in any property or assets.
"Officers' certificate" shall mean a request or direction or certification
in writing signed in the name of the Fund by any two of the President, a Vice
President, the Secretary and the Treasurer of the Fund, or any other persons
duly authorized to sign by the Board of Trustees.
The word "Board" shall mean Board of Trustees of the Fund.
2. NAMES, TITLES, AND SIGNATURES OF THE FUND'S OFFICERS
An officer of the Fund will certify to Custodian the names and signatures
of those persons authorized to sign the officers' certificates described in
Section 1 hereof and the names of the members of the Board, together with any
changes which may occur from time to time.
ADDITIONAL SERIES. The Fund is authorized to issue shares of beneficial
interest representing interests in separate investment portfolios. The
portfolios currently covered by this Agreement are: the Potomac Japan/Long Fund
and Potomac Japan/Short Fund Potomac U.S. Plus Fund, Potomac U.S./Short Fund,
Potomac OTC Plus Fund, Potomac OTC/Short Fund, and the Potomac U.S. Government
Money Market Fund. The parties intend that each portfolio established by the
Trust, now or in the future, be covered by the terms and conditions of this
Agreement.
<PAGE>
3. RECEIPT AND DISBURSEMENT OF MONEY
A. Custodian shall open and maintain a separate account or accounts in the
name of the Fund, subject only to draft or order by Custodian acting pursuant to
the terms of this Agreement. Custodian shall hold in such account or accounts,
subject to the provisions hereof, all cash received by it from or for the
account of the Fund. Custodian shall make payments of cash to, or for the
account of, the Fund from such cash only:
(a) for the purchase of securities for the portfolios of the Fund upon
the delivery of such securities to Custodian, registered in the name
of the Fund or of the nominee of Custodian referred to in Section 7
or in proper form for transfer;
(b) for the purchase or redemption of shares of beneficial interest of
the Fund upon delivery thereof to Custodian, or upon proper
instructions from the Fund;
(c) for the payment of interest, dividends, taxes, investment adviser's
fees or operating expenses (including, without limitation thereto,
fees for legal, accounting, auditing and custodian services and
expenses for printing and postage);
(d) for payments in connection with the conversion, exchange or
surrender of securities owned or subscribed to by the Fund held by
or to be delivered to Custodian; or
(e) for other proper corporate purposes certified by resolution of the
Board.
Before making any such payment, Custodian shall receive (and may rely
upon) an officers' certificate requesting such payment and stating that it is
for a purpose permitted under the terms of items (a), (b), (c), or (d) of this
Subsection A, and also, in respect of item (e), upon receipt of an officers'
certificate and a certified copy of a resolution of the Board specifying the
amount of such payment, setting forth the purpose for which such payment is to
be made, declaring such purpose to be a proper corporate purpose, and naming the
person or persons to whom such payment is to be made, provided, however, that an
officers' certificate and a certified copy of a resolution of the Board need not
precede the disbursement of cash for the purpose of purchasing a money market
instrument, or any other security with same or next-day settlement, if the
President, a Vice President, the Secretary or the Treasurer of the Funds issues
appropriate oral or facsimile instructions to Custodian and an appropriate
officers' certificate and a certified copy of a resolution of the Board is
received by Custodian within two business days thereafter.
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<PAGE>
B. Custodian is hereby authorized to endorse and collect all checks,
drafts or other orders for the payment of money received by Custodian for the
account of the Fund.
C. Custodian shall, upon receipt of proper instructions, make federal
funds available to the Fund as of specified times agreed upon from time to time
by the Fund and the Custodian in the amount of checks received in payment for
shares of the Fund which are deposited into the Fund's accounts.
D. Custodian shall collect on a timely basis all income dividends and
other payments with respect to registered securities held hereunder to which the
Fund shall be entitled either by law or pursuant to custom in the securities
business, and shall collect on a timely basis all income dividends and other
payments with respect to bearer securities if, on the date of payment by the
issuer, such securities are held by Custodian or agent thereof and shall credit
such income dividends and other payments, as collected, to the Fund's custodian
account. Without limiting the generality of the foregoing, Custodian shall
detach and present for payment all coupons and other income items requiring
presentation as and when they become due and shall collect interest when due on
securities held hereunder. Custodian will have no duty or responsibility in
connection therewith, other than to provide the Fund with such information or
data as may be necessary to assist the Fund in arranging for the timely delivery
to Custodian of the income to which the Fund is properly entitled.
4. SEGREGATED ACCOUNTS
Custodian shall hold in a separate account, and physically segregate at
all times from those of any other persons, firms or corporations, pursuant to
the provisions hereof, all securities and other investments other than cash and
cash equivalents received by it for, or for the account of, the Fund. All such
securities and other investments are to be held or disposed of by Custodian for,
and subject at all times to the instructions of, the Fund pursuant to the terms
of this Agreement. Custodian shall have no power or authority to assign,
hypothecate, pledge or otherwise dispose of any such securities or other
investments, except pursuant to the directive of the Fund and only for the
account of the Fund as set forth in Section 5 of this Agreement.
5. TRANSFER, EXCHANGE, REDELIVERY, ETC. OF SECURITIES
Custodian shall have sole power to release or deliver any securities of
the Fund held by it pursuant to this Agreement. Custodian agrees to transfer,
exchange or deliver securities held by it hereunder only:
(a) for sales of such securities for the account of the Fund upon
receipt by Custodian of payment therefor;
(b) when such securities are called, redeemed or retired or otherwise
become payable;
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<PAGE>
(c) for examination by any broker selling any such securities in
accordance with "street delivery" custom;
(d) in exchange for, or upon conversion into, other securities alone or
other securities and cash whether pursuant to any plan of merger,
consolidation, reorganization, recapitalization or readjustment, or
otherwise;
(e) upon conversion of such securities pursuant to their terms into
other securities;
(f) upon exercise of subscription, purchase or other similar rights
represented by such securities;
(g) for the purpose of exchanging interim receipts or temporary
securities for definitive securities;
(h) for the purpose of redeeming in kind shares of beneficial interest
of the Fund upon delivery thereof to Custodian;
(i) upon receipt of payment in connection with any repurchase agreement
related to such securities entered into by the Fund;
(j) for delivery in connection with any loans of securities made by the
Fund, but only against receipt of adequate collateral as agreed upon
from time to time by Custodian and Fund, which may be in the form of
cash;
(k) for delivery as security in connection with any borrowings by the
Fund requiring a pledge of assets by the Fund, but only against
receipt of amounts borrowed;
(l) for delivery in accordance with the provisions of any agreement
among the Fund, Custodian and a broker-dealer registered under the
Securities Exchange Act of 1934 and a member of The National
Association of Securities Dealers, Inc., relating to compliance with
the rules of The Options Clearing Corporation and of any registered
national securities exchange, or of any similar organization or
organizations, regarding escrow or other arrangements in connection
with transactions by the Fund;
(m) for release of securities to designated brokers under covered call
options; provided, however, that such securities shall be released
only upon payment to Custodian of monies for the premium due and a
receipt for the securities which are to be held in escrow. Upon
exercise of the option, or at expiration, Custodian will receive
from brokers the securities previously deposited. Custodian will act
strictly in accordance with proper instructions in the delivery of
securities to be held in escrow and will have no responsibility or
liability for any such securities which are not returned promptly
when due other than to make proper request for such return; or
4
<PAGE>
(n) for other proper corporate purposes.
As to any deliveries made by Custodian pursuant to items (a), (b), (d),
(e), (f), and (g), securities or cash receivable in exchange therefore shall be
deliverable to Custodian.
Before making any such transfer, exchange or delivery, Custodian shall
receive (and may rely upon) an officers' certificate requesting such transfer,
exchange or delivery, and stating that it is for a purpose permitted under the
terms of each item of this Section 5 above, except item (n) and also, in respect
of item (n), upon receipt of an officers' certificate and a certified copy of a
resolution of the Board specifying the securities to be delivered, setting forth
the purpose for which such delivery is to be made, declaring such purpose to be
a proper corporate purpose, and naming the person or persons to whom delivery of
such securities shall be made, provided, however, that an officers' certificate
and a certified copy of a resolution of the Board need not precede any such
transfer, exchange or delivery of a money market instrument, or any other
security with same or next-day settlement, if the President, a Vice President,
the Secretary or the Treasurer of the Funds issues appropriate oral or facsimile
instructions to Custodian and an appropriate officers' certificate and a
certified copy of a resolution of the Board is received by Custodian within two
business days thereafter.
6. CUSTODIAN'S ACTS WITHOUT INSTRUCTIONS
Unless and until Custodian receives an officers' certificate to the
contrary, Custodian shall: (a) present for payment all coupons and other income
items held by it for the account of the Fund, which call for payment upon
presentation and hold the cash received by it upon such payment for the account
of the Fund; (b) collect interest and cash dividends received, with notice to
the Fund, for the account of the Fund; (c) hold for the account of the Fund
hereunder all stock dividends, rights and similar securities issued with respect
to any securities held by it thereunder; and (d) execute, as agent on behalf of
the Fund, all necessary ownership certificates required by the Internal Revenue
Code or the Income Tax Regulations of the United States Treasury Department or
under the laws of any state now or hereafter in effect, inserting the Fund's
name on such certificates as the owner of the securities covered thereby, to the
extent it may lawfully do so.
7. REGISTRATION OF SECURITIES
Except as otherwise directed by an officers' certificate, Custodian shall
register all securities, except such as are in bearer form, in the name of the
Fund or of a registered nominee of the Fund assigned by the Fund as defined in
the Internal Revenue Code and any Regulations of the Treasury Department issued
hereunder or in any provision of any subsequent federal tax law exempting such
transaction from liability for stock transfer taxes, and shall execute and
deliver all such certificates in connection therewith as may be required by such
laws or regulations or under the laws of any state. Custodian shall use its best
efforts to the end that the specific securities held by it hereunder shall be at
all times identifiable in its records.
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The Fund shall from time to time furnish to Custodian appropriate
instruments to enable Custodian to hold or deliver in proper form for transfer,
or to register in the name of its registered nominee, any securities which it
may hold for the account of the Fund and which may from time to time be
registered in the name of the Fund.
8. VOTING AND OTHER ACTION
Neither Custodian nor any nominee of Custodian shall vote any of the
securities held hereunder by or for the account of the Fund, except in
accordance with the instructions contained in an officers' certificate.
Custodian shall promptly deliver, or cause to be executed and delivered, to the
Fund all notices, proxies and proxy soliciting materials with relation to such
securities, such proxies to be executed by the registered holder of such
securities (if registered otherwise than in the name of the Fund), but without
indicating the manner in which such proxies are to be voted.
Custodian shall transmit promptly to the Fund all written information
(including, without limitation, pendency of calls and maturities of securities
and expirations of rights in connection therewith and notices of exercise of
call and put options written by the Fund) received by Custodian from issuers of
the securities being held for the Fund. With respect to tender or exchange
offers, Custodian shall transmit promptly to the Fund all written information
received by Custodian from issuers of the securities whose tender or exchange is
sought and from the party (or its agent) making the tender or exchange offer.
9. TRANSFER TAX AND OTHER DISBURSEMENTS
The Fund shall pay or reimburse Custodian from time to time for any
transfer taxes payable upon transfers of securities made hereunder, and for all
other necessary and proper disbursements and expenses made or incurred by
Custodian in the performance of this Agreement, provided that all such payments,
disbursements and expenses shall be accounted for to the Fund.
Custodian shall execute and deliver such certificates in connection with
securities delivered to it or by it under this Agreement as may be required
under the provisions of the Internal Revenue Code and any Regulations of the
Treasury Department issued thereunder, or under the laws of any state, to exempt
from taxation any exemptable transfers and/or deliveries of any such securities.
10. CONCERNING CUSTODIAN
Custodian shall be paid as compensation for its services pursuant to this
Agreement such compensation as set forth in Appendix A, which from time to time
may be modified upon written agreement between the two parties.
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<PAGE>
Custodian shall not be liable for any action taken in good faith in
reliance on any officers' certificate herein described or certified copy of any
resolution of the Board, and may rely on the genuineness of any such document
which it may in good faith believe to have been properly executed.
Custodian shall use reasonable care in providing services to the Fund
pursuant to this Agreement. If the Fund requires the Custodian to advance cash
or securities for any purpose or in the event that the Custodian or its nominee
shall incur or be assessed any taxes, charges, expenses, assessments, claims and
liabilities (including counsel fees) in connection with the performance of this
Agreement, except such as may arise from its or its nominee's own negligent
action, negligent failure to act or willful misconduct, it shall be reimbursed
by the Fund for such advances or other costs within a reasonable time after the
receipt of written notice requesting reimbursement, and any property at any time
held for the account of the Fund shall be security therefor and should the Fund
fail to repay Custodian within a reasonable time after receipt of written
notice, Custodian shall be entitled to utilize available cash and to dispose of
Fund assets to the extent necessary to obtain reimbursement.
In any and every case where payment for purchase of securities for the
account of the Fund is made by Custodian in advance of receipt of the securities
purchased, in the absence of specific written instructions from the Fund to so
pay in advance, Custodian shall be absolutely liable to the Fund for such
securities to the same extent as if the securities had been received by
Custodian, except that in the case of repurchase agreements entered into by the
Fund with a bank which is a member of the Federal Reserve System, Custodian may
transfer funds to the account of such bank prior to the receipt of written
evidence that the securities subject to such repurchase agreement have been
transferred to book-entry into a segregated non-proprietary account of Custodian
or of the safe-keeping receipt, provided that such securities have in fact been
so transferred by book-entry.
Custodian agrees to indemnify and hold harmless the Fund or its nominees
from all charges, expenses, assessments, claims and liabilities (including
counsel fees) incurred or assessed against the Fund or its nominees in
connection with the performance of this Agreement, except such as may arise from
the Fund's or its nominees own negligent action, negligent failure to act, or
willful misconduct.
11. FOREIGN SUBCUSTODIANS
Custodian is hereby authorized to assign as subcustodians for the Fund's
securities and other assets maintained outside the United States the foreign
banking institutions and foreign securities depositories designated on Schedule
B hereto ("Foreign Subcustodians"), provided that, if the Custodian utilizes the
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<PAGE>
services of a Foreign Subcustodian, the Custodian shall remain fully liable and
responsible for any losses caused to the Fund by the Foreign Subcustodian as
fully as if the Custodian was directly responsible for any such losses under the
terms of this Agreement. Upon receipt of proper instructions from the Funds,
together with a certified resolution of the Board, Custodian and the Fund may
agree to amend Schedule B hereto from time to time to designate additional
foreign banking institutions and foreign securities depositories to act as
Foreign Subcustodians. Upon receipt of proper instructions from Custodian, the
Fund may instruct Custodian to cease the employment of any one or more Foreign
Subcustodians for maintaining custody of the Fund's assets.
Custodian shall limit the securities and other assets maintained in the
custody of Foreign Subcustodians to the following: (a) "foreign securities," as
defined in paragraph (c)(1) of Rule 17f-5 under the Investment Company Act of
1940, as amended (the "1940 Act"); and (b) cash and cash equivalents in such
amounts as Custodian or the Fund may determine to be reasonably necessary to
effect the Fund's foreign securities transactions. Custodian shall identify on
its books and records as belonging to the Fund, the foreign securities of the
Fund held by each Foreign Subcustodian.
12. REPORTS BY CUSTODIAN
Custodian shall furnish the Fund daily with a statement summarizing all
transactions and entries for the account of Fund. Custodian shall furnish to the
Fund, at the end of every month, a list of the portfolio securities showing the
adjusted average cost of each issue and the market value at the end of such
month. Custodian shall furnish the Fund, at the close of each quarter of the
Fund's fiscal year, with a list showing cost and market values of the securities
held by it for the Fund hereunder, adjusted for all commitments confirmed by the
Fund as of such close, certified by a duly authorized officer of Custodian.
13. TERMINATION
This Agreement may be terminated by the Fund or by Custodian on sixty (60)
days' notice, given in writing and sent by registered mail to Custodian at P.O.
Box 2054, Milwaukee, Wisconsin 53201, or to the Potomac Funds at 550 Mamaroneck
Avenue, Harrison, NY 10528, as the case may be. Upon termination of this
Agreement, the Fund shall pay to Custodian such compensation as may be due
hereunder as of the date of such termination and also shall reimburse Custodian
for its costs, expenses and disbursements as contemplated by this Agreement.
If a successor custodian shall be appointed by the Board, Custodian shall,
upon termination, deliver to such successor custodian at the office of
Custodian, all securities duly endorsed and in the form for transfer, and all
other property of the Fund then held by it hereunder.
8
<PAGE>
If this Agreement is terminated and no such successor custodian shall be
appointed, Custodian shall, in like manner, as directed by vote of the holders
of a majority of the outstanding shares of the Fund or upon receipt of a
certified copy of a vote or resolution of the Board, deliver at the office of
Custodian and transfer such securities, funds and other properties of the Fund
then held by it hereunder as specified and in accordance with such vote or
resolution.
In the event that no written order designating a successor custodian or
certified copy of a vote or resolution of the Board shall have been delivered to
Custodian on or before the date when the termination of this Agreement shall
become effective, then Custodian shall have the right to deliver to a bank or
trust company, which is a "bank" as defined in the 1940 Act, of its own
selection, having an aggregate capital surplus, and undivided profits, as shown
by its last published report, of not less than $2,000,000, all securities, funds
and other properties then held by Custodian hereunder and all instruments held
by it under this Agreement. Thereafter, such bank or trust company shall be the
successor of Custodian under this Agreement.
In the event that securities, funds and other properties of the Fund
remain in the possession of Custodian after the date of termination hereof owing
to failure of the Fund to delivery to Custodian the written order or certified
copy referred to above, or of the Board to appoint a successor custodian,
Custodian shall be entitled to fair compensation for its services during such
period as Custodian retains possession of such securities, funds and other
properties and the provisions of this Agreement relating to the duties and
obligations of Custodian shall remain in full force and effect.
This Agreement may not be assigned by Custodian without the consent of the
Fund, authorized or approved by a resolution of the Board.
14. DEPOSITS OF SECURITIES IN SECURITIES DEPOSITORIES
No provision of this Agreement shall be deemed to prevent the use by
Custodian of a central securities clearing agency or securities depository,
provided, however, that Custodian and the central securities clearing agency or
securities depository meet all applicable federal and state laws and
regulations, and the Board approves by resolution the use of such central
securities clearing agency or securities depository.
15. RECORDS
Custodian shall create and maintain all records relating to its activities
and obligations under this Agreement in such a manner as will meet the
obligations of the Investment Company Act of 1940, as amended, or the rules and
regulations promulgated thereunder. All such records shall be the property of
the Fund. Custodian agrees to make any such records available to the Funds upon
request and to preserve such records for the periods prescribed in Rule 3 laA2
9
<PAGE>
under the Investment Company Act of 1940, as amended. The books and records of
Custodian pertaining to its actions under this Agreement shall be open to
inspection and audit at reasonable times by officers of, and of auditors
employed by, the Fund.
16. REPORTS TO FUND BY INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Custodian shall provide the Fund, at such times as the Fund may reasonably
require, with reports by independent certified public accountants on the
accounting system, internal accounting control and procedures for safeguarding
securities, relating to the securities provided by Custodian under this
Agreement; such reports, shall be of sufficient scope and in sufficient detail,
as may reasonably be required by the Fund, and shall provide reasonable
assurance that any material inadequacies would be disclosed by such examination,
and, if there are no such inadequacies, shall so state.
17. CHOICE OF LAW
This Agreement shall be construed and the provisions thereof interpreted
under and in accordance with the laws of the State of Wisconsin.
Trustees and shareholders shall not be personally liable for obligations
of the Funds in connection with any matter arising from or in connection with
this Agreement.
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be
executed as of the date first written above by their respective officers
thereunto duly authorized.
Executed in several counterparts, each of which is an original.
POTOMAC FUNDS FIRSTAR TRUST COMPANY
_______________________________ ________________________________
Title:_________________________ First Vice President
Date:_________________________ Date:___________________________
Attest:________________________ Attest:__________________________
10
TRANSFER AGENT AGREEMENT
THIS AGREEMENT is made and entered into on this ________ day of September
1997, by and between the Potomac Funds, a Massachusetts business trust
(hereinafter referred to as the "Fund"), and Firstar Trust Company, a
corporation organized under the laws of the State of Wisconsin (hereinafter
referred to as the "Agent").
WHEREAS, the Fund is an open-end management investment company that is
registered under the Investment Company Act of 1940 ("1940 Act"), and
WHEREAS, the Agent is a trust company and, among other things, is in the
business of administering transfer and dividend disbursing agent functions for
the benefit of its customers,
NOW, THEREFORE, the Fund and the Agent do mutually promise and agree as
follows:
1. TERMS OF APPOINTMENT; DUTIES OF THE AGENT
Subject to the terms and conditions set forth in this Agreement, the Fund
hereby employs and appoints the Agent to act as transfer agent and dividend
disbursing agent.
The Fund is authorized to issue separate series of shares of beneficial
interest representing interests in separate investment portfolios (each, a
"Portfolio"). The parties intend that each Portfolio, as set forth in Appendix
A, established by the Fund, now or in the future, be covered by the terms and
conditions of this Agreement.
The Agent shall perform all of the customary services of a transfer agent
and dividend disbursing agent, and as relevant, agent in connection with
accumulation, open account or similar plans (including without limitation any
periodic investment plan or periodic withdrawal program), including but not
limited to:
A. Receive orders for the purchase of shares, with prompt delivery,
where appropriate, of payment and supporting documentation to the
Fund's custodian;
B. Process purchase orders and issue the appropriate number of
certificated or uncertificated shares with such uncertificated
shares being held in the appropriate shareholder account;
C. Process redemption requests received in good order and, where
relevant, deliver appropriate documentation to the Fund's
custodian;
D. Pay monies (upon receipt from the Fund's custodian, where
relevant) in accordance with the instructions of redeeming
shareholders;
E. Process transfers of shares in accordance with the shareholder's
instructions;
<PAGE>
F. Process exchanges between any Portfolio;
G. Prepare and transmit payments for dividends and distributions
declared by the Fund;
H. Make changes to shareholder records, including, but not limited
to, address changes in plans (i.e., systematic withdrawal,
automatic investment, dividend reinvestment, etc.);
I. Record the issuance of shares of the Fund and maintain, pursuant to
Rule 17Ad-10(e) under the Securities Exchange Act of 1934 ("1934
Act"), a record of the total number of shares of the Fund which are
authorized, issued and outstanding and such other records as are
required to be maintained by a transfer agent for open-end
registered investment companies by the rules under the 1934 Act;
J. Prepare shareholder meeting lists and, if applicable, mail,
receive and tabulate proxies;
K. Mail shareholder reports and the Fund's most current prospectus
and statement of additional information to current shareholders;
L. Prepare and file U.S. Treasury Department forms 1099 and other
appropriate information returns required with respect to
dividends and distributions for all shareholders;
M. Provide shareholder account information upon request of the Fund
and prepare and mail confirmations and statements of account to
shareholders for all purchases, redemptions and other confirmable
transactions as agreed upon by the Fund and the Agent; and
N. Provide a Blue Sky System which will enable the Fund to monitor
the total number of shares sold in each state. In addition, the
Fund shall identify to the Agent in writing those transactions
and assets to be treated as exempt from any Blue Sky reporting
requirements applicable to the Fund for each state. The
responsibility of the Agent for the Fund's Blue Sky state
registration status is solely limited to the initial compliance
by the Fund and the reporting of such transactions to the Fund.
The foregoing services shall be provided in a manner consistent with
the policies of the Fund as communicated to the Agent.
2. COMPENSATION
The Fund agrees to pay the Agent such fees as set forth in Appendix A for
performance of the duties listed in this Agreement in addition to any
out-of-pocket expenses incurred by the Agent. Such out-of-pocket expenses may
include the following: printing, postage, forms, stationery, record retention,
mailing, insertion, programming, labels, shareholder lists and proxy expenses.
These fees and out-of-pocket expenses may be modified from time to time subject
to mutual written agreement between the Fund and the Agent.
2
<PAGE>
The Fund agrees to pay all fees and out-of-pocket expenses within ten (10)
business days following receipt of the billing notice.
3. REPRESENTATIONS OF AGENT
The Agent represents and warrants to the Fund that:
A. It is a trust company duly organized, existing and in good
standing under the laws of Wisconsin;
B. It is a registered transfer agent under the 1934 Act;
C. It is duly qualified to carry on its business in the state of
Wisconsin;
D. It is empowered under applicable laws and by its charter and
bylaws to enter into and perform this Agreement;
E. All requisite corporate proceedings have been taken to authorize
it to enter and perform this Agreement;
F. It has and will continue to have access to the necessary
facilities, equipment and personnel to perform its duties and
obligations under this Agreement; and
G. It will comply with all applicable requirements of the Securities
Act of 1933, as amended, the 1934 Act, the 1940 Act and any laws,
rules, and regulations of governmental authorities having
jurisdiction over its operations.
4. REPRESENTATIONS OF THE FUND
The Fund represent and warrants to the Agent that:
A. The Fund is an open-end management investment company under the
1940 Act;
B. The Fund is a Massachusetts business trust organized, existing,
and in good standing under the laws of Massachusetts;
C. The Fund is empowered under applicable laws and by its
Declaration of Trust and By-Laws to enter into and perform this
Agreement;
D. All necessary proceedings required by the Declaration of Trust
have been taken to authorize the Fund to enter into and perform
this Agreement;
3
<PAGE>
E. The Fund will comply with all applicable requirements of the 1933
Act, the 1934 Act, the 1940 Act, and any laws, rules and
regulations of governmental authorities having jurisdiction overt
its operations; and
F. A registration statement under the 1933 Act is currently effective
or will become effective before any public offering commences and
will remain effective, and appropriate state securities law filings
have been made or will become effective before any public offering
commences and will continue to be made, with respect to all shares
of the Fund being offered for sale.
5. COVENANTS OF THE FUND AND AGENT
The Fund shall furnish the Agent a certified copy of the resolution of the
Board of Trustees of the Fund ("Board") authorizing the appointment of the Agent
and the execution of this Agreement. The Fund shall provide to the Agent a copy
of the Declaration of Trust, By-Laws of the Fund, and all amendments.
The Agent shall keep records relating to the services to be performed
hereunder, in the form and manner as it may deem advisable. To the extent
required by Section 31 of the 1940 Act, and the rules thereunder, the Agent
agrees that all such records prepared or maintained by the Agent relating to the
services to be performed by the Agent hereunder are the property of the Fund and
will be preserved, maintained and made available in accordance with such section
and rules and will be surrendered to the Fund on and in accordance with its
request.
6. INDEMNIFICATION; REMEDIES UPON BREACH
The Agent shall exercise reasonable care and act in good faith in the
performance of its duties under this Agreement. The Agent shall not be liable
for any error of judgment or mistake of law or for any loss suffered by the Fund
in connection with matters to which this Agreement relates, including losses
resulting from mechanical breakdowns or the failure of communication or power
supplies beyond the Agent's control, except a loss resulting from the Agent's
refusal or failure to comply with the terms of this Agreement or from bad faith,
negligence, or willful misconduct on its part in the performance of its duties
under this Agreement. Notwithstanding any other provision of this Agreement, the
Fund shall indemnify and hold harmless the Agent from and against any and all
claims, demands, losses, expenses, and liabilities (whether with or without
basis in fact or law) of any and every nature (including reasonable attorneys'
fees) which the Agent may sustain or incur or which may be asserted against the
Agent by any person arising out of or attributed to any action taken or omitted
to be taken by it in performing the services hereunder (i) in accordance with
the foregoing standards, or (ii) in reliance upon any written or oral
instruction for a proper corporate purpose provided to the Agent by any duly
authorized officer of the Fund, such duly authorized officer to be included in a
list of authorized officers furnished to the Agent and as amended from time to
time in writing by resolution of the Board of Trustees of the Fund.
4
<PAGE>
Further, the Fund will indemnify and hold the Agent harmless against any
and all losses, claims, damages, liabilities or expenses (including reasonable
counsel fees and expenses) resulting from any claim, demand, action, or suit as
a result of the negligence of the Fund (unless contributed to by the Agent's
breach of this Agreement or other agreements between the Fund and the Agent, or
the Agent's own negligence or bad faith); or as a result of the Agent acting
upon telephone instructions relating to the exchange or redemption of shares
received by the Agent and reasonably believed by the Agent under a standard of
care customarily used in the investment company industry to have originated from
the record owner of the subject shares; or as a result of acting in reliance
upon any genuine instrument or stock certificate signed, countersigned, or
executed by any person or persons authorized to sign, countersign, or execute
the same.
In the event of a mechanical breakdown or failure of communication or
power supplies beyond its control, the Agent shall take all reasonable steps to
minimize service interruptions for any period that such interruption continues
beyond the Agent's control. The Agent will make every reasonable effort to
restore any lost or damaged data and correct any errors resulting from such a
breakdown at the expense of the Agent. The Agent agrees that it shall, at all
times, have reasonable contingency plans with appropriate parties, making
reasonable provision for emergency use of electrical data processing equipment
to the extent appropriate equipment is available. Representatives of the Fund
shall be entitled to inspect the Agent's premises and operating capabilities at
any time during regular business hours of the Agent, upon reasonable notice to
the Agent.
Regardless of the above, the Agent reserves the right to reprocess and
correct administrative errors at its own expense.
In order that the indemnification provisions contained in this section
shall apply, it is understood that in any case in which the Fund may be asked to
indemnify or hold the Agent harmless, the Fund shall be fully and promptly
advised of all pertinent facts concerning the situation in question, and it is
further understood that the Agent will use all reasonable care to notify the
Fund promptly concerning any situation which presents or appears likely to
present the probability of such a claim for indemnification against the Fund.
The Fund shall have the option to defend the Agent against any claim which may
be the subject of this indemnification. In the event that the Fund so elect, the
Fund will so notify the Agent and thereupon the Fund shall take over complete
defense of the claim, and the Agent shall in such situation initiate no further
legal or other expenses for which it shall seek indemnification under this
section. The Agent shall in no case confess any claim or make any compromise in
any case in which the Fund may be asked to indemnify the Agent except with the
Fund prior written consent.
5
<PAGE>
The Agent shall indemnify and hold the Fund harmless from and against any
and all claims, demands, losses, expenses, and liabilities (whether with or
without basis in fact or law) of any and every nature (including reasonable
attorneys' fees) which the Fund may sustain or incur or which may be asserted
against the Fund by any person arising out of or attributed to any action taken
or omitted to be taken by the Agent as a result of the Agent's refusal or
failure to comply with the terms of this Agreement, or from its bad faith,
negligence, or willful misconduct of the Agent or any of its employees and
agents.
7. CONFIDENTIALITY
The Agent agrees on behalf of itself and its employees and agents to treat
confidentially all records and other information relative to the Fund and its
shareholders and shall not disclose to any other party, except after prior
notification to and approval in writing by the Fund, which approval shall not be
unreasonably withheld and may not be withheld where the Agent may be exposed to
civil or criminal contempt proceedings for failure to comply after being
requested to divulge such information by duly constituted authorities.
8. RECORDS
The Agent shall keep records relating to the services to be performed
hereunder, in the form and manner, and for such period as it may deem advisable
and is acceptable to the Fund but not inconsistent with the rules and
regulations of appropriate government authorities, in particular, Section 31 of
the 1940 Act, and the rules thereunder. The Agent agrees that all such records
prepared or maintained by the Agent relating to the services to be performed by
the Agent hereunder are the property of the Fund and will be preserved,
maintained, and made available with such section and rules of the 1940 Act and
will be promptly surrendered to the Fund on and in accordance with its request.
9. NOTICE
Any notice required to be given by the parties to each other under the
terms of this Agreement shall be in writing, addressed and delivered, or mailed
to the principal place of business of the other party. If to the Agent, such
notice should be sent to Firstar Trust Company/Mutual Fund Services, located at
615 East Michigan Street, Milwaukee, Wisconsin 53202. If to the Fund, such
notice should be sent to Potomac Funds, located at 550 Mamaroneck Avenue,
Harrison, NY 10528.
10. CHOICE OF LAW
This Agreement shall be construed and the provisions thereof interpreted
under and in accordance with the laws of the state of Wisconsin. Trustees and
shareholders of the Fund shall not be personally liable for obligations of the
Fund in connection with any matter arising from or in connection with this
Agreement.
6
<PAGE>
11. TERMS OF AGREEMENT
A. This Agreement shall become effective upon its execution and shall
continue until terminated by either party upon ninety (90) days'
written notice given by one party to the other party.
B. This Agreement may be amended by the mutual written consent of
both parties.
C. This Agreement and any right or obligation hereunder may not be
assigned by either party without the written consent of the other
party.
D. In the event that the Fund gives to the Agent its written intention
to terminate and appoint a successor transfer agent, the Agent
agrees to cooperate in the transfer of its duties and
responsibilities to the successor, including any and all relevant
books, records and other data established or maintained by the Agent
under this Agreement.
E. Should the Fund exercise its right to terminate this Agreement,
except where such termination follows a breach of this Agreement by
the Agent, all out-of-pocket expenses associated with the movement
of records and material will be paid by the Fund.
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be
executed as of the date first written above by their respective officers
thereunto duly authorized.
POTOMAC FUNDS FIRSTAR TRUST COMPANY
By:____________________________ By:_____________________________
Print:_________________________ Print:___________________________
Title:_________________________ Title: First Vice President
Date:__________________________ Date:____________________________
Attest:________________________ Attest:__________________________
7
FUND ACCOUNTING SERVICING AGREEMENT
This Agreement between the Potomac Funds, a Massachusetts business trust
(hereinafter referred to as the "Fund"), and Firstar Trust Company, a Wisconsin
corporation (hereinafter referred to as "FTC"), is entered into on this ________
day of September 1997.
WHEREAS, the Fund is an open-end management investment company
registered under the Investment Company Act of 1940 ("1940 Act"); and
WHEREAS, FTC is in the business of providing, among other things, mutual
fund accounting services to investment companies;
NOW, THEREFORE, the parties do mutually promise and agree as follows:
1. APPOINTMENT. The Fund hereby appoints FTC to provide certain accounting
services for the Fund on the terms set forth in this Agreement. FTC accepts such
appointment and agrees to furnish the services herein set forth in return for
the compensation as provided in paragraph 6 in this Agreement.
2. SERVICES. FTC agrees to provide the following mutual fund
accounting services to the Fund:
A. Portfolio Accounting Services:
(1) Maintain portfolio records on a trade date +l basis using
security trade information communicated from the investment adviser
on a timely basis.
(2) For each valuation date, obtain prices from a pricing
source approved by the Fund's Board of Trustees ("Board") and apply
those prices to the portfolio positions. For those securities where
market quotations are not readily available, the Board shall
approve, in good faith, the method for determining the fair value
for such securities in the manner specified in the Fund's current
registration statement.
(3) Identify interest and dividend accrual balances as of each
valuation date and calculate gross earnings on investments for the
accounting period.
(4) Determine gain/loss on security sales and identify them as
to short- or long-term status; account for periodic distributions of
gains or losses to shareholders and maintain undistributed gain or
loss balances as of each valuation date.
<PAGE>
B. Expense Accrual and Payment Services:
(1) For each valuation date, calculate the expense accrual
amounts as directed by the Fund as to methodology, rate or dollar
amount.
(2) Record payments for the Fund expenses upon receipt of
written authorization from the Fund.
(3) Account for Fund expenditures and maintain expense accrual
balances at the level of accounting detail, as agreed upon by FTC
and the Fund.
(4) Provide expense accrual and payment reporting.
C. Fund Valuation and Financial Reporting Services:
(1) Account for Fund share purchases, sales, exchanges,
transfers, dividend reinvestments, and other Fund share activity as
reported by the transfer agent on a timely basis.
(2) Apply equalization accounting as directed by the Fund.
(3) Determine net investment income (earnings) for the Fund as
of each valuation date. Account for periodic distributions of
earnings to shareholders and maintain undistributed net investment
income balances as of each valuation date.
(4) Maintain a general ledger for the Fund investment
securities in the form as agreed upon by FTC and the Fund.
(5) For each day the Fund is open as defined in the Fund's
current registration statement, determine the net asset value for
each portfolio of the Fund ("Portfolio") according to the accounting
policies and procedures set forth in the Fund's current registration
statement.
(6) Calculate per share net asset value, per share net
earnings, and other per share amounts reflective of each Portfolio's
operation at such time as required by the nature and characteristics
of the Fund.
(7) Communicate, at an agreed upon time, the per share price
for each valuation date to parties as agreed upon from time to time.
(8) Prepare monthly reports which document the adequacy of
accounting detail to support month-end ledger balances.
2
<PAGE>
D. Tax Accounting Services:
(1) Maintain accounting records for each Portfolio to support
the tax reporting required by Subchapter M of the Internal Revenue
Code.
(2) Maintain tax lot detail for a Portfolio.
(3) Calculate taxable gain/loss on security sales using the
tax lot relief method designated by the Fund.
(4) Provide the necessary financial information to support the
taxable components of income and capital gains distributions to the
transfer agent to support tax reporting to the shareholders.
E. Compliance Control Services:
(1) Support reporting to regulatory bodies and support
financial statement preparation by making the Fund accounting
records available to the Fund, the Securities and Exchange
Commission, and the outside auditors retained by the Fund.
(2) Maintain accounting records according to the 1940 Act
and regulations thereunder.
3. PRICING OF SECURITIES. For each valuation date, obtain prices from a
pricing source selected by FTC but approved by the Board and apply those prices
to the portfolio positions and to value collateral held with respect to
repurchase agreements and securities loans. For those securities where market
quotations are not readily available, the Fund's Board shall approve, in good
faith, the method for determining the fair value for such securities in
accordance with the method determined by the Board.
If the Fund desires to provide a price which varies from the pricing
source, the Fund shall promptly notify and supply FTC with the valuation of any
such security on each valuation date. All pricing changes made by the Fund will
be in writing and must specifically identify the securities to be changed by
CUSIP, name of security, new price or rate to be applied, and, if applicable,
the time period for which the new prices are effective.
4. CHANGES IN ACCOUNTING PROCEDURES. Any resolution passed by the Board
that affects accounting practices and procedures under this Agreement shall be
effective upon receipt and written acceptance by FTC.
5. CHANGES IN EQUIPMENT, SYSTEMS, SERVICE, ETC. FTC reserves the right to
make changes from time to time, as it deems advisable, relating to its services,
systems, programs, rules, operating schedules and equipment, so long as such
changes do not adversely affect the services provided to the Fund under this
Agreement.
3
<PAGE>
6. COMPENSATION. FTC shall be compensated for providing the services
set forth in this Agreement in accordance with the Fee Schedule attached
hereto as Exhibit A and as mutually agreed upon and amended from time to time.
7. PERFORMANCE OF SERVICE.
A. FTC shall exercise reasonable care and act in good faith in
the performance of its duties under this Agreement. FTC shall not be
liable for any error of judgment or mistake of law or for any loss
suffered by the Fund in connection with matters to which this
Agreement relates, including losses resulting from mechanical
breakdowns or the failure of communication or power supplies beyond
FTC's control, except a loss resulting from FTC's refusal or failure
to comply with the terms of this Agreement or from bad faith,
negligence, or willful misconduct on its part in the performance of
its duties under this Agreement. Notwithstanding any other provision
of this Agreement, the Fund shall indemnify and hold harmless FTC
from and against any and all claims, demands, losses, expenses, and
liabilities (whether with or without basis in fact or law) of any
and every nature (including reasonable attorneys' fees) which FTC
may sustain or incur or which may be asserted against FTC by any
person arising out of or attributed to any action taken or omitted
to be taken by it in performing the services hereunder (i) in
accordance with the foregoing standards, or (ii) in reliance upon
any written or oral instruction for a proper corporate purpose
provided to FTC by any duly authorized officer of the Fund, such
duly authorized officer to be included in a list of authorized
officers furnished to FTC and as amended from time to time in
writing by resolution of the Board.
In the event of a mechanical breakdown or failure of
communication or power supplies beyond its control, FTC shall take
all reasonable steps to minimize service interruptions for any
period that such interruption continues beyond FTC's control. FTC
will make every reasonable effort to restore any lost or damaged
data and correct any errors resulting from such a breakdown at the
expense of FTC. FTC agrees that it shall, at all times, have
reasonable contingency plans with appropriate parties, making
reasonable provision for emergency use of electrical data processing
equipment to the extent appropriate equipment is available.
Representatives of the Fund shall be entitled to inspect FTC's
premises and operating capabilities at any time during regular
business hours of FTC, upon reasonable notice to FTC.
Regardless of the above, FTC reserves the right to reprocess
and correct administrative errors at its own expense.
4
<PAGE>
B. In order that the indemnification provisions contained in
this section shall apply, it is understood that in any case in which
the Fund may be asked to indemnify or hold FTC harmless, the Fund
shall be fully and promptly advised of all pertinent facts
concerning the situation in question, and it is further understood
that FTC will use all reasonable care to notify the Fund promptly
concerning any situation which presents or appears likely to present
the probability of such a claim for indemnification against the
Fund. The Fund shall have the option to defend FTC against any claim
which may be the subject of this indemnification. In the event that
the Fund so elects, it will so notify FTC and thereupon the Fund
shall take over complete defense of the claim, and FTC shall in such
situation initiate no further legal or other expenses for which it
shall seek indemnification under this section. FTC shall in no case
confess any claim or make any compromise in any case in which the
Fund will be asked to indemnify FTC except with the Fund's prior
written consent.
C. FTC shall indemnify and hold the Fund harmless from and
against any and all claims, demands, losses, expenses, and
liabilities (whether with or without basis in fact or law) of any
and every nature (including reasonable attorneys' fees) which the
Fund may sustain or incur or which may be asserted against the Fund
by any person arising out of or attributed to any action taken or
omitted to be taken by FTC as a result of FTC's refusal or failure
to comply with the terms of this Agreement, or from its bad faith,
negligence, or willful misconduct of FTC or any of its employees or
agents.
8. RECORDS. FTC shall keep records relating to the services to be
performed hereunder, in the form and manner, and for such period as it may deem
advisable and is acceptable to the Fund but not inconsistent with the rules and
regulations of appropriate government authorities, in particular, Section 31 of
the 1940 Act and the rules thereunder. FTC agrees that all such records prepared
or maintained by FTC relating to the services to be performed by FTC hereunder
are the property of the Fund and will be preserved, maintained, and made
available with such section and rules of the 1940 Act and will be promptly
surrendered to the Fund on and in accordance with its request.
9. CONFIDENTIALITY. FTC agrees on behalf of itself and its employees and
agents to treat confidentially all records and other information relative to the
Fund and its shareholders and shall not disclose to any other party, except
after prior notification to and approval in writing by the Fund, which approval
shall not be unreasonably withheld and may not be withheld where FTC may be
exposed to civil or criminal contempt proceedings for failure to comply after
being requested to divulge such information by duly constituted authorities.
10. DATA NECESSARY TO PERFORM SERVICES. The Fund or its agent, which may
be FTC, shall furnish to FTC the data necessary to perform the services
described herein at times and in such form as mutually agreed upon by the Fund
and FTC.
5
<PAGE>
11. NOTIFICATION OF ERROR. The Fund will notify FTC of any balancing or
control error caused by FTC within three (3) business days after receipt of any
reports rendered by FTC to the Fund, or within three (3) business days after
discovery of any error or omission not covered in the balancing or control
procedure, or within three (3) business days of receiving notice from any
shareholder.
12. ADDITIONAL SERIES. In the event that the Fund establishes one or more
additional Portfolios with respect to which it desires to have FTC render
accounting services, under the terms hereof, it shall so notify FTC in writing,
and if FTC agrees in writing to provide such services, such Portfolio will be
subject to the terms and conditions of this Agreement, and shall be maintained
and accounted for by FTC on a discrete basis. The Portfolios currently covered
by this Agreement are: the Potomac Japan/Long Fund, Potomac Japan/Short Fund,
Potomac U.S. Plus Fund, Potomac U.S./Short Fund, Potomac OTC Plus Fund, Potomac
OTC/Short Fund and the Potomac U.S. Government Money Market Fund.
13. TERMS OF AGREEMENT. This Agreement shall become effective upon its
execution and shall continue until terminated by either party upon giving ninety
(90) days' prior written notice to the other party or such shorter period as is
mutually agreed upon in writing by the parties. However, this Agreement may be
replaced or modified by a subsequent written instrument between the parties.
This Agreement or any rights or obligations hereunder may not be assigned by
either party without the written consent of the other party.
14. DUTIES IN THE EVENT OF TERMINATION. In the event that in connection
with termination a successor to any of FTC's duties or responsibilities
hereunder is designated by the Fund by written notice to FTC, FTC will promptly,
upon such termination and at the expense of the Fund, transfer to such successor
all relevant books, records, correspondence and other data established or
maintained by FTC under this Agreement in a form reasonably acceptable to the
Fund (if such form differs from the form in which FTC has maintained the same,
the Fund shall pay any expenses associated with transferring the same to such
form), and will cooperate in the transfer of such duties and responsibilities,
including provision for assistance from FTC's personnel in the establishment of
books, records and other data by such successor.
15. NOTICES. Notices of any kind to be given by either party to the other
party shall be in writing and shall be duly given if mailed or delivered as
follows: notice to FTC shall be sent to Mutual Fund Services located at 615 East
Michigan Street, Milwaukee, Wisconsin 53202 and notice to the Fund shall be sent
to the Potomac Funds located at 550 Mamaroneck Avenue, Harrison, NY 10528.
16. CHOICE OF LAW. This Agreement shall be construed in accordance with
the laws of the State of Wisconsin. Trustees and shareholders of the Fund shall
not be personally liable for obligations of the Fund in connection with any
matter arising from or in connection with this Agreement.
6
<PAGE>
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be
executed as of the date first written above by their respective officers
thereunto duly authorized.
POTOMAC FUNDS FIRSTAR TRUST COMPANY
By:____________________________ By:_____________________________
Print:_________________________ Print:___________________________
Title:_________________________ Title: First Vice President
Date:__________________________ Date:____________________________
Attest:________________________ Attest:__________________________
7
FULFILLMENT SERVICING AGREEMENT
This Agreement between Firstar Trust Company ("FTC"), a Wisconsin corporation,
Rafferty Asset Management, LLC ("Rafferty"), a New York limited liability
company, and the Potomac Funds (the "Fund"), a Massachusetts business trust, is
entered into on this ____ day of September 1997.
WHEREAS, the Fund is an open-end management investment company which is
registered under the Investment Company Act of 1940;
WHEREAS, Rafferty is the Fund's investment adviser; and
WHEREAS, FTC provides fulfillment services to mutual funds and the Fund desires
FTC to provide it such services;
NOW THEREFORE, the parties agree as follows:
DUTIES AND RESPONSIBILITIES OF FTC
1. Answer all prospective shareholder calls concerning any portfolio of the
Fund (each a "Portfolio") listed in the attached Schedule A, which may be
modified from time to time.
2. Send all available materials concerning a Portfolio requested by a
prospective shareholder within 24 hours from time of the request. Such
materials may include the Fund's most current prospectus, statement of
additional information, financial statements, new account forms, fact
sheets, and sales literature or other materials at the direction of the
Fund ("fulfillment materials").
3. Receive and update all fulfillment materials concerning a Portfolio to
ensure that the most current information is sent and quoted.
4. Provide 24 hour answering service to record prospective shareholder
calls made after hours (8 p.m. to 9 a.m., eastern standard time).
5. Maintain and store fulfillment materials concerning a Portfolio.
6. Maintain records relating to the fulfillment services FTC provides the
Fund and provide the Fund with periodic reports on the fulfillment
services provided pursuant to this Agreement as agreed upon from time to
time between the Fund and FTC.
<PAGE>
DUTIES AND RESPONSIBILITIES OF THE FUND
1. Provide FTC updates to the fulfillment materials for each Portfolio as
necessary.
2. Represent that all fulfillment materials have been filed, as necessary,
with the National Association of Securities Dealers, Securities and
Exchange Commission, and state regulatory authorities, as appropriate.
3. Supply FTC with sufficient inventory of fulfillment materials concerning
for each Portfolio as requested from time to time by FTC.
4. Provide FTC with any information about a Portfolio necessary to answer
prospective shareholder questions.
COMPENSATION
Rafferty (and not the Fund) agrees to compensate FTC for the services performed
under this Agreement in accordance with the attached Schedule B. Rafferty agrees
to pay all invoices within ten days of receipt.
PROPRIETARY AND CONFIDENTIAL INFORMATION
FTC agrees on behalf of itself and its directors, officers, employees and agents
to treat confidentially and as proprietary information regarding each Portfolio,
all records and other information relative to such Portfolio, and prior,
present, or potential shareholders of the Fund (and clients of said
shareholders), and not to use such records or information for any purpose other
than performance of its responsibilities and duties hereunder, except after
prior notification to and approval in writing by the Fund, which approval shall
not be unreasonably withheld and may not be withheld where FTC may be exposed to
civil or criminal contempt proceedings for failure to comply, when requested to
divulge such information by duly constituted authorities, or when so requested
by the Fund.
NOTICES
Notices of any kind to be given by either party to the other party shall be in
writing and shall be duly given if mailed or delivered as follows: Notice to FTC
shall be sent to Firstar Trust Company, 615 East Michigan Street, Milwaukee, WI
53202, and notice to the Fund shall be sent to the Potomac Funds, located at 550
Mamaroneck Avenue, Harrison, NY 10528.
TERMS OF AGREEMENT
This Agreement shall become effective upon its execution and shall continue
until terminated by either party upon sixty (60) days' prior written notice
given by one party to the other party. This Agreement and any rights or
obligations hereunder may not be assigned by either party without the written
consent of the other party. This Agreement may be amended by the mutual written
consent of both parties.
2
<PAGE>
CHOICE OF LAW
This Agreement shall be construed in accordance with the laws of the State of
Wisconsin. Trustees, officers and shareholders of the Fund and members and
employees of the Fund shall not be personally liable for obligations of the Fund
in connection with any matter arising from or in connection with this Agreement.
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be
executed as of the date first written above by their respective officers
thereunto duly authorized.
POTOMAC FUNDS FIRSTAR TRUST COMPANY
By:________________________________ By:_______________________________
Print:_____________________________ Print:____________________________
Title:_____________________________ Title: First Vice President
Date:______________________________ Date:_____________________________
Attest:____________________________ Attest:___________________________
RAFFERTY ASSET MANAGEMENT, LLC
By:______________________________
Print:______________________________
Title:______________________________
Date:______________________________
Attest:______________________________
3
KIRKPATRICK & LOCKHART LLO
1800 Massachusetts Avenue, N.W.
2nd Floor
Washington, D.C. 20036
Telephone 202) 778-9000
Facsimile (202) 778-9100
September 16, 1997
The Potomac Funds
550 Mamaroneck Avenue
Harrison, NY 10528
Ladies and Gentlemen:
You have requested our opinion as to certain matters regarding the
issuance by the Potomac Funds (the "Trust") of shares of beneficial interest
(the "Shares") of the Potomac U.S. Government Money Market Fund, the Potomac
Japan/Long Fund, the Potomac Japan/Short Fund, the Potomac U.S. Plus Fund, the
Potomac U.S./Short Fund, the Potomac OTC Plus Fund and the Potomac OTC/Short
Fund, each a series of the Trust ("Series"). The Trust is about to file a
Registration Statement on Form N-1A (the "Form N-1A") for the purpose of
registering the Shares to be issued under the Securities Act of 1933, as amended
("1933 Act").
We have examined originals or copies believed by us to be genuine of the
Trust's Declaration of Trust and By-Laws and such other documents relating to
the authorization and issuance of the Shares as we have deemed relevant. Based
upon that examination, we are of the opinion that the Shares being registered by
the Form N-1A may be issued in accordance with the Trust's Declaration of Trust
and By-Laws, subject to compliance with the 1933 Act, the Investment Company Act
of 1940, as amended, and applicable state laws regulating the distribution of
securities, and when so issued, those Shares will be legally issued, fully paid
and non-assessable.
The Trust is an entity of the type commonly known as a "Massachusetts
business trust." Under Massachusetts law, Trust shareholders could, under
certain circumstances, be held personally liable for the obligations of the
Trust or a Series. The Declaration of Trust states that the creditors of,
contractors with, and claimants against, the Trust or a Series shall look only
to the assets of the Trust or such Series for payment. It also requires that
notice of such disclaimer be given in each note, bond, contract or other
undertaking issued by or on behalf of the Trust or the Trustees relating to the
Trust. The Declaration of Trust further provides: (i) for indemnification from
the assets of the applicable Series for all losses and expenses of any
shareholder held personally liable for the obligations of the Series solely by
virtue of ownership of Shares of a Series; and (ii) for a Series to assume the
defense of any claim against the shareholder for any act or obligation of the
Series. Thus, the risk of a shareholder incurring financial loss on account of
shareholder liability is limited to circumstances in which the Trust or a Series
would be unable to meet its obligations.
Sincerely yours,
KIRKPATRICK & LOCKHART LLP
By: /s/ Robert J. Zutz
--------------------------
Robert J. Zutz
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the use in the Statement of Additional Information
constituting part of this Pre-Effective Amendment No. 1 to the registration
statement on Form N-1A (the "Registration Statement") of our report dated
September 2, 1997, relating to the statement of assets and liabilities of the
Potomac Funds, which appears in such Statement of Additional Information, and to
the incorporation by reference of our report into the Prospectus which
constitutes part of this Registration Statement. We also consent to the
references to us under the heading "Independent Accountants" in such Statement
of Additional Information and to the reference under the hearing "Independent
Auditors" in such Prospectus.
Price Waterhouse LLP
Milwaukee, Wisconsin
September 15, 1997
POTOMAC FUNDS
LETTER OF INVESTMENT INTENT
To the Board of Trustees of Potomac Funds:
The undersigned (the "Purchaser") hereby subscribes to purchase a
beneficial interest ("Interest") of Potomac Funds in consideration for which the
Purchaser agrees to transfer to you upon demand cash in the amount of One
Hundred Thousand Dollars ($100,000.00).
The Purchaser agrees that the Interest is being purchased for investment
with no present intention of reselling or redeeming said Interest.
Dated and effective this 2nd day of September, 1997.
RAFFERTY ASSET MANAGEMENT, LLC
By: /s/ Thomas A. Mulrooney
--------------------------------
Thomas A. Mulrooney
Chief Operating Officer
POTOMAC FUNDS
DISTRIBUTION PLAN
WHEREAS, the Potomac Funds (the "Trust") is engaged in business as an
open-end management investment company and is registered as such under the
Investment Company Act of 1940, as amended (the "1940 Act"); and
WHEREAS, the Trust, on behalf of its one or more designated series
presently existing or hereafter established (hereinafter referred to as
"Portfolios"), desires to adopt a Distribution Plan pursuant to Rule l2b-1 under
the 1940 Act and the Board of Trustees of the Trust has determined that there is
a reasonable likelihood that adoption of this Distribution Plan will benefit the
Trust and the shareholders; and
WHEREAS, the Trust intends to employ a registered broker-dealer as
Distributor of the securities of which it is the issuer;
NOW, THEREFORE, the Trust hereby adopts this Distribution Plan (the
"Plan") in accordance with Rule l2b-1 under the 1940 Act on the following terms
and conditions:
1. PAYMENT OF FEES. The Trust is authorized to pay the Distributor
distribution and service fees for each Portfolio listed on Schedule A of this
Plan, as such schedule may be amended from time to time, on an annualized basis,
at such rates as shall be determined from time to time by the Board of Trustees
in the manner provided for approval of this Plan in Paragraph 4, up to the
maximum rates set forth in Schedule A, as such schedule may be amended from time
to time. Such fees shall be calculated and accrued daily and paid monthly or at
such other intervals as shall be determined by the Board in the manner provided
for approval of this Plan in Paragraph 4. The distribution and service fees
shall be payable by the Trust on behalf of a Portfolio regardless of whether
those fees exceed or are less than the actual expenses, described in Paragraph 2
below, incurred by the Distributor with respect to such Portfolio in a
particular year.
2. DISTRIBUTION AND SERVICE EXPENSES. The fee authorized by Paragraph 1 of
this Plan shall be paid pursuant to an appropriate Distribution Agreement in
payment for any activities or expenses intended to result in the sale and
retention of Trust shares, including compensation paid to registered
representatives of the Distributor and to participating dealers that have
entered into sales agreements with the Distributor, advertising, salaries and
other expenses of the Distributor relating to selling or servicing efforts,
expenses of organizing and conducting sales seminars, printing of prospectuses,
statements of additional information and reports for other than existing
shareholders, preparation and distribution of advertising material and sales
literature and other sales promotion expenses, or for providing ongoing services
to shareholders.
<PAGE>
3. ADDITIONAL COMPENSATION. This Plan shall not be construed to
prohibit or limit additional compensation derived from sales charges or other
sources that may be paid to the Distributor pursuant to the aforementioned
Distribution Agreement.
4. THIRD PARTY EXPENSES. Nothing in this Plan shall operate or be
construed to limit the extent to which the Trust's investment adviser or any
other person, other than the Trust, may incur costs and bear expenses associated
with the distribution of Shares of beneficial interest in a Portfolio. The
Trust's investment adviser may from time to time make payments to third parties
out of its advisory fee, not to exceed the amount of that fee, including
payments for fees for shareholder servicing and transfer agency functions. If
such payments are deemed to be indirect financing of an activity primarily
intended to result in the sale of shares issued by a Portfolio within the
context of Rule 12b-1 under the 1940 Act, such payments shall be authorized by
this Plan.
5. BOARD APPROVAL. This Plan shall not take effect with respect to any
Portfolio until it has been approved, together with any related agreements, by
vote of a majority of both (a) the Board of Trustees and (b) those members of
the Board who are not "interested persons" of the Trust, as defined in the 1940
Act, and have no direct or indirect financial interest in the operation of this
Plan or any agreements related to it (the "Independent Trustees"), cast in
person at a meeting or meetings called for the purpose of voting on this Plan
and such related agreements.
6. RENEWAL OF PLAN. This Plan shall continue in full force and effect with
respect to a Portfolio for successive periods of one year from its approval as
set forth in Paragraphs 4 for so long as such continuance is specifically
approved at least annually in the manner provided for approval of this Plan in
Paragraph 4.
7. REPORTS. Any Distribution Agreement entered into pursuant to this Plan
shall provide that the Distributor shall provide to the Board of Trustees and
the Board shall review, at least quarterly, or at such other intervals as
reasonably requested by the Board, a written report of the amounts so expended
and the purposes for which such expenditures were made.
8. TERMINATION. This Plan may be terminated with respect to a
Portfolio at any time by vote of a majority of the Independent Trustees or by
a vote of a majority of the outstanding voting securities of such Portfolio,
voting separately from any other Portfolio of the Trust.
2
<PAGE>
9. AMENDMENTS. Any change to the Plan that would materially increase the
distribution costs to a Portfolio may not be instituted unless such amendment is
approved in the manner provided for board approval in Paragraph 4 hereof and
approved by a vote of at least a majority of such Portfolio's outstanding voting
securities, as defined in the 1940 Act, voting separately from any other
Portfolio of the Trust. Any other material change to the Plan may not be
instituted unless such change is approved in the manner provided for initial
approval in Paragraph 4 hereof.
10. NOMINATION OF TRUSTEES. While this Plan is in effect, the
selection and nomination of Independent Trustees of the Trust shall be
committed to the discretion of the Independent Trustees then in office.
11. RECORDS. The Trust shall preserve copies of this Plan and any related
agreements and all reports made pursuant to Paragraph 6 hereof for a period of
not less than six years from the date of execution of this Plan, or of the
agreements or of such reports, as the case may be, the first two years in an
easily accessible place.
Date: August 1997
3
<PAGE>
POTOMAC FUNDS
DISTRIBUTION PLAN
SCHEDULE A
The maximum annualized fee rate pursuant to Paragraph 1 of the Potomac
Funds Distribution Plan shall be as follows:
Japan/Long Fund
Japan/Short Fund
U.S. Plus Fund
U.S./Short Fund
OTC Plus Fund
OTC/Short Fund
U.S. Government Money Market Fund
1.00% of the average daily net assets
Dated: August 1997
